##### 



Exhibit 13

MASSBANK CORP. AND SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL DATA

|                               |                                                                 |      |   |           |  |      |   |           |  |      |   |         |  |  |   |         |  |  |   |         | 
|------------------------------ | --------------------------------------------------------------- | ---- | - | --------- |  | ---- | - | --------- |  | ---- | - | ------- |  |  | - | ------- |  |  | - | ------- | 
|(IN THOUSANDS) AT DECEMBER 31, |                                                                 | 2003 |   | 2002      |  | 2001 |   | 2000      |  | 1999
|                               |                                                                 |      |   |           |  |      |   |           |  |     
|Balance Sheet Data:            |                                                                 |      |   |           |  |      |   |           |  |      |   |         |  |  |   |         |  |  |   |        
|                               | Total assets                                                    |      | $ | 1,010,249 |  |      | $ | 1,009,367 |  |      | $ | 971,317 |  |  | $ | 938,702 |  |  | $ | 924,716 | 
|                               | Mortgage loans                                                  |      |   | 241,886   |  |      |   | 302,788   |  |      |   | 296,469 |  |  |   | 272,951 |  |  |   | 288,580 | 
|                               | Other loans                                                     |      |   | 11,120    |  |      |   | 16,011    |  |      |   | 34,548  |  |  |   | 37,196  |  |  |   | 36,785  | 
|                               | Allowance for loan losses                                       |      |   | 1,554     |  |      |   | 2,271     |  |      |   | 2,494   |  |  |   | 2,594   |  |  |   | 2,555   | 
|                               | Allowance for loan losses on
off-balance sheet credit exposures |      |   | 626       |  |      |   | 384       |  |      |   | 149     |  |  |   |        |  |  |   |        | 
|                               | Investments(1)                                                  |      |   | 722,079   |  |      |   | 669,875   |  |      |   | 618,545 |  |  |   | 607,096 |  |  |   | 578,543 | 
|                               | Deposits                                                        |      |   | 882,024   |  |      |   | 883,928   |  |      |   | 849,684 |  |  |   | 823,625 |  |  |   | 818,057 | 
|                               | Stockholders equity                                            |      |   | 110,927   |  |      |   | 117,285   |  |      |   | 114,904 |  |  |   | 108,243 |  |  |   | 101,479 | 

|                                         |  |                              |  |      |        |      |  |      |        |      |  |   |        |  |  |   |        |  |  |   |        | 
|---------------------------------------- |  | ---------------------------- |  | ---- | ------ | ---- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------ |  |  | - | ------ | 
|(IN THOUSANDS) YEARS ENDED DECEMBER 31 , |  | 2003                         |  | 2002 |        | 2001 |  | 2000 |        | 1999
|                                         |  |                              |  |      |        |      |  |      |        |     
|Operating Data:                          |  |                              |  |      |        |      |  |      |        |      |  |   |        |  |  |   |        |  |  |  
|                                         |  | Interest and dividend income |  | $    | 38,137 |      |  | $    | 47,103 |      |  | $ | 55,117 |  |  | $ | 60,280 |  |  | $ | 58,206 | 
|                                         |  | Interest expense             |  |      | 15,854 |      |  |      | 22,701 |      |  |   | 32,391 |  |  |   | 35,397 |  |  |   | 33,204 | 
|                                         |  |                              |  |      |        |      |  |      |        |      |  |   |        |  |  |   |        |  |  |   |        | 
|                                         |  | Net interest income          |  |      | 22,283 |      |  |      | 24,402 |      |  |   | 22,726 |  |  |   | 24,883 |  |  |   | 25,002 | 
|                                         |  | Provision for loan losses    |  |      | (502   | )    |  |      |       |      |  |   | 40     |  |  |   | 60     |  |  |   | 140    | 
|                                         |  | Gains on securities, net     |  |      | 639    |      |  |      | 1,718  |      |  |   | 4,363  |  |  |   | 3,525  |  |  |   | 4,033  | 
|                                         |  | Other non-interest income    |  |      | 1,283  |      |  |      | 1,205  |      |  |   | 1,450  |  |  |   | 1,463  |  |  |   | 1,529  | 
|                                         |  | Non- interest expense        |  |      | 12,615 |      |  |      | 12,037 |      |  |   | 11,721 |  |  |   | 12,513 |  |  |   | 12,566 | 
|                                         |  |                              |  |      |        |      |  |      |        |      |  |   |        |  |  |   |        |  |  |   |        | 
|                                         |  | Income before income taxes   |  |      | 12,092 |      |  |      | 15,288 |      |  |   | 16,778 |  |  |   | 17,298 |  |  |   | 17,858 | 
|                                         |  | Income tax expense           |  |      | 4,229  |      |  |      | 5,474  |      |  |   | 6,019  |  |  |   | 6,187  |  |  |   | 6,547  | 
|                                         |  |                              |  |      |        |      |  |      |        |      |  |   |        |  |  |   |        |  |  |   |        | 
|                                         |  | Net income                   |  | $    | 7,863  |      |  | $    | 9,814  |      |  | $ | 10,759 |  |  | $ | 11,111 |  |  | $ | 11,311 | 
|                                         |  |                              |  |      |        |      |  |      |        |      |  |   |        |  |  |   |        |  |  |   |        | 

|                          |  |                                                            |         |      |       |      |  |      |       |      |  |   |        |      |  |   |       |      |  |   |        |      | 
|------------------------- |  | ---------------------------------------------------------- | ------- | ---- | ----- | ---- |  | ---- | ----- | ---- |  | - | ------ | ---- |  | - | ----- | ---- |  | - | ------ | ---- | 
|YEARS ENDED DECEMBER 31 , |  | 2003                                                       |         | 2002 |       | 2001 |  | 2000 |       | 1999
|                          |  |                                                            |         |      |       |      |  |      |       |     
|Other Data:               |  |                                                            |         |      |       |      |  |      |       |      |  |   |        |      |  |   |       |      |  |  
|                          |  | Yield on average interest-earning assets                   |         |      | 3.87  | %    |  |      | 4.85  | %    |  |   | 5.88   | %    |  |   | 6.67  | %    |  |   | 6.32   | %   
|                          |  | Cost of average interest-bearing liabilities               |         |      | 1.78  |      |  |      | 2.61  |      |  |   | 3.87   |      |  |   | 4.32  |      |  |   | 4.02   |     
|                          |  |                                                            |         |      |       |      |  |      |       |      |  |   |        |      |  |   |       |      |  |   |       
|                          |  | Interest rate spread                                       |         |      | 2.09  |      |  |      | 2.24  |      |  |   | 2.01   |      |  |   | 2.35  |      |  |   | 2.30   |     
|                          |  | Net interest margin                                        |         |      | 2.26  |      |  |      | 2.52  |      |  |   | 2.43   |      |  |   | 2.76  |      |  |   | 2.72   |     
|                          |  | Non-interest expense to average assets(3)                  |         |      | 1.25  |      |  |      | 1.21  |      |  |   | 1.23   |      |  |   | 1.35  |      |  |   | 1.34   |     
|                          |  | Efficiency ratio(2)(3)                                     |         |      | 49.9  |      |  |      | 43.9  |      |  |   | 41.1   |      |  |   | 41.9  |      |  |   | 41.4   |     
|                          |  | Return on assets (net income/average assets)               |         |      | 0.78  |      |  |      | 0.99  |      |  |   | 1.13   |      |  |   | 1.20  |      |  |   | 1.20   |     
|                          |  | Return on equity (net income/average
stockholders equity) |         |      | 7.08  |      |  |      | 8.39  |      |  |   | 9.53   |      |  |   | 10.93 |      |  |   | 10.66  |     
|                          |  | Percent non -performing loans to total loans               |         |      | 0.09  |      |  |      | 0.13  |      |  |   | 0.19   |      |  |   | 0.18  |      |  |   | 0.24   |     
|                          |  | Percent non -performing assets to total assets             |         |      | 0.02  |      |  |      | 0.04  |      |  |   | 0.07   |      |  |   | 0.06  |      |  |   | 0.09   |     
|                          |  | Stockholders equity to assets, at year-end                |         |      | 10.98 |      |  |      | 11.62 |      |  |   | 11.83  |      |  |   | 11.53 |      |  |   | 10.97  |     
|                          |  | Book value per share, at year-end(4)                       |         | $    | 25.17 |      |  | $    | 25.45 |      |  | $ | 24.34  |      |  | $ | 22.83 |      |  | $ | 20.43  |     
|                          |  | Market
price  close, at year-end(4)                       |         |      | 43.01 |      |  |      | 28.30 |      |  |   | 23.867 |      |  |   | 19.50 |      |  |   | 19.667 |     
|                          |  | Earnings per share:(4)                                     |         |      |       |      |  |      |       |      |  |   |        |      |  |   |       |      |  |   |        |     
|                          |  |                                                            | Basic   |      |       | 1.77 |  |      |       | 2.09 |  |   |        | 2.30 |  |   |       | 2.30 |  |   |        | 2.23 | 
|                          |  |                                                            | Diluted |      |       | 1.73 |  |      |       | 2.04 |  |   |        | 2.24 |  |   |       | 2.25 |  |   |        | 2.17 | 
|                          |  | Cash dividends paid per share(4)                           |         |      | 0.92  |      |  |      | 0.88  |      |  |   | 0.84   |      |  |   | 0.79  |      |  |   | 0.74   |     
|                          |  | Dividend payout ratio                                      |         |      | 52    | %    |  |      | 42    | %    |  |   | 37     | %    |  |   | 34    | %    |  |   | 33     | %   
|                          |  |                                                            |         |      |       |      |  |      |       |      |  |   |        |      |  |   |       |      |  |   |       



|(1) |  | Consist 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 (including the provision for loan losses) by fully taxable
equivalent net interest income plus non-interest income.           
|   
|(3) |  | Includes
non-recurring non-interest expense of $363 thousand in 2000 related to the
successful litigation to protect the Companys principal trademark.                   
|   
|(4) |  | All share information presented has been adjusted to reflect the 3-for-2
split of the Companys common stock effective April 19, 2002.                                    





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##### 



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 2003
presentation.

The preparation of consolidated financial statements requires management
to make estimates and assumptions, in the application of certain of its
accounting policies, about the effect of matters that are inherently
uncertain. These estimates and assumptions affect the reported amounts of
certain assets, liabilities, revenues and expenses. Different amounts could be
reported under different conditions, or if different assumptions were used in
the application of these accounting policies. The accounting policies
considered significant in this respect are the determination of the allowance
for loan losses and allowance for loan losses on off-balance sheet credit
exposures, and the determination of investment securities considered other
than temporarily impaired. These significant accounting policies are discussed
in the Provision for Loan Losses and Off-Balance Sheet Credit Exposures, and
Investment Securities Other Than Temporarily Impaired sections of this
discussion and analysis and in Note 1 of the Notes to Consolidated Financial
Statements.

The financial condition and results of operations of MASSBANK Corp. (the
Company) essentially reflect the operations of its subsidiary, MASSBANK (the
Bank).

The Banks principal business has historically consisted of offering
savings and other deposits to the general public and using the funds from
these deposits to primarily make loans secured by residential real estate and
consumer loans, and make investments in debt and equity securities. Most
residential mortgage loans granted by the Bank are for terms of 10, 12, 15 or
20 years and are generally low credit risk loans. The Banks debt securities
portfolio consists primarily of U.S. Treasury and Government agency securities
and Government agency mortgage-backed securities.

The Companys consolidated net income depends largely upon net interest
income, which is the difference between interest and dividend income from
loans and investments (interest-earning assets), and interest expense on
deposits (interest-bearing liabilities). Net interest income is significantly
affected by general economic conditions, particularly changes in
interest
rates, competition, government legislation and policies affecting fiscal
affairs, monetary policies of the Federal Reserve System, and the actions of
the bank regulatory authorities. Earnings results are also affected by the
Companys provision for loan losses; loan and investment activities,
particularly residential mortgage loan and mortgage-backed securities
prepayment activity; changes in non-interest income, such as fee-based
revenues and securities gains or losses; non-interest expense; and income
taxes.

FORWARD-LOOKING STATEMENT DISCLOSURE

This annual report may contain forward-looking information, including
information concerning the Companys expectations of future business prospects.
These forward-looking statements are made pursuant to the safe harbor provision
of the Private Securities Litigation Reform Act of 1995. These forward-looking
statements involve known and unknown risks, uncertainties and other factors
that may cause the Companys actual results or performance to be materially
different from the results and performance expressed or implied by the
forward-looking statements. Forward-looking statements include, but are not
limited to, statements concerning the Companys belief, expectations or
intentions concerning the Companys future performance, the financial outlook
of the markets it serves and the performance and activities of its competitors.
These statements reflect the Companys current views, are based on numerous
assumptions and are subject to numerous risks and uncertainties, including
unexpected fluctuations in market interest rates, unexpected fluctuations in
the markets for equities, bonds, federal funds and other financial instruments,
an increase in the level of nonperforming assets, an increase in competitive
pricing pressures within the Companys market, adverse legislative or
regulatory developments, adverse impacts resulting from the continuing war on
terrorism, an increase in other employee-related costs, the impact of deflation
or inflation, and other factors described in this report.





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##### 



CRITICAL ACCOUNTING POLICIES

The Companys consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
of America. As such, the Company is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the balance
sheet dates and the reported amounts of income and expense during the
reporting periods. Actual amounts could differ from such estimates.

The Company believes that the following accounting policies are among the
most critical because they involve significant judgments and uncertainties and
could potentially result in materially different results under different
assumptions and conditions.

PROVISION FOR LOAN LOSSES AND OFF BALANCE SHEET CREDIT EXPOSURES

The provision for loan losses represents a charge against current earnings and
an addition to the allowance for loan losses. In determining the amount to
provide for loan losses, the key factor is the adequacy of the allowance for
loan losses. Management uses a methodology to systematically measure the amount
of estimated loan loss exposure inherent in the portfolio for purposes of
establishing a sufficient allowance for loan losses. The methodology includes
three elements: an analysis of individual loans deemed to be impaired, general
loss allocations for various types of loans based on loss experience factors
and an unallocated allowance. The unallocated allowance is maintained based on
managements assessment of many factors including the risk characteristics of
the portfolio, concentrations of credit, current and anticipated economic
conditions that may affect borrowers ability to pay, and trends in loan
delinquencies and charge-offs. Any significant change in these assumptions and
conditions could result in higher than estimated loan losses that could
adversely affect the Companys earnings results. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Banks allowance for loan losses. Such agencies may
require the Bank to recognize additions to the allowance based on judgements
different from those of management. This could also adversely affect the
Companys earnings results.

The provision for loan losses on off-balance sheet credit exposures
represents a charge against current earnings (reported in other non-interest
expense) and an addition to the allowance for loan losses on off-balance sheet
credit exposures. In determining the amount to provide for off-balance sheet
credit exposures, the key factor is the adequacy of the balance of the
allowance. The allowance is maintained based on expected drawdowns of
committed loans and their loss experience factors and managements assessment
of various other factors including current and anticipated economic conditions
that may affect the borrowers ability to pay, and trends in loan
delinquencies and charge-offs.

INVESTMENT SECURITIES OTHER THAN TEMPORARILY IMPAIRED

Management judgment is involved in the evaluation of declines in value of
individual investment securities held by the Company. Declines that are deemed
other than temporary are recognized in the income statement through write-downs
in the recorded value of the affected securities. Management considers many
factors in their analysis, including industry analyst reports, sector credit
ratings, volatility in market price and other relevant information, such as the
financial condition, earnings capacity and near term prospects of the company
in which MASSBANK has invested and the length of time and extent to which
market value has been less than cost. Whenever a debt or equity security is
deemed to be other than temporarily impaired due to a fundamental
deterioration in its financial condition as determined by managements
analysis, it is written down to its current fair market value. U.S. Treasury
Securities and other securities backed by the U.S. Government are never
considered impaired due to a fundamental deterioration in financial condition.

If due to general market conditions an investment security declines in
price from its cost basis by 25% or more for more than a year, between 30% and
40% for more than nine months, between 40% and 50% for more than six months or
over 50% for more than ninety days, the security is considered other than
temporarily impaired and it is written down to its current fair market value
and the loss is recognized. U.S. Treasury and Government Agency securities
fluctuate in value based on changes in market interest rates and other factors,
however, they can be redeemed at par value if held to maturity and therefore,
if their maturity date is less than one year into the future regardless of
their market value they are considered only temporarily impaired. Any
unfavorable change in general market conditions could cause an increase in the
Companys impairment write downs of investment securities. This would have an
adverse effect on the Companys earnings results. Other than temporary
impairment write downs of investment securities in 2003 and 2002 totaled $9
thousand and $67 thousand, respectively. There were no other than temporary
impairment write downs of investment securities in 2001.





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##### 



FINANCIAL OVERVIEW

massbank Corp.s earnings for 2003 were $7.9 million, or $1.73 per
diluted share, compared to $9.8 million, or $2.04 per diluted share, in
2002. Basic earnings per share for 2003 were $1.77 compared to $2.09 in
the prior year. Return on assets and return on equity were 0.78% and
7.08%, respectively, in 2003, compared to 0.99% and 8.39%,
respectively, in 2002.

Decreases in earnings and operating ratios were mainly due to the
historically low market interest rate environment this past year which
resulted in significant mortgage-backed securities and residential
mortgage loan prepayment activity, and a Federal Reserve Bank monetary
policy that reduced the Federal Funds rate to 1% for most of 2003, due
to concerns about the slowdown in the U.S. economy. The Companys
earnings and operating ratios were also affected by the decline in net
gains on equity securities in 2003.

years ended december 31, 2003
compared to 2002:

|                                         |                            |      |        |        |  |          |        |        |  |   |        |        |  
|---------------------------------------- | -------------------------- | ---- | ------ | ------ |  | -------- | ------ | ------ |  | - | ------ | ------ | -
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,  |                            | 2003 |        | 2002   |  | VARIANCE
|                                         |                            |      |        |        |  |         
|Income Statement Data                    |                            |      |        |        |  |          |        |        |  |   |        |       
|Interest and dividend income:            |                            |      |        |        |  |          |        |        |  |   |        |       
|                                         | Mortgage loans             |      | $      | 17,682 |  |          | $      | 20,819 |  |   | $      | (3,137 | )
|                                         | Mortgage-backed securities |      |        | 8,250  |  |          |        | 14,683 |  |   |        | (6,433 | )
|                                         | Federal funds sold         |      |        | 2,266  |  |          |        | 2,974  |  |   |        | (708   | )
|                                         | Other                      |      |        | 9,939  |  |          |        | 8,627  |  |   |        | 1,312  |  
|                                         |                            |      |        |        |  |          |        |        |  |   |        |        |  
|Total interest and dividend income       |                            |      | 38,137 |        |  |          | 47,103 |        |  |   | (8,966 | )     
|Total interest expense                   |                            |      | 15,854 |        |  |          | 22,701 |        |  |   | 6,847  |       
|                                         |                            |      |        |        |  |          |        |        |  |   |        |        |  
|Net interest income                      |                            |      | 22,283 |        |  |          | 24,402 |        |  |   | (2,119 | )     
|Provision for loan losses                |                            |      | (502   | )      |  |          |       |        |  |   | 502    |       
|Gains on securities, net                 |                            |      | 639    |        |  |          | 1,718  |        |  |   | (1,079 | )     
|Other non-interest income                |                            |      | 1,283  |        |  |          | 1,205  |        |  |   | 78     |       
|Non-interest expense                     |                            |      | 12,615 |        |  |          | 12,037 |        |  |   | (578   | )     
|Taxes                                    |                            |      | 4,229  |        |  |          | 5,474  |        |  |   | 1,245  |       
|                                         |                            |      |        |        |  |          |        |        |  |   |        |        |  
|Net income                               |                            | $    | 7,863  |        |  | $        | 9,814  |        |  | $ | (1,951 | )     
|Diluted earnings per share (in dollars): |                            | $    | 1.73   |        |  | $        | 2.04   |        |  | $ | (0.31  | )     
|                                         |                            |      |        |        |  |          |        |        |  |   |        |        |  

|                                        |                            |      |         |         |  |          |         |         |  |   |        |          |  
|--------------------------------------- | -------------------------- | ---- | ------- | ------- |  | -------- | ------- | ------- |  | - | ------ | -------- | -
|(IN THOUSANDS) YEARS ENDED DECEMBER 31, |                            | 2003 |         | 2002    |  | VARIANCE
|                                        |                            |      |         |         |  |         
|Average Balance Sheet Data              |                            |      |         |         |  |          |         |         |  |   |        |         
|Earning assets:                         |                            |      |         |         |  |          |         |         |  |   |        |         
|                                        | Mortgage loans             |      | $       | 270,826 |  |          | $       | 308,710 |  |   | $      | (37,884  | )
|                                        | Mortgage-backed securities |      |         | 133,037 |  |          |         | 233,627 |  |   |        | (100,590 | )
|                                        | Federal funds sold         |      |         | 209,463 |  |          |         | 183,968 |  |   |        | 25,495   |  
|                                        | Other                      |      |         | 374,529 |  |          |         | 246,877 |  |   |        | 127,652  |  
|                                        |                            |      |         |         |  |          |         |         |  |   |        |          |  
|Total earning assets                    |                            | $    | 987,855 |         |  | $        | 973,182 |         |  | $ | 14,673 |         
|Total deposits                          |                            | $    | 892,329 |         |  | $        | 870,685 |         |  | $ | 21,644 |         
|                                        |                            |      |         |         |  |          |         |         |  |   |        |          |  

Earnings results for 2003 included the following that are more fully discussed
in other sections of this discussion and analysis:



| |  |  | Reduction in net interest income of $2.1 million due essentially to the
extraordinary prepayment activity on mortgage-
backed securities and residential mortgages that significantly reduced
interest income on these (higher yielding) earning
assets and a reduction in interest income on Federal funds sold due to a
lower Federal funds rate.                                                                                                                                                        
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Negative provision for loan losses in the amount of $502 thousand due
to the quality of loans in the portfolio and a decrease
in the Banks loan portfolio.                                                                                                                                                                                                                                                                                                                                                
|
| |  |  | A reduction in net securities gains taken during the year in the amount of $1.1 million.                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  |  | An increase in non-interest expense in the amount of $0.6 million primarily attributable to broad based salary increases of
$106 thousand, an increase in health and other benefit costs for employees of
$51 thousand, an increase of $237 in deferred
compensation expense related to the Banks supplemental retirement plan for
certain executive officers that is offset by a
corresponding increase in other non-interest income and an increase of $250
thousand in occupancy and equipment expense.
|
| |  |  | A reduction in income tax expense of $1.2 million due to lower income
before income taxes and a reduction in the Companys
effective income tax rate.                                                                                                                                                                                                                                                                                                                                                      





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##### 



CONDENSED CONSOLIDATED BALANCE SHEETS

|                                               |  |      |           |      |  |          |           |   |  |   |         |  
|---------------------------------------------- |  | ---- | --------- | ---- |  | -------- | --------- | - |  | - | ------- | -
|(IN THOUSANDS) AT DECEMBER 31,                 |  | 2003 |           | 2002 |  | VARIANCE
|                                               |  |      |           |      |  |         
|Short-term investments                         |  | $    | 214,532   |      |  | $        | 248,750   |   |  | $ | (34,218 | )
|Interest -bearing deposits in banks            |  |      | 5,685     |      |  |          | 4,854     |   |  |   | 831     |  
|Securities available for sale, at market value |  |      | 429,229   |      |  |          | 380,022   |   |  |   | 49,207  |  
|Trading securities, at market value            |  |      | 72,633    |      |  |          | 36,249    |   |  |   | 36,384  |  
|                                               |  |      |           |      |  |          |           |   |  |   |         |  
|Total investments                              |  |      | 722,079   |      |  |          | 669,875   |   |  |   | 52,204  |  
|Total loans                                    |  |      | 253,006   |      |  |          | 318,799   |   |  |   | (65,793 | )
|Allowance for loan losses                      |  |      | (1,554    | )    |  |          | (2,271    | ) |  |   | 717     |  
|                                               |  |      |           |      |  |          |           |   |  |   |         |  
|Net loans                                      |  |      | 251,452   |      |  |          | 316,528   |   |  |   | (65,076 | )
|Other assets                                   |  |      | 36,718    |      |  |          | 22,964    |   |  |   | 13,754  |  
|                                               |  |      |           |      |  |          |           |   |  |   |         |  
|Total assets                                   |  | $    | 1,010,249 |      |  | $        | 1,009,367 |   |  | $ | 882     |  
|                                               |  |      |           |      |  |          |           |   |  |   |         |  
|Total deposits                                 |  | $    | 882,024   |      |  | $        | 883,928   |   |  | $ | (1,904  | )
|Escrow deposits of borrowers                   |  |      | 1,139     |      |  |          | 1,387     |   |  |   | (248    | )
|Other liabilities                              |  |      | 16,159    |      |  |          | 6,767     |   |  |   | 9,392   |  
|                                               |  |      |           |      |  |          |           |   |  |   |         |  
|Total liabilities                              |  |      | 899,322   |      |  |          | 892,082   |   |  |   | 7,240   |  
|Total stockholders equity                     |  |      | 110,927   |      |  |          | 117,285   |   |  |   | (6,358  | )
|                                               |  |      |           |      |  |          |           |   |  |   |         |  
|Total liabilities and stockholders equity     |  | $    | 1,010,249 |      |  | $        | 1,009,367 |   |  | $ | 882     |  
|                                               |  |      |           |      |  |          |           |   |  |   |         |  

FINANCIAL CONDITION

The Companys total assets were $1.010 billion at December 31, 2003 compared to
$1.009 billion at December 31, 2002 reflecting virtually no asset growth in
2003. This was due to a decrease in stockholders equity and deposits declining
slightly this past year.

INVESTMENTS

At December 31, 2003 the Companys investment portfolio, consisting of
securities available for sale and trading, short-term investments and
interest-bearing bank deposits totaled $722.1 million or 71.5% of total assets,
an increase of $52.2 million or 7.8%, compared to $669.9 million representing
66.4% of total assets at December 31, 2002. The increase in investments was
essentially due to an increase of $36.4 million in trading securities
consisting primarily of U.S. Treasury obligations, and an increase of $49.2
million in securities available for sale, partially offset by a reduction in
short-term investments. The mix of available for sale securities in 2003, as in
2002, continued to shift from a large concentration of mortgage-backed
securities to U.S. Treasury and Government agency securities, including
callable government agency securities totaling $192.4 million at year-end 2003.
The banks mortgage-backed securities portfolio declined by $93.4 million in
2003, from $189-1 million at year-end 2002 to $95.7 million at year-end 2003.
The decrease in mortgage-backed-securities (MBS) results from significant
prepayment activity in 2003. In addition, because of the historically low
interest rate environment in 2003 and the anticipation of higher rates in 2004,
the bank only purchased $9.9 million in MBS in 2003. Instead, the Bank
increased its holdings of callable agency securities in order to help improve
its net interest spread. If rates increase in 2004 and the shape of the yield
curve remains positive, the Bank will likely add mortgage-backed securities to
its portfolio. This could lead to improvements in net interest margin.





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##### 



LOANS

The loan portfolio, net of allowance for loan losses, decreased $65.1 million
or 20.6% in 2003. At December 31, 2003 the loan portfolio, net of allowance
for loan losses, totaled $251.5 million representing 24.9% of total assets
compared to $316.5 million representing 31.4% of total assets at December 31,
2002. The decrease in loans is due to a year of low interest rates that
dramatically increased the number of refinances, pay downs and payoffs for the
Bank. Although the Bank originated $82.6 million in loans in 2003, it saw its
loan portfolio decline as a result of the extraordinary prepayment activity.
Management believes that both the refinancing of existing mortgages and new
loan originations are likely to decline in 2004.

The Banks loan portfolio consists predominately of residential mortgages.
Residential mortgage loans amounted to $240.3 million at December 31, 2003,
representing 95% of the loan portfolio. At year-end 2003, 90.4% and 9.6% of the
Companys residential mortgage loans were fixed rate and variable rate loans,
respectively. See Note 5 of Notes to Consolidated Financial Statements for a
table setting forth the composition of the loan portfolio at year-end 2003 and
2002.

NON-PERFORMING ASSETS

Non-accrual loans, generally those loans that are 90 days or more delinquent,
declined to $230 thousand at December 31, 2003 from $420 thousand at December
31, 2002. This represents 0.09% of total loans at December 31, 2003. The Bank
had no real estate acquired through foreclosure at year-end 2003.

DEPOSITS

Deposits have traditionally been the Banks primary source of funds for
lending and investment activities. MASSBANK attracts deposits within its
primary market area by offering a variety of deposit instruments including
demand and NOW accounts, money market accounts, different types of savings
accounts, certificates of deposit and retirement savings plans. Deposit flows
vary significantly and are influenced by prevailing interest rates, market
conditions, economic conditions and competition. The Banks management
attempts to manage its deposits through selective pricing and marketing.

Total deposits at December 31, 2003 amounted to $882.0 million,
reflecting a decrease of $1.9 million from the prior year total of $883.9
million. Deposits in 2003 remained essentially unchanged from the prior year.
Increased competition for deposits in the latter part of 2003 and more
attractive returns on equity securities were the principal reasons for deposit
outflows.

Savings deposits continued to increase in 2003 as in the prior year,
increasing $58.9 million or 10.7% year-over-year, to $607.8 million from $548.9
million at year-end 2002. Conversely, certificates of deposit decreased by
$60.0 million or 24.0% to $189.6 million as customers continued the trend of
shifting their deposits upon maturity from certificates of deposit to savings
accounts seeking liquidity in this low interest rate environment. Demand and
NOW account deposits amounted to $84.6 million at December 31, 2003 compared to
$85.3 million at December 31, 2002. For information concerning deposit balances
at year-end 2003 and 2002, their average cost and the maturity distribution and
related rate structure of the Banks time certificates of deposit, see Note 10
of Notes to Consolidated Financial Statements.

STOCKHOLDERS EQUITY

Total stockholders equity decreased $6.4 million to $110.9 million at
December 31, 2003, representing a book value of $25.17, from $117.3 million
representing a book value of $25.45 at December 31, 2002.

The decrease in stockholders equity was essentially the result of the
Companys repurchase of 278,751 shares of treasury stock in 2003 at a cost of
$8.1 million, the payment of dividends to stockholders of $4.1 million and the
decrease in other comprehensive income of $3.7 million due primarily to the
decline in market value of the Banks debt securities portfolio. This was
partially offset by the net income for the year of $79 million and the payments
and related tax benefits received from the exercise of stock options by the
Companys officers and directors of $1.7 million.





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##### 



RESULTS OF OPERATIONS

COMPARISON OF THE YEARS 2003 AND
2002


NET INTEREST INCOME

Net interest income is the primary source of MASSBANKS operating income. The
level of net interest income is affected by the volume and mix of average
interest-earning assets and interest-bearing liabilities, market interest
rates and other factors.

Net interest income on a fully taxable equivalent (FTE) basis totaled
$22.4 million in 2003 compared to $24.5 million in 2002. This decrease was
primarily attributable to a decrease in net interest margin partially offset
by growth in average earning assets. The Companys net interest margin for the
year ended December 31, 2003 decreased to 2.26% from 2.52% in the prior year.
Average earning assets increased $14.7 million or 1.5% to $987.9 million in
2003, from $973.2 million in 2002. The tables on pages 26 and 27 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. Information is provided for each category of interest-earning
assets and interest-bearing liabilities, 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 totaled $38.2
million for the year ended December 31, 2003, compared to $47.2 million for
the year ended December 31, 2002. The decrease in interest and dividend income
was the result of a decline in yield on average earning assets partially
offset by the increased interest income from higher average earning assets.
The yield on average earning assets dropped 98 basis points to 3.87% in 2003
from 4.85% the prior year. The average earning assets of the Company increased
$14.7 million in 2003.

The yield on earning assets has declined for three consecutive years due
to declining market interest rates, including the Federal Funds rate that is
currently at 1%, and the change in the mix of the Companys average earning
assets. The interest income from the Banks mortgage-backed securities (MBS)
and loans declined significantly in 2003 from the prior year as a result of
extraordinary prepayment activity in the historically low interest rate
environment of 2003. With respect to the MBS portfolio, the Bank only added
$9.9 million in MBS to the portfolio in 2003 because of low market interest
rates. Additionally, because the Bank maintained a significant portion of its
earning assets in Federal funds sold in 2003, the decrease in Federal funds
rate also contributed to a reduction in interest income this past year.

