Massbank (MASB) 10-Q 2007 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2007

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from______________to____________

Commission File Number 0-15137

MASSBANK Corp.

(Exact name of registrant as specified in its charter)

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

123 HAVEN STREET

Reading, Massachusetts 01867

(Address of principal executive offices, including Zip Code)

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

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

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

Large accelerated filer  ¨                    Accelerated filer  x                    Non-accelerated filer  ¨

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

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

Class: Common stock $1.00 per share.

Outstanding at October 31, 2007: 4,268,154 shares.

MASSBANK CORP. AND SUBSIDIARIES

INDEX

PART I - FINANCIAL INFORMATION

		Page
ITEM 1.	Financial Statements
	Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006 (Unaudited)	3
	Consolidated Statements of Income for the three months ended September 30, 2007 and 2006 (Unaudited)	4
	Consolidated Statements of Income for the nine months ended September 30, 2007 and 2006 (Unaudited)	5
	Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2007 and 2006 (Unaudited)	6 - 7
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006 (Unaudited)	8 - 9
	Condensed Notes to the Consolidated Financial Statements	10 - 18
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19 - 45
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	46
ITEM 4.	Controls and Procedures	47
PART II - OTHER INFORMATION
ITEM 1.	Legal Proceedings	48
ITEM 1A.	Risk Factors	48
ITEM 2c.	Share Repurchases	48
ITEM 3.	Defaults Upon Senior Securities	49
ITEM 4.	Submission of Matters to a Vote of Security Holders	49
ITEM 5.	Other Information	49
ITEM 6.	Exhibits	49
Signature Page		50

2

PART 1. ITEM 1

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands except share data)

(Unaudited)

	September 30, 2007			December 31, 2006
Assets:
Cash and due from banks	$	6,882		$	8,650
Short-term investments (Note 4)		162,452			139,240
Total cash and cash equivalents		169,334			147,890
Term federal funds sold		63,000			41,000
Securities available for sale, at fair value (amortized cost of $130,019 in 2007 and $407,604 in 2006)		129,863			403,079
Mortgage-backed securities held to maturity, at amortized cost (market value of $8,004 in 2007 and $5,276 in 2006)		8,127			5,396
Trading securities, at fair value:
Debt securities		231,160			—
Equity securities and mutual funds		2,817			1,931
Loans: (Note 5)
Mortgage loans		183,841			199,253
Other loans		9,571			9,674
Allowance for loan losses		(1,370	)		(1,382	)
Net loans		192,042			207,545
Premises and equipment		8,176			7,085
Real estate held for resale		425			425
Accrued interest and income receivable		5,322			5,083
Goodwill		1,090			1,090
Income tax receivable, net		380			88
Deferred income tax asset, net		1,968			3,347
Other assets		3,343			19,563
Total assets	$	817,047		$	843,522
Liabilities and Stockholders’ Equity:
Deposits	$	693,362		$	723,332
Escrow deposits of borrowers		963			1,006
Borrowed funds		10,000			—
Allowance for loan losses on off-balance sheet credit exposures		345			345
Other liabilities		4,954			11,954
Total liabilities		709,624			736,637
Stockholders’ Equity:
Preferred stock, par value $1.00 per share; 2,000,000 shares authorized, none issued		—			—
Common stock, par value $1.00 per share; 10,000,000 shares authorized, 7,872,017 and 7,850,317 shares issued in 2007 and 2006, respectively		7,872			7,850
Additional paid-in capital		58,482			57,953
Retained earnings		106,810			107,055
		173,164			172,858
Treasury stock at cost, 3,605,363 and 3,532,663 shares in 2007 and 2006, respectively		(65,385	)		(62,902	)
Accumulated other comprehensive loss		(356	)		(3,071	)
Shares held in rabbi trust at cost, 19,444 and 17,944 shares in 2007 and 2006, respectively (Note 7)		(475	)		(426	)
Deferred compensation obligation		475			426
Total stockholders’ equity		107,423			106,885
Total liabilities and stockholders’ equity	$	817,047		$	843,522

See accompanying condensed notes to consolidated financial statements.

3

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended September 30,
(In thousands except share data)	2007			2006
Interest and dividend income:
Mortgage loans	$	2,541		$	2,799
Other loans		193			200
Securities available for sale:
Mortgage-backed securities		1,702			1,799
Other securities		34			3,146
Mortgage-backed securities held to maturity		104			73
Trading securities		2,646			38
Federal funds sold		2,058			1,923
Other investments		735			74
Total interest and dividend income		10,013			10,052
Interest expense:
Deposits		5,364			4,872
Borrowed funds		4			—
Total interest expense		5,368			4,872
Net interest income		4,645			5,180
Provision (credit) for loan losses		—			82
Net interest income after provision (credit) for loan losses		4,645			5,098
Non-interest income:
Deposit account service fees		81			84
Gains (losses) on securities available for sale, net		(104	)		80
Gains on trading securities, net		2,209			88
Option fees		75			—
Deferred compensation plan income		9			48
Other		166			147
Total non-interest income		2,436			447
Non-interest expense:
Salaries and employee benefits		2,292			1,808
Deferred compensation plan expense		148			69
Occupancy and equipment		528			490
Data processing		149			146
Professional services		230			113
Advertising and marketing		56			46
Deposit insurance		27			31
Other		330			226
Total non-interest expense		3,760			2,929
Income before income taxes		3,321			2,616
Income tax expense		1,195			885
Net income	$	2,126		$	1,731
Weighted average common shares outstanding:
Basic		4,299,907			4,315,211
Diluted		4,328,422			4,349,187
Earnings per share (in dollars):
Basic	$	0.49		$	0.40
Diluted		0.49			0.40

See accompanying condensed notes to consolidated financial statements.

4

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Nine Months Ended September 30,
(In thousands except share data)	2007			2006
Interest and dividend income:
Mortgage loans	$	7,820		$	8,554
Other loans		585			570
Securities available for sale:
Mortgage-backed securities		5,236			5,469
Other securities		97			9,025
Mortgage-backed securities held to maturity		240			229
Trading securities		7,922			194
Federal funds sold		6,438			5,727
Other investments		1,710			86
Total interest and dividend income		30,048			29,854
Interest expense:
Deposits		15,844			13,845
Borrowed funds		4			—
Total interest expense		15,848			13,845
Net interest income		14,200			16,009
Provision (credit) for loan losses		(10	)		132
Net interest income after provision (credit) for loan losses		14,210			15,877
Non-interest income:
Deposit account service fees		245			258
Gains on securities available for sale, net		184			429
Gains on trading securities, net		3,049			109
Option fees		225			—
Deferred compensation plan income		118			109
Other		560			525
Total non-interest income		4,381			1,430
Non-interest expense:
Salaries and employee benefits		6,032			5,544
Deferred compensation plan expense		304			172
Occupancy and equipment		1,553			1,702
Data processing		436			417
Professional services		472			414
Advertising and marketing		125			102
Deposit insurance		82			96
Other		947			821
Total non-interest expense		9,951			9,268
Income before income taxes		8,640			8,039
Income tax expense		3,011			2,743
Net income	$	5,629		$	5,296
Weighted average common shares outstanding:
Basic		4,322,309			4,327,930
Diluted		4,348,828			4,363,386
Earnings per share (in dollars):
Basic	$	1.30		$	1.22
Diluted		1.29			1.21

See accompanying condensed notes to consolidated financial statements.

5

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For The Nine Months Ended September 30, 2007 (Unaudited)

(In thousands except share data)

	COMMON STOCK		ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			TREASURY STOCK			ACCUMULATED OTHER COMPREHENSIVE LOSS			SHARES HELD IN RABBI TRUST			DEFERRED COMPENSATION OBLIGATION		TOTAL
Balance at December 31, 2006	$	7,850	$	57,953	$	107,055		$	(62,902	)	$	(3,071	)	$	(426	)	$	426	$	106,885
Cumulative effect of adoption of the fair value option, net of tax		—		—		(2,235	)		—			2,235			—			—		—
Net Income		—		—		5,629			—			—			—			—		5,629
Other comprehensive income, net of tax:
Unrealized gains on securities, net of reclassification adjustment (Note 9)		—		—		—			—			486			—			—		486
Amortization of prior service cost and transition obligation on pension plan, net of tax (Note 9)		—		—		—			—			(6	)		—			—		(6	)
Comprehensive income																				6,109
Cash dividends paid ($0.84 per share)		—		—		(3,639	)		—			—			—			—		(3,639	)
Purchase of treasury stock		—		—		—			(2,483	)		—			—			—		(2,483	)
Purchase of company stock for deferred compensation plan		—		—		—			—			—			(49	)		49		—
Share-based payment compensation		—		66		—			—			—			—			—		66
Exercise of stock options		22		425		—			—			—			—			—		447
Tax benefit on stock options exercised		—		38		—			—			—			—			—		38
Balance at September 30, 2007	$	7,872	$	58,482	$	106,810		$	(65,385	)	$	(356	)	$	(475	)	$	475	$	107,423

See accompanying condensed notes to consolidated financial statements.

