SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

OR

¨ 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 0-15137

MASSBANK Corp.

(Exact name of registrant as specified in its charter)

Delaware	04-2930382
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

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 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  ¨    Accelerated filer  x    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-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 October 31, 2006: 4,318,004 shares.

MASSBANK CORP. AND SUBSIDIARIES

INDEX

		Page
ITEM 1.	Financial Statements
	Consolidated Balance Sheets as of September 30, 2006 (Unaudited) and December 31, 2005 (Audited)	3
	Consolidated Statements of Income (Unaudited) for the three months ended September 30, 2006 and 2005	4
	Consolidated Statements of Income (Unaudited) for the nine months ended September 30, 2006 and 2005	5
	Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2006 and 2005 (Unaudited)	6 - 7
	Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2006 and 2005	8 - 9
	Condensed Notes to the Consolidated Financial Statements	10 -17
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18 - 44
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	45
ITEM 4.	Controls and Procedures	46
PART II - OTHER INFORMATION
ITEM 1.	Legal Proceedings	47
ITEM 1A.	Risk Factors	47
ITEM 2C.	Share Repurchases	47 - 48
ITEM 3.	Defaults Upon Senior Securities	48
ITEM 4.	Submission of Matters to a Vote of Security Holders	48
ITEM 5.	Other Information	48
ITEM 6.	Exhibits	48
Signature Page		49

2

PART 1. ITEM 1

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands except share data)

(Unaudited)

	September 30, 2006			December 31, 2005
Assets:
Cash and due from banks	$	8,489		$	9,590
Short-term investments (Note 5)		138,854			167,787
Total cash and cash equivalents		147,343			177,377
Term federal funds sold		15,000			—
Interest-bearing deposits in banks		—			898
Securities available for sale, at market value (amortized cost of $434,564 in 2006 and $458,297 in 2005)		429,013			453,472
Mortgage-backed securities held to maturity, at amortized cost (market value of $5,277 in 2006 and $6,022 in 2005)		5,416			6,137
Trading securities, at market value		369			9,282
Loans: (Note 6)
Mortgage loans		204,036			215,904
Other loans		9,840			9,826
Allowance for loan losses		(1,395	)		(1,253	)
Net loans		212,481			224,477
Premises and equipment		7,476			6,525
Accrued interest receivable		5,573			3,898
Goodwill		1,090			1,090
Income tax receivable, net		246			—
Deferred income tax asset, net		3,587			3,240
Other assets		18,333			12,283
Total assets	$	845,927		$	898,679
Liabilities and Stockholders’ Equity:
Deposits	$	729,411		$	784,728
Escrow deposits of borrowers		992			1,059
Current income tax liability, net		—			35
Allowance for loan losses on off-balance sheet credit exposures		336			517
Other liabilities		9,286			7,076
Total liabilities		740,025			793,415
Stockholders’ Equity:
Preferred stock, par value $1.00 per share; 2,000,000 shares authorized, none issued		—			—
Common stock, par value $1.00 per share; 10,000,000 shares authorized, 7,840,167 and 7,811,680 shares issued, respectively		7,840			7,812
Additional paid-in capital		57,695			57,067
Retained earnings		106,532			104,743
		172,067			169,622
Treasury stock at cost, 3,525,663 and 3,483,163 shares, respectively		(62,672	)		(61,281	)
Accumulated other comprehensive loss		(3,493	)		(3,077	)
Shares held in rabbi trust at cost, 16,744 and 15,644 shares, respectively (Note 8)		(386	)		(351	)
Deferred compensation obligation		386			351
Total stockholders’ equity		105,902			105,264
Total liabilities and stockholders’ equity	$	845,927		$	898,679

See accompanying condensed notes to consolidated financial statements.

3

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended September 30,
(In thousands except share data)	2006		2005
Interest and dividend income:
Mortgage loans	$	2,799	$	2,998
Other loans		200		181
Securities available for sale:
Mortgage-backed securities		1,799		1,737
Other securities		3,146		2,450
Mortgage-backed securities held to maturity		73		59
Trading securities		38		187
Federal funds sold		1,923		1,722
Other investments		74		12
Total interest and dividend income		10,052		9,346
Interest expense:
Deposits		4,872		3,878
Total interest expense		4,872		3,878
Net interest income		5,180		5,468
Provision for loan losses		82		—
Net interest income after provision for loan losses		5,098		5,468
Non-interest income:
Deposit account service fees		84		100
Gains on securities available for sale, net		80		177
Gains on trading securities, net		88		61
Deferred compensation plan income		48		49
Other		147		167
Total non-interest income		447		554
Non-interest expense:
Salaries and employee benefits		1,808		1,877
Deferred compensation plan expense		69		71
Occupancy and equipment		490		521
Data processing		146		137
Professional services		113		115
Advertising and marketing		46		44
Deposit insurance		31		35
Other		226		376
Total non-interest expense		2,929		3,176
Income before income taxes		2,616		2,846
Income tax expense		885		962
Net income	$	1,731	$	1,884
Weighted average common shares outstanding:
Basic		4,315,211		4,342,872
Diluted		4,349,187		4,397,998
Earnings per share (in dollars):
Basic	$	0.40	$	0.43
Diluted		0.40		0.43

See accompanying condensed notes to consolidated financial statements.

4

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Nine Months Ended September 30,
(In thousands except share data)	2006		2005
Interest and dividend income:
Mortgage loans	$	8,554	$	9,148
Other loans		570		507
Securities available for sale:
Mortgage-backed securities		5,469		5,211
Other securities		9,025		7,158
Mortgage-backed securities held to maturity		229		181
Trading securities		194		620
Federal funds sold		5,727		4,310
Other investments		86		45
Total interest and dividend income		29,854		27,180
Interest expense:
Deposits		13,845		11,013
Total interest expense		13,845		11,013
Net interest income		16,009		16,167
Provision (credit) for loan losses		132		(53	)
Net interest income after provision (credit) for loan losses		15,877		16,220
Non-interest income:
Deposit account service fees		258		301
Gains on securities available for sale, net		429		307
Gains on trading securities, net		109		119
Deferred compensation plan income		109		59
Other		525		550
Total non-interest income		1,430		1,336
Non-interest expense:
Salaries and employee benefits		5,544		5,572
Deferred compensation plan expense		172		125
Occupancy and equipment		1,702		1,649
Data processing		417		404
Professional services		414		380
Advertising and marketing		102		104
Deposit insurance		96		110
Other		821		1,035
Total non-interest expense		9,268		9,379
Income before income taxes		8,039		8,177
Income tax expense		2,743		2,742
Net income	$	5,296	$	5,435
Weighted average common shares outstanding:
Basic		4,327,930		4,377,372
Diluted		4,363,386		4,440,659
Earnings per share (in dollars):
Basic	$	1.22	$	1.24
Diluted		1.21		1.22

See accompanying condensed notes to consolidated financial statements.

5

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For The Nine Months Ended September 30, 2006 (Unaudited)

(In thousands except share data)

	COMMON STOCK		ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			TREASURY STOCK			ACCUMULATED OTHER COMPREHENSIVE LOSS			SHARES HELD IN RABBI TRUST			DEFERRED COMPENSATION OBLIGATION		TOTAL
Balance at December 31, 2005	$	7,812	$	57,067	$	104,743		$	(61,281	)	$	(3,077	)	$	(351	)	$	351	$	105,264
Net Income		—		—		5,296			—			—			—			—		5,296
Other comprehensive loss, net of tax:
Unrealized losses on securities, net of reclassification adjustment (Note 10)		—		—		—			—			(416	)		—			—		(416	)
Comprehensive income																				4,880
Cash dividends paid ($0.81 per share)		—		—		(3,507	)		—			—			—			—		(3,507	)
Purchase of treasury stock		—		—		—			(1,391	)		—			—			—		(1,391	)
Purchase of company stock for deferred compensation plan		—		—		—			—			—			(35	)		35		—
Share-based payment compensation		—		50		—			—			—			—			—		50
Exercise of stock options		28		492		—			—			—			—			—		520
Tax benefit on stock options exercised		—		86		—			—			—			—			—		86
Balance at September 30, 2006	$	7,840	$	57,695	$	106,532		$	(62,672	)	$	(3,493	)	$	(386	)	$	386	$	105,902

See accompanying condensed notes to consolidated financial statements.

6

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For The Nine Months Ended September 30, 2005 (Unaudited)

(In thousands except share data)

	COMMON STOCK		ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			TREASURY STOCK			ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)			SHARES HELD IN RABBI TRUST			DEFERRED COMPENSATION OBLIGATION			TOTAL
Balance at December 31, 2004	$	7,736	$	55,313	$	102,003		$	(56,794	)	$	1,757		$	(553	)	$	553		$	110,015
Net Income		—		—		5,435			—			—			—			—			5,435
Other comprehensive loss, net of tax:
Unrealized losses on securities, net of reclassification adjustment (Note 10)		—		—		—			—			(3,974	)		—			—			(3,974	)
Comprehensive income																					1,461
Cash dividends paid ($0.78 per share)		—		—		(3,413	)		—			—			—			—			(3,413	)
Purchase of treasury stock		—		—		—			(4,138	)		—			—			—			(4,138	)
Purchase of company stock for deferred compensation plan		—		—		—			—			—			(14	)		14			—
Distribution of company stock from deferred compensation plan		—		—		—			—			—			232			(232	)		—
Exercise of stock options		58		1,094		—			—			—			—			—			1,152
Tax benefit on stock options exercised		—		263		—			—			—			—			—			263
Balance at September 30, 2005	$	7,794	$	56,670	$	104,025		$	(60,932	)	$	(2,217	)	$	(335	)	$	335		$	105,340

See accompanying condensed notes to consolidated financial statements.