As shown in the rate/volume analysis table on page 27, the decline in
yield on average earning assets in 2003 resulted in decreased interest and
dividend income of $3.6 million from 2002 levels. The total effect of the
change in mix of the Companys average earning assets on interest and dividend
income in 2003, partially offset by the effect of higher average earning
assets was a $5.4 million decrease from 2002. This resulted in a net decrease
in interest and dividend income of $9.0 million compared to the prior year.

INTEREST EXPENSE

Total interest expense decreased $6.8 million or 30.2% to $15.9 million for
the year ended December 31, 2003 from $22.7 million for the year ended
December 31, 2002. The decrease in interest expense is due primarily to the
lower interest rate environment in 2003 and the continued shift in the deposit
mix from certificate of deposit accounts to savings accounts. (This trend is
expected to start to reverse if market interest rates rise). This resulted in
a decrease in the Companys average cost of funds, from 2.61% in 2002 to 1.78%
in 2003. The decrease in average cost of funds was partially offset by an
increase in interest expense resulting from an increase in the Companys
average deposits. Average deposits in 2003 increased $21.6 million or 2.5% to
$892.3 million, from $870.7 million in the prior year.

As shown in the rate/volume analysis table on page 27, the effect on
total interest expense from changes in interest-bearing deposit rates was a
decrease of $6.8 million from 2002 levels. The total effect of higher average
deposits on interest expense was mitigated by the change in mix of the
Companys average deposits resulting in essentially no change in interest
expense due to volume when compared to 2002.

PROVISION FOR LOAN LOSSES

In 2003, the Bank recorded a negative provision for loan losses of $502
thousand due to the quality of loans in the portfolio and a decrease in the
Banks loan portfolio. This compares to a zero provision for loan losses in the
prior year. The Banks loan portfolio decreased $65.8 million or 20.6% from
$318.8 million at December 31, 2002 to $253.0 million at December 31, 2003. In
determining the amount to provide for loan losses, the key factor is the
adequacy of the allowance for loan losses. Management uses a methodology to
systematically measure the amount of estimated loan loss exposure inherent in
the portfolio for the purposes of establishing a sufficient allowance for loan
losses. The methodology includes three elements: an analysis of individual
loans deemed to be impaired, general loss allocations for various loan types
based on loss experience factors, and an unallocated allowance which is
maintained based on managements assessment of many factors including the risk
characteristics of the





---



##### 



portfolio, concentrations of credit, current and anticipated economic
conditions that may affect the borrowers ability to pay, and trends in loan
delinquencies and charge-offs. At December 31, 2003, the allowance for loan
losses was $1.6 million representing 0.61% of total loans and 676% of
non-accrual loans. Non-accrual loans totaled $230 thousand at December 31,
2003, down from $420 thousand a year earlier. The Bank recorded $11 thousand
in net loan recoveries in 2003 compared to $12 thousand in 2002.

The Bank also maintains an allowance for loan losses on off-balance sheet
credit exposures (shown separately on the balance sheet) that totaled $626
thousand at December 31, 2003. This compares to $384 thousand at December 31,
2002.

NON-INTEREST INCOME

Non-interest income consists of gains or losses on securities, deposit account
service fees and other non-interest income. Non-interest income for the year
ended December 31, 2003 decreased $1.0 million or 34.2% to $1.9 million, from
$2.9 million for the year ended December 31, 2002. The decrease is due
primarily to a decrease in net gains on securities available for sale and
trading of $1.1 million, from $1.7 million in 2002 to $0.6 million in 2003. Net
securities gains in 2003 were comprised of $0.3 million in net gains on equity
securities and $0.3 million in net gains on debt securities. This compares to
net gains on equity securities of $1.2 million and net gains on debt securities
of $0.5 million in 2002. Management, consistent with many analysts, is cautious
concerning its outlook regarding the likely performance of the equity markets
over the next several years, expecting only moderate returns in the near term.

Deposit account service fees and other non-interest income combined
increased $78 thousand to $1.3 million in 2003 from $1.2 million the prior
year.

NON-INTEREST EXPENSE

Non-interest expense totaled $12.6 million for the twelve months ended
December 31, 2003 compared to $12.0 million for the prior year, an increase of
$578 thousand or 4.8%. Salaries and employee benefits, the largest component
of non-interest expense, increased $394 thousand or 5.4% to $7.7 million in
2003 from $7.3 million in 2002. The increase in salaries and employee benefits
is primarily the result of broad based salary increases of $106 thousand and
an increase in health and other benefit costs for employees of $51 thousand.
Also reflected is an increase of $237 thousand in deferred compensation
expense related to the Banks supplemental retirement plan for certain
executive officers. This expense, however, is essentially offset by a
corresponding increase in other non-interest income. Occupancy and equipment
expense increased $250 thousand to $2.2 million in 2003 due to an increase in
depreciation expense of $123 thousand and increases in a variety of other
occupancy and equipment related costs. Additionally, the Companys data
processing, advertising and marketing, deposit insurance and other expenses
combined totaled $2.7 million in 2003 reflecting a decrease of $66 thousand
compared to the prior year.

INCOME TAX EXPENSE

For the years ended December 31, 2003 and 2002, income tax expense amounted to
$4.2 million and $5.5 million, respectively. The decrease in income tax
expense is primarily due to lower income before taxes and a decrease in the
Companys effective income tax rate. The Companys effective income tax rate
for the year ended December 31, 2003 was 34.98%, down from 35.81% for the year
ended December 31, 2002.

RESULTS OF OPERATIONS

COMPARISON OF THE YEARS 2002 AND 2001

MASSBANK Corp. reported consolidated net income of $9-8 million or $2.04 in
diluted earnings per share in 2002 compared to net income of $10.8 million or
$2.24 in diluted earnings per share in 2001. Basic earnings per share for 2002
were $2.09 compared to $2.30 in the prior year. The net income for the year
ended December 31, 2002 represents a return on assets of 0.99% and a return on
equity of 8.39%, compared to 1.13% and 9.53%, respectively, for the year ended
December 31, 2001.

The Companys net income in 2002 compared to 2001 primarily reflects an
improvement of $1.7 million in net interest income after provision for loan
losses offset by a decline in securities gains of $2.6 million. Earnings
results for 2002 also reflect a decrease in other non-interest income of $245
thousand, an increase in non-interest expense of $316 thousand and a reduction
in income tax expense of $545 thousand.





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##### 



NET INTEREST INCOME

Net interest income on a.fully taxable equivalent basis totaled $24.5 million
in 2002 compared to $22.8 million in 2001. This increase was primarily
attributable to an improvement in net interest margin and asset growth. The
Companys net interest margin for the year ended December 31, 2002 increased to
2.52% from 2.43% in the prior year. Average earning assets increased $35.1
million or 3.7% to $973.2 million in 2002, from $938.1 million in 2001.

The tables on pages 26 and 27 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 totaled $47.2
million for the year ended December 31, 2002, compared to $55.2 million for
the year ended December 31, 2001. The decrease in interest and dividend income
was the result of a decline in yield on average earning assets partially
offset by the increased interest income from higher average earning assets.
The yield on average earning assets dropped 103 basis points to 4.85% in 2002
from 5.88% the prior year, due primarily to a decline in market interest rates
in 2002. The average total earning assets of the Company increased $35.1
million in 2002.

As shown in the rate/volume analysis table on page 27, the decline in
yield on average earning assets in 2002 resulted in decreased interest and
divided income of $8.4 million from 2001 levels. Conversely, the total effect
of higher average earning assets and a change in mix of the Companys average
earning assets on interest and dividend income in 2002 was a $0.4 million
increase from 2001. This resulted in a net decrease in interest and dividend
income of $8.0 million compared to the prior year.

INTEREST EXPENSE

Total interest expense decreased $9.7 million or 29.9% to $22.7 million for
the year ended December 31, 2002 from $32.4 million for the year ended
December 31, 2001. The decrease in interest expense is due primarily to the
lower interest rate environment in 2002 and a shift in the deposit mix from
certificate of deposit accounts to savings accounts. This resulted in a
decrease in the Companys average cost of funds, from 3.87% in 2001 to 2.61%
in 2002. The decrease in the Companys average cost of funds was partially
offset by an increase in interest expense resulting from an increase in the
Companys average deposits. Average deposits in 2002 increased $34.1 million
or 4.1% to $870.7 million, from $836.6 million in the prior year.

As shown in the rate/volume analysis table on page 27, the effect on
total interest expense from changes in interest-bearing deposit rates was a
decrease of $9.3 million from 2001 levels. Additionally, the total effect of
higher average deposits and change in deposit mix on interest expense in 2002
was a decrease of $0.4 million from the prior year. This resulted in a net
decrease in total interest expense of $9.7 million compared to 2001.

PROVISION FOR LOAN LOSSES

The provision for loan losses represents a charge against current earnings and
an addition to the allowance for loan losses. There was no provision for loan
losses in 2002 compared to a provision for loan losses of $40 thousand in 2001.
In determining the amount to provide for loan losses, the key factor is the
adequacy of the allowance for loan losses. Management uses a methodology to
systematically measure the amount of estimated loan loss exposure inherent in
the portfolio for the purposes of establishing a sufficient allowance for loan
losses. The methodology includes three elements: an analysis of individual
loans deemed to be impaired, general loss allocations for various loan types
based on loss experience factors, and an unallocated allowance which is
maintained based on managements assessment of many factors including the risk
characteristics of the portfolio, concentrations of credit, current and
anticipated economic conditions that may affect borrowers ability to pay, and
trends in loan delinquencies and charge-offs. At December 31, 2002, the
allowance for loan losses was $2.3 million representing 0.71% of total loans
and 541% of non-accrual loans. Non-accrual loans totaled $420 thousand at
December 31, 2002, down from $644 thousand a year earlier. The bank recorded
$12 thousand in net loan recoveries in 2002 compared to $9 thousand in 2001.

NON-INTEREST INCOME

Non-interest income consists of gains or losses on securities, deposit account
service fees and other non-interest income.

Non-interest income for the year ended December 31, 2002 decreased $2.9
million or approximately 50% to $2.9 million, from $5.8 million for the year
ended December 31, 2001. The decrease is due primarily to a decrease in net
gains on securities available for sale and trading of approximately $2.7
million, from $4.4 million in 2001 to $1.7 million in 2002. Net securities
gains in 2002 were comprised of $1.2 million in net gains on equity securities
and $0.5 million in net gains on debt securities. This compares to net gains
on equity securities of $4.2 million and net gains on debt securities of $0.2
million in





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##### 



2001. The decline in net gains on equity securities is primarily
attributable to the decline in equity securities prices in 2002. Management
believes that the equity markets will provide more moderate returns in the
near future. This is expected to result in lower realized equity securities
gains in 2003.

Deposit account service fees and other non-interest income combined
declined $245 thousand to $1.2 million for the year ended December 31, 2002
from $1.5 million the prior year.

NON-INTEREST EXPENSE

Non-interest expense totaled $12.0 million for the twelve months ended
December 31, 2002 compared to $11.7 million for the prior year, an increase of
$316 thousand or 2.7%. Salaries and employee benefits, the largest component
of non-interest expense, increased $575 thousand or 8.6% to $7.3 million in
2002 from $6.7 million in 2001. The increase in salaries and employee benefits
is primarily the result of increases in pension and health insurance costs as
well as general salary increases, partially offset by a reduction in bonus
payments awarded to employees in 2002. The expense for professional services
increased $100 thousand or 23.5% in 2002 due primarily to higher legal fees.
The Companys amortization of intangibles decreased $298 thousand in 2002
compared to the prior year. This expense decreased for two reasons: 1) the
deposit acquisition premium that the Bank recorded in 1992 in connection with
its acquisition of the deposits and certain assets of the former Central
Savings Bank of Lowell was fully amortized as of February 2002, and 2) the
Company no longer amortizes the goodwill on its balance sheet but reviews it
for impairment periodically in accordance with Statement of Financial
Accounting Standard No. 142, Goodwill and Other Intangible Assets. The
Companys occupancy and equipment, data processing, advertising and marketing,
deposit insurance and other expenses combined totaled $4.2 million in 2002
reflecting a decrease of $61 thousand compared to the prior year.

INCOME TAX EXPENSE

The Company recorded income tax expense of $5.5 million in 2002, a decrease of
$545 thousand compared to the prior year. The decrease in income tax expense
is primarily due to lower income before taxes and a decline in the Companys
effective income tax rate. The Companys effective income tax rate for the
year ended December 31, 2002 was 35.81%, down from 35.87% for the year ended
December 31, 2001.

CONTRACTUAL OBLIGATIONS

The Companys contractual cash obligations and commitments to extend credit as
of December 31, 2003 are as follows:

|                              |                                                     |                                    |   |                                                  |        |             |   |            |       |            |   |         |       |           |   |       |        |  |   |        |        | 
|----------------------------- | --------------------------------------------------- | ---------------------------------- | - | ------------------------------------------------ | ------ | ----------- | - | ---------- | ----- | ---------- | - | ------- | ----- | --------- | - | ----- | ------ |  | - | ------ | ------ | 
|                              |                                                     |                                    |   | PAYMENTS
DUE OR COMMITMENTS EXPIRING  BY PERIOD
|                              |                                                     |                                    |   |                                                 
|                              |                                                     |                                    |   |                                                  |        |             |   | Less than  |       | One to     |   | Four to |       | More than
|(IN THOUSANDS)                |                                                     | Total                              |   | one year                                         |        | three years |   | five years |       | five years
|                              |                                                     |                                    |   |                                                  |        |             |   |            |       |           
|Contractual cash obligations: |                                                     |                                    |   |                                                  |        |             |   |            |       |            |   |         |       |           |   |       |        |  |   |       
|                              | Operating lease obligations                         |                                    | $ | 924                                              |        |             | $ | 176        |       |            | $ | 245     |       |           | $ | 186   |        |  | $ | 317    |       
|                              | Data
processing service obligations(1)              |                                    |   | 276                                              |        |             |   | 276        |       |            |   |        |       |           |   |      |        |  |   |       |       
|                              | Pension benefit obligations                         |                                    |   | 367                                              |        |             |   | 367        |       |            |   |        |       |           |   |      |        |  |   |       |       
|                              | Supplemental retirement benefit
obligations         |                                    |   | 5                                                |        |             |   | 52         |       |            |   |        |       |           |   |      |        |  |   |       |       
|                              |                                                     |                                    |   |                                                  |        |             |   |            |       |            |   |         |       |           |   |       |        |  |   |        |       
|                              |                                                     | Total contractual cash obligations |   | $                                                | 1,619  |             |   | $          | 871   |            |   | $       | 245   |           |   | $     | 186    |  |   | $      | 317    | 
|                              |                                                     |                                    |   |                                                  |        |             |   |            |       |            |   |         |       |           |   |       |        |  |   |        |       
|Other commitments:            |                                                     |                                    |   |                                                  |        |             |   |            |       |            |   |         |       |           |   |       |        |  |   |       
|                              | Commitments to originate residential
mortgage loans |                                    | $ | 3,300                                            |        |             | $ | 3,300      |       |            | $ |        |       |           | $ |      |        |  | $ |       |       
|                              | Unused lines of credit                              |                                    |   | 37,410                                           |        |             |   | 263        |       |            |   | 1,183   |       |           |   | 7,691 |        |  |   | 28,273 |       
|                              | Other loan commitments                              |                                    |   | 4,475                                            |        |             |   | 549        |       |            |   |        |       |           |   | 3,926 |        |  |   |       |       
|                              |                                                     |                                    |   |                                                  |        |             |   |            |       |            |   |         |       |           |   |       |        |  |   |        |       
|                              |                                                     | Total
other commitments(2)         |   | $                                                | 45,185 |             |   | $          | 4,112 |            |   | $       | 1,183 |           |   | $     | 11,617 |  |   | $      | 28,273 | 
|                              |                                                     |                                    |   |                                                  |        |             |   |            |       |            |   |         |       |           |   |       |        |  |   |        |       



|(1) |  | The fees charged by our data processing service provider fluctuate based on
the number of deposit and loan accounts serviced and therefore have been
estimated.                                                                                                                                                                                                
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | 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.
These commitments generally have fixed expiration dates. The total
commitment amounts do not necessarily represent future cash
requirements since many of the commitments may expire without being
drawn upon.





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##### 



LIQUIDITY AND CAPITAL RESOURCES

The Bank must maintain a sufficient level of cash and assets which can readily
be converted into cash in order to meet cash outflows from normal depositor
requirements and loan demands. The Banks primary sources of funds are
deposits, loan and mortgage-backed securities amortization and prepayments,
sales, calls or maturities of investment securities and income on earning
assets. In addition to loan payments and maturing investment securities, which
are relatively predictable sources of funds, the Bank maintains a high
percentage of its assets invested in federal funds sold and money market funds,
which can readily be converted into cash, and United States Treasury and
Government agency securities, which can be sold or pledged to raise funds. At
December 31, 2003, the Bank had $214.5 million or 21.2% of total assets and
$394.5 million or 39.1% of total assets invested, respectively, in federal
funds sold and money market funds, and United States obligations.

The Bank is a Federal Deposit Insurance Corporation insured institution
subject to the FDIC regulatory capital requirements. The FDIC regulations
require all FDIC insured institutions to maintain minimum levels of Tier I
capital. Highly rated banks (i.e., those with a composite rating of 1 under
the CAMELS rating system) are required to maintain a minimum leverage ratio of
Tier I capital to total average assets of at least 3.00%. An additional 100 to
200 basis points are required for all but these most highly rated
institutions. The Bank is also required to maintain a minimum level of
risk-based capital. Under the risk-based capital standards, FDIC insured
institutions must maintain a Tier I capital to risk-weighted assets ratio of
4.00% and are generally expected to meet a minimum total qualifying capital to
risk-weighted assets ratio of 8.00%. The risk-based capital guidelines take
into consideration risk factors, as defined by the regulators, associated with
various categories of assets, both on and off the balance sheet. Under the
guidelines, capital strength is measured in two tiers which are used in
conjunction with risk adjusted assets to determine the risk-based capital
ratios. Tier II capital components include supplemental capital components
such as qualifying allowance for loan losses, qualifying subordinated debt and
up to 45 percent of the pretax net unrealized holding gains on certain
available for sale equity securities. Tier I capital plus the Tier II capital
components are referred to as total qualifying capital.

The capital ratios of the Bank and the Company currently exceed the
minimum regulatory requirements. At December 31, 2003, the Bank had a leverage
Tier I capital to average assets ratio of 10.17%, a Tier I capital to
risk-weighted assets ratio of 33.29% and a total capital to risk-weighted
assets ratio of 34.13%. The Company, on a consolidated basis, had ratios of
leverage Tier I capital to average assets of 10.57%, Tier I capital to
risk-weighted assets of 34.56% and total capital to risk-weighted assets of
35.40% at December 31, 2003.

ASSET AND LIABILITY MANAGEMENT

The goal of asset/liability management is to ensure that liquidity, capital
and market risk are prudently managed. Asset/ liability management is governed
by policies reviewed and approved annually by the Banks Board of Directors
(the Board). The Board establishes policy limits for long-term interest rate
risk assumption and delegates responsibility for monitoring and measuring the
Companys exposure to interest rate risk to the Risk Management and
Asset/Liability Committee (theCommittee). The Committee which is comprised
of members of the Companys Board of Directors, members of senior management
and the Banks comptroller, generally meets four times a year 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 the Risk Management and Asset/Liability
Committee. These limits and guidelines reflect the Companys tolerance for
interest rate risk over both short-term and long-term time horizons. The
Company monitors its interest rate exposures using a variety of financial
tools, including income simulation models. These models, produced quarterly,
estimate the effect that instantaneous and permanent market interest rate
shocks of +/-100, 200 and 300 basis points would have on the Companys net
interest income, with no effect given to any steps that management might take
to counter the effect of these interest rate movements. These results are
compared to a flat interest rate scenario and a consensus forecast that
represents the most likely future course of interest rates. The Company 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 Bloomberg. The Company uses the results to review the
potential changes in market value resulting from immediate rate shifts and to
manage the effect of market value changes on the Companys capital position.

Reinvestment risk occurs when an asset and the liability funding the
asset do not reprice and/or mature at the same time. The difference or
mismatch with respect to repricing frequency and/or maturity is a risk to net
interest income.

Complicating managements efforts to control the Companys exposure to
interest rate risk is the fundamental uncertainty of the maturity, repricing
and/or runoff characteristics of a significant portion of the Companys assets
and liabilities. This uncertainty often reflects optional features embedded in
these financial instruments. The most important optional features are embedded
in the Companys deposits, loans, mortgage-backed securities and callable U.S.
Government agency securities.

For example, many of the Companys interest-bearing deposit products
(e.g., savings, money market deposit accounts and NOW accounts) have no
contractual maturity. Customers have the right to withdraw funds from these
deposit accounts freely. Deposit balances may therefore run off unexpectedly
due to changes in competitive or market conditions. In addition, when market
interest rates rise, customers with time certificates of deposit (CDs) often
pay a penalty to redeem their CDs and reinvest at higher rates. Given the
uncertainties surrounding deposit runoff and repricing, the interest rate
sensitivity of the Companys liabilities cannot be determined precisely.

Similarly, customers have the right to prepay loans, particularly
residential mortgage loans, usually without penalty. As a result, the Companys
mortgage based assets (i.e., mortgage loans and mortgage-backed securities) are
subject to prepayment risk. This risk tends to increase when interest rates
fall due to the benefits of refinancing. Since the future prepayment behavior
of the Companys customers is uncertain, the interest rate sensitivity of
mortgage based assets cannot be determined exactly. Additionally, some of the
Companys callable U.S. Government agency securities may be called prior to
maturity. As a result, the interest rate sensitivity of these investment
securities cannot be determined precisely.

Management monitors and adjusts the difference between the Companys
interest-earning assets and interest-bearing liabilities repricing within
various time frames (GAP position).

GAP analysis provides a static view of the maturity and repricing
characteristics of the Companys balance sheet positions. The interest rate
GAP is prepared by scheduling all interest-earning assets and interest-bearing
liabilities according to scheduled or anticipated repricing or maturity. The
GAP analysis identifies the difference between an institutions assets and
liabilities that will react to a change in market rates. GAP analysis theory
postulates that if the GAP is positive and rates increase, the institutions
net interest spread will increase as more assets than liabilities react to the
rate change. If the GAP is negative, more liabilities than assets will react
to a change in market rates. If rates rise, the institutions net interest
spread will fall as more liabilities react to market rates than assets. If
rates fall and the GAP is positive, the institutions net interest spread will
decrease as more assets than liabilities react to the rate change. If the GAP
is negative and rates fall, the institutions net interest spread will improve
as more liabilities react to market rates than assets.





---



##### 



INTEREST RATE RISK(continued)

In 2003, the Company maintained a significant portion of its assets in
short-term investments because it anticipated a rise in interest rates
the latter part of the year and wanted to take advantage of increases in
interest rates to enhance its long-term profitability. However, interest
rates did not increase as anticipated. As a result, the Company saw its
net interest spread decline.

The Company has historically managed its interest rate GAP
primarily by lengthening or shortening the maturity structure of its
securities portfolio, by continually modifying the composition of its
securities portfolio and by selectively pricing and marketing its
various deposit products. In anticipation of a rise in interest rates in
2004 and the current level of the Banks savings deposits, the Company
has shortened the maturity structure and mix of its investments.
Additionally, in January 2004, the Bank lowered the interest rate paid
on some of its savings and NOW deposit products. As a result, the
Companys one-year cumulative GAP position was converted from asset
sensitive to liability sensitive at year-end 2003. However, once the
repricing of the savings and NOW deposits takes place, the Companys
one-year cumulative GAP position will become asset sensitive again.

The following table presents the amounts of interest-earning assets
and interest-bearing liabilities at December 31, 2003 that are assumed
to mature or reprice during the periods indicated. The table also
summarizes the Companys GAP position at December 31, 2003. As of this
date, the Companys one-year cumulative GAP position was negative $68.8
million, representing approximately 6.8% of total assets compared to a
positive GAP of $325.8 million or 32.3% of total assets at December 31,
2002. The cumulative GAP-asset ratio measures the direction and extent
of imbalance between an institutions assets and liabilities repricing
through the end of a particular period.

|                                            |                                  |                                    |          |                              |         |           |          |          |        |         |         |       |        |   |         |   |         |   |          |   |         |   |         |         |         | 
|------------------------------------------- | -------------------------------- | ---------------------------------- | -------- | ---------------------------- | ------- | --------- | -------- | -------- | ------ | ------- | ------- | ----- | ------ | - | ------- | - | ------- | - | -------- | - | ------- | - | ------- | ------- | ------- | 
|                                            |                                  |                                    |          | INTEREST SENSITIVITY PERIODS
|                                            |                                  |                                    |          |                             
|                                            |                                  |                                    |          | 3 Months                     |         | 3 to 6    |          | 6 Months |        | 1 to 5  |         | Over  |        |   |         |  
|(IN THOUSANDS)                              |                                  | or Less                            |          | Months                       |         | to 1 Year |          | Years    |        | 5 Years |         | Total
|                                            |                                  |                                    |          |                              |         |           |          |          |        |         |         |      
|Interest-earning
assets:                    |                                  |                                    |          |                              |         |           |          |          |        |         |         |       |        |   |         |   |         |   |          |   |         |   |         |        
|Loans(3)                                    |                                  | $                                  | 28,997   |                              |         | $         | 17,605   |          |        | $       | 34,138  |       |        | $ | 152,771 |   |         | $ | 19,495   |   |         | $ | 253,006 |        
|Short-term investments:                     |                                  |                                    |          |                              |         |           |          |          |        |         |         |       |        |   |         |   |         |   |          |   |         |   |         |        
|                                            | Federal funds sold               |                                    |          | 190,684                      |         |           |          |         |        |         |         |      |        |   |         |  |         |   |          |  |         |   |         | 190,684 |        
|                                            | Investment in money market funds |                                    |          | 23,848                       |         |           |          |         |        |         |         |      |        |   |         |  |         |   |          |  |         |   |         | 23,848  |        
|Interest-bearing deposits in banks          |                                  |                                    | 969      |                              |         |           | 827      |          |        |         | 2,623   |       |        |   | 1,266   |   |         |   |         |   |         |   | 5,685   |        
|Securities available for sale(3)            |                                  |                                    | 84,152   |                              |         |           | 47,913   |          |        |         | 56,186  |       |        |   | 214,803 |   |         |   | 26,175   |   |         |   | 429,229 |        
|Trading securities                          |                                  |                                    | 72,633   |                              |         |           |         |          |        |         |        |       |        |   |        |   |         |   |         |   |         |   | 72,633  |        
|                                            |                                  |                                    |          |                              |         |           |          |          |        |         |         |       |        |   |         |   |         |   |          |   |         |   |         |        
|                                            |                                  | Total interest-earning assets      |          | $                            | 401,283 |           |          | $        | 66,345 |         |         | $     | 92,947 |   |         | $ | 368,840 |   |          | $ | 45,670  |   |         | $       | 975,085 | 
|                                            |                                  |                                    |          |                              |         |           |          |          |        |         |         |       |        |   |         |   |         |   |          |   |         |   |         |        
|Interest-bearing liabilities:               |                                  |                                    |          |                              |         |           |          |          |        |         |         |       |        |   |         |   |         |   |          |   |         |   |         |        
|Deposits(1)(2)(4)                           |                                  | $                                  | 563,799  |                              |         | $         | 29,645   |          |        | $       | 35,967  |       |        | $ | 31,985  |   |         | $ | 193,303  |   |         | $ | 854,699 |        
|                                            |                                  |                                    |          |                              |         |           |          |          |        |         |         |       |        |   |         |   |         |   |          |   |         |   |         |        
|                                            |                                  | Total interest-bearing liabilities |          | $                            | 563,799 |           |          | $        | 29,645 |         |         | $     | 35,967 |   |         | $ | 31,985  |   |          | $ | 193,303 |   |         | $       | 854,699 | 
|                                            |                                  |                                    |          |                              |         |           |          |          |        |         |         |       |        |   |         |   |         |   |          |   |         |   |         |        
|GAP for period                              |                                  | $                                  | (162,516 | )                            |         | $         | 36,700   |          |        | $       | 56,980  |       |        | $ | 336,855 |   |         | $ | (147,633 | ) |         | $ | 120,386 |        
|Cumulative GAP - December 31, 2003          |                                  | $                                  | (162,516 | )                            |         | $         | (125,816 | )        |        | $       | (68,836 | )     |        | $ | 268,019 |   |         | $ | 120,386  |   |         |   |         |        
|Cumulative GAP as a percent of total
assets |                                  |                                    | (16.1    | )%                           |         |           | (12.5    | )%       |        |         | (6.8    | )%    |        |   | 26.5    | % |         |   | 11.9     | % |         |   |         |        
|                                            |                                  |                                    |          |                              |         |           |          |          |        |         |         |       |        |   |         |   |         |   |          |   |         |   |         |        
|Cumulative GAP - December 31, 2002          |                                  | $                                  | 250,522  |                              |         | $         | 267,467  |          |        | $       | 325,767 |       |        | $ | 628,706 |   |         | $ | 131,393  |   |         |   |         |        
|                                            |                                  |                                    |          |                              |         |           |          |          |        |         |         |       |        |   |         |   |         |   |          |   |         |   |         |        



|(1) |  | Excludes non-interest bearing demand accounts of $28,464.                                                                                                                                                                                                                                                                                                                                                                          
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Includes escrow deposits of
borrowers of $1,139.                                                                                                                                                                                                                                                                                                                                                                                   
|   
|(3) |  | Loans and mortgage-backed securities reflect regular amortization of
principal and prepayment estimates. Callable U.S. Government agency
securities of $192,414 thousand are shown in the period they are expected to
be called or reprice, otherwise they are shown based on their maturity date.
It is assumed that a security will be called if the coupon rate on the
security exceeded market interest rates at year-end 2003.
|   
|(4) |  | Savings and NOW accounts that reprice in January 2004 are reflected in
the 3 months or less period. All other savings and NOW, except club
accounts
are shown in the over 5 years period. Club accounts are shown in the 6
months to 1 year period.                                                                                                                                                                          





---



##### 



INTEREST RATE RISK(continued)

The following table shows the Companys financial instruments that are
sensitive to changes in interest rates, categorized by initial call date
or expected maturity, and the instruments fair values as of December 31,
2003.