6

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

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

(In thousands except share data)

	COMMON STOCK		ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			TREASURY STOCK			ACCUMULATED OTHER COMPREHENSIVE LOSS			SHARES HELD IN RABBI TRUST			DEFERRED COMPENSATION OBLIGATION		TOTAL
Balance at December 31, 2005	$	7,812	$	57,067	$	104,743		$	(61,281	)	$	(3,077	)	$	(351	)	$	351	$	105,264
Net Income		—		—		5,296			—			—			—			—		5,296
Other comprehensive income, net of tax:
Unrealized losses on securities, net of reclassification adjustment (Note 9)		—		—		—			—			(416	)		—			—		(416	)
Comprehensive income																				4,880
Cash dividends paid ($0.81 per share)		—		—		(3,507	)		—			—			—			—		(3,507	)
Purchase of treasury stock		—		—		—			(1,391	)		—			—			—		(1,391	)
Purchase of company stock for deferred compensation plan		—		—		—			—			—			(35	)		35		—
Share-based payment compensation		—		50		—			—			—			—			—		50
Exercise of stock options		28		492		—			—			—			—			—		520
Tax benefit on stock options exercised		—		86		—			—			—			—			—		86
Balance at September 30, 2006	$	7,840	$	57,695	$	106,532		$	(62,672	)	$	(3,493	)	$	(386	)	$	386	$	105,902

See accompanying condensed notes to consolidated financial statements.

7

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended September 30,
	2007			2006
	(In thousands)
Cash flows from operating activities:
Net income	$	5,629		$	5,296
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		396			562
Provision (credit) for loan losses		(10	)		132
Provision (credit) for loan losses on off-balance sheet credit exposures		—			(181	)
Share-based payment compensation		66			50
Loan interest capitalized		(7	)		(8	)
Increase in accrued interest and income receivable		(239	)		(1,675	)
(Decrease) increase in other liabilities		(7,010	)		226
Increase in income tax receivable, net		(292	)		(246	)
Amortization of premiums (accretion of discounts) on securities, net		(31	)		15
Trading securities activity:
Proceeds from sales of debt securities		4,945			6,940
Proceeds from sales of equity securities		22,158			8,167
Proceeds from maturities and calls of debt securities		100,750			2,000
Purchases of debt securities		(72,970	)		(984	)
Purchases of equity securities		(22,688	)		(7,074	)
Principal repayments of securities		35			—
Amortization of premiums (accretion of discounts) on securities, net		29			(27	)
Gains on securities available for sale, net		(184	)		(429	)
Gains on trading securities, net		(3,049	)		(109	)
(Increase) decrease in net deferred mortgage loan origination costs, net of amortization		(15	)		(18	)
Decrease (increase) in deferred income tax asset, net		1,031			(35	)
(Decrease) increase in accrued income taxes, net		—			(35	)
Decrease (increase) in other assets		16,225			(4,068	)
Gains on sales of premises and equipment		—			(3	)
Net cash provided by operating activities		44,769			8,496
Cash flows from investing activities:
Purchases of term Federal funds		(188,000	)		(15,000	)
Proceeds from maturities of term Federal funds		166,000			—
Net decrease in interest-bearing bank deposits		—			898
Proceeds from sales of securities available for sale		5,083			15,565
Proceeds from maturities and calls of securities available for sale		—			75,000
Purchases of securities available for sale		(2,715	)		(70,097	)
Purchases of mortgage-backed securities available for sale		(9,048	)		(15,971	)
Purchases of mortgage-backed securities held to maturity		(2,966	)		—
Principal repayments of mortgage-backed securities		19,923			20,371
Loans originated		(13,380	)		(17,096	)
Loan principal payments received		28,915			28,986
Purchases of premises & equipment		(1,487	)		(1,513	)
Proceeds from sales of premises and equipment		—			3
Net cash provided by investing activities		2,325			21,146

8

MASSBANK CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited)

	Nine Months Ended September 30,
	2007			2006
	(In thousands)
Cash flows from financing activities:
Net decrease in deposits		(29,970	)		(55,317	)
Decrease in escrow deposits of borrowers		(43	)		(67	)
Proceeds from borrowed funds		10,000			—
Payments to acquire treasury stock		(2,483	)		(1,391	)
Options exercised, including tax benefit		485			606
Cash dividends paid on common stock		(3,639	)		(3,507	)
Net cash used in financing activities		(25,650	)		(59,676	)
Net increase (decrease) in cash and cash equivalents		21,444			(30,034	)
Cash and cash equivalents at beginning of period		147,890			177,377
Cash and cash equivalents at end of period	$	169,334		$	147,343
Supplemental cash flow disclosures:
Cash transactions:
Cash paid during the period for interest	$	15,848		$	13,840
Cash paid during the period for taxes, net of refunds		2,234			2,973
Non-cash transactions:
Transfer of securities from available for sale to trading securities (at fair value) upon early adoption of SFAS No. 159	$	261,256		$	—

See accompanying condensed notes to consolidated financial statements.

9

MASSBANK CORP.

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(1) Basis of Presentation

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

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and in the opinion of management, include all adjustments of a normal recurring nature necessary for the fair presentation of the financial condition of the Company as of September 30, 2007 and December 31, 2006, and its operating results for the three months and nine months ended September 30, 2007 and 2006, respectively. The results of operations for any interim period are not necessarily indicative of the results to be expected for the entire year.

Certain amounts in the prior year’s consolidated financial statements were reclassified to facilitate comparison with the current fiscal year.

The information in this report should be read in conjunction with the financial statements and related notes included in the Annual Report on Form 10-K for the year ended December 31, 2006.

10

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(2) Recent Accounting Pronouncements:

SFAS No. 157, Fair Value Measurements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (“FAS 157”), Fair Value Measurements, which defines fair value, establishes a framework for measuring the fair value of assets and liabilities based on a three-level hierarchy, and expands disclosures about fair value measurements. The FASB’s three-level fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the company has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability.

FAS 157 is effective for fiscal years beginning after November 15, 2007, and, with certain exceptions, is to be applied prospectively. Earlier adoption of FAS 157 is permitted as of the beginning of an earlier fiscal year, provided the company has not yet issued a financial statement for any period of that fiscal year. Thus, a company with a calendar year fiscal year may voluntarily adopt FAS 157 as of January 1, 2007. For those financial instruments identified in FAS 157 to which the standard must be applied retrospectively upon initial application, the effect of initially applying FAS 157 to these instruments should be recognized as a cumulative-effect adjustment to the opening balance of retained earnings at the beginning of the fiscal year of adoption.

The Company adopted FAS 157 as of January 1, 2007. The early adoption of FAS 157 did not have a material effect on MASSBANK Corp.’s financial condition.

SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 (“FAS 159”), The Fair Value Option for Financial Assets and Financial Liabilities, which gives companies the option to measure eligible financial assets and financial liabilities at fair value on an instrument by instrument basis with the changes in fair value included in earnings. In general, a company may elect the fair value option for an eligible financial asset or liability when it first recognizes the instrument on its balance sheet or enters into an eligible firm commitment. A company may also elect the fair value option for eligible items that exist on the effective date of FAS 159. A company’s decision to elect the fair value option for an eligible item is irrevocable. A company that elects the fair value option is expected to apply sound risk management and control practices to the assets and liabilities that will be accounted for at fair value under the option.

FAS 159 is effective as of the beginning of a company’s first fiscal year that begins after November 15, 2007, and should not be applied retrospectively to prior fiscal years, except as permitted in the standard’s early adoption provisions. A company may adopt FAS 159 and elect the fair value option for existing eligible items as of the beginning of a fiscal year that begins on or before November 15, 2007, subject to the conditions set forth in the standard, one of which is a requirement to adopt all of the requirements of FAS 157 at the early adoption date of FAS 159 or earlier. Under the early adoption provisions of FAS 159, a company with a calendar year fiscal year may adopt this standard as of January 1, 2007, provided it adopts FAS 157 as of that date or earlier. If a company elects the fair value option for eligible items that exist on the effective date of its adoption of FAS 159, the Company must report the effect of the first re-measurement of these items to fair value as a cumulative-effect adjustment to the opening balance of retained earnings at the beginning of the fiscal year of adoption.

The Company adopted FAS 159 as of January 1, 2007. The early adoption of FAS 159 did not have a material effect on MASSBANK Corp.’s financial condition (See Note 11).

11

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(3) Cash and Cash Equivalents:

For purposes of reporting cash flows, cash and cash equivalents consist of cash and due from banks, and short-term investments with original maturities of less than 90 days.