7

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended September 30,
	2006			2005
	(In thousands)
Cash flows from operating activities:
Net income	$	5,296		$	5,435
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		562			447
Share-based payment compensation		50			—
Loan interest capitalized		(8	)		(7	)
Increase in accrued interest receivable		(1,675	)		(852	)
(Decrease) increase in other liabilities		226			(179	)
(Increase) decrease in income tax receivable, net		(246	)		119
Amortization of premiums (accretion of discounts) on securities, net		15			(33	)
Net trading securities activity		9,022			36,329
Gains on securities available for sale, net		(429	)		(307	)
Gains on trading securities, net		(109	)		(119	)
Increase in net deferred mortgage loan origination costs, net of amortization		(18	)		(86	)
(Increase) decrease in deferred income tax asset, net		(35	)		229
Decrease in current tax liability		(35	)		—
Decrease (increase) in other assets		(4,068	)		584
Provision (credit) for loan losses		132			(53	)
Provision (credit) for loan losses on off-balance sheet credit exposures		(181	)		—
Gain on sale of equipment		(3	)		—
Net cash provided by operating activities		8,496			41,507
Cash flows from investing activities:
Purchases of term federal funds		(15,000	)		(15,000	)
Net decrease in interest-bearing bank deposits		898			1,606
Proceeds from sales of investment securities available for sale		15,565			24,732
Proceeds from maturities and redemption of investment securities available for sale		75,000			86,959
Purchases of investment securities available for sale		(70,097	)		(95,468	)
Purchases of mortgage-backed securities available for sale		(15,971	)		(32,662	)
Principal repayments of mortgage-backed securities		20,371			24,445
Loans originated		(17,096	)		(40,009	)
Loan principal payments received		28,986			45,224
Purchases of premises & equipment		(1,513	)		(163	)
Proceeds from sale of equipment		3			—
Net cash provided by (used in) investing activities		21,146			(336	)

8

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited)

	Nine Months Ended September 30,
	2006			2005
	(In thousands)
Cash flows from financing activities:
Net decrease in deposits		(55,317	)		(46,868	)
Decrease in escrow deposits of borrowers		(67	)		(65	)
Payments to acquire treasury stock		(1,391	)		(4,138	)
Purchase of company stock for deferred compensation plan		(35	)		(14	)
Increase in deferred compensation obligation		35			14
Proceeds from exercise of stock options, including tax benefit		606			1,415
Cash dividends paid on common stock		(3,507	)		(3,413	)
Net cash used in financing activities		(59,676	)		(53,069	)
Net decrease in cash and cash equivalents		(30,034	)		(11,898	)
Cash and cash equivalents at beginning of period		177,377			204,079
Cash and cash equivalents at end of period	$	147,343		$	192,181
Supplemental cash flow disclosures:
Cash transactions:
Cash paid during the period for interest	$	13,840		$	11,059
Cash paid during the period for taxes, net of refunds		2,973			2,132

See accompanying condensed notes to consolidated financial statements.

9

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 September 30, 2006 and December 31, 2005, and its operating results for the three months and nine months ended September 30, 2006 and 2005, respectively. 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 year’s consolidated financial statements were reclassified to facilitate comparison with the current fiscal year.

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, 2005.

(2) Share-Based Payment

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R) which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors, including stock option grants, based on estimated fair values. SFAS 123(R) supersedes previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) for periods beginning in fiscal year 2006.

SFAS 123(R) requires companies to estimate the fair value of stock-based awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Consolidated Statements of Income. The Company adopted SFAS 123(R) using the modified prospective transition method that requires the application of the accounting standard starting the first day of the fiscal year, January 1, 2006 for the Company. Under this method, compensation expense is also recognized for stock based awards that are modified after December 31, 2005. The Company’s Consolidated Financial Statements, as of and for the nine months ended September 30, 2006, reflect the impact of SFAS 123(R). Stock-based compensation expense for the nine months ended September 30, 2006 totaled $50,000. This stock-based compensation expense is related to the 35,000 stock options granted to employees and directors in 2006, net of any forfeitures, accounted for under SFAS 123(R) and to the modification of 11,250 stock options in the second quarter of 2006, due to the retirement of a Company Director. Typically, when a Director ceases to be a Director by reason of the director’s retirement after reaching the mandatory retirement age of 72, the Board has voted to extend the date that the director’s outstanding options shall become fully exercisable from a period of three months from the date of termination to a period of five years from the date of retirement or until the expiration date, if earlier. As required by SFAS 123R, the change in fair value as a result of this modification has been included in expense. The stock options that were granted in 2006 were granted at an exercise price equal to the Company’s closing stock price at the date of grant. The stock options issued vest at 20% per year over 5 years and have a contractual term of ten years.

10

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(2) Share-Based Payment (continued)

Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Under the intrinsic value based method, no stock-based compensation expense for employee stock options was recognized in the Company’s Consolidated Financial Statements, because the exercise price of the stock options granted to the Company’s employees and directors equaled the fair market value of the underlying stock at the date of grant. In accordance with the modified prospective transition method the Company used in adopting SFAS 123(R), the Company’s earnings results prior to fiscal year 2006 have not been restated to reflect, and do not include, the possible impact of SFAS 123(R). Prior to 2006, the stock options issued by the Company had a contractual term of ten years and vested immediately at the time of issuance.

Upon adoption of SFAS 123(R), the Company selected the Black-Scholes option-pricing model as the most appropriate method for determining the estimated fair value for stock-based awards.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 in 2005.

(In thousands except per share and option data)	Three Months Ended September 30, 2005		Nine Months Ended September 30, 2005
Net income, as reported	$	1,884	$	5,435
Less: Total share-based employee compensation expense associated with stock options determined under fair value method for all option awards, net of related tax effects(1)		—		(161	)
Pro forma net income	$	1,884	$	5,274
EARNINGS PER SHARE:
Basic – as reported	$	0.43	$	1.24
Basic – pro forma		0.43		1.20
Diluted – as reported		0.43		1.22
Diluted – pro forma		0.43		1.19

(1) A Black-Scholes option pricing model was used to determine the fair values of the options granted.

11

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(3) Recent Accounting Pronouncements:

SFAS No. 157, Fair Value Measurements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact, if any, that SFAS No. 157 will have on its financial position and results of operations.

SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of SFAS Nos. 87, 88, 106 and 132(R)

In September 2006, FASB issued SFAS No. 158, which requires employers to recognize the under-funded or over-funded status of a defined benefit plan as an asset or liability in its statement of financial position. The new reporting requirements and related new footnote disclosure rules of SFAS No. 158 are effective for the years ending after December 15, 2006, with changes in the funded status recognized through comprehensive income in the year in which they occur.

SFAS No. 158 will not change the amount of net periodic benefit expense recognized in an entity’s results of operations. As such, the adoption is not expected to have an impact to the Company’s results of operations in 2006. Adoption of SFAS No. 158 is not expected to have a material impact on the Company’s financial position.

SFAS No. 158 also requires employers to measure the funded status of a plan as of the date of its year-end statement of financial position. The new measurement date requirement applies for fiscal years ending after December 15, 2008.

SAB No. 108, Considering the Effects of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements

In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108 to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on their impact on each of the Company’s financial statements and related disclosures. SAB 108 is effective as of the first fiscal year ending after November 15, 2006, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006, for errors that were not previously deemed material, but are material under the guidance in SAB No. 108. The Company is currently evaluating the impact of adopting SAB No. 108 on its results of operations and financial position.

Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS No. 109

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes”, an interpretation of FASB Statement No. 109.

FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. The Company has not yet determined the potential financial impact of adopting FIN 48.

12

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(4) 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.

(5) Short-Term Investments

Short-term investments consist of the following:

(In thousands)	At September 30, 2006		At December 31, 2005
Federal funds sold (overnight)	$	115,177	$	152,785
Term federal funds sold		15,000		15,000
Institutional money market funds		8,674		—
Interest-bearing bank money market accounts		3		2
Total short-term investments	$	138,854	$	167,787

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

(6) Commitments

At September 30, 2006, the Company had outstanding commitments to originate mortgage loans and to advance funds for construction loans amounting to $1,964,000 and commitments under existing home equity lines of credit and other loans of approximately $30,864,000 which are not reflected on the consolidated balance sheet. The Bank maintains an allowance for loan losses on off-balance sheet credit exposures. At September 30, 2006 this allowance, which is shown separately on the balance sheet, totaled $336,000.

13

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(7) 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 period.

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 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:

(In thousands, except per share data)	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
Denominator for basic earnings per share:
Average common shares outstanding		4,315		4,343		4,328		4,377
Dilutive common stock options		34		55		35		64
Denominator for diluted earnings per share		4,349		4,398		4,363		4,441
Numerator:
Net income attributable to common shares	$	1,731	$	1,884	$	5,296	$	5,435
Earnings per share:
Basic	$	0.40	$	0.43	$	1.22	$	1.24
Diluted		0.40		0.43		1.21		1.22

(8) 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 a rabbi trust. At September 30, 2006, the Trust held 16,744 shares of MASSBANK Corp. common stock which were purchased in the open market or in private transactions over a period of time. The deferred compensation obligation of the Plan may be settled only by delivery of the shares of MASSBANK Corp. stock to the directors participating in the Plan. These shares are considered outstanding in the computation of earnings per share and book value per share.

