10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

Annual Report pursuant to sections 13 or 15(d) of the Securities Exchange Act of 1934

(Mark One)

þ	Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
	for the fiscal year ended DECEMBER 31, 2006

or

o	Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
	for the transition period from                                          to

Commission file number: 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)	(Zip Code)

Registrant’s telephone number, including area code: (781) 662-1000

Securities registered pursuant to Section 12(b) of the Act:

NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, par value $1.00 per share
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes þ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
o Yes þ No

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. þ Yes o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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 o       Accelerated filer þ       Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
o Yes þ No

The aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates of the registrant, computed by reference to the closing price per share of common stock on June 30, 2006, the last day of the registrant’s most recently completed second fiscal quarter, as reported on the NASDAQ Global Select Market, was $129,525,120. Although directors and executive officers of the registrant were assumed to be “affiliates” of the registrant for the purposes of this calculation, this classification is not to be interpreted as an admission of such status.

As of February 28, 2007, there were 4,338,154 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of MASSBANK Corp.’s 2006 Annual Report to Stockholders are incorporated by reference in Parts I, II, III and IV of this Form 10-K. Portions of the Definitive Notice of Annual Meeting and Proxy Statement for the 2007 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

2

MASSBANK Corp.
Form 10-K
For the Year Ended December 31, 2006

TABLE OF CONTENTS

			Page
		Description	Number
Part 1
	Item 1	Business	5
		Supervision and Regulation	21
		Executive Officers of the Registrant	27
	Item 1A	Risk Factors	28
	Item 1B	Unresolved Staff Comments	31
	Item 2	Properties	31
	Item 3	Legal Proceedings	31
	Item 4	Submission of Matters to a Vote of Security Holders	31
Part II
	Item 5	Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities	32
	Item 6	Selected Financial Data	33
	Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33
	Item 7A	Quantitative and Qualitative Disclosures about Market Risk	34
	Item 8	Financial Statements and Supplementary Data	34
	Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	34
	Item 9A	Controls and Procedures	34
	Item 9B	Other Information	34
Part III
	Item 10	Directors and Executive Officers of the Registrant	35
	Item 11	Executive Compensation	35
	Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	35
	Item 13	Certain Relationships and Related Transactions	35
	Item 14	Principal Accountant Fees and Services	36
Part IV
	Item 15	Exhibits and Financial Statement Schedules	36
Signatures			41
EX-13 2006 Annual Report to Stockholders
EX-21 Subsidiaries of the Registrant
EX-23 Consent of Independent Registered Public Accounting Firm
EX-31.1 Section 302 Certification of C.E.O.
EX-31.2 Section 302 Certification of C.F.O.
EX-32.1 Section 906 Certification of C.E.O.
EX-32.2 Section 906 Certification of C.F.O.

3

Forward-Looking Statement Disclosure.

     MASSBANK Corp. may from time to time make written or oral forward-looking statements, including statements contained in this annual report, in the Company’s filings with the Securities and Exchange Commission, in its reports to stockholders and in other MASSBANK Corp. communications. These statements relate to future, not past, events.

     These forward-looking statements include, among others, statements with respect to MASSBANK 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 the Company’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 and 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; (8) adverse impacts resulting from the continuing war on terrorism; (9) a significant increase in employee benefit costs; (10) the impact of changes in accounting principles; (11) the impact of inflation or deflation, and (12) the Company’s success at managing the risks involved in the foregoing.

Internet Access

     The Company maintains a website at www.massbank.com. The Company will make available free of charge on or through its website its annual reports on Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (Exchange Act) as soon as reasonably practicable following its filing of the same with the SEC. In addition, the Company’s code of ethics is posted on the Company’s website.

4

PART I

Item 1. Business

Business of MASSBANK Corp.

General

     MASSBANK Corp. (sometimes referred to as the Company) is a general business corporation incorporated under the laws of the State of Delaware on August 11, 1986. MASSBANK Corp. was organized for the purpose of becoming the holding company for MASSBANK (the Bank). The Company is a one-bank holding company registered with the Board of Governors of the Federal Reserve System (Federal Reserve Board) under the Bank Holding Company Act of 1956, as amended. As of and since December 2, 1986, the effective date of the reorganization whereby MASSBANK Corp. became the holding company for the Bank, the Bank has been a wholly owned subsidiary of MASSBANK Corp. The only office of MASSBANK Corp., and its principal place of business, is located at the main office of the Bank at 123 Haven Street, Reading, Massachusetts 01867.

     On August 28, 2006, Knabssam LLC was formed in the State of Delaware as a limited liability company and wholly owned subsidiary of MASSBANK Corp. The general character of the business of the LLC is to engage in investment in, and ownership and development of, real estate and interest therein. The only real estate the LLC currently owns is approximately 5.49 acres of excess land adjacent to the Bank’s branch in Westford, Massachusetts. Knabssam LLC has entered into an agreement with a local developer giving the developer an option to purchase the parcel. See Note 1 “Real Estate Held for Resale” of Notes to Consolidated Financial Statements contained in the Registrant’s 2006 Annual Report to Stockholders set forth on page 39 of such Annual Report.

     MASSBANK Corp. currently has no material assets other than its investment in the Bank. The Company’s primary business, therefore, is managing its investment in the stock of the Bank. MASSBANK Corp. is classified by the Commonwealth of Massachusetts as a securities corporation for tax purposes, which restricts its business to buying, selling, dealing in, or holding securities on its own behalf. In the future, MASSBANK Corp. may become an operating company or acquire banks or companies engaged in bank-related activities. In addition, MASSBANK Corp. may elect to become a financial holding company and to engage in activities permissible to financial holding companies. See “Supervision and Regulation of the Company and its Subsidiaries” later in this Form 10-K.

     The principal sources of revenues for MASSBANK Corp. are dividends from the Bank and, to a lesser extent, interest income received from its interest- bearing bank deposits. These revenues are used primarily for the payment of dividends to stockholders and for the repurchase of stock pursuant to the Company’s stock repurchase program. MASSBANK Corp.’s assets at December 31, 2006 are represented by its investment in the Bank of $101.2 million, its investment in Knabssam LLC of $0.6 million, cash of $5.1 million and other assets of $0.2 million. See Note 17 to the Consolidated Financial Statements for Parent Company only financial information. At December 31, 2006, MASSBANK Corp. on a consolidated basis had total assets of $843.5 million, deposits of $723.3 million, and stockholders’ equity of $106.9 million, which represents 12.67% of total assets. Book value per share at December 31, 2006 stood at $24.76, compared to $24.32 at year-end 2005.

     The Company does not own or lease any real estate (other than through its subsidiary Knabssam LLC as described above) or personal property. Instead it intends to utilize during the immediate future the premises, equipment and furniture of the Bank without the direct payment of rental fees to the Bank.

5

Competition

     The primary business of MASSBANK Corp. currently is the ongoing business of the Bank. Therefore, the competitive conditions faced by MASSBANK Corp. currently are the same as those faced by the Bank. See “Business of MASSBANK - - Competition.” In addition, many banks and financial institutions have formed holding companies. It is likely that these holding companies will attempt to acquire commercial banks, thrift institutions or companies engaged in bank-related activities. MASSBANK Corp. would face competition in undertaking any such acquisitions and in operating any such entity subsequent to its acquisition.

Employees

     MASSBANK Corp. does not employ any persons other than its management, which also serves as management of, and is paid by, the Bank. See “Item 10 – Directors and Executive Officers of the Registrant.” MASSBANK Corp. utilizes the support staff of the Bank from time to time and paid the Bank $18 thousand in 2006 for the support.

Dividends

     MASSBANK Corp. paid total cash dividends of $1.09 per share in 2006 compared to $1.05 per share in 2005. The Company’s dividend payout ratios (cash dividends paid divided by net income) for 2006 and 2005 were 67% and 63%, respectively.

6

Business of MASSBANK

General

     MASSBANK is a Massachusetts-chartered savings bank founded in 1872 as the Melrose Savings Bank. In 1983, the Reading Savings Bank was merged with and into the Melrose Savings Bank and the name of the resulting institution was changed to MASSBANK for Savings. In 1986, the Bank converted from mutual to stock form of ownership. In 1996, the name of the bank was changed from “MASSBANK for Savings” to “MASSBANK”.

     The Bank is primarily engaged in the business of attracting deposits from the general public through its fifteen full service banking offices in Reading, Chelmsford, Dracut, Everett, Lowell, Medford, Melrose, Stoneham, Tewksbury, Westford and Wilmington, and originating residential and commercial real estate mortgages, construction loans, commercial loans, and a variety of consumer loans. The Bank invests a significant portion of its funds in U.S. Treasury and Government agency securities (including callable agency securities), mortgage-backed securities, federal funds sold, and other authorized investments. The Bank also invests a portion of its funds in equity securities traded on a national securities exchange or quoted on the NASDAQ System. The Bank’s earnings depend largely upon net interest income, which is the difference between the interest and dividend income derived by the Bank from its loans and investments (interest-earning assets) and the interest paid by the Bank on its deposits (interest-bearing liabilities). Net interest income is significantly affected by loan and investment activity and volumes, including prepayment activity on loans and mortgage-backed securities and calls of callable government agency securities. Net interest income is also affected by general economic conditions, particularly changes in interest rates, competition, government legislation and policies affecting fiscal affairs, monetary policies of the Federal Reserve System, and the actions of the bank regulatory authorities. Earnings results are also affected by the Company’s provisions (credit) for loan losses and changes in non-interest income, such as fee-based revenues and securities gains or losses, non-interest expense and income taxes.

     The Bank’s deposits are insured to applicable limits by the Bank Insurance Fund (BIF) of the Federal Deposit Insurance Corporation (the FDIC) and excess deposit balances are insured by the Depositors Insurance Fund, Inc. (DIF), a private industry-sponsored deposit insurer.

     The Bank recognizes that loan and investment opportunities change over time and that yields derived from such opportunities can vary significantly even when the risks associated with those opportunities are comparable. By developing a relatively liquid loan and investment portfolio, the Bank has attempted to position itself so as to be able to take advantage of these changing opportunities. Consequently, the Bank expects that the relative mix of its loan and investment portfolios will change over time in response to changing market conditions.

7

Market Area

     The Bank is headquartered in Reading, Massachusetts, which is located approximately 15 miles north of Boston. The Bank’s market area includes a significant portion of eastern Massachusetts and is served by a network of 15 branch offices located on a broad arc stretching from Medford and Everett in the south, Dracut in the north, and Westford in the west.

     The Bank’s general market area consists of the municipalities in which it operates banking offices and all of the contiguous cities and towns.

     The Bank currently operates banking offices in the municipalities of Chelmsford, Dracut, Everett, Lowell, Medford, Melrose, Reading, Stoneham, Tewksbury, Westford and Wilmington.

Lending Activities

     The Bank’s net loan portfolio totaled $207.5 million at December 31, 2006.

The following table sets forth information concerning the Bank’s loan portfolio by type of loan at the dates shown:

(In thousands) At December 31,	2006			2005			2004			2003			2002
Mortgage loans:
Residential:
Conventional	$	192,977		$	212,684		$	224,542		$	240,443		$	300,528
FHA and VA		13			27			45			84			133
Commercial		4,443			2,335			1,623			1,601			2,348
Construction:
Residential		1,217			845			84			81			654
Commercial		563			—			—			—			—
Total mortgage loans		199,213			215,891			226,294			242,209			303,663
Premium on loans		2			2			5			10			20
Deferred mortgage loan origination costs (fees)		38			11			(102	)		(333	)		(895	)
Mortgage loans, net		199,253			215,904			226,197			241,886			302,788
Other loans:
Consumer:
Second mortgage loans		751			34			69			111			257
Installment		211			211			258			304			541
Guaranteed education		635			1,094			1,616			2,333			3,293
Other secured		408			499			504			518			515
Home equity lines of credit		7,460			7,722			7,284			7,549			11,102
Unsecured lines of credit		128			148			161			166			187
Total consumer loans		9,593			9,708			9,892			10,981			15,895
Commercial		81			118			109			139			116
Total other loans		9,674			9,826			10,001			11,120			16,011
Total loans		208,927			225,730			236,198			253,006			318,799
Allowance for loan losses (1)		(1,382	)		(1,253	)		(1,307	)		(1,554	)		(2,271	)
Net loans	$	207,545		$	224,477		$	234,891		$	251,452		$	316,528

(1) The allowance for loan losses for 2002 has been restated to reflect the reclassification of the allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) and to facilitate comparison with the current fiscal year.

8

     The following table shows the maturity distribution and interest rate sensitivity of the Bank’s loan portfolio at December 31, 2006:

			Maturity/Scheduled Payments (1)
	Within		One to		Five to		After
(In thousands)	one year		five years		ten years		ten years		Total
Mortgage loans:
Residential	$	287	$	8,553	$	58,267	$	125,954	$	193,061
Commercial & construction		1,154		4,025		176		837		6,192
Total mortgage loans		1,441		12,578		58,443		126,791		199,253
Other loans		861		4,140		4,214		459		9,674
Total loans	$	2,302	$	16,718	$	62,657	$	127,250	$	208,927

(1) Loan amounts are accumulated as if the entire balance came due on the last contractual payment date. Accordingly, the amounts do not reflect proceeds from contractual loan amortization or anticipated prepayments.

     The following table shows the amounts, included in the table above, which are due after one year and which have fixed or adjustable interest rates:

	Total Due After One Year
	Fixed		Adjustable
(In thousands)	Rate		Rate		Total
Mortgage loans:
Residential	$	168,848	$	23,926	$	192,774
Commercial & construction		368		4,670		5,038
Total mortgage loans		169,216		28,596		197,812
Other loans		1,598		7,215		8,813
Total loans	$	170,814	$	35,811	$	206,625

     Mortgage Lending. The Bank believes that the repayment periods of long-term first mortgage loans, the general resistance of the public in our market area to variable rate mortgage instruments and the highly competitive nature of the mortgage industry require a prudent approach to mortgage lending. Consequently, as part of its policy of generally attempting to match the maturities of its assets and its liabilities, the Bank has attempted to keep its mortgage loan portfolio to a level at which the Bank believes there is an acceptable risk-to-reward ratio in light of opportunities in the market-place and its long-term objectives. In 2006, however, the Bank’s mortgage loan portfolio decreased approximately $16.6 million or 7.7%. At December 31, 2006, the mortgage loan portfolio totaled $199.3 million compared to $215.9 million at December 31, 2005. The decrease in loans is principally due to loan principal payments, paydowns and payoffs combined with a decline in loan origination activity. Loan originations totaled $21.7 million in 2006, down 55.5% from $48.9 million in 2005. This is primarily attributable to a decline in mortgage refinancing activity due to the rise in market interest rates, a decline in new and existing home sales and the fierce competition for mortgages in the Bank’s market area. Consequently, the size of the Bank’s loan portfolio decreased this past year. At times of low loan demand, mortgage-backed securities may be used as substitutes for loans as certain of their financial characteristics are very similar to short-term mortgage loans.

9

Mortgage Lending (continued)

     Loan originations come from a number of sources, including referrals from real estate brokers, walk-in customers, purchasers of property owned by existing customers and refinancings for existing customers. In addition to actively soliciting loan applications, the Bank conducts an advertising and promotion program, directed both toward the general public and real estate professionals who might refer potential borrowers.

     Substantially all of the real estate loans originated by the Bank during 2006 were secured by real estate located in the Bank’s primary lending area, reflecting the Bank’s commitment to serve the credit needs of the local communities in which it operates banking offices.

     The Bank makes both conventional fixed and adjustable-rate loans on one- to-four family residential properties for a term of ten to thirty years. The Bank currently retains all of the mortgages it originates for its own portfolio. These are primarily 10, 12, 15 or 20 year fixed rate and adjustable rate mortgages (ARMs). The few long-term (30 year) fixed rate mortgage loans that the Bank originates from time to time are also added to the loan portfolio. Adjustable rate mortgage loans have rates that are re-set at either 1, 3, 5, 7 or 10 year intervals and are indexed to various financial indices.

     In addition to its traditional mortgage products, the Bank offers several other loan programs that have been well received by customers. It offers ARM programs featuring an initial fixed rate for 5 or 7 years and a 1 year adjustable rate thereafter. A special first time home buyers program has also been instituted featuring a discounted ARM. This program is designed for first- time home buyers meeting certain income and property location criteria.

     At December 31, 2006, 1-4 family residential mortgage loans totaled $194.3 million, or 93.0% of the total loan portfolio, compared to $212.7 million, or 94.2% of the total loan portfolio, at December 31, 2005. Residential mortgage and construction loan originations decreased to $13.2 million in 2006, from $42.0 million in 2005. Much of this decrease in volume was due to a significant reduction in mortgage refinancing activity. Loan origination volumes are sensitive to interest rates and are affected by the interest rate environment. The higher interest rate environment in 2006 created less demand for mortgage refinancings. This resulted in lower loan originations. In 2006, normal principal amortization and mortgage prepayments exceeded the bank’s volume of newly originated mortgages.

     The Bank also originates construction loans and mortgage loans secured by commercial or investment property. The commercial and multifamily real estate mortgages and construction loans totaled approximately $5.0 million, or 2.4% of the total loan portfolio at December 31, 2006. In 2006, construction and commercial mortgage loan originations amounted to $3.2 million. This compares to $2.3 million in 2005.

10

Mortgage Lending (continued)

     The total amount of first mortgage loans held by the Bank at December 31, 2006 was $199.3 million as indicated in the maturity distribution table appearing on page nine. Of this amount, $29.8 million was subject to interest rate adjustments. The remaining $169.5 million represents fixed rate mortgage loans, which constitute 81.1% of the Company’s total loans.

     Fees received for originating loans and related direct incremental loan origination costs are offset and the resulting net amount is deferred and amortized over the life of the related loans.

     The Bank also receives fees relating to existing loans, primarily late charges and prepayment penalties.

     Other Loans. The Bank makes a variety of consumer loans and had a consumer loan portfolio of approximately $9.6 million at December 31, 2006, representing 4.6% of the Bank’s total loan portfolio. Of this amount, $0.6 million, or 0.3% of the total loan portfolio, are education loans guaranteed by the American Student Assistance Services Corporation.

     The balance of the Bank’s consumer loan portfolio consists of home equity lines of credit, second mortgage loans and consumer loan contracts such as automobile loans, home improvement loans and other secured and unsecured financings. These loans totaled $9.0 million at December 31, 2006, representing 4.3% of the Bank’s total loan portfolio.

     At December 31, 2006, the Bank also had $0.1 million in outstanding loans to commercial enterprises not secured by real estate.

     Loan Approval. The Bank’s loan approval process for all loans generally includes a review of an applicant’s financial statements, credit history, banking history, and verification of income. For mortgage loans, the Bank generally obtains an independent appraisal of the subject property. The Bank has a formal lending policy approved by the Board of Directors of the Bank, which delegates levels of loan approval authority to Bank personnel. All loans in excess of established limits require approval of the Bank’s Board of Directors.

     The Bank issues commitments to prospective borrowers to make loans subject to certain conditions for generally up to 60 days. The interest rate applicable to the committed loans is usually the rate in effect at the time a rate lock fee is paid. At December 31, 2006, the Bank had issued commitments on residential first mortgage loans totaling $1.206 million, and had commitments totaling $645 thousand to advance funds on construction loans and reverse mortgages, and unused credit lines, including unused portions of home equity lines of credit, of $28.779 million. In addition, the Bank had commitments to provide $1.837 million, which represents its participating share of the funding for an affordable housing project in Lowell, Massachusetts, $45 thousand in commitments to advance funds for business development in downtown Lowell and unused commercial loan credit lines of $27 thousand.

     Loan Delinquencies. It is the Bank’s policy to manage its loan portfolio so as to recognize problem loans at an early stage and thereby minimize loan losses. Loans are considered delinquent when any payment of principal or interest is one month or more past due. The Bank generally commences collection procedures, however, when accounts are 15 days past due. It is the Bank’s practice to generally discontinue accrual of interest on all loans for which payments are 90 days or more past due. Loans with delinquent payments 90 or more days past due, as shown in the table on the following page, totaled $137 thousand at December 31, 2006, down from $257 thousand at year-end 2005.

11

Real Estate Acquired through Foreclosure.

     Real estate acquired through foreclosure is comprised of foreclosed properties where the Bank has actually received title and loans determined to be substantially repossessed. Real estate loans that are substantially repossessed include only those loans for which the Bank has taken possession of the collateral but has not completed legal foreclosure proceedings. Loan losses arising from the acquisition of such properties are charged against the allowance for loan losses. Real estate acquired through foreclosure is recorded at the lower of the carrying value of the loan or the fair value of the property constructively or actually received, less estimated costs to sell the property following foreclosure. Operating expenses and any subsequent provisions to reduce the carrying value to fair value are charged to current period earnings. Gains or losses upon disposition are reflected in earnings as realized. At year-end 2006, MASSBANK had no real estate acquired through foreclosure.

Non-Performing Assets

     The following table shows the composition of non-performing assets at the dates shown:

(In thousands) At December 31,	2006			2005			2004			2003			2002
Nonaccrual loans:
Mortgage loans:
Residential:
Conventional	$	113		$	176		$	41		$	152		$	269
FHA and VA		—			—			—			—			2
Consumer		24			81			33			78			149
Total nonaccrual loans		137			257			74			230			420
Total non-performing assets	$	137		$	257		$	74		$	230		$	420
Percent of non-performing loans to
total loans		0.07	%		0.11	%		0.03	%		0.09	%		0.13	%
Percent of non-performing assets to
total assets		0.02	%		0.03	%		0.01	%		0.02	%		0.04	%

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

(In thousands) Years Ended December 31,	2006		2005		2004		2003			2002
Interest income that would have been
recorded under original terms	$	8	$	16	$	4	$	17		$	31
Interest income actually recorded		5		9		1		20			27
Reduction (increase) in interest income	$	3	$	7	$	3	$	(3	)	$	4

12

Allowance for Loan Losses and Allowance for Loan Losses on Off-Balance Sheet Credit Exposures

     The Company maintains an allowance for possible losses that are inherent in the Company’s loan portfolio. The allowance for loan losses is increased (decreased) by provisions (credits) 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 that 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 borrowers’ ability to pay, and trends in loan delinquencies and charge-offs. Realized losses, net of recoveries, are charged directly to the allowance. While management uses the information available in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ from the assumptions used in making the evaluation. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management. In 2006, the Bank recorded a provision for loan losses of $123 thousand compared to a negative provision for loan losses of $53 thousand in 2005.

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

     The allowance for loan losses on off-balance sheet credit exposures totaled $345 thousand and $517 thousand, respectively, at December 31, 2006 and 2005. In 2006, the Company recorded a negative or credit provision for off-balance sheet credit exposures of $172 thousand compared to a negative or credit provision of $70 thousand in 2005. The credit or provision is included in other non-interest expense.

     The following table sets forth the activity in the allowance for loan losses during the years indicated:

(In thousands) Years ended December 31,	2006			2005			2004			2003			2002
Balance at beginning of year	$	1,253		$	1,307		$	1,554		$	2,271		$	2,494
Provision (credit) for loan losses		123			(53	)		(242	)		(502	)		—
Transfer to allowance for loan losses on off-balance sheet credit exposures		—			—			—			(226	)		(235	)
Charge-offs:
Consumer loans		(4	)		(1	)		(5	)		(4	)		(4	)
Commercial loans		(9	)		—			—			—			—
Recoveries:
Residential real estate		19			—			—			—			6
Consumer loans		—			—			—			15			10
Net recoveries (charge-offs)		6			(1	)		(5	)		11			12
Balance at end of year	$	1,382		$	1,253		$	1,307		$	1,554		$	2,271
Allowance for loan losses as a percent of total loans outstanding at year-end		0.66	%		0.56	%		0.55	%		0.61	%		0.83	%
Allowance for loan losses as a percent of nonaccrual loans		1008.8	%		487.5	%		1766.2	%		675.7	%		632.1	%

13

Investment Activities

     The Bank believes that investment opportunities in United States Government, corporate and other securities are at times more attractive than the opportunities present in the loan market. As compared to loans, these investments of the Bank are generally shorter-term and hence more liquid, are subject to lower risk of loss, and present an opportunity for appreciation. In addition, these investments often permit the Bank to better match the maturities of its assets and its liabilities.

     The Bank’s investment portfolio is managed by its officers in accordance with an investment policy approved by the Bank’s Board of Directors. The objectives of that policy are to provide a level of liquidity, earnings and diversification consistent with the exercise of prudent investment judgment. The policy authorizes the senior management of the Bank to make and execute investment decisions and requires that those persons report all investment transactions to the Bank’s Board of Directors at each of its regular meetings. In addition, management is required to report all gains or losses on all securities transactions at each meeting of the Bank’s Board of Directors. Purchases and sales of securities by the Bank are generally required to be made on a competitive basis and all investments must be permitted by applicable law.

     The Bank invests in a wide variety of securities and obligations, including: Federal funds sold (which are sold only to institutions included on the Bank’s internally-prepared approved list of adequately capitalized institutions); commercial paper and bankers’ acceptances; United States Treasury and Government agency obligations (including callable agency securities); United States agency guaranteed and other mortgage-backed securities; investment grade corporate debt securities (generally limited to those rated A or better by Standard & Poor’s); mutual funds; and equity securities traded on a national securities exchange or quoted on the NASDAQ System.

     Under the investment policy management determines the appropriate classification of securities at the time of purchase. Those debt securities that the Company has the intent and the ability to hold to maturity are classified as securities held to maturity and are carried at amortized historical cost.

     Those securities held for indefinite periods of time and not intended to be held to maturity are classified as available for sale. Securities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in market conditions, interest rates, prepayment risk, the need to increase regulatory capital and other factors. The Company records investment securities available for sale at aggregate market value with the net unrealized holding gains or losses reported, net of tax effect, as a separate component of stockholders’ equity until realized. As of December 31, 2006, stockholders’ equity included in accumulated other comprehensive loss approximately $2.9 million, representing the net unrealized losses on securities available for sale, less applicable income tax benefit.

     Securities that are bought and held principally for the purpose of sale in the near term are classified as trading securities. Trading generally reflects active and frequent buying and selling, and trading securities are generally used with the objective of generating profits on short-term differences in price caused by market volatility. Investments classified as trading securities are stated at market value with unrealized gains and losses included in earnings.

14

Investment Activities (continued)

     Income on debt securities available for sale is accrued and included in interest and dividend income.

     The specific identification method is used to determine realized gains or losses on sales of securities available for sale that are also reported in non-interest income under the caption “gains on securities available for sale, net.” When a security suffers a loss in value that is considered other than temporary, such loss is recognized by a charge to earnings.

     Most of the Company’s mortgage-backed securities are currently classified as available for sale. At times of low loan demand, short-term mortgage-backed securities may be used as substitutes for loans as certain of their financial characteristics are very similar to short-term mortgage loans.

     At December 31, 2006, the Company’s investments, which consist of securities available for sale (including mortgage-backed securities), securities held to maturity, trading securities, short-term investments, term federal funds sold and interest-bearing deposits in banks, totaled $590.6 million, representing 70.0% of the Company’s total assets.