(4) Short-Term Investments

Short-term investments consist of the following:

(In thousands)	At September 30, 2007		At December 31, 2006
Federal funds sold (overnight)	$	40,918	$	117,104
Term federal funds sold		57,000		—
Money market investment funds		64,531		22,133
Interest-bearing bank money market accounts		3		3
Total short-term investments	$	162,452	$	139,240

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

(5) Financial Instruments with Off-Balance Sheet Risk

The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts reflect the extent of involvement the Bank has in particular classes of these instruments. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument is represented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

	Contract or Notional Amount
(In thousands)	At September 30, 2007		At December 31, 2006
Financial instruments whose contract amounts represent credit risk:
Commitments to originate residential mortgage loans	$	700	$	1,206
Unadvanced portions of construction loans		998		217
Unused credit lines, including unused portions of equity lines of credit		26,688		28,779
Other loan commitments		2,225		2,337

Commitments to extend credit are agreements to lend to a customer as long as there is no violation for 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.

The Bank maintains an allowance for loan losses on off-balance sheet credit exposures. At September 30, 2007 and December 31, 2006 this allowance, which is shown separately on the balance sheet, totaled $345,000.

12

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(6) Earnings Per Common Share

Basic EPS is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period.

Diluted EPS reflects the effect on the weighted average shares outstanding of the number of additional shares outstanding if dilutive stock options were converted into common stock using the treasury stock method.

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

Earnings per share was calculated as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
(In thousands, except per share data)	2007		2006		2007		2006
Denominator for basic earnings per share:
Average common shares outstanding		4,300		4,315		4,322		4,328
Dilutive common stock options		28		34		27		35
Denominator for diluted earnings per share		4,328		4,349		4,349		4,363
Numerator:
Net income attributable to common shares	$	2,126	$	1,731	$	5,629	$	5,296
Earnings per share:
Basic	$	0.49	$	0.40	$	1.30	$	1.22
Diluted		0.49		0.40		1.29		1.21

(7) Directors’ Deferred Compensation Plan

In 1988, the Company established a deferred compensation plan for its directors. The Plan allows the Company’s directors to defer receipt of all or a portion of their compensation until (1) their attaining the age of 72, or (2) their termination as a director of the Company. The Plan was later amended to allow the directors’ compensation to be invested in Company stock held in a rabbi trust. At September 30, 2007 and December 31, 2006, the Trust held 19,444 and 17,944 shares of MASSBANK Corp. common stock, respectively. The deferred compensation obligation of the Plan may be settled only by delivery of the shares of MASSBANK Corp. stock to the directors participating in the Plan. These shares are considered outstanding in the computation of earnings per share and book value per share.

13

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(8) Stock Option Plan

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

The only type of share-based payment utilized by the Company to date is stock options. Stock options are awards which allow the employee or director to purchase shares of the Company’s stock at a fixed price. Stock options are granted at an exercise price equal to the Company’s 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 2007 and 2006 vest at 20% per year over five years and have a contractual term of ten years.

The following tables summarize stock option activity during the first nine months of 2007:

	Shares Under Option		Weighted Average Exercise Price Per Share
Outstanding at December 31, 2006	244,850		$	28.83
Options Granted	35,000			32.62
Options Exercised	(21,700	)		20.57
Options Forfeited	(2,150	)		36.95
Outstanding at September 30, 2007	256,000		$	29.98
Exercisable at September 30, 2007	194,500		$	29.12

At September 30, 2007		Options Outstanding			Options Exercisable
Range of Exercise Price	Number Outstanding	Weighted Avg. Remaining Contractual Life	Weighted Avg. Exercise Price		Number Exercisable	Weighted Avg. Exercise Price
$19.00   to $ 20.67	45,375	2.6 years	$	19.62	45,375	$	19.62
25.00   to     27.63	47,250	2.4 years		26.09	47,250		26.09
28.44   to     29.60	42,125	2.0 years		29.13	42,125		29.13
32.50   to     32.92	68,250	8.8 years		32.70	6,750		32.79
36.70   to     42.90	53,000	6.2 years		39.50	53,000		39.50
$19.00   to $ 42.90	256,000	4.8 years	$	29.98	194,500	$	29.12

14

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(8) Stock Option Plan (continued)

The Company estimates the fair value of stock option grants using the Black-Scholes valuation model. The Black-Scholes valuation model uses the following assumptions: expected volatility, expected term of option, risk-free interest rate and dividend yield. Expected volatility estimates are developed by the Company based on historical volatility of the Company’s stock. The Company uses historical data to estimate the expected term of the options. The risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury yield in effect at the grant date. The dividend yield represents the expected dividends on the Company stock. The Company believes that the valuation technique and the approach utilized to develop the underlying assumptions are consistent with SFAS 123R. Estimates of fair value are not intended to predict the actual future value ultimately realized by employees and directors who receive share-based awards, and subsequent events are not indicative of the reasonableness of original estimates of fair value made by the Company under SFAS 123R.

The following table presents the key input assumptions for the Black-Scholes valuation model:

	Nine Months Ended September 30,
	2007			2006
Expected Term (years)		7.3 years			7.3 years
Volatility		21.30	%		21.50	%
Risk-free interest rate		4.73	%		4.31	%
Dividend Yield		3.47	%		3.29	%
Fair value per share	$	6.67		$	6.58

The total intrinsic value (amount by which the fair value of the underlying stock exceeds the exercise price of an option on exercise date) of options exercised during the nine months ended September 30, 2007 and 2006, was $266,000 and $408,000, respectively. The total cash received from employees and directors as a result of stock option exercises for the nine months ended September 30, 2007 and 2006 was $447,000 and $520,000, respectively. The tax benefit realized as a result of the stock options exercised was $38,000 in the first nine months of 2007 compared to $86,000 for the same period in 2006.

As of September 30, 2007, there was $347,000 of unearned compensation cost related to non-vested stock options granted in 2007 and 2006. The Company expects to recognize the expense over a weighted-average period of 3.9 years. The total compensation cost related to options expensed during the nine months ended September 30, 2007 and September 30, 2006 was $66,000 and $50,000, respectively. These amounts are included in salary expense in the accompanying consolidated Statements of Income.

15

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(9) Comprehensive Income (Loss)

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

The components of other comprehensive income (loss) and related tax effect for the nine months ended September 30, 2007 and 2006 are as follows:

	Nine Months Ended September 30,
(In thousands)	2007			2006
Unrealized holding gains (losses) on available for sale securities and when issued securities contracts arising during the period	$	1,022		$	(298	)
Less: reclassification adjustment for gains realized in income		184			429
Net unrealized gains (losses)		838			(727	)
Tax (expense) or benefit		(352	)		311
Net unrealized gains (losses), net of tax		486			(416	)
Recognized pension prior service cost and transition obligation		(10	)		—
Tax benefit		4			—
Pension liability adjustment, net of tax		(6	)		—
Other comprehensive income (loss)	$	480		$	(416	)

16

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(10) Pension Plan

The Bank sponsors a noncontributory defined benefit pension plan that covers all employees who meet specified age and length of service requirements, which is administered by the Savings Banks Employees Retirement Association

(“SBERA”). The plan provides for benefits to be paid to eligible employees at retirement based primarily upon their years of service with the Bank and compensation levels near retirement. Contributions to the plan reflect benefits

attributed to employees’ service to date, as well as service expected to be earned in the future.

The following table sets forth the amount of net periodic pension expense recognized for the three months and nine months ended September 30, 2007 and 2006:

Pension Benefits

	Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands)	2007			2006			2007			2006
Service cost	$	118		$	103		$	354		$	310
Interest cost		153			144			460			431
Expected return on plan assets		(178	)		(164	)		(534	)		(491	)
Amortization of transition obligation		(5	)		(5	)		(16	)		(16	)
Amortization of prior service cost		2			2			6			6
Amortization of net (gains) losses		—			1			—			4
Net periodic pension expense	$	90		$	81		$	270		$	244

The Bank made an annual contribution to its defined benefit pension plan in the amount of $347,000 and $142,000, respectively, in the first nine months of 2007 and 2006.

(11) Fair Value Measurements

Effective January 1, 2007, the Company elected early adoption of Statement of Financial Accounting Standards (“FAS”) 159 and 157. FAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” was issued in February 2007 and permits the measurement of selected eligible financial instruments at fair value at specified election dates. The Company elected the fair value option to better manage its U.S. Treasury and Government Agency securities portfolio and to use the fair value measurement for these securities on a recurring basis.

The following table sets forth the Company’s assets that are measured at fair value on a recurring basis at the end of the recent quarter.