EXPECTED MATURITY DATE
AT DECEMBER 31, 2003

|                                          |                          |                                      |         |      |         |      |        |      |         |      |        |            |        |       |        |             |        |   |        |      |        |   |         |      |         |   |         |      |         |   |         |            |         | 
|----------------------------------------- | ------------------------ | ------------------------------------ | ------- | ---- | ------- | ---- | ------ | ---- | ------- | ---- | ------ | ---------- | ------ | ----- | ------ | ----------- | ------ | - | ------ | ---- | ------ | - | ------- | ---- | ------- | - | ------- | ---- | ------- | - | ------- | ---------- | ------- | 
|                                          |                          |                                      |         |      |         |      |        |      |         |      |        |            |        |       |        |             |        |   |        |      |        |   |         |      |         |   |         |      |         |   |         | Fair Value |        
|(IN THOUSANDS)                            |                          | 2004                                 |         | 2005 |         | 2006 |        | 2007 |         | 2008 |        | Thereafter |        | Total |        | at 12/31/03 |       
|                                          |                          |                                      |         |      |         |      |        |      |         |      |        |            |        |       |        |            
|Interest
sensitive assets:                |                          |                                      |         |      |         |      |        |      |         |      |        |            |        |       |        |             |        |   |        |      |        |   |         |      |         |   |         |      |         |   |         |           
|Fixed rate securities(5)                  |                          | $                                    | 148,059 |      |         | $    | 60,400 |      |         | $    | 51,228 |            |        | $     | 44,025 |             |        | $ | 50,943 |      |        | $ | 21,426  |      |         | $ | 376,081 |      |         | $ | 381,630 |           
|                                          | Average interest rate(1) |                                      |         | 3.75 | %       |      |        | 3.68 | %       |      |        | 3.42       | %      |       |        | 3.85        | %      |   |        | 3.82 | %      |   |         | 4.63 | %       |   |         | 3.76 | %       |   |         |            |        
|Variable rate securities(2)(3)            |                          |                                      | 20,555  |      |         |      | 4,000  |      |         |      | 4,000  |            |        |       | 4,000  |             |        |   | 7,993  |      |        |   | 6,246   |      |         |   | 46,794  |      |         |   | 47,599  |           
|                                          | Average interest rate(1) |                                      |         | 2.46 | %       |      |        | 3.00 | %       |      |        | 3.00       | %      |       |        | 2.00        | %      |   |        | 2.20 | %      |   |         | 2.28 | %       |   |         | 2.44 | %       |   |         |            |        
|Trading securities(6)                     |                          |                                      | 72,633  |      |         |      |       |      |         |      |       |            |        |       |       |             |        |   |       |      |        |   |        |      |         |   | 72,633  |      |         |   | 72,633  |           
|                                          | Average interest rate    |                                      |         | 1.36 | %       |      |        |     |         |      |        |           |        |       |        |            |        |   |        |     |        |   |         |     |         |   |         | 1.36 | %       |   |         |            |        
|Fixed rate loans                          |                          |                                      | 62,913  |      |         |      | 52,563 |      |         |      | 36,950 |            |        |       | 26,345 |             |        |   | 22,020 |      |        |   | 17,576  |      |         |   | 218,367 |      |         |   | 221,975 |           
|                                          | Average interest rate    |                                      |         | 5.89 | %       |      |        | 5.89 | %       |      |        | 5.92       | %      |       |        | 6.01        | %      |   |        | 6.00 | %      |   |         | 5.96 | %       |   |         | 5.90 | %       |   |         |            |        
|Variable rate loans                       |                          |                                      | 2,343   |      |         |      | 2,165  |      |         |      | 2,066  |            |        |       | 1,950  |             |        |   | 1,779  |      |        |   | 24,336  |      |         |   | 34,639  |      |         |   | 34,722  |           
|                                          | Average interest rate    |                                      |         | 5.86 | %       |      |        | 5.81 | %       |      |        | 5.82       | %      |       |        | 5.61        | %      |   |        | 5.76 | %      |   |         | 6.09 | %       |   |         | 6.00 | %       |   |         |            |        
|Other fixed rate assets(4)                |                          |                                      | 4,419   |      |         |      | 1,266  |      |         |      |       |            |        |       |       |             |        |   |       |      |        |   |        |      |         |   | 5,685   |      |         |   | 5,685   |           
|                                          | Average interest rate    |                                      |         | 2.63 | %       |      |        | 3.56 | %       |      |        |           |        |       |        |            |        |   |        |     |        |   |         |     |         |   |         | 2.84 | %       |   |         |            |        
|Other variable rate assets(3)             |                          |                                      | 214,532 |      |         |      |       |      |         |      |       |            |        |       |       |             |        |   |       |      |        |   |        |      |         |   | 214,532 |      |         |   | 214,532 |           
|                                          | Average interest rate    |                                      |         | 0.88 | %       |      |        |     |         |      |        |           |        |       |        |            |        |   |        |     |        |   |         |     |         |   |         | 0.88 | %       |   |         |            |        
|                                          |                          |                                      |         |      |         |      |        |      |         |      |        |            |        |       |        |             |        |   |        |      |        |   |         |      |         |   |         |      |         |   |         |           
|                                          |                          | Total interest sensitive assets      |         | $    | 525,454 |      |        | $    | 120,394 |      |        | $          | 94,244 |       |        | $           | 76,320 |   |        | $    | 82,735 |   |         | $    | 69,584  |   |         | $    | 968,731 |   |         | $          | 978,776 | 
|                                          |                          |                                      |         |      |         |      |        |      |         |      |        |            |        |       |        |             |        |   |        |      |        |   |         |      |         |   |         |      |         |   |         |           
|Interest sensitive liabilities:           |                          |                                      |         |      |         |      |        |      |         |      |        |            |        |       |        |             |        |   |        |      |        |   |         |      |         |   |         |      |         |   |         |           
|Savings and money market
deposit accounts |                          | $                                    | 2,099   |      |         | $    | 1,961  |      |         | $    | 1,838  |            |        | $     | 1,728  |             |        | $ | 1,630  |      |        | $ | 598,575 |      |         | $ | 607,831 |      |         | $ | 607,831 |           
|                                          | Average interest rate    |                                      |         | 0.90 | %       |      |        | 0.94 | %       |      |        | 0.97       | %      |       |        | 1.00        | %      |   |        | 1.03 | %      |   |         | 1.63 | %       |   |         | 1.62 | %       |   |         |            |        
|Fixed rate certificates of deposit        |                          |                                      | 95,151  |      |         |      | 22,589 |      |         |      | 7,000  |            |        |       | 1,361  |             |        |   | 1,035  |      |        |   | 2,074   |      |         |   | 129,210 |      |         |   | 130,244 |           
|                                          | Average interest rate    |                                      |         | 1.75 | %       |      |        | 2.44 | %       |      |        | 2.71       | %      |       |        | 3.59        | %      |   |        | 3.40 | %      |   |         | 4.02 | %       |   |         | 2.00 | %       |   |         |            |        
|Variable rate certificates of deposit     |                          |                                      | 16,608  |      |         |      | 23,644 |      |         |      | 13,036 |            |        |       | 7,123  |             |        |   |       |      |        |   |        |      |         |   | 60,411  |      |         |   | 60,411  |           
|                                          | Average interest rate    |                                      |         | 1.61 | %       |      |        | 1.65 | %       |      |        | 1.76       | %      |       |        | 1.76        | %      |   |        |     |        |   |         |     |         |   |         | 1.68 | %       |   |         |            |        
|NOW accounts                              |                          |                                      |        |      |         |      |       |      |         |      |       |            |        |       |       |             |        |   |       |      |        |   | 56,108  |      |         |   | 56,108  |      |         |   | 56,108  |           
|                                          | Average interest rate    |                                      |         |     |         |      |        |     |         |      |        |           |        |       |        |            |        |   |        |     |        |   |         | 0.37 | %       |   |         | 0.37 | %       |   |         |            |        
|Escrow deposits of borrowers              |                          |                                      | 1,139   |      |         |      |       |      |         |      |       |            |        |       |       |             |        |   |       |      |        |   |        |      |         |   | 1,139   |      |         |   | 1,139   |           
|                                          | Average interest rate    |                                      |         | 0.25 | %       |      |        |     |         |      |        |           |        |       |        |            |        |   |        |     |        |   |         |     |         |   |         | 0.25 | %       |   |         |            |        
|                                          |                          |                                      |         |      |         |      |        |      |         |      |        |            |        |       |        |             |        |   |        |      |        |   |         |      |         |   |         |      |         |   |         |           
|                                          |                          | Total interest sensitive liabilities |         | $    | 114,997 |      |        | $    | 48,194  |      |        | $          | 21,874 |       |        | $           | 10,212 |   |        | $    | 2,665  |   |         | $    | 656,757 |   |         | $    | 854,699 |   |         | $          | 855,733 | 
|                                          |                          |                                      |         |      |         |      |        |      |         |      |        |            |        |       |        |             |        |   |        |      |        |   |         |      |         |   |         |      |         |   |         |           



---

|(1) |  | Securities rates presented are on a tax equivalent basis.                                
|--- |  | -----------------------------------------------------------------------------------------
|   
|(2) |  | Includes equity securities.                                                              
|   
|(3) |  | Consist of Federal funds sold, money market funds and
interest-bearing deposits in banks.
|   
|(4) |  | Consist of interest-bearing deposits in banks.                                           
|   
|(5) |  | Securities presented are at amortized cost.                                              
|   
|(6) |  | Securities presented are at market value.                                                



|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|The Company uses certain assumptions to estimate fair values and
expected maturities. For interest-sensitive assets, except callable
government agency securities, expected maturities are based upon
contractual maturity, and projected repayments and prepayments of
principal. For callable government agency securities expected maturities
are based upon the next call date for those securities expected to be
called, otherwise, the securities are shown at their expected maturity
date. 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 $11.5 million at December 31, 2003.
The net unrealized gains on these securities totaled $0.9 million at
year-end 2003. 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.





---



##### 



AVERAGE BALANCE SHEETS



|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |      |   |      |  
|--------------------------------------------- | ----------------------------- | ---- | --------------------------------------------------- | ------- | ------- | --------- | ---------- | ------ | -------- | ------ | ------- | ---- | ---------- | ---- | ------- | ------- | -------- | ------- | ------- | ------ |  | ------ | ---- | ---- | - | ---- | -
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,       |                               | 2003 |                                                     | 2002   
|                                              |                               |      |                                                     |        
|                                              |                               |      |                                                     |         |         |           |            |        | Interest |        | Average |      |            |      |         |         | Interest |         | Average
|                                              |                               |      |                                                     |         | Average |           | Income/    |        | Yield/   |        | Average |      | Income/    |      | Yield/ 
|                                              |                               |      |                                                     |         | Balance |           | Expense(1) |        | Rate     |        | Balance |      | Expense(1) |      | Rate   
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |        
|Assets:                                       |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|Earning assets:                               |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|                                              | Federal funds sold            |      | $                                                   | 209,463 |         |           | $          | 2,266  |          |        |         | 1.08 | %          |      | $       | 183,968 |          |         | $       | 2,974  |  |        |      | 1.62 | %
|                                              | Short-term investments(4)     |      |                                                     | 29,672  |         |           |            | 435    |          |        |         | 1.47 |            |      |         | 31,063  |          |         |         | 671    |  |        |      | 2.16 |  
|                                              | Investment securities(2)      |      |                                                     | 259,148 |         |           |            | 7,638  |          |        |         | 2.95 |            |      |         | 158,978 |          |         |         | 5,815  |  |        |      | 3.66 |  
|                                              | Mortgage-backed securities(2) |      |                                                     | 133,037 |         |           |            | 8,250  |          |        |         | 6.20 |            |      |         | 233,627 |          |         |         | 14,863 |  |        |      | 6.36 |  
|                                              | Trading securities            |      |                                                     | 72,534  |         |           |            | 1,113  |          |        |         | 1.53 |            |      |         | 31,814  |          |         |         | 685    |  |        |      | 2.15 |  
|                                              | Mortgage loans(3)             |      |                                                     | 270,826 |         |           |            | 17,682 |          |        |         | 6.53 |            |      |         | 308,710 |          |         |         | 20,819 |  |        |      | 6.74 |  
|                                              | Other loans(3)                |      |                                                     | 13,175  |         |           |            | 834    |          |        |         | 6.33 |            |      |         | 25,022  |          |         |         | 1,362  |  |        |      | 5.44 |  
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|                                              |                               |      | Total earning assets                                |         |         | 987,855   |            |        |          | 38,218 |         |      |            | 3.87 | %       |         |          | 973,182 |         |        |  | 47,189 |      |      |   | 4.85 | %
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|Allowance for
loan losses                     |                               |      | (2,388                                              | )       |         |           |            |        |          |        |         |      |            |      | (2,644  | )       |          |         |         |        |  |        |      |     
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|                                              |                               |      | Total earning assets
less allowance for
loan losses |         |         | 985,467   |            |        |          |        |         |      |            |      |         |         |          | 970,538 |         |        |  |        |      |      |   |      |  
|Other assets                                  |                               |      | 22,410                                              |         |         |           |            |        |          |        |         |      |            |      | 22,410  |         |          |         |         |        |  |        |      |     
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|                                              |                               |      | Total assets                                        |         | $       | 1,007,877 |            |        |          |        |         |      |            |      |         |         | $        | 992,948 |         |        |  |        |      |      |   |      |  
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|Liabilities:                                  |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|Deposits:                                     |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|                                              | Demand and NOW                |      | $                                                   | 83,583  |         |           |            | 247    |          |        |         | 0.30 | %          |      | $       | 82,964  |          |         |         | 366    |  |        |      | 0.44 | %
|                                              | Savings                       |      |                                                     | 595,464 |         |           |            | 11,032 |          |        |         | 1.85 |            |      |         | 471,734 |          |         |         | 12,161 |  |        |      | 2.58 |  
|                                              | Time certificates of deposit  |      |                                                     | 213,282 |         |           |            | 4,575  |          |        |         | 2.15 |            |      |         | 315,987 |          |         |         | 10,174 |  |        |      | 3.22 |  
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|                                              |                               |      | Total deposits                                      |         |         | 892,329   |            |        |          | 15,854 |         |      |            | 1.78 | %       |         |          | 870,685 |         |        |  | 22,701 |      |      |   | 2.61 | %
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|Other liabilities                             |                               |      | 4,474                                               |         |         |           |            |        |          |        |         |      |            |      | 5,225   |         |          |         |         |        |  |        |      |     
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|                                              |                               |      | Total liabilities                                   |         |         | 896,803   |            |        |          |        |         |      |            |      |         |         |          | 875,910 |         |        |  |        |      |      |   |      |  
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|Stockholders Equity                          |                               |      | 111,074                                             |         |         |           |            |        |          |        |         |      |            |      | 117,038 |         |          |         |         |        |  |        |      |     
|                                              |                               |      | Total liabilities and
stockholders
equity          |         | $       | 1,007,877 |            |        |          |        |         |      |            |      |         |         | $        | 992,948 |         |        |  |        |      |      |   |      |  
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|Net interest income (tax-equivalent basis)    |                               |      |                                                     |         |         |           | 22,364     |        |          |        |         |      |            |      |         |         |          |         | 24,488  |        |  |        |      |     
|Less adjustment of tax-exempt interest income |                               |      |                                                     |         |         |           | 81         |        |          |        |         |      |            |      |         |         |          |         | 86      |        |  |        |      |     
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|Net interest income                           |                               |      |                                                     |         |         | $         | 22,283     |        |          |        |         |      |            |      |         |         |          | $       | 24,402  |        |  |        |      |     
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|Interest rate spread(5)                       |                               |      |                                                     |         |         |           |            |        |          |        | 2.09    | %    |            |      |         |         |          |         |         |        |  |        | 2.24 | %   
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     
|Net interest margin(6)                        |                               |      |                                                     |         |         |           |            |        |          |        | 2.26    | %    |            |      |         |         |          |         |         |        |  |        | 2.52 | %   
|                                              |                               |      |                                                     |         |         |           |            |        |          |        |         |      |            |      |         |         |          |         |         |        |  |        |      |     

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |      |   |      |  
|--------------------------------------------- | ----------------------------- | ---- | --------------------------------------------------- | ------- | ------- | ------- | ---------- | ------ | -------- | ------ | ------- | ---- | - | ---- | -
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,       |                               | 2001
|                                              |                               |     
|                                              |                               |      |                                                     |         |         |         |            |        | Interest |        | Average
|                                              |                               |      |                                                     |         | Average |         | Income/    |        | Yield/  
|                                              |                               |      |                                                     |         | Balance |         | Expense(1) |        | Rate    
|                                              |                               |      |                                                     |         |         |         |            |        |         
|Assets:                                       |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|Earning assets:                               |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|                                              | Federal funds sold            |      | $                                                   | 196,041 |         |         | $          | 7,444  |          |        |         | 3.80 | %
|                                              | Short-term investments(4)     |      |                                                     | 30,215  |         |         |            | 1,217  |          |        |         | 4.03 |  
|                                              | Investment securities(2)      |      |                                                     | 106,478 |         |         |            | 5,596  |          |        |         | 5.26 |  
|                                              | Mortgage-backed securities(2) |      |                                                     | 284,932 |         |         |            | 18,847 |          |        |         | 6.61 |  
|                                              | Trading securities            |      |                                                     | 2,984   |         |         |            | 158    |          |        |         | 5.29 |  
|                                              | Mortgage loans(3)             |      |                                                     | 281,492 |         |         |            | 19,631 |          |        |         | 6.97 |  
|                                              | Other loans(3)                |      |                                                     | 35,964  |         |         |            | 2,315  |          |        |         | 6.44 |  
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|                                              |                               |      | Total earning assets                                |         |         | 938,106 |            |        |          | 55,208 |         |      |   | 5.88 | %
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|Allowance for
loan losses                     |                               |      | (2,612                                              | )       |         |         |            |        |          |        |         |     
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|                                              |                               |      | Total earning assets
less allowance for
loan losses |         |         | 935,494 |            |        |          |        |         |      |   |      |  
|Other assets                                  |                               |      | 20,518                                              |         |         |         |            |        |          |        |         |     
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|                                              |                               |      | Total assets                                        |         | $       | 956,012 |            |        |          |        |         |      |   |      |  
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|Liabilities:                                  |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|Deposits:                                     |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|                                              | Demand and NOW                |      | $                                                   | 80,848  |         |         |            | 461    |          |        |         | 0.57 | %
|                                              | Savings                       |      |                                                     | 353,622 |         |         |            | 11,495 |          |        |         | 3.25 |  
|                                              | Time certificates of deposit  |      |                                                     | 402,155 |         |         |            | 20,435 |          |        |         | 5.08 |  
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|                                              |                               |      | Total deposits                                      |         |         | 836,625 |            |        |          | 32,391 |         |      |   | 3.87 | %
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|Other liabilities                             |                               |      | 6,545                                               |         |         |         |            |        |          |        |         |     
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|                                              |                               |      | Total liabilities                                   |         |         | 843,170 |            |        |          |        |         |      |   |      |  
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|Stockholders Equity                          |                               |      | 112,842                                             |         |         |         |            |        |          |        |         |     
|                                              |                               |      | Total liabilities and
stockholders
equity          |         | $       | 956,012 |            |        |          |        |         |      |   |      |  
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|Net interest income (tax-equivalent basis)    |                               |      |                                                     |         |         |         | 22,817     |        |          |        |         |     
|Less adjustment of tax-exempt interest income |                               |      |                                                     |         |         |         | 91         |        |          |        |         |     
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|Net interest income                           |                               |      |                                                     |         |         | $       | 22,726     |        |          |        |         |     
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|Interest rate spread(5)                       |                               |      |                                                     |         |         |         |            |        |          |        | 2.01    | %   
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     
|Net interest margin(6)                        |                               |      |                                                     |         |         |         |            |        |          |        | 2.43    | %   
|                                              |                               |      |                                                     |         |         |         |            |        |          |        |         |     

(1)Income on equity securities and municipal bonds is included on a tax
equivalent basis.

(2)Averages balances include net unrealized gains on securities available
for sale.

(3)Loans on non-accrual status are included in average balances.

(4)Short-term investments consist of interest-bearing deposits in banks
and investments in money market funds.

(5)Interest rate spread represents the difference
between the yield on earning assets and the cost of
the Companys deposits.

(6)Nef interest margin represents net interest income (tax equivalent basis)
divided by average interest-earning assets.





---



##### 



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.

|                              |                            |                     |                              |                                    |   |                       |        |                       |   |        |        |        |   |        |        |        |   |        |      |        |   |        |        |        |   |         |        |  
|----------------------------- | -------------------------- | ------------------- | ---------------------------- | ---------------------------------- | - | --------------------- | ------ | --------------------- | - | ------ | ------ | ------ | - | ------ | ------ | ------ | - | ------ | ---- | ------ | - | ------ | ------ | ------ | - | ------- | ------ | -
|                              |                            |                     |                              |                                    |   | 2003 COMPARED TO 2002 |        | 2002 COMPARED TO 2001
|(IN THOUSAND)                 |                            | INCREASE (DECREASE) |                              | INCREASE DECREASE)                
|YEAR ENDED DECEMBER 31,       |                            | DUE TO              |                              | DUE TO                            
|                              |                            |                     |                              |                                   
|                              |                            |                     |                              |                                    |   | Volume                |        | Rate                  |   | Total  |        | Volume |   | Rate   |        | Total 
|                              |                            |                     |                              |                                    |   |                       |        |                       |   |        |        |        |   |        |        |       
|Interest and dividend income: |                            |                     |                              |                                    |   |                       |        |                       |   |        |        |        |   |        |        |        |   |        |      |        |   |        |        |       
|                              | Federal funds sold         |                     | $                            | 372                                |   |                       | $      | (1,080                | ) |        | $      | (708   | ) |        | $      | (433   | ) |        | $    | (4,037 | ) |        | $      | (4,470 | )
|                              | Short-term investments     |                     |                              | (29                                | ) |                       |        | (207                  | ) |        |        | (236   | ) |        |        | 33     |   |        |      | (579   | ) |        |        | (546   | )
|                              | Investment securities      |                     |                              | 3,081                              |   |                       |        | (1,253                | ) |        |        | 1,828  |   |        |        | 2,205  |   |        |      | (1,981 | ) |        |        | 224    |  
|                              | Mortgage-backed securities |                     |                              | (6,247                             | ) |                       |        | (366                  | ) |        |        | (6,613 | ) |        |        | (3,287 | ) |        |      | (697   | ) |        |        | (3,984 | )
|                              | Trading securities         |                     |                              | 671                                |   |                       |        | (243                  | ) |        |        | 428    |   |        |        | 673    |   |        |      | (146   | ) |        |        | 527    |  
|                              | Mortgage loans             |                     |                              | (2,490                             | ) |                       |        | (647                  | ) |        |        | (3,137 | ) |        |        | 1,851  |   |        |      | (663   | ) |        |        | 1,188  |  
|                              | Other loans                |                     |                              | (723                               | ) |                       |        | 195                   |   |        |        | (528   | ) |        |        | (632   | ) |        |      | (321   | ) |        |        | (953   | )
|                              |                            |                     |                              |                                    |   |                       |        |                       |   |        |        |        |   |        |        |        |   |        |      |        |   |        |        |        |   |        
|                              |                            |                     |                              | Total interest and dividend income |   |                       | (5,365 | )                     |   |        | (3,601 | )      |   |        | (8,966 | )      |   |        | 410  |        |   |        | (8,424 | )      |   |         | (8,014 | )
|                              |                            |                     |                              |                                    |   |                       |        |                       |   |        |        |        |   |        |        |        |   |        |      |        |   |        |        |        |   |        
|Interest expense:             |                            |                     |                              |                                    |   |                       |        |                       |   |        |        |        |   |        |        |        |   |        |      |        |   |        |        |       
|                              | Deposits:                  |                     |                              |                                    |   |                       |        |                       |   |        |        |        |   |        |        |        |   |        |      |        |   |        |        |        |  
|                              |                            |                     | Demand and NOW               |                                    |   | 3                     |        |                       |   | (122   | )      |        |   | (119   | )      |        |   | 12     |      |        |   | (107   | )      |        |   | (95     | )     
|                              |                            |                     | Savings                      |                                    |   | 2,757                 |        |                       |   | (3,886 | )      |        |   | (1,129 | )      |        |   | 3,349  |      |        |   | (2,683 | )      |        |   | 666     |       
|                              |                            |                     | Time certificates of deposit |                                    |   | (2,762                | )      |                       |   | (2,837 | )      |        |   | (5,599 | )      |        |   | (3,787 | )    |        |   | (6,474 | )      |        |   | (10,261 | )     
|                              |                            |                     |                              |                                    |   |                       |        |                       |   |        |        |        |   |        |        |        |   |        |      |        |   |        |        |        |   |        
|                              |                            |                     |                              | Total interest expense             |   |                       | (2     | )                     |   |        | (6,845 | )      |   |        | (6,847 | )      |   |        | (426 | )      |   |        | (9,264 | )      |   |         | (9,690 | )
|                              |                            |                     |                              |                                    |   |                       |        |                       |   |        |        |        |   |        |        |        |   |        |      |        |   |        |        |        |   |        
|Net interest income           |                            | $                   | (5,363                       | )                                  |   | $                     | 3,244  |                       |   | $      | (2,119 | )      |   | $      | 836    |        |   | $      | 840  |        |   | $      | 1,676  |       
|                              |                            |                     |                              |                                    |   |                       |        |                       |   |        |        |        |   |        |        |        |   |        |      |        |   |        |        |        |   |        

IMPACT OF INFLATION AND CHANGING PRICES

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

RECENT ACCOUNTING PRONOUNCEMENTS

ACCOUNTING FOR STOCK-BASED
COMPENSATION  TRANSITION AND DISCLOSURE

In December 2002, SPAS No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure, was issued and provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, the statement amends the
disclosure requirements of SPAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. The statement was effective for massbank Corp. beginning
with the fiscal period ended December 31, 2002. Because the Company has
continued its accounting for stock-based compensation using the
intrinsic-value based method of accounting, the adoption of SPAS No. 148 did
not have a material impact on the companys results of operation or financial
position.

EMPLOYERS DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS

In December 2003, the Financial Accounting Standards Board (EASE) issued
SPAS No. 132 (revised), Employers Disclosures about Pensions and Other
Postretirement Benefits an amendment of FASB Statements 87, 88 and 106. This
Statement revises employers disclosures about pension plans and other
postretirement benefit plans. It does not change the measurement or
recognition of those plans required by FASB Statements 87, 88 and 106. This
Statement retains the disclosure requirements contained in FASB 132,
Employers Disclosures about Pensions and Other Postretirement Benefits, which
it replaces. It requires additional disclosures to those in the original
Statement 132 about the type of plan assets, investment strategy, measurement
date, plan obligations, and cash flows as well as the components of the net
periodic benefit cost recognized in interim periods. Interim reports issued by
public companies must now include these new or expanded disclosures about
their postretirement benefit plans. This Statement is effective for fiscal
years ending after December 15, 2003. The adoption of SFAS 132 (revised) did
not have a material impact on the Companys financial condition or results of
operations.





---



##### 



INDEPENDENT AUDITORS REPORT

(KPMG LOGO)

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, 2003 and 2002, and the related consolidated
statements of income, cash flows, and changes in stockholders equity for each
of the years in the three-year period ended December 31, 2003. These
consolidated financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Massbank
Corp. and subsidiaries as of December 31, 2003 and 2002, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America.

|                      |  |             
|--------------------- |  | ------------
|Boston, Massachusetts |  | -s- KPMG LLP
|January 15, 2004      |  |             





---



##### 



MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |         |           | 
|----------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ------- | --------- | - | ------- | ------- | --------- | 
|(IN THOUSANDS EXCEPT SHARE DATA) AT DECEMBER 31,                                                                  |                                                                                                                            | 2003                                       |         | 2002   
|                                                                                                                  |                                                                                                                            |                                            |         |        
|Assets:                                                                                                           |                                                                                                                            |                                            |         |         |           |   |         |        
|Cash and due from banks                                                                                           |                                                                                                                            | $                                          | 8,378   |         |           | $ | 8,356   |        
|Short-term investments (Note 2)                                                                                   |                                                                                                                            |                                            | 214,532 |         |           |   | 248,750 |        
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  |                                                                                                                            | Total cash and cash equivalents            |         |         | 222,910   |   |         |         | 257,106   | 
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|Interest-bearing deposits in banks                                                                                |                                                                                                                            |                                            | 5,685   |         |           |   | 4,854   |        
|Securities available for sale, at market value
(amortized cost of $422,875 in 2003 and $367,650 in 2002) (Note 3) |                                                                                                                            |                                            | 429,229 |         |           |   | 380,022 |        
|Trading securities, at market value (Note 4)                                                                      |                                                                                                                            |                                            | 72,633  |         |           |   | 36,249  |        
|Loans (Notes 5, 7 and 11):                                                                                        |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  | Mortgage loans                                                                                                             |                                            |         | 241,886 |           |   |         | 302,788 |          
|                                                                                                                  | Other loans                                                                                                                |                                            |         | 11,120  |           |   |         | 16,011  |          
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  |                                                                                                                            | Total loans                                |         |         | 253,006   |   |         |         | 318,799   | 
|                                                                                                                  | Allowance for loan losses (Note 6)                                                                                         |                                            |         | (1,554  | )         |   |         | (2,271  | )        
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  |                                                                                                                            | Net loans                                  |         |         | 251,452   |   |         |         | 316,528   | 
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|Premises and equipment (Note 9)                                                                                   |                                                                                                                            |                                            | 6,943   |         |           |   | 6,795   |        
|Accrued interest receivable                                                                                       |                                                                                                                            |                                            | 3,854   |         |           |   | 3,926   |        
|Goodwill (Note 1)                                                                                                 |                                                                                                                            |                                            | 1,090   |         |           |   | 1,090   |        
|Income tax receivable, net                                                                                        |                                                                                                                            |                                            | 325     |         |           |   | 199     |        
|Other assets                                                                                                      |                                                                                                                            |                                            | 16,128  |         |           |   | 2,598   |        
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  |                                                                                                                            | Total assets                               |         | $       | 1,010,249 |   |         | $       | 1,009,367 | 
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|Liabilities and Stockholders Equity:                                                                             |                                                                                                                            |                                            |         |         |           |   |         |        
|Deposits (Notes 10 and 11):                                                                                       |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  | Demand and NOW                                                                                                             |                                            | $       | 84,572  |           |   | $       | 85,327  |          
|                                                                                                                  | Savings                                                                                                                    |                                            |         | 607,831 |           |   |         | 548,947 |          
|                                                                                                                  | Time certificates of deposit                                                                                               |                                            |         | 189,621 |           |   |         | 249,654 |          
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  |                                                                                                                            | Total deposits                             |         |         | 882,024   |   |         |         | 883,928   | 
|Escrow deposits of borrowers                                                                                      |                                                                                                                            |                                            | 1,139   |         |           |   | 1,387   |        
|Deferred income taxes (Note 12)                                                                                   |                                                                                                                            |                                            | 783     |         |           |   | 2,671   |        
|Allowance for loan losses on off-balance
sheet credit exposures (Note 6)                                          |                                                                                                                            |                                            | 626     |         |           |   | 384     |        
|Other liabilities                                                                                                 |                                                                                                                            |                                            | 14,750  |         |           |   | 3,712   |        
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  |                                                                                                                            | Total liabilities                          |         |         | 899,322   |   |         |         | 892,082   | 
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|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, 7,688,333 and 7,610,195 shares issued, respectively |                                            |         | 7,688   |           |   |         | 7,610   |          
|                                                                                                                  | Additional paid-in capital                                                                                                 |                                            |         | 54,417  |           |   |         | 52,820  |          
|                                                                                                                  | Retained earnings                                                                                                          |                                            |         | 99,038  |           |   |         | 95,243  |          
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  |                                                                                                                            |                                            | 161,143 |         |           |   | 155,673 |        
|                                                                                                                  | Treasury stock at cost, 3,280,880 and 3,002,129 shares, respectively                                                       |                                            |         | (54,177 | )         |   |         | (46,080 | )        
|                                                                                                                  | Accumulated other comprehensive income (Note 1)                                                                            |                                            |         | 3,961   |           |   |         | 7,692   |          
|                                                                                                                  | Shares held in rabbi trust at cost, 25,200 and 24,000 shares,
respectively (Note 15)                                       |                                            |         | (515    | )         |   |         | (477    | )        
|                                                                                                                  | Deferred compensation obligation                                                                                           |                                            |         | 515     |           |   |         | 477     |          
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  |                                                                                                                            | Total stockholders equity                 |         |         | 110,927   |   |         |         | 117,285   | 
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        
|                                                                                                                  |                                                                                                                            | Total liabilities and stockholders equity |         | $       | 1,010,249 |   |         | $       | 1,009,367 | 
|                                                                                                                  |                                                                                                                            |                                            |         |         |           |   |         |        

See accompanying notes to consolidated financial statements.