14

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(9) Stock Option Plan

Effective January 1, 2006, the Company adopted SFAS 123(R) using the modified prospective transition method to account for share-based payments to employees and the Company’s Board of Directors.

The only type of share-based payment utilized by the Company to date is stock options. Stock options are awards which allow the employee or director to purchase shares of the Company’s stock at a fixed price. Stock options are granted at an exercise price equal to the Company closing stock price at the date of grant. Prior to 2006, the stock options issued by the Company had a contractual term of ten years and vested immediately at the time of issuance. The stock options issued in 2006 vest at 20% per year over five years and have a contractual term of ten years.

The following tables summarize stock option activity during the first nine months of 2006:

	Weighted Average Exercise Price Per Share		Shares Under Option
Outstanding at December 31, 2005	$	26.95	251,637
Options Granted		32.79	35,500
Options Exercised		18.29	(28,487	)
Options Forfeited		36.07	(950	)
Outstanding at September 30, 2006	$	28.68	257,700
Exercisable at September 30, 2006	$	28.04	222,700

At September 30, 2006			Options Outstanding			Options Exercisable
Range of Exercise Prices		Number Outstanding	Weighted Avg. Remaining Contractual Life	Weighted Avg. Exercise Price		Number Exercisable	Weighted Avg. Exercise Price
$	19.00 to $20.67	72,625	2.4 years	$	19.79	72,625	$	19.79
	25.00 to 27.63	49,125	3.4 years		26.09	49,125		26.09
	28.44 to 29.60	44,850	2.9 years		29.14	44,850		29.14
	32.50 to 32.80	35,000	9.2 years		32.79	—		—
	36.70 to 42.90	56,100	7.2 years		39.54	56,100		39.54
$	19.00 to $42.90	257,700	4.6 years	$	28.68	222,700	$	28.04

15

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(9) Stock Option Plan (continued)

The Company estimates the fair value of stock option grants using the Black-Scholes valuation model. The following table presents the key input assumptions for the Black-Sholes valuation model:

	Nine Months Ended September 30,
	2006			2005
Expected Term (years)		7.3 years			7.3 years
Volatility		21.50	%		21.20	%
Risk-free interest rate		4.31	%		3.97	%
Dividend Yield		3.29	%		2.80	%
Fair value per share	$	6.58		$	8.11

The total intrinsic value (amount by which the fair value of the underlying stock exceeds the exercise price of an option on exercise date) of options exercised during the nine months ended September 30, 2006 and 2005, was $408,000 and $938,000, respectively. The total cash received from employees and directors as a result of stock option exercises for the nine months ended September 30, 2006 and 2005 was $520,000 and $1,152,000, respectively. The tax benefit realized as a result of the stock option exercises was $86,000 in the first nine months of 2006 compared to $263,000 for the same period in 2005.

(10) Comprehensive Income (Loss)

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income (loss).

The components of other comprehensive income (loss) and related tax effect for the nine months ended September 30, 2006 and 2005 are as follows:

(In thousands)	Nine Months Ended September 30,
	2006			2005
Unrealized holding losses arising during period	$	(298	)	$	(6,070	)
Less: reclassification adjustment for gains realized in income		429			307
Net unrealized losses		(727	)		(6,377	)
Tax (expense) or benefit		311			2,403
Other comprehensive loss	$	(416	)	$	(3,974	)

16

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(11) Pension Plan

The Bank sponsors a noncontributory defined benefit pension plan that covers all employees who meet specified age and length of service requirements, which is administered by the Savings Banks Employees Retirement Association (“SBERA”). The plan provides for benefits to be paid to eligible employees at retirement based primarily upon their years of service with the Bank and compensation levels near retirement. Contributions to the plan reflect benefits attributed to employees’ service to date, as well as service expected to be earned in the future.

The following table sets forth the amount of net periodic pension expense recognized for the three months and nine months ended September 30, 2006 and 2005:

Pension Benefits

(In thousands)	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
Service cost	$	103		$	114		$	310		$	344
Interest cost		144			136			431			409
Expected return on plan assets		(164	)		(151	)		(491	)		(455	)
Amortization of prior service cost		(3	)		(3	)		(10	)		(10	)
Amortization of net (gains) losses		1			12			4			36
Net periodic pension expense	$	81		$	108		$	244		$	324

The Bank made an annual contribution to its defined benefit pension plan in the amount of $142,000 and $364,000, respectively, in the first quarter of 2006 and 2005.

17

PART I. ITEM 2

MASSBANK CORP. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION & ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

September 30, 2006

Forward-Looking Statement Disclosure.

This Form 10-Q may contain forward-looking statements. These statements relate to future, not past, events and include, among others, statements with respect to MASSSBANK Corp.’s beliefs, plans, objectives, goals, guidelines, expectations, financial condition, results of operations, future performance and business of the Company. You can identify forward-looking statements by the use of the words “may”, “could”, “should”, “believe”, “expect”, “anticipate”, “intend”, “estimate”, “assume”, “will”, “would”, “plan”, “projects”, “outlook” or similar expressions. These statements are based upon the current beliefs and expectations of the Company’s management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements. These forward- looking statements involve certain risks and uncertainties that are subject to change based on various factors (many of which are beyond MASSBANK Corp.’s control).

The following factors, among others, could cause the Company’s performance to differ materially from that expressed in any forward-looking statements: (1) the strength of the United States economy in general and the strength of the local economy in which the Company conducts operations may be different than expected; (2) unexpected fluctuations in market interest rates; (3) adverse conditions in the stock market, the public debt market and other capital markets; (4) an increase in the level of non-performing assets; (5) an increase in the competitive pricing pressures within the Company’s market which may result in an increase in the Company’s cost of funds, a decrease in loan originations, a decrease in deposits and assets; (6) adverse legislative and regulatory developments; (7) a significant decline in residential real estate values in the Company’s market area; (10) the impact of changes in accounting principles; (11) the impact of inflation or deflation; (12) an increase in employee-related costs; (13) MASSBANK Corp.’s success at managing the risks involved in the foregoing and other risk factors described in the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2005.

18

Critical Accounting Policies

The Company’s consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. 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.

Provisions (Credit) for Loan Losses

The provision (credit) for loan losses represents a charge or credit against current earnings and an addition to or deduction from the allowance for loan losses. In determining the amount to provide for loan losses, the key factor is the adequacy of the allowance for loan losses (“loan allowance”). Management uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the portfolio for purposes of establishing a sufficient loan allowance. 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.

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

Any significant changes in these assumptions and/or conditions could result in higher than estimated 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 allowances. Such agencies may require the Bank to recognize additional allowances based on judgments different from those of management, which could also adversely affect the Company’s earnings results.

Investment Securities Other Than Temporarily Impaired

Management judgment is involved in the evaluation of declines in value (“impairment”) of individual investment securities held by the Company. Declines in value 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 of other than temporarily impaired securities, including industry analyst reports, sector credit ratings, volatility in market price and other relevant information, such as the financial condition, earnings capacity and near term prospects of the company and the length of time and extent to which the market value has been less than cost.

19

INVESTMENT SECURITIES OTHER THAN TEMPORARILY IMPAIRED (continued)

Whenever a debt or equity security is deemed to be “other than temporarily impaired” due to a fundamental deterioration in its financial condition as determined by management’s analysis, it is written down to its current fair market value. U.S. Treasury securities and other securities backed by the U.S. Government are never considered impaired due to a fundamental deterioration in financial condition.

If “due to general market conditions” an investment security declines in price from its cost basis by 25% or more for more than a year, between 30% and 40% for more than nine months, between 40% and 50% for more than six months or over 50% for more than ninety days, and in each case the value of the investment security has been below its cost basis for the entire period in question, then the security is considered “other than temporarily impaired” and it is written down to its current fair market value and the loss is recognized in earnings. U.S. Treasury and Government Agency securities fluctuate in value based on changes in market interest rates and other factors; however, they can be redeemed at par value if held to maturity and therefore, if their maturity date is less than one year into the future, regardless of their market value, they are considered only temporarily impaired. Any unfavorable change in general market conditions could cause an increase in the Company’s impairment write downs of investment securities. This would have an adverse effect on the Company’s earnings results. There were no other than temporary impairment write downs of investment securities in the first nine months of 2006 and 2005.

Securities available for sale deemed temporarily impaired are carried at market value in the asset section of the Company’s balance sheet. Any change in value is reflected in accumulated other comprehensive income (loss) in the stockholders’ equity section of the Company’s balance sheet.

20

FINANCIAL OVERVIEW

MASSBANK Corp. provides a broad range of banking services through its subsidiary, MASSBANK (“the Bank”). The Bank offers a full range of retail and commercial deposit products through its fifteen banking offices located in Eastern Massachusetts. The Bank’s lending business includes residential and commercial real estate mortgages, construction loans, commercial loans and a variety of consumer loans. The Bank’s loan portfolio is concentrated among borrowers from the municipalities in which it operates banking offices and all of the contiguous cities and towns. The Bank also invests a significant portion of its funds in U.S. Treasury and Government agency securities, mortgage-backed securities, federal funds sold and other authorized investments. The Bank’s earnings depend largely upon net interest income. Securities gains are also an important source of revenue for the Bank.

The Bank faces strong competition from banks and other financial services providers in our market area. The principal methods of competition are through interest rates, financing terms and other customer conveniences. Among the external factors affecting MASSBANK’s operating results are market interest rates, the shape of the U.S. Treasury securities yield curve, the condition of the financial markets and both regional and national economic conditions.

