10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20529

FORM 10-Q

þ Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934

For the quarterly period ended September 30, 2006

o Transition Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934

For the transition period from                      to                      

Commission File Number 000-32955

LSB Corporation

(Exact name of Registrant as specified in its Charter)

Massachusetts	04-3557612
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

30 Massachusetts Avenue, North Andover, MA	01845
(Address of principal executive offices)	(Zip Code)

(978) 725-7500
(Registrant’s telephone number, including area code)

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 report), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ     No o

Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one).

Large Accelerated Filer o     Accelerated Filer o     Non-Accelerated Filer þ     

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o     No þ 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

Class	Outstanding as of November 2, 2006
Common Stock, par value $.10 per share	4,573,117 shares

LSB CORPORATION AND SUBSIDIARY

INDEX

		Page:
	PART I — FINANCIAL INFORMATION
ITEM 1	FINANCIAL STATEMENTS
	Consolidated Balance Sheets		3
	Consolidated Statements of Income		4
	Consolidated Statements of Changes in Stockholders’ Equity		5
	Consolidated Statements of Cash Flows		6
	Notes to Consolidated Financial Statements		7-11
ITEM 2	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		11-23
ITEM 3	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK		23
ITEM 4	CONTROLS AND PROCEDURES		23
	PART II — OTHER INFORMATION
ITEM 1	LEGAL PROCEEDINGS		24
ITEM 1A	RISK FACTORS		24
ITEM 2	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		24
ITEM 3	DEFAULTS UPON SENIOR SECURITIES		24
ITEM 4	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		24
ITEM 5	OTHER INFORMATION		24
ITEM 6	EXHIBITS		24
SIGNATURES			25
EXHIBIT INDEX			26
EX-31.1 Certification of CEO Section 302
EX-31.2 Certification of CFO Section 302
EX-32.1 Certification of CEO Section 1350, as added by Section 906
EX-32.2 Certification of CFO Section 1350, as added by Section 906

2

PART 1 — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

	September 30,			December 31,
	2006			2005
	(In thousands, except share data)
ASSETS
Assets:
Cash and due from banks	$	9,018		$	10,489
Federal funds sold		2,354			198
Total cash and cash equivalents		11,372			10,687
Investment securities held to maturity (market value of $208,615 in 2005)		—			213,683
Investment securities available for sale (amortized cost of $231,701 in 2006 and $47,554 in 2005)		228,384			46,363
Federal Home Loan Bank stock, at cost		9,347			10,097
Loans, net of allowance for loan losses		260,372			230,485
Bank premises and equipment		3,665			3,251
Accrued interest receivable		2,290			2,458
Current income tax receivable		328			—
Deferred income tax asset		4,488			3,446
Other assets		1,339			1,330
Total assets	$	521,585		$	521,800
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits	$	301,810		$	303,087
Borrowed funds		157,377			153,380
Advance payments by borrowers for taxes and insurance		636			506
Other liabilities		4,650			4,905
Total liabilities		464,473			461,878
Stockholders’ equity:
Preferred stock, $.10 par value per share:
5,000,000 shares authorized, none issued		—			—
Common stock, $.10 par value per share; 20,000,000 shares authorized; 4,573,117 and 4,464,033 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively		457			446
Additional paid-in capital		61,190			59,856
Retained earnings (accumulated deficit)		(2,449	)		326
Accumulated other comprehensive loss, net of tax		(2,086	)		(706	)
Total stockholders’ equity		57,112			59,922
Total liabilities and stockholders’ equity	$	521,585		$	521,800

The accompanying notes are an integral part of these unaudited Consolidated Financial Statements.

3

LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

	Three months ended				Nine months ended
	Sept. 30,				Sept. 30,
	2006		2005		2006			2005
			(In thousands, except share data)
Interest and dividend income:
Loans	$	4,568	$	3,789	$	12,794		$	11,066
Investment securities held to maturity		—		2,078		1,925			6,136
Investment securities available for sale		2,631		465		5,805			1,505
Federal Home Loan Bank stock		273		108		404			299
Short term interest income		81		27		207			65
Total interest and dividend income		7,553		6,467		21,135			19,071
Interest expense:
Deposits		1,990		1,339		5,238			3,595
Borrowed funds		1,934		1,673		5,670			4,936
Total interest expense		3,924		3,012		10,908			8,531
Net interest income		3,629		3,455		10,227			10,540
Provision for loan losses		30		—		60			—
Net interest income after provision for loan losses		3,599		3,455		10,167			10,540
Non-interest income (loss):
Loan servicing fees		24		33		66			109
Deposit account fees		188		220		586			639
Gain on sales of mortgage loans, net		—		13		6			35
Loss on sales of investment securities		—		—		(2,417	)		—
Other income		115		115		341			350
Total non-interest income (loss)		327		381		(1,418	)		1,133
Non-interest expense:
Salaries and employee benefits		1,656		1,524		5,660			4,708
Occupancy and equipment expenses		263		229		1,087			708
Data processing expenses		250		230		745			668
Marketing expenses		18		70		473			230
Professional expenses		113		111		464			407
Other expenses		345		343		1,588			1,127
Total non-interest expenses		2,645		2,507		10,017			7,848
Income (loss) before income tax expense (benefit)		1,281		1,329		(1,268	)		3,825
Income tax expense (benefit)		473		472		(394	)		1,351
Net income (loss)	$	808	$	857	$	(874	)	$	2,474
Average shares outstanding		4,559,260		4,455,652		4,531,934			4,415,223
Common stock equivalents		38,123		76,434		49,256			108,213
Average diluted shares outstanding		4,597,383		4,532,086		4,581,190			4,523,436
Basic earnings (loss) per share	$	0.18	$	0.19	$	(0.19	)	$	0.56
Diluted earnings (loss) per share	$	0.18	$	0.19	$	(0.19	)	$	0.55

The accompanying notes are an integral part of these unaudited Consolidated Financial Statements

4

LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2005 AND THE
NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)

					(Accumulated			Accumulated
			Additional		Deficit)/			Other			Total
	Common		Paid-In		Retained			Comprehensive			Stockholders’
	Stock		Capital		Earnings			Loss			Equity
	(In thousands, except per share data)
Balance at December 31, 2004	$	434	$	59,145	$	(1,347	)	$	(394	)	$	57,838
Net income		—		—		4,157			—			4,157
Other comprehensive income:
Unrealized loss on securities available for sale, net (tax effect $211)		—		—		—			(312	)		(312	)
Total comprehensive income												3,845
Exercise of stock options		12		500		—			—			512
Tax benefit of stock options exercised		—		211		—			—			211
Dividends declared and paid ($0.56 per share)		—		—		(2,484	)		—			(2,484	)
Balance at December 31, 2005	$	446	$	59,856	$	326		$	(706	)	$	59,922

					(Accumulated			Accumulated
			Additional		Deficit)/			Other			Total
	Common		Paid-In		Retained			Comprehensive			Stockholders’
	Stock		Capital		Earnings			Loss			Equity
	(In thousands, except per share data)
Balance at December 31, 2005	$	446	$	59,856	$	326		$	(706	)	$	59,922
Net loss		—		—		(874	)		—			(874	)
Other comprehensive income:
Unrealized loss on securities available for sale, net (tax effect $746)		—		—		—			(1,380	)		(1,380	)
Total comprehensive loss												(2,254	)
Stock-based compensation		—		95		—			—			95
Exercise of stock options		11		1,148		—			—			1,159
Tax benefit of stock options exercised		—		91		—			—			91
Dividends declared and paid ($0.42 per share)		—		—		(1,901	)		—			(1,901	)
Balance at September 30, 2006	$	457	$	61,190	$	(2,449	)	$	(2,086	)	$	57,112

The accompanying notes are an integral part of these unaudited Consolidated Financial Statements.