15

     The following table sets forth the composition of the Company’s investment portfolio as of the dates indicated:

Investment Portfolio

(In thousands) At December 31,	2006			2005			2004
Short-term investments:
Federal funds sold (overnight)	$	117,104		$	152,785		$	193,728
Term federal funds sold		—			15,000			—
Money market investment fund		22,133			—			302
Interest-bearing bank money market accounts		3			2			220
Total short-term investments		139,240			167,787			194,250
Term federal funds sold		41,000			—			—
Interest-bearing deposits in banks:
Certificates of deposit		—			898			2,718
Total short-term investments, term federal funds sold and interest-bearing bank deposits	$	180,240		$	168,685		$	196,968
Percent of total assets		21.4	%		18.8	%		20.2	%

(In thousands) At December 31,	2006			2005			2004
Securities held to maturity: (a)
Mortgage-backed securities	$	5,396		$	6,137		$	4,877
Securities available for sale: (b) (c)
U.S. Treasury obligations		21,709			76,116			125,097
U.S. Government agency obligations		239,547			234,537			188,519
Equity securities		7,352			7,387			7,428
Mortgage-backed securities		134,471			135,432			122,709
Total securities available for sale		403,079			453,472			443,753
Trading securities: (b)
U.S. Treasury obligations		—			7,896			57,878
Equity securities		1,926			1,382			1,131
Investments in mutual funds		5			4			4
Total trading securities		1,931			9,282			59,013
Total securities	$	410,406		$	468,891		$	507,643
Percent of total assets		48.7	%		52.1	%		52.0	%
Total investments	$	590,646		$	637,576		$	704,611
Total investments as a percent of total assets		70.0	%		70.9	%		72.2	%

(a)	At amortized cost.
(b)	At market value.
(c)	The market value of callable agency securities included in securities available for sale at December 31, 2006, 2005 and 2004, totaled $161.3 million, $189.3 million and $158.8 million, respectively.

16

     The following table presents the amortized cost of debt securities available for sale at December 31, 2006 maturing within stated periods with the weighted average interest yield from securities falling within the range of maturities:

Debt Securities Available for Sale

				U.S.
	U. S.			Government			Mortgage-
	Treasury			agency			backed
(Dollars in thousands)	obligations			obligations (2)			securities (1)			Total
Maturing within 1 year
Amount	$	14,019		$	75,000		$	100		$	89,119
Yield		3.19	%		4.01	%		7.16	%		3.88	%
Maturing after 1 but within 5 years
Amount		7,999			150,745			7,508			166,252
Yield		3.12	%		4.21	%		6.52	%		4.26	%
Maturing after 5 but within 10 years
Amount		—			15,995			17,155			33,150
Yield		—			5.01	%		6.31	%		5.68	%
Maturing after 10 but within 15 years
Amount		—			1,035			110,608			111,643
Yield		—			5.81	%		5.11	%		5.12	%
Maturing after 15 years
Amount		—			—			74			74
Yield		—			—			5.07	%		5.07	%
Total
Amount	$	22,018		$	242,775		$	135,445		$	400,238
Yield		3.16	%		4.21	%		5.34	%		4.53	%

(1)	Mortgage-backed securities are shown based on contractual maturities. Actual maturities will differ from contractual maturities due to scheduled amortization and prepayments.
(2)	The amortized cost of callable securities included in securities available for sale totaled $163.7 million as of December 31, 2006.

     At December 31, 2006, the Company did not have an investment in any issuer (other than securities of the U.S. Government and Government Agencies) in excess of 10% of stockholders equity.

17

Deposits and Other Sources of Funds

     General. Deposits have been the Bank’s primary source of funds for making investments and loans. In addition to deposits, the Bank’s other major sources of funds are derived from amortization and prepayment of loans and mortgage-backed securities, from sales, calls or maturities of investment securities, and from operations. Deposit flows can vary significantly and are influenced by prevailing interest rates, money market conditions, economic conditions and competition. The Bank can respond to changing market conditions and competition through the pricing of its deposit accounts. Management can attempt to control the level of its deposits to a significant degree through its pricing policies. Another important factor in attracting deposits is convenience. In addition to the Bank’s fifteen conveniently located banking offices, customers can access accounts through the Bank’s Automated Teller Machine (ATM) network. The Bank is a member of the Transaxion (TX), NYCE and CIRRUS System, Inc. (CIRRUS) networks, which allow access to ATMs in over 100,000 locations worldwide. Additionally, MASSBANK has joined with over 400 other financial institutions to form the SUM Program. This program allows MASSBANK customers to access over 2,500 SUM ATM’s throughout the Northeast and Midwest without having to pay an access or surcharge fee.

     Deposits. A substantial amount of the Bank’s deposits are derived from customers who live or work within the Bank’s market area. The Bank does not solicit deposits through any outside agents. The Bank’s deposits at December 31, 2006 consist of regular, silver and smart savings accounts, holiday club savings accounts, NOW and Super NOW accounts, regular and business checking accounts, money market deposit accounts, IRA and Keogh accounts, and term deposit accounts.

     Deposits decreased by $61.4 million, or 7.8%, to $723.3 million at December 31, 2006, from $784.7 million at year-end 2005. Management believes that increased competition for deposits and more attractive returns from alternative investments, such as stocks and mutual funds, were the principal reasons for deposit outflows. These competing investment vehicles have recently produced higher returns than bank deposits.

     Borrowed Funds. From time to time the Bank has obtained funds through repurchase agreements with its customers and federal funds purchased. The Bank also has the ability, although it has never exercised it, to borrow from the Federal Reserve Bank and The Depositors Insurance Fund, Inc. The Bank did not have any borrowed funds in 2006 or 2005.

18

DEPOSITS

     The following table shows the composition of the deposits as of the dates indicated:

(In thousands) at December 31,	2006					2005					2004
			Percent					Percent					Percent
			of					of					of
	Amount		Deposits			Amount		Deposits			Amount		Deposits
Demand and NOW
NOW	$	51,856		7.17	%	$	54,924		7.00	%	$	58,991		6.95	%
Demand accounts (non interest-bearing)		27,004		3.73			27,326		3.48			28,662		3.37
Total demand and NOW		78,860		10.90			82,250		10.48			87,653		10.32
Savings:
Regular savings and special notice accounts		335,142		46.33			430,771		54.90			549,657		64.71
Money market accounts		9,666		1.34			10,770		1.37			11,656		1.37
Total savings		344,808		47.67			441,541		56.27			561,313		66.08
Time certificates of deposit:
Fixed rate certificates		230,710		31.90			197,743		25.20			145,249		17.10
Variable rate certificates		68,954		9.53			63,194		8.05			55,250		6.50
Total time certificates of deposit		299,664		41.43			260,937		33.25			200,499		23.60
Total deposits	$	723,332		100.00	%	$	784,728		100.00	%	$	849,465		100.00	%

     In the following table the average amount of deposits and average rate is shown for each of the years as indicated.

(In thousands) Years Ended December 31,	2006					2005					2004
	Average		Average			Average		Average			Average		Average
	Balance		Rate			Balance		Rate			Balance		Rate
NOW accounts	$	52,437		0.43	%	$	55,983		0.33	%	$	56,273		0.30	%
Demand (non interest-bearing) accounts		26,997		—			28,619		—			28,020		—
Escrow deposits of borrowers		754		0.54			724		0.44			773		0.27
Money market accounts		10,426		0.63			11,728		1.32			11,727		0.53
Savings accounts		378,834		1.88			488,044		1.60			573,512		1.48
Time certificates of deposit		280,989		4.16			231,479		3.03			192,386		2.08
	$	750,437		2.53	%	$	816,577		1.85	%	$	862,691		1.48	%

19

Investment Management and Trust Services

     The Bank’s Trust and Investment Services Division offers a variety of investment, trust and estate planning services and also serves as trustee, executor, and executor’s agent for bank customers.

     As of December 31, 2006 the Trust Division had approximately $20.6 million (market value) of assets in custody and under management.

Competition

     The Bank faces substantial competition both in originating loans and in attracting deposits. Competition in originating loans comes primarily from other thrift institutions, commercial banks, credit unions and mortgage banking companies. The Bank competes for loans principally on the basis of interest rates and loan fees, the types of loans originated and the quality of services provided to borrowers.

     In attracting deposits, the Bank’s primary competitors are other thrift institutions, commercial banks, mutual funds and credit unions located in its market area. The Bank’s attraction and retention of deposits depends on its ability to provide investment opportunities that satisfy the requirements of customers with respect to rate of return, liquidity, risk and other factors. The Bank attracts a significant amount of deposits through its branch offices, primarily from the communities in which those branch offices are located. The Bank competes for these deposits by offering competitive rates, convenient branch and ATM locations and convenient business hours.

     The Bank also faces strong competition from banks and other financial services providers in the bank’s market area for both loans and deposits.

20

Supervision and Regulation of the Company and its Subsidiary

     The business in which the Company and its subsidiary are engaged is subject to extensive supervision, regulation and examination by various bank regulatory authorities and other governmental agencies. State and federal banking laws have as their principal objective either the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system or the protection of consumers or classes of consumers, and depositors in particular, rather than the specific protection of stockholders of a bank or its parent company.

     Set forth below is a brief description of certain laws and regulations that relate to the regulation of the Company. To the extent the following material describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation.

Regulation of the Company. As a registered bank holding company, we are subject to regulation under the Bank Holding Company Act of 1956, as amended, (BHCA) and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (FRB). The Company is also subject to laws of the Commonwealth of Massachusetts and the jurisdiction of the Massachusetts Board of Bank Incorporation (BBI) and the Massachusetts Commissioner of Banks (Commissioner). The Company is incorporated in the State of Delaware and is, therefore, also subject to Delaware corporation law.

The FRB has the authority to issue orders to bank holding companies to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals who violate the BHCA or orders or regulations thereunder, to order termination of non-banking activities of non-banking subsidiaries of bank holding companies, and to order termination of ownership and control of a non-banking subsidiary by a bank holding company. Under the BHCA, the Company may not generally engage in activities or acquire more than 5% of any class of voting securities of any company engaged in activities other than banking or activities that are closely related to banking. However, if the Company elects to be treated as a financial holding company, the Company may engage in activities that are financial in nature or incidental or complimentary to such financial activities, as determined by the FRB and the Secretary of the Department of the Treasury. The Company has not elected financial holding company status. Under certain circumstances, the Company may be required to give notice to or seek approval of the FRB before engaging in activities other than banking.

Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. (Riegle- Neal), Riegle-Neal permits adequately capitalized and adequately managed bank holding companies, as determined by the FRB, to acquire banks in any state subject to certain concentration limits and other conditions. Riegle-Neal also generally authorizes the inte rstate merger of banks. In addition, among other things, Riegle-Neal permits banks to establish new branches on an interstate basis provided that the law of the host state specifically authorizes such action. However, as a bank holding company, we are required to obtain prior FRB approval before acquiring more than 5% of a class of voting securities, or substantially all of the assets of a bank holding company, bank or savings association.

Control Acquisitions. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank holding company, such as the Company, unless the FRB has been notified and has not objected to the transaction. Under a rebuttal presumption established by the FRB, the acquisition of 10% or more of a class of voting securities of a bank holding company with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended, would, under the circumstances set forth in the presumption, constitute acquisition of control of the bank holding company.

21

Supervision and Regulation of the Company and its Subsidiary (continued)

In addition, a company is required to obtain the approval of the FRB under the BHCA before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of outstanding voting securities of a bank holding company, or otherwise obtaining control or a “controlling influence” over that bank holding company. Massachusetts law also imposes certain limitations on the ability of persons and entities to acquire control of banking institutions and their parent companies.

Bank Holding Company Dividends. The FRB has authority to prohibit bank holding companies from paying dividends if such payment is deemed to be an unsafe or unsound practice. The FRB has indicated generally that it may be an unsafe or unsound practice for bank holding companies to pay dividends unless the bank holding company’s net income over the preceding year is sufficient to fund the dividends and the expected rate of earnings retention is consistent with the organization’s capital needs, asset quality and overall financial condition. In addition, Delaware corporate law includes limitations on a corporation’s payment of dividends if such dividends exceed the corporation’s surplus or current net profits. The Company depends upon dividends received from its subsidiary bank to fund its activities, including the payment of dividends to its stockholders. As described below, the Federal Deposit Insurance Corporation (FDIC) may regulate the amount of dividends payable by the subsidiary bank. The inability of the bank to pay dividends may have an adverse effect on the Company.

Regulation of the Bank. The Bank is subject to regulation, supervision and examination by the Massachusetts Division of Banks (Division) and the FDIC.

Insurance of Accounts and FDIC Regulation. The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund-member institutions. In 2006, the FDIC enacted various rules to implement the provisions of the Federal Deposit Insurance Reform Act of 2005 (the FDIR Act). Pursuant to the FDIR Act, in 2006 the FDIC merged the Bank Insurance Fund (BIF) with the FDIC’s Savings Association Insurance Fund, creating the Deposit Insurance Fund (the DIF) that covers both banks and savings associations. The FDIC also revised, effective January 1, 2007, the risk-based premium system under which the FDIC classifies institutions based on their capital ratios and on other relevant factors and generally assesses higher rates on those institutions that tend to pose greater risks to the DIF. For most banks and savings associations, including the Bank, FDIC rates will depend upon a combination of CAMELS component ratings and financial ratios. CAMELS ratings reflect the applicable bank regulatory agency’s evaluation of the financial institution’s capital, asset quality, management, earnings, liquidity and sensitivity to risk. For large banks and savings associations that have long-term debt issuer ratings, assessment rates will depend upon such ratings, and CAMELS component ratings. For institutions, such as the Bank, which are in the lowest risk category, assessment rates will vary initially from five (5) to seven (7) basis points per $100 of insured deposits. The Federal Deposit Insurance Act (FDIA) as amended by the FDIR Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits, the designated reserve ratio (the DRR) for a particular year within a range of 1.15% to 1.50%. For 2007, the FDIC has set the initial DRR at 1.25%. Under the FDIR Act and the FDIC’s revised premium assessment program, every FDIC-insured institution will pay some level of deposit insurance assessments regardless of the level of the DRR. In 2006, the Bank paid no FDIC deposit insurance assessment put paid a FICO assessment in the amount of $100 thousand. (The Financing Corporation (FICO) is a mixed-ownership government corporation whose sole purpose is to function as a financing vehicle for the Federal Savings & Loan Insurance Corporation (FSLIC). The FICO has assessment authority, separate from the FDIC’s authority to assess risk-based premiums for deposit insurance, to collect funds from FDIC-insured institutions sufficient to pay interest on FICO Bonds. The FDIC acts a collection agent for the FICO.) We cannot predict whether, as a result of an adverse change in economic conditions or other

22

Supervision and Regulation of the Company and its Subsidiary (continued)

reasons, the FDIC will be required in the future to increase deposit insurance assessments above 2007 levels. The Federal Deposit Insurance Reform Act of 2005 allows “eligible insured depository institutions” to share a one-time assessment credit pool of approximately $4.7 billion. Assessment credits will be applied to reduce deposit insurance assessments, not to include FICO assessments, payable after the one-time credit regulations become effective in 2007. In October 2006, the FDIC provided the Bank with a preliminary Statement of One-Time Assessment Credit. The Bank’s one-time assessment credit as indicated on that statement is approximately $1.2 million.

Bank Holding Company Support of Subsidiary Banks. Under FRB policy, a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to commit resources to their support. This support may be required at times when the bank holding company may not have the resources to provide it. Similarly, under the cross-guarantee provisions of FDIA, the FDIC can hold any FDIC-insured depository institution liable for any loss suffered or anticipated by the FDIC in connection with (1) the “default” of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution “in danger of default.” Our subsidiary bank is an FDIC- insured depository institution.

Regulatory Capital Requirements. The FRB and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to United States banking organizations. In addition, these regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels, whether because of its financial condition or actual or anticipated
growth.

The FRB risk-based guidelines define a three-tier capital framework. Tier 1 capital includes common shareholders’ equity and qualifying preferred stock, less goodwill and other adjustments. Tier 2 capital consists of preferred stock not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for credit losses up to 1.25 percent of risk-weighted assets. Tier 3 capital includes subordinated debt that is unsecured, fully paid, has an original maturity of at least two years, is not redeemable before maturity without prior approval by the FRB and includes a lock-in clause precluding payment of either interest or principal if the payment would cause the issuing bank’s risk-based capital ratio to fall or remain below the required minimum. The sum of Tier 1 and Tier 2 capital less investments in unconsolidated subsidiaries represents qualifying total capital. Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets. Assets and off-balance sheet exposures are assigned to one of four categories of risk-weights, based primarily on relative credit risk. The minimum Tier 1 capital ratio is four percent and the minimum total capital ratio is eight percent. The Company’s tier 1 capital (to risk-weighted assets) was 36.58% at December 31, 2006.

The leverage ratio is determined by dividing Tier 1 capital by adjusted average total assets. Although the stated minimum ratio is 100 to 200 basis points above three percent, banking organizations are required to maintain a ratio of at least five percent to be classified as well capitalized. The Company’s leverage ratio was 12.78% at December 31, 2006.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the federal bank regulatory agencies to implement systems for “prompt corrective

23

Supervision and Regulation of the Company and its Subsidiary (continued)

action” for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An “undercapitalized” bank must develop a capital restoration plan and its parent holding company must guarantee that bank’s compliance with the plan. The liability of the parent company under any such guarantee is limited to the lesser of five percent of the bank’s assets at the time it became “undercapitalized” or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent’s general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet such standards.

The various regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered under- capitalized. Under the regulations, a “well capitalized” institution must have a Tier 1 risk-based capital ratio of at least six percent, a total risk-based capital ratio of a least ten percent and a leverage ratio of at least five percent and not be subject to a capital directive order. Regulators also must take into consideration (a) concentrations of credit risk; (b) interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position); and (c) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as a part of the institution’s regular safety and soundness examination. In addition, the Company, and any Bank with significant trading activity, must incorporate a measure for market risk in their regulatory capital calculations.

Limitations on Bank Dividends. The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis.

Customer Information Security. The FDIC and other bank regulatory agencies have adopted final guidelines for establishing standards for safeguarding nonpublic personal information about customers that implement provisions of the Gramm- Leach Bliley Act (1999) (GLBA), which establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHCA framework. Specifically, the Information Security Guidelines established by the GLBA require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against anticipated threats or hazards to the security or integrity of such information; and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.

24

Supervision and Regulation of the Company and its Subsidiary (continued)

Privacy. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the statute requires financial institutions to explain to consumers their policies and procedures regarding the disclosure of such nonpublic personal information, and, unless otherwise required or permitted by law, financial institutions are prohibited from disclosing such information except as provided in their policies and procedures.

Bank Secrecy Act. The Bank Secrecy Act requires financial institutions to keep records and file reports that are determined to have a high degree of usefulness in criminal, tax and regulatory matters, and to implement counter-money laundering programs and compliance procedures.

USA Patriot Act. The USA Patriot Act of 2001, designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The USA Patriot Act, together with the implementing regulations of various federal regulatory agencies, have caused financial institutions, including banks, to adopt and implement additional, or amend existing, policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity and currency transaction reporting, customer identity verification and customer risk analysis. The statute and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the FRB (and other federal banking agencies) to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHCA or under the Bank Merger Act. Management believes that the Company is in compliance with all the requirements prescribed by the USA Patriot Act and all applicable final implementing regulations.

The Community Reinvestment Act. The Community Reinvestment Act (CRA) requires lenders to identify the communities served by the institution’s offices and other deposit taking facilities and to make loans and investments and provide services that meet the credit needs of these communities. Regulatory agencies examine each of the banks and rate such institutions’ compliance with CRA as “Outstanding”, “Satisfactory”, “Needs to Improve”, or “Substantial Noncompliance”. Failure of an institution to receive at least a “Satisfactory” rating could inhibit such institution or its holding company from undertaking certain activities, including engaging in activities newly permitted as a financial holding company under the GLBA and acquisitions of other financial institutions. The FRB must take into account the record of performance of banks in meeting the credit needs of the entire community served, including low-and moderate-income neighborhoods. The Bank achieved a rating of Satisfactory on its most recent examination. The Commonwealth of Massachusetts also has enacted substantially similar community reinvestment requirements.

25

Employees

     MASSBANK Corp. utilizes the support staff of the Bank from time to time, for which a fee of $18 thousand was paid to the Bank in 2006. No separate compensation is being paid to the executive officers of MASSBANK Corp., all of whom are executive officers of the Bank and receive compensation as such. As of December 31, 2006, the Bank had 107 full-time employees (including 27 officers) and 44 part-time employees (including 1 officer). None of the Bank’s employees is represented by a collective bargaining group, and management believes that its employee relations are good. The Bank provides its employees with formal training in product knowledge, sales techniques, mortgage origination, fair lending, privacy and various other bank related functions and topics. In addition, each supervisor at the Bank receives management training before assuming his or her supervisory duties and periodically thereafter. The Bank maintains a comprehensive employee benefits program for qualified employees that includes a qualified pension plan, an Employee Stock Ownership Plan (ESOP), health and dental insurance, life and long-term disability insurance and tuition assistance.

Subsidiaries

     The Bank has three wholly owned subsidiaries: Readibank Investment Corporation, Melbank Investment Corporation, and Readibank Properties, Inc.

     Readibank Investment Corporation and Melbank Investment Corporation were established for the purpose of managing portions of the Bank’s investment portfolio. They are classified by the Commonwealth of Massachusetts as securities corporations for tax purposes, which restricts their business to buying, selling, dealing in, or holding securities on their own behalf. As securities corporations they are currently taxed at a lower rate than the Bank. Legislative proposals have been discussed that may impact this favorable tax treatment.

     Assets of Readibank Investment Corporation and Melbank Investment Corporation totaled $159.9 million and $159.7 million, respectively, at December 31, 2006.

     Readibank Properties, Inc. was incorporated primarily for the purpose of real estate development projects. These projects were completed many years ago and this subsidiary is currently inactive. Its assets totaled $617 thousand at December 31, 2006, consisting primarily of an inter-company receivable from the Bank.

26

Executive Officers of the Registrant

     The executive officers of the Company and the Bank and the age of each officer as of December 31, 2006 are as follows:

Name	Age		Office
Gerard H. Brandi		58	Chairman of the Board of Directors,
			President and Chief Executive
			Officer of the Company and the Bank
Reginald E. Cormier		58	Senior Vice President, Treasurer and
			Chief Financial Officer of the
			Company and the Bank
James L. Milinazzo		52	Senior Vice President and
			Senior Lending Officer of the Bank
Joseph P. Orefice		29	Vice President of the Bank
Thomas J. Queeney		44	Vice President and Senior Trust
			Officer of the Bank
William F. Rivers		51	Vice President of the Bank
Donna H. West		61	Senior Vice President and Chief
			Operating Officer of the Bank
			and Assistant Secretary of the
			Company

     Gerard H. Brandi. Mr. Brandi has served in various capacities with MASSBANK since he joined the Bank in 1975 as Vice President of the Lending Division. He served as Senior Vice President from 1978 to 1981, Executive Vice President and Senior Lending Officer from 1981 to 1983, and Executive Vice President and Treasurer from 1983 to 1986. Mr. Brandi was named President of the Company and the Bank in 1986, Chief Executive Officer in 1992 and Chairman in 1993.

     Reginald E. Cormier. Mr. Cormier joined the Bank as Treasurer in September, 1987 and served in this capacity until his promotion to Vice President, Treasurer and Chief Financial Officer in January, 1995. In December 1999, he was promoted to Senior Vice President, Treasurer and Chief Financial Officer.

     James L. Milinazzo. Mr. Milinazzo joined the Bank as Senior Vice President of the Lending Division in March 2005. Prior to joining the Bank, he worked for Banknorth for three years as Vice President of Commercial Lending. Mr. Milinazzo also served as Executive Director/Chief Executive Officer of the Lowell Housing Authority from 1993-2002.

     Joseph P. Orefice. Mr. Orefice has been employed by the Bank since April, 2000. Starting at the Bank as a Systems Analyst, Mr. Orefice was promoted to Information Technology (IT) Officer in 2000, Director of IT in 2003 and in 2005 he was promoted to Vice President of Information Technology. Mr. Orefice is Mr. Brandi’s son-in-law.

27

Executive Officers of the Registrant (continued)

     Thomas J. Queeney. Mr. Queeney joined the Bank in 1986 as a Management Trainee in Loan Origination. He became an Assistant Manager in 1987 and was promoted to Assistant Treasurer in 1988. He then served as a Marketing and Investor Relations Representative until his promotion to Loan Servicing Manager in 1990. In 1992, he was promoted to Loan Officer and Commercial Lending Manager. He was promoted to Assistant Vice President, Lending in 1997, where he served until his promotion to AVP/Trust Administrator in July of 1998. In January of 1999, he was promoted to Vice President and Senior Trust Officer.

     William F. Rivers. Mr. Rivers joined the Bank as Vice President of Operations in 2004. Prior to joining the Bank, Mr. Rivers worked for Medford Bank for over 28 years. His most recent position there was Senior Vice President, Operations & Administration.

     Donna H. West. Mrs. West has been employed by the Bank since 1979 and has served as Vice President of the Community Banking Division since October, 1987. Starting at the Bank as an Assistant Branch Manager in 1979, Mrs. West became a Branch Manager in 1981, an Assistant Treasurer and Branch Manager in 1982, an Assistant Treasurer and Regional Branch Administrator in 1984 and an Assistant Vice President and Regional Branch Administrator in 1986. She served in this capacity until her October, 1987 promotion to Vice President of the Community Banking Division. In June 1994, Mrs. West was promoted to Senior Vice President of the Community Banking Division. In January 2007, she was promoted to Senior Vice President of the Community Banking Division and Chief Operating Officer of the Bank.

Item 1A. Risk Factors

     In addition to the other information in this Annual Report on Form 10-K, shareholders or prospective investors should carefully consider the following risk factors:

     Our business is concentrated in and dependent upon the continued economic growth and welfare of our primary market areas.

     We operate primarily in Eastern Massachusetts. The Bank’s general market areas consist of the municipalities in which it operates banking offices and all of the contiguous cities and towns. Our 15 branch offices are located on a broad arc stretching from Medford and Everett in the south, Dracut in the north, and Westford in the west. Our success depends upon the business activity, population, income levels, deposits and real estate activity in these markets. Adverse economic conditions that affect these market areas could reduce our growth rate, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations. Because of our geographical concentration, we are less able than national financial institutions to diversify our credit risks across multiple markets.

     We face intense competition in all phases of our business from other banks and financial institutions.

     The banking and financial services business in our market is highly competitive. Our competitors include large national and regional banks, local community banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds, credit unions and other non-bank financial service providers. Some of these competitors are not subject to the same regulatory restrictions, have advantages of scale due to their size, or have cost advantages due to their tax status. These competitive factors may limit our growth and profitability.

28

     We may face adverse conditions in the securities markets.