	Fair Value Measurements at Report Date Using
(In thousands) Description	Fair Value Measurements 09/30/07		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Trading Securities	$	233,977	$	233,977	—	—
Securities available for sale		129,863		129,863	—	—

17

CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)

(11) Fair Value Measurements (continued)

Upon adoption of FAS 159, the Company selected the fair value option for all of its U.S. Treasury and Government Agency securities available for sale, a portfolio totaling $261.3 million as of January 1, 2007. The initial fair value measurement of these securities resulted in a $2.2 million cumulative effect adjustment, net of tax, recorded as a reduction in retained earnings as of January 1, 2007 as shown in the table below:

(In thousands) Description	Balance Sheet 01/01/07 prior to Adoption			Balance Sheet Adjustment Pretax			Balance Sheet 01/01/07 after Adoption of FVO
Securities available for sale, at amortized cost	$	407,604		$	(264,793	)	$	142,811
Net unrealized losses on securities available for sale		(4,525	)		3,537			(988	)
Securities available for sale, at fair value		403,079			(261,256	)		141,823
Trading securities, at fair value		5,396			261,256			266,652
	$	408,475		$	—		$	408,475
Pretax cumulative effect of adoption of fair value option				$	(3,537	)
Deferred tax asset					1,302
Cumulative effect of adoption of fair value option, net of tax (charge to retained earnings)				$	(2,235	)

The charge to retained earnings has no overall impact on total stockholders’ equity because the fair value adjustment had previously been included as an element of stockholders’ equity in the accumulated other comprehensive loss account as shown in the table below:

Stockholders’ Equity	Balance Sheet 01/01/07 prior to Adoption			Cumulative Effect Adjustment of FVO (net of tax)		Balance Sheet 01/01/07 after Adoption of FVO
Common stock	$	7,850		—		$	7,850
Additional paid-in-capital		57,953					57,953
Retained earnings		107,055		(2,235	)		104,820
Treasury stock		(62,902	)				(62,902	)
Accumulated other comprehensive loss		(3,071	)	2,235			(836	)
Shares held in rabbi trust		(426	)				(426	)
Deferred compensation obligation		426					426
Total Stockholder’s Equity	$	106,885		—		$	106,885

18

PART I. ITEM 2

MASSBANK CORP. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION & ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

September 30, 2007

Forward-Looking Statement Disclosure.

This Form 10-Q may contain forward-looking statements. These statements relate to future, not past, events and include, among others, statements with respect to MASSSBANK Corp.’s beliefs, plans, objectives, goals, guidelines, expectations, financial condition, results of operations, future performance and business of the Company. You can identify forward-looking statements by the use of the words “may”, “could”, “should”, “believe”, “expect”, “anticipate”, “intend”, “estimate”, “assume”, “will”, “would”, “plan”, “projects”, “outlook” or similar expressions. These statements are based upon the current beliefs and expectations of the Company’s management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements. These forward- looking statements involve certain risks and uncertainties that are subject to change based on various factors (many of which are beyond MASSBANK Corp.’s control). The following factors, among others, could cause the Company’s performance to differ materially from that expressed in any forward-looking statements: (1) the strength of the United States economy in general and the strength of the local economy in which the Company conducts operations may be different than expected; (2) unexpected fluctuations in market interest rates; (3) adverse conditions in the stock market, the public debt market and other capital markets; (4) an increase in the level of non-performing assets; (5) an increase in the competitive pricing pressures within the Company’s market which may result in an increase in the Company’s cost of funds, a decrease in loan originations, a decrease in deposits and assets; (6) adverse legislative and regulatory developments; (7) a significant decline in residential real estate values in the Company’s market area; (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 and other risk factors described in the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2006.

19

Critical Accounting Policies

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

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

Provisions (Credit) for Loan Losses

The provision (credit) for loan losses represents a charge or credit against current earnings and an addition to or deduction from the allowance for loan losses. In determining the amount to provide for loan losses, the key factor is the adequacy

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

The provision (credit) for loan losses on off-balance sheet credit exposures represents a charge or credit against current earnings (reported in other non-interest expense) and an addition to or deduction from the allowance for loan losses on off-balance sheet credit exposures (“off-balance sheet exposures”). In determining the amount to provide for off-balance sheet exposures, the key factor is

the adequacy of the balance. The balance of the off-balance sheet exposures is maintained based on expected draw downs of committed loans, their loss experience factors, management’s assessment of various other factors including current and anticipated economic conditions that may affect the borrowers’ ability to pay and trends in loan delinquencies and charge-offs.

Any significant changes in these assumptions and/or conditions could result in higher than estimated losses that could adversely affect the Company’s earnings results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowances. Such agencies may require the Bank to recognize additional allowances based on judgments different from those of management, which could also adversely affect the Company’s earnings results.

Investment Securities Other Than Temporarily Impaired

Management judgment is involved in the evaluation of declines in value (“impairment”) of individual investment securities held by the Company. Declines in value that are deemed other than temporary are recognized in the income statement

through write-downs in the recorded value of the affected securities. Management considers many factors in their analysis of other than temporarily impaired securities, including industry analyst reports, sector credit ratings, volatility in market price and other relevant information, such as the financial condition, earnings capacity and near term prospects of the company and the length of time and extent to which the market value has been less than cost.

20

Investment Securities Other Than Temporarily Impaired (continued)

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

If “due to general market conditions” an investment security declines in price from its cost basis by 25% or more for more than a year, between 30% and 40% for more than nine months, between 40% and 50% for more than six months or over 50% for more than ninety days, and in each case the value of the investment security has been below its cost basis for the entire period in question, then the security is considered “other than temporarily impaired” and it is written down to its current fair market value and the loss is recognized in earnings. U.S. Treasury and Government Agency securities fluctuate in value based on changes in market interest rates and other factors; however, they can be redeemed at par value if held to maturity and therefore, if their maturity date is less than one year into the future, regardless of their fair market value, they are considered only temporarily impaired. Any unfavorable change in general market conditions could cause an increase in the Company’s impairment write downs of investment securities. This would have an adverse effect on the Company’s earnings results. There were no other than temporary impairment write downs of investment securities in the first nine months of 2007 and 2006.

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

21

FINANCIAL OVERVIEW

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

The Bank faces strong competition from banks and other financial services providers in 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.

For the quarter ended September 30, 2007, MASSBANK Corp. reported net income of $2,126,000 compared to $1,731,000 for the quarter ended September 30, 2006, an increase of $395,000 or 22.8%. Diluted and basic earnings per share were $0.49 for the third quarter of 2007 compared to $0.40 for the same period in 2006, an increase of 22.5%.

The Company’s return on average assets and return on average equity for the third quarter of 2007 increased to 1.05% and 8.00%, respectively, from 0.82% and 6.72%, respectively, for the third quarter of the prior year.

22

FINANCIAL OVERVIEW (continued)

The major factors affecting the Company’s increased earnings results for the third quarter of 2007 compared to the same quarter of 2006 were:

• The decrease in net interest income of $535,000.

• The decrease in provision for loan losses of $82,000.

• The change from net gains to net losses on securities available for sale of $184,000.

• The increase in net trading securities gains of $2,121,000.

• The decrease in deferred compensation plan income of $39,000.

• The increase in other non-interest income of $91,000.

• The increase in non-interest expense of $831,000.

• The increase in income tax expense of $310,000.

(In thousands) Quarters Ended September 30,	2007			2006		Variance
Income Statement Data
Total interest and dividend income	$	10,013		$	10,052	$	(39	)
Total interest expense		5,368			4,872		(496	)
Net interest income		4,645			5,180		(535	)
Provision (credit) for loan losses		—			82		82
Gains (losses) on securities available for sale, net		(104	)		80		(184	)
Gains on trading securities, net		2,209			88		2,121
Deferred compensation plan income		9			48		(39	)
Other non-interest income		322			231		91
Non-interest expense		3,760			2,929		(831	)
Income tax expense		1,195			885		(310	)
Net income	$	2,126		$	1,731	$	395
Diluted earnings per share	$	0.49		$	0.40	$	0.09
(In thousands) Quarters Ended September 30,	2007			2006		Variance
Average Balance Sheet Data
Earning assets:
Mortgage and other loans	$	195,508		$	214,885	$	(19,377	)
Mortgage-backed securities		133,535			138,206		(4,671	)
Other securities available for sale		6,601			314,664		(308,063	)
Trading securities		238,731			4,739		233,992
Federal funds sold		154,300			143,922		10,378
Short-term investments		57,439			5,750		51,689
Total earning assets	$	786,114		$	822,166	$	(36,052	)
Total deposits	$	698,988		$	741,044	$	(42,056	)
Total borrowed funds	$	326		$	—	$	326

23

FINANCIAL OVERVIEW (Continued)

Condensed Consolidated Balance Sheets

(In thousands)	September 30, 2006			December 31, 2007			Variance
Assets:
Short-term investments	$	162,452		$	139,240		$	23,212
Term federal funds sold		63,000			41,000			22,000
Securities available for sale, at fair value		129,863			403,079			(273,216	)
Securities held to maturity, at amortized cost		8,127			5,396			2,731
Trading securities, at fair value		233,977			1,931			232,046
Total investments		597,419			590,646			6,773
Total loans		193,412			208,927			(15,515	)
Allowance for loan losses		(1,370	)		(1,382	)		12
Net loans		192,042			207,545			(15,503	)
Other assets		27,586			45,331			(17,745	)
Total assets	$	817,047		$	843,522		$	(26,475	)
Liabilities:
Total deposits	$	693,362		$	723,332		$	(29,970	)
Escrow deposits of borrowers		963			1,006			(43	)
Total borrowed funds		10,000			—			10,000
Other liabilities		5,299			12,299			(7,000	)
Total liabilities		709,624			736,637			(27,013	)
Total stockholders’ equity		107,423			106,885			538
Total liabilities and stockholders’ equity	$	817,047		$	843,522		$	(26,475	)

Financial Condition

The Company’s total assets were $817.0 million at September 30, 2007, compared to $843.5 million at December 31, 2006 reflecting a decrease of $26.5 million. This includes an increase of $6.8 million in total investments offset by a decrease of $15.5 million in total loans and a decrease of $17.8 million in other assets. Deposits, the primary funding source for the Company’s assets, decreased $29.9 million during the first nine months of 2007, from $723.3 million at December 31, 2006 to $693.4 million at September 30, 2007 due to intense competition for short-term deposits and more attractive returns in the equity securities markets. The decline in deposits was also due in part to management’s decision to seek to protect the Company’s net interest margin. Borrowed funds, which represent the Company’s short-term borrowings from the Federal Reserve Bank of Boston discount window, amounted to $10.0 million at September 30, 2007. There were no such borrowings as of year-end 2006.