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##### 



MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |        |        | 
|--------------------------------------------------------- | ------------------------------------------- | ---------------------------- | --------------------------------------------------- | --------- | ------ | ------ | ----- | --------- | ------ | ------ | ----- | --------- | ------ | ------ | 
|(IN THOUSANDS EXCEPT SHARE DATA) YEARS ENDED DECEMBER 31, |                                             | 2003                         |                                                     | 2002      |        | 2001  
|                                                          |                                             |                              |                                                     |           |        |       
|Interest and dividend income:                             |                                             |                              |                                                     |           |        |        |       |           |        |        |       |          
|                                                          | Mortgage loans                              |                              | $                                                   | 17,682    |        |        | $     | 20,819    |        |        | $     | 19,631    |       
|                                                          | Other loans                                 |                              |                                                     | 834       |        |        |       | 1,362     |        |        |       | 2,315     |       
|                                                          | Securities available for sale:              |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|                                                          |                                             | Mortgage-backed securities   |                                                     |           | 8,250  |        |       |           | 14,863 |        |       |           | 18,847 |       
|                                                          |                                             | Other securities             |                                                     |           | 7,557  |        |       |           | 5,729  |        |       |           | 5,502  |       
|                                                          | Trading securities                          |                              |                                                     | 1,113     |        |        |       | 685       |        |        |       | 158       |       
|                                                          | Federal funds sold                          |                              |                                                     | 2,266     |        |        |       | 2,974     |        |        |       | 7,444     |       
|                                                          | Other investments                           |                              |                                                     | 435       |        |        |       | 671       |        |        |       | 1,220     |       
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|                                                          |                                             |                              | Total interest and dividend income                  |           |        | 38,137 |       |           |        | 47,103 |       |           |        | 55,117 | 
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|Interest expense:                                         |                                             |                              |                                                     |           |        |        |       |           |        |        |       |          
|                                                          | Deposits:                                   |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|                                                          |                                             | NOW                          |                                                     |           | 247    |        |       |           | 366    |        |       |           | 461    |       
|                                                          |                                             | Savings                      |                                                     |           | 11,032 |        |       |           | 12,161 |        |       |           | 11,495 |       
|                                                          |                                             | Time certificates of deposit |                                                     |           | 4,575  |        |       |           | 10,174 |        |       |           | 20,435 |       
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|                                                          |                                             |                              | Total interest expense                              |           |        | 15,854 |       |           |        | 22,701 |       |           |        | 32,391 | 
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|                                                          |                                             |                              | Net interest income                                 |           |        | 22,283 |       |           |        | 24,402 |       |           |        | 22,726 | 
|Provision for loan losses(Note 6)                         |                                             |                              | (502                                                | )         |        |        |      |           |        |        | 40    |          
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|                                                          |                                             |                              | Net interest income after provision for loan losses |           |        | 22,785 |       |           |        | 24,402 |       |           |        | 22,686 | 
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|Non-interest income:                                      |                                             |                              |                                                     |           |        |        |       |           |        |        |       |          
|                                                          | Deposit account service fees                |                              |                                                     | 494       |        |        |       | 567       |        |        |       | 638       |       
|                                                          | Gains on securities available for sale, net |                              |                                                     | 558       |        |        |       | 1,566     |        |        |       | 4,263     |       
|                                                          | Gains on trading securities, net            |                              |                                                     | 81        |        |        |       | 152       |        |        |       | 100       |       
|                                                          | Other                                       |                              |                                                     | 789       |        |        |       | 638       |        |        |       | 812       |       
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|                                                          |                                             |                              | Total non-interest income                           |           |        | 1,922  |       |           |        | 2,923  |       |           |        | 5,813  | 
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|Non-interest expense:                                     |                                             |                              |                                                     |           |        |        |       |           |        |        |       |          
|                                                          | Salaries and employee benefits              |                              |                                                     | 7,692     |        |        |       | 7,298     |        |        |       | 6,723     |       
|                                                          | Occupancy and equipment                     |                              |                                                     | 2,248     |        |        |       | 1,998     |        |        |       | 2,056     |       
|                                                          | Data processing                             |                              |                                                     | 528       |        |        |       | 528       |        |        |       | 494       |       
|                                                          | Professional services                       |                              |                                                     | 394       |        |        |       | 526       |        |        |       | 426       |       
|                                                          | Advertising and marketing                   |                              |                                                     | 154       |        |        |       | 168       |        |        |       | 192       |       
|                                                          | Amortization of intangibles                 |                              |                                                     |          |        |        |       | 29        |        |        |       | 327       |       
|                                                          | Deposit insurance                           |                              |                                                     | 177       |        |        |       | 182       |        |        |       | 173       |       
|                                                          | Other                                       |                              |                                                     | 1,422     |        |        |       | 1,308     |        |        |       | 1,330     |       
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|                                                          |                                             |                              | Total non-interest expense                          |           |        | 12,615 |       |           |        | 12,037 |       |           |        | 11,721 | 
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|                                                          |                                             |                              | Income before income taxes                          |           |        | 12,092 |       |           |        | 15,288 |       |           |        | 16,778 | 
|Income tax expense(Note 12)                               |                                             |                              | 4,229                                               |           |        |        | 5,474 |           |        |        | 6,019 |          
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|                                                          |                                             |                              | Net income                                          |           | $      | 7,863  |       |           | $      | 9,814  |       |           | $      | 10,759 | 
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       
|Weighted average common shares outstanding:               |                                             |                              |                                                     |           |        |        |       |           |        |        |       |          
|                                                          | Basic                                       |                              |                                                     | 4,439,394 |        |        |       | 4,697,826 |        |        |       | 4,685,873 |       
|                                                          | Diluted                                     |                              |                                                     | 4,544,594 |        |        |       | 4,822,501 |        |        |       | 4,809,665 |       
|Earnings per share(in dollars):                           |                                             |                              |                                                     |           |        |        |       |           |        |        |       |          
|                                                          | Basic                                       |                              | $                                                   | 1.77      |        |        | $     | 2.09      |        |        | $     | 2.30      |       
|                                                          | Diluted                                     |                              |                                                     | 1.73      |        |        |       | 2.04      |        |        |       | 2.24      |       
|                                                          |                                             |                              |                                                     |           |        |        |       |           |        |        |       |           |       

See accompanying notes to consolidated financial statements.





---



##### 



MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

|                                        |            |                                                                                                          |                                                                                  |                                                     |          |         |         |       |          |         |         |        |          |        |        | 
|--------------------------------------- | ---------- | -------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------- | --------------------------------------------------- | -------- | ------- | ------- | ----- | -------- | ------- | ------- | ------ | -------- | ------ | ------ | 
|(IN THOUSANDS) YEARS ENDED DECEMBER 31, |            | 2003                                                                                                     |                                                                                  | 2002                                                |          | 2001   
|                                        |            |                                                                                                          |                                                                                  |                                                     |          |        
|Cash flows from operating activities:   |            |                                                                                                          |                                                                                  |                                                     |          |         |         |       |          |         |         |       
|                                        | Net income |                                                                                                          | $                                                                                | 7,863                                               |          |         | $       | 9,814 |          |         | $       | 10,759 |         
|                                        |            | Adjustments to reconcile net income to net cash (used in) provided
by operating activities:              |                                                                                  |                                                     |          |         |         |       |          |         |         |        |          |       
|                                        |            |                                                                                                          | Depreciation and amortization                                                    |                                                     |          | 721     |         |       |          | 658     |         |        |          | 892    |       
|                                        |            |                                                                                                          | Loan interest capitalized                                                        |                                                     |          | (12     | )       |       |          | (33     | )       |        |          | (37    | )     
|                                        |            |                                                                                                          | Tax benefit resulting from stock options exercised                               |                                                     |          | 511     |         |       |          | 599     |         |        |          | 238    |       
|                                        |            |                                                                                                          | Amortization of ESOP shares committed to be released                             |                                                     |          |        |         |       |          | 202     |         |        |          | 151    |       
|                                        |            |                                                                                                          | Tax benefit resulting from dividends paid on unallocated shares
held by the ESOP |                                                     |          |        |         |       |          | 4       |         |        |          | 7      |       
|                                        |            |                                                                                                          | Decrease in accrued interest receivable                                          |                                                     |          | 72      |         |       |          | 24      |         |        |          | 1,805  |       
|                                        |            |                                                                                                          | Increase in other liabilities                                                    |                                                     |          | 11,038  |         |       |          | 966     |         |        |          | 29     |       
|                                        |            |                                                                                                          | (Increase) decrease in income tax receivable, net                                |                                                     |          | (126    | )       |       |          | 9       |         |        |          | 76     |       
|                                        |            |                                                                                                          | Amortization of premiums (accretion of discounts)
on securities, net             |                                                     |          | 613     |         |       |          | 450     |         |        |          | (643   | )     
|                                        |            |                                                                                                          | Net trading securities activity                                                  |                                                     |          | (36,303 | )       |       |          | (33,008 | )       |        |          | 17,389 |       
|                                        |            |                                                                                                          | Gains on securities available for sale, net                                      |                                                     |          | (567    | )       |       |          | (1,633  | )       |        |          | (4,263 | )     
|                                        |            |                                                                                                          | Valuation writedowns of equity securities available for sale                     |                                                     |          | 9       |         |       |          | 67      |         |        |          |       |       
|                                        |            |                                                                                                          | Gains on trading securities, net                                                 |                                                     |          | (81     | )       |       |          | (152    | )       |        |          | (100   | )     
|                                        |            |                                                                                                          | Decrease in deferred mortgage loan origination fees,
net of amortization         |                                                     |          | (562    | )       |       |          | (344    | )       |        |          | (44    | )     
|                                        |            |                                                                                                          | Deferred income tax expense (benefit)                                            |                                                     |          | 236     |         |       |          | (219    | )       |        |          | (195   | )     
|                                        |            |                                                                                                          | (Increase) decrease in other assets                                              |                                                     |          | (12,443 | )       |       |          | (42     | )       |        |          | 1,035  |       
|                                        |            |                                                                                                          | Provision for loan losses                                                        |                                                     |          | (502    | )       |       |          |        |         |        |          | 40     |       
|                                        |            |                                                                                                          | Provision for loan losses on off-balance
sheet credit exposures                  |                                                     |          | 16      |         |       |          |        |         |        |          |       |       
|                                        |            |                                                                                                          | Transfer from allowance for loan losses                                          |                                                     |          | (226    | )       |       |          | (235    | )       |        |          | (149   | )     
|                                        |            |                                                                                                          | Transfer to allowance for loan losses on
off-balance sheet credit exposures      |                                                     |          | 226     |         |       |          | 235     |         |        |          | 149    |       
|                                        |            |                                                                                                          | Gains on sales of premises and equipment                                         |                                                     |          |        |         |       |          |        |         |        |          | (4     | )     
|                                        |            |                                                                                                          | (Decrease) increase in escrow deposits of borrowers                              |                                                     |          | (248    | )       |       |          | (16     | )       |        |          | 16     |       
|                                        |            |                                                                                                          |                                                                                  |                                                     |          |         |         |       |          |         |         |        |         
|                                        |            |                                                                                                          |                                                                                  | Net cash (used in) provided by operating activities |          |         | (29,765 | )     |          |         | (22,654 | )      |          |        | 27,151 | 
|                                        |            |                                                                                                          |                                                                                  |                                                     |          |         |         |       |          |         |         |        |         
|Cash flows from investing activities:   |            |                                                                                                          |                                                                                  |                                                     |          |         |         |       |          |         |         |       
|                                        |            | Purchases of term federal funds                                                                          |                                                                                  |                                                     | (15,000  | )       |         |       |         |         |         |        | (10,000  | )     
|                                        |            | Proceeds from maturities of term federal funds                                                           |                                                                                  |                                                     | 15,000   |         |         |       |         |         |         |        | 40,000   |       
|                                        |            | Net (increase) decrease in interest-bearing bank deposits                                                |                                                                                  |                                                     | (831     | )       |         |       | 587      |         |         |        | (3,766   | )     
|                                        |            | Proceeds from sales of investment securities available for sale                                          |                                                                                  |                                                     | 36,810   |         |         |       | 50,158   |         |         |        | 32,819   |       
|                                        |            | Proceeds from maturities and redemption of investment securities
held to maturity and available for sale |                                                                                  |                                                     | 175,000  |         |         |       | 76,500   |         |         |        | 87,230   |       
|                                        |            | Purchases of investment securities available for sale                                                    |                                                                                  |                                                     | (355,995 | )       |         |       | (209,923 | )       |         |        | (72,548  | )     
|                                        |            | Purchases of mortgage-backed securities                                                                  |                                                                                  |                                                     | (9,937   | )       |         |       | (19,977  | )       |         |        | (54,143  | )     
|                                        |            | Principal repayments of mortgage-backed securities                                                       |                                                                                  |                                                     | 97,916   |         |         |       | 99,266   |         |         |        | 81,231   |       
|                                        |            | Principal repayments of securities available for sale                                                    |                                                                                  |                                                     | 2        |         |         |       | 90       |         |         |        | 4        |       
|                                        |            | Loans originated                                                                                         |                                                                                  |                                                     | (82,598  | )       |         |       | (104,631 | )       |         |        | (103,246 | )     
|                                        |            | Loan principal payments received                                                                         |                                                                                  |                                                     | 148,966  |         |         |       | 117,207  |         |         |        | 82,412   |       
|                                        |            | Purchases of premises and equipment                                                                      |                                                                                  |                                                     | (859     | )       |         |       | (465     | )       |         |        | (3,507   | )     
|                                        |            | Proceeds from sale of premises and equipment                                                             |                                                                                  |                                                     |         |         |         |       |         |         |         |        | 4        |       
|                                        |            |                                                                                                          |                                                                                  |                                                     |          |         |         |       |          |         |         |        |         
|                                        |            |                                                                                                          | Net cash provided by investing activities                                        |                                                     |          | 8,474   |         |       |          | 8,812   |         |        |          | 76,490 |       
|                                        |            |                                                                                                          |                                                                                  |                                                     |          |         |         |       |          |         |         |        |         

(Continued)





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##### 



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

|                                               |                                                          |                                                      |         |        |         |      |         |        |        |   |         |        |         | 
|---------------------------------------------- | -------------------------------------------------------- | ---------------------------------------------------- | ------- | ------ | ------- | ---- | ------- | ------ | ------ | - | ------- | ------ | ------- | 
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,        |                                                          | 2003                                                 |         | 2002   |         | 2001
|                                               |                                                          |                                                      |         |        |         |     
|Cash
flows from financing activities:          |                                                          |                                                      |         |        |         |      |         |        |        |   |         |       
|                                               | Net (decrease) increase in deposits                      |                                                      |         | (1,904 | )       |      |         | 34,215 |        |   |         | 25,832 |        
|                                               | Payments to acquire treasury stock                       |                                                      |         | (8,097 | )       |      |         | (7,230 | )      |   |         | (1,989 | )      
|                                               | Purchase of company stock for deferred compensation plan |                                                      |         | (38    | )       |      |         | (55    | )      |   |         | (56    | )      
|                                               | Increase in deferred compensation obligation             |                                                      |         | 38     |         |      |         | 55     |        |   |         | 56     |        
|                                               | Issuance of common stock under stock option plan         |                                                      |         | 1,164  |         |      |         | 1,726  |        |   |         | 803    |        
|                                               | Cash dividends paid on common stock                      |                                                      |         | (4,068 | )       |      |         | (4,139 | )      |   |         | (3,935 | )      
|                                               |                                                          |                                                      |         |        |         |      |         |        |        |   |         |        |        
|                                               |                                                          | Net cash (used in) provided by financing activities  |         |        | (12,905 | )    |         |        | 24,572 |   |         |        | 20,711  | 
|                                               |                                                          |                                                      |         |        |         |      |         |        |        |   |         |        |        
|                                               |                                                          | Net (decrease) increase in cash and cash equivalents |         |        | (34,196 | )    |         |        | 10,730 |   |         |        | 124,352 | 
|Cash and cash equivalents at beginning of year |                                                          |                                                      | 257,106 |        |         |      | 246,376 |        |        |   | 122,024 |       
|                                               |                                                          |                                                      |         |        |         |      |         |        |        |   |         |        |        
|Cash and cash equivalents at end of year       |                                                          | $                                                    | 222,910 |        |         | $    | 257,106 |        |        | $ | 246,376 |       
|                                               |                                                          |                                                      |         |        |         |      |         |        |        |   |         |        |        
|Supplemental cash flow disclosures:            |                                                          |                                                      |         |        |         |      |         |        |        |   |         |       
|Cash transactions:                             |                                                          |                                                      |         |        |         |      |         |        |        |   |         |       
|                                               | Cash paid during the year for interest                   |                                                      | $       | 15,922 |         |      | $       | 22,765 |        |   | $       | 35,484 |        
|                                               | Cash paid during the year for taxes, net of refunds      |                                                      |         | 3,608  |         |      |         | 5,080  |        |   |         | 5,898  |        
|                                               |                                                          |                                                      |         |        |         |      |         |        |        |   |         |        |        

See accompanying notes to consolidated financial statements.





---



##### 



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

(IN THOUSANDS EXCEPT SHARE DATA)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001



|                             |                                                                                  |                                                                             |       |        |   |         |        |            |   |          |        |               |        |   |         |        |   |       |       |             |        |  
|---------------------------- | -------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | ----- | ------ | - | ------- | ------ | ---------- | - | -------- | ------ | ------------- | ------ | - | ------- | ------ | - | ----- | ----- | ----------- | ------ | -
|                             |                                                                                  |                                                                             |       |        |   |         |        |            |   |          |        |               |        |   |         |        |   |       |       | Accumulated
|                             |                                                                                  |                                                                             |       |        |   |         |        | Additional |   |          |        |               |        |   |         |        |   | other
|                             |                                                                                  |                                                                             |       | Common |   | paid-in |        | Retained   |   | Treasury |        | comprehensive
|                             |                                                                                  |                                                                             |       | stock  |   | capital |        | earnings   |   | stock    |        | income       
|                             |                                                                                  |                                                                             |       |        |   |         |        |            |   |          |        |              
|Balance at December 31, 2000 |                                                                                  | $                                                                           | 7,448 |        |   | $       | 61,308 |            |   | $        | 93,165 |               |        | $ | (59,338 | )      |   | $     | 5,972 |            
|                             | Net Income                                                                       |                                                                             |       |       |   |         |        |           |   |          |        | 10,759        |        |   |         |       |   |       |       |            |       
|                             | Other comprehensive income, net of tax:                                          |                                                                             |       |        |   |         |        |            |   |          |        |               |        |   |         |        |   |       |       |             |       
|                             |                                                                                  | Unrealized gains on securities, net of
reclassification adjustment (Note 1) |       |        |  |         |        |            |  |          |        |               |       |   |         |        |  |       |       |             | 471    |  
|                             | Comprehensive income                                                             |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             | Cash dividends paid ($0.84 per share)                                            |                                                                             |       |       |   |         |        |           |   |          |        | (3,935        | )      |   |         |       |   |       |       |            |       
|                             | Tax benefit resulting from dividends paid
on unallocated shares held by the ESOP |                                                                             |       |       |   |         |        |           |   |          |        | 7             |        |   |         |       |   |       |       |            |       
|                             | Net decrease in liability to ESOP                                                |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             | Amortization of ESOP shares
committed to be released                             |                                                                             |       |       |   |         |        | 151        |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             | Purchase of treasury stock                                                       |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         | (1,989 | ) |       |       |            |       
|                             | Purchase of company stock for
deferred compensation plan                         |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             | Exercise of stock options and
related tax benefits                               |                                                                             |       | 47     |   |         |        | 994        |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             |                                                                                  |                                                                             |       |        |   |         |        |            |   |          |        |               |        |   |         |        |   |       |       |            
|Balance at December 31, 2001 |                                                                                  |                                                                             | 7,495 |        |   |         | 62,453 |            |   |          | 99,996 |               |        |   | (61,327 | )      |   |       | 6,443 |            
|                             | Net Income                                                                       |                                                                             |       |       |   |         |        |           |   |          |        | 9,814         |        |   |         |       |   |       |       |            |       
|                             | Other comprehensive income, net of tax:                                          |                                                                             |       |        |   |         |        |            |   |          |        |               |        |   |         |        |   |       |       |             |       
|                             |                                                                                  | Unrealized gains on securities, net of
reclassification adjustment (Note 1) |       |        |  |         |        |            |  |          |        |               |       |   |         |        |  |       |       |             | 1,249  |  
|                             | Comprehensive income                                                             |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             |                                                                                  | Cash dividends paid ($0.88 per share)                                       |       |        |  |         |        |            |  |          |        |               | (4,139 | ) |         |        |  |       |       |             |       |  
|                             | Tax benefit resulting from dividends paid
on unallocated shares held by the ESOP |                                                                             |       |       |   |         |        |           |   |          |        | 4             |        |   |         |       |   |       |       |            |       
|                             | Net decrease in liability to ESOP                                                |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             | Amortization of ESOP shares
committed to be released                             |                                                                             |       |       |   |         |        | 202        |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             | Purchase of treasury stock                                                       |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         | (7,230 | ) |       |       |            |       
|                             | Purchase of company stock for
deferred compensation plan                         |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             | Exercise of stock options and
related tax benefits                               |                                                                             |       | 115    |   |         |        | 2,210      |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             | Transfer resulting from
three-for-two stock split                                |                                                                             |       |       |   |         |        | (12,045    | ) |          |        | (10,432       | )      |   |         | 22,477 |   |       |       |            |       
|                             |                                                                                  |                                                                             |       |        |   |         |        |            |   |          |        |               |        |   |         |        |   |       |       |            
|Balance at December 31, 2002 |                                                                                  |                                                                             | 7,610 |        |   |         | 52,820 |            |   |          | 95,243 |               |        |   | (46,080 | )      |   |       | 7,692 |            
|                             | Net Income                                                                       |                                                                             |       |       |   |         |        |           |   |          |        | 7,863         |        |   |         |       |   |       |       |            |       
|                             | Other comprehensive income, net of tax:                                          |                                                                             |       |        |   |         |        |            |   |          |        |               |        |   |         |        |   |       |       |             |       
|                             |                                                                                  | Unrealized gains on securities, net of
reclassification adjustment (Note 1) |       |        |  |         |        |            |  |          |        |               |       |   |         |        |  |       |       |             | (3,731 | )
|                             | Comprehensive income                                                             |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             |                                                                                  | Cash dividends paid ($0.92 per share)                                       |       |        |  |         |        |            |  |          |        |               | (4,068 | ) |         |        |  |       |       |             |       |  
|                             | Purchase of treasury stock                                                       |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         | (8,097 | ) |       |       |            |       
|                             | Purchase of company stock for
deferred compensation plan                         |                                                                             |       |       |   |         |        |           |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             | Exercise of stock options and
related tax benefits                               |                                                                             |       | 78     |   |         |        | 1,597      |   |          |        |              |        |   |         |       |   |       |       |            |       
|                             |                                                                                  |                                                                             |       |        |   |         |        |            |   |          |        |               |        |   |         |        |   |       |       |            
|Balance
at December 31, 2003 |                                                                                  | $                                                                           | 7,688 |        |   | $       | 54,417 |            |   | $        | 99,038 |               |        | $ | (54,177 | )      |   | $     | 3,961 |            
|                             |                                                                                  |                                                                             |       |        |   |         |        |            |   |          |        |               |        |   |         |        |   |       |       |            

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                             |                                                                                  |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |        |        |  
|---------------------------- | -------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | ---- | ------- | - | ------------ | --- | -------- | - | ------ | ---- | --- | - | - | ------- | ------ | ------ | -
|                             |                                                                                  |                                                                             |      | Shares  |   |              |     |          |   | Common |      |     |   |  
|                             |                                                                                  |                                                                             |      | held in |   | Deferred     |     | stock    |   |        |      |    
|                             |                                                                                  |                                                                             |      | Rabbi   |   | compensation |     | acquired |   |        |      |    
|                             |                                                                                  |                                                                             |      | Trust   |   | obligation   |     | by ESOP  |   | Total 
|                             |                                                                                  |                                                                             |      |         |   |              |     |          |   |       
|Balance at December 31, 2000 |                                                                                  | $                                                                           | (366 | )       |   | $            | 366 |          |   | $      | (312 | )   |   | $ | 108,243 |       
|                             | Net Income                                                                       |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 10,759 |       
|                             | Other comprehensive income, net of tax:                                          |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |        |       
|                             |                                                                                  | Unrealized gains on securities, net of
reclassification adjustment (Note 1) |      |         |  |              |     |          |  |        |      |     |  |   |         |        | 471    |  
|                             |                                                                                  |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |       
|                             | Comprehensive income                                                             |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 11,230 |       
|                             | Cash dividends paid ($0.84 per share)                                            |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | (3,935 | )     
|                             | Tax benefit resulting from dividends paid
on unallocated shares held by the ESOP |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 7      |       
|                             | Net decrease in liability to ESOP                                                |                                                                             |      |        |   |              |     |         |   |        |      | 156 |   |   |         | 156    |       
|                             | Amortization of ESOP shares
committed to be released                             |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 151    |       
|                             | Purchase of treasury stock                                                       |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | (1,989 | )     
|                             | Purchase of company stock for
deferred compensation plan                         |                                                                             |      | (56     | ) |              |     | 56       |   |        |      |    |   |   |         |       |       
|                             | Exercise of stock options and
related tax benefits                               |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 1,041  |       
|                             |                                                                                  |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |       
|Balance at December 31, 2001 |                                                                                  |                                                                             | (422 | )       |   |              | 422 |          |   |        | (156 | )   |   |   | 114,904 |       
|                             | Net Income                                                                       |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 9,814  |       
|                             | Other comprehensive income, net of tax:                                          |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |        |       
|                             |                                                                                  | Unrealized gains on securities, net of
reclassification adjustment (Note 1) |      |         |  |              |     |          |  |        |      |     |  |   |         |        | 1,249  |  
|                             |                                                                                  |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |       
|                             | Comprehensive income                                                             |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 11,063 |       
|                             |                                                                                  | Cash dividends paid ($0.88 per share)                                       |      |         |  |              |     |          |  |        |      |     |  |   |         |        | (4,139 | )
|                             | Tax benefit resulting from dividends paid
on unallocated shares held by the ESOP |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 4      |       
|                             | Net decrease in liability to ESOP                                                |                                                                             |      |        |   |              |     |         |   |        |      | 156 |   |   |         | 156    |       
|                             | Amortization of ESOP shares
committed to be released                             |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 202    |       
|                             | Purchase of treasury stock                                                       |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | (7,230 | )     
|                             | Purchase of company stock for
deferred compensation plan                         |                                                                             |      | (55     | ) |              |     | 55       |   |        |      |    |   |   |         |       |       
|                             | Exercise of stock options and
related tax benefits                               |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 2,325  |       
|                             | Transfer resulting from
three-for-two stock split                                |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         |       |       
|                             |                                                                                  |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |       
|Balance at December 31, 2002 |                                                                                  |                                                                             | (477 | )       |   |              | 477 |          |   |        |     |     |   |   | 117,285 |       
|                             | Net Income                                                                       |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 7,863  |       
|                             | Other comprehensive income, net of tax:                                          |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |        |       
|                             |                                                                                  | Unrealized gains on securities, net of
reclassification adjustment (Note 1) |      |         |  |              |     |          |  |        |      |     |  |   |         |        | (3,731 | )
|                             |                                                                                  |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |       
|                             | Comprehensive income                                                             |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 4,132  |       
|                             |                                                                                  | Cash dividends paid ($0.92 per share)                                       |      |         |  |              |     |          |  |        |      |     |  |   |         |        | (4,068 | )
|                             | Purchase of treasury stock                                                       |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | (8,097 | )     
|                             | Purchase of company stock for
deferred compensation plan                         |                                                                             |      | (38     | ) |              |     | 38       |   |        |      |    |   |   |         |       |       
|                             | Exercise of stock options and
related tax benefits                               |                                                                             |      |        |   |              |     |         |   |        |      |    |   |   |         | 1,675  |       
|                             |                                                                                  |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |       
|Balance at December 31, 2003 |                                                                                  | $                                                                           | (515 | )       |   | $            | 515 |          |   | $      |     |     |   | $ | 110,927 |       
|                             |                                                                                  |                                                                             |      |         |   |              |     |          |   |        |      |     |   |   |         |       

See accompanying notes to consolidated financial statements.





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##### 





|MASSBANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
|-----------------------------------------------------------------------------------------------------------------------



|1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|MASSBANK Corp. (the Company) is a Delaware chartered holding company whose
principal subsidiary is MASSBANK (the Bank). The Bank operates fifteen full
service banking offices in Reading, Melrose, Stoneham, Wilmington, Medford,
Chelmsford, Tewksbury, Westford, Dracut, Lowell and Everett, Massachusetts
providing a variety of deposit, lending and trust services. As a
Massachusetts chartered savings bank whose deposits are insured by the
Federal Deposit Insurance Corporation (FDIC) and the 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 Company has one reportable operating segment. All significant
intercompany balances and transactions have been eliminated in consolidation.
The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America and to general
practices within the banking industry. In preparing the consolidated
financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
balance sheet date and income and expenses for the period. Material estimates
that are particularly susceptible to change in the near term relate to the
determination of the allowance for loan losses, the allowance for loan losses
on off-balance sheet credit exposures and other than temporary declines in
value of investment securities requiring impairment write downs due to
general market conditions or other factors.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Certain amounts in the prior years consolidated financial statements
were reclassified to facilitate comparison with the current fiscal year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|INVESTMENTS IN DEBT AND EQUITY SECURITIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Under its investment policy, management determines the appropriate
classification of securities at the time of purchase. Those debt securities
that the Company has the intent and the ability to hold to maturity are
classified as securities held to maturity and are carried at amortized
historical cost. There were no securities held to maturity in either 2003 or
2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Those securities held for indefinite periods of time and not intended to
be held to maturity are classified as available for sale. Securities held for
indefinite periods of time include securities that management intends to use
as part of its asset/liability management strategy and that may be sold in
response to changes in market conditions, interest rates, prepayment risk,
the need to increase regulatory capital and other factors. The Company
records investment securities available for sale at aggregate market value
with the net unrealized holding gains or losses reported, net of tax effect,
as a separate component of stockholders equity until realized. As of
December 31, 2003, stockholders equity included approximately $4.0 million,
representing the net unrealized gains on securities available for sale, less
applicable income taxes.                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Securities that are bought and held principally for the purpose of sale
in the near term are classified as trading securities.Trading generally
reflects active and frequent buying and selling, and trading securities are
generally used with the objective of generating profits on short-term
differences in price caused by market volatility. Investments classified as
trading securities are stated at market value with unrealized gains and losses
included in earnings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Income on debt securities is accrued and included in interest and
dividend income. The specific identification method is used to determine
realized gains or losses on sales of securities available for sale which are
also reported in non-interest income under the caption gains on securities
available for sale, net. When a security suffers a loss in value which is
considered other than temporary, such loss is recognized by a charge to
earnings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  





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##### 





|1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|LOANS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Loans are reported at the principal amount outstanding, net of unearned fees.
Loan origination fees and related direct incremental loan origination costs
are offset and the resulting net amount is deferred and amortized over the
life of the loan using the level-yield method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|The Bank generally does not accrue interest on loans which are 90 days
or more past due. When a loan is placed on nonaccrual status, all interest
previously accrued but not collected is reversed from income and all
amortization of deferred loan fees is discontinued. Interest received on
nonaccrual loans is either applied against principal or reported as income
according to managements judgment as to the collectibility of principal.
Interest accruals are resumed on such loans only when they are brought
current with respect to interest and principal and when, in the judgment of
management, the loans are estimated to be fully collectible as to both
principal and interest.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Impairment on loans for which it is probable that the creditor will be
unable to collect all amounts due according to the contractual terms of the
loan agreement are measured on a discounted cash flow method, or at the
loans observable market price, or at the fair value of the collateral if the
loan is collateral dependent. However, impairment must be measured based on
the fair value of the collateral if it is determined that foreclosure is
probable. Impaired loans consist of all nonaccrual commercial loans.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|ALLOWANCE FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES ON OFF-BALANCE SHEET
CREDIT EXPOSURES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|The Company maintains an allowance for probable losses that are inherent in
the Companys loan portfolio. The allowance for loan losses is increased by
provisions charged to operations based on the estimated loan loss exposure
inherent in the portfolio. Management uses a methodology to systematically
measure the amount of estimated loan loss exposure inherent in the portfolio
for purposes of establishing a sufficient allowance for loan losses. The
methodology includes three elements: an analysis of individual loans deemed to
be impaired, general loss allocations for various loan types based on loss
experience factors and an unallocated allowance which is maintained based on
managements assessment of many factors including the risk characteristics of
the portfolio, concentrations of credit, current and anticipated economic
conditions that may affect borrowers ability to pay, and trends in loan
delinquencies and charge-offs. Realized losses, net of recoveries, are charged
directly to the allowance. While management uses the information available in
establishing the allowance for loan losses, future adjustments to the
allowance may be necessary if economic conditions differ from the assumptions
used in making the evaluation. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Banks
allowance for loan losses. Such agencies may require the Bank to recognize
additions to the allowance based on judgments different from those of
management.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|The Company also maintains an allowance for probable losses on its
outstanding loan commitments. The allowance for loan losses on off-balance
sheet credit exposures (shown separately on the balance sheet) is maintained
based on expected drawdowns of committed loans and their loss experience
factors and managements assessment of various other factors including current
and anticipated economic conditions that may effect the borrowers ability to
pay, and trends in loan delinquencies and charge-offs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|PREMISES AND EQUIPMENT                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Land is carried at cost. Premises, equipment and leasehold improvements are
stated at cost, less accumulated depreciation and amortization computed
primarily by use of the straight-line method over the estimated useful lives
of the related assets or terms of the related leases.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|STOCK OPTION PLAN                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|The Company applies the intrinsic-value-based method of accounting prescribed
by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees and related interpretations including FASB
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation, an interpretation of APB Opinion No. 25, issued in March 2000,
to account for its fixed-plan stock options. Under this method, compensation
expense is recorded on the date of grant only if the current market price of
the underlying stock exceeded the exercise price. SFAS No. 123, Accounting
for Stock-Based Compensation, established accounting and disclosure
requirements using a fair-value-based method of accounting for stock-based
employee compensation plans. As allowed by SFAS No. 123, the Company has
elected to continue to apply the intrinsic-value-based method of accounting
described above, and has adopted only the disclosure requirements of
SFAS No.
123, as amended by SFAS No. 148, to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on
reported results. The following table illustrates the effect on net income if
the fair-value-based method had been applied to all outstanding awards in
each period.                                                                                                                                                                       