     As of December 31, 2006, we have an equity securities portfolio with a market value of $7.4 million. Due to general market conditions, we may face declines in the market value of our equity securities portfolio. Since securities gains are a source of revenue for the Bank, this could have an adverse effect on our results of operations and our financial condition. Additionally, in a rising interest rate environment, we may face declines in the market value of our debt securities portfolio. This could also have an adverse effect on our results of operations and our financial condition.

     Interest rates and other conditions impact our results of operations.

     Our profitability is in part a function of the spread between the interest rates earned on investments and the interest rates paid on deposits. Like most banking institutions, our net interest spread and margin will be affected by general economic conditions and other factors, including fiscal and monetary policies of the federal government, that influence market interest rates and our ability to respond to changes in such rates. At any given time, our assets and liabilities (deposits) will be such that they are affected differently by a given change in interest rates. As a result, an increase or decrease in rates, the length of loan terms, the average duration of our investment securities or the mix of adjustable and fixed rate loans, mortgage-backed securities and various U.S. Treasury and Government agency securities in our portfolio could have a positive or negative effect on our net income, capital and liquidity. Although we believe our current level of interest rate sensitivity is reasonable and effectively managed, significant fluctuations in interest rates, changes in the U.S. Treasury yield curve and other similar factors may have an adverse effect on our business, financial condition and results of operations.

     We must effectively manage our credit risk.

     There are risks inherent in making any loan, including risks inherent in dealing with individual borrowers, risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions. We attempt to minimize our credit risk through prudent loan application approval procedures that include a review of an applicant’s financial statements, credit history, banking history and verification of income. The majority of the bank’s loan portfolio is invested in residential real estate loans. These mortgage loans are primarily for terms of 10, 12, 15, or 20 years, are generally made to borrowers with significant equity in their homes and therefore represent a lower risk to the Bank. For mortgage loans, we generally obtain an independent appraisal of the subject property. We have a formal lending policy that is approved by the Board of Directors of the Bank that delegates levels of loan approval authority to bank personnel based upon their expertise and experience. All loans in excess of established limits require approval of the Bank’s Board of Directors. However prudent these procedures may be, they do not eliminate credit risk.

     Our allowance for loan losses may prove to be insufficient to absorb potential losses in our loan portfolio.

     The allowance for loan losses is reviewed quarterly and is maintained at a level considered adequate by management to absorb losses that are inherent in the portfolio. The amount of future loan losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, and such losses may exceed current estimates. At December 31, 2006, our allowance for loan losses as a percentage of total loans was 0.66% and as a percentage of non-performing loans was approximately 1009%. Although management believes that the allowance for loan losses is adequate to absorb losses inherent in the portfolio, we cannot predict loan losses with certainty, and we cannot assure you that our allowance for loan losses will prove sufficient to cover actual loan losses in the future. Loan losses

29

in excess of our reserves may adversely affect our business, financial condition and results of operations. Additional information regarding our allowance for loan losses and the methodology we use to determine an appropriate level of reserves is located in the “Allowance for Loan Losses and Allowance for Loan Losses on Off-Balance Sheet Credit Exposures” section included under Item 1 of Part I of this Form 10-K.

     Government regulation can result in limitations on our operations.

     We operate in a highly regulated environment and are subject to supervision and regulation by a number of governmental regulatory agencies, including the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation, Securities and Exchange Commission (SEC), NASDAQ and the Massachusetts Commissioner of Banks. Regulations adopted by these agencies govern a comprehensive range of matters relating to our acquisition of other companies and businesses, permissible activities for us to engage in, maintenance of adequate capital levels, matters of internal control over financial reporting and other aspects of our operations. These regulators possess broad authority to prevent or remedy unsafe or unsound practices or violations of law or regulation. The laws and regulations applicable to the Company could change at any time and we cannot predict the effects of these changes on our business and profitability. Increased regulation could increase our cost of compliance and adversely affect profitability. For example, new legislation or regulation may limit the manner in which we may conduct our business, including our ability to offer new products, attract deposits, make loans and achieve satisfactory spreads.

     Our employee benefit costs are increasing.

     Our employee benefit costs, particularly health benefits, have increased significantly in recent years. Additional significant increases in employee benefit costs could have an adverse effect on our results of operations.

     Changes in accounting principles can have a significant impact on our operations.

     Changes required by new accounting pronouncements issued by the Financial Accounting Standards Board (FASB) could have a material effect on our reported financial condition or results of operations.

     We may be facing increased costs when introducing new technology-based services.

     The cost of technological innovation, which for a while appeared to be decreasing, is in fact increasing due to the cost of security, privacy protection and related expenses. We may incur higher costs when we introduce new technology-based services. This could have an adverse effect on our financial condition and results of operations.

     Due to the nature of our business, we may be subject to litigation from time to time.

     From time to time, we are involved as a plaintiff or defendant in various legal actions incident to our business. These could involve claims for monetary damages as well as legal fees. Although we maintain insurance, the scope of this coverage may not provide us with full, or even partial coverage in any particular case. As a result, a judgment against us in any such litigation could have an adverse effect on our financial condition and results of operations.

30

Item 1B. Unresolved Staff Comments

     There are no unresolved written comments that were received from the SEC staff 180 days ago or more before the end of our fiscal year relating to our periodic or current reports under the Securities and Exchange Act of 1934.

Item 2. Properties

     The main office of MASSBANK Corp. and MASSBANK is located at 123 Haven Street, Reading, Massachusetts. Additionally, the Bank has fourteen branches and three operations facilities. The Bank owns its main office, three operations facilities and nine of its branches. All of the remaining branches and other facilities are leased under various leases. At December 31, 2006, management believes that the Bank’s existing facilities are adequate for the conduct of its business.

The following table sets forth certain information relating to the Bank’s existing facilities.

		Owned	Lease	Renewal
		or	Expiration	Option
Location		Leased	Date	Through
MAIN OFFICE:	123 Haven Street, Reading, MA	Owned	—	—
BRANCH OFFICES:	291 Chelmsford Street, Chelmsford, MA	Owned	—	—
	17 North Road, Chelmsford, MA	Owned	—	—
	45 Broadway Road, Dracut, MA	Leased	2012	2022
	738 Broadway, Everett, MA	Owned	—	—
	50 Central Street, Lowell, MA	Owned	—	—
	755 Lakeview Avenue, Lowell, MA	Owned	—	—
	4110 Mystic Valley Pkwy, Medford, MA	Leased	2007	—
	476 Main Street, Melrose, MA	Owned	—	—
	27 Melrose Street, Towers Plaza, Melrose, MA	Leased	2014	—
	240 Main Street, Stoneham, MA	Leased	2009	2014
	1800 Main Street, Tewksbury, MA	Owned	—	—
	203 Littleton Road, Westford, MA	Owned	—	—
	370 Main Street, Wilmington, MA	Owned	—	—
	219 Lowell Street, Lucci’s Plaza, Wilmington, MA	Leased	2016	—
OPERATIONS
FACILITIES:	159 Haven Street, Reading, MA	Owned	—	—
	169 Haven Street, Reading, MA	Owned	—	—
	11 North Road, Chelmsford, MA	Owned	—	—

Item 3. 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 December 31, 2006, none of these actions individually or in the aggregate is believed by management to be material to the financial condition and results of operations of MASSBANK Corp. or the Bank.

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

     None during the fourth quarter of 2006.

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PART II

Item 5. Market for Registrant’s Common Stock and Related Stockholder Matters

     The information contained under the caption “MASSBANK Corp. and Subsidiaries Stockholder Data” in the Registrant’s 2006 Annual Report to Stockholders is incorporated herein by reference.

Refer to Part III Item 12 of this Form 8-K for the Equity Compensation Plan table incorporated herein by reference.

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 quarter ended December 31, 2006:

					Total Number
					of Shares		Maximum Number
					Purchased as		of Shares That
					Part of Publicly		May Yet Be
	Total Number		Average Price		Announced		Purchased Under
	of Shares		Paid Per		Repurchase		The Repurchase
Period	Purchased		Share		Program		Program
10/01/06								80,217
10/18/06								50,000	(1)
								130,217
10/01/06-10/31/06		0	$	0.00		0		130,217
11/01/06-11/30/06		0	$	0.00		0		130,217
12/01/06-12/31/06		7,000	$	32.85		7,000		123,217
Total for quarter		7,000				7,000

(1) On October 18, 2006 the Registrant’s Board of Directors extended for another year, the stock repurchase program previously authorized. Additionally, the Board approved an increase of 50,000 in the number of shares of the Registrant’s common stock authorized for repurchase in the current program.

     In addition, the following number of shares were purchased for the Company’s Directors’ Deferred Compensation Plan and Trust during the quarter ended December 31, 2006:

					Total Number
					of Shares		Maximum Number
					Purchased as		of Shares That
					Part of Publicly		May Yet Be
	Total Number		Average Price		Announced		Purchased Under
	of Shares		Paid Per		Repurchase		The Repurchase
Period	Purchased		Share		Program (1)		Program
10/01/06-10/31/06		0	$	0.00		0		0
11/01/06-11/30/06		0	$	0.00		0		0
12/01/06-12/31/06		1,200	$	32.65		0		0
Total for quarter		1,200

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Five-Year Stock Performance Graph

     The following chart compares the performance of the Common Stock of the Company (assuming reinvestment of dividends) to the total returns on the S&P 500 Index and the NASDAQ Bank Index over a five-year period. The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks selected by Standard & Poor’s. The NASDAQ Bank Index is a broad based capitalization weighted index of domestic and foreign common stocks of banks that are traded on the NASDAQ Global Select Market System as well as the SmallCap Market. The chart assumes a $100 investment was made on December 31, 2001 in the Common Stock of MASSBANK Corp., the stocks included in the S&P 500 Index and the stocks included in the NASDAQ Bank Index. The Company obtained the data for the chart from Bloomberg. The information about the indices that the Company obtained from Bloomberg is believed to be reliable, but neither the accuracy nor the completeness of such information is guaranteed by the Company.

Comparison of Five Year Cumulative Return
Among MASSBANK Corp., the S&P 500 Index and the NASDAQ Bank Index

	12/31/01		12/31/02		12/31/03		12/31/04		12/31/05		12/31/06
MASSBANK Corp.	$	100.00	$	122.26	$	189.79	$	169.67	$	154.26	$	158.84
NASDAQ Bank Index	$	100.00	$	106.98	$	141.83	$	160.89	$	157.70	$	179.22
S&P 500 Index	$	100.00	$	78.03	$	100.16	$	110.92	$	116.28	$	134.43

Item 6. Selected Financial Data

     The information contained under the caption “MASSBANK Corp. and Subsidiaries - Selected Consolidated Financial Data” in the Registrant’s 2006 Annual Report to Stockholders is incorporated herein by reference.

     This selected consolidated financial data should be read in conjunction with the consolidated statements and related notes thereto appearing in the Registrant’s 2006 Annual Report to Stockholders which are incorporated herein by reference.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The information contained under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Registrant’s 2006 Annual Report to Stockholders is incorporated herein by reference.

33

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

     The information contained under the captions “Asset and Liability Management”, “Interest Rate Risk” and “Other Market Risks” included in Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Registrant’s 2006 Annual Report to Stockholders is incorporated herein by reference.

Item 8. Financial Statements and Supplementary Data

     The Registrant’s consolidated financial statements and notes thereto, together with the reports of the Company’s Independent Registered Public Accounting Firm, Parent, McLaughlin & Nangle, contained in the Registrant’s 2006 Annual Report to Stockholders are incorporated herein by reference. The unaudited quarterly financial data set forth on page 62 of such Annual Report is incorporated herein by reference.

Item 9. Changes in and Disagreements with Independent Accountants on Accounting and Financial Disclosure

     None.

Item 9A. Controls and Procedures

     As required by Rule 13a-15 under the Securities Exchange Act of 1934 (Exchange Act), the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that material information relating to the Company required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. In designing and evaluating the disclosure controls and procedures, the Company’s management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily was required to apply its judgment in designing and evaluating the controls and procedures. The Company currently is in the process of further reviewing and documenting its disclosure controls and procedures, and its internal control over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.

Changes in Internal Control Over Financial Reporting.

     There were no changes in our internal control over financial reporting during the fourth quarter of fiscal year 2006 that have materially affected, or that are reasonably likely to materially affect, our internal controls over financial reporting.

Item 9B. Other Information

     None.

34

PART III

Item 10. Directors, Executive Officers and Corporate Governance

     The information appearing under the captions “Election of Directors” and “Section 16(A) Beneficial Ownership Reporting Compliance” in the Registrant’s definitive proxy statement relating to its 2007 Annual Meeting of Stockholders is incorporated herein by reference. Information required by this item concerning the Executive Officers of the Registrant is contained in Part I of this Form 10-K. The Registrant adopted a code of ethics that applies to all of MASSBANK Corp.’s and MASSBANK’s directors, officers and employees. This code of ethics is available on the Corporation’s website at www.massbank.com. The Company intends to disclose any amendments to, or waivers from, its code of ethics that are required to be publicly disclosed pursuant to the rules of the SEC and the NASDAQ Global Select Market by filing such amendment or waiver with the SEC and by posting it on our website.

Audit Committee. MASSBANK Corp. has a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The members of the Audit Committee are William F. Rucci, Jr. (Chairman), Allan S. Bufferd, Alexander S. Costello and Nancy L. Pettinelli, each of whom is independent as independence for audit committee members is defined under NASDAQ listing standards applicable to the Company as well as the SEC.

Audit Committee Financial Expert. MASSBANK Corp.’s Board of Directors has determined that William F. Rucci, Jr. and Allan S. Bufferd, Audit Committee members, are audit committee financial experts as defined in Item 407(d)(5) of Regulation S-K of the Exchange Act.

There have been no material changes to the procedures by which security holders may recommend nominees to the Company’s Board of Directors.

Item 11. Executive Compensation

     The information appearing under the captions “Executive Compensation”, “Compensation Committee Interlocks and Insider Participation”, “Director Compensation”, “Compensation Discussion and Analysis”, and “Compensation and Option Committee Report” in the Registrant’s definitive proxy statement relating to its 2007 Annual Meeting of Stockholders is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     The information appearing under the captions “Election of Directors”, “Principal Stockholders” and “Equity Compensation Plan Information” in the Registrant’s definitive proxy statement relating to its 2007 Annual Meeting of Stockholders is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions, and Director Independence

     The information (i) contained in Note 5 of the Consolidated Financial Statements under the caption “Loans” in the Registrant’s 2006 Annual Report to Stockholder’s, and (ii) appearing under the captions “Certain Relationships and Related Party Transactions” and “Polices and Procedures for Related Party Transactions” in the Registrant’s definitive proxy statement relating to its 2007 Annual Meeting of Stockholders, is incorporated herein by reference.

35

     Information concerning the independence of MASSBANK Corp. directors required by this item is set forth under the caption “Election of Directors” in the Registrant’s definitive proxy statement relating to its 2007 Annual Meeting of Stockholders and is incorporated herein by reference.

Item 14. Principal Accountant Fees and Services

     The information appearing under the caption “Independent Registered Public Accountants” in the Registrant’s definitive proxy statement relating to its 2007 Annual Meeting of Stockholders is incorporated herein by reference.

PART IV

Item 15. Exhibits and Financial Statement Schedules

     The following financial statements and financial statement schedules are contained herein or are incorporated herein by reference:

(a)1. Financial Statements

	Reference to 2006
	Annual Report
	to Stockholders
	(Pages) *
Reports of Independent Registered Public Accounting Firm		30
Consolidated Balance Sheets at December 31, 2006 and 2005		32
Consolidated Statements of Income for the three years ended December 31, 2006		33
Consolidated Statements of Cash Flows for the three years ended December 31, 2006		34-35
Consolidated Statements of Changes in Stockholders’ Equity for the three years ended December 31, 2006		36
Notes to Consolidated Financial Statements		37-62

* Incorporated, by reference to pages 29 through 62 of the Registrant’s 2006 Annual Report to Stockholders attached to this filing as Exhibit 13.

     2. Financial Statement Schedules

     All schedules are omitted, as the required information is either not applicable or is included in the consolidated financial statements or related notes.

36

3. Exhibits

Exhibit No.		Description of Exhibit
	3.1	Restated Certificate of Incorporation of the Registrant — incorporated by reference to Exhibit 3.1 of the Registrant’s Form S-4 Registration Statement (Reg. No. 33-7916).
	3.2	By-Laws of the Registrant — incorporated by reference to Exhibit 3 of the Registrant’s Form 10-Q for the quarter ended September 30, 1991.
	4.1	Shareholder Rights Agreement dated as of January 18, 2000, between the Company and The First National Bank of Boston, as Rights Agent — incorporated herein by reference to the Exhibit to the Company’s Report on Form 8-K dated as of January 20, 2000. (SEC file number 0-15137)
	10.1	MASSBANK Corp. 1986 Stock Option Plan, as amended - incorporated by reference to Exhibit 28.1 to the Registrant’s Form S-8 Registration Statement (Reg. No. 33-11949).
	10.1.2	Amendment to MASSBANK Corp. 1986 Stock Option Plan dated April 19, 1991 — incorporated by reference to Exhibit 10.1.2 to the Registrant’s annual report on Form 10-K for the year ended December 31, 1992.
	10.1.3	MASSBANK Corp. 1994 Stock Incentive Plan — incorporated by reference to Exhibit 10.1 to the Registrant’s Form S-8 Registration Statement (Reg. No. 33-82110).
	10.1.4	Amendment to MASSBANK Corp. 1994 Stock Incentive Plan dated April 21, 1998 — incorporated by reference to Exhibit 10.1.4 to the Registrant’s annual report on Form 10-K for the year ended December 31, 1997.
	10.1.5	MASSBANK Corp. 2004 Stock Option and Incentive Plan – incorporated by reference to exhibit 10.1.5 to the Registrant’s Form S-8 Registration Statement (Ref. No. 33-118028).
	10.1.6	Form of Incentive Stock Option Agreement under the MASSBANK Corp. 2004 Stock Option and Incentive Plan – incorporated by reference to exhibit 10.1 to the Registrant’s report on Form 8-K dated January 14, 2005.
	10.1.7	Form of Non-Qualified Stock Option Agreement under the MASSBANK Corp. 2004 Stock Option and Incentive Plan – incorporated by reference to exhibit 10.2 to the Registrant’s report on Form 8-K dated January 14, 2005.
	10.1.8	Form of Incentive Stock Option Agreement under the MASSBANK Corp. 2004 Stock Option and Incentive Plan – incorporated by reference to exhibit 10.1 to the Registrant’s report on Form 8-K dated January 13, 2006.
	10.1.9	Form of Non-Qualified Stock Option Agreement for MASSBANK Corp. employees under the MASSBANK Corp. 2004 Stock Option and Incentive Plan – incorporated by reference to exhibit 10.2 to the Registrant’s report on Form 8-K dated January 13, 2006.

37

Exhibit No.		Description of Exhibit
	10.1.10	Form of Non-Qualified Stock Option Agreement for MASSBANK Corp. directors under the MASSBANK Corp. 2004 Stock Option and Incentive Plan – incorporated by reference to exhibit 10.3 to the Registrant’s report on Form 8-K dated January 13, 2006.
	10.2	MASSBANK for Savings Employees’ Stock Ownership Plan and Trust Agreement — incorporated by reference to Exhibit 10.2 of the Registrant’s Form S-4 Registration Statement (Reg. No. 33-7916).
	10.2.1	Amendments to the MASSBANK for Savings Employee’s Stock Ownership Plan and Trust Agreement — incorporated by reference to Exhibit 10.2.1 to the Registrant’s annual report on Form 10-K for the year ended December 31, 1993.
	10.2.2	Amendments to the MASSBANK for Savings Employee’s Stock Ownership Plan and Trust Agreement — incorporated by reference to Exhibit 10.2.2 to the Registrant’s annual report on Form 10-K for the year ended December 31, 1997.
	10.2.3	Amended and Restated MASSBANK Employees’ Stock Ownership Plan and Trust Agreement incorporated by reference to Exhibit 10.2.3 to the Registrant’s annual report on Form 10K for the year ended December 31, 2003.
	10.3.16	Amended and Restated Employment Agreement with Gerard H. Brandi dated as of October 28, 2002 – incorporated by reference to exhibit 10.3.16 to the Registrant’s quarterly report on Form 10-Q for the period ended September 30, 2002.
	10.3.18	Amended and Restated Employment Agreement with Reginald E. Cormier dated as of October 28, 2002 – incorporated by reference to exhibit 10.3.18 to the Registrant’s quarterly report on Form 10-Q for the period ended September 30, 2002.
	10.3.20	Amended and Restated Employment Agreement with Donna H. West dated as of October 28, 2002 – incorporated by reference to exhibit 10.3.20 to the Registrant’s quarterly report on Form 10-Q for the period ended September 30, 2002.
	10.3.21	Form of Employment Agreement with Thomas J. Queeney dated as of October 28, 2002 – incorporated by reference to exhibit 10.3.21 to the Registrant’s quarterly report on Form 10-Q for the period ended September 30, 2002.
	10.3.22	Form of Employment Agreement with William F. Rivers dated as of March 23, 2005 – incorporated by reference to exhibit 10.3.22 to the Registrant’s report on Form 8-K dated March 24, 2005.
	10.3.23	Form of Employment Agreement with James L. Milinazzo dated March 23, 2005 – incorporated by reference to exhibit 10.3.23 to the Registrant’s report on Form 8-K dated March 24, 2005.

38

Exhibit No.		Description of Exhibit
	10.3.24	Form of Employment Agreement with Joseph P. Orefice dated March 10, 2006 – incorporated by reference to exhibit 10.3.24 to the Registrant’s report on Form 8-K dated March 14, 2006.
	10.3.25	Amended and Restated Employment Agreement with James L. Milinazzo dated March 10, 2006 – incorporated by reference to exhibit 10.3.25 to the Registrant’s report on Form 8-K dated March 14, 2006.
	10.4	Form of Executive Supplemental Retirement Agreement, as amended, with Gerard H. Brandi — incorporated by reference to Exhibit 10.4 of Registrant’s annual report on Form 10-K for the year ended December 31, 1986.
	10.4.1	Amendments to the Executive Supplemental Retirement Agreement with Gerard H. Brandi are incorporated by reference to Exhibit 10.4.1 of the Registrant’s annual report on Form 10-K for the year ended December 31, 1996.
	10.5	Amended Deferred Compensation Plan for Directors of MASSBANK Corp. adopted March 8, 2000 – incorporated by reference to Exhibit 10.5 of the Registrant’s annual report on Form 10-K for the year ended December 31, 2000. (SEC file number 0-15137)
	10.5.1	Amended and Restated Deferred Compensation Plan for Directors of MASSBANK Corp. (the “Company”) and MASSBANK (the “Bank”) dated August 10, 2005 – incorporated by reference to exhibit 10.5.1 to the Registrant’s report on Form 8-K dated August 11, 2005.
	10.6	Deferred Compensation Program for Bank employees dated November 14, 1994 – incorporated by reference to Exhibit 10.6 of the Registrant’s annual report on Form 10-K for the year ended December 31, 2001. (SEC file number 0-15137)
	10.6.1	Amended and Restated Terms and Conditions of Deferred Compensation Program for employees of MASSBANK (the “Bank”) dated August 10, 2005 – incorporated by reference to exhibit 10.6.1 to the Registrant’s report on Form 8-K dated August 11, 2005.
	11	The computation of per share earnings can be readily determined from the material contained in the Annual Report on Form 10-K for the fiscal year ended December 31, 2006.
	12	Statement re: Computation of Ratios — Not applicable as MASSBANK Corp. does not have any debt securities registered under Section 12 of the Securities Exchange Act of 1934.
	13	2006 Annual Report to Stockholders — except for those portions of the 2006 Annual Report to Stockholders which are expressly incorporated by reference in this report, such 2006 Annual Report to Stockholders is furnished for the information of the SEC and is not to be deemed “filed” with the SEC.

39

Exhibit No.	Description of Exhibit
21	Subsidiaries of the Registrant.
23	Consent of Independent Registered Public Accounting Firm – Parent, McLaughlin & Nangle.
31.1	Certification Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 by Chief Executive Officer.
31.2	Certification Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 by Chief Financial Officer.
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Chief Executive Officer.
32.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Chief Financial Officer.
(b)	Exhibits to this Form 10-K are attached or incorporated by reference as stated in the Index to Exhibits.

40

Signatures

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

MASSBANK CORP.
 

/s/ Gerard H. Brandi  

Gerard H. Brandi 

Chairman, President and Chief Executive Officer 

     Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

/s/ Gerard H. Brandi Gerard H. Brandi	Chairman, President, Chief Executive Officer and Director	March 6, 2007
/s/ Reginald E. Cormier Reginald E. Cormier	Senior Vice President, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer)	March 6, 2007
/s/ Mathias B. Bedell	Director	March 6, 2007
Mathias B. Bedell
/s/ Allan S. Bufferd	Director	March 6, 2007
Allan S. Bufferd
/s/ Kathleen M. Camilli	Director	March 6, 2007
Kathleen M. Camilli
/s/ Alexander S. Costello	Director	March 6, 2007
Alexander S. Costello

41

/s/ Stephen W. Carr	Director	March 6, 2007
Stephen W. Carr
/s/ O. Bradley Latham	Director	March 6, 2007
O. Bradley Latham
/s/ Stephen E. Marshall	Director	March 6, 2007
Stephen E. Marshall
/s/ Nancy L. Pettinelli	Director	March 6, 2007
Nancy L. Pettinelli
/s/ William F. Rucci, Jr.	Director	March 6, 2007
William F. Rucci, Jr.