For the quarter ended September 30, 2006, MASSBANK Corp. reported net income of $1,731,000 or $0.40 in basic and diluted earnings per share compared to net income of $1,884,000 or $0.43 in basic and diluted earnings per share in the third quarter of 2005. Return on average assets and return on average equity were 0.82% and 6.72%, respectively, in the third quarter of 2006 compared to 0.82% and 7.06%, respectively, in the same quarter of 2005.

21

FINANCIAL OVERVIEW (continued)

The major factors affecting the Company’s earnings results for the third quarter of 2006 compared to the third quarter of 2005 were:

• The decrease in net interest income of $288,000.

• The provision for loan losses in the recent quarter of $82,000 compared to no provision for loan losses in the same quarter last year.

• The decrease in net securities gains of $70,000.

• The decrease in deferred compensation plan income and other non-interest income of $37,000.

• The decrease in non-interest expense of $247,000.

• The decrease in income tax expense of $77,000.

(In thousands) Quarters Ended September 30,	2006		2005		Variance
Income Statement Data
Total interest and dividend income	$	10,052	$	9,346	$	706
Total interest expense		4,872		3,878		(994	)
Net interest income		5,180		5,468		(288	)
Provision (credit) for loan losses		82		—		(82	)
Gains on securities, net		168		238		(70	)
Deferred compensation plan income		48		49		(1	)
Other non-interest income		231		267		(36	)
Non-interest expense		2,929		3,176		247
Income tax expense		885		962		77
Net income	$	1,731	$	1,884	$	(153	)
Diluted earnings per share	$	0.40	$	0.43	$	(0.03	)
(In thousands) Quarters Ended September 30,	2006		2005		Variance
Average Balance Sheet Data
Earning assets:
Mortgage and other loans	$	214,885	$	228,626	$	(13,741	)
Mortgage-backed securities		138,206		135,396		2,810
Federal funds sold		143,922		199,336		(55,414	)
Short-term investments		5,750		1,345		4,405
Other securities available for sale and trading		319,403		332,889		(13,486	)
Total earning assets	$	822,166	$	897,592	$	(75,426	)
Total deposits	$	741,044	$	809,607	$	(68,563	)

22

FINANCIAL OVERVIEW (Continued)

Condensed Consolidated Balance Sheets

(In thousands)	September 30, 2006			December 31, 2005			Variance
Assets:
Short-term investments	$	138,854		$	167,787		$	(28,933	)
Term federal funds sold		15,000			—			15,000
Interest-bearing deposits in banks		—			898			(898	)
Securities available for sale, at market value		429,013			453,472			(24,459	)
Securities held to maturity, at amortized cost		5,416			6,137			(721	)
Trading securities, at market value		369			9,282			(8,913	)
Total investments		588,652			637,576			(48,924	)
Total loans		213,876			225,730			(11,854	)
Allowance for loan losses		(1,395	)		(1,253	)		(142	)
Net loans		212,481			224,477			(11,996	)
Other assets		44,794			36,626			8,168
Total assets	$	845,927		$	898,679		$	(52,752	)
Liabilities:
Total deposits	$	729,411		$	784,728		$	(55,317	)
Escrow deposits of borrowers		992			1,059			(67	)
Other liabilities		9,622			7,628			1,994
Total liabilities		740,025			793,415			(53,390	)
Total stockholders’ equity		105,902			105,264			638
Total liabilities and stockholders’ equity	$	845,927		$	898,679		$	(52,752	)

Financial Condition

The Company’s total assets were $845.9 million at September 30, 2006, compared to $898.7 million at December 31, 2005 reflecting a decrease of $52.8 million. This includes a decrease of $48.9 million in total investments and a decrease of $12.0 million in total loans, partially offset by an increase in other assets of $8.1 million. Deposits, the primary funding source for the Company’s assets, decreased $55.3 million during the first nine months of 2006, due to increased competition for deposits.

23

Investments

At September 30, 2006, the Company’s total investments were $588.7 million representing 69.6% of total assets compared to $637.6 million representing 70.9% of total assets at December 31, 2005. Total investments have decreased $48.9 million from year-end 2005. The Company’s total investments were reduced because of the decrease in the Bank’s total deposits during the first nine months of 2006.

The decline in total investments includes a decrease in short-term investments, primarily federal funds sold, of $28.9 million. The Company, however, continues to maintain a strong liquidity position with over 16% of its assets in short-term investments, primarily federal funds sold. This also helps the Bank capitalize on the current inverted yield curve environment (an environment where short-term rates actually exceed long-term rates).

Loans

The loan portfolio, net of allowance for loan losses, decreased $12.0 million or 5.3% in the first nine months of 2006. At September 30, 2006, the loan portfolio, net of allowance for loan losses, totaled $212.5 million representing 25.1% of total assets compared to $224.5 million representing 25.0% of total assets at December 31, 2005. The decrease in loans is due to regular principal payments and prepayments exceeding the volume of new loan originations. New loan originations decreased $22.9 million or approximately 57% to $17.1 million in the first nine months of 2006 from $40.0 million in the same period of 2005. Mortgage loan origination activity (particularly refinancing activity) has decreased significantly in the Bank’s market area due to the rise in market interest rates.

The Bank’s loan portfolio consists predominately of residential mortgages. Residential mortgage loans (excluding residential construction loans) amounted to $197.5 million at September 30, 2006, representing 92.4% of the total loan portfolio. See page 41 of this Form 10-Q for a table setting forth the composition of the loan portfolio at September 30, 2006 and December 31, 2005.

Non-Performing Assets

Non-accrual loans, generally those loans that are 90 days or more delinquent, are at historical lows totaling only $5,000 at September 30, 2006 compared to $257,000 at December 31, 2005 and $267,000 as of September 30, 2005. The Bank had no impaired loans or real estate acquired through foreclosure at September 30, 2006.

Deposits

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

Deposits at September 30, 2006 totaled $729.4 million, reflecting a decrease of $55.3 million or 7.0% from $784.7 million at December 31, 2005. In the first nine months of 2006 there was an outflow of deposits due to increased competition for deposits and some deposits being reinvested in the stock market and other types of investments.

For information concerning deposit balances at September 30, 2006 and December 31, 2005, see page 44 of this Form 10-Q.

24

Stockholders’ Equity

Total stockholders’ equity increased $0.6 million to $105.9 million at September 30, 2006, from $105.3 million at December 31, 2005. This represents a book value of $24.55 per share at September 30, 2006, up $0.23 from $24.32 per share at December 31, 2005.

The increase in stockholders’ equity was essentially the result of the following: the Company’s net income for the first nine months of 2006 of $5.3 million and the payments and related tax benefits received from the exercise of stock options by the Company’s officers and directors of $0.6 million. This was essentially offset by the payment of dividends to stockholders of $3.5 million; the Company’s repurchase of treasury stock in the amount of $1.4 million during the first nine months of 2006; and an increase in accumulated other comprehensive loss of $0.4 million due primarily to the decline in market value of the Company’s debt securities portfolio as a result of rising interest rates.

Comparison of Operating Results for the Three Months ended September 30, 2006 and 2005.

Net interest income

Net interest income for the recent quarter decreased by $288,000 or 5.3% to $5,180,000 from $5,468,000 in the same quarter of 2005, as the Bank continued to be challenged by the current inverted yield curve environment (an environment where short-term rates actually exceed long-term rates). Additionally, the market for deposits has become more competitive as financial institutions have been more aggressive in pricing their deposit products to retain deposits. MASSBANK has chosen not to match these competitors’ rates in order to protect its net interest margin.

The decrease in net interest income reflects an improvement in net interest margin offset by the reduction in net interest income resulting from a decrease in average earning assets and average deposits. The Company’s net interest margin in the recent quarter improved 9 basis points to 2.53% from 2.44% in the third quarter of 2005. This is the eighth consecutive quarter that the Company has reported a year-over-year improvement in net interest margin.

Average earning assets for the recent quarter declined $75.4 million to $822.2 million, from $897.6 million in the third quarter of last year. Average total deposits were $741.0 million for the third quarter 2006 compared to $809.6 million for the same quarter of 2005.

25

Interest and Dividend Income

Interest and dividend income on a fully taxable equivalent basis for the three months ended September 30, 2006 increased $711,000 or 7.6% to $10,073,000 from $9,362,000 for the three months ended September 30, 2005. The increase in interest and dividend income resulted from an increase in yield on the Company’s average earning assets, partially offset by a decrease in interest income resulting from a decrease of $75.4 million in average earning assets. As reflected in the table on page 27 of this report, the yield on the Company’s average earning assets in the third quarter of 2006 was 4.90%, as compared to 4.17% in the same quarter of 2005. The improvement in yield on the Company’s average earning assets is primarily attributable to an increase in interest income on federal funds sold due to higher short-term interest rates and an increase in interest income on investment securities available for sale, due to higher market interest rates, higher replacement yields on new securities purchased and to a lesser extent, a change in mix of securities in the portfolio.

Interest Expense

Total interest expense for the three months ended September 30, 2006 increased $994,000, or 25.6% to $4,872,000 from $3,878,000 for the three months ended September 30, 2005. The increase in interest expense is due primarily to rising interest rates and the continued shift in the Bank’s deposit mix from savings accounts to certificates of deposit accounts. This has resulted in an increase in the Company’s average cost of funds, from 1.90% in the third quarter of 2005 to 2.61% in the third quarter of 2006. The increase in interest expense resulting from the higher average cost of funds was partially offset by a decrease in interest expense resulting from a decrease in the Company’s average deposits. The Company’s average deposits in the recent quarter, as shown in the table on page 28, decreased $68.6 million or 8.5% to $741.0 million, from $809.6 million in the same quarter of the prior year.