24

Investments

At September 30, 2007, the Company’s total investments were $597.4 million representing 73.1% of total assets compared to $590.6 million representing 70.0% of total assets at December 31, 2006. Total investments have increased $6.8 million from year-end 2006. The increase in total investments includes an increase in short-term investments, primarily federal funds sold, of $23.2 million. In addition, term federal funds sold were increased by $22.0 million to lock these funds in at a higher rate in anticipation of the Federal Reserve Bank reducing its (overnight) federal funds target interest rate.

Upon adoption of FAS 159 effective January 1, 2007, the Company selected the fair value option for all its U.S. Treasury and Government Agency securities available for sale, a portfolio totaling $261.3 million as of January 1, 2007. As a result, these securities were moved from the available for sale category to the trading account. As shown in the detail from the condensed consolidated balance sheets on page 24, in the first nine months of 2007 the Company’s portfolio of securities available for sale decreased $273.2 million while the Company’s portfolio of trading securities increased $232.0 million.

Loans

The loan portfolio, net of allowance for loan losses, decreased $15.5 million or 7.5% in the first nine months of 2007. At September 30, 2007, the loan portfolio, net of allowance for loan losses, totaled $192.0 million representing 23.5% of total assets compared to $207.5 million representing 24.6% of total assets at December 31, 2006. The decrease in loans is due to regular principal payments and prepayments exceeding the volume of new loan originations. New loan originations decreased $3.7 million to $13.4 million in the first nine months of 2007 from $17.1 million in the same period of 2006. Mortgage loan origination activity (particularly refinancing activity) has decreased significantly in the Bank’s market area.

The Bank’s loan portfolio consists predominately of residential mortgages. Residential mortgage loans (excluding residential construction loans) amounted to $178.4 million at September 30, 2007, representing 92.2% of the total loan portfolio. See page 42 of this Form 10-Q for a table setting forth the composition of the loan portfolio at September 30, 2007 and December 31, 2006.

Non-Performing Assets

Non-accrual loans, generally those loans that are 90 days or more delinquent, remain near historical lows totaling $206,000 at September 30, 2007 compared to $137,000 at December 31, 2006 and $5,000 as of September 30, 2006. The Bank had no impaired loans or real estate acquired through foreclosure at September 30, 2007.

Deposits

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

Deposits at September 30, 2007 totaled $693.4 million, reflecting a decrease of $29.9 million or 4.1% from $723.3 million at December 31, 2006. In the first nine months of 2007 there was an outflow of deposits due to increased competition for deposits and some deposits being reinvested in the stock market and other types of investments. The decline in deposits was also due in part to management’s decision to seek to protect the Company’s net interest margin.

For information concerning deposit balances at September 30, 2007 and December 31, 2006, see page 45 of this Form 10-Q.

25

Borrowed Funds

The Bank has the ability to obtain advances from the Federal Reserve Bank of Boston discount window. On September 28, 2007, as part of the Bank’s test of its business continuity plan, the Bank borrowed $10.0 million for three days. The loan was repaid on October 1, 2007.

Stockholders’ Equity

Total stockholders’ equity increased $0.5 million to $107.4 million at September 30, 2007, from $106.9 million at December 31, 2006. This represents a book value of $25.18 per share at September 30, 2007, up $0.42 from $24.76 per share at December 31, 2006.

The increase in stockholders’ equity was essentially the result of the following: the Company’s net income for the first nine months of 2007 of $5.6 million, the payments and related tax benefits received from the exercise of stock options by the Company’s officers and directors of $0.5 million and a decrease in accumulated other comprehensive loss of $0.5 million due to an increase in market of the Company’s available for sale securities portfolio, partially offset by the payment of dividends to stockholders of $3.6 million and the Company’s repurchase of treasury stock in the amount of $2.5 million.

The Company’s total stockholders’ equity as of September 30, 2007 includes a $2.2 million cumulative effect adjustment, net of tax, recorded as a reduction in retained earnings as of January 1, 2007 due to the early adoption of FAS 159. The charge to retained earnings was offset by a corresponding increase in other comprehensive income, included as an element of stockholders’ equity, thus having no overall impact on total stockholders’ equity.

Comparison of Operating Results for the Three Months ended September 30, 2007 and 2006.

Net interest income

Net interest income for the three months ended September 30, 2007 was $4,645,000 compared to $5,180,000 for the same period in 2006. The decrease in net interest income was due in part to a flat yield curve, increased funding costs due to intense competition for deposits and a decrease in the Company’s average earning assets.

Average earning assets for the third quarter of 2007 declined to $786.1 million, from $822.2 million in the third quarter of the prior year due to a decrease in deposits. Average total deposits were $699.0 million for the third quarter of 2007 compared to $741.0 million for the same quarter last year. Deposits declined due in part to management’s decision to seek to protect the Company’s net interest margin. The Company’s net interest margin for the recent quarter was 2.37% compared to 2.53% for the same quarter in 2006.

26

Interest and Dividend Income

Interest and dividend income on a fully taxable equivalent basis for the three months ended September 30, 2007 decreased $43,000 to $10,030,000 from $10,073,000 for the three months ended September 30, 2006. The decrease in interest and dividend income resulted from a decrease of $36.1 million in average earning assets, partially offset by an increase in interest income resulting from an improvement in yield on the Company’s average earning assets. As reflected in the table on page 28 of this report, the yield on the Company’s average earning assets in the third quarter of 2007 was 5.10%, as compared to 4.90% in the same quarter of 2006.

Interest Expense

Total interest expense for the three months ended September 30, 2007 increased $496,000, or 10.2% to $5,368,000 from $4,872,000 for the three months ended September 30, 2006. The increase in interest expense is due primarily to higher interest rates and the continued shift in the Bank’s deposit mix from savings accounts to certificates of deposit accounts. This has resulted in an increase in the Company’s average cost of funds, from 2.61% in the third quarter of 2006 to 3.04% in the third quarter of 2007. The increase in interest expense resulting from the higher average cost of funds was partially offset by a decrease in interest expense resulting from a decrease in the Company’s average deposits. The Company’s average deposits in the recent quarter, as shown in the table on page 29, decreased $42.0 million or 5.7% to $699.0 million, from $741.0 million in the same quarter of the prior year.

27

	AVERAGE BALANCE SHEETS Three Months Ended September 30,
	2007							2006
(In thousands)	Average Balance			Interest Income/ Expense (1)		Average Yield/ Rate		Average Balance			Interest Income/ Expense (1)		Average Yield/ Rate
Assets:
Earning assets:
Federal funds sold	$	154,300		$	2,058	5.29	%	$	143,922		$	1,923	5.30	%
Short-term investments (4)		57,439			735	5.08			5,750			74	5.08
Securities available for sale:
Other securities (2)		6,601			48	2.95			314,664			3,165	4.02
Mortgage-backed securities (2)		125,971			1,702	5.40			132,667			1,799	5.42
Mortgage-backed securities held to maturity		7,564			104	5.47			5,539			73	5.29
Trading securities		238,731			2,649	4.44			4,739			40	3.35
Mortgage loans (3)		185,756			2,541	5.47			205,321			2,799	5.45
Other loans (3)		9,752			193	7.88			9,564			200	8.32
Total earning assets		786,114		$	10,030	5.10	%		822,166		$	10,073	4.90	%
Allowance for loan losses		(1,371	)						(1,302	)
Total earning assets less allowance for loan losses		784,743							820,864
Other assets		26,036							27,753
Total assets	$	810,779						$	848,617

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

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

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

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

28

	AVERAGE BALANCE SHEETS - (continued) Three Months Ended September 30,
	2007						2006
(In thousands)	Average Balance		Interest Income/ Expense		Average Yield/ Rate		Average Balance		Interest Income/ Expense		Average Yield/ Rate
Liabilities:
Deposits:
Demand and NOW	$	72,808	$	66	0.36	%	$	80,129	$	61	0.30	%
Savings		318,761		1,598	1.99			377,669		1,750	1.84
Time certificates of deposit		307,419		3,700	4.78			283,246		3,061	4.29
Total deposits		698,988		5,364	3.04	%		741,044		4,872	2.61	%
Borrowed funds		326		4	5.25	%		—		—	—
Total deposits and borrowed funds		699,314		5,368	3.04	%		741,044		4,872	2.61	%
Other liabilities		5,174						4,478
Total liabilities		704,488						745,522
Stockholders’ equity		106,291						103,095
Total liabilities and stockholders’ equity	$	810,779					$	848,617
Net interest income (tax-equivalent basis)				4,662						5,201
Less adjustment for tax-exempt interest income				17						21
Net interest income			$	4,645					$	5,180
Interest rate spread (5)					2.06	%					2.29	%
Net interest margin (6)					2.37	%					2.53	%

(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.