42

EX-13

Exhibit 13

F i n a n c i a l H i g h l i g h t s

Massbank Corp. and Subsidiaries
Selected Consolidated Financial Data

(In thousands) At December 31,	2006		2005		2004		2003		2002
Balance Sheet Data:
Total assets	$	843,522	$	898,679	$	976,168	$	1,010,733	$	1,009,367
Mortgage loans		199,253		215,904		226,197		241,886		302,788
Other loans		9,674		9,826		10,001		11,120		16,011
Allowance for loan losses		1,382		1,253		1,307		1,554		2,271
Allowance for loan losses on off-balance sheet credit exposures		345		517		588		626		384
Investments(1)		590,646		637,576		704,611		722,079		669,875
Deposits		723,332		784,728		849,465		882,508		883,928
Stockholders’ equity		106,885		105,264		110,015		110,927		117,285

(In thousands) Years ended December 31,	2006		2005			2004			2003			2002
Operating Data:
Interest and dividend income	$	39,939	$	36,801		$	33,581		$	38,137		$	47,103
Interest expense		18,951		15,141			12,729			15,854			22,701
Net interest income		20,988		21,660			20,852			22,283			24,402
Provision (credit) for loan losses		123		(53	)		(242	)		(502	)		—
Gains on securities, net		797		679			1,229			639			1,718
Other non-interest income		1,408		1,238			1,307			1,335			1,255
Non-interest expense		12,360		12,514			12,352			12,667			12,087
Income before income taxes		10,710		11,116			11,278			12,092			15,288
Income tax expense		3,683		3,793			3,898			4,229			5,474
Net income	$	7,027	$	7,323		$	7,380		$	7,863		$	9,814

Years ended December 31,	2006			2005			2004			2003			2002
Other Data:
Yield on average interest-earning assets		4.80	%		4.07	%		3.52	%		3.87	%		4.85	%
Cost of average interest-bearing liabilities		2.53			1.85			1.48			1.78			2.61
Interest rate spread
Interest rate spread		2.27			2.22			2.04			2.09			2.24
Net interest margin		2.53			2.40			2.19			2.26			2.52
Non-interest expense to average assets		1.44			1.35			1.26			1.26			1.22
Efficiency ratio(2)		53.7			52.7			51.6			50.0			44.0
Return on assets (net income/average assets)		0.82			0.79			0.75			0.78			0.99
Return on equity (net income/average stockholders’ equity)		6.74			6.84			6.71			7.08			8.39
Percent non-performing loans to total loans		0.07			0.11			0.03			0.09			0.13
Percent non-performing assets to total assets		0.02			0.03			0.01			0.02			0.04
Stockholders’ equity to assets, at year-end		12.67			11.71			11.27			10.97			11.62
Book value per share,at year-end(3)	$	24.76		$	24.32		$	25.11		$	25.17		$	25.45
Market price – close, at year-end(3)		32.89			33.00			37.45			43.01			28.30
Earnings per share:(3)
Basic		1.62			1.68			1.67			1.77			2.09
Diluted		1.61			1.66			1.64			1.73			2.04
Cash dividends paid per share(3)		1.09			1.05			1.00			0.92			0.88
Dividend payout ratio		67	%		63	%		60	%		52	%		42	%

(1)	Consist of securities held to maturity and available for sale, trading securities, short-term investments, term Federal funds sold and interest-bearing deposits in banks.
(2)	Determined by dividing non-interest expense (including the provision (credit) for loan losses) by fully taxable equivalent net interest income plus non-interest income.
(3)	All share information presented has been adjusted to reflect the 3-for-2 split of the Company’s common stock effective April 19, 2002.

3

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

General

The following discussion should be read in conjunction with the consolidated financial statements and related notes included in this report. Certain amounts reported for prior years have been reclassified to conform to the 2006 presentation.

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

     The financial condition and results of operations of Massbank Corp. (the “Company”) essentially reflect the operations of its subsidiary, Massbank (the “Bank”).

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

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

Forward-Looking Statement Disclosure

     Massbank Corp. may from time to time make written or oral forward-looking statements, including statements contained in this annual report, in the Company’s filings with the Securities and Exchange Commission, in its reports to stockholders and in other Massbank Corp. communications. These statements relate to future, not past events.

     These forward-looking statements include, among others, statements with respect to Massbank 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; (8) adverse impacts resulting from the continuing war on terrorism; (9) a significant increase in employee benefit costs; (10) the impact of changes in accounting principles; (11) the impact of inflation or deflation; and (12) Massbank Corp.’s success at managing the risks involved in the foregoing.

9

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 the 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 deduct ion 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 drawdowns of committed loans, their loss experience factors, management’s assesment 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 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 judgements 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 its 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.

     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 2006, 2005 or 2004.

     Available for sale securities deemed temporarily impaired are carried at market value in the asset section of the Company’s balance sheet. Any change in value, net of income taxes, is reflected in accumulated other comprehensive income in the stockholders’ equity section of the Company’s balance sheet.

10

Financial Overview
Comparison of the years 2006 and 2005

     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 its 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.

     Fiscal 2006 was a challenging year for the Company. The flat-to-inverted yield curve environment in 2006 made it difficult for the Company to profitably grow deposits. Additionally, rising short-term interest rates influenced by the rate setting actions of the Federal Reserve Bank resulted in increased competition for shorter-term deposits. In this environment, the Company decided to more aggressively price its medium term certificates of deposit (CDs) contributing to a shifting of deposits from savings to these CD maturities.

     In 2006, the Company generated net income of $7.0 million, or $1.61 per diluted share, compared with $7.3 million or $1.66 per diluted share in 2005. Return on average assets in 2006 improved to 0.82% from 0.79% in the prior year. Return on average equity was 6.74% in 2006 compared to 6.84% in 2005.

     The major factors affecting the comparison of earnings and diluted earnings per share between 2006 and 2005 were:

• The decrease in net interest income of $672 thousand due primarily to a decrease in average earning assets.

• The provision for loan losses of $123 thousand versus a credit for loan losses of $53 thousand the prior year.

• The increase in net securities gains of $118 thousand.

• The increase in other non-interest income of $170 thousand.

• The decrease in non-interest expense of $154 thousand.

• The decrease in income tax expense of $110 thousand due to lower income before taxes partially offset by an increase in the Company’s effective income tax rate.

Years ended December 31, 2006 compared to 2005:

(In thousands) Years ended December 31,	2006		2005			change
Income Statement Data
Interest and dividend income:
Mortgage and other loans	$	12,070	$	12,792		$	(722	)
Mortgage-backed securities		7,592		7,217			375
Federal funds sold		7,731		6,116			1,615
Other securities and investments		12,546		10,676			1,870
Total interest and dividend income		39,939		36,801			3,138
Total interest expense		18,951		15,141			(3,810	)
Net interest income		20,988		21,660			(672	)
Provision (credit) for loan losses		123		(53	)		(176	)
Gains on securities, net		797		679			118
Other non-interest income		1,408		1,238			170
Non-interest expense		12,360		12,514			154
Income tax expense		3,683		3,793			110
Net income	$	7,027	$	7,323		$	( 296	)
Diluted earnings per share (in dollars):	$	1.61	$	1.66		$	(0.05	)

(In thousands) Years ended December 31,	2006		2005		change
Average Balance Sheet Data
Total average earning assets	$	833,842	$	904,646	$	(70,804	)
Total average deposits	$	750,437	$	816,577	$	(66,140	)

11

Financial Condition

The Company’s total assets decreased $55.2 million, or 6.1% to $843.5 million at December 31, 2006 from $898.7 million at December 31, 2005. The reduction in total assets reflects a decrease in investments of $46.9 million and a decrease in total loans of $16.8 million.

     Deposits decreased $61.4 million, or 7.8% to $723.3 million at year-end 2006 from $784.7 million at year-end 2005. This was due to increased competition for deposits, more attractive returns on other investment opportunities and various other market factors.

Condensed Consolidated Balance Sheets

(In thousands) at December 31,	2006			2005			change
Short-term investments	$	139,240		$	167,787		$	(28,547	)
Interest-bearing deposits in banks		—			898			(898	)
Term Federal funds sold		41,000			—			41,000
Securities available for sale, at market value		403,079			453,472			(50,393	)
Securities held to maturity, at amortized cost		5,396			6,137			(741	)
Trading securities, at market value		1,931			9,282			(7,351	)
Total investments		590,646			637,576			(46,930	)
Total loans		208,927			225,730			(16,803	)
Allowance for loan losses		(1,382	)		(1,253	)		(129	)
Net loans		207,545			224,477			(16,932	)
Other assets		45,331			36,626			8,705
Total assets	$	843,522		$	898,679		$	(55,157	)
Total deposits	$	723,332		$	784,728		$	(61,396	)
Escrow deposits of borrowers		1,006			1,059			(53	)
Other liabilities		12,299			7,628			4,671
Total liabilities		736,637			793,415			(56,778	)
Total stockholders’ equity		106,885			105,264			1,621
Total liabilities and stockholders’ equity	$	843,522		$	898,679		$	(55,157	)

Investments

At December 31, 2006 the Company’s investment portfolio consisted of short-term investments, term Federal funds sold, and securities available for sale, held to maturity and trading totaling $590.6 million representing 70.0% of total assets. This reflects a decrease of $46.9 million compared to $637.6 million or 70.9% of total assets at December 31, 2005. Massbank’s investment portfolio is concentrated in U.S. Treasury and Government agency securities and 15-year contractual life mortgage-backed securities issued by Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”) and other agency issuers. U.S. Treasury and Government agency securities totaled $261.3 million at year-end 2006. This included $161.3 million in callable agency securities. The mortgage-backed securities portfolio totaled $139.9 million at December 31, 2006, essentially unchanged from the prior year. The Company also holds $7.4 million in equity securities at year-end 2006. Massbank’s strategy is to purchase liquid investments with short to intermediate maturities in the current interest rate environment. If the currently inverted Treasury yield curve becomes more normalized in 2007, the Company will likely add to its mortgage-backed securities portfolio and reduce its short-term investments and term Federal funds sold which totaled $180.2 million at December 31, 2006. In such event, we believe that this would likely improve the Company’s net interest margin.

12

Loans

Massbank’s loan portfolio at December 31, 2006 totaled $208.9 million representing 24.8% of total assets compared to $225.7 million representing 25.1% of total assets at December 31, 2005. The loan portfolio consists predominantly of residential mortgages. Residential mortgage loans amounted to $194.3 million at year-end 2006, representing approximately 93.0% of the total loan portfolio as compared to $213.6 million representing 94.6% of the total loan portfolio as of December 31, 2005. Commercial real estate loans increased from $2.3 million at December 31, 2005 to $5.0 million at year-end 2006, as the bank has focused more on this type of lending this past year.

Non-Performing Assets

Non-accrual loans, generally those loans that are 90 days or more delinquent, were near historical lows totaling $137 thousand at December 31, 2006, representing 0.07% of total loans. This compares to $257 thousand representing 0.11% of total loans at December 31, 2005. The Bank generally places all loans on non-accrual status when 90 days delinquent. The Bank had no real estate acquired through foreclosure at year-end 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.

     Total deposits at December 31, 2006 were $723.3 million, compared to $784.7 million at December 31 ,2005. Increased competition for deposits and more attractive returns on other investment opportunities were the principal reasons for the deposit outflows.

     In 2006, savings deposits decreased $96.7 million or 21.9% year-over-year, to $344.8 million from $441.5 million at year-end 2005. Conversely, certificates of deposit increased by $38.7 million or 14.8% to $299.7 million at year-end 2006 as customers continued to shift deposits from savings accounts to certificates of deposit seeking a higher rate of return on their deposits. Demand and NOW deposits totaled $78.9 million at December 31, 2006 compared to $82.3 million at December 31, 2005. For information concerning deposit balances at year-end 2006 and 2005, the average cost and the maturity distribution of the deposits and related rate structure of the Bank’s time certificates of deposit, see Note 10 of Notes to Consolidated Financial Statements.

Stockholders’ Equity

Total stockholders’ equity increased $1.6 million or 1.5% to $106.9 million at December 31, 2006, from $105.3 million at year-end 2005. Book value per share increased $0.44 or 1.8% to $24.76 per share at December 31, 2006, from $24.32 per share at December 31, 2005.

     The increase in total stockholders’ equity was due principally to the 2006 net income of $7.0 million and the payments and related tax benefits received from the exercise of stock options by the Company’s officers and directors of $0.9 million. This was partially offset by the payment of dividends to stockholders of $4.7 million and the Company’s repurchase of 49,500 shares of treasury stock at a cost of $1.6 million.

     As of December 31, 2006, the Company has recognized as a component of other comprehensive income, the under-funded status of its defined benefit pension plan, net of tax, in accordance with the provisions of Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” See Consolidated Statements of Changes in Stockholders’ Equity.

13

Results of Operations
Comparison of the years 2006 and 2005

Net Interest Income

Net interest income is the primary source of Massbank’s operating income. Net interest income is affected by the volume and mix of average interest earning-assets and interest-bearing liabilities, market interest rates, the shape of the U.S. Treasury securities (interest rate) yield curve and other factors. In 2006, short-term interest rates rose at a greater rate than intermediate and long rates. This caused the yield curve to “invert.” An inverted curve significantly limits the ability to benefit from investing assets at long term rates. Because of this situation, we maintain a significant position of short term investments. Due to our current asset mix and other factors, we would expect to benefit from an increase in interest rates along with a steeper interest rate yield curve.

     Net interest income on a fully taxable equivalent (FTE) basis totaled $21.1 million in 2006 compared to $21.7 million in 2005, reflecting a decrease of 3.1%. The decrease in net interest income in 2006 is primarily attributable to lower levels of interest earning assets partially offset by lower levels of interest bearing liabilities and an improvement in net interest margin. The Company’s average earning assets in 2006 declined $70.8 million or 7.8% to $833.8 million, from $904.6 million in 2005. Average deposits declined $66.1 million or 8.1% to $750.4 million in 2006, from $816.6 million in 2005. The market for deposits was very competitive in 2006. Financial institutions were aggressive in pricing their deposit products in order to retain deposits. Massbank chose not to match these competitors’ rates in order to protect its net interest margin.

     The Company’s net interest margin (net interest income on a FTE basis divided by average interest earning assets) for the year ended December 31, 2006 increased 13 basis points to 2.53% from 2.40% in the prior year. The increase in margin was driven by the increases to short term interest rates in 2006. This was partially offset by the unfavorable changes in the mix of our deposits and competitive market conditions which contributed to our increased funding costs.

     The tables on pages 26 and 27 set forth, among other things, the extent to which changes in interest rates and changes in the average balances of interest earning assets and interest-bearing liabilities have affected interest income and expense during the years indicated. Information is provided for each category of interest-earning assets and interest-bearing liabilities, on changes due to (1) changes in volume and (2) changes in interest rates.

     Interest on investment securities available for sale (AFS) on a fully taxable equivalent basis was $12.1 million in 2006 compared to $9.9 million in 2005. The average balance of investment securities AFS was $308.7 million with an average yield of 3.93% for the year ended December 31, 2006 compared to an average balance of $313.7 million with an average yield of 3.16% for the year ended December 31, 2005. The increase in yield is primarily due to the replacement yields on new securities purchased being higher because of a rise in market interest rates and to a lesser extent a change in mix of securities in the portfolio.

     Interest on mortgage-backed securities AFS and held to maturity was $7.6 million in 2006 compared to $7.2 million in 2005. The average balance of mortgage-backed securities was $141.0 million with an average yield of 5.39% in 2006 compared to an average balance of $134.8 million with an average yield of 5.35% in 2005. The increase in yield is due primarily to the higher replacement yields on the securities purchased in 2006. However, with the flat-to-inverted yield curve environment in 2006, the Company only purchased $25.9 million in mortgage-backed securities during the year as compared to $49.3 million in 2005. Principal repayments (including prepayments) on our mortgage-backed securities portfolio in 2006 declined to $26.7 million, from $31.5 million in the prior year.

     Interest on trading securities was $0.2 million in 2006, down from $0.8 million in the prior year. The average balance of trading securities was $5.7 million in 2006 compared to $32.2 million in 2005. The average yield on these securities improved to 3.55% in the recent year, from 2.40% in 2005 due primarily to rising market interest rates.

     Interest income on Federal funds sold and short-term investments was $8.0 million in 2006, up 30.0% from $6.2 million in the prior year. The average balance of these investments was $161.2 million with an average yield of 4.97% in 2006 compared to an average balance of $193.8 million with an average yield of 3.18% in 2005. The significant improvement in yield was driven by the Federal Reserve’s increases to the short-term interest rates. The Federal Reserve Bank Board’s Federal Open Market Committee raised the target interest rate for Federal Funds four times in 2006, increasing the rate from 4.25% to 5.25% by mid-year 2006.

     Interest on loans fell to $12.1 million in 2006, from $12.8 million in 2005. The average balance for mortgage and other loans in 2006 was $217.3 million with an average yield of 5.56%. This compares to an average balance for mortgage and other loans of $230.1 million in 2005 with an average yield of 5.56%. The decline in average balances is due to principal payments, pay downs and prepayments on mortgages and lower loan origination volume in 2006 compared to 2005. Loan originations totaled $21.7 million in 2006 compared to $48.9 million in 2005. This is primarily attributable to a decline in mortgage refinancing activity due to the rise in market interest rates and a decline in new and existing home sales in the Bank’s market area.

     Interest on total deposits was $19.0 million in 2006 compared to $15.1 million in 2005. The average balance of total deposits was $750.4 million with an average cost of 2.53% in 2006 compared to an average balance of $816.6 million with an average cost of 1.85% in 2005. The decrease in average balance was due primarily to increased competition for deposits and more attractive returns on other investment opportunities. The year-over-year increase in the average cost of funds is due primarily to the increases to short-term interest rates over the past year (which were partially passed on to our customers) as well as changes in the mix of deposits.

14

Provisions (Credit) for Loan Losses

In 2006, the Bank recorded a provision for loan losses of $123 thousand compared to a negative or credit provision for loan losses of $53 thousand in 2005. The provision was to increase the Bank’s allowance for possible losses on its outstanding loan balances due to certain recently funded loan commitments. At the same time, because of the funding of the loan commitments, the Bank reduced its allowance for possible losses on outstanding loan commitments by $172 thousand. This compares to a negative provision or reduction of $71 thousand in this allowance over the prior year. These credits are included in other non-interest expense. On a combined basis, the Bank reduced its overall allowance on loan balances and outstanding loan commitments by $49 thousand in 2006, as compared to a reduction of $124 thousand in 2005.

     The Bank’s loan portfolio decreased $16.8 million or 7.4% from $225.7 million at December 31, 2005 to $208.9 million at December 31, 2006. 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 effect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs. At December 31, 2006, the allowance for loan losses was $1.4 million representing 0.66% of total loans and over ten times the balance of non-accrual loans. This compares to $1.3 million representing 0.56% of total loans and almost five times the balance of non-accrual loans at December 31, 2005. Non-accrual loans were near historical lows totaling $137 thousand at December 31, 2006, down from $257 thousand a year earlier. The Bank had net recoveries of loans previously charged-off of $6 thousand in 2006 compared to $1 thousand in net charge-offs in 2005.

     The Bank’s allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) totaled $345 thousand and $517 thousand, respectively, at December 31, 2006 and 2005.

Non-Interest Income

Non-interest income consists of gains or losses on securities, deposit account service fees and other non-interest income. Non-interest income for the year ended December 31, 2006 increased $288 thousand or 15.0% to $2.2 million, from $1.9 million for the year ended December 31, 2005. The increase is due primarily to an increase in net gains on securities available for sale and trading of $118 thousand, from $679 thousand in 2005 to $797 thousand in 2006 and option fess of $150 thousand generated in 2006. The Company has granted a local developer an option to purchase a parcel of land that the Company owns and is not being used for operations purposes. As consideration for this option, the developer will make quarterly option payments of $75,000 to the Company until the option is either exercised and the closing transaction for the purchase occurs or the option is allowed to lapse. The Closing is expected to take place in the third quarter of 2007. Option payments received are not applied towards the purchase price and are not refundable.

     Deposit account service fees, deferred compensation plan income and other non-interest income combined increased $20 thousand in 2006 compared to the prior year.

Non-Interest Expense

Non-interest expense totaled $12.4 million for the twelve months ended December 31, 2006 compared to $12.5 million for the prior year, a decrease of $154 thousand or 1.2%. Salaries and employee benefits, the largest component of non-interest expense decreased $125 thousand or 1.7% to $7.3 million in 2006 from $7.5 million in 2005.

     The decrease in salaries and employee benefits is due principally to a reduction in the number of bank employees and a decrease in pension expense. These were partially offset by the share based compensation expense recorded by the Company with respect to stock option grants in 2006 and the increased costs of other employee benefits.

     Deferred compensation plan expense increased $91 thousand to $263 thousand in 2006 from $172 thousand in 2005. This increase was offset by the increased earnings on plan assets reflected in non-interest income of $94 thousand.

     The Company’s other expenses consisting of occupancy and equipment, data processing, professional services, advertising and marketing, deposit insurance and other expenses totaled $4.8 million in 2006 reflecting a decrease of $120 thousand or 2.5% from the prior year. The decrease essentially results from a higher negative provision for off-balance sheet credit exposures in 2006 than the prior year. In 2006, the Bank reduced its allowance for possible losses on outstanding commitments by $172 thousand versus a reduction of $71 thousand in 2005.

Income Tax Expense

For the years ended December 31, 2006 and 2005, income tax expense amounted to $3.7 million and $3.8 million, respectively. The decrease in income tax expense is primarily due to lower income before taxes partially offset by an increase in the Company’s effective income tax rate. The Company’s effective income tax rate for the year ended December 31, 2006 was 34.39%, up from 34.12% for the year ended December 31, 2005. For additional information with respect to Massbank’s income taxes, see Note 12 of Notes to Consolidated Financial Statements.

15

Financial Overview
Comparison of the years 2005 and 2004

     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.

     We experienced a successful year in 2005 as the Company improved its net interest margin throughout the year as a result of the interest sensitive position of our balance sheet and the rise in short-term interest rates. The Federal Reserve Bank Board’s Federal Open Market Committee (FOMC) raised the target rate for Federal funds by 25 basis points eight times during 2005, increasing the rate from 2.25% to 4.25%.

     In 2005, the Company generated net income of $7.3 million, or $1.66 per diluted share, compared with $7.4 million or $1.64 per diluted share in 2004. Return on average assets and return on average equity improved to 0.79% and 6 .84%, respectively, in 2005, compared to 0.75% and 6.71%, respectively, in 2004.

     The improvement in earnings per share and operating ratios was driven by an increase in net interest income partially offset by a decline in net gains on securities in 2005. The Company’s earnings performance was also negatively affected by a reduction in the credit for loan losses recorded in 2005 compared to 2004 due primarily to a smaller decrease in the size of the bank’s loan portfolio in 2005 compared to 2004.

     The major factors affecting the comparison of earnings and diluted earnings per share between 2005 and 2004 were:

• The increase in net interest income of $808 thousand due primarily to the higher yield on Federal funds sold and the resulting increase in interest income on Federal funds.

• The credit to the provision for loan losses that was $189 thousand less than the prior year.

• The decrease in net securities gains of $550 thousand.

• The decrease in other non-interest income of $69 thousand.

• The increase in non-interest expense of $162 thousand.

• The decrease in income tax expense of $105 thousand due to lower income before taxes and a reduction in the Company’s effective income tax rate.

16

Years ended December 31, 2005 compared to 2004:

(In thousands) Years ended December 31,	2005			2004			change
Income Statement Data
Interest and dividend income:
Mortgage and other loans	$	12,792		$	14,247		$	(1,455	)
Mortgage-backed securities		7,217			6,571			646
Federal funds sold		6,116			2,438			3,678
Other securities and investments		10,676			10,325			351
Total interest and dividend income		36,801			33,581			3,220
Total interest expense		15,141			12,729			(2,412	)
Net interest income		21,660			20,852			808
Provision (credit) for loan losses		(53	)		(242	)		(189	)
Gains on securities, net		679			1,229			(550	)
Other non-interest income		1,238			1,307			(69	)
Non-interest expense		12,514			12,352			(162	)
Income tax expense		3,793			3,898			105
Net income	$	7,323		$	7,380		$	(57	)
Diluted earnings per share (in dollars):	$	1.66		$	1.64		$	0.02

(In thousands) Years ended December 31,	2005		2004		change
Average Balance Sheet Data
Total average earning assets	$	904,646	$	955,267	$	(50,621	)
Total average deposits	$	816,577	$	862,691	$	(46,114	)

Financial Condition

The Company’s total assets decreased $77.5 million, or 7.9% to $898.7 million at December 31, 2005 from $976.2 million at December 31, 2004. The reduction in total assets reflects a decrease in investments of $67.0 million and a decrease in total loans of $10.5 million.

     Deposits decreased $64.7 million, or 7.6% to $784.7 million at year-end 2005 from $849.5 million at year-end 2004. This was due to increased competition for deposits, more attractive returns on other investment opportunities and various other market factors.

Condensed Consolidated Balance Sheets

(In thousands) at December 31,	2005			2004			change
Short-term investments	$	167,787		$	194,250		$	(26,463	)
Interest-bearing deposits in banks		898			2,718			(1,820	)
Securities available for sale, at market value		453,472			443,753			9,719
Securities held to maturity, at amortized cost		6,137			4,877			1,260
Trading securities, at market value		9,282			59,013			(49,731	)
Total investments		637,576			704,611			(67,035	)
Total loans		225,730			236,198			(10,468	)
Allowance for loan losses		(1,253	)		(1,307	)		54
Net loans		224,477			234,891			(10,414	)
Other assets		36,626			36,666			(40	)
Total assets	$	898,679		$	976,168		$	(77,489	)
Total deposits	$	784,728		$	849,465		$	(64,737	)
Escrow deposits of borrowers		1,059			1,074			(15	)
Other liabilities		7,628			15,614			(7,986	)
Total liabilities		793,415			866,153			(72,738	)
Total stockholders’ equity		105,264			110,015			(4,751	)
Total liabilities and stockholders’ equity	$	898,679		$	976,168		$	(77,489	)

17

Investments

At December 31, 2005 the Company’s investment portfolio consisted of short-term investments, interest-bearing deposits in banks, and securities available for sale, held to maturity and trading totaling $637.6 million representing 70.9% of total assets. This reflects a decrease of $67.0 million compared to $704.6 million or 72.2% of total assets at December 31, 2004. MASSBANK’s investment portfolio is concentrated in U.S. Treasury and Government agency securities and 15-year contractual life mortgage-backed securities issued by Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”) and other agency issuers. U.S. Treasury and Government agency securities totaled $318.5 million at year-end. This included $189.3 million in callable agency securities. The mortgage-backed securities portfolio totaled $141.5 million at December 31, 2005. MASSBANK’s strategy is to purchase liquid investments with short to intermediate maturities that generally match the Company’s deposit structure. This strategy seeks to maintain the Company’s overall interest rate risk position within policy requirements. The Company also holds $7.4 million in equity securities at December 31, 2005. In 2005, the Company increased its mortgage-backed securities portfolio from $127.6 million at December 31, 2004 to $141.5 million at December 31, 2005 to help improve its net interest margin. If the difference between longer term and short term interest rates widens to a sufficient extent in 2006, the Company will likely add to its mortgage-backed securities portfolio and reduce its short-term investments (primarily Federal funds sold) that totaled $167.8 million at December 31, 2005. We believe that this would likely improve the Company’s net interest margin.

Loans

MASSBANK’s loan portfolio at December 31, 2005 was $225.7 million, compared to $236.2 million at December 31, 2004, and was comprised of $213.6 million of residential mortgage loans, $2.3 million of commercial real estate loans, $9.7 million of consumer loans and $0.1 million of commercial loans. The bank’s loan portfolio composition shifted slightly in 2005 as the portfolio was 94.6% residential mortgages, 1.0% commercial mortgages, 4.3% consumer and 0.1% commercial compared to 95.1% residential mortgages, 0.7% commercial mortgages and 4.2% consumer at December 31, 2004.

Non-Performing Assets

Non-accrual loans, generally those loans that are 90 days or more delinquent, were $257 thousand at December 31, 2005, compared to $74 thousand at December 31, 2004. This represents 0.11% of total loans and 0.03% of total assets at December 31, 2005 . The Bank generally places all loans on non-accrual status at 90 days delinquent. The Bank had no real estate acquired through foreclosure at year-end 2005.

Deposits

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

     Total deposits at December 31, 2005 were $784.7 million, compared to $849.5 million at December 31,2004. Increased competition for deposits and more attractive returns on other investment opportunities were the principal reasons for the deposit outflows.