5

LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

	Nine months ended September 30,
	2006			2005
	(In thousands)
Cash flows from operating activities:
Net income (loss)	$	(874	)	$	2,474
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan loss		60			—
Gains on sales of mortgage loans		(6	)		(35	)
Losses on sales of investment securities available for sale		2,417			—
Net amortization of investment securities		577			1,123
Depreciation of premises and equipment		496			330
Loans originated for sale		(1,043	)		(3,437	)
Proceeds from sales of mortgage loans		1,521			3,322
Decrease in accrued interest receivable		168			134
Deferred income tax benefit		(296	)		(222	)
Stock-based compensation		95			—
Tax benefit from exercise of stock options		—			211
(Increase) decrease in other assets		(337	)		224
Increase in advance payments by borrowers		130			122
Decrease in other liabilities		(255	)		(172	)
Net cash provided by operating activities		2,653			4,074
Cash flows from investing activities:
Proceeds from maturities of investment securities held to maturity		2,900			47,970
Proceeds from maturities of investment securities available for sale		11,500			25,000
Sales of investment securities available for sale		78,457			—
Purchases of investment securities held to maturity		—			(65,952	)
Purchases of mortgage-backed securities held to maturity		—			(23,971	)
Purchases of investment securities available for sale		(20,265	)		(14,198	)
Purchases of mortgage-backed securities available for sale		(63,545	)		—
Purchase of other equity securities available for sale		(107	)		(72	)
Purchases of Federal Home Loan Bank stock		—			(2,210	)
Redemption of FHLB stock		750			—
Principal payments of investment securities held to maturity		4,680			19,697
Principal payments of investment securities available for sale		12,922			3,959
Increase in loans, net		(30,419	)		(877	)
Purchases of Bank premises and equipment		(910	)		(176	)
Net cash used in investing activities		(4,037	)		(10,830	)
Cash flows from financing activities:
Net (decrease) increase in deposits		(1,277	)		9,370
Additions to Federal Home Loan Bank advances		37,000			48,900
Payments on Federal Home Loan Bank advances		(55,308	)		(32,103	)
Net increase in agreements to repurchase securities		1,305			686
Net increase (decrease) in other borrowed funds		21,000			(13,000	)
Dividends paid		(1,901	)		(1,859	)
Proceeds from exercise of stock options		1,159			512
Excess tax benefit from exercise of stock options		91			—
Net cash provided by financing activities		2,069			12,506
Net increase in cash and cash equivalents		685			5,750
Cash and cash equivalents, beginning of period		10,687			7,402
Cash and cash equivalents, end of period	$	11,372		$	13,152
Cash paid during the period for:
Interest on deposits	$	5,233		$	3,601
Interest on borrowed funds		5,588			4,918
Income taxes		906			1,810
Cash received during the year for:
Income taxes		192			215
Supplemental schedule of non-cash activities:
Change in valuation of investment securities available for sale, net		(1,380	)		(310	)

The accompanying notes are an integral part of these unaudited Consolidated Financial Statements.

6

LSB CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)

1. BASIS OF PRESENTATION

LSB Corporation (the “Corporation” or the “Company”) is a Massachusetts corporation and the holding company of its wholly-owned subsidiary River Bank (the “Bank”), a state-chartered Massachusetts savings bank, formerly known as Lawrence Savings Bank and organized in 1868. The Corporation was organized by the Bank on July 1, 2001 to be a bank holding company and to acquire all of the capital stock of the Bank.

The Corporation is supervised by the Board of Governors of the Federal Reserve System (“FRB”), and it is also subject to the jurisdiction of the Massachusetts Division of Banks, while the Bank is subject to the regulations of, and periodic examination by, the Federal Deposit Insurance Corporation (“FDIC”) and the Massachusetts Division of Banks. The Bank’s deposits are insured by the Deposit Insurance Fund of the FDIC up to $100,000 per account, as defined by the FDIC (except for certain retirement accounts which are insured up to $250,000), and the Depositors Insurance Fund (“DIF”) of Massachusetts, a private industry-sponsored insurer, for customer deposit amounts in excess of FDIC insurance limits. The Consolidated Financial Statements include the accounts of LSB Corporation and its wholly-owned consolidated subsidiary, River Bank, and the Bank’s wholly-owned subsidiaries, Shawsheen Security Corporation, Shawsheen Security Corporation II, Pemberton Corporation, and Spruce Wood Realty Trust. All inter-company balances and transactions have been eliminated in consolidation. The Company has one reportable operating segment. In the opinion of management, the accompanying Consolidated Financial Statements reflect all necessary adjustments consisting of normal recurring accruals for fair presentation. Certain amounts in prior periods have been re-classified to conform to the current presentation.

The Corporation’s Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America. Accordingly, management is required to make estimates and assumptions that affect amounts reported in the balance sheets and statements of income. Actual results could differ significantly from those estimates and judgments. A material estimate that is particularly susceptible to change relates to the allowance for loan losses.

The interim results of consolidated income are not necessarily indicative of the results for any future interim period or for the entire year. These interim Consolidated Financial Statements do not include all disclosures associated with annual financial statements and, accordingly, should be read in conjunction with the annual Consolidated Financial Statements and accompanying notes included in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2005 filed with the Securities and Exchange Commission.

2. STOCK OPTIONS

The following table presents the amount of cumulatively granted options and restricted stock awards, net of cancellations, through September 30, 2006:

					Cumulative
					Awards, Net of
	Authorized Option Awards		Stock Awards		Expirations
1986 Plan		720,500		N/A		430,250
1997 Plan		449,500		N/A		427,850
2006 Plan		400,000				—
		1,570,000				858,100

At September 30, 2006, there were no shares available for grant under either the 1986 Plan due to its expiration or the 1997 Plan due to all authorized awards being granted by December 31, 2005. Of the authorized awards under the 1997 Plan, subsequent forfeitures by former participants allowed an additional 10,425 options to become available to issue under future grants during the third quarter of 2006. Under all plans, the option exercise price equals the fair market value on the date of grant. All options granted under the 1986 and 1997 Plans vested over three years from the date of grant and have ten-year contractual terms. Options granted under these plans expire

7

between 2006 and 2015. The Company issues shares for option exercises and restricted stock issuances from its pool of authorized but unissued shares. The 2006 Stock Option Plan was approved by shareholders on May 2, 2006. No options were granted under the 2006 Plan during the first nine months of 2006.

Prior to January 1, 2006, the Company accounted for its stock-based plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related interpretations, as permitted by Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). No compensation cost was recognized for stock options in the Consolidated Statement of Income for the periods ended on or prior to December 31, 2005, as options granted under those plans had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB Statement No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”) for all share-based payments, using the modified prospective transition method. Under this transition method, compensation cost recognized in the nine months ended September 30, 2006 includes: (1) compensation expense recognized over the requisite service period for all share-based awards granted prior to, but not yet fully vested, as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (2) compensation cost for all share-based awards granted on or subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R, of which the Company has none to date. In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R or SFAS 123. Upon adoption of SFAS 123R, the Company elected to retain its method of valuation for share-based awards granted using the Black-Scholes option-pricing model which was also previously used for the Company’s pro forma information required under SFAS 123. The Company is recognizing compensation expense for its awards on a straight-line basis over the requisite service period for the entire award (straight-line attribution method), ensuring that the amount of compensation cost recognized at any date at least equals the portion of the grant-date fair value of the award that is vested at that time.

The total compensation expense before tax recognized in earnings by the Company in the nine months ended September 30, 2006 was approximately $95,000.

As required, prior to the adoption of SFAS 123R, the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Consolidated Statement of Cash Flows. SFAS 123R requires the cash flows resulting from the tax benefits from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. Therefore, the Company had $91,000 of excess tax benefits classified as a financing cash inflow during the nine months ended September 30, 2006.

