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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

For the quarterly period ended March 31, 2003

OR

For the transition period from            to            

Commission File Number 0-15137

MASSBANK Corp.

(Exact name of registrant as specified in its charter)

123 HAVEN STREET

Reading, Massachusetts 01867

(Address of principal executive offices, including Zip Code)

Registrant’s telephone number, including area code:  (781) 662-0100

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12(b)-2 of the Exchange Act). Yes  x  No  ¨

The number of shares outstanding of the issuer’s classes of common stock, as of the latest practicable date is:

Class: Common stock $1.00 per share.

Outstanding at April 30, 2003: 4,386,174 shares.

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MASSBANK CORP. AND SUBSIDIARIES

INDEX

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MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands except share data)

See accompanying condensed notes to consolidated financial statements.

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MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

See accompanying condensed notes to consolidated financial statements.

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MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For The Three Months Ended March 31, 2003 (unaudited)

(In thousands except share data)

See accompanying condensed notes to consolidated financial statements.

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MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For The Three Months Ended March 31, 2002 (unaudited)

(In thousands except share data)

See accompanying condensed notes to consolidated financial statements.

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MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

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MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(unaudited)

See accompanying condensed notes to consolidated financial statements.

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MASSBANK CORP.

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(1) Basis of Presentation

The financial condition and results of operations of MASSBANK Corp. (the “Company”) essentially reflect the operations of its subsidiary, MASSBANK (the “Bank”). All significant intercompany balances and transactions have been eliminated in consolidation.

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and in the opinion of management, include all adjustments of a normal recurring nature necessary for the fair presentation of the financial condition of the Company as of March 31, 2003 and December 31, 2002, and its operating results for the three months ended March 31, 2003 and 2002. The results of operations for any interim period are not necessarily indicative of the results to be expected for the entire year.

Certain amounts in the prior years’ consolidated financial statements were reclassified to facilitate comparison with the current fiscal year. The Company’s reported per share amounts and weighted average common shares outstanding for the current and prior year have been restated to reflect the Company’s three-for-two stock split of April 19, 2002.

The information in this report should be read in conjunction with the financial statements and related notes included in the Annual Report on Form 10-K for the year ended December 31, 2002.

(2) Recent Accounting Pronouncements:

In December 2002, Statement of Financial Accounting Standards (“SFAS”) 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 SFAS 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. This statement was effective for MASSBANK Corp. beginning with the fiscal period ending December 31, 2002. Because the Company plans to continue its accounting for stock-based compensation using the intrinsic-value based method of accounting, the adoption of SFAS No. 148 is not expected to have a material impact on results of operations or financial position. See Note 8 of the Condensed Notes to the Consolidated Financial Statements for required disclosure.

(3) 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.

(4) Short-Term Investments

Short-term investments consist of the following:

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CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(continued)

The investments above are stated at cost which approximates market value and have original maturities of less than 90 days.

(5) Commitments

At March 31, 2003, the Company had outstanding commitments to originate mortgage loans and to advance funds for construction loans amounting to $5,315,000 and commitments under existing home equity lines of credit and other loans of approximately $41,733,000 which are not reflected on the consolidated balance sheet.

(6) 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 quarter reduced by the weighted average number of unallocated shares held by the Employee Stock Ownership Plan (“ESOP”). Diluted EPS reflects the effect on the weighted average shares outstanding of the number of additional shares outstanding if dilutive stock options were converted into common stock using the treasury stock method.

The treasury shares acquired in connection with the Company’s directors deferred compensation plan are considered outstanding in the computation of earnings per share and book value per share.

Earnings per share was calculated as follows:

(7) 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 (1) their attaining the age of 72, or (2) their termination as a director of the Company. The plan was later amended to allow the directors’ compensation to be invested in Company stock held in an irrevocable trust. At March 31, 2003 the trust held 24,700 shares of MASSBANK Corp. common stock that the Company has classified as treasury stock. The treasury shares are considered outstanding in the computation of earnings per share and book value per share.

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CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(8) Stock-Based Employee Compensation

MASSBANK Corp. utilizes stock options to compensate its officers and non-employee directors under the, shareholder approved, 1994 Stock Incentive Plan (“the Plan”). Under the Plan, options to purchase MASSBANK Corp. common stock have been granted to bank officers and non-employee directors of the Company at prices equal to the fair market value of the underlying stock on the dates the options were granted. The options are 100% vested at date of grant, and expire in 10 years. The Company accounts for the Plan using the intrinsic-value based method of accounting. Since all options granted under the Plan had an exercise price equal to the market value of the underlying common stock on the date of grant, the granting of the options had no impact on net income. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value method for stock-based employee compensation.