     In 2005, savings deposits decreased $119.8 million or 21.3% year-over-year, to $441.5 million from $561.3 million at year-end 2004. Conversely, certificates of deposit increased by $60.4 million or 30.1% to $260.9 million at year-end 2005 as customers shifted deposits from savings accounts to certificates of deposit seeking a higher rate of return on their deposits as rates increased throughout the year. Demand and NOW deposits totaled $82.3 million at December 31, 2005 compared to $87.7 million at December 31, 2004. For information concerning deposit balances at year-end 2005 and 2004, the average cost and the maturity distribution of the deposits and related rate structure of the Bank’s time certificates of deposit, see Note 10 of Notes to Consolidated Financial Statements.

Stockholders’ Equity

Total stockholders’ equity decreased $4.8 million to $105.3 million at December 31, 2005, representing a book value of $24.32 per share, from $110.0 million representing a book value of $25.11 per share at December 31, 2004.

     The decrease in total stockholders’ equity was due principally to the Company’s repurchase of 128,460 shares of treasury stock at a cost of $4.5 million, the payment of dividends to stockholders of $4.6 million and the decrease in other comprehensive income of $4.8 million due primarily to the decline in market value of the Bank’s debt securities portfolio. This was partially offset by the net income for the year of $7.3 million and the payments and related tax benefits received from the exercise of stock options by the Company’s officers and directors of $1.8 million.

18

Results of Operations
Comparison of the years 2005 and 2004

Net Interest Income

Net interest income is the primary source of MASSBANK’s operating income. Net interest income is affected by the volume and mix of average interest-earning assets and interest-bearing liabilities, market interest rates, the shape of the U.S. Treasury securities (interest rate) yield curve and other factors. In 2005, short-term interest rates rose at a greater rate than intermediate and long rates. This caused the yield curve to “flatten.” A flat curve limits the ability to benefit from investing assets at long term rates. Because of this situation we maintain a significant position of short term investments. Due to our current asset mix and other factors we would expect to benefit from any substantial sustained increase in interest rates and a steeper interest rate yield curve.

     Net interest income on a fully taxable equivalent (FTE) basis totaled $21.7 million in 2005 compared to $20.9 million in 2004, or an increase of 3.9%. The increase in net interest income in 2005 was due primarily to an improvement in net interest margin. The Company’s net interest margin (net interest income on a FTE basis divided by average interest-earning assets) for the year ended December 31, 2005 increased 21 basis points to 2.40% from 2.19% in the prior year. The increase in margin was driven by the Federal Reserve’s increases to short term interest rates over the past year. This was partially offset by the unfavorable mix changes in our deposit costs. The net interest margin was also impacted by the decline in the Company’s average earning assets in 2005. Average total earning assets decreased $50.6 million or 5.3% to $904.6 million in 2005, from $955.3 million in 2004.

     The tables on pages 26 and 27 set forth, among other things, the extent to which changes in interest rates and changes in the average balances of interest-earning assets and interest-bearing liabilities have affected interest income and expense during the years indicated. Information is provided for each category of interest-earning assets and interest-bearing liabilities, on changes due to (1) changes in volume and (2) changes in interest rates.

     Interest on investment securities available for sale (AFS) on a fully taxable equivalent basis was $9.9 million for 2005 compared to $9.0 million for 2004. The average balance of investment securities AFS was $313.7 million with an average tax equivalent yield of 3.16% for the year ended December 31, 2005 compared to an average balance of $324.2 million with an average yield of 2.78% for the year ended December 31, 2004. The increase in yield is primarily due to a rise in market interest rates and to a lesser extent a change in mix of securities in the portfolio.

     Interest on mortgage-backed securities AFS and held to maturity was $7.2 million for 2005 compared to $6.6 million for 2004. The average balance of mortgage-backed securities was $134.8 million with an average yield of 5.35% for 2005 compared to an average balance of $115.8 million with an average yield of 5.67% for 2004. The decrease in yield is due primarily to normal amortization and prepayments and the replacement yields on new securities purchased being lower. Longer-term rates have stayed flat which has negatively impacted our mortgage-backed securities yields. Prepayment activity on our mortgage-backed securities portfolio declined in 2005 compared to the prior two years.

     Interest on trading securities was $0.8 million for 2005, down from $1.1 million in the prior year. The average balance of trading securities was $32.2 million for 2005 compared to $69.3 million for 2004. The yield on these securities improved to 2.40% for the recent year, from 1.65% for 2004 due primarily to rising short term interest rates.

      Interest income on Federal funds sold and short-term investments was $6.2 million for 2005, up 130.4% from $2.7 million in the prior year. The average balance of these investments was $193.8 million with an average yield of 3.18% for 2005 compared to an average balance of $202.5 million with an average yield of 1.32% for 2004. The significant improvement in yield was driven by the Federal Reserve’s increases to the short-term interest rates. The Federal Reserve Bank Board’s Federal Open Market Committee raised the target interest rate for Federal funds eight times in 2005, increasing the rate from 2.25% to 4.25% by year-end 2005.

     Interest on loans fell to $12.8 million for 2005, from $14.2 million for 2004. The average balance of mortgage and other loans for 2005 was $230.1 million with an average yield of 5.56%. This compares to an average balance of mortgage and other loans of $243.4 million for 2004 with an average yield of 5.85%. The decline in average balances is due to principal payments, pay downs and prepayments on mortgages and lower loan origination volume for 2005 compared to 2004. Loan originations totaled $48.9 million in 2005 compared to $60.3 million in 2004. The decline in average yields is due to normal amortization and prepayment of higher yielding mortgages and the lower rate on newly originated replacement mortgages.

     Interest on total deposits was $15.1 million for 2005 compared to $12.7 million for 2004. The average balance of total deposits was $816.6 million with an average cost of 1.85% for 2005 compared to an average balance of $862.7 million with an average cost of 1.48% for 2004. The decrease in average balance was due primarily to increased competition for deposits and more attractive returns on other investment opportunities. The increase in the average cost year to year is due primarily to the e Federal Reserve’s increases to short-term interest rates over the past year (which were partially passed on to our customers) as well as changes in the mix of deposits.

19

Provisions (Credit) for Loan Losses

In 2005, the Bank recorded a negative provision for loan losses of $53 thousand due to the quality of the loans in the portfolio and a decrease in the size of the Bank’s loan portfolio. This compares to a negative provision for loan losses of $242 thousand in 2004. The Bank’s loan portfolio decreased $10.5 million or 4.4% from $236.2 million at December 31, 2004 to $225.7 million at December 31,2005. 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 effect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs. At December 31, 2005, the allowance for loan losses was $1.3 million representing 0.56% of total loans and 488% of non-accrual loans. This compares to $1.3 million representing 0.55% of total loans and 1766% of non-accrual loans at December 31, 2004. Non-accrual loans totaled $257 thousand at December 31, 2005, up from $74 thousand a year earlier. The Bank’s net charge-offs totaled $1 thousand in 2005 compared to $5 thousand in 2004. The Bank also maintains an allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) that totaled $517 thousand and $588 thousand, respectively, at December 31, 2005 and 2004. In 2005, the Company recorded a negative provision for off-balance sheet credit exposures of $70 thousand compared to a negative provision of $39 thousand in 2004. The credit or provision is included in other non-interest expense.

Non-Interest Income

Non-interest income consists of gains or losses on securities, deposit account service fees and other non-interest income. Non-interest income for the year ended December 31, 2005 decreased $619 thousand or 24.4% to $1.9 million, from $2.5 million for the year ended December 31, 2004. The decrease is due primarily to a decrease in net gains on securities available for sale and trading of $550 thousand, from $1.2 million in 2004 to $679 thousand in 2005. Net securities gains in 2005 were comprised of $725 thousand in net gains on equity securities and $46 thousand in net losses on debt securities. This compares to $1.5 million in net gains on equity securities and $299 thousand in net losses on debt securities in 2004. Deposit account service fees and other non-interest income combined were $1.2 million and $1.3 million, respectively, in 2005 and 2004.

Non-Interest Expense

Non-interest expense totaled $12.5 million for the twelve months ended December 31, 2005 compared to $12.4 million for the prior year, an increase of $162 thousand or 1.3%. Salaries and employee benefits, the largest component of non-interest expense increased $202 thousand or 2.8% to $7.5 million in 2005 from $7.3 million in 2004. The increase in salaries and employee benefits is due principally to broad based salary increases of $149 thousand and the increased costs of employee benefits. The Company’s other expenses consisting of deferred compensation plan expense, occupancy and equipment, data processing, advertising and marketing, deposit insurance and other expenses totaled $4.6 million in 2005 reflecting an increase of $106 thousand or 2.4% from the prior year. This was offset by a decrease in professional services expenses of $146 thousand, from $631 thousand in 2004 to $485 thousand in 2005. The decrease essentially results from a reduction in audit fees paid to our independent registered public accountants in 2005 compared to the prior year.

Income Tax Expense

For the years ended December 31, 2005 and 2004, income tax expense amounted to $3.8 million and $3.9 million, respectively. The decrease in income tax expense is primarily due to lower income before taxes and a decrease in the Company’s effective income tax rate. The Company’s effective income tax rate for the year ended December 31, 2005 was 34.12%, down from 34.56% for the year ended December 31, 2004. For additional information with respect to Massbank’s income taxes, see Note 12 of Notes to Consolidated Financial Statements.

20

Contractual Obligations

The Company’s contractual cash obligations and commitments to extend credit as of December 31, 2006 are as follows:

	Payments Due or Commitments Expiring - by Period
			Less than		One to		Four to		More than
(In thousands)	Total		one year		three years		five years		five years
Contractual cash obligations:
Operating lease obligations	$	1,390	$	295	$	458	$	330	$	307
Data processing service obligations(1)		1,511		590		921		—		—
Pension benefit obligations		347		347		—		—		—
Supplemental retirement benefit obligations		79		79		—		—		—
Total contractual cash obligations	$	3,327	$	1,311	$	1,379	$	330	$	307
Other commitments:
Commitments to originate residential mortgage loans	$	1,206	$	1,206	$	—	$	—	$	—
Unused lines of credit		28,779		842		7,764		5,167		15,006
Other loan commitments		2,554		217		1,882		26		429
Total other commitments(2)	$	32,539	$	2,265	$	9,646	$	5,193	$	15,435

(1)	The fees charged by our data processing service provider fluctuate based on the number of deposit and loan accounts serviced and therefore have been estimated.
(2)	Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates. The total commitment amounts do not necessarily represent future cash requirements since many of the commitments may expire without being drawn upon.

21

Liquidity and Capital Resources

The Bank must maintain a sufficient level of cash and assets which can readily be converted into cash in order to meet cash outflows from normal depositor requirements and loan demands. The Bank’s primary sources of funds are deposits, loan and mortgage-backed securities amortization and prepayments, sales, calls or maturities of investment securities and income on earning assets. In addition to loan payments and maturing investment securities, which are relatively predictable sources of funds, the Bank maintains a high percentage of its assets invested in Federal funds sold (overnight) and money market funds, which can readily be converted into cash, and United States Treasury and Government agency securities, which can be sold or pledged to raise funds. At December 31, 2006, the Bank had $139.2 million or 16.5% of total assets and $261.3 million or 31.0% of total assets invested, respectively, in Federal funds sold and money market funds, and United States obligations.

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

     The capital ratios of the Bank and the Company currently exceed the minimum regulatory requirements. At December 31, 2006, the Bank had a leverage Tier I capital to average assets ratio of 12.39%, a Tier I capital to risk-weighted assets ratio of 34.77% and a total capital to risk-weighted assets ratio of 35.35%. The Company, on a consolidated basis, had ratios of leverage Tier I capital to average assets of 12.78%, Tier I capital to risk-weighted assets of 36.58% and total capital to risk-weighted assets of 37.17% at December 31, 2006.

Asset and Liability Management

The goal of asset/liability management is to ensure that liquidity, capital and market risk are prudently managed. Asset/ liability management is governed by policies reviewed and approved annually by the Bank’s Board of Directors (the “Board”). The Board establishes policy limits for long-term interest rate risk assumptions and delegates responsibility for monitoring and measuring the Company’s exposure to interest rate risk to the Risk Management and Asset/Liability Committee (the“Committee”). The Committee which is comprised of members of the Company’s Board of Directors, members of senior management and the Bank’s controller, generally meets four times a year to review the economic environment and the volume, mix and maturity of the Company’s assets and liabilities.

22

Interest Rate Risk

The primary goal of interest-rate risk management is to control the Company’s exposure to interest rate risk both within limits approved by the Board and within narrower guidelines approved by the Risk Management and Asset/Liability Committee. These limits and guidelines reflect the Company’s tolerance for interest rate risk over both short-term and long-term time horizons. The Company monitors its interest rate exposures using a variety of financial tools, including income simulation models. These models, produced quarterly, estimate the effect that instantaneous and permanent “market interest rate shocks” of +/-100, 200 and 300 basis points would have on the Company’s net interest income, with no effect given to any steps that management might take to counter the effect of these interest rate movements. These results are compared to an existing interest rate scenario and a consensus forecast that represents the most likely future course of interest rates.

     Interest rate risk materializes in two forms, market value risk and reinvestment risk.

     Financial instruments calling for future cash flows show market value increases or decreases when rates change. Management monitors the potential change in market value of the Company’s debt securities assuming an immediate (parallel) shift in interest rates of up to 200 basis points up or down. Results are calculated using industry standard analytics and securities data from Bloomberg. The Company uses the results to review the potential changes in market value resulting from immediate rate shifts and to manage the effect of market value changes on the Company’s capital position.

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

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

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

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

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

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

23

Interest rate risk (continued)

The Company, despite having a one-year negative GAP position as of year-end 2006, estimates that it would benefit from any significant rise in interest rates in 2007 rather than have its net interest income move in the opposite direction as the change in market interest rates as GAP theory postulates. (Net interest income, however, may be adversely affected by the shape of the yield curve). One of the more significant reasons for this is the fact that a GAP presentation does not reflect the degrees to which interest-earning assets and deposit costs respond to changes in market interest rates. The rates on all financial instruments do not always move by the same amount as the general change in market rates. Since the Company has elected to raise rates by less than the market movement on some savings and transaction-oriented accounts in response to a change in market rates, these deposits are included in the three months or less category. As a result, the Company’s one-year cumulative GAP position was converted from asset sensitive to liability sensitive as of year-end 2006.

     The Company has historically managed its interest rate GAP primarily by lengthening or shortening the maturity structure of its securities portfolio, by continually modifying the composition of its securities portfolio and by selectively pricing and marketing its various deposit products. In the current inverted yield curve environment, the Company’s strategy is to purchase liquid investments with short to intermediate maturities and currently not to pay market rates on short-term deposits.

     The following table presents the amounts of interest-earning assets and interest-bearing liabilities at December 31, 2006 that are assumed to mature or reprice during the periods indicated. The table also summarizes the Company’s GAP position at December 31, 2006. As of this date, the Company’s one-year cumulative GAP position was negative $296.0 million, representing approximately 35.1% of total assets compared to a negative GAP of $282.4 million or 31.4% of total assets at December 31, 2005. The cumulative GAP-asset ratio measures the direction and extent of imbalance between an institution’s assets and liabilities repricing through the end of a particular period.

	Interest Sensitivity Periods
	3 Months			3 to 6			6 Months			1 to 5			Over
(In thousands)	or Less			Months			to 1 Year			Years			5 Years			Total
Interest-earning assets:
Loans(3)	$	16,053		$	7,696		$	16,465		$	95,536		$	73,177		$	208,927
Short-term investments:
Federal funds sold		117,104			—			—			—			—			117,104
Money market investment fund		22,133			—			—			—			—			22,133
Term Federal funds sold		41,000			—			—			—			—			41,000
Interest-bearing deposits in banks		3			—			—			—			—			3
Securities available for sale(3) (5)		53,881			26,987			42,750			227,568			56,418			407,604
Securities held to maturity		189			182			346			2,033			2,646			5,396
Trading securities		1,931			—			—			—			—			1,931
Total interest-earning assets	$	252,294		$	34,865		$	59,561		$	325,137		$	132,241		$	804,098
Interest-bearing liabilities:
Deposits(1) (2) (4)	$	527,659		$	52,091		$	63,016		$	54,264		$	304		$	697,334
Total interest-bearing liabilities	$	527,659		$	52,091		$	63,016		$	54,264		$	304		$	697,334
GAP for period	$	(275,365	)	$	(17,226	)	$	(3,455	)	$	270,873		$	131,937		$	106,764
Cumulative GAP — December 31, 2006	$	(275,365	)	$	(292,591	)	$	(296,046	)	$	(25,173	)	$	106,764
Cumulative GAP as a percent of total assets		(32.6	)%		(34.7	)%		(35.1	)%		(3.0	)%		12.7	%
Cumulative GAP — December 31, 2005	$	(297,094	)	$	(309,173	)	$	(282,412	)	$	(41,165	)	$	104,845

(1)	Excludes non-interest bearing demand accounts of $27,004 thousand.
(2)	Includes escrow deposits of borrowers of $1,006 thousand.
(3)	Loans and mortgage-backed securities reflect regular amortization of principal and prepayment estimates. Callable U.S. Government agency securities of $163,743 thousand are shown in the period they are expected to be called or reprice, otherwise they are shown based on their maturity date. It is assumed that a security will be called if the coupon rate on the security exceeded market interest rates at year-end 2006 .
(4)	It is assumed that the Bank’s Savings and NOW account rates will be increased within 3 months or less.
(5)	Excludes net unrealized losses on securities available for sale of $(4,525) thousand.

24

Interest rate risk (continued)

     The following table shows the Company’s financial instruments that are sensitive to changes in interest rates, categorized by expected call date or maturity, and the instruments’ fair values as of December 31, 2006.

Expected Maturity Date
At December 31, 2006

																						Fair Value
(In thousands)	2007			2008			2009			2010			2011			Thereafter			Total			at 12/31/06
Interest sensitive assets:
Fixed rate securities(5)	$	112,968		$	101,686		$	50,940		$	36,008		$	23,966		$	56,071		$	381,639		$	377,197
Average interest rate(1)		4.04	%		3.91	%		4.60	%		4.63	%		5.11	%		6.39	%		4.55	%
Variable rate securities(2)(5)		11,366			—			9,000			4,000			4,000			2,995			31,361			31,158
Average interest rate(1)		3.98	%		—			3.67	%		5.00	%		5.19	%		4.58	%		4.23	%
Trading securities(6)		1,931			—			—			—			—			—			1,931			1,931
Average interest rate		0.57	%		—			—			—			—			—			0.57	%
Fixed rate loans		25,632			21,120			18,504			17,158			17,391			71,649			171,454			165,643
Average interest rate		5.42	%		5.47	%		5.49	%		5.47	%		5.51	%		5.28	%		5.39	%
Variable rate loans		14,583			5,433			7,586			3,573			4,852			1,446			37,473			36,335
Average interest rate		7.40	%		5.98	%		5.98	%		6.23	%		6.59	%		5.63	%		6.41	%
Other fixed rate assets(4)		41,000			—			—			—			—			—			41,000			41,000
Average interest rate		5.29	%		—			—			—			—			—			5.29	%
Other variable rate assets(3)		139,240			—			—			—			—			—			139,240			139,240
Average interest rate		5.14	%		—			—			—			—			—			5.14	%
Total interest sensitive assets	$	346,720		$	128,239		$	86,030		$	60,739		$	50,209		$	$132,161		$	804,098		$	792,504
Interest sensitive liabilities:
Savings and money market deposit accounts	$	344,808		$	—		$	—		$	—		$	—		$	—		$	344,808		$	344,808
Average interest rate		3.1.96	%		—			—			—			—			—			1.96	%
Fixed rate certificates of deposit		176,142			44,332			7,831			1,242			859			304			230,710			230,348
Average interest rate		4.30	%		4.62	%		4.52	%		4.36	%		4.48	%		4.93	%		4.38	%
Variable rate certificates of deposit		27,106			15,874			13,300			12,674			—			—			68,954			68,954
Average interest rate		5.50	%		5.51	%		5.69	%		5.69	%		—			—			5.57	%
NOW accounts		51,856			—			—			—			—			—			51,856			51,856
Average interest rate		0.53	%		—			—			—			—			—			0.53	%
Escrow deposits of borrowers		1,006			—			—			—			—			—			1,006			1,006
Average interest rate		0.75	%		—			—			—			—			—			0.75	%
Total interest sensitive liabilities	$	600,918		$	60,206		$	21,131		$	13,916		$	859		$	304		$	697,334		$	696,972

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

     The Company uses certain assumptions to estimate fair values and expected maturities. For interest-sensitive assets, except callable government agency securities, expected maturities are based upon contractual maturity, and projected repayments and prepayments of principal. For callable government agency securities expected maturities are based upon the next call date for those securities expected to be called, otherwise, the securities are shown at their expected maturity date. For interest-sensitive deposit liabilities, maturities are based on contractual maturity. The actual maturity of the Company’s financial instruments could vary significantly from what has been presented in the above table if actual experience differs from the assumptions used.

Other Market Risks

The Company’s investment securities portfolio includes equity securities with a market value of approximately $7.4 million at December 31, 2006. The net unrealized losses on these securities totaled $14 thousand at year-end 2006. Movements in equity prices may effect the amount of securities gains or losses which the Company realizes from the sale of these securities and thus may have an impact on earnings.

25

Average Balance Sheets

(In thousands) Years ended December 31,	2006								2005								2004
				Interest		Average						Interest		Average						Interest		Average
	Average			Income/		Yield/			Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense(1)		Rate			Balance			Expense(1)		Rate			Balance			Expense(1)		Rate
Assets:
Earning assets:
Federal funds sold	$	155,556		$	7,731		4.97	%	$	192,154		$	6,116		3.18	%	$	186,615		$	2,438		1.31	%
Short-term investments(4)		5,691			289		5.08			1,653			53		3.21			15,870			239		1.51
Securities available for sale:
Investment securities(2)		308,716			12,124		3.93			313,708			9,923		3.16			324,239			9,002		2.78
Mortgage-backed securities(2)		135,267			7,293		5.39			129,850			6,961		5.36			112,445			6,398		5.69
Mortgage-backed securities held to maturity		5,695			299		5.25			4,989			256		5.13			3,402			173		5.09
Trading securities		5,657			201		3.55			32,222			772		2.40			69,345			1,145		1.65
Mortgage loans(3)		207,650			11,305		5.44			220,020			12,111		5.50			232,709			13,578		5.83
Other loans(3)		9,610			765		7.96			10,050			681		6.78			10,642			669		6.29
Total earning assets		833,842			40,007		4.80	%		904,646			36,873		4.07	%		955,267			33,642		3.52	%
Allowance for loan losses		(1,299	)							(1,266	)							(1,460	)
Total earning assets less allowance for loan losses		832,543								903,380								953,807
Other assets		26,655								25,174								25,541
Total assets	$	859,198							$	928,554							$	979,348
Liabilities:
Deposits:
Demand and NOW	$	80,188			228		0.28	%	$	85,326			187		0.22	%	$	85,066			171		0.20	%
Savings		389,260			7,043		1.81			499,772			7,949		1.59			585,239			8,563		1.46
Time certificates of deposit		280,989			11,680		4.16			231,479			7,005		3.03			192,386			3,995		2.08
Total deposits		750,437			18,951		2.53	%		816,577			15,141		1.85	%		862,691			12,729		1.48	%
Other liabilities		4,434								4,984								6,660
Total liabilities		754,871								821,561								869,351
Stockholders’ Equity		104,327								106,993								109,997
Total liabilities and stockholders’ equity	$	859,198							$	928,554							$	979,348
Net interest income (tax- equivalent basis)					21,056								21,732								20,913
Less adjustment of tax- exempt interest income					68								72								61
Net interest income				$	20,988							$	21,660							$	$20,852
Interest rate spread(5)							2.27	%							2.22	%							2.04	%
Net interest margin(6)							2.53	%							2.40	%							2.19	%

(1)	Income on equity securities is included on a tax equivalent basis.
(2)	Averages balances include net unrealized gains (losses) on securities available for sale.
(3)	Loans on non-accrual status are included in average balances.
(4)	Short-term investments consist of interest-bearing deposits in banks and investments in money market funds.
(5)	Interest rate spread represents the difference between the yield on earning assets and the cost of the Company’s deposits.
(6)	Net interest margin represents net interest income (tax equivalent basis) divided by average interest-earning assets.

26

Rate/Volume Analysis

The following table presents, for the years indicated, the changes in interest and dividend income and the changes in interest expense attributable to changes in interest rates and changes in the volume of earning assets and interest-bearing liabilities. A change attributable to both volume and rate has been allocated proportionately to the change due to volume and the change due to rate.

	2006 Compared to 2005									2005 Compared To 2004
(In thousands)	Increase (Decrease)									Increase (Decrease)
Years ended December 31,	Due To									DUE TO
	Volume			Rate			Total			Volume			Rate			Total
Interest and dividend income:
Federal funds sold	$	(1,331	)	$	2,946		$	1,615		$	75		$	3,603		$	3,678
Short-term investments		191			45			236			(321	)		135			(186	)
Investment securities		(159	)		2,358			2,199			(298	)		1,220			922
Mortgage-backed securities		330			45			375			1,032			(386	)		646
Trading securities		(812	)		247			(565	)		(759	)		374			(385	)
Mortgage loans		(675	)		(131	)		(806	)		(720	)		(747	)		(1,467	)
Other loans		(31	)		115			84			(38	)		50			12
Total interest and dividend income		(2,487	)		5,625			3,138			(1,029	)		4,249			3,220
Interest expense:
Deposits:
Demand and NOW		(12	)		53			41			1			15			16
Savings		(1,907	)		1,001			(906	)		(1,319	)		705			(614	)
Time certificates of deposit		1,702			2,973			4,675			926			2,084			3,010
Total interest expense		(217	)		4,027			3,810			(392	)		2,804			2,412
Net interest income	$	(2,270	)	$	1,598		$	(672	)	$	(637	)	$	1,445		$	808

Impact of Inflation and Changing Prices

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

27

Recent Accounting Pronouncements

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 position s 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 is currently evaluating the potential financial impact of adopting FIN 48.

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 the Company 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 adoption of SAB No. 108 did not have a material effect on Massbank Corp.’s financial condition or results of operations.

SFAS No. 157, Fair Value Measurements

In September 2006, the Financial Accounting Standards Board 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. The Company will adopt the provisions of this statement January 1, 2008.

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 did not have an impact to the Company’s results of operations in 2006.

     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.

     On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS No. 158. The effect of adopting SFAS No. 158 on the Company’s financial condition at December 31, 2006 has been included in the accompanying consolidated financial statements. SFAS No. 158 did not have an affect on the Company’s consolidated financial condition at December 31, 2005 or 2004. See Note 15 of Notes to Consolidated Financial Statements for further discussion.