Cash received from stock option exercises for the nine months ended September 30, 2006 and 2005 was approximately $1.2 million and $512,000, respectively. The actual tax benefit realized for the tax deductions from option exercises under all plans totaled $91,000 and $211,000, respectively, for the nine months ended September 30, 2006 and 2005. No cash was used by the Company to settle equity instruments granted under share-based compensation arrangements during the nine months ended September 30, 2006 and 2005.

For purposes of pro forma disclosures for periods prior to January 1, 2006, the estimated fair value of the stock options is amortized to expense over the vesting period of the options. The Company’s net income and earnings per share for the quarter ended September 30, 2005, had the Company elected to recognize compensation expense for the granting of options under SFAS 123 using the Black-Scholes option pricing model would have been reduced to the following pro forma amounts:

8

	Three months ended			Nine months ended
	9/30/05			9/30/05
	(In thousands, except share data)
Net income:
As reported	$	857		$	2,474
Less: pro forma stock based compensation cost (net of taxes)		(31	)		(91	)
Pro forma	$	826		$	2,383
Basic earnings per share:
As reported	$	0.19		$	0.56
Pro forma		0.19			0.54
Diluted earnings per share:
As reported	$	0.19		$	0.55
Pro forma		0.18			0.53

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2005: expected volatility of 23.8%, expected average life of 4.3 years, risk-free interest rate of 3.8% and expected dividend yield of 3.21%.

A summary of the status of the Company’s 2006 Plan, 1997 Plan and 1986 Plan for the nine months ended September 30, 2006 is presented in the table below:

	2006
				Weighted		Wtd. Avg.		Aggregate
				Average		Remaining		Intrinsic
	Option			Exercise		Contractual		Value
	Shares			Price ($)		Term (years)		($000)
Balance, January 1		349,100		$	12.88		5.4
Granted		—			—		—
Exercised		(127,275	)	$	11.59		5.2
Forfeited		(10,425	)	$	16.77		7.7
Expired		—			—		—
Balance, September 30		211,400		$	13.46		5.4	$	748
Options exercisable at Sept. 30		193,325		$	13.14		5.2	$	746
Weighted average grant date fair value of options granted		n/a			n/a

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the average of the high price and low price at which the Company’s common stock traded on September 30, 2006 of $17.00, which would have been received by the option holders had all option holders exercised their options as of that date.

A summary of the status of the Company’s nonvested stock options as of September 30, 2006 and changes during the nine months then ended is presented in the table below:

	Nonvested Shares Issued Under the Plans
	Stock Options
				Weighted
				Average
				Grant Date
	Shares			Fair Value
Nonvested at January 1, 2006		55,050		$	16.84
Granted		—			—
Vested		(28,800	)	$	16.88
Forfeited		(8,175	)	$	16.77
Nonvested at September 30, 2006		18,075		$	16.80

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3. DEFINED BENEFIT PLAN

The Company provides pension benefits for its employees through membership in the Savings Bank Employees’ Retirement Association (the “Plan”). The Plan is a multiple-employer, non-contributory, defined benefit plan. Bank employees become eligible after attaining 21 years of age and completing one year of service. Benefits become fully vested after three years of eligible service. The Company’s annual contribution to the Plan is calculated according to standards established under the Employee Retirement Income Security Act (“ERISA”). The contribution is based on an actuarial method intended to provide not only for benefits attributable to service to date, but also for those expected to be earned in the future.

On October 18, 2006, the Company announced that its Board of Directors had approved the termination of its defined benefit employee pension plan effective on December 31, 2006. All assets of the defined benefit plan will be applied to the payment of the accrued benefit obligations and plan expenses in connection with the plan’s termination. No pension benefits accrued under the defined benefit plan as of the termination date will be reduced or forfeited in connection with the plan termination. In connection with the termination of the defined benefit plan, the Company will freeze future pension benefits effective December 31, 2006. As a result of that cessation of future pension benefits, the Company will recognize a curtailment gain of $663,000 after-tax (or $0.14 per diluted share), due to the reversal of the accrued pension liability recorded on the financial statements.

The Company does not expect to contribute to the Plan for the Plan year ending October 31, 2006.

Net pension cost components for the three months and nine months ended September 30, 2006 and 2005, follow:

	Three months ended						Nine months ended
	9/30/06			9/30/05			9/30/06			9/30/05
				(In thousands)
Service cost	$	89		$	87		$	265		$	260
Interest cost		120			107			360			322
Expected return on plan assets		(145	)		(136	)		(435	)		(407	)
Net amortization and deferrals		(1	)		(1	)		(3	)		(3	)
Net periodic pension cost	$	63		$	57		$	187		$	172

4. CONTINGENCIES

The Bank is involved in various legal proceedings incidental to its business. After review with legal counsel, management does not believe resolution of such litigation will have a material adverse effect on the financial condition and operating results of the Company.

5. RECENT ACCOUNTING PRONOUNCEMENTS

On September 29, 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“SFAS 158”), which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date — the date at which the benefit obligation and plan assets are measured — is required to be the company’s fiscal year end. SFAS 158 is effective for publicly-held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company is currently analyzing the effects of SFAS 158 but does not expect its implementation will have a significant impact on the Company’s financial conditions or results of operations.

On September 13, 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108 (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, Companies might evaluate the materiality of financial statement misstatements using either the income statement or

10

the balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. The Company has analyzed SAB 108 and determined that upon adoption it will have no impact on the reported results of operations or financial conditions.

In July 2006, the FASB issued Financial Accounting Standards Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprises’ financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently analyzing the effects of FIN 48.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

In this report, the Company has made forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 as amended) that are subject to risks and uncertainties. Such forward-looking statements are expressions of management’s expectations as of the date of this report regarding future events or trends and which do not relate to historical matters. Such expectations may or may not be realized, depending on a number of variable factors, including but not limited to, changes in interest rates, general economic conditions, regulatory considerations and competition. For more information about these factors, please see our 2005 Annual Report on Form 10-K on file with the SEC, including the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. As a result of such risk factors and uncertainties, the Company’s actual results may differ materially from such forward-looking statements. The Company does not undertake and specifically disclaims any obligation to publicly release updates or revisions to any such forward-looking statements as a result of new information, future events or otherwise.

Critical Accounting Policies & Estimates

The Company has not changed its significant accounting and reporting policies from those disclosed in its 2005 Annual Report on Form 10-K. In applying these accounting policies, management is required to exercise judgment in determining many of the methodologies, assumptions and estimates to be utilized. As discussed in the Company’s 2005 Annual Report on Form 10-K, the three most significant areas in which management applies critical assumptions and estimates that are particularly susceptible to change relate to the determination of the allowance for loan losses, deferred tax asset valuation and impairment of the investment portfolio. Management’s estimates and assumptions affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ from those estimates.

EXECUTIVE LEVEL OVERVIEW

The Company’s financial results are dependent on the following areas of the income statement: net interest income, provision for loan losses, non-interest income, non-interest expense and provision for income taxes. Net interest income is the primary earnings of the Company and the main focus of management. Management’s efforts are to increase the commercial loan portfolios, which include construction, commercial real estate and commercial loans. Management’s efforts for funding are to increase core deposit accounts, which are lower interest bearing accounts. Net interest income is the difference between interest earned on loans and investment securities and interest paid on deposits and borrowings. Deposits and borrowings have short durations and the costs of these funds do not necessarily rise and fall concurrent with earnings from loans and investment securities. There are many risks involved in managing net interest income including, but not limited to, credit risk, interest rate risk and duration risk.

11

These risks have a direct impact on the level of net interest income. The Company manages these risks through its internal credit and underwriting function and review at meetings of the Asset and Liability Management Committee (“ALCO”) on a regular basis. The credit review process reviews loans for underwriting and grading of loan quality while ALCO reviews the liquidity, interest rate risk, duration risk and allocation of capital resources. Loan quality has a direct impact on the amount of provisions for loan losses the Company reports.