---



##### 



1.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)

|                                                                                                                                            |                       |           |       |           |  |           |       |      |  |   |        |      | 
|------------------------------------------------------------------------------------------------------------------------------------------- | --------------------- | --------- | ----- | --------- |  | --------- | ----- | ---- |  | - | ------ | ---- | 
|(IN THOUSANDS EXCEPT PER SHARE DATA) YEARS ENDED DECEMBER 31,                                                                               |                       | 2003      |       | 2002      |  | 2001     
|                                                                                                                                            |                       |           |       |           |  |          
|Net income, as reported                                                                                                                     |                       | $         | 7,863 |           |  | $         | 9,814 |      |  | $ | 10,759 |     
|Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects |                       |           | (74   | )         |  |           | (75   | )    |  |   | (90    | )   
|                                                                                                                                            |                       |           |       |           |  |           |       |      |  |   |        |     
|Pro forma net income                                                                                                                        |                       | $         | 7,789 |           |  | $         | 9,739 |      |  | $ | 10,669 |     
|                                                                                                                                            |                       |           |       |           |  |           |       |      |  |   |        |     
|Earnings per share:                                                                                                                         |                       |           |       |           |  |           |       |      |  |   |        |     
|                                                                                                                                            | Basic  as reported   |           | $     | 1.77      |  |           | $     | 2.09 |  |   | $      | 2.30 | 
|                                                                                                                                            | Basic  pro forma     |           |       | 1.75      |  |           |       | 2.07 |  |   |        | 2.28 | 
|                                                                                                                                            |                       |           |       |           |  |           |       |      |  |   |        |     
|                                                                                                                                            | Diluted  as reported |           | $     | 1.73      |  |           | $     | 2.04 |  |   | $      | 2.24 | 
|                                                                                                                                            | Diluted  pro forma   |           |       | 1.71      |  |           |       | 2.02 |  |   |        | 2.22 | 
|                                                                                                                                            |                       |           |       |           |  |           |       |      |  |   |        |     
|Weighted average fair value                                                                                                                 |                       | $         | 5.44  |           |  | $         | 5.76  |      |  | $ | 6.98   |     
|Expected life                                                                                                                               |                       | 7.3 years |       | 7.2 years |  | 7.4 years
|Risk-free interest rate                                                                                                                     |                       |           | 3.55  | %         |  |           | 4.62  | %    |  |   | 4.66   | %   
|Expected volatility                                                                                                                         |                       |           | 21.8  | %         |  |           | 21.3  | %    |  |   | 22.5   | %   
|Expected dividend yield                                                                                                                     |                       |           | 3.2   | %         |  |           | 3.3   | %    |  |   | 3.1    | %   
|                                                                                                                                            |                       |           |       |           |  |           |       |      |  |   |        |     



|GOODWILL IMPAIRMENT                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|The Company adopted Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangibles, effective January 1, 2002. The statement
addresses the method of identifying and measuring goodwill and other
intangible assets acquired in a business combination, eliminates further
amortization of goodwill, and requires periodic impairment evaluations of
goodwill. Impairment evaluations are required to be performed annually and
may be required more frequently if certain conditions indicating potential
impairment exists. In the event that the Company were to determine that its
goodwill were impaired, the recognition of an impairment charge could have an
adverse impact on its results of operations in the period that the impairment
occurred or on its financial position.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|EARNINGS PER COMMON SHARE                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|Basic EPS is computed by dividing net income by the weighted average number of
shares of common stock outstanding during the year reduced by the weighted
average number of unallocated shares held by the Employee Stock Ownership Plan
(ESOP). There were no unallocated shares held by the ESOP in 2003.
Diluted EPS reflects the effect on the weighted average shares outstanding of
the number of additional shares outstanding if dilutive stock options were
converted into common stock using the treasury stock method.                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|The treasury shares acquired in connection with the Companys directors
deferred compensation plan are considered outstanding in the computation of
earnings per share and book value per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|A reconciliation of the weighted average shares outstanding for the years
ended December 31, 2003, 2002 and 2001 follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

|                                        |  |      |       |      |  |      |       |  |  |  |       | 
|--------------------------------------- |  | ---- | ----- | ---- |  | ---- | ----- |  |  |  | ----- | 
|(IN THOUSANDS) YEARS ENDED DECEMBER 31, |  | 2003 |       | 2002 |  | 2001
|                                        |  |      |       |      |  |     
|Basic shares(1)                         |  |      | 4,439 |      |  |      | 4,698 |  |  |  | 4,686 | 
|Dilutive impact of stock options(1)     |  |      | 106   |      |  |      | 125   |  |  |  | 124   | 
|                                        |  |      |       |      |  |      |       |  |  |  |       | 
|Diluted shares(1)                       |  |      | 4,545 |      |  |      | 4,823 |  |  |  | 4,810 | 
|                                        |  |      |       |      |  |      |       |  |  |  |       | 



|(1)All share information presented has been adjusted to reflect the 3-for-2
split of the Companys common stock effective April 19, 2002.
|-----------------------------------------------------------------------------------------------------------------------------------------





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##### 





|1.                                                                                                                                                                                                                                                                                                                                                                                                                                  |  | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                   
|COMPREHENSIVE INCOME                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from non-owner sources. It includes all changes in
equity during a period except those resulting from investments by and
distributions to shareholders. The term comprehensive income
describes the total of all components of comprehensive income including
net income.
|                                                                                                                                                                                                                                                                                                                                                                                                                                   
|The Companys other comprehensive income and related tax effect
for the years ended December 31, 2003 and 2002 is as follows:                                                                                                                                                                                                                                                                                                      

|                                         |                                                                    |      |             |        |            |  |        |       |            |  |            |        |        |  |     |       |      |  |   |        |   |  |   |       | 
|---------------------------------------- | ------------------------------------------------------------------ | ---- | ----------- | ------ | ---------- |  | ------ | ----- | ---------- |  | ---------- | ------ | ------ |  | --- | ----- | ---- |  | - | ------ | - |  | - | ----- | 
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,  |                                                                    | 2003 |             | 2002  
|                                         |                                                                    |      |             |       
|                                         |                                                                    |      |             |        |            |  | Tax    |       | Net-       |  |            |        |        |  | Tax |       | Net-
|                                         |                                                                    |      | Before -Tax |        | (Expense)  |  | of-Tax |       | Before-Tax |  | (Expense)  |        | of-Tax
|                                         |                                                                    |      | Amount      |        | or Benefit |  | Amount |       | Amount     |  | or Benefit |        | Amount
|                                         |                                                                    |      |             |        |            |  |        |       |            |  |            |        |       
|Unrealized gains (losses) on securities: |                                                                    |      |             |        |            |  |        |       |            |  |            |        |        |  |     |       |      |  |   |        |   |  |   |      
|                                         | Unrealized holding gains (losses)
arising during period            |      | $           | (5,298 | )          |  | $      | 1,892 |            |  | $          | (3,406 | )      |  | $   | 3,429 |      |  | $ | (1,266 | ) |  | $ | 2,163 | 
|                                         | Less: reclassification adjustment for
gains realized in net income |      |             | 558    |            |  |        | (233  | )          |  |            | 325    |        |  |     | 1,566 |      |  |   | (652   | ) |  |   | 914   | 
|                                         |                                                                    |      |             |        |            |  |        |       |            |  |            |        |        |  |     |       |      |  |   |        |   |  |   |       | 
|                                         | Net unrealized gains (losses)                                      |      |             | (5,856 | )          |  |        | 2,125 |            |  |            | (3,731 | )      |  |     | 1,863 |      |  |   | (614   | ) |  |   | 1,249 | 
|                                         |                                                                    |      |             |        |            |  |        |       |            |  |            |        |        |  |     |       |      |  |   |        |   |  |   |       | 
|                                         | Other comprehensive income (loss)                                  |      | $           | (5,856 | )          |  | $      | 2,125 |            |  | $          | (3,731 | )      |  | $   | 1,863 |      |  | $ | (614   | ) |  | $ | 1,249 | 
|                                         |                                                                    |      |             |        |            |  |        |       |            |  |            |        |        |  |     |       |      |  |   |        |   |  |   |       | 



|CASH AND CASH EQUIVALENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|For purposes of reporting cash flows, cash and cash equivalents consist of
cash and due from banks, and short-term investments with original maturities
of less than 90 days.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|As a regulated financial institution, the Bank is required to maintain
certain reserve requirements of vault cash and/or deposits with the Federal
Reserve Bank of Boston. The amount of this reserve requirement, included in
Cash and Due from Banks, was $5.6 million at December 31, 2003 and 2002,
respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|INCOME TAXES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|The Bank recognizes income taxes under the asset and liability method. Under
this method, deferred tax assets and liabilities are established for the
temporary differences between the accounting basis and the tax basis of the
Banks assets and liabilities at enacted tax rates expected to be in effect
when the amounts related to such temporary differences are realized or
settled. The Banks deferred tax asset is reviewed and adjustments to such
asset are recognized as deferred income tax expense or benefit based upon
managements judgment relating to the realizability of such asset. Based on
the Banks historical and current pretax earnings, management believes it is
more likely than not that the Bank will realize its existing gross deferred
tax asset.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

|                                            |  |      |         |      |  |   |         | 
|------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|(IN THOUSANDS) AT DECEMBER 31,              |  | 2003 |         | 2002
|                                            |  |      |         |     
|Federal funds sold                          |  | $    | 190,684 |      |  | $ | 221,586 | 
|Money market investment fund                |  |      | 23,337  |      |  |   | 27,077  | 
|Interest-bearing bank money market accounts |  |      | 511     |      |  |   | 87      | 
|                                            |  |      |         |      |  |   |         | 
|Total short-term investments                |  | $    | 214,532 |      |  | $ | 248,750 | 
|                                            |  |      |         |      |  |   |         | 



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





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##### 





|3.                                                                    |  | INVESTMENT SECURITIES
|--------------------------------------------------------------------- |  | ---------------------
|                                                                     
|The amortized cost and market value of investment securities follows:

|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |         | 
|----------------------------------- | ----------------------------------------------------- | ---------------- | ---------------------------------- | ---------------------------------------- | - | --------- | ------- | ---------- | - | ---------- | ----- | ------ | - | ------ | ------ | ------ | - | ------- | ------- | 
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   | Gross      |       | Gross  |   |        |        |       
|                                    |                                                       |                  |                                    |                                          |   | Amortized |         | Unrealized |   | Unrealized |       | Market
|(IN
THOUSANDS) AT DECEMBER 31, 2003 |                                                       | Cost             |                                    | Gains                                    |   | Losses    |         | Value     
|                                    |                                                       |                  |                                    |                                          |   |           |         |           
|Securities available for sale:      |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |       
|                                    |                                                       | Debt securities: |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |        
|                                    |                                                       |                  | U.S. Treasury obligations          |                                          | $ | 122,902   |         |            | $ | 900        |       |        | $ | (160   | )      |        | $ | 123,642 |        
|                                    |                                                       |                  | U.S. Government agency obligations |                                          |   | 199,057   |         |            |   | 531        |       |        |   | (1,125 | )      |        |   | 198,463 |        
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        
|                                    |                                                       |                  |                                    | Total                                    |   |           | 321,959 |            |   |            | 1,431 |        |   |        | (1,285 | )      |   |         | 322,105 | 
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        
|                                    |                                                       |                  | Mortgage-backed securities:        |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        
|                                    |                                                       |                  |                                    | Government National Mortgage Association |   |           | 9,002   |            |   |            | 617   |        |   |        |       |        |   |         | 9,619   | 
|                                    |                                                       |                  |                                    | Federal Home Loan Mortgage Corporation   |   |           | 80,957  |            |   |            | 4,669 |        |   |        |       |        |   |         | 85,626  | 
|                                    |                                                       |                  |                                    | Federal National Mortgage Association    |   |           | 198     |            |   |            | 8     |        |   |        |       |        |   |         | 206     | 
|                                    |                                                       |                  |                                    | Collateralized mortgage obligations      |   |           | 204     |            |   |            | 3     |        |   |        |       |        |   |         | 207     | 
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        
|                                    |                                                       |                  |                                    | Total mortgage-backed securities         |   |           | 90,361  |            |   |            | 5,297 |        |   |        |       |        |   |         | 95,658  | 
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        
|                                    |                                                       |                  |                                    | Total debt securities                    |   |           | 412,320 |            |   |            | 6,728 |        |   |        | (1,285 | )      |   |         | 417,763 | 
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        
|                                    | Equity securities                                     |                  |                                    | 10,555                                   |   |           |         | 1,177      |   |            |       | (266   | ) |        |        | 11,466 |  
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        
|                                    |                                                       |                  |                                    | Total securities available for sale      |   |           | 422,875 |            |   | $          | 7,905 |        |   | $      | (1,551 | )      |   | $       | 429,229 | 
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        
|                                    | Net unrealized gains on securities
available for sale |                  |                                    | 6,354                                    |   |           |         |            |   |            |       |        |   |        |        |        |  
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        
|                                    |                                                       |                  |                                    | Total securities available for sale, net |   |           | 429,229 |            |   |            |       |        |   |        |        |        |   |         |         | 
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        
|                                    |                                                       |                  |                                    | Total investment securities, net         |   | $         | 429,229 |            |   |            |       |        |   |        |        |        |   |         |         | 
|                                    |                                                       |                  |                                    |                                          |   |           |         |            |   |            |       |        |   |        |        |        |   |         |        



| |  | The amortized cost and market value of investment securities follows:
| |  | ---------------------------------------------------------------------

|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |         | 
|----------------------------------- | ---------------- | ----------------------------------------------------- | ---------------------------------------- | ----- | ------- | ------- |  | ----- | ---------- | ------ | ---------- | - | ------ | ------ | - | - | ------- | ------- | 
|                                    |                  |                                                       |                                          |       |         |         |  |       | Gross      |        | Gross      |   |        |        |  
|                                    |                  |                                                       |                                          |       |         |         |  |       | Unrealized |        | Unrealized |   | Market
|(IN
THOUSANDS) AT DECEMBER 31, 2002 |                  | Amortized Cost                                        |                                          | Gains |         | Losses  |  | Value
|                                    |                  |                                                       |                                          |       |         |         |  |      
|Securities available for sale:      |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |  
|                                    | Debt securities: |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |        
|                                    |                  | U.S. Treasury obligations                             |                                          | $     | 101,017 |         |  | $     | 2,229      |        |            | $ |       |        |   | $ | 103,246 |        
|                                    |                  | U.S. Government agency obligations                    |                                          |       | 73,044  |         |  |       | 794        |        |            |   |       |        |   |   | 73,838  |        
|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  |                                                       | Total                                    |       |         | 174,061 |  |       |            | 3,023  |            |   |        |       |   |   |         | 177,084 | 
|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  | Mortgage-backed securities:                           |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  |                                                       | Government National Mortgage Association |       |         | 15,613  |  |       |            | 1,178  |            |   |        |       |   |   |         | 16,791  | 
|                                    |                  |                                                       | Federal Home Loan Mortgage Corporation   |       |         | 161,167 |  |       |            | 9,857  |            |   |        |       |   |   |         | 171,024 | 
|                                    |                  |                                                       | Federal National Mortgage Association    |       |         | 788     |  |       |            | 34     |            |   |        |       |   |   |         | 822     | 
|                                    |                  |                                                       | Collateralized mortgage obligations      |       |         | 454     |  |       |            | 14     |            |   |        |       |   |   |         | 468     | 
|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  |                                                       | Total mortgage-backed securities         |       |         | 178,022 |  |       |            | 11,083 |            |   |        |       |   |   |         | 189,105 | 
|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  |                                                       | Total debt securities                    |       |         | 352,083 |  |       |            | 14,106 |            |   |        |       |   |   |         | 366,189 | 
|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  | Equity securities                                     |                                          |       | 15,567  |         |  |       | 383        |        |            |   | (2,117 | )      |   |   | 13,833  |        
|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  |                                                       | Total securities available for sale      |       |         | 367,650 |  |       | $          | 14,489 |            |   | $      | (2,117 | ) |   | $       | 380,022 | 
|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  | Net unrealized gains on securities
available for sale |                                          |       | 12,372  |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  |                                                       | Total securities available for sale, net |       |         | 380,022 |  |       |            |        |            |   |        |        |   |   |         |         | 
|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        
|                                    |                  |                                                       | Total investment securities, net         |       | $       | 380,022 |  |       |            |        |            |   |        |        |   |   |         |         | 
|                                    |                  |                                                       |                                          |       |         |         |  |       |            |        |            |   |        |        |   |   |         |        





---



##### 





|3.                                                                                                                                                                                                           |  | INVESTMENT SECURITIES(continued)
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | --------------------------------
|                                                                                                                                                                                                            
|During the years ended December 31, 2003, 2002 and 2001, the Company realized
gains and losses on sales and recorded other-than-temporary impairment
writedowns of securities available for sale as follows:

|                                            |                               |      |          |      |          |      |          |    |        |  |       |       |        |  |   |        |   |  |   |       |  |  |   |        |  
|------------------------------------------- | ----------------------------- | ---- | -------- | ---- | -------- | ---- | -------- | -- | ------ |  | ----- | ----- | ------ |  | - | ------ | - |  | - | ----- |  |  | - | ------ | -
|(IN THOUSANDS) AT DECEMBER 31,              |                               | 2003 |          | 2002 |          | 2001
|                                            |                               |      |          |      |          |     
|                                            |                               |      | Realized |      | Realized |      | Realized
|                                            |                               |      | Gains    |      | Losses   |      | Gains    |    | Losses |  | Gains |       | Losses
|                                            |                               |      |          |      |          |      |          |    |        |  |       |       |       
|Sales:                                      |                               |      |          |      |          |      |          |    |        |  |       |       |        |  |   |        |   |  |   |       |  |  |   |       
|                                            | U.S. Treasury obligations     |      | $        | 309  |          |      | $        |   |        |  | $     | 363   |        |  | $ |       |   |  | $ | 135   |  |  | $ |       |  
|                                            | Marketable equity securities  |      |          | 258  |          |      |          |    |        |  |       | 4,721 |        |  |   | (3,451 | ) |  |   | 5,160 |  |  |   | (1,032 | )
|Other-than-temporary impairment writedowns: |                               |      |          |      |          |      |          |    |        |  |       |       |        |  |   |        |   |  |   |       |  |  |   |       
|                                            | Marketable equity securities  |      |          |     |          |      |          | (9 | )      |  |       |      |        |  |   | (67    | ) |  |   |      |  |  |   |       |  
|                                            |                               |      |          |      |          |      |          |    |        |  |       |       |        |  |   |        |   |  |   |       |  |  |   |        |  
|                                            | Total realized gains (losses) |      | $        | 567  |          |      | $        | (9 | )      |  | $     | 5,084 |        |  | $ | (3,518 | ) |  | $ | 5,295 |  |  | $ | (1,032 | )
|                                            |                               |      |          |      |          |      |          |    |        |  |       |       |        |  |   |        |   |  |   |       |  |  |   |        |  



|Proceeds from sales of debt securities available for sale during 2003, 2002
and 2001 were $26.0 million, $35.0 million and $20.6 million, respectively.
Proceeds from sales of equity securities available for sale during 2003,
2002 and 2001, were $11.4 million, $14.6 million and $14.2 million,
respectively.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                  
|There were no sales of investment securities held-to-maturity during
2003, 2002 and 2001.                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                  
|The amortized cost and market value of debt securities available for sale by
contractual maturity are as follows:                                                                                                                                                                                                 

|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |         |         | 
|----------------------------------------- |  | ---------------------------------------------------------- | ------------------------------------------- | ------------------------------------------------------------ | ----- | --------- | ------- | ------ | - | --------- | ------- | ------ | ------ | ------- | ------- |  | - | ------- | ------- | 
|(IN THOUSANDS) AT DECEMBER 31,            |  | 2003                                                       |                                             | 2002                                                        
|                                          |  |                                                            |                                             |                                                             
|                                          |  |                                                            |                                             |                                                              |       | Amortized |         | Market |   | Amortized |         | Market
|                                          |  |                                                            |                                             |                                                              |       | Cost      |         | Value  |   | Cost      |         | Value 
|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |       
|Investment securities available for sale: |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         | 
|                                          |  | U.S. Treasury obligations:                                 |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |        
|                                          |  |                                                            | Maturing within 1 year                      |                                                              | $     | 53,281    |         |        | $ | 53,583    |         |        | $      | 29,996  |         |  | $ | 30,443  |        
|                                          |  |                                                            | Maturing after 1 year but within 5 years    |                                                              |       | 62,449    |         |        |   | 62,891    |         |        |        | 71,021  |         |  |   | 72,803  |        
|                                          |  |                                                            | Maturing after 5 years but within 10 years  |                                                              |       | 7,172     |         |        |   | 7,168     |         |        |        |        |         |  |   |        |        
|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |         |        
|                                          |  |                                                            |                                             | Total                                                        |       |           | 122,902 |        |   |           | 123,642 |        |        |         | 101,017 |  |   |         | 103,246 | 
|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |         |        
|                                          |  | U.S. Government agency obligations:                        |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |        
|                                          |  |                                                            | Maturing within 1 year                      |                                                              |       |          |         |        |   |          |         |        |        | 10,000  |         |  |   | 10,000  |        
|                                          |  |                                                            | Maturing after 1 year but within 5 years    |                                                              |       | 175,015   |         |        |   | 174,691   |         |        |        | 59,000  |         |  |   | 59,719  |        
|                                          |  |                                                            | Maturing after 5 years but within 10 years  |                                                              |       | 22,000    |         |        |   | 21,708    |         |        |        | 4,000   |         |  |   | 4,075   |        
|                                          |  |                                                            | Maturing after 10 years but within 15 years |                                                              |       | 2,042     |         |        |   | 2,064     |         |        |        | 44      |         |  |   | 44      |        
|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |         |        
|                                          |  |                                                            |                                             | Total                                                        |       |           | 199,057 |        |   |           | 198,463 |        |        |         | 73,044  |  |   |         | 73,838  | 
|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |         |        
|                                          |  | Mortgage-backed securities:                                |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |        
|                                          |  |                                                            | Maturing within 1 year                      |                                                              |       | 40        |         |        |   | 41        |         |        |        | 35      |         |  |   | 35      |        
|                                          |  |                                                            | Maturing after 1 year but within 5 years    |                                                              |       | 5,160     |         |        |   | 5,481     |         |        |        | 4,469   |         |  |   | 4,771   |        
|                                          |  |                                                            | Maturing after 5 years but within 10 years  |                                                              |       | 34,065    |         |        |   | 36,328    |         |        |        | 70,525  |         |  |   | 75,376  |        
|                                          |  |                                                            | Maturing after 10 years but within 15 years |                                                              |       | 50,825    |         |        |   | 53,531    |         |        |        | 102,104 |         |  |   | 108,003 |        
|                                          |  |                                                            | Maturing after 15 years                     |                                                              |       | 271       |         |        |   | 277       |         |        |        | 889     |         |  |   | 920     |        
|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |         |        
|                                          |  |                                                            |                                             | Total                                                        |       |           | 90,361  |        |   |           | 95,658  |        |        |         | 178,022 |  |   |         | 189,105 | 
|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |         |        
|                                          |  |                                                            |                                             | Total debt securities available for sale                     |       |           | 412,320 |        |   |           | 417,763 |        |        |         | 352,083 |  |   |         | 366,189 | 
|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |         |        
|                                          |  | Net unrealized gains on debt securities
available for sale |                                             |                                                              | 5,443 |           |         |        |  |           |         |        | 14,106 |         |         |  |  |        
|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |         |        
|                                          |  |                                                            |                                             | Total debt securities available for sale,
net carrying value |       | $         | 417,763 |        |   | $         | 417,763 |        |        | $       | 366,189 |  |   | $       | 366,189 | 
|                                          |  |                                                            |                                             |                                                              |       |           |         |        |   |           |         |        |        |         |         |  |   |         |        



|Maturities of mortgage-backed securities are shown at final contractual
maturity but are expected to have shorter lives because borrowers have the
right to prepay obligations without prepayment penalties.                                                                                                 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                             
|Included in U.S. Government agency obligations are investments that
can be called prior to final maturity with an amortized cost of $193.0
million and a market value of $192.4 million at December 31, 2003 and an
amortized cost of $73.0 million and a market value of $73.8 million at
December 31, 2002.





---



##### 



3. INVESTMENT SECURITIES(continued)

The fair value and unrealized losses of temporarily impaired investments
aggregated by category of investments is as follows:

|                                    |                                       |                     |       |                     |  |            |            |        |   |            |       |        |            |  |      |      |   |  |            |         |  |  |      |        |  
|----------------------------------- | ------------------------------------- | ------------------- | ----- | ------------------- |  | ---------- | ---------- | ------ | - | ---------- | ----- | ------ | ---------- |  | ---- | ---- | - |  | ---------- | ------- |  |  | ---- | ------ | -
|(IN THOUSANDS) AT DECEMBER 31, 2003 |                                       | LESS THAN 12 MONTHS |       | 12 MONTHS OR LONGER |  | TOTAL     
|                                    |                                       |                     |       |                     |  |           
|                                    |                                       |                     |       |                     |  |            | Unrealized |        |   |            |       |        | Unrealized |  |      |      |   |  | Unrealized
|Description of Securities           |                                       | Fair value          |       | Losses              |  | Fair Value |            | Losses |   | Fair Value |       | Losses
|                                    |                                       |                     |       |                     |  |            |            |        |   |            |       |       
|Debt securities:                    |                                       |                     |       |                     |  |            |            |        |   |            |       |        |            |  |      |      |   |  |            |         |  |  |      |       
|                                    | U.S. Treasury obligations             |                     | $     | 30,350              |  |            | $          | (160   | ) |            | $     |       |            |  | $    |     |   |  | $          | 30,350  |  |  | $    | (160   | )
|                                    | U.S. Government agency obligations    |                     |       | 98,867              |  |            |            | (1,125 | ) |            |       |       |            |  |      |     |   |  |            | 98,867  |  |  |      | (1,125 | )
|                                    |                                       |                     |       |                     |  |            |            |        |   |            |       |        |            |  |      |      |   |  |            |         |  |  |      |        |  
|                                    | Total debt securities                 |                     |       | 129,217             |  |            |            | (1,285 | ) |            |       |       |            |  |      |     |   |  |            | 129,217 |  |  |      | (1,285 | )
|Equity securities                   |                                       |                     | 1,436 |                     |  |            | (164       | )      |   |            | 2,622 |        |            |  | (102 | )    |   |  | 4,058      |         |  |  | (266 | )     
|                                    |                                       |                     |       |                     |  |            |            |        |   |            |       |        |            |  |      |      |   |  |            |         |  |  |      |        |  
|                                    | Total temporarily impaired securities |                     | $     | 130,653             |  |            | $          | (1,449 | ) |            | $     | 2,622  |            |  | $    | (102 | ) |  | $          | 133,275 |  |  | $    | (1,551 | )
|                                    |                                       |                     |       |                     |  |            |            |        |   |            |       |        |            |  |      |      |   |  |            |         |  |  |      |        |  

At December 31, 2003 the Company had thirty-one U.S. Treasury and Government
agency securities and eight equity securities investment positions that had
been in a loss position for less than twelve months that it considered
temporarily impaired. This is due to the volatility of market interest rates
and the price volatility of equity securities. U.S. Treasury and Government
agency securities fluctuate in value based on changes in market interest rates
and other factors, however, they can be redeemed at par value if held to
maturity and therefore if their maturity date is less than one year into the
future regardless of their market value they are considered only temporarily
impaired.

At December 31, 2003 the Company had three equity investment positions
that had been in a continuous unrealized loss position for twelve or more
months that it considered temporarily impaired. The total unrealized losses on
these three securities were $77 thousand, $22 thousand and $3 thousand,
respectively, representing a 4.2%, 3.8% and 0.9% loss in value, respectively.

Management considers industry analyst reports, sector credit ratings,
volatility in market price and other relevant information, such as the
financial condition, earnings capacity and near term prospects of the company,
in determining whether an equity securitys impairment is due to a fundamental
deterioration in its financial condition or due to general market conditions.
If the impairment is due to a fundamental deterioration in its financial
condition as determined by the Companys analysis, it is written down to its
current fair market value and the loss is recognized. If the impairment is due
to general market conditions and the equity security declines in price from
its cost basis by more than 25% for more than a year, between 30% and 40% for
more than nine months, between 40% and 50% for more than six months or over
50% for more than ninety days, the stock is considered other than temporarily
impaired and it is written down to its current fair market value and the loss
is recognized.