29

Provision (Credit) for Loan Losses

There was no loan loss provision recorded by the Company in the third quarter of 2007 compared with a provision of $82,000 in same quarter of the prior year. The reduced provision reflects a decrease in the size of the loan portfolio and a relatively low level of loan delinquencies and charge-offs.

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

At September 30, 2007, the allowance for loan losses was $1,370,000 representing 0.71% of total loans. This compares to $1,382,000 representing 0.66% of total loans at December 31, 2006. Non-accrual loans totaled $206,000 at September 30, 2007. This compares to $137,000 at December 31, 2006 and $5,000 at September 30, 2006. Management believes that the allowance for loan losses as of September 30, 2007 is adequate to cover the risks inherent in the loan portfolio under current conditions.

The Bank also maintains an allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) that totaled $345,000 at September 30, 2007 and December 31, 2006. This is intended to protect the Bank against losses on loan commitments made to customers that have not yet been drawn down.

Non-Interest Income

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

Non-interest income for the three months ended September 30, 2007 was $2,436,000 compared to $447,000 for the three months ended September 30, 2006, an increase of $1,989,000 or 445.0% over the same period last year. The growth in non-interest income was mainly due to an increase in net securities gains of $1,937,000 resulting primarily from net gains on trading securities. Net gains on trading securities were $2,209,000 in the recent quarter, up from $88,000 in the same quarter of 2006. The strong performance of the Company’s trading securities portfolio in the recent quarter reflects an increase in fair value of the trading securities portfolio of $2,036,000 over the same quarter last year. The increase in fair value of the securities is due in part to the securities the bank selected for its trading portfolio in anticipation of lower interest rates. In addition, all other non-interest income in the recent quarter increased $52,000 over the same period last year. This included option fees of $75,000 from a local developer. No option fees were recorded in the third quarter of 2006.

In August 2006, the Company 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 exercised and the closing transaction for the purchase occurs or the option is either extended or allowed to lapse. Option payments received are not applied towards the purchase price and are not refundable.

The developer may extend the option period on no more than four (4) occasions, for sixty (60) days each from the end of August 2007. There shall be an option fee of $75,000 for each such 60-day extension, which fee is not applied towards the purchase price and is non-refundable. The developer, still seeking to obtain all of the necessary permits for the construction project, has extended the option through December 2007. The option may be extended further or possibly allowed to lapse.

30

Non-Interest Expense

Non-interest expense for the three months ended September 30, 2007, increased $831,000 or 28.4% to $3,760,000 from $2,929,000 for the same period in 2006. The increases were predominately in compensation related costs, professional services and other expenses.

Salaries and employee benefits increased $484,000 to $2,292,000 in the recent quarter from $1,808,000 in the third quarter of 2006. The increase was due principally to an accrual of $390,000 for a profit sharing and incentive compensation bonus plan distribution to Company employees at year-end based on the Company’s earnings performance, the increased costs of employee benefits and an increase in stock-based compensation costs.

Deferred compensation plan expense increased $79,000 to $148,000 in the recent quarter from $69,000 for the same quarter in 2006 due principally to a higher expense provision for the Company’s executive supplemental retirement plan.

Professional services expense increased $117,000 to $230,000 in the third quarter of 2007 from $113,000 in the third quarter of 2006 due to higher legal fees incurred related to various shareholder and other business matters.

Other expenses increased $104,000 to $330,000 for the three months ended September 30, 2007 compared to $226,000 for the same period in 2006. The increase was due primarily to a benefit of $107,000 recorded in the third quarter of 2006 resulting from a decrease in the Bank’s allowance for loan losses on off-balance sheet credit exposures.

The remaining categories of non-interest expense consisting of occupancy and equipment, data processing, advertising and marketing, and deposit insurance expense combined increased $47,000 in the recent quarter to $760,000 from $713,000 in the same quarter of 2006.

Income Tax Expense

The Company files a consolidated federal income tax return for the Parent Company, its subsidiaries, Knabssam LLC and the Bank, and bank subsidiaries – Melbank Investment Corporation, Readibank Investment Corporation and Readibank Properties, Inc. Each of these companies is subject to a Massachusetts Corporate Excise Tax as calculated in separately filed Massachusetts tax returns.

The Company recorded income tax expense of $1,195,000 in the third quarter of 2007, an increase of $310,000 when compared to $885,000 in the same quarter last year. The increase in income tax expense is due primarily to an increase in income before income taxes and an increase in effective income tax rate. The Company’s income before income taxes was $3,321,000 in the recent quarter compared to $2,616,000 for the same quarter a year ago. The effective income tax rate for the three months ended September 30, 2007 and 2006 was 35.98% and 33.83%, respectively.

31

Comparison of Operating Results for the Nine Months ended September 30, 2007 and 2006.

FINANCIAL OVERVIEW

For the nine months ended September 30, 2007, the Company reported net income of $5,629,000 compared to $5,296,000 for the same period in 2006, an increase of $333,000 or 6.3%. Diluted earnings per share for the first nine months of 2007 increased 6.6% to $1.29 from $1.21 for the same period last year. Basic earnings per share for the nine months ended September 30, 2007 were $1.30 compared to $1.22 for the same period in 2006. Return on average assets and return on average equity was 0.92% and 7.02%, respectively, in the first nine months of 2007 compared to 0.81% and 6.81%, respectively, in the same period of 2006.

The major factors affecting the Company’s increased earnings results for the first nine months of 2007 compared to the same period of 2006 were:

• The decrease in net interest income of $1,809,000.

• The decrease in provision for loan losses of $142,000.

• The decrease in net gains on securities available for sale of $245,000.

• The increase in net gains on trading securities of $2,940,000.

• The increase in deferred compensation plan income of $9,000.

• The increase in other non-interest income of $247,000.

• The increase in non-interest expense of $683,000.

• The increase in income tax expense of $268,000.

(In thousands) Nine Months Ended September 30,	2007			2006		Variance
Income Statement Data
Total interest and dividend income	$	30,048		$	29,854	$	194
Total interest expense		15,848			13,845		(2,003	)
Net interest income		14,200			16,009		(1,809	)
Provision (credit) for loan losses		(10	)		132		142
Gains on securities available for sale, net		184			429		(245	)
Gains on trading securities, net		3,049			109		2,940
Deferred compensation plan income		118			109		9
Other non-interest income		1,030			783		247
Non-interest expense		9,951			9,268		(683	)
Income tax expense		3,011			2,743		(268	)
Net income	$	5,629		$	5,296	$	333
Diluted earnings per share	$	1.29		$	1.21	$	0.08
(In thousands) Nine Months Ended September 30,	2007			2006		Variance
Average Balance Sheet Data
Earning assets:
Mortgage and other loans	$	200,823		$	219,179	$	(18,356	)
Mortgage-backed securities		135,961			140,752		(4,791	)
Other securities available for sale		7,386			315,231		(307,845	)
Trading securities		244,639			7,284		237,355
Federal funds sold		162,560			157,431		5,129
Short-term investments		44,327			2,420		41,907
Total earning assets	$	795,696		$	842,297	$	(46,601	)
Total deposits	$	708,069		$	759,739	$	(51,670	)
Total borrowed funds	$	110		$	—	$	110

32

Net Interest Income

Net interest income totaled $14,200,000 for the nine months ended September 30, 2007, a decrease of $1,809,000 from the same period in 2006. The decrease in net interest income reflects a decline in net interest margin and net interest spread, as well as a decrease in the average volume of earning assets and interest bearing liabilities.