26

	AVERAGE BALANCE SHEETS Three Months Ended September 30,
	2006							2005
(In thousands)	Average Balance			Interest Income/ Expense (1)		Average Yield/ Rate		Average Balance			Interest Income/ Expense (1)		Average Yield/ Rate
Assets:
Earning assets:
Federal funds sold	$	143,922		$	1,923	5.30	%	$	199,336		$	1,722	3.43	%
Short-term investments (4)		5,750			74	5.08			1,345			12	3.51
Securities available for sale:
Other securities (2)		314,664			3,165	4.02			304,074			2,466	3.24
Mortgage-backed securities (2)		132,667			1,799	5.42			130,809			1,737	5.31
Mortgage-backed securities held to maturity		5,539			73	5.29			4,587			59	5.08
Trading securities		4,739			40	3.35			28,815			187	2.57
Mortgage loans (3)		205,321			2,799	5.45			218,316			2,998	5.49
Other loans (3)		9,564			200	8.32			10,310			181	6.96
Total earning assets		822,166		$	10,073	4.90	%		897,592		$	9,362	4.17	%
Allowance for loan losses		(1,302	)						(1,253	)
Total earning assets less allowance for loan losses		820,864							896,339
Other assets		27,753							23,946
Total assets	$	848,617						$	920,285

(1) Dividend income on equity securities is included on a tax equivalent basis.

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

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

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

27

	AVERAGE BALANCE SHEETS - (continued) Three Months Ended September 30,
	2006						2005
(In thousands)	Average Balance		Interest Income/ Expense		Average Yield/ Rate		Average Balance		Interest Income/ Expense		Average Yield/ Rate
Liabilities:
Deposits:
Demand and NOW	$	80,129	$	61	0.30	%	$	86,239	$	45	0.21	%
Savings		377,669		1,750	1.84			484,754		1,967	1.61
Time certificates of deposit		283,246		3,061	4.29			238,614		1,866	3.10
Total deposits		741,044		4,872	2.61	%		809,607		3,878	1.90	%
Other liabilities		4,478						4,003
Total liabilities		745,522						813,610
Stockholders’ equity		103,095						106,675
Total liabilities and stockholders’ equity	$	848,617					$	920,285
Net interest income (tax-equivalent basis)				5,201						5,484
Less adjustment for tax-exempt interest income				21						16
Net interest income			$	5,180					$	5,468
Interest rate spread (5)					2.29	%					2.27	%
Net interest margin (6)					2.53	%					2.44	%

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

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

28

Provision (Credit) for Loan Losses

The Bank, in the third quarter of 2006, recorded a provision for loan losses of $82,000 compared to no provision for loan losses in the same quarter of last year. This, however, is offset by a credit of $107,000 to the Bank’s provision for off-balance sheet exposures, which is included in non-interest expense. As loan commitments made to customers are drawn down, loss reserves against such commitments are reduced and loss reserves against outstanding loans are generally increased.

In determining the amount to provide for loan losses, the key factor is the adequacy of the allowance for loan losses. Management uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the portfolio for the purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: an analysis of individual loans deemed to be impaired, general loss allocations for various loan types based on loss experience factors, and an unallocated allowance which is maintained based on management’s assessment of many factors including the risk characteristics of the portfolio, concentrations of credit, current and anticipated economic conditions that may affect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.

At September 30, 2006, the allowance for loan losses was $1,395,000 representing 0.65% of total loans. This compares to $1,253,000 representing 0.56% of total loans at December 31, 2005. Non-accrual loans totaled only $5,000 at September 30, 2006. This compares to $257,000 at December 31, 2005 and $267,000 a year earlier. Management believes that the allowance for loan losses as of September 30, 2006 is adequate to cover the risks inherent in the loan portfolio under current conditions.

The Bank also maintains an allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) that totaled $336,000 at September 30, 2006 and $517,000 as of December 31, 2005. This is intended to protect the Bank against losses on loan commitments made to customers that have not yet been drawn down.

Non-Interest Income

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

Non-interest income decreased $107,000 to $447,000 in the third quarter of 2006, from $554,000 in the comparable quarter of the prior year.

In the recent quarter, the Company recorded net gains on securities of $168,000 compared to net securities gains of $238,000 in the same quarter last year. Net securities gains in the recent quarter consisted of net gains on securities available for sale of $80,000 and net gains on trading securities of $88,000. This compares to net gains on securities available for sale of $177,000 and net gains on trading securities of $61,000 in the third quarter of 2005.

The Bank has a supplemental retirement plan for certain executive officers. In the recent quarter, the Bank recorded plan income of $48,000 due primarily to the appreciation in market value of plan assets, compared to plan income of $49,000 in the third quarter of 2005.

The Bank’s deposit account service fees and other non-interest income totaled $84,000 and $147,000, respectively, for the third quarter of 2006. This compares to $100,000 and $167,000, respectively, in the third quarter of 2005. The combined total of these two items decreased $36,000 from the same quarter of the prior year. Deposit account service fees have declined due to a decrease in the number of deposit accounts subject to these types of charges.

29

Non-Interest Expense

Non-interest expense decreased $247,000 or 7.8% to $2,929,000 for the three months ended September 30, 2006 compared to the same period in 2005.

Salaries and employee benefits, the largest component of non-interest expense decreased $69,000 or 3.7% to $1,808,000 in the recent quarter, from $1,877,000 in the comparable quarter of 2005. The decrease is primarily attributable to a decrease in employee salary expense of $45,000 due to a decrease in the number of employees. Additionally, the Company recognized $11,000 in stock-based compensation expense in the recent quarter that is included in salaries and employee benefits expense. The recognition of this expense is required under SFAS 123R which the Company adopted effective January 1, 2006.

Occupancy and equipment expense decreased $31,000 or 6.0% to $490,000 in the recent quarter from $521,000 in the third quarter of 2005. This decrease is primarily attributable to a decrease in equipment depreciation expense as the cost of some of the Bank’s equipment has been fully depreciated.

All other non-interest expenses combined decreased $147,000 or 18.9% to $631,000 for the three months ended September 30, 2006 from $778,000 for the three months ended September 30, 2005. The decrease is primarily attributable to an increase of $111,000 in the credit provision for off-balance sheet credit exposures recorded in the recent quarter, reducing the Bank’s loan loss reserves against outstanding loan commitments.

Income Tax Expense

The Company, the Bank and its subsidiaries file a consolidated federal income tax return. The Parent Company, the Bank and its subsidiaries are subject to a Massachusetts Corporate Excise Tax as calculated in separately filed Massachusetts tax returns.

The Company recorded income tax expense of $885,000 in the third quarter of 2006, a decrease of $77,000 when compared to the same quarter last year. The decrease in income tax expense is due primarily to a decrease in income before income taxes. The Company’s income before income taxes was $2,616,000 in the recent quarter compared to $2,846,000 for the same quarter a year ago. The effective income tax rate for the three months ended September 30, 2006 and 2005 was 33.83% and 33.80%, respectively.

30

Comparison of Operating Results for the Nine Months ended September 30, 2006 and 2005.

FINANCIAL OVERVIEW

For the nine months ended September 30, 2006, the Company reported net income of $5,296,000, or $1.21 in diluted earnings per share compared to net income of $5,435,000 or $1.22 in diluted earnings per share for the first nine months of 2005. Basic earnings per share in the first nine months of 2006 were $1.22 per share compared to $1.24 per share in the same period of the prior year. Return on average assets and return on average equity were 0.81% and 6.81%, respectively, in the first nine months of 2006 up from 0.77% and 6.72%, respectively, in the same period of 2005.

The major factors affecting the Company’s earnings results for the first nine months of 2006 compared to the same period of 2005 were:

• The decrease in net interest income of $158,000.

• The provision for loan losses in the first nine months of 2006 of $132,000 compared to a credit provision for loan losses of $53,000 in the same period last year.

• The increase in net securities gains of $112,000.

• The increase in deferred compensation plan income of $50,000.

• The decrease in other non-interest income of $68,000.

• The decrease in non-interest expense of $111,000.

(In thousands) Nine Months Ended September 30,	2006		2005			Variance
Income Statement Data
Interest and dividend income:
Mortgage and other loans	$	9,124	$	9,655		$	(531	)
Mortgage-backed securities		5,698		5,392			306
Federal funds sold		5,727		4,310			1,417
Other securities and short-term investments		9,305		7,823			1,482
Total interest and dividend income		29,854		27,180			2,674
Total interest expense		13,845		11,013			(2,832	)
Net interest income		16,009		16,167			(158	)
Provision (credit) for loan losses		132		(53	)		(185	)
Gains on securities, net		538		426			112
Deferred compensation plan income		109		59			50
Other non-interest income		783		851			(68	)
Non-interest expense		9,268		9,379			111
Income tax expense		2,743		2,742			(1	)
Net income	$	5,296	$	5,435		$	(139	)
Diluted earnings per share	$	1.21	$	1.22		$	(0.01	)
(In thousands) Nine Months Ended September 30,	2006		2005			Variance
Average Balance Sheet Data
Earning assets:
Mortgage and other loans	$	219,179	$	230,774		$	(11,595	)
Mortgage-backed securities		140,752		134,255			6,497
Federal funds sold		157,431		196,101			(38,670	)
Short-term investments		2,420		1,897			523
Other securities available for sale and trading		322,515		352,142			(29,627	)
Total earning assets	$	842,297	$	915,169		$	(72,872	)
Total deposits	$	759,739	$	825,946		$	(66,207	)

31

Net Interest Income

Net interest income totaled $16,009,000 for the nine months ended September 30, 2006, a decrease of $158,000 from the same period in 2005. The decrease in net interest income reflects a decrease in average earning assets due to a lower deposit base, partially offset by an improvement in net interest margin and net interest spread.