The amortized cost and market value of U.S. Government agency securities
available for sale that can be called prior to maturity by scheduled maturity
and next call dates are as follows:

|                                         |                                     |                                       |       |       |           |         |        |       |           |         |        |   |        |        |  |   |        |        | 
|---------------------------------------- | ----------------------------------- | ------------------------------------- | ----- | ----- | --------- | ------- | ------ | ----- | --------- | ------- | ------ | - | ------ | ------ |  | - | ------ | ------ | 
|(IN THOUSANDS) AT DECEMBER 31,           |                                     | 2003                                  |       | 2002 
|                                         |                                     |                                       |       |      
|                                         |                                     |                                       |       |       | Amortized |         | Market |       | Amortized |         | Market
|Based on Scheduled Maturity              |                                     | Cost                                  |       | Value |           | Cost    |        | Value
|                                         |                                     |                                       |       |       |           |         |        |      
|Investment securities available for sale |                                     |                                       |       |       |           |         |        |       |           |         |        |   |        |        |  |  
|                                         | U.S. Government agency obligations: |                                       |       |       |           |         |        |       |           |         |        |   |        |        |  |   |       
|                                         |                                     | Maturing within 1 year                |       | $     |          |         |        | $     |          |         |        | $ | 10,000 |        |  | $ | 10,000 |       
|                                         |                                     | Maturing after 1 but within 2 years   |       |       | 13,000    |         |        |       | 13,011    |         |        |   | 6,000  |        |  |   | 6,030  |       
|                                         |                                     | Maturing after 2 but within 3 years   |       |       | 43,998    |         |        |       | 44,048    |         |        |   | 22,000 |        |  |   | 22,127 |       
|                                         |                                     | Maturing after 3 but within 4 years   |       |       | 42,000    |         |        |       | 41,990    |         |        |   | 21,000 |        |  |   | 21,231 |       
|                                         |                                     | Maturing after 4 but within 5 years   |       |       | 69,992    |         |        |       | 69,636    |         |        |   | 10,000 |        |  |   | 10,332 |       
|                                         |                                     | Maturing after 5 but within 10 years  |       |       | 22,000    |         |        |       | 21,708    |         |        |   | 4,000  |        |  |   | 4,074  |       
|                                         |                                     | Maturing after 10 but within 15 years |       |       | 2,000     |         |        |       | 2,021     |         |        |   |       |        |  |   |       |       
|                                         |                                     |                                       |       |       |           |         |        |       |           |         |        |   |        |        |  |   |        |       
|                                         |                                     |                                       | Total |       | $         | 192,990 |        |       | $         | 192,414 |        |   | $      | 73,000 |  |   | $      | 73,794 | 
|                                         |                                     |                                       |       |       |           |         |        |       |           |         |        |   |        |        |  |   |        |       

|                                         |                                     |                                     |       |       |           |         |        |       |           |         |        |   |        |        |  |   |        |        | 
|---------------------------------------- | ----------------------------------- | ----------------------------------- | ----- | ----- | --------- | ------- | ------ | ----- | --------- | ------- | ------ | - | ------ | ------ |  | - | ------ | ------ | 
|                                         |                                     |                                     |       |       | Amortized |         | Market |       | Amortized |         | Market
|Based on Next Call Dates                 |                                     | Cost                                |       | Value |           | Cost    |        | Value
|                                         |                                     |                                     |       |       |           |         |        |      
|Investment securities available for sale |                                     |                                     |       |       |           |         |        |       |           |         |        |   |        |        |  |  
|                                         | U.S. Government agency obligations: |                                     |       |       |           |         |        |       |           |         |        |   |        |        |  |   |       
|                                         |                                     | Callable within 1 year              |       | $     | 178,990   |         |        | $     | 178,287   |         |        | $ | 63,000 |        |  | $ | 63,346 |       
|                                         |                                     | Callable after 1 but within 2 years |       |       | 10,000    |         |        |       | 10,124    |         |        |   | 6,000  |        |  |   | 6,232  |       
|                                         |                                     | Callable after 2 but within 3 years |       |       | 4,000     |         |        |       | 4,003     |         |        |   | 4,000  |        |  |   | 4,216  |       
|                                         |                                     |                                     |       |       |           |         |        |       |           |         |        |   |        |        |  |   |        |       
|                                         |                                     |                                     | Total |       | $         | 192,990 |        |       | $         | 192,414 |        |   | $      | 73,000 |  |   | $      | 73,794 | 
|                                         |                                     |                                     |       |       |           |         |        |       |           |         |        |   |        |        |  |   |        |       





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##### 



4. TRADING SECURITIES

The carrying amount and market value of trading securities are as follows:

|                               |                          |      |          |        |        |   |          |        |        |   |        |        |  |   |        |        | 
|------------------------------ | ------------------------ | ---- | -------- | ------ | ------ | - | -------- | ------ | ------ | - | ------ | ------ |  | - | ------ | ------ | 
|(IN THOUSANDS) AT DECEMBER 31, |                          | 2003 |          | 2002  
|                               |                          |      |          |       
|                               |                          |      | Carrying |        | Market |   | Carrying |        | Market
|                               |                          |      | Amount   |        | Value  |   | Amount   |        | Value 
|                               |                          |      |          |        |        |   |          |        |       
|U.S. Treasury obligations      |                          | $    | 72,408   |        |        | $ | 72,408   |        |        | $ | 36,228 |        |  | $ | 36,228 |       
|Marketable equity securities   |                          |      | 2223     |        |        |   | 2223     |        |        |   | 19     |        |  |   | 19     |       
|Investments in mutual funds    |                          |      | 3        |        |        |   | 3        |        |        |   | 2      |        |  |   | 2      |       
|                               |                          |      |          |        |        |   |          |        |        |   |        |        |  |   |        |       
|                               | Total trading securities |      | $        | 72,633 |        |   | $        | 72,633 |        |   | $      | 36,249 |  |   | $      | 36,249 | 
|                               |                          |      |          |        |        |   |          |        |        |   |        |        |  |   |        |       

During the years ended December 31, 2003, 2002 and 2001, the Company realized
gains and losses on sales of trading securities as follows:

|                                        |                               |      |          |      |          |      |          |      |        |   |       |     |        |   |     |     |   |   |     |     |  |   |     |     |  
|--------------------------------------- | ----------------------------- | ---- | -------- | ---- | -------- | ---- | -------- | ---- | ------ | - | ----- | --- | ------ | - | --- | --- | - | - | --- | --- |  | - | --- | --- | -
|(IN THOUSANDS) YEARS ENDED DECEMBER 31, |                               | 2003 |          | 2002 |          | 2001
|                                        |                               |      |          |      |          |     
|                                        |                               |      | Realized |      | Realized |      | Realized
|                                        |                               |      | Gains    |      | Losses   |      | Gains    |      | Losses |   | Gains |     | Losses
|                                        |                               |      |          |      |          |      |          |      |        |   |       |     |       
|U.S. Treasury obligations               |                               | $    | 145      |      |          | $    | (262     | )    |        | $ | 77    |     |        | $ | (50 | )   |   | $ | 32  |     |  | $ |    |    
|Marketable equity securities            |                               |      | 88       |      |          |      |         |      |        |   | 30    |     |        |   |    |     |   |   | 104 |     |  |   | (28 | )  
|                                        |                               |      |          |      |          |      |          |      |        |   |       |     |        |   |     |     |   |   |     |     |  |   |     |    
|                                        | Total realized gains (losses) |      | $        | 233  |          |      | $        | (262 | )      |   | $     | 107 |        |   | $   | (50 | ) |   | $   | 136 |  |   | $   | (28 | )
|                                        |                               |      |          |      |          |      |          |      |        |   |       |     |        |   |     |     |   |   |     |     |  |   |     |    

Proceeds from sales of trading
securities during 2003, 2002 and 2001 were $72.9 million, $49.5 million and $27.3 million,
respectively. Mark-to-market adjustments included in income in 2003, 2002 and 2001 were $110 thousand, $95 thousand and $(8) thousand, respectively.





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##### 



5. LOANS

The Banks lending activities are conducted principally in the local
communities in which it operates banking offices, and to a lesser extent, in
selected areas of Massachusetts and southern New Hampshire.

The Bank offers single family and multi-family residential mortgage
loans and a variety of consumer loans. The Bank also offers mortgage loans
secured by commercial or investment property such as apartment buildings and
commercial or corporate facilities; loans for the construction of
residential homes, multi-family properties and for land development; and
business loans for other commercial purposes. Most loans granted by the Bank
are either collateralized by real estate or guaranteed by federal or local
governmental authorities. The ability of single family residential and
consumer borrowers to honor their repayment commitments is generally
dependent on the level of overall economic activity within the borrowers
geographic areas. The ability of commercial real estate and commercial loan
borrowers to honor their repayment commitments is generally dependent on the
economic health of the real estate sector in the borrowers geographic areas
and the overall economy. The composition of the Banks loan portfolio is
summarized as follows:

|                                        |              |                             |               |                      |       |         |         |       |        |         |         | 
|--------------------------------------- | ------------ | --------------------------- | ------------- | -------------------- | ----- | ------- | ------- | ----- | ------ | ------- | ------- | 
|(IN THOUSANDS) AT DECEMBER 31,          |              | 2003                        |               | 2002                
|                                        |              |                             |               |                     
|Mortgage loans:                         |              |                             |               |                      |       |         |         |      
|                                        | Residential: |                             |               |                      |       |         |         |       |       
|                                        |              | Conventional:               |               |                      |       |         |         |       |        |        
|                                        |              |                             | Fixed rate    |                      | $     | 217,487 |         |       | $      | 268,984 |        
|                                        |              |                             | Variable rate |                      |       | 22,956  |         |       |        | 31,544  |        
|                                        |              | FHA and VA                  |               |                      | 84    |         |         |       | 133    |        
|                                        | Commercial   |                             |               | 1,601                |       |         |         | 2,348 |       
|                                        | Construction |                             |               | 81                   |       |         |         | 654   |       
|                                        |              |                             |               |                      |       |         |         |       |        |         |        
|                                        |              |                             |               | Total mortgage loans |       |         | 242,209 |       |        |         | 303,663 | 
|Premium on loans                        |              |                             | 10            |                      |       |         | 20      |      
|Deferred mortgage loan origination fees |              |                             | (333          | )                    |       |         | (895    | )    
|                                        |              |                             |               |                      |       |         |         |       |        |         |        
|                                        |              |                             |               | Mortgage loans, net  |       |         | 241,886 |       |        |         | 302,788 | 
|                                        |              |                             |               |                      |       |         |         |       |        |         |        
|Other loans:                            |              |                             |               |                      |       |         |         |      
|                                        | Consumer:    |                             |               |                      |       |         |         |       |       
|                                        |              | Installment                 |               |                      | 415   |         |         |       | 798    |        
|                                        |              | Guaranteed education        |               |                      | 2,333 |         |         |       | 3,293  |        
|                                        |              | Other secured               |               |                      | 518   |         |         |       | 515    |        
|                                        |              | Home equity lines of credit |               |                      | 7,549 |         |         |       | 11,102 |        
|                                        |              | Unsecured                   |               |                      | 166   |         |         |       | 187    |        
|                                        |              |                             |               |                      |       |         |         |       |        |         |        
|                                        |              |                             |               | Total consumer loans |       |         | 10,981  |       |        |         | 15,895  | 
|                                        | Commercial   |                             |               | 139                  |       |         |         | 116   |       
|                                        |              |                             |               |                      |       |         |         |       |        |         |        
|                                        |              |                             |               | Total other loans    |       |         | 11,120  |       |        |         | 16,011  | 
|                                        |              |                             |               |                      |       |         |         |       |        |         |        
|                                        |              |                             |               | Total loans          |       | $       | 253,006 |       |        | $       | 318,799 | 
|                                        |              |                             |               |                      |       |         |         |       |        |         |        

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, 2003 follows:

|                             |  |   |       |  
|---------------------------- |  | - | ----- | -
|(IN THOUSANDS)               |  |   |       |  
|Balance at December 31, 2002 |  | $ | 800   |  
|Additions                    |  |   | 1,353 |  
|Repayments                   |  |   | (567  | )
|                             |  |   |       |  
|Balance at December 31, 2003 |  | $ | 1,586 |  
|                             |  |   |       |  





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##### 



6. ALLOWANCE FOR LOAN LOSSES(1)

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

|                                                                            |                |      |       |      |   |       |       |    |   |       |       |     |   |       | 
|--------------------------------------------------------------------------- | -------------- | ---- | ----- | ---- | - | ----- | ----- | -- | - | ----- | ----- | --- | - | ----- | 
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,                                     |                | 2003 |       | 2002 |   | 2001 
|                                                                            |                |      |       |      |   |      
|Balance at beginning of year                                                |                | $    | 2,271 |      |   | $     | 2,494 |    |   | $     | 2,594 |    
|Provision for loan losses                                                   |                |      | (502  | )    |   |       |      |    |   |       | 40    |    
|Transfer to allowance for loan losses on
off-balance sheet credit exposures |                |      | (226  | )    |   |       | (235  | )  |   |       | (149  | )  
|Recoveries of loans previously charged-off                                  |                |      | 15    |      |   |       | 16    |    |   |       | 31    |    
|                                                                            |                |      |       |      |   |       |       |    |   |       |       |    
|                                                                            |                |      | Total |      |   | 1,558 |       |    |   | 2,275 |       |     |   | 2,516 | 
|                                                                            |                |      |       |      |   |       |       |    |   |       |       |    
|Charge-offs:                                                                |                |      |       |      |   |       |       |    |   |       |       |    
|                                                                            | Mortgage loans |      |       |     |   |       |       |   |   |       |       |    |  
|                                                                            | Other loans    |      |       | (4   | ) |       |       | (4 | ) |       |       | (22 | )
|                                                                            |                |      |       |      |   |       |       |    |   |       |       |    
|Balance at end of year                                                      |                | $    | 1,554 |      |   | $     | 2,271 |    |   | $     | 2,494 |    
|                                                                            |                |      |       |      |   |       |       |    |   |       |       |    



| |  | (1)The prior years allowance for loan losses have been restated to
reflect the reclassification of the allowance for loan losses on
off-balance sheet crecdit exposures (shown separately on the balance
sheet) and to facilitate comparison with the current fiscal year.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The following table shows the allocation of the allowance for loan losses by
category of loans at December 31, 2003, 2002 and 2001.

|                               |             |       |     |        |       |          |   |            |     |          |     |        |       |            |   |    |     |   |       |            |       |  |   |    |     |  
|------------------------------ | ----------- | ----- | --- | ------ | ----- | -------- | - | ---------- | --- | -------- | --- | ------ | ----- | ---------- | - | -- | --- | - | ----- | ---------- | ----- |  | - | -- | --- | -
|(IN THOUSANDS) AT DECEMBER 31, |             | 2003  |     | 2002   |       | 2001    
|                               |             |       |     |        |       |         
|                               |             |       |     |        |       |          |   | Percentage |     |          |     |        |       | Percentage |   |    |     |   |       | Percentage
|                               |             |       |     |        |       |          |   | of Loans   |     |          |     |        |       | of Loans   |   |    |     |   |       | of Loans  
|                               |             |       |     | Amount |       | to Total |   | Amount     |     | to Total |     | Amount |       | to Total  
|                               |             |       |     |        |       |          |   |            |     |          |     |        |       |           
|Mortgage loans:                |             |       |     |        |       |          |   |            |     |          |     |        |       |            |   |    |     |   |       |            |       |  |   |   
|                               | Residential |       | $   | 934    |       |          |   | 95         | %   |          | $   | 1,309  |       |            |   | 94 | %   |   | $     | 958        |       |  |   | 89 | %  
|                               | Commercial  |       |     | 76     |       |          |   | 1          |     |          |     | 9      |       |            |   | 1  |     |   |       | 8          |       |  |   | 1  |    
|Consumer loans                 |             |       | 185 |        |       |          | 4 |            |     |          | 198 |        |       |            | 5 |    |     |   | 140   |            |       |  | 6 |   
|Commercial loans               |             |       | 48  |        |       |          |  |            |     |          | 69  |        |       |            |  |    |     |   | 346   |            |       |  | 4 |   
|Unallocated                    |             |       | 311 |        |       |          |  |            |     |          | 686 |        |       |            |  |    |     |   | 1,042 |            |       |  |  |   
|                               |             |       |     |        |       |          |   |            |     |          |     |        |       |            |   |    |     |   |       |            |       |  |   |    |    
|                               |             | Total |     | $      | 1,554 |          |   |            | 100 | %        |     | $      | 2,271 |            |   |    | 100 | % |       | $          | 2,494 |  |   |    | 100 | %
|                               |             |       |     |        |       |          |   |            |     |          |     |        |       |            |   |    |     |   |       |            |       |  |   |    |    

An integral component of the Companys risk management process is to ensure
the proper allocation of the allowance for loan losses based upon an
analysis of risk characteristics, demonstrated losses and other factors.
The unallocated component of the allowance for loan losses represents
managements view that there are probable losses that have been incurred
within the portfolio but have not yet been specifically identified. The
unallocated portion of the allowance for loan losses is based on
managements assessment of many factors including the risk characteristics
of the loan portfolio, concentrations of credit, current and anticipated
economic conditions that may affect borrowers ability to pay, and trends
in loan delinquencies and charge-offs. The unallocated portion of the
allowance for loan losses may change periodically after evaluating factors
impacting assumptions utilized in the calculation of the allocated portion
of the allowance for loan losses. In addition, various regulatory agencies,
as an integral part of their examination process, periodically review the
Banks allowance for loan losses. Such agencies may require the Bank to
recognize additions to the allowance based on judgments different from
those of management.

7. NON-PERFORMING ASSETS

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

|                                                 |                             |      |      |      |  |      |      |     |  |   |      |     | 
|------------------------------------------------ | --------------------------- | ---- | ---- | ---- |  | ---- | ---- | --- |  | - | ---- | --- | 
|(IN THOUSANDS) AT DECEMBER 31,                   |                             | 2003 |      | 2002 |  | 2001
|                                                 |                             |      |      |      |  |     
|Total nonaccrual loans                           |                             | $    | 230  |      |  | $    | 420  |     |  | $ | 644  |    
|Total real estate acquired through foreclosure   |                             |      |     |      |  |      |     |     |  |   |     |    
|                                                 |                             |      |      |      |  |      |      |     |  |   |      |    
|                                                 | Total non-performing assets |      | $    | 230  |  |      | $    | 420 |  |   | $    | 644 | 
|                                                 |                             |      |      |      |  |      |      |     |  |   |      |    
|Percent of non-performing loans to total loans   |                             |      | 0.09 | %    |  |      | 0.13 | %   |  |   | 0.19 | %  
|Percent of non-performing assets to total assets |                             |      | 0.02 | %    |  |      | 0.04 | %   |  |   | 0.07 | %  





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##### 



7. NON-PERFORMING ASSETS(continued)

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

|                                                                   |  |      |    |      |  |      |    |  |  |   |    | 
|------------------------------------------------------------------ |  | ---- | -- | ---- |  | ---- | -- |  |  | - | -- | 
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,                            |  | 2003 |    | 2002 |  | 2001
|                                                                   |  |      |    |      |  |     
|Interest income that would have been recorded under original terms |  | $    | 17 |      |  | $    | 31 |  |  | $ | 60 | 
|Interest income actually recorded                                  |  |      | 20 |      |  |      | 27 |  |  |   | 37 | 
|                                                                   |  |      |    |      |  |      |    |  |  |   |    | 
|Reduction (increase) in interest income                            |  | $    | (3 | )    |  | $    | 4  |  |  | $ | 23 | 
|                                                                   |  |      |    |      |  |      |    |  |  |   |    | 

During 2003, 2002 and 2001 the Company had no impaired loans.

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.

|                                                                    |                                                                          |      |                              |        |  |  |   |        | 
|------------------------------------------------------------------- | ------------------------------------------------------------------------ | ---- | ---------------------------- | ------ |  |  | - | ------ | 
|                                                                    |                                                                          |      | CONTRACT  OR NOTIONAL AMOUNT
|                                                                    |                                                                          |      |                             
|(IN THOUSANDS) AT DECEMBER 31,                                      |                                                                          | 2003 |                              | 2002  
|                                                                    |                                                                          |      |                              |       
|Financial instruments whose contract amounts represent credit risk: |                                                                          |      |                              |        |  |  |   |       
|                                                                    | Commitments to originate residential mortgage loans                      |      | $                            | 3,300  |  |  | $ | 11,331 | 
|                                                                    | Unadvanced portions of construction loans                                |      |                              | 479    |  |  |   | 111    | 
|                                                                    | Unused credit lines, including unused portions of equity lines of credit |      |                              | 37,410 |  |  |   | 40,929 | 
|                                                                    | Other loan commitments                                                   |      |                              | 3,996  |  |  |   |       | 
|                                                                    |                                                                          |      |                              |        |  |  |   |        | 

Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee by the customer. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
The Bank evaluates each customers credit-worthiness on a case-by-case
basis. The amount of collateral obtained, if any, is based on managements
credit evaluation of the borrower.

At December 31, 2002 the Bank also had commitments to purchase
when-issued investment securities in the amount of $4.0 million.

9. PREMISES AND EQUIPMENT

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

|                                                |                                     |                                   |        |       |       |            |        |       |       |  |      |             |  | 
|----------------------------------------------- | ----------------------------------- | --------------------------------- | ------ | ----- | ----- | ---------- | ------ | ----- | ----- |  | ---- | ----------- |  | 
|                                                |                                     |                                   |        |       |       |            |        |       |       |  |      | ESTIMATED  
|                                                |                                     |                                   |        |       |       |            |        |       |       |  |      | USEFUL LIFE
|(IN THOUSANDS) AT DECEMBER 31,                  |                                     | 2003                              |        | 2002  |       | (IN YEARS)
|                                                |                                     |                                   |        |       |       |           
|Premises:                                       |                                     |                                   |        |       |       |            |        |       |       |  |      |            
|                                                | Land                                |                                   | $      | 2,392 |       |            | $      | 2,227 |       |  |      |            | 
|                                                | Buildings                           |                                   |        | 5,917 |       |            |        | 5,824 |       |  |      | 25-45       | 
|                                                | Building and leasehold improvements |                                   |        | 5,069 |       |            |        | 2,396 |       |  |      | 2-30        | 
|Equipment                                       |                                     |                                   | 2,487  |       |       |            | 4,564  |       |       |  | 3-15 |            
|                                                |                                     |                                   |        |       |       |            |        |       |       |  |      |             | 
|                                                |                                     |                                   | 15,865 |       |       |            | 15,011 |       |       |  |      |            
|Less: accumulated depreciation and amortization |                                     |                                   | 8,922  |       |       |            | 8,216  |       |       |  |      |            
|                                                |                                     |                                   |        |       |       |            |        |       |       |  |      |             | 
|                                                |                                     | Total premises and equipment, net |        | $     | 6,943 |            |        | $     | 6,795 |  |      |             |  | 
|                                                |                                     |                                   |        |       |       |            |        |       |       |  |      |             | 

The Bank is obligated under a number of noncancelable operating leases for
various banking offices. These operating leases expire at various dates
through 2012 with options for renewal. Rental expenses for the years ended
December 31, 2003, 2002 and 2001 amounted to $274 thousand, $277 thousand,
and $391 thousand, respectively.





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##### 



9.     PREMISES AND EQUIPMENT(continued)

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, 2003, are as follows:

|                                         |  |          |     | 
|---------------------------------------- |  | -------- | --- | 
|(IN THOUSANDS) YEARS ENDING DECEMBER 31, |  | PAYMENTS
|                                         |  |         
|2004                                     |  | $        | 176 | 
|2005                                     |  |          | 125 | 
|2006                                     |  |          | 120 | 
|2007                                     |  |          | 93  | 
|2008                                     |  |          | 93  | 
|LATER YEARS                              |  |          | 317 | 
|                                         |  |          |     | 
|Total                                    |  | $        | 924 | 
|                                         |  |          |     | 

10.  DEPOSITS

Deposits are summarized as follows:

|                               |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |      |      |  
|------------------------------ | ------------------------------------------- | ----------------------- | - | ------- | ------- | ---- |  | ------ | ---- | ---- | - | ------- | ------- |  |  | ---- | ---- | -
|(IN THOUSANDS) AT DECEMBER 31, |                                             | 2003                    |   | 2002   
|                               |                                             |                         |   |        
|                               |                                             |                         |   | Amount  |         | Rate |  | Amount |      | Rate
|                               |                                             |                         |   |         |         |      |  |        |      |     
|Demand and NOW:                |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |     
|                               | NOW accounts                                |                         | $ | 56,108  |         |      |  | 0.37   | %    |      | $ | 57,293  |         |  |  | 0.65 | %   
|                               | Demand accounts                             |                         |   | 28,464  |         |      |  |       |      |      |   | 28,034  |         |  |  |     |     
|                               |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |      |     
|                               |                                             | Total demand and NOW    |   |         | 84,572  |      |  |        | 0.24 |      |   |         | 85,327  |  |  |      | 0.43 |  
|                               |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |      |     
|Savings:                       |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |     
|                               | Regular savings and special notice accounts |                         |   | 595,575 |         |      |  | 1.64   |      |      |   | 535,122 |         |  |  | 2.28 |     
|                               | Money market accounts                       |                         |   | 12,256  |         |      |  | 0.45   |      |      |   | 13,825  |         |  |  | 1.00 |     
|                               |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |      |     
|                               |                                             | Total savings           |   |         | 607,831 |      |  |        | 1.62 |      |   |         | 548,947 |  |  |      | 2.25 |  
|                               |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |      |     
|Time certificates:             |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |     
|                               | Fixed rate certificates                     |                         |   | 129,210 |         |      |  | 2.00   |      |      |   | 170,527 |         |  |  | 2.75 |     
|                               | Variable rate certificates                  |                         |   | 60,411  |         |      |  | 1.68   |      |      |   | 79,127  |         |  |  | 2.12 |     
|                               |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |      |     
|                               |                                             | Total time certificates |   |         | 189,621 |      |  |        | 1.89 |      |   |         | 249,654 |  |  |      | 2.55 |  
|                               |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |      |     
|                               |                                             | Total deposits          |   | $       | 882,024 |      |  |        | 1.55 | %    |   | $       | 883,928 |  |  |      | 2.16 | %
|                               |                                             |                         |   |         |         |      |  |        |      |      |   |         |         |  |  |      |     

The maturity distribution and related rate structure of the Banks time
certificates of deposit at December 31, 2003 follows:

|                               |       |      |        |         |               |  |         |      |  
|------------------------------ | ----- | ---- | ------ | ------- | ------------- |  | ------- | ---- | -
|(IN THOUSANDS) AT DECEMBER 31, |       | 2003
|                               |       |     
|                               |       |      |        |         |               |  | Average
|                               |       |      | Amount |         | Interest Rate
|                               |       |      |        |         |              
|Due within 3 months            |       | $    | 31,251 |         |               |  | 1.62    | %   
|Due within 3-6 months          |       |      | 31,924 |         |               |  | 1.58    |     
|Due within 6-12 months         |       |      | 48,585 |         |               |  | 1.91    |     
|Due within 1  2 years         |       |      | 46,232 |         |               |  | 2.04    |     
|Due within 2-3 years           |       |      | 20,036 |         |               |  | 2.09    |     
|Due within 3-5 years           |       |      | 9,519  |         |               |  | 2.20    |     
|Thereafter                     |       |      | 2,074  |         |               |  | 4.02    |     
|                               |       |      |        |         |               |  |         |     
|                               | Total |      | $      | 189,621 |               |  |         | 1.89 | %
|                               |       |      |        |         |               |  |         |     





---



##### 



10.     DEPOSITS(continued)

At December 31, 2003 and 2002, the Bank had individual time certificates of
deposit of $100 thousand or more maturing as follows:

|                               |       |      |        |        |  |   |        |        | 
|------------------------------ | ----- | ---- | ------ | ------ |  | - | ------ | ------ | 
|(IN THOUSANDS) AT DECEMBER 31, |       | 2003 |        | 2002  
|                               |       |     
|Due within 3 months            |       | $    | 4,605  |        |  | $ | 17,174 |       
|Due within 3-6 months          |       |      | 5,442  |        |  |   | 9,308  |       
|Due within 6-12 months         |       |      | 13,792 |        |  |   | 9,657  |       
|Due within 1-2 years           |       |      | 10,374 |        |  |   | 11,458 |       
|Due within 2-3 years           |       |      | 5,221  |        |  |   | 7,600  |       
|Due within 3-5 years           |       |      | 3,198  |        |  |   | 4,085  |       
|Thereafter                     |       |      | 1,279  |        |  |   | 1,234  |       
|                               |       |      |        |        |  |   |        |       
|                               | Total |      | $      | 43,911 |  |   | $      | 60,516 | 
|                               |       |      |        |        |  |   |        |       

11.     FAIR VALUE OF FINANCIAL INSTRUMENTS

SPAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires that the Bank disclose estimated fair values for its financial
instruments. Fair value estimates, methods, and assumptions are set forth
below for the Banks financial instruments.

CASH AND DUE FROM BANKS, SHORT-TERM INVESTMENTS AND ACCRUED INTEREST
RECEIVABLE

The carrying amounts for these financial instruments approximate fair value
because of the short-term nature of these financial
instruments.

INTEREST-BEARING DEPOSITS IN BANKS AND TERM FEDERAL FUNDS SOLD

The carrying amounts of the interest-bearing deposits in banks and term
federal funds sold reported in the balance sheet at
December 31, 2003 and 2002 approximate fair value.

SECURITIES

The fair value of investment securities is based principally on quoted market
prices and dealer quotes.

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:

|                               |                  |                 |         |         |      |                 |                 |         |  |   |         |         |                 |   |         |         | 
|------------------------------ | ---------------- | --------------- | ------- | ------- | ---- | --------------- | --------------- | ------- |  | - | ------- | ------- | --------------- | - | ------- | ------- | 
|                               |                  |                 | 2003    |         | 2002
|                               |                  |                 |         |         |     
|                               |                  |                 |         |         |      |                 | Calculated Fair |         |  |   |         |         | Calculated Fair
|(IN THOUSANDS) AT DECEMBER 31, |                  | Carrying Amount |         | Value   |      | Carrying Amount |                 | Value  
|                               |                  |                 |         |         |      |                 |                 |        
|Securities available for sale  |                  | $               | 429,229 |         |      | $               | 429,229         |         |  | $ | 380,022 |         |                 | $ | 380,022 |        
|Trading securities             |                  |                 | 72,633  |         |      |                 | 72,633          |         |  |   | 36,249  |         |                 |   | 36,249  |        
|                               |                  |                 |         |         |      |                 |                 |         |  |   |         |         |                 |   |         |        
|                               | Total securities |                 | $       | 501,862 |      |                 | $               | 501,862 |  |   | $       | 416,271 |                 |   | $       | 416,271 | 
|                               |                  |                 |         |         |      |                 |                 |         |  |   |         |         |                 |   |         |        

LOANS

Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as residential mortgage,
commercial real estate, consumer and commercial.

The fair values of residential and commercial real estate, and certain
consumer loans are calculated by discounting scheduled cash flows through
the estimated maturity using estimated market discount rates that reflect
the credit and interest rate risk inherent in the loan. The estimate of
maturity is based on the Banks historical experience with repayments for
each loan classification, modified, as required, by an estimate of the
effect of current economic and lending conditions. For variable rate
commercial loans and certain variable rate consumer loans, including home
equity lines of credit, carrying value approximates fair value. Assumptions
regarding credit risk, cash flows, and discount rates are judgmentally
determined using available market information.





---



##### 



11.     FAIR VALUE OF FINANCIAL INSTRUMENTS(Continued)

The following table presents information for loans:

|                               |              |             |        |                 |         |          |        |                 |         |  |        |   |         |  |        |   |         | 
|------------------------------ | ------------ | ----------- | ------ | --------------- | ------- | -------- | ------ | --------------- | ------- |  | ------ | - | ------- |  | ------ | - | ------- | 
|                               |              |             |        | 2003            |         | 2002    
|                               |              |             |        |                
|                               |              | Carrying    |        | Calculated Fair |         | Carrying |        | Calculated Fair
|(IN THOUSANDS) AT DECEMBER 31, |              | Amount      |        | Value           |         | Amount   |        | Value          
|                               |              |             |        |                 |         |          |        |                
|Real estate:                   |              |             |        |                 |         |          |        |                 |         |  |        |   |         |  |        |  
|                               | Residential: |             |        |                 |         |          |        |                 |         |  |        |   |         |  |        |   |        
|                               |              | Variable    |        | $               | 22,949  |          |        | $               | 22,991  |  |        | $ | 31,526  |  |        | $ | 32,222  | 
|                               |              | Fixed       |        |                 | 217,344 |          |        |                 | 220,972 |  |        |   | 268,925 |  |        |   | 274,606 | 
|                               | Commercial:  |             |        |                 |         |          |        |                 |         |  |        |   |         |  |        |   |        
|                               |              | Variable    |        |                 | 1,593   |          |        |                 | 1,605   |  |        |   | 2,126   |  |        |   | 2,150   | 
|                               |              | Fixed       |        |                 |        |          |        |                 |        |  |        |   | 211     |  |        |   | 211     | 
|Consumer                       |              |             | 10,981 |                 |         |          | 11,015 |                 |         |  | 15,895 |   |         |  | 16,010 |  
|Commercial                     |              |             | 139    |                 |         |          | 114    |                 |         |  | 116    |   |         |  | 99     |  
|                               |              |             |        |                 |         |          |        |                 |         |  |        |   |         |  |        |   |         | 
|                               |              | Total loans |        |                 | 253,006 |          |        |                 | 256,697 |  |        |   | 318,799 |  |        |   | 325,298 | 
|Allowance for loan losses      |              |             | (1,554 | )               |         |          |       |                 |         |  | (2,271 | ) |         |  |       |  
|                               |              |             |        |                 |         |          |        |                 |         |  |        |   |         |  |        |   |         | 
|                               |              | Net loans   |        | $               | 251,452 |          |        | $               | 256,697 |  |        | $ | 316,528 |  |        | $ | 325,298 | 
|                               |              |             |        |                 |         |          |        |                 |         |  |        |   |         |  |        |   |         | 

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, 2003 and 2002. 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.

|                                            |                |        |          |         |                |        |          |         |                |   |         |         |  |   |         |         | 
|------------------------------------------- | -------------- | ------ | -------- | ------- | -------------- | ------ | -------- | ------- | -------------- | - | ------- | ------- |  | - | ------- | ------- | 
|                                            |                | 2003   |          | 2002   
|                                            |                |        |          |        
|                                            |                |        | Carrying |         | Estimated Fair |        | Carrying |         | Estimated Fair
|(IN THOUSANDS) AT DECEMBER 31,              |                | Amount |          | Value   |                | Amount |          | Value  
|                                            |                |        |          |         |                |        |          |        
|Demand accounts                             |                | $      | 28,464   |         |                | $      | 28,464   |         |                | $ | 28,034  |         |  | $ | 28,034  |        
|NOW accounts                                |                |        | 56,108   |         |                |        | 56,108   |         |                |   | 57,293  |         |  |   | 57,293  |        
|Regular savings and special notice accounts |                |        | 595,575  |         |                |        | 595,575  |         |                |   | 535,122 |         |  |   | 535,122 |        
|Money market accounts                       |                |        | 12,256   |         |                |        | 12,256   |         |                |   | 13,825  |         |  |   | 13,825  |        
|Time certificates                           |                |        | 189,621  |         |                |        | 190,655  |         |                |   | 249,654 |         |  |   | 251,512 |        
|                                            |                |        |          |         |                |        |          |         |                |   |         |         |  |   |         |        
|                                            | Total deposits |        |          | 882,024 |                |        |          | 883,058 |                |   |         | 883,928 |  |   |         | 885,786 | 
|Escrow deposits of borrowers                |                |        | 1,139    |         |                |        | 1,139    |         |                |   | 1,387   |         |  |   | 1,387   |        
|                                            |                |        |          |         |                |        |          |         |                |   |         |         |  |   |         |        
|                                            | Total          |        | $        | 883,163 |                |        | $        | 884,197 |                |   | $       | 885,315 |  |   | $       | 887,173 | 
|                                            |                |        |          |         |                |        |          |         |                |   |         |         |  |   |         |        

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, 2003 and 2002 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. The Banks other loan
commitments approximate fair value.