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CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(9) 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 three months ended March 31, 2003 and 2002 is as follows:

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PART I. ITEM 2

MASSBANK CORP. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION & ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

March 31, 2003

Forward-Looking Statement Disclosure.

This Form 10-Q 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. The Company may also make written or oral forward-looking statements in other documents filed with the Securities and Exchange Commission (“SEC”), in annual reports to stock-holders, in press releases and other written materials, and in oral statements made by the Company’s officers, directors or employees. You can identify forward-looking statements by the use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” “will,” “should,” and other expressions which predict or indicate future events and trends and which do not relate to historical matters. 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, uncertainties and other factors including but not limited to the following:

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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

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

Investment Securities Other Than Temporarily Impaired

Management judgment is involved in evaluating the nature of declines in value of individual investment securities held by the Company. Declines that are deemed other than temporary are recognized in the income statement through write-downs in the recorded value of the affected securities. Management considers many factors in their analysis, such as the financial condition, earnings capacity and near term prospects of the company in which MASSBANK has invested and the length of time and extent to which market value has been less than cost. Whenever a debt or equity security is deemed to be “other than temporarily impaired” due to a fundamental deterioration in its financial condition as determined by management’s analysis, it is written down to its current fair market value. If “due to general market conditions” an investment security declines in price by a certain percentage from its cost for more than a specified period of time, it is written down to its current fair market value. Any unfavorable change in general market conditions could cause an increase in the Company’s impairment write downs of investment securities. This would have an adverse effect on the Company’s earnings results.

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Results of Operations for the three months ended March 31, 2003

GENERAL

For the quarter ended March 31, 2003, MASSBANK Corp. reported net income of $1,945,000, or $0.42 in diluted earnings per share compared to net income of $2,650,000 or $0.55 in diluted earnings per share in the first quarter of 2002. Basic earnings per share in the recent quarter were $0.43 per share compared to $0.56 per share in the first quarter of the prior year.

The decrease in the Company’s net income in the first quarter 2003 compared to the same quarter of 2002 is primarily due to a decrease in securities gains of $893,000 due to the poor performance of the stock markets and the impact on the Company’s equity investments. Earnings results also reflect a decrease in net interest income of $198,000 due to the continued pressure on the Company’s net interest margin resulting from low interest rates. First quarter 2003 earnings results reflect a decrease in other non-interest income of $57,000 and an increase in non-interest expense of $14,000 partially offset by a decrease in income tax expense of $457,000 due to lower income before taxes and a decline in the Company’s effective income tax rate.

Net interest income

Net interest income totaled $5,748,000 in the first quarter of 2003, a decrease of $198,000 from the same quarter a year ago. This decrease was principally attributable to a decline in net interest margin, partially offset by the positive effect of average earning asset growth. Net interest margin represents the relationship between net interest income and average earning assets. Net interest margin is affected by several factors, including fluctuations in the overall interest rate environment, funding strategies, and the mix of interest earning assets and interest bearing liabilities. The Company’s net interest margin for the three months ended March 31, 2003 was 2.33%, a decrease from 2.49% reported in the first quarter of 2002. Average earning assets for the quarter ended March 31, 2003 increased $31.2 million to $989.5 million, from $958.3 million in the same quarter of 2002.

Interest and Dividend Income

Interest and dividend income on a fully taxable equivalent basis for the three months ended March 31, 2003, decreased $1,681,000 or 13.9% to $10,382,000 from $12,063,000 for the three months ended March 31, 2002. The decrease in interest and dividend income resulted from a decrease in yield on the Company’s average earning assets, partially offset by the higher interest income resulting from an increase of $31.2 million in average earning assets. As reflected in the table on page 16 of this report, the yield on the Company’s average earning assets in the first quarter of 2003 was 4.20%, down from 5.04% in the same quarter of 2002. The reduction in yield on the Company’s average earning assets is primarily attributable to lower market interest rates.

Interest Expense

Total interest expense for the three months ended March 31, 2003 decreased $1,481,000, or 24.3% to $4,613,000 from $6,094,000 for the three months ended March 31, 2002. The decrease in interest expense is due primarily to a reduction in the Bank’s average cost of funds, partially offset by an increase in interest expense due to higher average deposits. A decrease in the Bank’s deposit rates, due to declining market interest rates in the last twelve months, caused the Bank’s cost of funds to decrease 78 basis points, from 2.89% in the first quarter of 2002 to 2.11% in the recent quarter. The Company’s average deposits, as shown in the table on page 17, increased $31.9 million to $888.2 million in the first quarter of 2003, from $856.3 million in the first quarter of 2002.

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