28

Massbank Corp.
Management’s Annual Report On Internal Control Over Financial Reporting

Massbank Corp.’s management is responsible for the preparation, content and integrity of the financial statements and other statistical data and analyses compiled for this annual report. The financial statements and related notes have been prepared in conformity with U.S. generally accepted accounting principles and reflect management’s best estimates and judgments. Management believes that the financial statements and notes present fairly Massbank Corp.’s financial position, results of operations and cash flows in all material respects.

     Management is responsible for establishing and maintaining a system of internal control that is intended to protect Massbank Corp.’s assets and the integrity of its financial reporting. This corporate-wide system of controls includes self-monitoring mechanisms, written policies and procedures, proper delegation of authority and organizational division of responsibility, and the selection and training of qualified personnel.

     An annual code of ethics certification process is conducted, and compliance with the code of ethics is required of all Company employees. Although any system of internal control can be compromised by human error or intentional circumvention of required procedures, management believes the Company’s system provides reasonable assurances that financial transactions are recorded and reported properly, providing an adequate basis for reliable financial statements.

     The Board of Directors discharges its responsibility for Massbank Corp.’s financial statements through its Audit Committee. This committee, which draws its members exclusively from the independent directors, also hires the independent registered public accounting firm.

Management’s Assessment of Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting for Massbank Corp. Management has assessed the effectiveness of Massbank Corp.’s internal control and procedures over financial reporting using criteria described in “Internal Control — Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that assessment, management believes that the Company maintained an effective system of internal control over financial reporting as of December 31, 2006. Massbank Corp.’s independent registered public accounting firm has issued an attestation report, dated March 6, 2007, on management’s assessment of Massbank Corp.s internal control over financial reporting, which is included in this annual report.

Gerard H. Brandi
Chairman, President and CEO

Reginald E. Cormier
Sr. Vice President, Treasurer and CFO

29

report of independent registered public accounting firm

The Board of Directors and Stockholder
Massbank Corp.:

We have audited the accompanying consolidated balance sheets of Massbank Corp. and Subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the years then ended. We also have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Massbank Corp. maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Massbank Corp.’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these consolidated financial statements, an opinion on management’s assessment, and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits. The consolidated financial statements of Massbank Corp. and Subsidiaries as of December 31, 2004, were audited by other auditors whose report dated March 14, 2005, expressed an unqualified opinion on those statements.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

30

report of independent registered public accounting firm (continued)

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Massbank Corp. and Subsidiaries as of December 31, 2006 and 2005, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, management’s assessment that Massbank Corp. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, in our opinion, Massbank Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

Certified Public Accountants, Inc.

Boston, Massachusetts
March 6, 2007

31

Massbank Corp. and Subsidiaries
Consolidated Balance Sheets

(In thousands except share data) At December 31,	2006			2005
Assets:
Cash and due from banks	$	8,650		$	9,590
Short-term investments (Note 2)		139,240			167,787
Total cash and cash equivalents		147,890			177,377
Interest-bearing deposits in banks		—			898
Term Federal funds sold		41,000			—
Securities available for sale, at market value (amortized cost of $407,604 in 2006 and $458,297 in 2005) (Note 3)		403,079			453,472
Securities held to maturity, at amortized cost (market value of $5,276 in 2006 and $6,022 in 2005) (Note 3)		5,396			6,137
Trading securities, at market value (Note 4)		1,931			9,282
Loans (Notes 5 and 7):
Mortgage loans		199,253			215,904
Other loans		9,674			9,826
Total loans		208,927			225,730
Allowance for loan losses (Note 6)		(1,382	)		(1,253	)
Net loans		207,545			224,477
Premises and equipment (Note 9)		7,085			6,525
Real estate held for resale		425			—
Accrued interest and income receivable		5,083			3,898
Goodwill		1,090			1,090
Income tax receivable, net		88			—
Deferred income tax asset, net (Note 12)		3,347			3,240
Other assets		19,563			12,283
Total assets	$	843,522		$	898,679
Liabilities and Stockholders’ Equity:
Deposits (Note 10):
Demand and NOW	$	78,860		$	82,250
Savings		344,808			441,541
Time certificates of deposit		299,664			260,937
Total deposits		723,332			784,728
Escrow deposits of borrowers		1,006			1,059
Accrued income taxes, net		—			35
Allowance for loan losses on off-balance sheet credit exposures		345			517
Other liabilities		11,954			7,076
Total liabilities		736,637			793,415
Commitments and contingent liabilities (Notes 8 and 9)
Stockholders’ equity (Notes 12, 14, 15 and 16):
Preferred stock, par value $1.00 per share; 2,000,000 shares authorized, none issued		—			—
Common stock, par value $1.00 per share; 10,000,000 shares authorized, 7,850,317 and 7,811,680 shares issued in 2006 and 2005, respectively		7,850			7,812
Additional paid-in capital		57,953			57,067
Retained earnings		107,055			104,743
		172,858			169,622
Treasury stock at cost, 3,532,663 and 3,483,163 shares in 2006 and 2005, respectively		(62,902	)		(61,281	)
Accumulated other comprehensive income (loss)		(3,071	)		(3,077	)
Shares held in rabbi trust at cost, 17,944 and 15,644 shares in 2006 and 2005, respectively		(426	)		(351	)
Deferred compensation obligation		426			351
Total stockholders’ equity		106,885			105,264
Total liabilities and stockholders’ equity	$	843,522		$	898,679

See accompanying notes to consolidated financial statements.

32

Massbank Corp. and Subsidiaries
Consolidated Statements of Income

(In thousands except share data) Years ended December 31,	2006		2005			2004
Interest and dividend income:
Mortgage loans	$	11,305	$	12,111		$	13,578
Other loans		765		681			669
Securities available for sale:
Mortgage-backed securities		7,293		6,961			6,398
Other securities		12,062		9,863			8,941
Mortgage-backed securities held to maturity		299		256			173
Trading securities		195		760			1,145
Federal funds sold		7,731		6,116			2,438
Other investments		289		53			239
Total interest and dividend income		39,939		36,801			33,581
Interest expense:
Deposits:
NOW		228		187			171
Savings		7,043		7,949			8,563
Time certificates of deposit		11,680		7,005			3,995
Total interest expense		18,951		15,141			12,729
Net interest income		20,988		21,660			20,852
Provision (credit) for loan losses (Note 6)		123		(53	)		(242	)
Net interest income after provision (credit) for loan losses		20,865		21,713			21,094
Non-interest income:
Deposit account service fees		343		393			448
Gains on securities available for sale, net		736		515			1,361
Gains (losses) on trading securities, net		61		164			(132	)
Option fees		150		—			—
Deferred compensation plan income		178		84			108
Other		737		761			751
Total non-interest income		2,205		1,917			2,536
Non-interest expense:
Salaries and employee benefits		7,338		7,463			7,261
Deferred compensation plan expense		263		172			167
Occupancy and equipment		2,176		2,212			2,169
Data processing		583		540			521
Professional services		553		485			631
Advertising and marketing		139		155			110
Deposit insurance		126		145			160
Other		1,182		1,342			1,333
Total non-interest expense		12,360		12,514			12,352
Income before income taxes		10,710		11,116			11,278
Income tax expense (Note 12)		3,683		3,793			3,898
Net income	$	7,027	$	7,323		$	7,380
Weighted average common shares outstanding:
Basic		4,325,879		4,365,932			4,408,293
Diluted		4,360,688		4,422,529			4,501,537
Earnings per share (in dollars):
Basic	$	1.62	$	1.68		$	1.67
Diluted		1.61		1.66			1.64

See accompanying notes to consolidated financial statements.

33

Massbank Corp. and Subsidiaries
Consolidated Statements of Cash Flows

(In thousands) Years ended December 31,	2006			2005			2004
Cash flows from operating activities:
Net income	$	7,027		$	7,323		$	7,380
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		669			642			676
Share-based payment compensation		60			—			—
Loan interest capitalized		(11	)		(9	)		(8	)
(Increase) decrease in accrued interest and income receivable		(1,185	)		(482	)		438
Increase (decrease) in other liabilities		554			(22	)		276
(Increase) decrease in income tax receivable, net		(88	)		164			161
Amortization of premiums (accretion of discounts) on securities, net		(79	)		(48	)		566
Net trading securities activity		7,412			49,895			13,488
Gains on securities available for sale, net		(736	)		(515	)		(1,361	)
Appreciation on donated equity securities		5			—			—
(Gains) losses on trading securities, net		(61	)		(164	)		132
Decrease in deferred mortgage loan origination fees, net of amortization		(27	)		(113	)		(231	)
(Decrease) increase in accrued income taxes, net		(35	)		35			—
Deferred income tax expense (benefit)		(56	)		250			28
(Increase) decrease in other assets		(3,301	)		(5,088	)		847
Provision (credit) for loan losses		123			(53	)		(242	)
Provision (credit) for loan losses on off-balance sheet credit exposures		(172	)		(71	)		(38	)
Gains on sales of premises and equipment		(3	)		—			(4	)
Net cash provided by operating activities		10,096			51,744			22,108
Cash flows from investing activities:
Purchases of term Federal funds		(41,000	)		(15,000	)		—
Proceeds from maturities of term Federal funds		—			15,000			—
Net decrease in interest-bearing bank deposits		898			1,820			2,967
Proceeds from sales of investment securities available for sale		20,405			28,252			28,942
Proceeds from maturities and redemption of investment securities held to maturity and available for sale		122,250			103,961			207,509
Purchases of investment securities available for sale		(91,205	)		(132,546	)		(225,318	)
Purchases of mortgage-backed securities available for sale		(25,943	)		(47,696	)		(63,922	)
Purchases of mortgage-backed securities held to maturity		—			(1,581	)		(4,925	)
Principal repayments of mortgage-backed securities		26,730			31,450			35,671
Principal repayments of securities available for sale		2			—			1
Donated equity securities		5			—			—
Loans originated		(21,736	)		(48,874	)		(60,332	)
Loan principal payments received		38,583			59,460			77,369
Purchases of premises and equipment		(1,654	)		(700	)		(193	)
Proceeds from sales of premises and equipment		3			—			4
Net cash provided by (used in) investing activities		27,338			(6,454	)		(2,227	)

(Continued)

34

Massbank Corp. and Subsidiaries
Consolidated Statements of Cash Flows (Continued)

(In thousands) Years ended December 31,	2006			2005			2004
Cash flows from financing activities:
Net decrease in deposits		(61,396	)		(64,737	)		(33,043	)
Decrease in escrow deposits of borrowers		(53	)		(15	)		(65	)
Payments to acquire treasury stock		(1,621	)		(4,487	)		(2,617	)
Purchase of company stock for deferred compensation plan, net of distributions		(75	)		(30	)		(38	)
Increase in deferred compensation obligation		75			30			38
Options exercised, including tax benefit		864			1,830			944
Cash dividends paid on common stock		(4,715	)		(4,583	)		(4,415	)
Net cash used in financing activities		(66,921	)		(71,992	)		(39,196	)
Net decrease in cash and cash equivalents		(29,487	)		(26,702	)		(19,315	)
Cash and cash equivalents at beginning of year		177,377			204,079			223,394
Cash and cash equivalents at end of year	$	147,890		$	177,377		$	204,079
Supplemental cash flow disclosures:
Cash transactions:
Cash paid during the year for interest	$	18,950		$	15,203		$	12,769
Cash paid during the year for taxes, net of refunds		3,745			3,002			3,401
Non-cash transactions:
Transfer of property from premises and equipment to real estate held for resale	$	425		$	—		$	—

See accompanying notes to consolidated financial statements.

35

Massbank Corp. and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity

(In thousands except share data) Years ended December 31, 2006, 2005 and 2004
											Accumulated			Shares
			Additional								other			held in			Deferred
	Common		paid-in		Retained			Treasury			comprehensive			Rabbi			compensation
	stock		capital		earnings			stock			income			Trust			obligation			Total
Balance at December 31, 2003	$	7,688	$	54,417	$	99,038		$	(54,177	)	$	3,961		$	(515	)	$	515		$	110,927
Net Income		—		—		7,380			—			—			—			—			7,380
Other comprehensive loss, net of tax:
Unrealized losses on securities, net of reclassification adjustment (Note 1)		—		—		—			—			(2,204	)		—			—			(2,204	)
Comprehensive income		—		—		—			—			—			—			—			5,176
Cash dividends paid ($1.00 per share)		—		—		(4,415	)		—			—			—			—			(4,415	)
Purchase of treasury stock		—		—		—			(2,617	)		—			—			—			(2,617	)
Purchase of company stock for deferred compensation plan, net of distributions		—		—		—			—			—			(38	)		38			—
Exercise of stock options		48		588		—			—			—			—			—			636
Tax benefit on stock options exercised		—		308		—			—			—			—			—			308
Balance at December 31, 2004		7,736		55,313		102,003			(56,794	)		1,757			(553	)		553			110,015
Net Income		—		—		7,323			—			—			—			—			7,323
Other comprehensive loss, net of tax:
Unrealized losses on securities, net of reclassification adjustment (Note 1)		—		—		—			—			(4,834	)		—			—			(4,834	)
Comprehensive income		—		—		—			—			—			—			—			2,489
Cash dividends paid ($1.05 per share)		—		—		(4,583	)		—			—			—			—			(4,583	)
Purchase of treasury stock		—		—		—			(4,487	)		—			—			—			(4,487	)
Purchase of company stock for deferred compensation plan		—		—		—			—			—			(30	)		30			—
Distribution of company stock from deferred compensation plan		—		—		—			—			—			232			(232	)		—
Exercise of stock options		76		1,412		—			—			—			—			—			1,488
Tax benefit on stock options exercised		—		342		—			—			—			—			—			342
Balance at December 31, 2005		7,812		57,067		104,743			(61,281	)		(3,077	)		(351	)		351			105,264
Net Income		—		—		7,027			—			—			—			—			7,027
Other comprehensive income, net of tax:
Unrealized gains on securities, net of reclassification adjustment (Note 1)		—		—		—			—			202			—			—			202
Pension liability adjustment to initially apply SFAS No. 158, net of tax		—		—		—			—			(196	)		—			—			(196	)
Comprehensive income		—		—		—			—			—			—			—			7,033
Share-based payment compensation		—		60		—			—			—			—			—			60
Cash dividends paid ($1.09 per share)		—		—		(4,715	)		—			—			—			—			(4,715	)
Purchase of treasury stock		—		—		—			(1,621	)		—			—			—			(1,621	)
Purchase of company stock for deferred compensation plan		—		—		—			—			—			(75	)		75			—
Exercise of stock options		38		712		—			—			—			—			—			750
Tax benefit on stock options exercised		—		114		—			—			—			—			—			114
Balance at December 31, 2006	$	7,850	$	57,953	$	107,055		$	(62,902	)	$	(3,071	)	$	(426	)	$	426		$	106,885

     See accompanying notes to consolidated financial statements.

36

Massbank Corp. and Subsidiaries
Notes to Consolidated Financial Statements
Years ended December 31, 2006, 2005 and 2004

1.	Summary of Significant Accounting Policies
	Massbank Corp. (the “Company”) is a Delaware chartered holding company whose principal subsidiary is Massbank (the “Bank”). The Bank operates fifteen full service banking offices in Reading, Melrose, Stoneham, Wilmington, Medford, Chelmsford, Tewksbury, Westford, Dracut, Lowell and Everett, Massachusetts providing a variety of deposit, lending and trust services. As a Massachusetts chartered savings bank whose deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) and the Depositors Insurance Fund (“DIF”), the activities of the Bank are subject to regulation, supervision and examination by federal and state regulatory authorities, including, but not limited to the FDIC, the Massachusetts Commissioner of Banks and the DIF. In addition, as a bank holding company, the Company is subject to supervision, examination and regulation by the Board of Governors of the Federal Reserve System.
	Basis of Presentation
	The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries Knabssam LLC and Massbank and its subsidiaries: Readibank Properties, Inc., Readibank Investment Corporation and Melbank Investment Corporation.
	The Company has one reportable operating segment. All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles and to general practices within the banking industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the balance sheet date and income and expenses for the period. Material estimates that are particularly susceptible to change in the near term relate to the determination of the allowance for loan losses, the allowance for loan losses on off-balance sheet credit exposures and other than temporary declines in value of investment securities requiring impairment write downs due to general market conditions or other factors.
	Certain amounts in the prior years’ consolidated financial statements were reclassified to facilitate comparison with the current fiscal year.
	Investments in Debt and Equity Securities
	Under its investment policy, management determines the appropriate classification of securities at the time of purchase. Those debt securities that the Company has the intent and the ability to hold to maturity are classified as securities held to maturity and are carried at amortized historical cost.
	Those securities held for indefinite periods of time and not intended to be held to maturity are classified as available for sale. Securities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in market conditions, interest rates, prepayment risk, the need to increase regulatory capital and other factors. The Company records investment securities available for sale at aggregate market value with the net unrealized holding gains or losses reported, net of tax effect, as a separate component of stockholders’ equity until realized. As of December 31, 2006, stockholders’ equity included approximately $2.9 million of accumulated other comprehensive loss, representing the net unrealized losses on securities available for sale, less applicable income tax benefits.
	Securities that are bought and held principally for the purpose of sale in the near term are classified as trading securities. Trading generally reflects active and frequent buying and selling, and trading securities are generally used with the objective of generating profits on short-term differences in price caused by market volatility. Investments classified as trading securities are stated at market value with unrealized gains and losses included in earnings.
	Income on debt securities is accrued and included in interest and dividend income. The specific identification method is used to determine realized gains or losses on sales of securities available for sale which are also reported in non-interest income under the caption “gains on securities available for sale, net.” When a security suffers a loss in value which is considered other than temporary, such loss is recognized by a charge to earnings.

37

1.	Summary of Significant Accounting Policies (continued)
	Loans
	Loans are reported at the principal amount outstanding, net of unearned fees. Loan origination fees and related direct incremental loan origination costs are offset and the resulting net amount is deferred and amortized over the life of the loan using the level-yield method.
	The Bank generally does not accrue interest on loans which are 90 days or more past due. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed from income and all amortization of deferred loan fees is discontinued. Interest received on nonaccrual loans is either applied against principal or reported as income according to management’s judgment as to the collectibility of principal. Interest accruals are resumed on such loans only when they are brought current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.
	Impairment on loans for which it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement are measured on a discounted cash flow method, or at the loan’s observable market price, or at the fair value of the collateral if the loan is collateral dependent. However, impairment must be measured based on the fair value of the collateral if it is determined that foreclosure is probable. Impaired loans consist of all nonaccrual commercial loans.
	Allowance for Loan Losses and Allowance for Loan Losses on Off-Balance Sheet Credit Exposures
	The Company maintains an allowance for 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 historical loss experience factors and an unallocated allowance which is maintained based on management’s assessment of many factors including the risk characteristics of the portfolio, concentrations of credit, current and anticipated economic conditions that may affect borrowers’ ability to pay, and trends in loan delinquencies and charge-offs. Realized losses, net of recoveries, are charged directly to the allowance. While management uses the information available in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ from the assumptions used in making the evaluation. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management.
	The Company also maintains an allowance for possible losses on its outstanding loan commitments. The allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) is maintained based on expected drawdowns of committed loans and their loss experience factors and management’s assessment of various other factors including current and anticipated economic conditions that may effect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.

38

Premises and Equipment

Land is carried at cost. Premises, equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization computed primarily by use of the straight-line method over the estimated useful lives of the related assets or terms of the related leases.

Real Estate Held for Resale

Real estate held for resale consists of a parcel of land owned by the Company’s subsidiary, Knabssam LLC that is not being used for operations purposes. The land is carried at cost. The Company, through its subsidiary, has granted a local developer an option purchase the land. As consideration for this option, the developer will make quarterly option payments to Knabssam LLC until the option is either exercised and the closing transaction for the purchase occurs or the option is allowed to lapse. The closing is expected to take place in the third quarter of 2007. Option payments received prior to the expiration of the option period in August 2007 are not applied towards the purchase price and are not refundable. Under the option agreement, the option period may be extended in accordance with the terms of the agreement.

Impairment of the Long-lived Assets — Except Goodwill

The Company reviews long-lived assets for impairment at least annually or whenever events or changes in business circumstances indicate that the remaining useful life may warrant revision or that the carrying amount of the long-lived asset may not be fully recoverable. The Company performs undiscounted cash flow analyses to determine if impairment exists. If impairment is determined to exist, any related impairment loss is calculated based on the fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less any cost of disposal.

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 year ended December 31, 2006, reflect the impact of SFAS 123(R). Stock-based compensation expense for the year ended December 31, 2006 totaled $60,000. This stock-based compensation expense is related to the 34,250 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 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 123(R), the change in fair value resulting from 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.

     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.

39

1.	Summary of Significant Accounting Policies (continued)
	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 and 2004.

(In thousands except per share data) Years Ended December 31,	2005			2004
Net income, as reported	$	7,323		$	7,380
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects(1)		(161	)		(170	)
Pro forma net income	$	7,162		$	7,210
Earnings per share:
Basic – as reported	$	1.68		$	1.67
Basic – pro forma		1.64			1.64
Diluted – as reported	$	1.66		$	1.64
Diluted – pro forma		1.62			1.60
Weighted average fair value per share	$	8.11		$	9.55
Expected term (years)	7.3 years			7.3 years
Risk-free interest rate		3.97	%		3.49	%
Volatility		21.2	%		21.9	%
Dividend yield		2.8	%		2.3	%

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

Goodwill Impairment

The Company adopted SFAS No. 142, Goodwill and Other Intangibles, effective January 1, 2002. The statement addresses the method of identifying and measuring goodwill and other intangible assets acquired in a business combination, eliminates further amortization of goodwill, and requires periodic impairment evaluations of goodwill. Impairment evaluations are required to be performed annually and may be required more frequently if certain conditions indicating potential impairment exists. In the event that the Company were to determine that its goodwill were impaired, the recognition of an impairment charge could have an adverse impact on its results of operations in the period that the impairment occurred or on its financial position.

Pension Plan

The Bank accounts for pension benefits on the net periodic pension cost method for financial reporting purposes. This method recognizes the compensation cost of an employee’s pension benefit over that employee’s approximate service period. Pension costs are funded in the year of accrual using the aggregate cost method.

Earnings per Common Share

Basic EPS is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted EPS reflects the effect on the weighted average shares outstanding of the number of additional shares outstanding if dilutive stock options were converted into common stock using the treasury stock method.

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

      A reconciliation of the weighted average shares outstanding for the years ended December 31, 2006, 2005 and 2004 follows:

(In thousands) Years ended December 31,	2006		2005		2004
Basic shares		4,326		4,366		4,408
Dilutive impact of stock options		35		57		94
Diluted shares		4,361		4,423		4,502

40

1.	Summary of Significant Accounting Policies (continued)
	Comprehensive Income
	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 separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
	The components of other comprehensive income and related tax effects at December 31 are as follows:

(In thousands)Years ended December 31,	2006			2005			2004
Unrealized holding gains (losses) on available for sale securities and when issued securities contracts arising during period	$	1,027		$	(7,221	)	$	(2,242	)
Less: reclassification adjustment for gains realized in income		735			515			1,361
Net unrealized gains (losses)		292			(7,736	)		(3,603	)
Tax (expense) or benefit		(90	)		2,902			1,399
Net unrealized gains (losses), net of tax		202			(4,834	)		(2,204	)
Pension liability adjustment to initially apply SFAS No. 158		(337	)		—			—
Tax benefit		141			—			—
Pension liability adjustment, net of tax		(196	)		—			—
Other comprehensive income (loss)	$	6		$	(4,834	)	$	(2,204	)

	Cash and Cash Equivalents
	For purposes of reporting cash flows, cash and cash equivalents consist of cash and due from banks, and short-term investments with original maturities of less than 90 days.
	As a regulated financial institution, the Bank is required to maintain certain reserve requirements of vault cash and/or deposits with the Federal Reserve Bank of Boston. The amount of this reserve requirement, included in “Cash and Due from Banks,” was $4.6 million and $7.6 million at December 31, 2006 and 2005, respectively.
	Income Taxes
	The Bank recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are established for the temporary differences between the accounting basis and the tax basis of the Bank’s assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled. The Bank’s deferred tax asset is reviewed and adjustments to such asset are recognized as deferred income tax expense or benefit based upon management’s judgment relating to the realizability of such asset. Based on the Bank’s historical and current pre-tax earnings, management believes it is more likely than not that the Bank will realize its existing gross deferred tax asset.
2.	Short-Term Investments
	Short-term investments consist of the following:

(In thousands)At December 31,	2006		2005
Federal funds sold (overnight)	$	117,104	$	152,785
Term Federal funds sold		—		15,000
Money market investment funds		22,133		—
Interest-bearing bank money market accounts		3		2
Total short-term investments	$	139,240	$	167,787

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

41

3.	Investment Securities
	The amortized cost and market value of investment securities follows:

				Gross		Gross
	Amortized			Unrealized		Unrealized			Market
(In thousands) At December 31, 2006	Cost			Gains		Losses			Value
Securities held to maturity:
Mortgage-backed securities:
Federal National Mortgage Association	$	5,396		$	—	$	(120	)	$	5,276
Total	$	5,396		$	—	$	(120	)	$	5,276
Securities available for sale:
Debt securities:
U.S. Treasury obligations	$	22,018		$	—	$	(309	)	$	21,709
U.S. Government agency obligations		242,775			10		(3,238	)		239,547
Total		264,793			10		(3,547	)		261,256
Mortgage-backed securities:
Government National Mortgage Association		1,554			19		—			1,573
Federal Home Loan Mortgage Corporation		131,399			602		(1,555	)		130,446
Federal National Mortgage Association		2,418			—		(40	)		2,378
Collateralized mortgage obligations		74			—		—			74
Total mortgage-backed securities		135,445			621		(1,595	)		134,471
Total debt securities		400,238			631		(5,142	)		395,727
Equity securities		7,366			589		(603	)		7,352
Total securities available for sale		407,604		$	1,220	$	(5,745	)	$	403,079
Net unrealized losses on securities available for sale		(4,525	)
Total securities available for sale, net		403,079
Total investment securities, net	$	408,475

The amortized cost and market value of investment securities follows:

				Gross		Gross
	Amortized			Unrealized		Unrealized			Market
(In thousands) At December 31, 2005	Cost			Gains		Losses			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		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

42

3.	Investment Securities (continued)
	During the years ended December 31, 2006, 2005 and 2004, the Company realized gains and losses on sales of securities available for sale as follows:

(In thousands) At December 31,	2006					2005					2004
	Realized					Realized					Realized
	Gains		Losses			Gains		Losses			Gains		Losses
Sales:
U.S. Treasury obligations	$	—	$	(105	)	$	29	$	(55	)	$	35	$	(68	)
Marketable equity securities		1,083		(248	)		761		(220	)		1,720		(326	)
Securities donated to Massbank Charitable Foundation:
Marketable equity securities		5		—			—		—			—		—
Total realized gains (losses)	$	1,088	$	(353	)	$	790	$	(275	)	$	1,755	$	(394	)

Proceeds from sales of debt securities available for sale during 2006, 2005 and 2004 were $9.9 million, $22.0 million and $18.3 million, respectively. Proceeds from sales of equity securities available for sale during 2006, 2005 and 2004, were $10.5 million, $6.3 million and $10.6 million, respectively.