The Company’s net interest spread improved to 2.29% for the first nine months of 2006 from 2.19% in the same period last year. Net interest spread represents the difference between the yield on earning assets and the cost of the Company’s deposits. 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 nine months ended September 30, 2006 improved 18 basis points to 2.54% from 2.36% reported in the first nine months of last year. Average earning assets for the nine months ended September 30, 2006 decreased $72.9 million to $842.3 million, from $915.2 million in the same period of 2005.

Interest and Dividend Income

Interest and dividend income on a fully taxable equivalent basis for the nine months ended September 30, 2006 increased $2,685,000 or 9.9% to $29,908,000 from $27,223,000 for the nine months ended September 30, 2005. The increase in interest and dividend income resulted from an increase in yield on the Company’s average earning assets, partially offset by a decrease in interest income resulting from a decrease of $72.9 million in average earning assets. As reflected in the table on page 33 of this report, the yield on the Company’s average earning assets in the first nine months of 2006 was 4.73%, as compared to 3.97% in the same period of 2005. The improvement in yield on the Company’s average earning assets is primarily attributable to an increase in interest income on federal funds sold due to higher short-term interest rates and an increase in interest income on securities available for sale due to higher rates on intermediate and longer term investments. Market rates increased due to the Federal Reserve Bank’s rate setting actions. The Federal Reserve Bank Board’s Federal Open Market Committee (FOMC) raised the target rate for federal funds (the rate for overnight borrowings between banks) by 25 basis points seventeen times from the end of June 2004 to the end of September 2006, increasing the rate from 1.00% to 5.25%.

Interest Expense

Total interest expense for the nine months ended September 30, 2006 increased $2,832,000, or 25.7% to $13,845,000 from $11,013,000 for the nine months ended September 30, 2005. The increase in interest expense is due primarily to the higher interest rate environment in 2006 and the continued shift in the Bank’s deposit mix from savings accounts to certificates of deposit accounts. This has resulted in an increase in the Company’s average cost of funds, from 1.78% in the first nine months of 2005 to 2.44% in the first nine months of 2006. The increase in interest expense resulting from the higher average cost of funds was partially offset by a decrease in interest expense resulting from a decrease in the Company’s average deposits. The Company’s average deposits in the first nine months of 2006, as shown in the table on page 34, decreased $66.2 million or 8.0% to $759.7 million, from $825.9 million in the same period of the prior year.

32

	AVERAGE BALANCE SHEETS Nine Months Ended September 30,
	2006							2005
(In thousands)	Average Balance			Interest Income/ Expense (1)		Average Yield/ Rate		Average Balance			Interest Income/ Expense (1)		Average Yield/ Rate
Assets:
Earning assets:
Federal funds sold	$	157,431		$	5,727	4.86	%	$	196,101		$	4,310	2.94	%
Short-term investments (4)		2,420			86	4.76			1,897			45	3.19
Securities available for sale:
Other securities (2)		315,231			9,073	3.84			314,980			7,201	3.05
Mortgage-backed securities (2)		134,961			5,469	5.40			129,547			5,211	5.36
Mortgage-backed securities held to maturity		5,791			229	5.28			4,708			181	5.12
Trading securities		7,284			200	3.67			37,162			620	2.22
Mortgage loans (3)		209,602			8,554	5.44			220,690			9,148	5.53
Other loans (3)		9,577			570	7.96			10,084			507	6.72
Total earning assets		842,297		$	29,908	4.73	%		915,169		$	27,223	3.97	%
Allowance for loan losses		(1,267	)						(1,271	)
Total earning assets less allowance for loan losses		841,030							913,898
Other assets		26,811							25,145
Total assets	$	867,841						$	939,043

(1) Dividend income on equity securities is included on a tax equivalent basis.

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

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

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

33

	AVERAGE BALANCE SHEETS - (continued) Nine Months Ended September 30,
	2006						2005
(In thousands)	Average Balance		Interest Income/ Expense		Average Yield/ Rate		Average Balance		Interest Income/ Expense		Average Yield/ Rate
Liabilities:
Deposits:
Demand and NOW	$	81,428	$	164	0.27	%	$	85,808	$	137	0.21	%
Savings		401,614		5,362	1.78			515,216		6,022	1.56
Time certificates of deposit		276,697		8,319	4.02			224,922		4,854	2.89
Total deposits		759,739		13,845	2.44	%		825,946		11,013	1.78	%
Other liabilities		4,420						5,240
Total liabilities		764,159						831,186
Stockholders’ equity		103,682						107,857
Total liabilities and stockholders’ equity	$	867,841					$	939,043
Net interest income (tax-equivalent basis)				16,063						16,210
Less adjustment for tax-exempt interest income				54						43
Net interest income			$	16,009					$	16,167
Interest rate spread (5)					2.29	%					2.19	%
Net interest margin (6)					2.54	%					2.36	%

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

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

34

Provision (Credit) for Loan Losses

In the first nine months of 2006, the Bank recorded a provision for loan losses of $132,000 compared to a credit provision of $53,000 in the comparable period of 2005. This, however, is offset by a credit of $181,000 to the Bank’s provision for off-balance sheet credit exposures, which is included in non-interest expense. As loan commitments made to customers are drawn down, loss reserves against outstanding loans are generally increased.

In determining the amount to provide for loan losses, the key factor is the adequacy of the allowance for loan losses (“loan allowance”). Management uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the portfolio for the purposes of establishing a sufficient loan allowance. The methodology includes three elements: an analysis of individual loans deemed to be impaired, general loss allocations for various loan types based on loss experience factors and an unallocated allowance. 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 the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.

At September 30, 2006, the allowance for loan losses was $1,395,000 representing 0.65% of total loans. This compares to $1,253,000 representing 0.56% of total loans at December 31, 2005. Non-accrual loans totaled only $5,000 at September 30, 2006. This compares to $257,000 at December 31, 2005 and $267,000 a year earlier. Management believes that the allowance for loan losses as of September 30, 2006 is adequate to cover the risks inherent in the loan portfolio under current conditions.

The Bank also maintains an allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) that totaled $336,000 and $517,000 at September 30, 2006 and December 31, 2005, respectively. This is intended to protect the Bank against losses on loan commitments made to customers that have not yet been drawn down.

Non-Interest Income

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

Non-interest income increased $94,000 to $1,430,000 in the nine months ended September 30, 2006, from $1,336,000 in the comparable period of the prior year.

In the first nine months of 2006, the Company’s net securities gains increased $112,000 or 26.3% to $538,000 from $426,000 in the same period last year. Net securities gains in the first nine months of 2006 consisted of net gains on securities available for sale of $429,000 and net gains on trading securities of $109,000. This compares to net gains on securities available for sale of $307,000 and net gains on trading securities of $119,000 in the first nine months of 2005.

The Bank has a supplemental retirement plan for certain executive officers. In the first nine months of 2006, the Bank recorded income of $109,000 due primarily to the appreciation in market value of plan assets, compared to income of $59,000 in the same period last year. This increase is offset by a similar increase in deferred compensation plan expense reported in non-interest expense.

The Bank’s deposit account service fees and other non-interest income totaled $258,000 and $525,000, respectively, for the nine months ended September 30, 2006. This compares to $301,000 and $550,000, respectively, in the nine months ended September 30, 2005. Deposit account service fees have declined due to a decrease in the number of deposit accounts subject to these types of charges.

35

Non-Interest Expense

Non-interest expense decreased $111,000 or 1.2% to $9,268,000 for the nine months ended September 30, 2006 from $9,379,000 for the same period in 2005.

Salaries and employee benefits, the largest component of non-interest expense decreased $28,000 or less than 1.0% to $5,544,000 in the first nine months of 2006, from $5,572,000 for the same period of 2005. The decrease is primarily attributable to a decrease in employee salary expense, due to a decrease in the number of employees and a decrease in the Company’s pension expense. These are partially offset by the share-based payment compensation expense of $50,000 that the Company recognized in the first nine months of 2006. The recognition of this expense is required under SFAS 123R which the Company adopted effective January 1, 2006.

Deferred compensation plan expense related to the Bank’s supplemental retirement plan for certain executive officers increased $47,000 to $172,000 in the first nine months of 2006 compared to the same period last year. This increase is offset by an increase in deferred compensation plan income reported in non-interest income.

Occupancy and equipment expense increased $53,000 or 3.2% to $1,702,000 in the first nine months of 2006 from $1,649,000 in the first nine months of 2005. This increase is primarily attributable to an increase in building depreciation expense. The Bank completed construction of a new branch facility in Everett, Massachusetts and accelerated the depreciation of its former branch facility, which was demolished to make room for a parking lot for the new facility.

All other non-interest expenses combined decreased $183,000 or 9.0% to $1,850,000 for the nine months ended September 30, 2006 from $2,033,000 for the nine months ended September 30, 2005. The decrease is primarily attributable to an increase of $182,000 in the credit provision for off-balance sheet credit exposures recorded in the first nine months of this year compared to the same period last year, reducing the Bank’s loan loss reserves against outstanding loan commitments.

Income Tax Expense

The Company, the Bank and its subsidiaries file a consolidated federal income tax return. The Parent Company, the Bank and its subsidiaries are subject to a Massachusetts Corporate Excise Tax as calculated in separately filed Massachusetts tax returns.