The Company’s net interest spread declined to 2.05% for the first nine months of 2007 from 2.29% in the same period last year. Net interest spread represents the difference between the yield on earning assets and the cost of the Company’s deposits. Net interest margin represents the relationship between net interest income and average earning assets. Net interest margin is affected by several factors, including fluctuations in the overall interest rate environment, funding strategies, and the mix of interest earning assets and interest bearing liabilities. The Company’s net interest margin for the nine months ended September 30, 2007 declined 15 basis points to 2.39% from 2.54% reported in the first nine months of last year. Average earning assets for the nine months ended September 30, 2007 decreased $46.6 million to $795.7 million, from $842.3 million in the same period of 2006.

Interest and Dividend Income

Interest and dividend income on a fully taxable equivalent basis for the nine months ended September 30, 2007 increased $188,000 to $30,096,000 from $29,908,000 for the nine months ended September 30, 2006. The increase in interest and dividend

income resulted from an increase in yield on the Company’s average earning assets, partially offset by a decrease in interest income resulting from a decrease of $46.6 million in average earning assets. As reflected in the table on page 34 of this report, the yield on the Company’s average earning assets in the first nine months of 2007 was 5.04%, as compared to 4.73% in the same period of 2006. The improvement in yield on the Company’s average earning assets is primarily attributable to an increase in interest income on federal funds sold and short-term investments of $2,335,000 due to higher short-term interest rates and higher average balances in 2007 compared to 2006. Interest income on securities available for sale, held to maturity and trading combined decreased $1,428,000 due to a decrease in average balances partially offset by an improvement in yield. Interest income on loans decreased $719,000 due to a decrease in the size of the loan portfolio partially offset by an improvement in yield.

Interest Expense

Total interest expense for the nine months ended September 30, 2007 increased $2,003,000 to $15,848,000 from $13,845,000 for the nine months ended September 30, 2007. The increase in interest expense is due primarily to rising interest rates and the continued shift in the Bank’s deposit mix from savings accounts to certificates of deposit accounts. This has resulted in an increase in the Company’s average cost of funds, from 2.44% in the first nine months of 2006 to 2.99% in the first nine months of 2007. The increase in interest expense resulting from the higher average cost of funds was partially offset by a decrease in interest expense resulting from a decrease in the Company’s average deposits. The Company’s average deposits in the first nine months of 2007, as shown in the table on page 35, decreased $51.6 million to $708.1 million, from $759.7 million in the same period of the prior year.

33

	AVERAGE BALANCE SHEETS Nine Months Ended September 30,
	2007							2006
(In thousands)	Average Balance			Interest Income/ Expense (1)		Average Yield/ Rate		Average Balance			Interest Income/ Expense (1)		Average Yield/ Rate
Assets:
Earning assets:
Federal funds sold	$	162,560		$	6,438	5.30	%	$	157,431		$	5,727	4.86	%
Short-term investments (4)		44,327			1,710	5.16			2,420			86	4.76
Securities available for sale:
Other securities (2)		7,386			137	2.45			315,231			9,073	3.84
Mortgage-backed securities (2)		129,943			5,236	5.37			134,961			5,469	5.40
Mortgage-backed securities held to maturity		6,018			240	5.33			5,791			229	5.28
Trading securities		244,639			7,930	4.32			7,284			200	3.67
Mortgage loans (3)		191,058			7,820	5.46			209,602			8,554	5.44
Other loans (3)		9,765			585	8.01			9,577			570	7.96
Total earning assets		795,696		$	30,096	5.04	%		842,297		$	29,908	4.73	%
Allowance for loan losses		(1,378	)						(1,267	)
Total earning assets less allowance for loan losses		794,318							841,030
Other assets		25,650							26,811
Total assets	$	819,968						$	867,841

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

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

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

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

34

	AVERAGE BALANCE SHEETS - (continued) Nine Months Ended September 30,
	2007						2006
(In thousands)	Average Balance		Interest Income/ Expense		Average Yield/ Rate		Average Balance		Interest Income/ Expense		Average Yield/ Rate
Liabilities:
Deposits:
Demand and NOW	$	74,238	$	195	0.35	%	$	81,428	$	164	0.27	%
Savings		328,133		4,808	1.96			401,614		5,362	1.78
Time certificates of deposit		305,698		10,841	4.74			276,697		8,319	4.02
Total deposits		708,069		15,844	2.99			759,739		13,845	2.44
Borrowed funds		110		4	5.25			—		—	—
Total deposits and borrowed funds		708,179		15,848	2.99	%		759,739		13,845	2.44	%
Other liabilities		4,809						4,420
Total liabilities		712,988						764,159
Stockholders’ equity		106,980						103,682
Total liabilities and stockholders’ equity	$	819,968					$	867,841
Net interest income (tax-equivalent basis)				14,248						16,063
Less adjustment for tax-exempt interest income				48						54
Net interest income			$	14,200					$	16,009
Interest rate spread (5)					2.05	%					2.29	%
Net interest margin (6)					2.39	%					2.54	%

(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.

35

Provision (Credit) for Loan Losses

In the first nine months of 2007, the Bank recorded a credit provision for loan losses of $10,000 compared to a provision of $132,000 in the first nine months of 2006.

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

At September 30, 2007, the allowance for loan losses was $1,370,000 representing 0.71% of total loans and 665% of non-accrual loans. This compares to $1,382,000 representing 0.66% of total loans and 1009% of non-accrual loans at December 31, 2006. Non-accrual loans totaled $206,000 at September 30, 2007. This compares to $137,000 at December 31, 2006 and $5,000 a year earlier. Management believes that the allowance for loan losses as of September 30, 2007 is adequate to cover the risks inherent in the loan portfolio under current conditions.

The Bank also maintains an allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) that totaled $345,000 at September 30, 2007 and December 31, 2006. This is intended to protect the Bank against losses on loan commitments made to customers that have not yet been drawn down.

Non-Interest Income

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

Non-interest income for the nine months ended September 30, 2007 increased $2,951,000 or 206.4% to $4,381,000 from $1,430,000 for the same period in 2006. This increase is due primarily to an increase in net securities gains of $2,695,000 from $538,000 in the first nine months of 2006 to $3,233,000 in the first nine months of this year. Net securities gains in the first nine months of 2007 were comprised of $3,049,000 in net gains on trading securities and $184,000 in net gains on available for sale securities. This compares to net gains on trading securities and available for sale securities of $109,000 and $429,000, respectively, for the same period in 2006. The net gains on trading securities for the first nine months of 2007 consisted of $202,000 in realized gains primarily from the sales of equity securities and net gains of $2,847,000 related to the change in fair value of the portfolio during the first nine months of 2007. The increase in fair value of the securities is due in part to the securities the bank selected for its trading portfolio in anticipation of lower interest rates.

The Bank has a supplemental retirement plan for certain executive officers. In the first nine months of 2007, the Bank recorded plan income of $118,000 due primarily to the appreciation in market value of plan assets, compared to plan income of $109,000 in the first nine months of the prior year. The Bank’s deposit account service fees and other non-interest income totaled $245,000 and $560,000, respectively, for the first nine months of 2007. This compares to $258,000 and $525,000, respectively, in the first nine months of 2006. The combined total of these two items increased $22,000 from the same period of the prior year. Deposit account service fees have declined due to a decrease in the number of deposit accounts subject to these types of charges.

In the first nine months of 2007, the Company recorded option fees of $225,000. There were no option fees recorded in the same period last year.

36

Non-Interest Income (continued)

In August 2006, the Company 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 exercised and the closing transaction for the purchase occurs or the option is either extended or allowed to lapse. Option payments received are not applied towards the purchase price and are not refundable.

The developer may extend the option period on no more than four (4) occasions, for sixty (60) days each from the end of August 2007. There shall be an option fee of $75,000 for each such 60-day extension, which fee is not applied towards the purchase price and is non-refundable. The developer, still seeking to obtain all of the necessary permits for the construction project, has extended the option through December 2007. The option may be extended further or possibly allowed to lapse.

Non-Interest Expense

Non-interest expense for the nine months ended September 30, 2007, increased $683,000 to $9,951,000 compared to $9,268,000 for the same period in 2006. The increases were predominately in compensation related costs, professional services and other expenses.

Salaries and employee benefits increased $488,000 to $6,032,000 in the first nine months of 2007 from $5,544,000 for the same period in 2006. This was due principally to an accrual of $390,000 for a profit sharing and incentive compensation bonus plan distribution to Company employees at year-end based on the Company’s earnings performance, the increased costs of employee benefits and an increase in stock-based compensation costs.

Deferred compensation plan expense increased $132,000 to $304,000 in the first nine months of 2007 compared to $172,000 for the same period last year due principally to a higher expense provision for the Company’s executive supplemental retirement plan.

Occupancy and equipment expense decreased $149,000 to $1,553,000 for the nine months ended September 30, 2007 from $1,702,000 for the same period in 2006. The decrease is primarily due to a reduction in building and equipment depreciation expense.

Professional services expense increased $58,000 to $472,000 for the nine months ended September 30, 2007 from $414,000 for the same period last year due to higher legal fees incurred related to various shareholder and other business matters.