---



##### 



11.     FAIR VALUE OF FINANCIAL INSTRUMENTS(Continued)

LIMITATIONS

Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial instrument.
These estimates do not reflect any premium or discount that could result
from offering for sale at one time the Banks entire holdings of a
particular financial instrument. Because no active market exists for a
portion of the Banks financial instruments, fair value estimates are based
on judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments and other
factors. These estimates are subjective in nature and involve uncertainties
and matters of significant judgment and therefore cannot be determined with
precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are determined without attempting to estimate the
value of anticipated future business and the value of assets and
liabilities that are not considered financial instruments. For example, the
Bank has a trust department that contributes fee income annually. The trust
department is not considered a financial instrument, and its value has not
been incorporated into the fair value estimates. Other significant assets
and liabilities that are not considered financial assets or liabilities
include deferred tax liabilities, premises and equipment and goodwill. In
addition, the tax ramifications related to the realization of the
unrealized gains and losses can have a significant effect on fair value
estimates and have not been considered in any of the estimates.

12.     INCOME TAXES

Income tax expense (benefit) was allocated as follows:

|                                        |         |                                      |   |       |       |      |   |       |       |   |   |       |       |  
|--------------------------------------- | ------- | ------------------------------------ | - | ----- | ----- | ---- | - | ----- | ----- | - | - | ----- | ----- | -
|(IN THOUSANDS) YEARS ENDED DECEMBER 31, |         | 2003                                 |   | 2002  |       | 2001
|                                        |         |                                      |   |       |       |     
|Current income tax expense:             |         |                                      |   |       |       |      |   |       |       |   |   |      
|                                        | Federal |                                      | $ | 3,702 |       |      | $ | 5,210 |       |   | $ | 5,891 |      
|                                        | State   |                                      |   | 291   |       |      |   | 438   |       |   |   | 367   |      
|                                        |         |                                      |   |       |       |      |   |       |       |   |   |       |      
|                                        |         | Total current tax expense            |   |       | 3,993 |      |   |       | 5,648 |   |   |       | 6,258 |  
|                                        |         |                                      |   |       |       |      |   |       |       |   |   |       |      
|Deferred income tax expense (benefit):  |         |                                      |   |       |       |      |   |       |       |   |   |      
|                                        | Federal |                                      |   | 175   |       |      |   | (132  | )     |   |   | (181  | )    
|                                        | State   |                                      |   | 61    |       |      |   | (42   | )     |   |   | (58   | )    
|                                        |         |                                      |   |       |       |      |   |       |       |   |   |       |      
|                                        |         | Total deferred tax expense (benefit) |   |       | 236   |      |   |       | (174  | ) |   |       | (239  | )
|                                        |         |                                      |   |       |       |      |   |       |       |   |   |       |      
|                                        |         | Total income tax expense             |   | $     | 4,229 |      |   | $     | 5,474 |   |   | $     | 6,019 |  
|                                        |         |                                      |   |       |       |      |   |       |       |   |   |       |      

Income tax expense attributable to income from operations for the years
ended December 31, differed from the amounts computed by applying the
federal income tax rate of 35 percent as a result of the following:

|                                                         |                                                      |      |       |      |   |      |       |      |   |   |       |     |  
|-------------------------------------------------------- | ---------------------------------------------------- | ---- | ----- | ---- | - | ---- | ----- | ---- | - | - | ----- | --- | -
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,                  |                                                      | 2003 |       | 2002 |   | 2001
|                                                         |                                                      |      |       |      |   |     
|Computed expected income tax expense at statutory rate |                                                      | $    | 4,232 |      |   | $    | 5,351 |      |   | $ | 5,872 |    
|Increase (reduction) in income taxes resulting from:     |                                                      |      |       |      |   |      |       |      |   |   |       |    
|                                                         | Reduction in federal income tax rate                 |      |       | (97  | ) |      |       | (101 | ) |   |       |    |  
|                                                         | State and local income taxes, net of federal benefit |      |       | 229  |   |      |       | 257  |   |   |       | 201 |  
|                                                         | Dividends received deduction                         |      |       | (54  | ) |      |       | (57  | ) |   |       | (59 | )
|                                                         | Dividends paid to ESOP deduction                     |      |       | (67  | ) |      |       | (34  | ) |   |       | (7  | )
|                                                         | Other                                                |      |       | (14  | ) |      |       | 58   |   |   |       | 12  |  
|                                                         |                                                      |      |       |      |   |      |       |      |   |   |       |    
|Income tax expense                                       |                                                      | $    | 4,229 |      |   | $    | 5,474 |      |   | $ | 6,019 |    
|                                                         |                                                      |      |       |      |   |      |       |      |   |   |       |    
|Effective income tax rate                                |                                                      |      | 34.98 | %    |   |      | 35.81 | %    |   |   | 35.87 | %  
|                                                         |                                                      |      |       |      |   |      |       |      |   |   |       |    





---



##### 



12.     INCOME TAXES (Continued)

At December 31, 2003 and 2002, the Bank had gross deferred tax assets and
gross deferred tax liabilities as follows:

|                                        |                                        |      |     |       |  |   |       |       |  | 
|--------------------------------------- | -------------------------------------- | ---- | --- | ----- |  | - | ----- | ----- |  | 
|(IN THOUSANDS) YEARS ENDED DECEMBER 31, |                                        | 2003 |     | 2002 
|                                        |                                        |      |     |      
|Deferred tax assets:                    |                                        |      |     |       |  |   |       |      
|                                        | Loan losses                            |      | $   | 914   |  |   | $     | 997   | 
|                                        | Deferred loan fees, net                |      |     | 7     |  |   |       | 30    | 
|                                        | Deferred compensation and pension cost |      |     | 715   |  |   |       | 671   | 
|                                        | Depreciation                           |      |     | 29    |  |   |       | 40    | 
|                                        | Purchase accounting                    |      |     | 263   |  |   |       | 347   | 
|                                        | Other                                  |      |     | 48    |  |   |       | 84    | 
|                                        |                                        |      |     |       |  |   |       |       | 
|                                        | Gross deferred tax asset               |      |     | 1,976 |  |   |       | 2,169 | 
|                                        |                                        |      |     |       |  |   |       |       | 
|Deferred tax liabilities:               |                                        |      |     |       |  |   |       |      
|                                        | Valuation of securities                |      |     | 2,555 |  |   |       | 4,680 | 
|                                        | Other unrealized securities gains      |      |     | 106   |  |   |       | 106   | 
|                                        | Other                                  |      |     | 98    |  |   |       | 54    | 
|                                        |                                        |      |     |       |  |   |       |       | 
|                                        | Gross deferred tax liability           |      |     | 2,759 |  |   |       | 4,840 | 
|                                        |                                        |      |     |       |  |   |       |       | 
|Net deferred tax liability              |                                        | $    | 783 |       |  | $ | 2,671 |      
|                                        |                                        |      |     |       |  |   |       |       | 

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, 2003. The primary
sources of recovery of the gross federal deferred tax asset are federal
income taxes paid in 2003, 2002 and 2001 that are available for carryback
and the expectation that the existing net deductible temporary differences
will reverse during periods in which the Company generates net taxable
income. Since there is no carryback provision for state income tax purposes,
management believes the existing net deductible temporary differences which
give rise to the gross deferred state income tax asset will reverse during
periods in which the Company generates net taxable income. There can be no
assurance, however, that the Company will generate any earnings or any
specific level of continuing earnings.

As a result of the Tax Reform Act of 1996, the special tax bad debt
provisions were amended to eliminate the reserve method. However, the tax
effect of the pre-1988 bad debt reserve amount of approximately $7.3 million
remains subject to recapture in the event that the Bank pays dividends in
excess of its reserves and profits.

13.     EARNINGS PER SHARE

The following is a calculation of earnings per share for the years indicated:

|                                    |                                                             |       |           |         |  |       |           |         |  |       |           |         |   |   |           |         |   |   |           |         |   |   |           |         |  
|----------------------------------- | ----------------------------------------------------------- | ----- | --------- | ------- |  | ----- | --------- | ------- |  | ----- | --------- | ------- | - | - | --------- | ------- | - | - | --------- | ------- | - | - | --------- | ------- | -
|YEARS ENDED DECEMBER 31,            |                                                             | 2003  |           | 2002    |  | 2001 
|                                    |                                                             |       |           |         |  |      
|(IN THOUSANDS EXCEPT SHARE DATA)    |                                                             | Basic |           | Diluted |  | Basic |           | Diluted |  | Basic |           | Diluted
|                                    |                                                             |       |           |         |  |       |           |         |  |       |           |        
|Net income                          |                                                             | $     | 7,863     |         |  | $     | 7,863     |         |  | $     | 9,814     |         |   | $ | 9,814     |         |   | $ | 10,759    |         |   | $ | 10,759    |        
|Average shares outstanding          |                                                             |       | 4,439,394 |         |  |       | 4,439,394 |         |  |       | 4,708,783 |         |   |   | 4,708,783 |         |   |   | 4,710,030 |         |   |   | 4,710,030 |        
|Dilutive stock options              |                                                             |       |          |         |  |       | 105,200   |         |  |       |          |         |   |   | 124,675   |         |   |   |          |         |   |   | 123,792   |        
|Unallocated Employee Stock          |                                                             |       |           |         |  |       |           |         |  |       |           |         |   |   |           |         |   |   |           |         |   |   |           |        
|                                    | Ownership Plan (ESOP) shares
not committed to be released |       |           |        |  |       |           |        |  |       |           | (10,957 | ) |   |           | (10,957 | ) |   |           | (24,157 | ) |   |           | (24,157 | )
|                                    |                                                             |       |           |         |  |       |           |         |  |       |           |         |   |   |           |         |   |   |           |         |   |   |           |        
|Weighted average shares outstanding |                                                             |       | 4,439,394 |         |  |       | 4,544,594 |         |  |       | 4,697,826 |         |   |   | 4,822,501 |         |   |   | 4,685,873 |         |   |   | 4,809,665 |        
|Earnings per share (in dollars)     |                                                             | $     | 1.77      |         |  | $     | 1.73      |         |  | $     | 2.09      |         |   | $ | 2.04      |         |   | $ | 2.30      |         |   | $ | 2.24      |        
|                                    |                                                             |       |           |         |  |       |           |         |  |       |           |         |   |   |           |         |   |   |           |         |   |   |           |        





---



##### 





|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, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | The Bank is a Federal Deposit Insurance Corporation insured institution
subject to the FDIC regulatory capital requirements. The FDIC regulations
require all FDIC insured institutions to maintain minimum levels of Tier I
capital. Highly rated banks (i.e., those with a composite rating of 1 under
the CAMELS rating system) are required to maintain a minimum leverage ratio
of Tier I capital to total average assets of at least 3.00%. An additional
100 to 200 basis points are required for all but these most highly rated
institutions. The Bank is also required to maintain a minimum level of
risk-based capital. Under the new risk-based capital standards, FDIC insured
institutions must maintain a Tier I capital to risk-weighted assets ratio of
4.00% and are generally expected to meet a minimum total qualifying capital
to risk-weighted assets ratio of 8.00%. The new risk-based capital guidelines
take into consideration risk factors, as defined by the regulators,
associated with various categories of assets, both on and off the balance
sheet. Under the guidelines, capital strength is measured in two tiers which
are used in conjunction with risk adjusted assets to determine the risk-based
capital ratios. Tier II capital components include supplemental capital
components such as qualifying allowance for loan losses, qualifying
subordinated debt and up to 45 percent of the pretax net unrealized holding
gains on certain available for sale equity securities. Tier I capital plus
the Tier II capital components are referred to as total qualifying capital.
|
| | The capital ratios of the Company and its principal subsidiary
MASSBANK set forth below currently exceed the minimum ratios for well
capitalized banks as defined by federal regulators.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | As of December 31, 2003, the most recent notification from the FDIC
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank
must maintain minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios as set forth in the following table. There are no conditions
or events since that notification that management believes would cause a
change in the Banks categorization.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

|                                          |  |        |         |                   |  |                |       |       |  |             |        |            |  |  |      |   |  |   |        |  |  |  |       |  
|----------------------------------------- |  | ------ | ------- | ----------------- |  | -------------- | ----- | ----- |  | ----------- | ------ | ---------- |  |  | ---- | - |  | - | ------ |  |  |  | ----- | -
|(IN THOUSANDS)                            |  |        |         |                   |  |                |       |       |  | FOR CAPITAL |        | TO BE WELL
|AT DECEMBER 31, 2003                      |  | ACTUAL |         | ADEQUACY PURPOSES |  | CAPITALIZED(1)
|                                          |  |        |         |                   |  |               
|                                          |  | Amount |         | Ratio             |  | Amount         |       | Ratio |  | Amount      |        | Ratio     
|                                          |  |        |         |                   |  |                |       |       |  |             |        |           
|Tier I Capital (to Average Assets):       |  |        |         |                   |  |                |       |       |  |             |        |            |  |  |      |   |  |   |        |  |  |  |       |  
|MASSBANK Corp. (consolidated)             |  | $      | 105,876 |                   |  |                | 10.57 | %     |  | $           | 30,054 |            |  |  | 3.00 | % |  |   | N/A    |  |  |  |      |  
|MASSBANK (the Bank)                     |  |        | 101,908 |                   |  |                | 10.17 |       |  |             | 30,054 |            |  |  | 3.00 |   |  | $ | 50,090 |  |  |  | 5.00  | %
|Tier I Capital (to Risk-Weighted Assets): |  |        |         |                   |  |                |       |       |  |             |        |            |  |  |      |   |  |   |        |  |  |  |       |  
|MASSBANK Corp. (consolidated)             |  |        | 105,876 |                   |  |                | 34.56 |       |  |             | 12,254 |            |  |  | 4.00 |   |  |   | N/A    |  |  |  |      |  
|MASSBANK (the Bank)                     |  |        | 101,908 |                   |  |                | 33.29 |       |  |             | 12,246 |            |  |  | 4.00 |   |  |   | 18,369 |  |  |  | 6.00  |  
|Total Capital (to Risk-Weighted Assets):  |  |        |         |                   |  |                |       |       |  |             |        |            |  |  |      |   |  |   |        |  |  |  |       |  
|MASSBANK Corp. (consolidated)             |  |        | 108,466 |                   |  |                | 35.40 |       |  |             | 24,509 |            |  |  | 8.00 |   |  |   | N/A    |  |  |  |      |  
|MASSBANK (the Bank)                     |  |        | 104,498 |                   |  |                | 34.13 |       |  |             | 24,492 |            |  |  | 8.00 |   |  |   | 30,615 |  |  |  | 10.00 |  
|                                          |  |        |         |                   |  |                |       |       |  |             |        |            |  |  |      |   |  |   |        |  |  |  |       |  



---

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

|                                          |  |        |         |                   |  |                |       |       |  |             |        |            |  |  |      |   |  |   |        |  |  |  |       |  
|----------------------------------------- |  | ------ | ------- | ----------------- |  | -------------- | ----- | ----- |  | ----------- | ------ | ---------- |  |  | ---- | - |  | - | ------ |  |  |  | ----- | -
|(IN THOUSANDS)                            |  |        |         |                   |  |                |       |       |  | FOR CAPITAL |        | TO BE WELL
|AT DECEMBER 31, 2002                      |  | ACTUAL |         | ADEQUACY PURPOSES |  | CAPITALIZED(1)
|                                          |  |        |         |                   |  |               
|                                          |  | Amount |         | Ratio             |  | Amount         |       | Ratio |  | Amount      |        | Ratio     
|                                          |  |        |         |                   |  |                |       |       |  |             |        |           
|Tier I Capital (to Average Assets):       |  |        |         |                   |  |                |       |       |  |             |        |            |  |  |      |   |  |   |        |  |  |  |       |  
|MASSBANK Corp. (consolidated)             |  | $      | 107,494 |                   |  |                | 10.96 | %     |  | $           | 29,414 |            |  |  | 3.00 | % |  |   | N/A    |  |  |  |      |  
|MASSBANK (the Bank)                     |  |        | 101,857 |                   |  |                | 10.32 |       |  |             | 29,606 |            |  |  | 3.00 |   |  | $ | 49,343 |  |  |  | 5.00  | %
|Tier I Capital (to Risk-Weighted Assets): |  |        |         |                   |  |                |       |       |  |             |        |            |  |  |      |   |  |   |        |  |  |  |       |  
|MASSBANK Corp. (consolidated)             |  |        | 107,494 |                   |  |                | 32.47 |       |  |             | 13,242 |            |  |  | 4.00 |   |  |   | N/A    |  |  |  |      |  
|MASSBANK (the Bank)                     |  |        | 101,857 |                   |  |                | 30.76 |       |  |             | 13,243 |            |  |  | 4.00 |   |  |   | 19,865 |  |  |  | 6.00  |  
|Total Capital (to Risk-Weighted Assets):  |  |        |         |                   |  |                |       |       |  |             |        |            |  |  |      |   |  |   |        |  |  |  |       |  
|MASSBANK Corp. (consolidated)             |  |        | 110,149 |                   |  |                | 33.27 |       |  |             | 26,483 |            |  |  | 8.00 |   |  |   | N/A    |  |  |  |      |  
|MASSBANK (the Bank)                     |  |        | 104,512 |                   |  |                | 31.57 |       |  |             | 26,486 |            |  |  | 8.00 |   |  |   | 33,108 |  |  |  | 10.00 |  
|                                          |  |        |         |                   |  |                |       |       |  |             |        |            |  |  |      |   |  |   |        |  |  |  |       |  



---

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



---



##### 



1

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 service
expected to be earned in the future. Pension plan assets consist principally
of equity securities, bond and equity mutual funds, and money market funds
and cash.
|
| | 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, 2003, 2002, and 2001, the plans latest valuation
dates:                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

|                                           |                                                                      |      |       |        |   |      |       |        |   |   |       |       |  
|------------------------------------------ | -------------------------------------------------------------------- | ---- | ----- | ------ | - | ---- | ----- | ------ | - | - | ----- | ----- | -
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,    |                                                                      | 2003 |       | 2002   |   | 2001
|                                           |                                                                      |      |       |        |   |     
|Actuarial present value of vested benefits |                                                                      | $    | 6,548 |        |   | $    | 5,929 |        |   | $ | 5,700 |      
|Total accumulated benefit obligation       |                                                                      |      | 6,617 |        |   |      | 5,969 |        |   |   | 5,730 |      
|Change in benefit obligation:              |                                                                      |      |       |        |   |      |       |        |   |   |       |      
|                                           | Projected benefit obligation at beginning of year                    |      | $     | 7,646  |   |      | $     | 7,009  |   |   | $     | 6,432 |  
|                                           | Service cost                                                         |      |       | 385    |   |      |       | 386    |   |   |       | 375   |  
|                                           | Interest cost                                                        |      |       | 516    |   |      |       | 493    |   |   |       | 499   |  
|                                           | Amendments                                                           |      |       |       |   |      |       | 129    |   |   |       |      |  
|                                           | Actuarial loss (gain)                                                |      |       | 91     |   |      |       | (173   | ) |   |       | (130  | )
|                                           | Benefits paid                                                        |      |       | (249   | ) |      |       | (199   | ) |   |       | (167  | )
|                                           |                                                                      |      |       |        |   |      |       |        |   |   |       |      
|                                           | Projected benefit obligation at end of year                          |      | $     | 8,389  |   |      | $     | 7,645  |   |   | $     | 7,009 |  
|                                           |                                                                      |      |       |        |   |      |       |        |   |   |       |      
|Change in plan assets:                     |                                                                      |      |       |        |   |      |       |        |   |   |       |      
|                                           | Fair value of plan assets at beginning of year                       |      | $     | 5,963  |   |      | $     | 6,804  |   |   | $     | 7,785 |  
|                                           | Actual return on plan assets                                         |      |       | 902    |   |      |       | (643   | ) |   |       | (843  | )
|                                           | Employer contribution                                                |      |       | 420    |   |      |       |       |   |   |       | 29    |  
|                                           | Benefits paid                                                        |      |       | (249   | ) |      |       | (199   | ) |   |       | (167  | )
|                                           | Other                                                                |      |       | 2      |   |      |       | 1      |   |   |       |      |  
|                                           |                                                                      |      |       |        |   |      |       |        |   |   |       |      
|                                           | Fair value of plan assets at end of year                             |      | $     | 7,038  |   |      | $     | 5,963  |   |   | $     | 6,804 |  
|                                           |                                                                      |      |       |        |   |      |       |        |   |   |       |      
|                                           | (Deficiency) excess of plan assets over projected benefit obligation |      | $     | (1,351 | ) |      | $     | (1,682 | ) |   | $     | (205  | )
|                                           |                                                                      |      |       |        |   |      |       |        |   |   |       |      



| | Certain changes in the items shown are not recognized as they occur, but are amortized systematically over
subsequent periods.
| | ------------------------------------------------------------------------------------------------------------------------------
|
| | Unrecognized amounts to be amortized and the amounts included in the consolidated balance sheets
are shown below:             

|                                                                     |  |   |        |   |   |   |        |   |  |   |      |  
|-------------------------------------------------------------------- |  | - | ------ | - | - | - | ------ | - |  | - | ---- | -
|Unrecognized net actuarial gain (loss)                               |  | $ | (459   | ) | $ |   | (915   | ) |  | $ | 85   |  
|Transition asset                                                     |  |   | 84     |   |   |   | 106    |   |  |   | 126  |  
|Past service cost                                                    |  |   | (121   | ) |   |   | (129   | ) |  |   |     |  
|Accrued benefit cost                                                 |  |   | (855   | ) |   |   | (744   | ) |  |   | (416 | )
|                                                                     |  |   |        |   |   |   |        |   |  |   |      |  
|(Deficiency) excess of plan assets over projected benefit obligation |  | $ | (1,351 | ) |   | $ | (1,682 | ) |  | $ | (205 | )
|                                                                     |  |   |        |   |   |   |        |   |  |   |      |  



| | Assumptions used in determining the actuarial present value of the projected
benefit obligation were as follows:
| | ----------------------------------------------------------------------------------------------------------------

|                                                                     |                                        |  |   |      |   |  |   |      |   |  |   |      |  
|-------------------------------------------------------------------- | -------------------------------------- |  | - | ---- | - |  | - | ---- | - |  | - | ---- | -
|                                                                     | Discount rate                          |  |   | 6.25 | % |  |   | 6.75 | % |  |   | 7.00 | %
|                                                                     | Rate of compensation increase          |  |   | 4.00 | % |  |   | 4.00 | % |  |   | 4.50 | %
|Assumptions used to develop the
net periodic benefit cost data were: |                                        |  |   |      |   |  |   |      |   |  |   |     
|                                                                     | Discount rate                          |  |   | 6.75 | % |  |   | 7.00 | % |  |   | 7.75 | %
|                                                                     | Expected return on plan assets         |  |   | 7.75 | % |  |   | 7.75 | % |  |   | 7.75 | %
|                                                                     | Rate of compensation increase          |  |   | 4.00 | % |  |   | 4.50 | % |  |   | 5.00 | %
|Components of net periodic pension (benefit) expense:                |                                        |  |   |      |   |  |   |      |   |  |   |     
|                                                                     | Service cost                           |  | $ | 385  |   |  | $ | 386  |   |  | $ | 375  |  
|                                                                     | Interest cost                          |  |   | 516  |   |  |   | 494  |   |  |   | 498  |  
|                                                                     | Expected return on plan assets         |  |   | (462 | ) |  |   | (527 | ) |  |   | (603 | )
|                                                                     | Transition obligation                  |  |   | (21  | ) |  |   | (21  | ) |  |   | (21  | )
|                                                                     | Past service cost                      |  |   | 7    |   |  |   |     |   |  |   |     |  
|                                                                     | Recognized net actuarial (gain) loss   |  |   | 107  |   |  |   | (4   | ) |  |   | (253 | )
|                                                                     |                                        |  |   |      |   |  |   |      |   |  |   |      |  
|                                                                     | Net periodic pension (benefit) expense |  | $ | 532  |   |  | $ | 328  |   |  | $ | (4   | )
|                                                                     |                                        |  |   |      |   |  |   |      |   |  |   |      |  



---



##### 



2

15.     EMPLOYEE BENEFITS (continued)



| | The approximate composition of pension plan assets as of the end of the plan
years ended October 31, 2003 and 2002 is as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------

|                        |                                   |      |     |      |   |  |     |    |  
|----------------------- | --------------------------------- | ---- | --- | ---- | - |  | --- | -- | -
|YEARS ENDED OCTOBER 31, |                                   | 2003 |     | 2002
|                        |                                   |      |     |     
|Asset Category:         |                                   |      |     |      |   |  |     |   
|                        | Cash and money market funds       |      |     | 21   | % |  |     | 10 | %
|                        | Equity securities                 |      |     | 47   | % |  |     | 22 | %
|                        | Mutual funds - equities           |      |     | 8    | % |  |     | 39 | %
|                        | Mutual funds - bonds              |      |     | 24   | % |  |     | 28 | %
|                        | Mutual funds - bonds and equities |      |     |     |   |  |     | 1  | %
|                        |                                   |      | 100 | %    |   |  | 100 | % 



| | The expected long-term rate of return on plan assets is based on prevailing
yields on high quality fixed income investments increased by a premium of 3% -
5% for equity investments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | The Bank expects to contribute $367 thousand to its pension plan in 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | The investment policies and strategies for the Banks pension plan are as
follows: MASSBANK (the Bank) is a member of the Savings Bank Employees
Retirement Association (SBERA) within which the Bank maintains a Defined
Benefit pension plan. SBERA offers a common and collective trust as the
underlying investment structure for pension plans participating in the
Association. The target allocation mix for the common and collective trust
portfolio calls for an equity-based investment deployment range from 55% to 75%
of total portfolio assets. The remainder of the portfolio is allocated to fixed
income. The actual investment allocation of the portfolio is approximately 68%
Equities, 28% Fixed Income and 4% Money Market. The Trustees of SBERA, through
the Associations Investment Committee, select investment managers for the
common and collective trust portfolio. A professional investment advisory firm
is retained by the Investment Committee to provide allocation analysis,
performance measurement and to assist with manager searches. The overall
investment objective is to diversify equity investments across a spectrum of
investment types (e.g., small cap, large cap, international, etc.) and styles
(e.g., growth, value, etc.)
|
| | 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. There were no payments awarded under the
profit sharing and incentive compensation bonus plans in 2003. Because some of
the target goals and individual goals and objectives were met in 2002 and 2001,
bonuses were awarded to officers and non-officer employees of the Bank in the
amount of $67 thousand and $158 thousand, respectively. There were no profit
sharing distributions in 2002 and 2001 because the criteria for making such
distributions were not met.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| | 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. The
balance of the ESOP loan was repaid in 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | Shares of the Companys common stock purchased with the loan proceeds were
held in a suspense account. As the loan was repaid, a proportionate number of
shares were released for allocation to plan participants, annually. In 2003,
the Bank contributed $161,000 to the ESOP to invest in the Companys common
stock. These shares were allocated to plan participants, on a pro rata basis,
based on compensation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | At December 31, 2003, the ESOP held 206,044 shares of the Companys common
stock which have been allocated to plan participants and no unallocated shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | Dividends on allocated shares held by the ESOP are allocated to plan
participants proportionately based on the number of shares in the participants
allocated accounts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | The Companys total expense applicable to the ESOP amounted to $135
thousand, $373 thousand and $328 thousand for the years ended December 31,
2003, 2002 and 2001, 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                



---



##### 





15.     EMPLOYEE BENEFITS (continued)



| | 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. The Company made contributions of $50 thousand, $59 thousand and
$78 thousand to a rabbi trust for the benefits payable under the agreements
in 2003, 2002 and 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | DIRECTORS DEFERRED COMPENSATION PLAN                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | In 1988, the Company established a deferred compensation plan for its
directors. The plan allows the Companys directors to defer receipt of all
or a portion of their compensation until the earlier of: (1) their attaining
the age of 72, or (2) their termination as a director of the Company. In
2000, the plan was amended to allow the directors compensation to be
invested in Company stock held in an irrevocable trust. At December 31,
2003, the trust held 25,200 shares of MASSBANK Corp. stock. The shares are
considered outstanding in the computation of earnings per share and book
value per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| | STOCK OPTION PLAN                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | Effective May 28, 1986, the Board of Directors of the Bank adopted a stock
option plan for the benefit of its officers and other employees. In January,
1991, the plan was amended to authorize the grant of options to non-employee
Directors of the Company. All but 8 of the 1,035,000 shares reserved for
issuance under the plan were issued. On April 19, 1994, shareholders
approved and the Bank adopted the Companys 1994 Stock Incentive Plan. The
total number of shares of common stock that can be issued under this plan is
540,000 shares. Both incentive stock options and non-qualified stock options
may be granted under the plans. As of December 31, 2003, there were 98,266
non-qualified stock options and 220,068 incentive stock options granted and
outstanding to purchase shares under the plans. The maximum option term is
ten years. Further stock options may be granted pursuant to the 1994 Stock
Incentive Plan and will generally have an exercise price equal to, or in
excess of, the fair market value of a share of common stock of the Company
on the date the option is granted.
|
| | A summary of the status of the Companys fixed stock option plan as of
December 31, 2003, 2002 and 2001, and changes during the years ended on
those dates is presented below. All share information presented has been
adjusted to reflect the 3-for-2 split of the Companys common stock
effective April 19, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

|                                 |  |        |         |          |  |        |       |          |  |        |          |          |  |   |       |  |  |  |         |   |  |   |       | 
|-------------------------------- |  | ------ | ------- | -------- |  | ------ | ----- | -------- |  | ------ | -------- | -------- |  | - | ----- |  |  |  | ------- | - |  | - | ----- | 
|YEARS ENDED DECEMBER 31,         |  | 2003   |         | 2002     |  | 2001  
|                                 |  |        |         |          |  |       
|                                 |  |        |         | Weighted |  |        |       | Weighted |  |        |          | Weighted
|                                 |  | Shares |         | Average  |  | Shares |       | Average  |  | Shares |          | Average 
|                                 |  | Under  |         | Exercise |  | Under  |       | Exercise |  | Under  |          | Exercise
|FIXED OPTIONS                    |  | Option |         | Price    |  | Option |       | Price    |  | Option |          | Price   
|                                 |  |        |         |          |  |        |       |          |  |        |          |         
|Outstanding at beginning of year |  |        | 376,122 |          |  | $      | 19.27 |          |  |        | 475,651  |          |  | $ | 17.09 |  |  |  | 519,526 |   |  | $ | 16.21 | 
|Granted                          |  |        | 22,600  |          |  |        | 28.56 |          |  |        | 32,250   |          |  |   | 27.63 |  |  |  | 32,625  |   |  |   | 20.67 | 
|Exercised                        |  |        | (78,138 | )        |  |        | 14.90 |          |  |        | (130,277 | )        |  |   | 13.26 |  |  |  | (70,497 | ) |  |   | 11.39 | 
|Forfeited                        |  |        | (2,250  | )        |  |        | 29.50 |          |  |        | (1,502   | )        |  |   | 28.55 |  |  |  | (6,003  | ) |  |   | 27.25 | 
|                                 |  |        |         |          |  |        |       |          |  |        |          |          |  |   |       |  |  |  |         |   |  |   |       | 
|Outstanding at end of year       |  |        | 318,334 |          |  | $      | 20.94 |          |  |        | 376,122  |          |  | $ | 19.27 |  |  |  | 475,651 |   |  | $ | 17.09 | 
|                                 |  |        |         |          |  |        |       |          |  |        |          |          |  |   |       |  |  |  |         |   |  |   |       | 
|Options exercisable at year-end  |  |        | 318,334 |          |  |        |       |          |  |        | 376,122  |          |  |   |       |  |  |  | 475,651 |   |  |   |       | 
|                                 |  |        |         |          |  |        |       |          |  |        |          |          |  |   |       |  |  |  |         |   |  |   |       | 



| |  |  | The following table summarizes information about fixed stock options
outstanding and exercisable at December 31, 2003:
| |  |  | ----------------------------------------------------------------------------------------------------------------------

|                     |  |                     |         |                     |  |               |  |               |       |          |  |  |         |               |  |   |       |  |  | 
|-------------------- |  | ------------------- | ------- | ------------------- |  | ------------- |  | ------------- | ----- | -------- |  |  | ------- | ------------- |  | - | ----- |  |  | 
|AT DECEMBER 31, 2003 |  | 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   
|                     |  |                     |         |                     |  |               |  |               |       |         
|$11.25 to $12.19     |  |                     | 47,750  |                     |  | 0.7 years     |  | $             | 11.53 |          |  |  | 47,750  |               |  | $ | 11.53 | 
|13.25 to 16.63       |  |                     | 42,987  |                     |  | 2.0 years     |  |               | 15.44 |          |  |  | 42,987  |               |  |   | 15.44 | 
|19.00 to 20.67       |  |                     | 104,875 |                     |  | 5.0 years     |  |               | 19.81 |          |  |  | 104,875 |               |  |   | 19.81 | 
|25.00 to 29.50       |  |                     | 121,522 |                     |  | 6.0 years     |  |               | 27.45 |          |  |  | 121,522 |               |  |   | 27.45 | 
|29.60 to 36.70       |  |                     | 1,200   |                     |  | 9.4 years     |  |               | 30.78 |          |  |  | 1,200   |               |  |   | 30.78 | 
|                     |  |                     |         |                     |  |               |  |               |       |          |  |  |         |               |  |   |       | 
|$11.25 to $36.70     |  |                     | 318,334 |                     |  | 4.3 years     |  | $             | 20.94 |          |  |  | 318,334 |               |  | $ | 20.94 | 
|                     |  |                     |         |                     |  |               |  |               |       |          |  |  |         |               |  |   |       | 