The Company recorded income tax expense of $2,743,000 in the first nine months of 2006, essentially unchanged from the same period last year. The income tax expense reflects a decrease in income before income taxes offset by an increase in effective income tax rate. The Company’s income before income taxes was $8,039,000 in the first nine months of 2006 compared to $8,177,000 for the same period a year ago. The effective income tax rate for the nine months ended September 30, 2006 increased to 34.12% from 33.53% for the same period in 2005.

36

FINANCIAL CONDITION

INVESTMENT SECURITIES

The amortized cost and market value of investment securities at September 30, 2006 with gross unrealized gains and losses follows:

(In thousands) At September 30, 2006	Amortized Cost			Gross Unrealized Gains		Gross Unrealized Losses			Market Value
Securities held to maturity:
Mortgage-backed securities:
Federal National Mortgage Association	$	5,416		$	—	$	(139	)	$	5,277
Total securities held to maturity	$	5,416		$	—	$	(139	)	$	5,277
Securities available for sale:
Debt securities:
U.S. Treasury obligations	$	36,043		$	—	$	(432	)	$	35,611
U.S. Government agency obligations		257,026			30		(3,640	)		253,416
Total		293,069			30		(4,072	)		289,027
Mortgage-backed securities:
Government National Mortgage Association		1,876			17		—			1,893
Federal Home Loan Mortgage Corporation		127,275			541		(1,582	)		126,234
Federal National Mortgage Association		2,571			—		(45	)		2,526
Collateralized mortgage obligations		78			—		—			78
Total mortgage-backed securities		131,800			558		(1,627	)		130,731
Total debt securities available for sale		424,869			588		(5,699	)		419,758
Equity securities		9,695			481		(921	)		9,255
Total securities available for sale		434,564		$	1,069	$	(6,620	)	$	429,013
Net unrealized losses on securities available for sale		(5,551	)
Total securities available for sale, net		429,013
Total investment securities, net	$	434,429
TRADING SECURITIES
The market value of trading securities is as follows:
(In thousands) At September 30, 2006									Market Value
Marketable equity securities									$	365
Investments in mutual funds										4
Total trading securities									$	369

37

FINANCIAL CONDITION

INVESTMENT SECURITIES (continued)

The amortized cost and market value of investment securities at December 31, 2005 with gross unrealized gains and losses follows:

(In thousands) At December 31, 2005	Amortized Cost			Gross Unrealized Gains		Gross Unrealized Losses			Market Value
Securities held to maturity:
Mortgage-backed securities:
Federal National Mortgage Association	$	6,137		$	—	$	(115	)	$	6,022
Total	$	6,137		$	—	$	(115	)	$	6,022
Securities available for sale:
Debt securities:
U.S. Treasury obligations	$	77,051		$	—	$	(935	)	$	76,116
U.S. Government agency obligations		239,024			10		(4,497	)		234,537
Total		316,075			10		(5,432	)		310,653
Mortgage-backed securities:
Government National Mortgage Association		3,262			89		—			3,351
Federal Home Loan Mortgage Corporation		128,942			1,003		(1,058	)		128,887
Federal National Mortgage Association		3,138			2		(37	)		3,103
Collateralized mortgage obligations		92			—		(1	)		91
Total mortgage-backed securities		135,434			1,094		(1,096	)		135,432
Total debt securities available for sale		451,509			1,104		(6,528	)		446,085
Equity securities		6,788			722		(123	)		7,387
Total securities available for sale		458,297		$	1,826	$	(6,651	)	$	453,472
Net unrealized losses on securities available for sale		(4,825	)
Total securities available for sale, net		453,472
Total investment securities, net	$	459,609
TRADING SECURITIES
The market value of trading securities is as follows:
(In thousands) At December 31, 2005									Market Value
U.S. Treasury obligations									$	7,896
Marketable equity securities										1,382
Investments in mutual funds										4
Total trading securities									$	9,282

38

Investments (continued)

The amortized cost and market value of debt securities available for sale by contractual maturity at September 30, 2006 and December 31, 2005 are shown in the following table. Actual maturities will differ from contractual maturities because of callable government agency securities in the Company’s portfolio that may be called prior to maturity.

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

(In thousands)	September 30, 2006					December 31, 2005
	Amortized Cost			Market Value		Amortized Cost			Market Value
Investment securities available for sale:
U.S. Treasury obligations:
Maturing within 1 year	$	24,034		$	23,904	$	50,950		$	50,595
Maturing after 1 year but within 5 years		12,009			11,707		26,101			25,521
Total		36,043			35,611		77,051			76,116
U.S. Government agency obligations:
Maturing within 1 year		79,000			78,463		45,999			45,612
Maturing after 1 year but within 5 years		152,994			150,281		171,992			168,254
Maturing after 5 years but within 10 years		23,996			23,663		19,996			19,665
Maturing after 10 years but within 15 years		1,036			1,009		1,037			1,006
Total		257,026			253,416		239,024			234,537
Mortgage-backed securities:
Maturing within 1 year		81			82		19			20
Maturing after 1 year but within 5 years		8,162			8,280		7,238			7,451
Maturing after 5 years but within 10 years		18,820			19,131		22,333			22,955
Maturing after 10 years but within 15 years		104,659			103,160		105,779			104,940
Maturing after 15 years		78			78		65			66
Total		131,800			130,731		135,434			135,432
Total debt securities available for sale		424,869		$	419,758		451,509		$	446,085
Net unrealized losses on debt securities available for sale		(5,111	)				(5,424	)
Total debt securities available for sale, net carrying value	$	419,758				$	446,085

Maturities of mortgage-backed securities are shown at final contractual maturity but are expected to have shorter lives because borrowers have the right to prepay obligations without prepayment penalties.

Included in U.S. Government agency obligations are investments that can be called prior to final maturity with an amortized cost of $176.0 million and a market value of $173.2 million at September 30, 2006 and an amortized cost of $193.0 million and a market value of $189.3 million at December 31, 2005.

39

INVESTMENT SECURITIES (continued)

The following table presents temporarily impaired investment securities aggregated by category of investments as of September 30, 2006, December 31, 2005, and September 30, 2005.

Temporarily Impaired Investment Securities (Unaudited)

	Temporarily Impaired Less Than 12 Months					Temporarily Impaired 12 Months or Longer					Total
(In thousands)	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
At September 30, 2006 Debt Securities:
U.S. Treasury obligations	$	995	$	(2	)	$	34,616	$	(430	)	$	35,611	$	(432	)
U.S. Government agency obligations		73,728		(271	)		160,622		(3,369	)		234,350		(3,640	)
Mortgaged-backed securities		47,746		(434	)		53,028		(1,332	)		100,774		(1,766	)
Total debt securities		122,469		(707	)		248,266		(5,131	)		370,735		(5,838	)
Equity securities		4,306		(921	)		—		—			4,306		(921	)
Total temporarily impaired investment securities at:
September 30, 2006	$	126,775	$	(1,628	)	$	248,266	$	(5,131	)	$	375,041	$	(6,759	)
December 31, 2005	$	248,034	$	(2,938	)	$	156,694	$	(3,828	)	$	404,728	$	(6,766	)
September 30, 2005	$	254,601	$	(3,287	)	$	98,081	$	(2,392	)	$	352,682	$	(5,679	)

As of September 30, 2006 management concluded that the unrealized losses above are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the ability to hold these investments for a time necessary to recover its cost. The unrealized losses above (with the exception of the equity securities) are on securities that have contractual maturity dates and are primarily related to market interest rates.

40

LOANS

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

(In thousands)	At September 30, 2006		At December 31, 2005
Mortgage loans:
Residential	$	197,529	$	212,711
Commercial		4,647		2,335
Construction		1,829		845
		204,005		215,891
Premium on loans		2		2
Deferred mortgage loan origination costs (fees), net		29		11
Total mortgage loans		204,036		215,904
Other loans:
Consumer:
Installment		815		245
Guaranteed education		696		1,094
Other secured		404		499
Home equity lines of credit		7,708		7,722
Unsecured		132		148
Total consumer loans		9,755		9,708
Commercial		85		118
Total other loans		9,840		9,826
Total loans	$	213,876	$	225,730

The Bank’s loan portfolio decreased $11.8 million during the first nine months of 2006, from $225.7 million at December 31, 2005 to $213.9 million at September 30, 2006. This is due to a decrease in mortgage loans.

The Bank’s mortgage lending activity, particularly refinancing activity, has decreased significantly in 2006 compared to the prior year. Loan originations, as a result, decreased to $5.8 million in the recent quarter from $17.5 million in the third quarter of last year. For the first nine months of 2006, loan originations totaled $17.1 million compared to $40.0 million in the first nine months of 2005.

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NON-PERFORMING ASSETS

The following table shows the composition of the Bank’s non-performing assets at September 30, 2006 and 2005, and December 31, 2005:

(In thousands)	At September 30, 2006			At December 31, 2005			At September 30, 2005
Non-Performing Assets:
Non-accrual loans	$	5		$	257		$	267
Real estate acquired through foreclosure		—			—			—
Total non-performing assets	$	5		$	257		$	267
Allowance for loan losses	$	1,395		$	1,253		$	1,253
Allowance as a percent of total loans		0.65	%		0.56	%		0.54	%
Non-accrual loans as a percent of total loans		0.00	%		0.11	%		0.12	%

The Bank generally does not accrue interest on loans which are 90 days or more past due. It is the Bank’s policy to place such loans on non-accrual status and to reverse from income all interest previously accrued but not collected and to discontinue all amortization of deferred loan fees.