The provision for loan losses was $60,000 for the nine months ended September 30, 2006 based on management’s assessment of the adequacy of the allowance based on an evaluation of the Bank’s loan portfolio and the level of non-performing loans.

Non-interest income includes losses on sales of investment securities and various fees. Customers’ loan and deposit accounts generate various amounts of fee income depending on the product selected. The Company receives fee income from servicing loans that were sold in previous periods. Non-interest income is primarily impacted by the volume of customer transactions, which could change in response to changes in interest rates, pricing and competition.

Non-interest expenses include salaries and employee benefits, occupancy and equipment, professional, data processing and other expenses of the Company, which generally are directly related to business volume and are controlled by a budget process.

Provisions for income taxes are directly related to earnings of the Company. Changes in the statutory tax rates and the earnings of the Company, the Bank and its subsidiaries, as well as the mix of earnings among the different entities would affect the amount of income tax expense reported and the overall effective income tax rate recorded.

The Company believes that the most significant challenge in the current interest rate environment is to increase net interest income while also maintaining competitive deposit rates. The Company was able to achieve a 5% increase in the net interest income for the three months ended September 30, 2006 over the comparable period in 2005 in spite of the decline in total average assets due to the balance sheet restructuring in the second quarter of 2006 along with the continued emphasis on increasing loan originations instead of lower-yielding investment securities.

FINANCIAL CONDITION

SUMMARY

The Company maintains its commitment to servicing the banking needs of the local community in the Merrimack Valley area of northeastern Massachusetts and southern New Hampshire. The Company had total assets of $521.6 million at September 30, 2006 compared to $521.8 million at December 31, 2005. The modest decline in asset size at September 30, 2006 from December 31, 2005 is mainly attributable to a decrease of $31.7 million in investment securities due to the balance sheet restructuring in the second quarter of 2006 partially offset by an increase of $30.0 million in total loan growth since year end 2005.

Investments:

The investment securities portfolio totaled $228.4 million or 43.8% of total assets at September 30, 2006, compared to $260.0 million or 49.8% of total assets at December 31, 2005, a decrease of $31.7 million from year-end.

During the third quarter of 2006, approximately $7.8 million of investments available for sale matured or paid down and the funds were reinvested in new loan originations. The Company intends to use the principle paydowns and maturities from the investment portfolio to fund future loan growth as a strategy to improve the Company’s net interest margin.

During the second quarter of 2006, the Company restructured its balance sheet by selling approximately $80 million of fixed-rate investments securities available for sale. These investment securities had an average yield of 3.30%, an average life of 2.0 years and represented almost 30% of the investment portfolio. Approximately $50 million of the proceeds were reinvested in securities yielding 5.70% with an average life of 4.2 years.

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During the first quarter of 2006, $205.8 million of investments held to maturity were reclassified into investments available for sale. The impact of the reclassification required the total unrealized loss on the entire investment portfolio to be reflected on the balance sheet in the “accumulated other comprehensive loss” portion of stockholders’ equity. The reclassification reflected the opinion of management that all investments may not be held until maturity and that the Company was considering strategic changes in the entire investment portfolio.

The unrealized loss as of September 30, 2006 totaled $3.3 million, or $2.1 million net of taxes. The unrealized losses are attributable to changes in interest rates and a corresponding decline in market value and are not related to credit quality, nor are they deemed to be other than temporarily impaired.

The change in mix in the investment securities portfolio was due to the aforementioned balance sheet restructuring with most of the sales coming from federal agency bonds and collateralized mortgage obligations (“CMOs”), offset by purchases of mortgage-backed securities (“MBSs”) and, to a lesser extent, corporate bonds. In addition, the portfolio experienced maturities of its corporate obligations as well as maturities and prepayments on its asset-backed securities, CMOs and MBSs.

The following table reflects the components and carrying values of the investment securities portfolio at September 30, 2006 and December 31, 2005:

	9/30/06									12/31/05
	Amortized		Unrealized					Market		Amortized		Unrealized					Market
	Cost		Gains		Losses			Value		Cost		Gains		Losses			Value
	(In thousands)									(In thousands)
Investment securities available for sale:
U.S. treasury bonds	$	5,108	$	—	$	(384	)	$	4,724	$	5,119	$	—	$	(350	)	$	4,769
Federal agency bonds		40,863		27		(612	)		40,278		9,932		—		(265	)		9,667
U.S. treasury & federal agency bonds		45,971		27		(996	)		45,002		15,051		—		(615	)		14,436
Corporate bonds		7,483		47		(2	)		7,528		3,181		—		(135	)		3,046
Municipal bonds		—		—		—			—		—		—		—			—
Mutual funds		1,000		—		(52	)		948		1,000		—		(45	)		955
Other investments/equity securities		284		—		—			284		240		—		(7	)		233
Other investment securities		8,767		47		(54	)		8,760		4,421		—		(187	)		4,234
Asset-backed securities/CMO		75,073		82		(1,535	)		73,620		24,662		9		(342	)		24,329
Mortgaged-backed securities		101,890		527		(1,415	)		101,002		3,420		10		(66	)		3,364
ABS/CMO/MBS		176,963		609		(2,950	)		174,622		28,082		19		(408	)		27,693
Total investment securities available for sale	$	231,701	$	683	$	(4,000	)	$	228,384	$	47,554	$	19	$	(1,210	)	$	46,363
Investment securities held to maturity:
U.S. treasury bonds	$	—	$	—	$	—		$	—	$	—	$	—	$	—		$	—
Federal agency bonds		—		—		—			—		87,017		56		(1,944	)		85,129
U.S. treasury & federal agency bonds		—		—		—			—		87,017		56		(1,944	)		85,129
Corporate bonds		—		—		—			—		8,143		11		(280	)		7,874
Commercial paper		—		—		—			—		2,881		—		—			2,881
Municipal bonds		—		—		—			—		1,526		—		(14	)		1,512
Mutual funds		—		—		—			—		—		—		—			—
Other investments/equity securities		—		—		—			—		—		—		—			—
Other investment securities		—		—		—			—		12,550		11		(294	)		12,267
Asset-backed securities/CMO		—		—		—			—		70,415		4		(1,679	)		68,740
Mortgage-backed securities		—		—		—			—		43,701		40		(1,262	)		42,479
ABS/CMO/MBS		—		—		—			—		114,116		44		(2,941	)		111,219
Total investment securities held to maturity	$	—	$	—	$	—		$	—	$	213,683	$	111	$	(5,179	)	$	208,615
Total investment securities	$	231,701	$	683	$	(4,000	)	$	228,384	$	261,237	$	130	$	(6,389	)	$	254,978

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Loans:

Total loans increased $30.0 million to $264.6 million or 50.7% of total assets at September 30, 2006 versus $234.6 million or 44.2% of total assets at December 31, 2005. Retail loans, comprised primarily of residential mortgage loans, increased $14.6 million during the first nine months of 2006 while corporate loans, comprised mainly of construction and commercial real estate loans, increased $15.4 million during the same period. The loan growth has been experienced in all loan categories and reflects the continued interest in loan originations over investment purchases.