     There were no sales of investment securities held to maturity during 2006, 2005 and 2004.

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

(In thousands) At December 31,	2006					2005
	Amortized			Market		Amortized			Market
	Cost			Value		Cost			Value
Investment securities available for sale:
U.S. Treasury obligations:
Maturing within 1 year	$	14,019		$	13,911	$	50,950		$	50,595
Maturing after 1 year but within 5 years		7,999			7,798		26,101			25,521
Total		22,018			21,709		77,051			76,116
U.S. Government agency obligations:
Maturing within 1 year		75,000			74,594		45,999			45,612
Maturing after 1 year but within 5 years		150,745			148,246		171,992			168,254
Maturing after 5 years but within 10 years		15,995			15,706		19,996			19,665
Maturing after 10 years but within 15 years		1,035			1,001		1,037			1,006
Total		242,775			239,547		239,024			234,537
Mortgage-backed securities:
Maturing within 1 year		100			101		19			20
Maturing after 1 year but within 5 years		7,508			7,666		7,238			7,451
Maturing after 5 years but within 10 years		17,155			17,473		22,333			22,955
Maturing after 10 years but within 15 years		110,608			109,157		105,779			104,940
Maturing after 15 years		74			74		65			66
Total		135,445			134,471		135,434			135,432
Total debt securities available for sale		400,238			395,727		451,509			446,085
Net unrealized losses on debt securities available for sale		(4,511	)		—		(5,424	)		—
Total debt securities available for sale, net carrying value	$	395,727		$	395,727	$	446,085		$	446,085

Maturities of mortgage-backed securities are shown at final contractual maturity and do not reflect any principal amortization or prepayments.

      Included in U.S. Government agency obligations are investments that can be called prior to final maturity with an amortized cost of $163.7 million and a market value of $161.3 million at December 31, 2006 and an amortized cost of $193.0 million and a market value of $189.3 million at December 31, 2005.

43

3.	Investment Securities (continued)
	The fair value and unrealized losses of temporarily impaired investments aggregated by category of investments is as follows:

(In thousands) At December 31, 2006	Less Than 12 months					12 Months or longer					Total
			Unrealized					Unrealized					Unrealized
Description of Securities	Fair value		Losses			Fair Value		Losses			Fair Value		Losses
Debt securities available for sale and held to maturity:
U.S. Treasury obligations	$	—	$	—		$	21,709	$	(309	)	$	21,709	$	(309	)
U.S. Government agency obligations		48,670		(79	)		178,832		(3,159	)		227,502		(3,238	)
Mortgage-backed securities		38,135		(203	)		68,953		(1,512	)		107,088		(1,715	)
Total debt securities		86,805		(282	)		269,494		(4,980	)		356,299		(5,262	)
Equity securities		3,292		(603	)		—		—			3,292		(603	)
Total temporarily impaired securities	$	90,097	$	(885	)	$	269,494	$	(4,980	)	$	359,591	$	(5,865	)

As of December 31, 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 intent and ability to hold these investments for a time necessary to recover its cost. The 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.
The fair value and unrealized losses of temporarily impaired investments aggregated by category of investments is as follows:

(In thousands) At December 31, 2005	Less than 12 months					12 months or longer					Total
			Unrealized					Unrealized					Unrealized
Description of Securities	Fair value		Losses			Fair Value		Losses			Fair Value		Losses
Debt securities available for sale and held to maturity:
U.S. Treasury obligations	$	42,489	$	(279	)	$	32,625	$	(656	)	$	75,114	$	(935	)
U.S. Government agency obligations		107,529		(1,458	)		120,960		(3,039	)		228,489		(4,497	)
Mortgage-backed securities		96,160		(1,084	)		3,050		(127	)		99,210		(1,211	)
Total debt securities		246,178		(2,821	)		156,635		(3,822	)		402,813		(6,643	)
Equity securities		1,856		(117	)		59		(6	)		1,915		(123	)
Total temporarily impaired securities	$	248,034	$	(2,938	)	$	156,694	$	(3,828	)	$	404,728	$	(6,766	)

As of December 31, 2005, 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 intent and ability to hold these investments for a time necessary to recover its cost. The 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.

44

3.	Investment Securities (continued)
	The amortized cost and market value of U.S. Government agency securities available for sale that can be called prior to maturity by scheduled maturity and next call date are as follows:

(In thousands) At December 31,	2006				2005
	Amortized		Market		Amortized		Market
Based on Scheduled Maturity	Cost		Value		Cost		Value
Investment securities available for sale
U.S. Government agency obligations:
Maturing within 1 year	$	32,000	$	31,735	$	19,999	$	19,775
Maturing after 1 but within 2 years		46,750		45,824		47,000		46,122
Maturing after 2 but within 3 years		36,000		35,418		51,000		49,758
Maturing after 3 but within 4 years		18,000		17,704		32,000		31,299
Maturing after 4 but within 5 years		16,000		15,974		22,000		21,688
Maturing after 5 but within 10 years		13,994		13,710		19,996		19,665
Maturing after 10 but within 15 years		1,000		966		1,000		969
Total	$	163,744	$	161,331	$	192,995	$	189,276

	Amortized		Market		Amortized		Market
Based on Next Call Date	Cost		Value		Cost		Value
Investment securities available for sale
U.S. Government agency obligations:
Callable within 1 year	$	157,744	$	155,391	$	182,995	$	179,365
Callable after 1 but within 2 years		6,000		5,940		7,000		6,945
Callable after 2 but within 3 years		—		—		3,000		2,966
Total	$	163,744	$	161,331	$	192,995	$	189,276

4.	Trading Securities
	The carrying amount and market value of trading securities are as follows:

(In Thousands) At December 31,	2006		2005
	Market		Market
	Value		Value
U.S. Treasury obligations	$	—	$	7,896
Marketable equity securities		1,926		1,382
Investments in mutual funds		5		4
Total trading securities	$	1,931	$	9,282

During the years ended December 31, 2006, 2005 and 2004, the Company realized gains and losses on sales of trading securities as follows:

(In Thousands) Years Ended December 31,	2006					2005					2004
	Realized					Realized					Realized
	Gains		Losses			Gains		Losses			Gains		Losses
U.S. Treasury obligations	$	—	$	(29	)	$	1	$	(119	)	$	101	$	(40	)
Marketable equity securities		224		—			99		(3	)		72		(19	)
Total realized gains (losses)	$	224	$	(29	)	$	100	$	(122	)	$	173	$	(59	)

Proceeds from sales of trading securities during 2006, 2005 and 2004 were $21.2 million, $24.4 million and $46.4 million, respectively. Mark-to-market adjustments included in income in 2006, 2005 and 2004 were $(134) thousand, $186 thousand and $(246) thousand, respectively.

45

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

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

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

(In thousands) At December 31,	2006		2005
Mortgage loans:
Residential:
Conventional:
Fixed rate	$	169,036	$	189,736
Variable rate		23,941		22,948
FHA and VA		13		27
Construction		1,217		845
Commercial:
Fixed rate		367		191
Variable rate		4,076		2,144
Construction		563		—
Total mortgage loans		199,213		215,891
Premium on loans		2		2
Deferred mortgage loan origination costs, net		38		11
Mortgage loans, net		199,253		215,904
Other loans:
Consumer:
Second mortgage loans		751		34
Installment		211		211
Guaranteed education		635		1,094
Other secured		408		499
Home equity lines of credit		7,460		7,722
Unsecured		128		148
Total consumer loans		9,593		9,708
Commercial		81		118
Total other loans		9,674		9,826
Total loans	$	208,927	$	225,730

In the ordinary course of business, the Bank makes loans to its directors, officers and their associates and affiliated companies (“related parties”) at substantially the same terms as those prevailing at the time of origination for comparable transactions with unrelated borrowers. An analysis of total related party loans for the year ended December 31, 2006 follows:

(In thousands)
Balance at December 31, 2005	$	1,489
Additions		76
Repayments		(162	)
Balance at December 31, 2006	$	1,403

46

6.	Allowance for Loan Losses
An analysis of the activity in the allowance for loan losses is as follows:

(In thousands) Years ended December 31,	2006			2005			2004
Balance at beginning of year	$	1,253		$	1,307		$	1,554
Provision (credit) for loan losses		123			(53	)		(242	)
Recoveries of loans previously charged-off		19			—			—
Total		1,395			1,254			1,312
Charge-offs:
Mortgage loans		—			—			—
Other loans		(13	)		(1	)		(5	)
Balance at end of year	$	1,382		$	1,253		$	1,307

The following table shows the allocation of the allowance for loan losses by category of loans at December 31, 2006, 2005 and 2004.

(In thousands) At December 31,	2006					2005					2004
			Percentage					Percentage					Percentage
			of Loans					of Loans					of Loans
	Amount		to Total			Amount		to Total			Amount		to Total
Mortgage loans:
Residential	$	795		93	%	$	770		95	%	$	767		95	%
Commercial		324		2			111		1			79		1
Consumer loans		98		5			139		4			154		4
Commercial loans		40		—			46		—			46		—
Unallocated		125		—			187		—			261		—
Total	$	1,382		100	%	$	1,253		100	%	$	1,307		100	%

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

(In thousands) At December 31,	2006			2005			2004
Total nonaccrual loans	$	137		$	257		$	74
Total non-performing assets	$	137		$	257		$	74
Percent of non-performing loans to total loans		0.07	%		0.11	%		0.03	%
Percent of non-performing assets to total assets		0.02	%		0.03	%		0.01	%

47

7.	Non-performing Assets (continued)
	The reduction in interest income associated with nonaccrual loans is as follows:

(In thousands) Years ended December 31,	2006		2005		2004
Interest income that would have been recorded under original terms	$	8	$	16	$	4
Interest income actually recorded		5		9		1
Reduction in interest income	$	3	$	7	$	3

	During 2006, 2005 and 2004 the Company had no impaired loans.
8.	Financial Instruments with Off-Balance Sheet Risk
	The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts reflect the extent of involvement the Bank has in particular classes of these instruments. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instru ment is represented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

	Contract or Notional Amount
(In thousands) At December 31,	2006		2005
Financial instruments whose contract amounts represent credit risk:
Commitments to originate residential mortgage loans	$	1,206	$	1,257
Unadvanced portions of construction loans		217		530
Unused credit lines, including unused portions of equity lines of credit		28,779		31,413
Other loan commitments		2,337		2,451

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

					Estimated
					Useful Life
(In thousands) At December 31,	2006		2005		(In Years)
Premises:
Land	$	1,967	$	2,392		—
Buildings		7,438		6,204		25-45
Building and leasehold improvements		2,862		2,723		2-30
Equipment		5,591		5,309		1-15
		17,858		16,628
Less: accumulated depreciation and amortization		10,773		10,103
Total premises and equipment, net	$	7,085	$	6,525

The Bank is obligated under a number of noncancelable operating leases for various banking offices. These operating leases expire at various dates through 2016 with options for renewal. Rent expense for the years ended December 31, 2006, 2005 and 2004 amounted to $312 thousand, $298 thousand, and $294 thousand, respectively.

48

9.	Premises and Equipment (continued)
	The minimum rental commitments, with initial or remaining terms of one year or more exclusive of operating costs and real estate taxes to be paid by the Bank under these leases, as of December 31, 2006, are as follows:

(In thousands) Years ending December 31,	PAYMENTS
2007	$	295
2008		267
2009		191
2010		165
2011		165
Later years		307
Total	$	1,390

10.	Deposits
	Deposits are summarized as follows:

(In Thousands) AT December 31,	2006					2005
	Amount		Rate			Amount		Rate
Demand and NOW:
NOW accounts	$	51,856		0.53	%	$	54,924		0.37	%
Demand accounts		27,004		—			27,326		—
Total demand and NOW		78,860		0.35			82,250		0.25
Savings:
Savings accounts		335,142		1.96			430,771		1.75
Money market accounts		9,666		1.99			10,770		1.73
Total savings		344,808		1.96			441,541		1.75
Time certificates of deposit:
Fixed rate certificates		230,710		4.38			197,743		3.19
Variable rate certificates		68,954		5.57			63,194		4.80
Total time certificates of deposit		299,664		4.65			260,937		3.58
Total deposits	$	723,332		2.90	%	$	784,728		2.20	%

The maturity distribution and related rate structure of the Bank’s time certificates of deposit at December 31, 2006 follows:

(In Thousands) AT December 31,	2006
			Average
	Amount		Interest Rate
Due within 3 months	$	74,084		4.44	%
Due within 3–6 months		57,942		4.44
Due within 6–12 months		71,222		4.50
Due within 1–2 years		60,206		4.86
Due within 2–3 years		21,131		5.26
Due within 3–5 years		14,775		5.50
Thereafter		304		4.93
Total	$	299,664		4.65	%

49

10.	Deposits (continued)
	At December 31, 2006 and 2005, the Bank had individual time certificates of deposit of $100 thousand or more maturing as follows:

(In Thousands) At December 31,	2006		2005
Due within 3 months	$	33,060	$	17,824
Due within 3–6 months		21,323		21,777
Due within 6–12 months		26,980		22,174
Due within 1–2 years		22,322		21,363
Due within 2–3 years		10,050		3,381
Due within 3–5 years		5,021		7,736
Thereafter		155		200
Total	$	118,911	$	94,455

11.	Fair Value of Financial Instruments
	The Bank is required to disclose estimated fair values for its financial instruments. Fair value estimates, methods, and assumptions are set forth below for the Bank’s financial instruments.
	Cash and Due from Banks, Short-Term Investments and Accrued Interest and Income Receivable The carrying amounts for these financial instruments approximate fair value because of the short-term nature of these financial instruments.
	Interest-bearing Deposits in Banks and Term Federal Funds Sold The carrying amounts of the interest-bearing deposits in banks and term Federal funds sold reported in the balance sheet at December 31, 2006 and 2005 approximate fair value.
	Securities The fair value of investment securities is based principally on quoted market prices and dealer quotes.

     SFAS No. 107 specifies that fair values should be calculated based on the value of one unit without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications, or estimated transaction costs.

     The carrying amount and estimated fair values of the Company’s investment securities are as follows:

(In Thousands) At December 31,	2006				2005
	Carrying		Calculated		Carrying		Calculated
	Amount		Fair Value		Amount		Fair Value
Securities available for sale	$	403,079	$	403,079	$	453,472	$	453,472
Securities held to maturity		5,396		5,276		6,137		6,022
Trading securities		1,931		1,931		9,282		9,282
Total securities	$	410,406	$	410,286	$	468,891	$	468,776

Loans

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

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

50

11.	Fair Value of Financial Instruments (continued)
	The following table presents information for loans:

(In thousands) At December 31,	2006					2005
	Carrying			Calculated		Carrying			Calculated
	Amount			Fair Value		Amount			Fair Value
Real estate:
Residential:
Variable	$	25,168		$	24,171	$	23,113		$	22,202
Fixed		169,112			163,378		190,471			186,377
Commercial:
Fixed		367			347		192			175
Variable		4,606			4,445		2,128			2,057
Consumer		9,593			9,569		9,708			9,709
Commercial		81			68		118			94
Total loans		208,927			201,978		225,730			220,614
Allowance for loan losses		(1,382	)		—		(1,253	)		—
Net loans	$	207,545		$	201,978	$	224,477		$	220,614

Deposits

The fair value of deposits with no stated maturity, such as demand deposits, NOW accounts, savings accounts, and money market accounts for purposes of this disclosure, is equal to the amount payable on demand as of December 31, 2006 and 2005. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

(In thousands) At December 31,	2006				2005
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Demand accounts	$	27,004	$	27,004	$	27,326	$	27,326
NOW accounts		51,856		51,856		54,924		54,924
Savings accounts		335,142		335,142		430,771		430,771
Money market accounts		9,666		9,666		10,770		10,770
Time certificates of deposit		299,664		299,302		260,937		259,755
Total deposits		723,332		722,970		784,728		783,546
Escrow deposits of borrowers		1,006		1,006		1,059		1,059
Total	$	724,338	$	723,976	$	785,787	$	784,605

The fair value estimates and the carrying amounts above do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.

Commitments to Extend Credit

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

     The Bank estimates the fair value of the cost to terminate commitments to advance funds on construction loans and for residential mortgage loans in the pipeline at December 31, 2006 and 2005 to be immaterial. Unused credit lines, including unused portions of equity lines of credit, are at floating interest rates and therefore there is no fair value adjustment. The Bank’s other loan commitments approximate fair value.

51

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

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

12.	Income Taxes
	Income tax expense was allocated as follows:

(In Thousands) Years ended december 31,	2006			2005		2004
Current income tax expense:
Federal	$	3,507		$	3,430	$	3,606
State		232			113		264
Total current tax expense		3,739			3,543		3,870
Deferred income tax (benefit) expense:
Federal		(44	)		186		23
State		(12	)		64		5
Total deferred tax (benefit) expense:		(56	)		250		28
Total income tax expense	$	3,683		$	3,793	$	3,898

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

(In Thousands) Years ended december 31,	2006			2005			2004
Computed “expected” income tax expense at statutory rate	$	3,749		$	3,891		$	3,947
Increase (reduction) in income taxes resulting from:
Reduction in federal income tax rate		(100	)		(91	)		(98	)
State and local income taxes, net of federal benefit		143			115			175
Dividends received deduction		(40	)		(42	)		(40	)
Dividends paid to ESOP deduction		(70	)		(72	)		(73	)
Other		1			(8	)		(13	)
Income tax expense	$	3,683		$	3,793		$	3,898
Effective income tax rate		34.39	%		34.12	%		34.56	%

52

12.	Income Taxes (continued)
	At December 31, 2006 and 2005, the Bank had gross deferred tax assets and gross deferred tax liabilities as follows:

(In Thousands) Years ended december 31,	2006		2005
Deferred tax assets:
Unrealized losses on securities available for sale	$	1,656	$	1,746
Loan losses		722		740
Deferred compensation and pension cost		889		672
Depreciation		166		147
Purchase accounting		11		95
Deferred loan fees, net		3		4
Other		19		11
Gross deferred tax asset		3,466		3,415
Deferred tax liabilities:
Other unrealized securities gains		111		167
Other		8		8
Gross deferred tax liability		119		175
Net deferred tax asset	$	3,347	$	3,240

     Based on the Company’s historical and current pretax earnings, management believes it is more likely than not that the Company will realize the gross deferred tax asset existing at December 31, 2006. The primary sources of recovery of the gross federal deferred tax asset are federal income taxes paid in 2006, 2005 and 2004 that are available for carryback and the expectation that the existing net deductible temporary differences will reverse during periods in which the Company generates net taxable income. Since there is no carryback provision for state income tax purposes, management believes the existing net deductible temporary differences which give rise to the gross deferred state income tax asset will reverse during periods in which the Company generates net taxable income. There can be no assurance, however, that the Company will generate any earnings or any specific level of continuing earnings.

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

13.	Earnings Per Share
	The following is a calculation of earnings per share for the years indicated:

Years Ended December 31,	2006				2005				2004
(In thousands except share data)	Basic		Diluted		Basic		Diluted		Basic		Diluted
Net income	$	7,027	$	7,027	$	7,323	$	7,323	$	7,380	$	7,380
Average shares outstanding		4,325,879		4,325,879		4,365,932		4,365,932		4,408,293		4,408,293
Dilutive stock options		—		34,809		—		56,597		—		93,244
Weighted average shares outstanding		4,325,879		4,360,688		4,365,932		4,422,529		4,408,293		4,501,537
Earnings per share (in dollars)	$	1.62	$	1.61	$	1.68	$	1.66	$	1.67	$	1.64

53

14.	Stockholders’ Equity
	The Company may not declare or pay cash dividends on its shares of common stock if the effect thereof would cause its stockholders’ equity to be reduced below or to otherwise violate legal or regulatory requirements. Substantially all of the Company’s retained earnings are unrestricted at December 31, 2006.

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

     The capital ratios of the Company and its principal subsidiary “MASSBANK” set forth below currently exceed the minimum ratios for “well capitalized” banks as defined by federal regulators.

     As of December 31, 2006, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes would cause a change in the Bank’s categorization.

(IN THOUSANDS)						For Capital					TO BE WELL
At December 31, 2006	Actual					Adequacy Purposes					Capitalized(1)
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Tier I Capital (to Average Assets):
MASSBANK Corp. (consolidated)	$	108,852		12.78	%	$	25,547		3.00	%		N/A		—
MASSBANK (the “Bank”)		103,245		12.39			24,992		3.00		$	41,653		5.00	%
Tier I Capital (to Risk-Weighted Assets):
MASSBANK Corp. (consolidated)		108,852		36.58			11,901		4.00			N/A		—
MASSBANK (the “Bank”)		103,245		34.77			11,876		4.00			17,815		6.00
Total Capital (to Risk-Weighted Assets):
MASSBANK Corp. (consolidated)		110,579		37.17			23,803		8.00			N/A		—
MASSBANK (the “Bank”)		104,972		35.35			23,753		8.00			29,691		10.00

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

(In thousands)						For Capital					To Be Well
At December 31, 2005	Actual					Adequacy Purposes					Capitalized(1)
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Tier I Capital (to Average Assets):
MASSBANK Corp. (consolidated)	$	107,251		11.94	%	$	26,942		3.00	%		N/A		—
MASSBANK (the “Bank”)		103,122		11.48			26,940		3.00		$	44,900		5.00	%
Tier I Capital (to Risk-Weighted Assets):
MASSBANK Corp. (consolidated)		107,251		39.03			10,990		4.00			N/A		—
MASSBANK (the “Bank”)		103,122		37.54			10,989		4.00			16,484		6.00
Total Capital (to Risk-Weighted Assets):
MASSBANK Corp. (consolidated)		109,290		39.78			21,981		8.00			N/A		—
MASSBANK (the “Bank”)		105,161		38.28			21,978		8.00			27,473		10.00

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

54

15.	Employee Benefits
	Pension Plan
	The Bank sponsors a noncontributory defined benefit pension plan that covers all employees who meet specified age and length of service requirements, which is administered by the Savings Banks Employees Retirement Association (“SBERA”). The Plan provides for benefits to be paid to eligible employees at retirement based primarily upon their years of service with the Bank and compensation levels near retirement. Contributions to the Plan reflect benefits attributed to employees’ service to date, as well as service expected to be earned in the future. Pension plan assets consist principally of equity securities; mutual funds – bonds, mutual funds – equities, and all assets mutual funds; and money market funds and cash.

     The following table sets forth the Plan’s funded status and amounts recognized in the Company’s consolidated financial statements for the plan years ended December 31, 2006 and 2005, the plan’s latest valuation dates:

(In thousands) Years ended december 31,	2006			2005
Accumulated benefit obligation	$	8,837		$	7,842
Change in benefit obligation:
Benefit obligation at beginning of year	$	9,994		$	9,488
Service cost		413			459
Interest cost		575			546
Actuarial loss (gain)		326			(52	)
Benefits paid		(646	)		(447	)
Benefit obligation at end of year	$	10,662		$	9,994
Change in plan assets:
Fair value of plan assets at beginning of year	$	8,443		$	7,834
Actual return on plan assets		1,242			691
Employer contribution		141			364
Benefits paid		(646	)		(447	)
Other		1			1
Fair value of plan assets at end of year	$	9,181		$	8,443
Funded status	$	(1,481	)	$	(1,551	)

On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS No. 158 which requires an employer to recognize in its balance sheet as an asset or liability the over-funded or under-funded status of a defined benefit postretirement plan, measured as the difference between the fair value of plan assets and the benefit obligation. For a pension plan, the benefit obligation is the projected benefit obligation. SFAS No. 158 requires that gains or losses and prior service costs or credits that arise during the period, but are not included as components of net periodic benefit expense pursuant to SFAS No. 87 or SFAS No. 106, be recognized as a component of other comprehensive income (loss). The impact of adopting the new standard on the Company’s consolidated balance sheet at December 31, 2006 was to increase certain accounts as follows:

	Defined Benefit
(In Thousands) At December 31, 2006	Pension Plan
Other liabilities (accrued pension liability)	$	337
Deferred income tax asset, net		(141	)
Other comprehensive loss		(196	)

After the adoption of SFAS No. 158 at December 31, 2006 defined benefit pension cost recognized in the accompanying consolidated balance sheets at December 31 are as follows:

	Defined Benefit
	Pension Plan
(In thousands) At December 31,	2006		2005
Accrued pension liability	$	1,481	$	959
Unrecognized net actuarial loss		—		528
Unrecognized transition asset		—		(42	)
Unrecognized past service cost		—		106
Funded status of pension plan — net under-funded amount	$	1,481	$	1,551

55

15.	Employee benefits (continued)
	The amounts in accumulated other comprehensive loss that have not yet been recognized as components of net periodic benefit expense at December 31, 2006 are as follows:

	Defined benefit
(In thousands)	Pension plan
Prior service cost, net of tax of $41	$	57
Actuarial loss, net of tax of $109		151
Transition asset, net of tax of $9		(12	)
Total	$	196

The following table reflects the amortization of amounts in accumulated other comprehensive loss that is expected to be recognized as components of net periodic benefit expense during 2007:

	Defined benefit
(In thousands)	Pension plan
Amortization of net prior service cost (credit)	$	8
Amortization of actuarial loss		—
Amortization of transition asset		(21	)

Assumptions used in determining the actuarial present value of the Company’s benefit obligation were as follows:

(In thousands) years ende december 31,	2006			2005			2004
Discount rate		5.75	%		5.75	%		5.75	%
Rate of compensation increase		4.00	%		4.00	%		4.00	%
Assumptions used to develop the net periodic benefit cost data were:
Discount rate		5.75	%		5.75	%		6.25	%
Expected return on plan assets		7.75	%		7.75	%		7.75	%
Rate of compensation increase		4.00	%		4.00	%		4.00	%
Components of net periodic pension expense:
Service cost	$	413		$	459		$	430
Interest cost		575			546			524
Expected return on plan assets		(654	)		(607	)		(545	)
Amortization of transition obligation		(21	)		(21	)		(21	)
Amortization of prior service cost		7			7			7
Amortization of unrecognized net actuarial (gain) loss		6			48			8
Net periodic pension expense	$	326		$	432		$	403

The approximate composition of pension plan assets as of the end of the plan years ended October 31, 2006 and 2005 is as follows:

Years ended october 31,	2006			2005
Asset Category:
Fixed Income Securities (including money market funds)		36.5	%		35.1	%
Domestic Equity Securities		48.5			50.5
International Equity Securities		15.0			14.4
		100.0	%		100.0	%

56

15. Employee benefits (continued)

The expected long-term rate of return on plan assets is based on prevailing yields on high quality fixed income investments increased by a premium of 3% — 5% for equity investments.

The Bank expects to contribute $347 thousand to its pension plan in 2007.