The Company’s non-accrual loans are at historical lows totaling only $5,000 at September 30, 2006 down from $257,000 at December 31, 2005 and $267,000 at September 30, 2005.

The Bank did not have any impaired loans as of September 30, 2006, December 31, 2005 or September 30, 2005.

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ALLOWANCE FOR LOAN LOSSES

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

	Nine Months Ended September 30,
	2006			2005
	(In thousands)
Balance at December 31, 2005 and 2004	$	1,253		$	1,307
Provision (credit) for loan losses		132			(53	)
Recoveries of loans previously charged-off		19			—
Charge-offs		(9	)		(1	)
Balance at September 30,	$	1,395		$	1,253

The Company maintains an allowance for possible losses that are inherent in the Company’s loan portfolio. The allowance for loan losses is increased by provisions charged to operations based on the estimated loan loss exposure inherent in the portfolio. Management uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: an analysis of individual loans deemed to be impaired, general loss allocations for various loan types based on loss experience factors and an unallocated allowance which is maintained based on management’s assessment of many factors including the risk characteristics of the portfolio, concentrations of credit, current and anticipated economic conditions that may effect the borrower’s ability to pay, and trends in loan delinquencies and charge-offs. Realized losses, net of recoveries, are charged directly to the allowance. While management uses currently available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ from the assumptions used in making the evaluation. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management.

At September 30, 2006 the balance of the allowance for loan losses was $1,395,000 representing 0.65% of total loans compared to $1,253,000 representing 0.54% of total loans at September 30, 2005. Management believes that the allowance for loan losses is adequate to cover the risks inherent in the portfolio under current conditions.

The Company also maintains an allowance for possible losses on its outstanding loan commitments that totaled $336,000 and $588,000 at September 30, 2006 and 2005, respectively. The allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) is maintained based on expected drawdowns of committed loans and their loss experience factors and management’s assessment of various other factors including current and anticipated economic conditions that may effect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.

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DEPOSITS

Deposit accounts of all types have traditionally been the primary source of funds for the Bank’s lending and investment activities. The Bank’s deposit flows are influenced by prevailing interest rates, competition and other market conditions. The Bank’s management attempts to manage its deposits through selective pricing and marketing.

The Bank’s total deposits decreased $55.3 million to $729.4 million at September 30, 2006 from $784.7 million at December 31, 2005. The market for deposits has become more competitive as financial institutions have been aggressive in pricing their deposit products to retain deposits. MASSBANK has chosen not to match these competitors’ rates in order to protect its net interest margin.

The composition of the Bank’s total deposits as of the dates shown are summarized as follows:

	September 30, 2006		December 31, 2005
	(In thousands)
Demand and NOW	$	77,577	$	82,250
Savings and money market accounts		363,610		441,541
Time certificates of deposit		288,224		260,937
Total deposits	$	729,411	$	784,728

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PART I. ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in prices. The Company’s investment securities portfolio includes equity securities with a market value of $9.3 million at September 30, 2006. Movements in equity prices affect the value of the equity portfolio and affect the amount of securities gains or losses that the Company realizes from the sale of equity securities. The Company’s debt securities available for sale portfolio has market value of $419.8 million at September 30, 2006. Interest rate changes affect the value of this portfolio. Rising interest rates would generally reduce the value of the portfolio.

Interest Rate Risk

Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change the interest income and expense streams associated with the Company’s financial instruments also change, which impacts net interest income, the primary component of the Company’s earnings. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process. For additional information about the Company’s asset/liability management and interest rate risk, see the Management Discussion and Analysis section of the Company’s Form 10-K for the year ended December 31, 2005.

Liquidity and Capital Resources

The Bank must maintain a sufficient amount of cash and assets which can readily be converted into cash in order to meet cash outflows from normal depositor requirements and loan demands. The Bank’s primary sources of funds are deposits, loan and mortgage-backed securities amortization and prepayments, sales or maturities of investment securities, investment securities called before maturity and income on earning assets. In addition to loan payments and maturing investment securities, which are relatively predictable sources of funds, the Bank maintains a high percentage of its assets invested in overnight federal funds sold and money market funds, which can be immediately converted into cash and United States Treasury and Government agency securities, which can be sold or pledged to raise funds. At September 30, 2006 the Bank had $123.9 million or 14.6% of total assets and $289.0 million or 34.2% of total assets invested, respectively, in overnight federal funds sold and money market funds, and United States Treasury and Government agency obligations.

The Bank is a Federal Deposit Insurance Corporation (“FDIC”) insured institution subject to the FDIC regulatory capital requirements. The FDIC regulations require all FDIC insured institutions to maintain minimum levels of Tier 1 capital. Highly rated banks (i.e., those with a composite rating of 1 under the CAMELS rating system) are required to maintain a minimum leverage ratio of Tier 1 capital to total assets of at least 3.00%. An additional 100 to 200 basis points are required for all but these most highly rated institutions. The Bank is also required to maintain a minimum level of risk-based capital. Under the risk-based capital standards, FDIC insured institutions must maintain a Tier 1 capital to risk-weighted assets ratio of 4.00% and are generally expected to meet a minimum total qualifying capital to risk-weighted assets ratio of 8.00%. The risk-based capital guidelines take into consideration risk factors, as defined by the regulators, associated with various categories of assets, both on and off the balance sheet. Under the guidelines, capital strength is measured in two tiers which are used in conjunction with risk adjusted assets to determine the risk-based capital ratios.

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Liquidity and Capital Resources (continued)

Tier II components include supplemental capital components such as qualifying allowance for loan losses and qualifying subordinated debt and up to 45 percent of the pre-tax net unrealized holding gains on certain available for sale equity securities. Tier I capital plus the Tier II capital components are referred to as total qualifying capital.

The capital ratios of the Bank and the Company currently exceed the minimum regulatory requirements. At September 30, 2006, the Bank had a leverage Tier I capital to average assets ratio of 12.10%, a Tier I capital to risk- weighted assets ratio of 36.20% and a total capital to risk-weighted assets ratio of 36.81%. The Company, on a consolidated basis, had ratios of leverage Tier I capital to average assets of 12.69%, Tier I capital to risk-weighted assets of 37.90% and total capital to risk-weighted assets of 38.50% at September 30, 2006.

PART I. ITEM 4

Controls and Procedures

(a) Evaluation of disclosure controls and procedures. Our principal executive officer and our principal financial officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report. Based upon that evaluation, such officers have concluded that our disclosure controls and procedures are effective as of the end of such period.

(b) Changes in internal controls over financial reporting. There have been no changes during the period covered by this Quarterly Report in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, MASSBANK Corp. and/or the Bank are involved as a plaintiff or defendant in various legal actions incident to their business. As of September 30, 2006, none of these actions individually or in the aggregate is believed by management to be material to the financial condition of MASSBANK Corp. or the Bank.

Item 1A. Risk Factors

There have been no material changes to the Risk Factors previously disclosed in Item 1A of the Company’s Annual Report on Form 10-K for the period ended December 31, 2005.

Item 2(c). Share Repurchases

Issuer Purchases of Equity Securities

The following table sets forth purchases made by the Company of its shares of common stock under the stock repurchase program during the three months ended September 30, 2006:

Period	Total Number of Shares Purchased	Average Price Paid Per Share		Total Number of Shares Purchased as Part of a Publicly Announced Repurchase Program (1)	Maximum Number of Shares That May Yet Be Purchased Under the Repurchase Program
June 30, 2006					90,217	(1)
July 1-31, 2006	10,000	$	32.60	10,000	80,217
August 1-31, 2006	—		—	—	80,217
September 1-30, 2006	—		—	—	80,217
	10,000	$	32.60	10,000

(1) On October 19, 2005 the Registrant’s Board of Directors extended for another year the stock repurchase program previously authorized. Additionally, the Board approved an increase of 125,000 in the number of shares of the Registrant’s common stock authorized for repurchase in the current program, bringing the total shares available for repurchase to 133,317. In the fourth quarter of 2005 and the first two quarters of 2006, the Company repurchased 43,100 shares further reducing the total shares available for repurchase to 90,217 at June 30, 2006.

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Item 2(c). (Continued)

In addition, the following number of shares were purchased for the Company’s Employees’ Stock Ownership Plan and Trust during the quarter ended September 30, 2006:

Period	Total Number of Shares Purchased	Average Price Paid Per Share		Total Number of Shares Purchased as Part of a Publicly Announced Repurchase Program (1)	Maximum Number of Shares That May Yet Be Purchased Under the Repurchase Program
July 1-31, 2006	0	$	0.00	0	0
August 1-31, 2006	0	$	0.00	0	0
September 1-30, 2006	2,100	$	32.58	0	0
	2,100	$	32.58

Item 3. Defaults Upon Senior Securities

Not Applicable.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None.

Item 6. Exhibits

a.	Exhibit Index
	31.1	Section 302 Certification of Chief Executive Officer. (filed herewith)
	31.2	Section 302 Certification of Chief Financial Officer. (filed herewith)
	32.1	Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Gerard H. Brandi, Chief Executive Officer of the Company. (filed herewith)
	32.2	Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Reginald E. Cormier, Chief Financial Officer of the Company. (filed herewith)

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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.

	MASSBANK Corp. & Subsidiaries
	(Registrant)
Date: November 7, 2006	/s/Gerard H. Brandi
	(Signature)
	Gerard H. Brandi
	President and CEO
Date: November 7, 2006	/s/Reginald E. Cormier
	(Signature)
	Reginald E. Cormier
	Sr. V.P., Treasurer and CFO

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