The following table reflects the loan portfolio at September 30, 2006 and December 31, 2005:

	9/30/06			12/31/05
	(In thousands)
Residential mortgage loans	$	68,731		$	62,659
Equity loans		18,688			10,412
Consumer loans		675			468
Total retail loans		88,094			73,539
Construction loans		33,112			24,137
Commercial real estate loans		133,688			127,617
Commercial loans		9,692			9,318
Total corporate loans		176,492			161,072
Total loans		264,586			234,611
Allowance for loan losses		(4,214	)		(4,126	)
Total loans, net	$	260,372		$	230,485

Allowance For Loan Losses:

The following table summarizes changes in the allowance for loan losses for the three months and nine months ended September 30, 2006 and 2005:

	Three months ended						Nine months ended
	9/30/06			9/30/05			9/30/06			9/30/05
	(In thousands)
Beginning balance	$	4,184		$	4,135		$	4,126		$	4,140
Provision charged to operations		30			—			60			—
Recoveries on loans previously charged-off		9			3			49			8
Loans charged-off		(9	)		(5	)		(21	)		(15	)
Ending balance	$	4,214		$	4,133		$	4,214		$	4,133

The allowance for loan losses increased slightly to $4.2 million at September 30, 2006 as compared to December 31, 2005. However, the allowance for loan losses as a percent of total loans has decreased to 1.59% at September 30, 2006 down from 1.76% at December 31, 2005, due to an increase in total loans outstanding at September 30, 2006 compared to December 31, 2005. As mentioned previously, the loan portfolio grew $30.0 million in the first nine months of 2006 without a significant change in credit risk to the Company.

The balance of the allowance for loan losses reflects management’s assessment of estimated credit quality and is based on a review of the risk characteristics of the loan portfolio. The Company considers many factors in determining the adequacy of the allowance for loan losses. Collateral value on a loan by loan basis, trends of loan delinquencies on a portfolio segment level, risk classification identified in the Company’s regular review of individual loans, and economic conditions are primary factors in establishing allowance levels. Management believes the allowance level is adequate to absorb the estimated credit losses inherent in the loan portfolio. The allowance for loan losses reflects information available to management at the end of each period.

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Risk Assets:

Risk assets consist of non-performing loans and other real estate owned (OREO). Non-performing loans consist of both a) loans 90 days or more past due, and b) loans placed on non-accrual because full collection of the principal balance is in doubt. Other real estate owned is comprised of foreclosed properties where the Company has formally received title or has possession of the collateral.

Total risk assets were $1.1 million and $32,000, respectively, at September 30, 2006 and December 31, 2005. At September 30, 2006, total impaired loans were $1.0 million, none of which required a related allowance. All of the $1.0 million in impaired loans have been measured using the fair value of the collateral method. The Company had no impaired loans at December 31, 2005 or September 30, 2005. The increase in non-performing and impaired loans as of September 30, 2006 was primarily due to the deterioration of one borrower with multiple loans that are collateral dependent.

The following table summarizes the Company’s risk assets at September 30, 2006, December 31, 2005 and September 30, 2005:

	9/30/06			12/31/05			9/30/05
	(Dollars in thousands)
Non-performing loans	$	1,142		$	32		$	33
Other real estate owned		—			—			—
Total risk assets	$	1,142		$	32		$	33
Risk assets as a percent of total loans		0.43	%		0.01	%		0.01	%
Risk assets as a percent of total assets		0.22	%		0.01	%		0.01	%

Deposits:

Total interest bearing deposits amounted to $269.6 million at September 30, 2006 compared to $284.2 million at December 31, 2005, a decrease of $14.6 million. Partially offsetting this decrease was an increase of $13.3 million in non-interest bearing or demand deposit accounts. The largest change from December 31, 2005 was due primarily to a decrease of $21.2 million in NOW accounts. Partially offsetting this decrease was an increase of $14.4 million in higher costing certificates of deposit. The increase in term certificates of deposit reflects the customers’ preference in achieving the highest yields possible as the rates paid on these accounts have increased in conjunction with the increases in interest rates.

The following table reflects the components of the deposit portfolio at September 30, 2006 and December 31, 2005:

	9/30/06		12/31/05
	(In thousands)
NOW and super NOW accounts	$	17,184	$	38,349
Demand deposit accounts		32,219		18,912
Savings accounts		36,127		41,941
Money market investment accounts		74,589		76,594
Certificates of deposit		141,691		127,291
Total deposits	$	301,810	$	303,087

Borrowings:

Borrowings consist of Federal Home Loan Bank advances, other borrowed funds (short term FHLB advances under 6 months) and securities sold under agreements to repurchase. Total borrowings amounted to $157.4 million at September 30, 2006 compared to $153.4 million at December 31, 2005, an increase of $4.0 million. While the total borrowings increased since year-end by $4.0 million, total borrowings decreased from the first quarter of 2006 by $24.4 million and reflected the balance sheet restructuring whereby the proceeds from the investment sales were used to pay down the long-term FHLB advances coming due.

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The following table reflects the components of borrowings at September 30, 2006 and December 31, 2005:

	9/30/06		12/31/05
	(In thousands)
Federal Home Loan Bank advances	$	103,553	$	121,861
FHLB short-term borrowings		48,000		27,000
Customer repurchase agreements		5,824		4,519
Total borrowings	$	157,377	$	153,380

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

SUMMARY

The Company reported net income of $808,000, or $0.18 per diluted share, as compared to net income of $857,000, or $0.19 per diluted share, for the three months ended September 30, 2006 and 2005, respectively. The third quarter of 2006 experienced an increase in the net interest income, but it was offset by a provision for loan loss of $30,000 and an increase of total non-interest expenses of $138,000 over the corresponding period for 2005. Additionally, the third quarter of 2006 had lower non-interest income than the third quarter of 2005. This overall impact was a reduction in net income for the quarter ending September 30, 2006 as compared to 2005.

Net Interest Income From Operations:

Net interest income for the three months ended September 30, 2006 increased by $174,000, or 5.0%, to $3.6 million from $3.5 million for the same period of 2005. The net interest rate spread increased to 2.33% for the three months ended September 30, 2006 versus 2.27% for the same period of 2005. Interest income for the three months ended September 30, 2006 increased $1.1 million primarily due to higher investment security and loan rates and higher average loan balances from the same period of 2005. Partially offsetting the increase in total interest income was a corresponding increase of $912,000 in total interest expense primarily due to higher rates paid on deposits and borrowings. Although the Company expects the balance sheet restructuring to have a positive impact on its net interest margin in the long-term, much of the restructuring was not completed until late in the second quarter, and as a result, the effect of the restructuring on the margin during the full nine month period ending September 30, 2006 was minimal. However, during the quarter ended September 30, 2006, the balance sheet restructuring led to an increase in the net interest margin to 2.86% versus 2.61% for the quarter ended September 30, 2006 and 2005, respectively. In addition, a change in the timing of the FHLB dividend resulted in the recognition of $273,000 in dividend income for 183 days in the quarter ended September 30, 2006 compared to $108,000 for 92 days for the same quarter of 2005.

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The following table presents the Company’s average balance sheet, net interest income and average interest rates for the three months ended September 30, 2006 and 2005. Average loans include non-performing loans.