---



##### 



4

16.     SHAREHOLDER RIGHTS PLAN



| | The Company has in effect a Shareholder Rights Plan, pursuant to which the
Board of Directors authorized the issuance of one preferred stock purchase
right for each share of common stock of the Company outstanding. Under the
Plan, the Rights automatically become part of and trade with the Companys
shares of common stock. Although the Rights are not exercisable initially,
they become exercisable if a person becomes an acquiring person by
acquiring 11% or more of the Companys common stock or if a person commences
a tender offer that could result in that person owning 11% or more of the
common stock of Massbank Corp. In the event that a person becomes an
acquiring person, each holder of a Right (other than the acquiring person)
would be entitled to acquire such number of shares of preferred stock which
are equivalent to Massbank Corp. common stock having a value of twice the
exercise price of the Right. The exercise price of a Right initially shall be
$136.00 per one one-thousandth of a share of the Companys preferred stock.
If Massbank Corp. is acquired in a merger or other business combination
transaction after any such event, each holder of a Right would be entitled to
purchase, at the then-current exercise price, shares of the acquiring
companys common stock having a value of twice the exercise price of the
Right. The Rights will expire on January 19, 2010, but may be redeemed at the
option of the Board of Directors for $0.01 per Right at any time prior to the
time at which any person becomes an acquiring person or until the expiration
date of the Shareholder Rights Plan.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

17.     PARENT COMPANY FINANCIAL STATEMENTS



| |  |  | The following are the condensed financial statements for Massbank Corp. (the
Parent Company) only:
| |  |  | ----------------------------------------------------------------------------------------------------

|                                                 |                                                                                                                            |                                            |         |         |         |  |         |         |         | 
|------------------------------------------------ | -------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ------- | ------- |  | ------- | ------- | ------- | 
|BALANCE SHEETS                                   |                                                                                                                            |                                            |         |         |         |  |         |        
|(IN THOUSANDS EXCEPT SHARE DATA) AT DECEMBER 31, |                                                                                                                            | 2003                                       |         | 2002   
|                                                 |                                                                                                                            |                                            |         |        
|Assets:                                          |                                                                                                                            |                                            |         |         |         |  |         |        
|                                                 | Cash                                                                                                                       |                                            | $       | 5       |         |  | $       | 8       |        
|                                                 | Interest-bearing deposits in banks                                                                                         |                                            |         | 3,742   |         |  |         | 6,401   |        
|                                                 | Investment in subsidiaries                                                                                                 |                                            |         | 106,959 |         |  |         | 111,648 |        
|                                                 | Other assets                                                                                                               |                                            |         | 238     |         |  |         | 382     |        
|                                                 |                                                                                                                            |                                            |         |         |         |  |         |         |        
|                                                 |                                                                                                                            | Total assets                               |         | $       | 110,944 |  |         | $       | 118,439 | 
|                                                 |                                                                                                                            |                                            |         |         |         |  |         |         |        
|Liabilities:                                     |                                                                                                                            |                                            |         |         |         |  |         |        
|                                                 | Due to subsidiaries                                                                                                        |                                            | $       |        |         |  | $       | 42      |        
|                                                 | Other liabilities                                                                                                          |                                            |         | 17      |         |  |         | 1,112   |        
|                                                 |                                                                                                                            |                                            |         |         |         |  |         |         |        
|                                                 |                                                                                                                            | Total liabilities                          |         |         | 17      |  |         |         | 1,154   | 
|                                                 |                                                                                                                            |                                            |         |         |         |  |         |         |        
|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, 7,688,333 and 7,610,195 shares issued, respectively |                                            |         | 7,688   |         |  |         | 7,610   |        
|                                                 | Additional paid-in capital                                                                                                 |                                            |         | 54,417  |         |  |         | 52,820  |        
|                                                 | Retained earnings                                                                                                          |                                            |         | 99,038  |         |  |         | 95,243  |        
|                                                 |                                                                                                                            |                                            |         |         |         |  |         |         |        
|                                                 |                                                                                                                            |                                            | 161,143 |         |         |  | 155,673 |        
|                                                 | Treasury stock at cost, 3,280,880 and 3,002,129 shares, respectively                                                       |                                            |         | (54,177 | )       |  |         | (46,080 | )      
|                                                 | Accumulated other comprehensive income (Note 1)                                                                            |                                            |         | 3,961   |         |  |         | 7,692   |        
|                                                 | Shares held in rabbi trust at cost
3,000 and 2,600 shares, respectively                                                    |                                            |         | (72     | )       |  |         | (59     | )      
|                                                 | Deferred compensation obligation                                                                                           |                                            |         | 72      |         |  |         | 59      |        
|                                                 |                                                                                                                            |                                            |         |         |         |  |         |         |        
|                                                 |                                                                                                                            | Total stockholders equity                 |         |         | 110,927 |  |         |         | 117,285 | 
|                                                 |                                                                                                                            |                                            |         |         |         |  |         |         |        
|                                                 |                                                                                                                            | Total liabilities and stockholders equity |         | $       | 110,944 |  |         | $       | 118,439 | 
|                                                 |                                                                                                                            |                                            |         |         |         |  |         |         |        



---



##### 



17.     PARENT COMPANY FINANCIAL STATEMENTS (continued)



|                                                 |                                      |                                                                |        |       |       |      |        |        |        |  |       |       |        | 
|------------------------------------------------ | ------------------------------------ | -------------------------------------------------------------- | ------ | ----- | ----- | ---- | ------ | ------ | ------ |  | ----- | ----- | ------ | 
|STATEMENTS OF INCOME                             |                                      |                                                                |        |       |       |      |        |        |        |  |       |      
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,          |                                      | 2003                                                           |        | 2002  |       | 2001
|                                                 |                                      |                                                                |        |       |       |     
|Income:                                          |                                      |                                                                |        |       |       |      |        |        |        |  |       |      
|                                                 | Dividends received from subsidiaries |                                                                | $      | 9,300 |       |      | $      | 11,000 |        |  | $     | 8,800 |       
|                                                 | Interest and dividend income         |                                                                |        | 15    |       |      |        | 76     |        |  |       | 41    |       
|                                                 |                                      |                                                                |        |       |       |      |        |        |        |  |       |       |       
|                                                 |                                      | Total interest and dividend income                             |        |       | 9,315 |      |        |        | 11,076 |  |       |       | 8,841  | 
|Non-interest expense                             |                                      |                                                                | 166    |       |       |      | 172    |        |        |  | 123   |      
|                                                 |                                      |                                                                |        |       |       |      |        |        |        |  |       |       |       
|                                                 |                                      | Income before income taxes                                     |        |       | 9,149 |      |        |        | 10,904 |  |       |       | 8,718  | 
|Income tax benefit                               |                                      |                                                                | 93     |       |       |      | 40     |        |        |  | 16    |      
|                                                 |                                      |                                                                |        |       |       |      |        |        |        |  |       |       |       
|                                                 |                                      | Income before equity in undistributed earnings of
subsidiaries |        |       | 9,242 |      |        |        | 10,944 |  |       |       | 8,734  | 
|Equity in undistributed earnings of subsidiaries |                                      |                                                                | (1,379 | )     |       |      | (1,130 | )      |        |  | 2,025 |      
|                                                 |                                      |                                                                |        |       |       |      |        |        |        |  |       |       |       
|                                                 |                                      | Net income                                                     |        | $     | 7,863 |      |        | $      | 9,814  |  |       | $     | 10,759 | 
|                                                 |                                      |                                                                |        |       |       |      |        |        |        |  |       |       |       



| |  |  | The Parent Company only Statements of Changes in Stockholders Equity are
identical to the consolidated statements and therefore are not presented here.
| |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | STATEMENTS OF CASH FLOWS                                                                                                                                

|                                               |                                                                                   |                                                      |                                                      |        |       |         |       |        |       |        |       |        |        |        |  
|---------------------------------------------- | --------------------------------------------------------------------------------- | ---------------------------------------------------- | ---------------------------------------------------- | ------ | ----- | ------- | ----- | ------ | ----- | ------ | ----- | ------ | ------ | ------ | -
|(IN THOUSANDS) YEARS ENDED DECEMBER 31,        |                                                                                   | 2003                                                 |                                                      | 2002   |       | 2001   
|                                               |                                                                                   |                                                      |                                                      |        |       |        
|Cash flows from operating activities:          |                                                                                   |                                                      |                                                      |        |       |         |       |        |       |        |       |       
|                                               | Net income                                                                        |                                                      | $                                                    | 7,863  |       |         | $     | 9,814  |       |        | $     | 10,759 |       
|                                               | Adjustments to reconcile net income to net cash provided by
operating activities: |                                                      |                                                      |        |       |         |       |        |       |        |       |        |       
|                                               |                                                                                   | Equity in undistributed earnings of subsidiaries     |                                                      |        | 1,379 |         |       |        | 1,130 |        |       |        | (2,025 | )     
|                                               |                                                                                   | Decrease (increase) in current income tax asset, net |                                                      |        | 151   |         |       |        | (164  | )      |       |        | (17    | )     
|                                               |                                                                                   | Increase in deferred income tax asset, net           |                                                      |        | (6    | )       |       |        | (6    | )      |       |        | (5     | )     
|                                               | Tax benefit resulting from stock options exercised                                |                                                      |                                                      | 89     |       |         |       | 148    |       |        |       | 33     |       
|                                               | (Decrease) increase in other liabilities                                          |                                                      |                                                      | (1,095 | )     |         |       | 1,098  |       |        |       | (282   | )     
|                                               | Decrease in amount due from subsidiaries                                          |                                                      |                                                      |       |       |         |       |       |       |        |       | 84     |       
|                                               | (Decrease) increase in amount due to subsidiaries                                 |                                                      |                                                      | (42    | )     |         |       | (246   | )     |        |       | 288    |       
|                                               |                                                                                   |                                                      |                                                      |        |       |         |       |        |       |        |       |        |       
|                                               |                                                                                   |                                                      | Net cash provided by operating activities            |        |       | 8,339   |       |        |       | 11,774 |       |        |        | 8,835  |  
|                                               |                                                                                   |                                                      |                                                      |        |       |         |       |        |       |        |       |        |       
|Cash flow from financing activities:           |                                                                                   |                                                      |                                                      |        |       |         |       |        |       |        |       |       
|                                               | Payments to acquire treasury stock                                                |                                                      |                                                      | (8,097 | )     |         |       | (7,230 | )     |        |       | (1,989 | )     
|                                               | Purchase of company stock for deferred compensation plan                          |                                                      |                                                      | (13    | )     |         |       | (16    | )     |        |       | (18    | )     
|                                               | Increase in deferred compensation obligation                                      |                                                      |                                                      | 13     |       |         |       | 16     |       |        |       | 18     |       
|                                               | Issuance of common stock under stock option plan                                  |                                                      |                                                      | 1,164  |       |         |       | 1,726  |       |        |       | 803    |       
|                                               | Dividends paid on common stock                                                    |                                                      |                                                      | (4,068 | )     |         |       | (4,139 | )     |        |       | (3,935 | )     
|                                               | Tax benefit resulting from dividends paid on unallocated
shares held by the ESOP  |                                                      |                                                      |       |       |         |       | 4      |       |        |       | 7      |       
|                                               |                                                                                   |                                                      |                                                      |        |       |         |       |        |       |        |       |        |       
|                                               |                                                                                   |                                                      | Net cash used in financing activities                |        |       | (11,001 | )     |        |       | (9,639 | )     |        |        | (5,114 | )
|                                               |                                                                                   |                                                      |                                                      |        |       |         |       |        |       |        |       |        |       
|                                               |                                                                                   |                                                      | Net increase (decrease) in cash and cash equivalents |        |       | (2,662  | )     |        |       | 2,135  |       |        |        | 3,721  |  
|Cash and cash equivalents at beginning of year |                                                                                   |                                                      | 6,409                                                |        |       |         | 4,274 |        |       |        | 553   |       
|                                               |                                                                                   |                                                      |                                                      |        |       |         |       |        |       |        |       |        |       
|Cash and cash equivalents at end of year       |                                                                                   | $                                                    | 3,747                                                |        |       | $       | 6,409 |        |       | $      | 4,274 |       
|                                               |                                                                                   |                                                      |                                                      |        |       |         |       |        |       |        |       |        |       

| |  |  | During the years ended December 31, 2003, 2002 and 2001, the Company made cash
payments for income taxes of $32 thousand, $40 thousand and $24 thousand,
respectively, and no payments for interest.                        
| |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | In addition, the Company made cash payments to the state of Delaware for
franchise taxes in the amount of $38 thousand, $38 thousand and $37 thousand
during the years ended December 31, 2003, 2002 and 2001, respectively.



---



##### 





18.     TEN-YEAR
STATISTICAL SUMMARY (UNAUDITED)



|                                     |  |      |       |      |  |      |       |      |  |      |        |   |  |   |        |   |  |   |        |  
|------------------------------------ |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  | ---- | ------ | - |  | - | ------ | - |  | - | ------ | -
|(IN THOUSANDS EXCEPT PER SHARE DATA) |  |      |       |      |  |      |       |      |  |      |        |   |  |   |        |  
|YEARS ENDED DECEMBER 31,             |  | 2003 |       | 2002 |  | 2001 |       | 2000 |  | 1999
|                                     |  |      |       |      |  |      |       |      |  |     
|Net income                           |  | $    | 7,863 |      |  | $    | 9,814 |      |  | $    | 10,759 |   |  | $ | 11,111 |   |  | $ | 11,311 |  
|Diluted earnings per share           |  |      | 1.73  |      |  |      | 2.04  |      |  |      | 2.24   |   |  |   | 2.25   |   |  |   | 2.17   |  
|Cash dividends paid per share        |  |      | 0.92  |      |  |      | 0.88  |      |  |      | 0.84   |   |  |   | 0.79   |   |  |   | 0.74   |  
|Book value per share, at year-end    |  |      | 25.17 |      |  |      | 25.45 |      |  |      | 24.34  |   |  |   | 22.83  |   |  |   | 20.43  |  
|Return on average assets             |  |      | 0.78  | %    |  |      | 0.99  | %    |  |      | 1.13   | % |  |   | 1.20   | % |  |   | 1.20   | %
|Return on average equity             |  |      | 7.08  | %    |  |      | 8.39  | %    |  |      | 9.53   | % |  |   | 10.93  | % |  |   | 10.66  | %
|                                     |  |      |       |      |  |      |       |      |  |      |        |   |  |   |        |   |  |   |        |  

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                     |  |      |        |      |  |      |        |      |  |      |       |   |  |   |       |   |  |   |       |  
|------------------------------------ |  | ---- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ----- | - |  | - | ----- | - |  | - | ----- | -
|(IN THOUSANDS EXCEPT PER SHARE DATA) |  |      |        |      |  |      |        |      |  |      |       |   |  |   |       |   |  |   |       |  
|YEARS ENDED DECEMBER 31,             |  | 1998 |        | 1997 |  | 1996 |        | 1995 |  | 1994
|                                     |  |      |        |      |  |      |        |      |  |     
|Net income                           |  | $    | 10,914 |      |  | $    | 10,167 |      |  | $    | 9,427 |   |  | $ | 8,759 |   |  | $ | 8,185 |  
|Diluted earnings per share           |  |      | 1.98   |      |  |      | 1.85   |      |  |      | 1.72  |   |  |   | 1.56  |   |  |   | 1.42  |  
|Cash dividends paid per share        |  |      | 0.68   |      |  |      | 0.59   |      |  |      | 0.46  |   |  |   | 0.361⁄2 |   |  |   | 0.30  |  
|Book value per share, at year-end    |  |      | 21.05  |      |  |      | 19.38  |      |  |      | 17.17 |   |  |   | 16.56 |   |  |   | 13.39 |  
|Return on average assets             |  |      | 1.17   | %    |  |      | 1.12   | %    |  |      | 1.08  | % |  |   | 1.04  | % |  |   | 0.96  | %
|Return on average equity             |  |      | 10.05  | %    |  |      | 10.51  | %    |  |      | 10.65 | % |  |   | 10.65 | % |  |   | 10.62 | %
|                                     |  |      |        |      |  |      |        |      |  |      |       |   |  |   |       |   |  |   |       |  

19.     QUARTERLY DATA (UNAUDITED)

|                                                    |         |            |       |         |       |         |       |         |       |         |       |         |       |         |        |         |       |   |        |       |       |   |        |       |       |   |        |       |       |   |        |       |       | 
|--------------------------------------------------- | ------- | ---------- | ----- | ------- | ----- | ------- | ----- | ------- | ----- | ------- | ----- | ------- | ----- | ------- | ------ | ------- | ----- | - | ------ | ----- | ----- | - | ------ | ----- | ----- | - | ------ | ----- | ----- | - | ------ | ----- | ----- | 
|                                                    |         | 2003       |       | 2002   
|YEARS ENDED DECEMBER 31,                            |         |            |       |        
|(IN THOUSANDS EXCEPT                                |         | 4th        |       | 3rd     |       | 2nd     |       | 1st     |       | 4th     |       | 3rd     |       | 2nd     |        | 1st    
|PER SHARE DATA)                                     |         | Quarter    |       | Quarter |       | Quarter |       | Quarter |       | Quarter |       | Quarter |       | Quarter |        | Quarter
|                                                    |         |            |       |         |       |         |       |         |       |         |       |         |       |         |        |        
|Interest and dividend income                        |         | $          | 8,690 |         |       | $       | 9,226 |         |       | $       | 9,860 |         |       | $       | 10,361 |         |       | $ | 11,385 |       |       | $ | 11,728 |       |       | $ | 11,950 |       |       | $ | 12,040 |      
|Interest expense                                    |         |            | 3,483 |         |       |         | 3,622 |         |       |         | 4,136 |         |       |         | 4,613  |         |       |   | 5,062  |       |       |   | 5,602  |       |       |   | 5,943  |       |       |   | 6,094  |      
|                                                    |         |            |       |         |       |         |       |         |       |         |       |         |       |         |        |         |       |   |        |       |       |   |        |       |       |   |        |       |       |   |        |      
|Net interest income                                 |         |            | 5,207 |         |       |         | 5,604 |         |       |         | 5,724 |         |       |         | 5,748  |         |       |   | 6,323  |       |       |   | 6,126  |       |       |   | 6,007  |       |       |   | 5,946  |      
|Provision for loan losses                           |         |            | (52   | )       |       |         | (450  | )       |       |         |      |         |       |         |       |         |       |   |       |       |       |   |       |       |       |   |       |       |       |   |       |      
|                                                    |         |            |       |         |       |         |       |         |       |         |       |         |       |         |        |         |       |   |        |       |       |   |        |       |       |   |        |       |       |   |        |      
|Net interest income after
provision for loan losses |         |            | 5,259 |         |       |         | 6,054 |         |       |         | 5,724 |         |       |         | 5,748  |         |       |   | 6,323  |       |       |   | 6,126  |       |       |   | 6,007  |       |       |   | 5,946  |      
|Gains (losses) on securities, net                   |         |            | 335   |         |       |         | 72    |         |       |         | 192   |         |       |         | 40     |         |       |   | (83    | )     |       |   | (50    | )     |       |   | 918    |       |       |   | 933    |      
|Other non-interest income                           |         |            | 346   |         |       |         | 271   |         |       |         | 400   |         |       |         | 266    |         |       |   | 317    |       |       |   | 247    |       |       |   | 318    |       |       |   | 323    |      
|Non-interest expense                                |         |            | 3,204 |         |       |         | 3,133 |         |       |         | 3,229 |         |       |         | 3,049  |         |       |   | 3,085  |       |       |   | 2,930  |       |       |   | 2,987  |       |       |   | 3,035  |      
|                                                    |         |            |       |         |       |         |       |         |       |         |       |         |       |         |        |         |       |   |        |       |       |   |        |       |       |   |        |       |       |   |        |      
|Income before income taxes                          |         |            | 2,736 |         |       |         | 3,264 |         |       |         | 3,087 |         |       |         | 3,005  |         |       |   | 3,472  |       |       |   | 3,393  |       |       |   | 4,256  |       |       |   | 4,167  |      
|Income tax expense                                  |         |            | 941   |         |       |         | 1,127 |         |       |         | 1,101 |         |       |         | 1,060  |         |       |   | 1,220  |       |       |   | 1,183  |       |       |   | 1,554  |       |       |   | 1,517  |      
|                                                    |         |            |       |         |       |         |       |         |       |         |       |         |       |         |        |         |       |   |        |       |       |   |        |       |       |   |        |       |       |   |        |      
|                                                    |         | Net income |       | $       | 1,795 |         |       | $       | 2,137 |         |       | $       | 1,986 |         |        | $       | 1,945 |   |        | $     | 2,252 |   |        | $     | 2,210 |   |        | $     | 2,702 |   |        | $     | 2,650 | 
|                                                    |         |            |       |         |       |         |       |         |       |         |       |         |       |         |        |         |       |   |        |       |       |   |        |       |       |   |        |       |       |   |        |      
|Earnings
per share (in dollars):(1)                
|                                                    | Basic   | $          | 0.41  |         |       | $       | 0.49  |         |       | $       | 0.45  |         |       | $       | 0.43   |         |       | $ | 0.48   |       |       | $ | 0.47   |       |       | $ | 0.57   |       |       | $ | 0.56   |      
|                                                    | Diluted |            |       | 0.40    |       |         |       | 0.48    |       |         |       | 0.44    |       |         |        | 0.42    |       |   |        | 0.47  |       |   |        | 0.46  |       |   |        | 0.56  |       |   |        | 0.55  |      
|                                                    |         |            |       |         |       |         |       |         |       |         |       |         |       |         |        |         |       |   |        |       |       |   |        |       |       |   |        |       |       |   |        |      
|Weighted average common
shares outstanding:(1)     
|                                                    | Basic   |            | 4,397 |         |       |         | 4,378 |         |       |         | 4,428 |         |       |         | 4,557  |         |       |   | 4,665  |       |       |   | 4,670  |       |       |   | 4,724  |       |       |   | 4,734  |      
|                                                    | Diluted |            |       | 4,523   |       |         |       | 4,490   |       |         |       | 4,531   |       |         |        | 4,637   |       |   |        | 4,775 |       |   |        | 4,795 |       |   |        | 4,860 |       |   |        | 4,862 |      
|                                                    |         |            |       |         |       |         |       |         |       |         |       |         |       |         |        |         |       |   |        |       |       |   |        |       |       |   |        |       |       |   |        |      



---

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



---



##### 





| |  |  | MASSBANK CORP. AND SUBSIDIARIES STOCKHOLDER DATA                                                                                                                                                                                                                                                                            
| |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | YEARS ENDED DECEMBER 31, 2003 AND 2002                                                                                                                                                                                                                                                                                      
|
| |  |  | MASSBANK Corp.s common stock is currently traded on the Nasdaq Stock Market
under the symbol MASB. At December 31, 2003 there were 4,407,453 shares
outstanding and 803 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 closing
sales prices for the common stock, as reported by Nasdaq, and dividends
declared per share for the periods indicated.                                                                                                                             

|                        |  |                 |       |           |  |  |  |     |  |          |       |  |  |   |      | 
|----------------------- |  | --------------- | ----- | --------- |  |  |  | --- |  | -------- | ----- |  |  | - | ---- | 
|                        |  | Price per Share |       | Cash     
|                        |  |                 |       | Dividends
|                        |  | High            |       |           |  |  |  | Low |  | Declared
|                        |  |                 |       |           |  |  |  |     |  |         
|YEAR
ENDED DECEMBER 31, |  | 2003            |       |           |  | 
|Fourth Quarter          |  | $               | 44.27 |           |  |  |  |     |  | $        | 37.23 |  |  | $ | 0.23 | 
|Third Quarter           |  |                 | 37.72 |           |  |  |  |     |  |          | 31.91 |  |  |   | 0.23 | 
|Second Quarter          |  |                 | 36.20 |           |  |  |  |     |  |          | 27.47 |  |  |   | 0.23 | 
|First Quarter           |  |                 | 28.90 |           |  |  |  |     |  |          | 27.50 |  |  |   | 0.23 | 

|                        |  |      |       |  |  |  |  |  |  |   |       |  |  |   |      | 
|----------------------- |  | ---- | ----- |  |  |  |  |  |  | - | ----- |  |  | - | ---- | 
|YEAR
ENDED DECEMBER 31, |  | 2002 |       |  |  | 
|Fourth Quarter          |  | $    | 31.40 |  |  |  |  |  |  | $ | 27.37 |  |  | $ | 0.22 | 
|Third Quarter           |  |      | 34.93 |  |  |  |  |  |  |   | 27.70 |  |  |   | 0.22 | 
|Second Quarter          |  |      | 35.38 |  |  |  |  |  |  |   | 28.90 |  |  |   | 0.22 | 
|First Quarter           |  |      | 31.50 |  |  |  |  |  |  |   | 23.73 |  |  |   | 0.22 | 



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##### 



MASSBANK BRANCH OFFICES d/b/a

MASSBANK of Reading*
123
Haven Street
Reading, MA 01867
(781) 942-8188
(978) 446-9200 MASSBANK
of Chelmsford
291 Chelmsford Street
Chelmsford, MA 01824
(978) 256-3751 
17
North Road
Chelmsford, MA 01824
(978) 256-3733 MASSBANK
of Dracut
45 Broadway Road
Dracut, MA 01826
(978) 441-0040 MASSBANK
of Everett
738 Broadway
Everett, MA 02149
(617) 387-5115 MASSBANK
of Lowell
50 Central Street
Lowell, MA 01852
(978) 446-9200 
755
Lakeview Avenue
Lowell, MA 01850
(978) 446-9216 MASSBANK
of Medford
4110 Mystic Valley Parkway
Wellington Circle Plaza
Medford, MA 02155
(781) 395-4899 MASSBANK
of Melrose
476 Main Street
Melrose, MA 02176
(781) 662-0100 
27
Melrose Street
Towers Plaza
Melrose, MA 02176
(781) 662-0165 MASSBANK
of Stoneham
240 Main Street
Stoneham, MA 02180
(781) 662-0177 MASSBANK
of Tewksbury
1800 Main Street
Tewksbury, MA 01876
(978) 851-0300 MASSBANK
of Westford
203 Littleton Road
Westford, MA 01886
(978) 692-3467 MASSBANK
of Wilmington
370 Main Street
Wilmington, MA 01887
(978) 658-4000 
219
Lowell Street
Luccis Plaza
Wilmington, MA 01887
(978) 658-5775



|* |  | Main Office
|- |  | -----------



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##### 



9

CORPORATE INFORMATION

Massbank Corp.
123 Haven Street
Reading, MA 01867
(781) 662-0100
(978) 446-9200
FAX (781) 942-1022

Savings and Mortgage
24-Hour-Rate Lines
(781) 662-0154
(978) 446-9285

Notice of Shareholders Meeting
The Annual Meeting of the
Shareholders of Massbank Corp.
will be held at 10:00 A.M.
on Tuesday, April 20, 2004 at the
Sheraton Ferncroft Resort
50 Ferncroft Road
Danvers, MA 01923

Trademark
Massbank and its logo are
registered trademarks of
the Company

Form 10-K
Shareholders may obtain without
charge a copy of the Companys
2003 Form 10-K. Written requests
should be addressed to:
Shareholder Services
Massbank Corp.
159 Haven Street
Reading, MA 01867

Dividend Reinvestment and
Stock Purchase Plan
Shareholders may obtain a brochure
containing a detailed description of
the plan by writing to:
Shareholder Services
Massbank Corp.
159 Haven Street
Reading, MA 01867

Transfer Agent
American Stock Transfer &
Trust Company
59 Maiden Lane
New York, NY 10038
(800) 937-5449
(877) 777-0800
Website address:
www.amstock.com

Independent Auditors
KPMG LLP
99 High Street
Boston, MA 02110

Legal Counsel
Goodwin Procter LLP
Exchange Place
Boston, MA 02109



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##### 



OFFICERS AND DIRECTORS
MASSBANK CORP.

OFFICERS

Gerard H. BrandiChairman, President and
Chief Executive Officer

Reginald E. CormierSenior Vice President, Treasurer and
Chief Financial Officer

Robert S. CummingsSecretary

Donna H. WestAssistant Secretary

BOARD OF DIRECTORS

*Mathias B. BedellRetired, Bedell Brothers Insurance
Agency, Inc.

*Gerard H. BrandiChairman, President and
Chief Executive Officer,
Massbank Corp.

Allan S. BufferdTreasurer,
Massachusetts Institute of Technology

Kathleen M. CamilliU.S. Economist
Credit Suisse Asset Management, LLC

Peter W. CarrRetired, Guilford Transportation
Industries

Alexander S. CostelloTeacher, Brooks School

*Robert S. CummingsSenior Counsel,
Nixon Peabody LLP

Leonard LapidusBanking and Bank Regulation
Consultant

*Stephen E. MarshallRetired, C.H. Cleaves Insurance
Agency, Inc.

Nancy L. PettinelliExecutive Director,
Visiting Nurse Association

*Herbert G. SchurianCertified Public Accountant

*Dr. Donald B. StackhouseRetired, Dental Health Concepts



---

|* |  | Member, Executive Committee
|- |  | ---------------------------
| 
|  |  | Member, Audit Committee   

OFFICERS AND DIRECTORS
MASSBANK

OFFICERS

Gerard H. BrandiChairman, President and
Chief Executive Officer

Donald R. WashburnSenior Vice President, Lending

Donna H. WestSenior Vice President,
Community Banking

Reginald E. CormierSenior Vice President, Treasurer
and Chief Financial Officer

David F. CarrollVice President, Operations

Richard J. FlanniganVice President and
Senior Trust Officer

Thomas J. QueeneyVice President and
Senior Trust Officer

Marilyn H. AbbottAssistant Treasurer

Carol A. AxelrodLoan Officer

Kathleen M. BaldassariAssistant Treasurer

Kenneth R. BerardAssistant Treasurer

David M. BiancoAssistant Treasurer

Andrea S. BradfordAssistant Vice President

Melanie M. BuckinghamAssistant Treasurer

Ernest G. Campbell, Jr.Collections Officer

Marianne J. CarpenterAssistant Vice President

Lisa A. DiCiccoTrust Operations Officer

Claudeia F. DowningAssistant Treasurer

Karen L. FlammiaAssistant Vice President

Scott M. ForbesMortgage Origination Officer

Rachael E. GarneauAssistant Treasurer

Martin J. HeneghanAssistant Comptroller

Brian W. HurleyAssistant Vice President

Kimberly A. JudgeAssistant Treasurer

Anne M. LeeDirector of Human Resources

Kenneth A. MassonAssistant Vice President,
Marketing

Davia A. MelloInformation Technology Officer

Laura M. OConnorAssistant Treasurer

Erik C. OlsonAuditor and
Compliance Officer

Joseph P. OreficeInformation Technology Officer

Karen L. ORourkeAssistant Treasurer

Joseph D. ReganComptroller

Charles E. SamourSecurity Officer

Margaret E. WhiteAssistant Treasurer

Patricia A. WittsAssistant Treasurer

Michael J. WoodsAssistant Vice President

BOARD OF DIRECTORS
AND
EXECUTIVE COMMITTEE

Mathias B. Bedell
Gerard H. Brandi, Chairman
Robert S. Cummings, Clerk
Stephen E. Marshall
Herbert G. Schurian
Dr. Donald B. Stackhouse
Donna H. West