     The investment policies and strategies for the Bank’s pension plan are as follows: Massbank (the “Bank”) is a member of the Savings Banks Employees Retirement Association (“SBERA”) within which the Bank maintains a Defined Benefit pension plan. SBERA offers a common and collective trust as the underlying investment structure for pension plans participating in the Association. The target allocation mix for the common and collective trust portfolio calls for an equity-based investment deployment range from 55% to 75% of total portfolio assets. The remainder of the portfolio is allocated to fixed income. The approximate investment allocation of the portfolio is shown in the table above. The Trustees of SBERA, through the Association’s Investment Committee, select investment managers for the common and collective trust portfolio. A professional investment advisory firm is retained by the Investment Committee to provide allocation analysis, performance measurement and to assist with manager searches. The overall investment objective is to diversify equity investments across a spectrum of investment types (e.g., small cap, large cap, international, etc.) and styles (e.g., growth, value, etc.).

The Bank expects to make benefit payments for the plan years ending October 31, as follows:

(In thousands) Years ending October 31,	Payments
2007	$	907
2008		1,654
2009		501
2010		569
2011		1,584
2012		685
2013		1,347
2014		2,363
2015		848
2016		1,043
2017		1,065

Profit Sharing And Incentive Compensation Bonus Plans

The Bank’s Profit Sharing and Incentive Compensation Bonus Plans provide for payments to employees under certain circumstances based upon a year-end measurement of the Company’s net income and attainment of individual goals and objectives by certain key officers. There were no profit sharing or incentive compensation bonus distributions in 2006, 2005 and 2004 because the criteria for making such distributions were not met.

     The Board of Directors approved a holiday distribution to all non-officer employees in 2006 in the amount of $38 thousand. In 2005 and 2004, approval was given for a holiday distribution to all officers, excluding the CEO, and non-officer employees in the amount of $76 thousand and $47 thousand, respectively.

Employee Stock Ownership Plan

The Bank has an Employees’ Stock Ownership Plan (“ESOP”) for the benefit of each employee who has completed at least 1,000 hours of service with the Company in the previous twelve months.

     In 2006, 2005 and 2004, the Bank contributed $154,000, $160,000 and $145,000, respectively, to the ESOP to invest in the Company’s common stock. These shares were allocated to plan participants, on a pro rata basis, based on compensation.

     At December 31, 2006, the ESOP held 185,582 shares of the Company’s common stock which have been allocated to plan participants and no unallocated shares. The shares are considered outstanding in the computation of earnings per share and book value per share.

     Dividends on allocated shares held by the ESOP are allocated to plan participants proportionately based on the number of shares in the participant’s allocated accounts.

     The Company’s total expense applicable to the ESOP amounted to $121 thousand, $133 thousand and $205 thousand for the years ended December 31, 2006, 2005 and 2004, respectively.

Employee Agreements

The Bank has entered into employment agreements with certain executive officers which provide that the officer will receive a minimum amount of annual compensation from the Bank for a specified period. The agreements also provide for the continued payment of compensation to the officer for a specified period after termination under certain circumstances, including if the officer’s termination follows a “change of control,” generally defined to mean a person or group attaining ownership of 25% or more of the shares of the Company.

Executive Supplemental Retirement Agreements

The Bank maintains executive supplemental retirement agreements for certain executive officers. These agreements provide retirement benefits designed to supplement benefits available through the Bank’s retirement plan for employees. The Company made contributions of $67 thousand, $55 thousand and $52 thousand to a rabbi trust for the benefits payable under the agreements in 2006, 2005 and 2004.

57

15. Employee Benefits (continued)

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. In 2000, the plan was amended to allow the directors’ compensation to be invested in Company stock held in an irrevocable trust. At December 31, 2006, the trust held 17,944 shares of Massbank Corp. common stock. The shares are considered outstanding in the computation of earnings per share and book value per share.

Stock Option Plan

Effective April 20, 2004, the Board of Directors adopted and the shareholders approved the Corporation’s 2004 Stock Option and Incentive Plan (the “2004 Plan”). This new plan replaced the Corporation’s 1994 Stock Incentive Plan, which expired in January 2004. The 2004 Plan provides for awards of incentive stock options, non-qualified stock options, stock appreciation rights, a limited number of restricted stock awards and cash replacement awards. The total number of shares of common stock that can be issued under this plan is 400,000 shares, subject to adjustment for stock splits, stock dividends and similar events. Of this amount, no more than 100,000 shares of common stock may be issued as awards of restricted stock under the 2004 Plan. Under the 2004 Plan, the Corporation may not grant stock options with an exercise price less than 100% of the fair market value of the Corporation’s common stock on the date of grant. The maximum option term is ten years.

     Effective January 1, 2006, the Company adopted SFAS 123(R) using the modified prospective transition method to account for share-based payments to officers and directors of the Company. The only type of share-based payment utilized by the Company to-date is stock options. Stock options are awards which allow the officer 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.

     As of December 31, 2006, there were 93,332 non-qualified stock options and 151,518 incentive stock options outstanding to purchase shares under the 1994 and 2004 plans.

     A summary of the status of the Company’s fixed stock option plan as of December 31, 2006, 2005 and 2004, and changes during the years ended on those dates is presented below. All share information presented has been adjusted for stock splits.

Years Ended December 31,	2006					2005					2004
				Weighted					Weighted					Weighted
	Shares			Average		Shares			Average		Shares			Average
	Under			Exercise		Under			Exercise		Under			Exercise
Fixed options	Option			Price		Option			Price		Option			Price
Outstanding at beginning of year		251,637		$	26.95		300,087		$	24.35		318,334		$	20.94
Granted		35,500			32.79		32,850			37.15		30,250			42.76
Exercised		(38,637	)		19.41		(75,250	)		19.76		(48,097	)		13.22
Forfeited		(3,650	)		37.47		(6,050	)		42.42		(400	)		42.90
Outstanding at end of year		244,850		$	28.83		251,637		$	26.95		300,087		$	24.35
Options exercisable at year-end		210,600					251,637					300,087

The following table summarizes information about fixed stock options outstanding and exercisable at December 31,2006:

At December 31, 2006		Options Outstanding				Options exercisable
			Weighted Avg.	Weighted Avg.				Weighted Avg.
RANGE OF	Number		Remaining	Exercise		Number		Exercise
EXERCISE PRICES	Outstanding		Contractual Life	Price		Exercisable		Price
$19.00 to $20.67		65,875	2.3 years	$	19.76		65,875	$	19.76
25.00 to 27.63		47,250	3.1 years		26.09		47,250		26.09
28.44 to 29.60		43,325	2.7 years		29.14		43,325		29.14
32.50 to 32.80		34,250	8.9 years		32.79		—		—
36.70 to 42.90		54,150	7.0 years		39.52		54,150		39.52
$19.00 to $42.90		244,850	4.5 years	$	28.83		210,600	$	28.19

58

15. Employee Benefits (continued)

The Company estimates the fair value of stock option grants using the Black-Scholes valuation model. Expected volatilities are based on a combination of implied and historical volatilities of our common stock; the expected life represents the weighted average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and our historical exercise patterns; and the risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option. The following table presents the key input assumptions for the Black-Scholes valuation model:

Years ended December 31,	2006			2005
Weighted average fair value per share	$	6.58		$	8.11
Expected term (years)	7.3 years			7.3 years
Risk free interest rate		4.31	%		3.97	%
Dividend Yield		3.29	%		2.80	%
Volatility		21.5	%		21.2	%

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 in 2006 and 2005 was $511 thousand and $1.158 million, respectively. The total cash received from officers and directors of the Company as a result of stock option exercises in 2006 and 2005 was $750 thousand and $1.488 million, respectively. The tax benefit realized as a result of the stock option exercises was $114 thousand in 2006 compared to $342 thousand in 2005.

     In 2006, the Company recognized compensation cost amounting to $42 thousand, which has been charged against income, for options granted in January 2006 that will vest after the first year. As of December 31, 2006 there was $183 thousand of unrecognized compensation related to nonvested options granted in 2006. That cost is expected to be recognized pro-rata over the next four years as these options vest. Tax benefits recognized in the income statement related to compensation costs of these options was $14 thousand for 2006.

     During 2006, the Company extended the contractural life of 11,250 fully vested options to a retiring Director of the Company. As a result of this modification, the Company recognized additional compensation expense of $18 thousand for the year ended December 31, 2006.

16. Shareholder Rights Plan

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

59

17. Parent Company Financial Statements

The following are the condensed financial statements for Massbank Corp. (the “Parent Company”) only:

Balance Sheets

(In thousands except share data) At December 31,	2006			2005
Assets:
Cash	$	5,087		$	12
Interest-bearing deposits in banks		—			3,894
Total cash and cash equivalents		5,087			3,906
Investment in subsidiaries		101,789			101,135
Income tax receivable, net		155			210
Deferred income tax asset, net		32			25
Other assets		1			—
Total assets	$	107,064		$	105,276
Liabilities:
Other liabilities	$	179		$	12
Total liabilities		179			12
Stockholders’ Equity (Notes 12, 14, 15 and 16):
Preferred stock, par value $1.00 per share; 2,000,000 shares authorized, none issued
Common stock, par value $1.00 per share; 10,000,000 shares authorized, 7,850,317 and 7,811,680 shares issued in 2006 and 2005, respectively		7,850			7,812
Additional paid-in capital		57,953			57,067
Retained earnings		107,055			104,743
		172,858			169,622
Treasury stock at cost, 3,532,663 and 3,483,163 shares in 2006 and 2005, respectively		(62,902	)		(61,281	)
Accumulated other comprehensive income (loss)		(3,071	)		(3,077	)
Shares held in rabbi trust at cost 3,004 and 2,479 shares in 2006 and 2005, respectively		(84	)		(67	)
Deferred compensation obligation		84			67
Total stockholders’ equity		106,885			105,264
Total liabilities and stockholders’ equity	$	107,064		$	105,276

Statements of Income
(In thousands) Years ended December 31,	2006		2005		2004
Income:
Dividends received from subsidiaries	$	7,055	$	7,000	$	7,100
Interest and dividend income		14		31		18
Total interest and dividend income		7,069		7,031		7,118
Non-interest expense		186		170		179
Income before income taxes		6,883		6,861		6,939
Income tax benefit		110		99		108
Income before equity in undistributed earnings of subsidiaries		6,993		6,960		7,047
Equity in undistributed earnings of subsidiaries		34		363		333
Net income	$	7,027	$	7,323	$	7,380

The Parent Company only Statements of Changes in Stockholders’ Equity are identical to the consolidated statements and therefore are not presented here.

60

17. Parent Company Financial Statements (continued)

Statements Of Cash Flows
(In Thousands) Years Ended December 31,	2006			2005			2004
Cash flows from operating activities:
Net income	$	7,027		$	7,323		$	7,380
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed earnings of subsidiaries		(34	)		(363	)		(333	)
Dividend from subsidiary in the form of land		(480	)		—			—
Decrease (increase) in current income tax receivable, net		55			(23	)		22
Decrease (increase) in deferred income tax asset, net		(7	)		(4	)		7
Decrease (increase) in other assets		(1	)		29			(28	)
Increase (decrease) in other liabilities		167			(1	)		(4	)
Decrease (increase) in amount due from subsidiaries		—			196			(196	)
Share-based payment compensation		5			—			—
Net cash provided by operating activities		6,732			7,157			6,848
Cash flow from financing activities:
Payments to acquire treasury stock		(1,621	)		(4,487	)		(2,617	)
Purchase of company stock for deferred compensation plan, net of distributions		(17	)		(8	)		(13	)
Increase in deferred compensation obligation		17			8			13
Options exercised, including tax benefits		785			1,572			684
Dividends paid on common stock		(4,715	)		(4,583	)		(4,415	)
Net cash used in financing activities		(5,551	)		(7,498	)		(6,348	)
Net increase (decrease) in cash and cash equivalents		1,181			(341	)		500
Cash and cash equivalents at beginning of year		3,906			4,247			3,747
Cash and cash equivalents at end of year	$	5,087		$	3,906		$	4,247

During the years ended December 31, 2006, 2005 and 2004, the Company made cash payments for income taxes of $18 thousand, $30 thousand and $20 thousand, respectively, and no payments for interest.

     In addition, the Company made cash payments to the state of Delaware for franchise taxes in the amount of $39 thousand, $42 thousand and $48 thousand during the years ended December 31, 2006, 2005 and 2004, respectively.

18. Ten-Year Statistical Summary (Unaudited)

(In thousands except per share data)
Years ended December 31,	2006			2005			2004			2003			2002			2001			2000			1999			1998			1997
Net income	$	7,027		$	7,323		$	7,380		$	7,863		$	9,814		$	10,759		$	11,111		$	11,311		$	10,914		$	10,167
Diluted earnings per share		1.61			1.66			1.64			1.73			2.04			2.24			2.25			2.17			1.98			1.85
Cash dividends paid per share		1.09			1.05			1.00			0.92			0.88			0.84			0.79			0.74			0.68			0.59
Book value per share, at year-end		24.76			24.32			25.11			25.17			25.45			24.34			22.83			20.43			21.05			19.38
Return on average assets		0.82	%		0.79	%		0.75	%		0.78	%		0.99	%		1.13	%		1.20	%		1.20	%		1.17	%		1.12	%
Return on average equity		6.74	%		6.84	%		6.71	%		7.08	%		8.39	%		9.53	%		10.93	%		10.66	%		10.05	%		10.51	%

61

19. Quarterly Data (Unaudited)

Years ended december 31,	2006									2005
(In thousands except	4th			3rd		2nd		1st		4th		3rd		2nd		1st
Per share data)	Quarter			Quarter		Quarter		Quarter		Quarter		Quarter		Quarter		Quarter
Interest and dividend income	$	10,085		$	10,052	$	10,001	$	9,801	$	9,621	$	9,346	$	9,069	$	8,765
Interest expense		5,106			4,872		4,613		4,360		4,128		3,878		3,674		3,461
Net interest income		4,979			5,180		5,388		5,441		5,493		5,468		5,395		5,304
Provision (credit) for loan losses		(9	)		82		50		—		—		—		—		(53	)
Net interest income after provision (credit) for loan losses		4,988			5,098		5,338		5,441		5,493		5,468		5,395		5,357
Gains (losses) on securities, net		259			168		119		251		253		238		244		(56	)
Other non-interest income		477			292		279		360		290		329		354		265
Non-interest expense		3,053			2,942		3,058		3,307		3,097		3,189		3,185		3,043
Income before income taxes		2,671			2,616		2,678		2,745		2,939		2,846		2,808		2,523
Income tax expense		940			885		923		935		1,051		962		951		829
Net income	$	1,731		$	1,731	$	1,755	$	1,810	$	1,888	$	1,884	$	1,857	$	1,694
Earnings per share (in dollars):(1)
Basic	$	0.40		$	0.40	$	0.41	$	0.42	$	0.44	$	0.43	$	0.42	$	0.39
Diluted		0.40			0.40		0.40		0.41		0.43		0.43		0.42		0.38
Weighted average common shares outstanding:(1)
Basic		4,320			4,315		4,329		4,340		4,332		4,343		4,390		4,400
Diluted		4,353			4,349		4,364		4,377		4,371		4,398		4,452		4,470

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

62

Massbank Corp. And Subsidiaries Stockholder Data

Years ended December 31, 2006 and 2005

     Massbank Corp.’s common stock is currently traded on the NASDAQ Global Select Market under the symbol “MASB.” At December 31, 2006 there were 4,317,654 shares outstanding and 712 shareholders of record. Shareholders of record do not reflect the number of persons or entities who hold their stock in nominee or “street” name.

     The following table includes the quarterly ranges of high and low closing sales prices for the common stock, as reported by NASDAQ, and dividends declared per share for the periods indicated.

	Price per Share				Cash
					Dividends
	High		Low		Declared
Year ended december 31,	2006
Fourth Quarter	$	33.63	$	32.33	$	0.28
Third Quarter		33.94		32.44		0.27
Second Quarter		33.29		32.32		0.27
First Quarter		34.692		31.77		0.27

Year ended december 31,	2005
Fourth Quarter	$	33.48	$	28.567	$	0.27
Third Quarter		35.12		33.13		0.26
Second Quarter		37.84		34.25		0.26
First Quarter		38.52		36.94		0.26

Comparative Massbank Corp. Stock Performance Data

The following data compares the performance of the Common Stock of the Company (assuming reinvestment of dividends) to the total return of the S&P 500 Index. The S&P 500 Index is a well known, unmanaged index of the prices of 500 large-company common stocks selected by Standard & Poor’s. The data assumes a $100 initial investment in the Common Stock of MASSBANK Corp. and the stocks included in the S&P 500 Index.

Comparative cumulative Return Totals (years ended december 31,)

Comparative 5 year cumulative total return

	2001		2002		2003		2004		2005		2006
Massbank Corp.	$	100.00	$	122.26	$	189.79	$	169.67	$	154.26	$	158.84
S&P500 Index	$	100.00	$	78.03	$	100.16	$	110.92	$	116.28	$	134.43

Comparative 10 Year Cumulative Total Return

	1996		1997		1998		1999		2000		2001		2002		2003		2004		2005		2006
Massbank Corp.	$	100.00	$	169.65	$	143.01	$	111.88	$	115.43	$	146.25	$	178.81	$	277.56	$	248.14	$	225.61	$	232.31
S&P500 Index	$	100.00	$	133.10	$	170.82	$	206.49	$	187.84	$	165.58	$	129.21	$	165.85	$	183.66	$	192.54	$	222.59

Comparative 15 Year Cumulative Total Return

	1991		1992		1993		1994		1995		1996		1997		1998		1999		2000		2001		2002		2003		2004		2005		2006
Massbank Corp.	$	100.00	$	195.10	$	211.62	$	211.40	$	300.16	$	369.13	$	626.23	$	527.88	$	412.99	$	426.08	$	539.85	$	660.03	$	1,024.57	$	915.94	$	832.79	$	857.52
S&P500 Index	$	100.00	$	107.43	$	118.09	$	119.61	$	164.01	$	201.21	$	267.81	$	343.70	$	415.48	$	377.95	$	333.16	$	259.98	$	333.70	$	369.53	$	387.39	$	447.87

Comparative 20 year cumulative total return

	1986		1987		1988		1989		1990		1991		1992		1993		1994		1995		1996
Massbank Corp.	$	100.00	$	98.10	$	136.05	$	126.27	$	96.66	$	125.60	$	245.05	$	265.80	$	265.51	$	377.00	$	463.62
S&P500 Index	$	100.00	$	105.67	$	122.94	$	161.31	$	156.27	$	203.15	$	218.25	$	239.91	$	242.99	$	333.18	$	408.75

	1997		1998		1999		2000		2001		2002		2003		2004		2005		2006
Massbank Corp.	$	786.54	$	663.01	$	518.71	$	535.15	$	678.05	$	829.00	$	1,286.85	$	1,150.41	$	1,045.97	$	1,077.03
S&P500 Index	$	544.05	$	698.22	$	844.05	$	767.81	$	676.82	$	528.16	$	677.92	$	750.71	$	786.99	$	909.86

Refer to page 7 of this report for performance graphs.

63

Officers and directors
Massbank Corp.

OFFICERS

Gerard H. Brandi
Chairman, President and
Chief Executive Officer

Reginald E. Cormier
Senior Vice President, Treasurer and
Chief Financial Officer

Robert S. Cummings
Secretary

Donna H. West
Assistant Secretary

Board of Directors

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

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

†* Allan S. Bufferd
     Treasurer Emeritus,
     Massachusetts Institute of Technology

     Kathleen M. Camilli
     President
     Camilli Economics, LLC

* Stephen W. Carr
   Retired Partner, Attorney
   Goodwin Procter LLP

† Alexander S. Costello
   Teacher, Brooks School

 
   O. Bradley Latham
   Attorney, Principal
   Latham, Latham & Lamond, P.C.

* Stephen E. Marshall
   Retired, C.H. Cleaves Insurance
   Agency, Inc.

† Nancy L. Pettinelli
   Executive Director,
   Visiting Nurse Association
   of Greater Lowell, Inc.

†* William F. Rucci, Jr.
     Certified Public Accountant, Partner
     Rucci, Bardaro & Barrett, PC

* Member, Executive Committee
† Member, Audit Committee

Officers and Directors
Massbank

OFFICERS

Gerard H. Brandi
Chairman, President and
Chief Executive Officer

James L. Milinazzo
Senior Vice President, Lending

Donna H. West
Senior Vice President,
Community Banking and
Chief Operating Officer

Reginald E. Cormier
Senior Vice President, Treasurer
and Chief Financial Officer

William F. Rivers
Vice President, Operations

Richard J. Flannigan
Vice President and
Senior Trust Officer

Thomas J. Queeney
Vice President and
Senior Trust Officer

Joseph P. Orefice
Vice President and Director,
Information Technology

Carol A. Axelrod
Loan Origination Officer

Kenneth R. Berard
Assistant Treasurer

David M. Bianco
Assistant Treasurer

Ernest G. Campbell, Jr.
Collections Officer

Marianne J. Carpenter
Director, Human Resources

Lisa A. DiCicco
Trust Operations Officer and
Executive Administrator

Karen L. Flammia
Assistant Vice President

Scott M. Forbes
Mortgage Origination Officer

Rachael E. Garneau
Assistant Vice President

Martin J. Heneghan
Assistant Controller

Brian W. Hurley
Assistant Vice President,
Loan Operations

Richard H. Jordan
Security/BSA Officer

Brian P. Mahoney
Director of Audit

Kenneth A. Masson
Assistant Vice President,
Marketing

Seda Sam
Assistant Treasurer

John J. Spinello
Controller

Shaun Tulley
Information Technology Officer

Karen L. Trevisone
Assistant Treasurer

Margaret E. White
Assistant Treasurer

Patricia A. Witts
Assistant Treasurer

Michael J. Woods
Assistant Vice President,
Operations

Board of Directors
and
Executive Committee

Mathias B. Bedell
Gerard H. Brandi, Chairman
Allan S. Bufferd
Stephen W. Carr
Robert S. Cummings, Clerk
Stephen E. Marshall
William F. Rucci, Jr.
Donna H.West

64

Corporate Information

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

Savings and Mortgage
24-Hour-Rate Lines

(781) 662-0154
(978) 446-9285

Notice of Shareholders’ Meeting

The Annual Meeting of the
Shareholders of Massbank Corp.
will be held at 10:00 A.M.
on Tuesday, April 17, 2007 at the
Sheraton Ferncroft Resort
50 Ferncroft Road
Danvers, MA 01923

Trademark

MASSBANK and its logo are
registered trademarks of
the Company

Form 10-K

Shareholders may obtain without
charge a copy of the Company’s
2006 Form 10-K. Written requests
should be addressed to:
Shareholder Services
Massbank Corp.
159 Haven Street
Reading, MA 01867

Dividend Reinvestment and
Stock Purchase Plan

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

Transfer Agent

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

Independent Registered
Public Accounting Firm

Parent, McLaughlin & Nangle
160 Federal Street
Boston, MA 02110-1713

Legal Counsel

Goodwin Procter LLP
Exchange Place
Boston, MA 02109

Massbank Branch Offices d/b/a

Massbank of Reading*

123 Haven Street
Reading, MA 01867
(781) 942-8188
(978) 446-9200
*Main Office

Massbank of Chelmsford

291 Chelmsford Street
Chelmsford, MA 01824
(978) 256-3751

17 North Road
Chelmsford, MA 01824
(978) 256-3733

Massbank of Dracut

45 Broadway Road
Dracut, MA 01826
(978) 441-0040

Massbank of Everett

738 Broadway
Everett, MA 02149
(617) 387-5115

Massbank of Lowell

50 Central Street
Lowell, MA 01852
(978) 446-9200

755 Lakeview Avenue
Lowell, MA 01850
(978) 446-9216

Massbank of Medford

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

Massbank of Melrose

476 Main Street
Melrose, MA 02176
(781) 662-0100

27 Melrose Street
Towers Plaza
Melrose, MA 02176
(781) 662-0165

Massbank of Stoneham

240 Main Street
Stoneham, MA 02180
(781) 662-0177

Massbank of Tewksbury

1800 Main Street
Tewksbury, MA 01876
(978) 851-0300

Massbank of Westford

203 Littleton Road
Westford, MA 01886
(978) 692-3467

Massbank of Wilmington

370 Main Street
Wilmington, MA 01887
(978) 658-4000

211 Lowell Street, Unit G
Lucci’s Plaza
Wilmington, MA 01887
(978) 658-5775

EX-21

Exhibit 21

List of Subsidiaries of MASSBANK Corp.

MASSBANK Corp. is the parent company of:

MASSBANK (the “Bank”)
Knabssam LLC

MASSBANK has three wholly-owned subsidiaries:

Readibank Properties, Inc.
Readibank Investment Corporation
Melbank Investment Corporation

EX-23

\

EXHIBIT 23

Consent of Independent Registered Public Accounting Firm

The Board of Directors
MASSBANK Corp.

We consent to incorporation by reference in the registration statements Form S-8, (File Nos. 33-11949, 33-82110 and 33-118028) of MASSBANK Corp. of our reports dated March 6, 2007, with respect to the consolidated balance sheets of MASSBANK Corp. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, cash flows and changes in stockholders’ equity for the years ended December 31, 2006 and 2005, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, and the effectiveness of internal control over financial reporting as of December 31, 2006, which reports appear in the Annual Report on Form 10-K of MASSBANK Corp.

	/s/ Parent, McLaughlin & Nangle
	Certified Public Accountants, Inc.
Boston, Massachusetts
March 14, 2007

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Gerard H. Brandi certify that:

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

a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)	Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and
d)	Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent function):

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

Date: March 15, 2007	/s/ Gerard H. Brandi
	Gerard H. Brandi, President and CEO
	(principal executive officer)

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Reginald E. Cormier certify that:

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

a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)	Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and
d)	Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent function):

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

Date: March 15, 2007	/s/ Reginald E. Cormier
	Reginald E. Cormier, Sr. V.P., Treasurer & CFO
	(principal financial officer)

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

     In connection with the Annual Report on Form 10-K of MASSBANK Corp. (the “Registrant”) for the year ended December 31, 2006 (the “Report”) as filed with the Securities and Exchange Commission on the date hereof, I, Gerard H. Brandi, President and Chief Executive Officer of the Registrant, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1.	The Annual Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.	To my knowledge, the information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant as of and for the period covered by the report.

Dated: March 15, 2007	/s/ Gerard H. Brandi
	Gerard H. Brandi
	President and Chief Executive Officer

The foregoing certification is being furnished solely pursuant to 18 U.S.C. Section 1350 and is not being filed as part of the Report or as a separate disclosure document.

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

     In connection with the Annual Report on Form 10-K of MASSBANK Corp. (the “Registrant”) for the year ended December 31, 2006 (the “Report”) as filed with the Securities and Exchange Commission on the date hereof, I, Reginald E. Cormier, Sr. Vice President, Treasurer and Chief Financial Officer of the Registrant, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1.	The Annual Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.	To my knowledge, the information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant as of and for the period covered by the report.

Dated: March 15, 2007	/s/ Reginald E. Cormier
	Reginald E. Cormier
	Sr. Vice President, Treasurer Chief Financial Officer

The foregoing certification is being furnished solely pursuant to 18 U.S.C. Section 1350 and is not being filed as part of the Report or as a separate disclosure document.