	Three months ended								Three months ended
	9/30/06								9/30/05
						Average								Average
	Average					Interest			Average					Interest
	Balance			Interest		Rate			Balance			Interest		Rate
	(Dollars in thousands)
Assets
Investment securities:
Short-term investments	$	6,010		$	81		5.35	%	$	3,234		$	28		3.43	%
U. S. Government and federal agency bonds		44,731			428		3.80			102,480			803		3.11
Corporate and municipal bonds and other securities		18,085			388		8.51			28,313			268		3.76
Collateralized mortgage obligations and mortgage- backed securities		176,111			2,088		4.70			154,523			1,579		4.05
Total investment securities		244,937			2,985		4.83			288,550			2,678		3.68
Loans:
Residential real estate		66,345			911		5.45			60,746			784		5.12
Equity		15,786			243		6.11			9,647			129		5.31
Consumer		812			12		5.86			605			9		5.90
Total retail loans		82,943			1,166		5.58			70,998			922		5.15
Construction		33,411			800		9.50			20,609			396		7.62
Commercial real estate		132,606			2,414		7.22			131,214			2,249		6.80
Commercial		9,025			188		8.26			12,855			222		6.85
Total corporate loans		175,042			3,402		7.71			164,678			2,867		6.91
Total loans		257,985			4,568		7.02			235,676			3,789		6.38
Total interest-earning assets		502,922			7,553		5.96	%		524,226			6,467		4.89	%
Allowance for loan losses		(4,200	)							(4,168	)
Other assets		18,871								19,518
Total assets	$	517,593							$	539,576
Liabilities and Stockholders’ Equity
Deposits:
NOW and Super NOW accounts	$	22,200		$	8		0.14	%	$	39,571		$	12		0.12	%
Regular savings accounts		36,995			46		0.49			44,541			56		0.50
Money market investment accounts		75,856			552		2.89			81,141			385		1.88
Certificates of deposit and escrow		139,678			1,384		3.93			123,469			886		2.85
Total interest bearing deposits		274,729			1,990		2.87			288,722			1,339		1.84
Borrowed funds:
Other borrowed funds		57,694			762		5.24			49,594			424		3.39
FHLB Advances		96,631			1,172		4.81			118,487			1,249		4.18
Total borrowed funds		154,325			1,934		4.97			168,081			1,673		3.95
Total interest bearing liabilities		429,054			3,924		3.63	%		456,803			3,012		2.62	%
Non-interest bearing deposits		28,524								20,949
Other liabilities		4,994								3,374
Total liabilities		462,572								481,126
Stockholders’ equity		55,021								58,450
Total liabilities and stockholders’ equity	$	517,593							$	539,576
Net interest rate spread							2.33	%							2.27	%
Net interest income				$	3,629							$	3,455
Net interest margin on average earning assets							2.86	%							2.61	%

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Interest Income:

Interest income increased $1.1 million, or 16.8%, during the third quarter of 2006 versus the same quarter in 2005, primarily attributable to a rise in average investment security interest rates coupled with the FHLB dividend timing issue previously mentioned.

Average loan interest rates increased 64 basis points from 6.38% to 7.02% during the third quarters of 2005 and 2006, respectively, contributing $370,000 to interest income. Average loan balances rose $22.3 million from $235.6 million in 2005 to $258.0 million in 2006 contributing $409,000 to interest income.

Average investment security interest rates increased 115 basis points during the third quarter of 2006 from 3.68% in 2005 to 4.83% in 2006 adding $686,000 to interest income. Average investment security balances declined $43.6 million from $288.6 million in 2005 to $244.9 million in 2006 reducing interest income by $379,000. As mentioned above, the full impact of the balance sheet restructuring was recognized in the third quarter of 2006 and dividend income from the FHLB was received during the third quarter of 2006 of $273,000 compared to $108,000 in 2005.

Interest Expense:

Interest expense increased $912,000, or 30.3%, during the third quarter of 2006 from $3.0 million in the third quarter of 2005 to $3.9 million in the third quarter of 2006 primarily due to the rise in overall market interest rates experienced by both the deposit portfolio and borrowed funds position.

Average deposit interest rates increased 103 basis points from 1.84% to 2.87% in the third quarter of 2005 and 2006, respectively, contributing $565,000 to interest expense. Average interest-bearing deposit balances decreased by $14.0 million from $288.7 million in 2005 to $274.7 million in 2006 but a change in the mix resulting in a preference for higher costing certificates of deposit increased interest expense by $86,000.

Average borrowed funds interest rates increased 102 basis points from 3.95% in the third quarter of 2005 to 4.97% in the same quarter of 2006 resulting in a rise of $432,000 to interest expense, the majority of which, $260,000, related to short-term borrowed funding. Average borrowed fund balances declined $13.8 million, or 8.2%, from $168.1 million in 2005 to $154.3 million in 2006. This decline reduced interest expense by $171,000 primarily due to $249,000 reduction in long-term borrowed funds interest expense partially offset by an increase of $78,000 in short-term borrowed funds interest expense.

Provision for Loan Losses:

The provision for loan losses totaled $30,000 and zero for the three months ended September 30, 2006 and 2005, respectively. The provision of $30,000 in 2006 reflects management’s analysis of loan growth during the third quarter of 2006. The absence of a provision for loan losses in 2005 was based on management’s assessment of the adequacy of the allowance based on an evaluation of the Bank’s loan portfolio and the level of non-performing loans. The balance of the allowance for loan losses has remained fairly consistent at $4.2 million and $4.1 million at September 30, 2006 and September 30, 2005, respectively. The coverage of the allowance for loan losses has decreased to 1.59% at September 30, 2006 from 1.77% at September 30, 2005 due to the loan growth experienced during 2006.

Non-Interest Income:

Non-interest income decreased $54,000 for the three months ended September 30, 2006 compared to the same period in 2005 and totaled $327,000 and $381,000, respectively. The decrease was primarily attributable to a decrease in deposit account fees. Loan servicing fees decreased to $24,000 and $33,000 for the three months ended September 30, 2006 and 2005, respectively. Deposit account fees declined to $188,000 from $220,000 for the three months ended September 30, 2006 and 2005, respectively, due to a reduction in NOW account fees. Gains on sales of mortgage loans declined to zero in 2006 from $13,000 in 2005 due to a reduction in loan sale volume. Other income remained flat at $115,000 for both the three months ended September 30, 2006 and 2005, respectively.

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Non-Interest Expense:

Non-interest expenses rose $138,000, or 5.5%, during 2006 to $2.6 million in the third quarter of 2006 versus $2.5 million for the same period of 2005. The majority of the increase was attributable to an increase in salary and employee benefits expenses. There was an increase of $132,000, or 8.7%, in salaries and employee benefits from $1.5 million in the third quarter of 2005 to $1.7 million in the third quarter of 2006 primarily due to an accrual reversal of $121,000 for deferred compensation included in 2005 not included in 2006 and compensation expenses related to stock options of $31,000 in conjunction with the adoption of SFAS 123R. Occupancy and equipment expense increased $34,000, or 14.8%, to $263,000 in the third quarter of 2006 from $229,000 in the same period of 2005. The bulk of the increase in the third quarter of 2006 was due to additional clean-up costs associated with an environmental issue at one of the Bank’s branch locations. Data processing expenses increased $20,000, or 8.7%, to $250,000 in the third quarter of 2006 from $230,000 in 2005 due to an increase in computer software and license fees and service bureau charges. Marketing expenses decreased $52,000, or 74.3%, during the third quarter of 2006 to $18,000 from $70,000 in the third quarter of 2005 due to the reversal of an accrual in the amount of $43,000 associated with the name change costs that had been projected in the second quarter of 2006 and reversed in the third quarter of 2006. Professional fees increased modestly to $113,000 in the third quarter of 2006 from $111,000 in the third quarter of 2005. Other expenses increased modestly to $345,000 in the third quarter of 2006 from $343,000 in the same period of 2005. The costs included in other expenses reflect the reversal of an accrual for stockholder expenses in the amount of $50,000 in the third quarter 2005 which was not repeated in 2006 and which was partially offset by the receipt of $41,000 in additional insurance reimbursement proceeds relating to the flood experienced in the second quarter of 2006 at the corporate headquarters.

Income Taxes:

The Company reported an income tax expense of $473,000 for the three months ended September 30, 2006, for an effective income tax expense rate of 36.9%. This compares to an income tax expense of $472,000 for the three months ended September 30, 2005 or effective income tax rate of 35.5%. Income tax expense remained flat quarter to quarter.

NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

SUMMARY

The Company reported a net loss of $874,000, or $(0.19) per diluted share, versus net income of $2.5 million, or $0.55 per diluted share, for the nine months ended September 30, 2006 and 2005, respectively. The decline in net income for the nine month period ending September 30, 2006 was primarily due to the balance sheet restructuring in the second quarter of 2006, name change expenses relating to the Company’s subsidiary bank and former employee severance payments. The Company’s net interest margin remained at 2.67% in the first nine months of 2005 and 2006, respectively.

Net Interest Income From Operations:

Net interest income for the nine months ended September 30, 2006 and 2005 decreased by $313,000, or 3.0%, to $10.2 million from $10.5 million, respectively. The net interest rate spread decreased to 2.23% for the nine months ended September 30, 2006 versus 2.36% for the same period of 2005. Interest income for the nine months ended September 30, 2006 experienced an increase of $2.1 million primarily due to higher interest rates on investment security and loan balances and higher loan balances from the same period of 2005. More than offsetting the increase in total interest income was a corresponding increase of $2.4 million in total interest expense primarily due to higher rates paid on deposits and borrowed funds.

19

The following table presents the Company’s average balance sheet, net interest income and average interest rates for the nine months ended September 30, 2006 and 2005. Average loans include non-performing loans.

	Nine months ended								Nine months ended
	9/30/06								9/30/05
						Average								Average
	Average					Interest			Average					Interest
	Balance			Interest		Rate			Balance			Interest		Rate
	(Dollars in thousands)
Assets
Investment securities:
Short-term investments	$	5,456		$	207		5.07	%	$	2,895		$	66		3.05	%
U. S. Government and federal agency bonds		75,939			1,908		3.36			114,329			2,676		3.13
Corporate and municipal bonds and other securities		22,957			779		4.54			27,980			776		3.71
Collateralized mortgage obligations and mortgage-backed securities		160,883			5,447		4.53			148,111			4,487		4.05
Total investment securities		265,235			8,341		4.20			293,315			8,005		3.65
Loans:
Residential real estate		64,501			2,607		5.40			60,430			2,362		5.23
Equity		12,521			576		6.15			9,172			348		5.07
Consumer		632			29		6.13			657			29		5.90
Total retail loans		77,654			3,212		5.53			70,259			2,739		5.21
Construction		31,182			2,124		9.11			18,015			972		7.21
Commercial real estate		129,577			6,932		7.15			132,896			6,707		6.75
Commercial		8,780			526		8.01			13,417			648		6.46
Total corporate loans		169,539			9,582		7.56			164,328			8,327		6.77
Total loans		247,193			12,794		6.92			234,587			11,066		6.31
Total interest-earning assets		512,428			21,135		5.51	%		527,902			19,071		4.83	%
Allowance for loan losses		(4,174	)							(4,151	)
Other assets		19,410								18,391
Total assets	$	527,664							$	542,142
Liabilities and Stockholders’ Equity
Deposits:
NOW and Super NOW accounts	$	31,325		$	30		0.13	%	$	38,854		$	35		0.12	%
Regular savings accounts		39,123			146		0.50			45,334			168		0.50
Money market investment accounts		78,254			1,425		2.43			80,934			954		1.58
Certificates of deposit and escrow		133,105			3,637		3.65			120,914			2,438		2.70
Total interest bearing deposits		281,807			5,238		2.49			286,036			3,595		1.68
Borrowed funds:
Other borrowed funds		49,916			1,838		4.92			59,007			1,292		2.93
FHLB Advances		112,986			3,832		4.53			117,161			3,644		4.16
Total borrowed funds		162,902			5,670		4.65			176,168			4,936		3.75
Total interest bearing liabilities		444,709			10,908		3.28	%		462,204			8,531		2.47	%
Non-interest bearing deposits		21,108								18,561
Other liabilities		4,661								3,268
Total liabilities		470,478								484,033
Stockholders’ equity		57,186								58,109
Total liabilities and stockholders’ equity	$	527,664							$	542,142
Net interest rate spread							2.23	%							2.36	%
Net interest income				$	10,227							$	10,540
Net interest margin on average earning assets							2.67	%							2.67	%

20

Interest Income:

Interest income increased $2.1 million, or 10.8%, during the nine months ended September 30, 2006 versus the same period in 2005, mainly attributable to a rise in average loan interest rates.

Average loan interest rates increased 61 basis points from 6.31% to 6.92% during the nine months ended September 30, 2005 and 2006, respectively, contributing $1.0 million to interest income. Average loan balances rose $12.6 million from $234.6 million in 2005 to $247.2 million in 2006 contributing $728,000 to interest income.

Average investment security interest rates increased 55 basis points during the first nine months of 2006 from 3.65% in 2005 to 4.20% in 2006 adding $955,000 to interest income. Average investment security balances declined $28.1 million from $293.3 million in 2005 to $265.2 million in 2006 reducing interest income by $619,000.

Interest Expense:

Interest expense increased $2.4 million, or 27.8%, to $10.9 million during the first nine months of 2006 from $8.5 million in the same period of 2005 primarily due to the rise in interest rates paid on average deposits and borrowed funds.

Average deposit interest rates increased 81 basis points from 1.68% to 2.49% in the first nine months of 2005 and 2006, respectively, contributing $1.4 million to interest expense. Average interest-bearing deposit balances decreased by $4.2 million from $286.0 million in 2005 to $281.8 million in 2006 increasing interest expense by $202,000.

Average borrowed funds interest rates increased 88 basis points from 3.75% in the nine months ended of 2005 to 4.63% in the same quarter of 2006 resulting in a rise of $1.1 million to interest expense, the majority of which, $770,000, related to short-term borrowed funding. Average borrowed fund balances declined $13.3 million or 7.5% from $176.2 million in 2005 to $162.9 million in 2006. This decline reduced interest expense by $357,000 primarily due to $224,000 reduction in short-term borrowed funds interest expense.

Provision for Loan Losses:

The provision for loan losses was $60,000 and zero for the nine months ended September 30, 2006 and 2005, respectively. The provision of $60,000 in 2006 reflects management’s analysis of loan growth during 2006. The absence of a provision for loan losses in 2005 was based on management’s assessment of the adequacy of the allowance based on an evaluation of the Bank’s loan portfolio and the level of non-performing loans. The balance of the allowance for loan losses has remained fairly consistent at $4.2 million and $4.1 million at September 30, 2006 and September 30, 2005, respectively. The coverage of the allowance for loan losses has decreased to 1.59% at September 30, 2006 from 1.77% at September 30, 2005 due to the loan growth experienced during 2006.

Non-Interest Income:

Non-interest income decreased for the nine months ended September 30, 2006 to a loss of $(1.4) million from non-interest income of $1.1 million in the same period in 2005. The decrease was primarily attributable to a loss on sales of low yielding investments securities totaling $2.4 million due to the balance sheet restructuring. Loan servicing fees decreased from $109,000 in 2005 to $66,000 in 2006 primarily due to the acceleration of amortization of mortgage servicing rights (“MSR”). Deposit account fees decreased from $639,000 to $586,000, respectively, in 2006 and 2005 due to a reduction in NOW account fees. Gains on sales of mortgage loans declined from $35,000 to $6,000 in 2006 and 2005, respectively, as the Company has decided to hold current loan production as compared to selling loans in the corresponding period in 2005. Other income remained flat at $341,000 and $350,000, respectively in 2006 versus 2005.

Non-Interest Expense:

Non-interest expenses increased $2.2 million, or 27.6%, during 2006 to $10.0 million in the first nine months of 2006 versus $7.8 million for the same period of 2005. Contributing to this increase were costs associated with the name change of the Company’s subsidiary bank to River Bank and severance payments to former employees. There was an

21

increase of $952,000, or 20.2%, in salaries and employee benefits to $5.7 million from $4.7 million primarily due to costs of $699,000 incurred with former employee severance payments and $95,000 in conjunction with the adoption of SFAS 123R by the Company on stock options as well as increases in the medical insurance rates. In addition, during the third quarter of 2005, the Company reversed an accrual for deferred compensation in the amount of $121,000. Occupancy and equipment expenses increased $379,000, or 53.5%, to $1.1 million in the first nine months of 2006 from $708,000 in the same period of 2005 primarily due to accelerated deprecation of $197,000 on damaged property and equipment resulting from the flooding of the corporate headquarters and main office as well as obsolete fixed assets and an increase of $155,000 in repairs and maintenance costs. The majority of the repairs pertain to costs of $128,000 incurred in the clean-up and remediation of a small environment issue at one of the Bank’s branch locations. Data processing expenses increased to $745,000 from $668,000 in 2005 due to an increase of $43,000 in computer software and license fees and $24,000 in service bureau charges. Marketing expenses increased $243,000, or 105.7%, during 2006 due to $292,000 in marketing and promotional expenses relating to the name change of the Company’s subsidiary bank offset by a decrease of $32,000 in direct mail advertising. Professional fees increased $57,000 to $464,000 in 2006 from $407,000 in 2005’s first nine months due to an increase in consulting and tax preparation fees due to the Company changing its tax year end from October 31 to December 31. Other expenses increased $461,000, or 40.9%, to $1.6 million from $1.1 million, respectively, for the nine months ended 2006 and 2005 due to costs associated with the subsidiary bank name change of $250,000, costs of $26,000 incurred as a result of the flood of the corporate headquarters in May 2006 that were not covered by insurance reimbursements and an increase of $141,500 in stockholder’s related expenses. The majority of the increase in the stockholder related expenses resulted from the adoption of the Shareholder Rights Plan in January 2006 and the adoption of the 2006 Stock Option Plan in May 2006.

Income Taxes:

The Company reported an income tax benefit of $394,000 for the nine months ended September 30, 2006 or an effective income tax benefit rate of 31.1%. This compares to an income tax expense of $1.4 million for the nine months ended September 30, 2005 or an effective income tax rate of 35.3%. Income tax expense decreased $1.7 million from the first nine months of 2006 versus the same period of 2005 primarily due to a decrease in taxable earnings within the consolidated group. Subsidiaries within the consolidated group pay various state income tax rates and the mix of taxable income within the group can change. An additional factor for the decrease in the effective tax rate for the nine months in 2006 as compared to the same period in 2005 was due to the inability to recognize income tax benefits resulting from the net operating losses for state income tax purposes as the state of Massachusetts does not permit the net operating losses to be carried back to prior taxable years or carried forward to future taxable years.

Liquidity and Capital Resources:

The Company’s primary source of funds is cash dividends from its wholly-owned subsidiary, River Bank. The Bank did not pay a dividend to the Company in the first nine months of 2006. The Bank paid dividends to the Company in the amount of $1.2 million during the first nine months of 2005. The Company made cash payments of dividends to shareholders in the amount of $1.9 million in the first nine months of both 2006 and 2005, respectively.

The Bank’s primary sources of funds include collections of principal payments and repayments on outstanding loans, increases in deposits, advances from the Federal Home Loan Bank of Boston (“FHLB”) and securities sold under agreements to repurchase. The Bank has a line of credit of $6.8 million with the FHLB. The Bank currently has a $5.0 million unsecured Federal funds line of credit with another institution. At September 30, 2006, the entire $11.8 million in available lines of credit was available.

The FHLB requires member banks to maintain qualified collateral for its advances. Collateral is comprised of the Bank’s investments in FHLB stock, its residential mortgage portfolio and the portion of the investment portfolio which meets FHLB qualifying collateral requirements and has been designated as such. The Bank’s borrowing capacity at the FHLB at September 30, 2006 was $239.2 million, of which $151.6 million had been borrowed.

At September 30, 2006, the Company’s stockholders’ equity was $57.1 million as compared to $59.9 million at December 31, 2005. The change during the first nine months of 2006 occurred due to a net loss of $874,000, a tax benefit associated with the exercise of stock options of $91,000, proceeds of $1.1 million from the exercise of stock options and compensation expense relating to stock options of $95,000 in conjunction with the Company’s adoption

22

of SFAS 123R. Stockholders’ equity was reduced by the declaration of cash dividends to shareholders of $1.9 million and a $1.4 million decrease in the market value of investment securities available for sale, net of taxes due mainly to the transfer of securities previously held in the held to maturity portfolio to the available for sale portfolio during the first quarter of 2006.

The Company’s leverage ratio at September 30, 2006 and December 31, 2005 was 11.35% and 11.34%, respectively. The Company’s and the Bank’s total risk based capital ratios were 18.26% and 17.54% at September 30, 2006, respectively, compared with 20.34% and 19.54% at December 31, 2005, respectively. The total risk based capital ratios declined from December 31, 2005 due to an increase in the total loan balance portfolio and in the total loan commitments. The Company exceeds all regulatory minimum capital ratio requirements set forth by the FRB, and the Bank exceeds all minimum capital ratio requirements as defined by the FDIC.

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The response is incorporated herein by reference to the discussion under the sub-caption “Interest Rate Sensitivity” of the caption “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” of the Company’s 2005 Annual Report on Form 10-K.

ITEM 4: CONTROLS AND PROCEDURES

The Company’s chief executive officer and chief financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report (the “Evaluation Date”), have concluded that as of the Evaluation Date the Company’s disclosure controls and procedures were effective and designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

During the period covered by this quarterly report, there were no changes in the Company’s internal controls that have materially affected, or are reasonable likely to materially affect, the Company’s internal controls over financial reporting.

23

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Bank is involved in various legal proceedings incidental to its business. After review with legal counsel, management does not believe resolution of such litigation will have a material adverse effect on the financial condition and operating results of the Company.

ITEM 1A. RISK FACTORS

Management believes that there have been no material changes in the Company’s risk factors as reported in the Annual Report on Form 10-K for the year ended December 31, 2005.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

          None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

          None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

          None.

ITEM 5. OTHER INFORMATION

          None

ITEM 6. EXHIBITS

Number		Description
	31.1	Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002.

24

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	LSB CORPORATION
November 13, 2006	/s/ Gerald T. Mulligan
	Gerald T. Mulligan
	President and Chief Executive Officer
November 13, 2006	/s/ Diane L. Walker
	Diane L. Walker
	Senior Vice President Chief Financial Officer

25

EXHIBIT INDEX

		Page
31.1	Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002		27
31.2	Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002		28
32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002		29
32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002		30

26

EX-31.1

Exhibit 31.1

CERTIFICATIONS

I, Gerald T. Mulligan, certify that:

1.	I have reviewed this Form 10-Q of LSB Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusion about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and,
c)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and,

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting to the registrant’s auditors and the Audit Committee of the registrant’s Board of Directors (or persons performing the equivalent functions):

a)	All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting,

Date: November 13, 2006

/s/ Gerald T. Mulligan  

Gerald T. Mulligan 

President and
Chief Executive Officer 

EX-31.2

Exhibit 31.2

I, Diane L. Walker, certify that:

1.	I have reviewed this report on Form 10-Q of LSB Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a)	Designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusion about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation and;
c)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting and;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting to the registrant’s auditors and the Audit Committee of registrant’s Board of Directors (or persons performing the equivalent functions):

a)	All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 13, 2006

/s/ Diane L. Walker  

Diane L. Walker 

Executive Vice President
Chief Financial Officer 

EX-32.1

Exhibit 32.1

LSB CORPORATION AND SUBSIDIARY

CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
AS ADDED BY SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of LSB Corporation (the “Company”) on Form 10-Q for the period ending September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gerald T. Mulligan, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as added by section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition of the Company as of September 30, 2006 and results of operations of the Company for the nine months ended September 30, 2006.

/s/ Gerald T. Mulligan  

Gerald T. Mulligan 

President and
Chief Executive Officer

November 13, 2006

EX-32.2

Exhibit 32.2

LSB CORPORATION AND SUBSIDIARY

CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
AS ADDED BY SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of LSB Corporation (the “Company”) on Form 10-Q for the period ending September 30, 2006, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Diane L. Walker, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as added by section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition of the Company as of September 30, 2006 and results of operations of the Company for the nine months ended September 30, 2006.

/s/ Diane L. Walker  

Diane L. Walker 

Executive Vice President
Chief Financial Officer

November 13, 2006