Other expenses increased $126,000 to $947,000 for the first nine months of 2007 compared to $821,000 for the same period last year. The increase was due primarily to a benefit of $181,000 recorded in the first nine months of 2006 resulting from a decrease in the Company’s allowance for loan losses on off-balance sheet credit exposures.

The remaining categories of non-interest expense consisting of data processing, advertising and marketing, and deposit insurance expense combined increased $28,000 in the nine months ended September 30, 2007 to $643,000 from $615,000 for the same period in 2006.

Income Tax Expense

The Company files a consolidated federal income tax return for the Parent Company, its subsidiaries, Knabssam LLC and the Bank, and bank subsidiaries – Melbank Investment Corporation, Readibank Investment Corporation and Readibank Properties, Inc. Each of these companies is subject to a Massachusetts Corporate Excise Tax as calculated in separately filed Massachusetts tax returns.

The Company recorded income tax expense of $3,011,000 in the first nine months of 2007, an increase of $268,000 when compared to $2,743,000 in the same period last year. The increase in income tax expense is due primarily to an increase in income before income taxes and an increase in effective income tax rate. The Company’s income before income taxes was $8,640,000 for the first nine months of 2007 compared to $8,039,000 for the same period a year ago. The effective income tax rate for the nine months ended September 30, 2007 and 2006 was 34.85% and 34.12%, respectively.

37

FINANCIAL CONDITION

INVESTMENT SECURITIES

The amortized cost and fair value of investment securities held to maturity and available for sale at September 30, 2007 with gross unrealized gains and losses follows:

(In thousands) At September 30, 2007	Amortized Cost			Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Securities held to maturity:
Mortgage-backed securities:
Federal National Mortgage Association	$	8,127		$	41	$	(164	)	$	8,004
Total securities held to maturity	$	8,127		$	41	$	(164	)	$	8,004
Securities available for sale:
Debt securities:
Mortgage-backed securities:
Government National Mortgage Association	$	776		$	10	$	—		$	786
Federal Home Loan Mortgage Corporation		122,021			508		(1,525	)		121,004
Federal National Mortgage Association		1,979			—		(17	)		1,962
Collateralized mortgage obligations		61			2		—			63
Total mortgage-backed securities		124,837			520		(1,542	)		123,815
Total debt securities available for sale		124,837			520		(1,542	)		123,815
Equity securities		5,182			955		(89	)		6,048
Total securities available for sale		130,019		$	1,475	$	(1,631	)	$	129,863
Net unrealized losses on securities available for sale		(156	)
Total securities available for sale, net		129,863
Total investment securities, net	$	137,990

TRADING SECURITIES

The trading securities portfolio at September 30, 2007 consist of the following:

(In thousands) At September 30, 2007	Fair Value
U.S. Treasury obligations	$	8,949
U.S. Government agency obligations		222,211
Marketable equity securities		2,813
Investments in mutual funds		4
Total trading securities	$	233,977

38

FINANCIAL CONDITION

INVESTMENT SECURITIES (continued)

The amortized cost and fair value of investment securities held to maturity and available for sale at December 31, 2006 with gross unrealized gains and losses follows:

(In thousands) At December 31, 2006	Amortized Cost			Gross Unrealized Gains		Gross Unrealized Losses			Fair 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 available for sale		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

TRADING SECURITIES

The trading securities portfolio at December 31, 2006 consist of the following:

(In thousands) At December 31, 2006	Fair Value
Marketable equity securities	$	1,926
Investments in mutual funds		5
Total trading securities	$	1,931

39

Investments (continued)

The amortized cost and fair value of debt securities available for sale by contractual maturity at September 30, 2007 and December 31, 2006 are shown in the following table. Actual maturities will differ from contractual maturities because of callable government agency securities in the Company’s portfolio that may be called prior to maturity.

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

(In thousands)	September 30, 2007					December 31, 2006
	Amortized Cost			Fair Value		Amortized Cost			Fair Value
Investment securities available for sale:
U.S. Treasury obligations:(a)
Maturing within 1 year	$	—		$	—	$	14,019		$	13,911
Maturing after 1 year but within 5 years		—			—		7,999			7,798
Total		—			—		22,018			21,709
U.S. Government agency obligations:(a)
Maturing within 1 year		—			—		75,000			74,594
Maturing after 1 year but within 5 years		—			—		150,745			148,246
Maturing after 5 years but within 10 years		—			—		15,995			15,706
Maturing after 10 years but within 15 years		—			—		1,035			1,001
Total		—			—		242,775			239,547
Mortgage-backed securities:(b)
Maturing within 1 year		30			30		100			101
Maturing after 1 year but within 5 years		6,049			6,196		7,508			7,666
Maturing after 5 years but within 10 years		14,928			15,235		17,155			17,473
Maturing after 10 years but within 15 years		103,830			102,354		110,608			109,157
Maturing after 15 years		—			—		74			74
Total		124,837			123,815		135,445			134,471
Total debt securities available for sale		124,837		$	123,815		400,238		$	395,727
Net unrealized losses on debt securities available for sale		(1,022	)				(4,511	)
Total debt securities available for sale, net carrying value	$	123,815				$	395,727

(a) Upon adoption of FAS 159 effective January 1, 2007, the Company selected the fair value option for all of its U.S. Treasury and Government Agency securities available for sale. Consequently, these securities were moved from the available for sale category to the trading account.

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

40

INVESTMENT SECURITIES (continued)

The following table shows the gross unrealized losses and fair value of the Company’s securities available for sale and held to maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2007, December 31, 2006, and September 30, 2006.

Temporarily Impaired Investment Securities (Unaudited)

	Temporarily Impaired Less Than 12 Months					Temporarily Impaired 12 Months or Longer					Total
(In thousands)	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
At September 30, 2007
Mortgaged-backed securities	$	24,498	$	(169	)	$	69,282	$	(1,537	)	$	93,780	$	(1,706	)
Equity securities		1,185		(89	)		—		—			1,185		(89	)
Total temporarily impaired investment securities at:
September 30, 2007	$	25,683	$	(258	)	$	69,282	$	(1,537	)	$	94,965	$	(1,795	)
December 31, 2006	$	90,097	$	(885	)	$	269,494	$	(4,980	)	$	359,591	$	(5,865	)
September 30, 2006	$	126,775	$	(1,628	)	$	248,266	$	(5,131	)	$	375,041	$	(6,759	)

As of September 30, 2007 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 unrealized losses above (with the exception of the equity securities) are on securities that have contractual maturity dates and are primarily related to market interest rates.

41

LOANS

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

(In thousands)	At September 30, 2007		At December 31, 2006
Mortgage loans:
Residential:
Conventional:
Fixed rate	$	154,661	$	169,036
Variable rate		23,690		23,941
FHA and VA		6		13
Construction-Variable rate		397		1,217
Commercial:
Fixed rate		348		367
Variable rate		3,991		4,076
Construction-Fixed rate		693		563
Total mortgage loans		183,786		199,213
Premium on loans		2		2
Deferred mortgage loan origination costs, net		53		38
Mortgage loans, net		183,841		199,253
Other loans:
Consumer:
Second mortgage loans		1,265		751
Installment		267		211
Guaranteed education		494		635
Other secured		436		408
Home equity lines of credit		6,852		7,460
Unsecured		131		128
Total consumer loans		9,445		9,593
Commercial		126		81
Total other loans		9,571		9,674
Total loans	$	193,412	$	208,927

The Bank’s loan portfolio decreased $15.5 million during the first nine months of 2007, from $208.9 million at December 31, 2006 to $193.4 million at September 30, 2007. This is primarily due to a decrease in mortgage loans.

The Bank’s mortgage lending activity, particularly refinancing activity, has decreased in 2007 compared to the prior year. Loan originations were $5.2 million in the recent quarter compared to $5.8 million in the third quarter of last year. For the first nine months of 2007, loan originations decreased to $13.4 million from $17.1 million for the same period in 2006.

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NON-PERFORMING ASSETS

The following table shows the composition of the Bank’s non-performing assets at September 30, 2007 and 2006, and December 31, 2006:

(In thousands)	At September 30, 2007			At December 31, 2006			At September 30, 2006
Non-Performing Assets:
Non-accrual loans	$	206		$	137		$	5
Real estate acquired through foreclosure		—			—			—
Total non-performing assets	$	206		$	137		$	5
Allowance for loan losses	$	1,370		$	1,382		$	1,395
Allowance as a percent of total loans		0.71	%		0.66	%		0.65	%
Non-accrual loans as a percent of total loans		0.11	%		0.07	%		N/M

N/M = Not Meaningful

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

The Company’s non-accrual loans remain near historical lows totaling $206,000 at September 30, 2007 up however from $137,000 at December 31, 2006 and $5,000 at September 30, 2006.

The Bank did not have any impaired loans as of September 30, 2007, December 31, 2006 or September 30, 2006.

43

ALLOWANCE FOR LOAN LOSSES

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

	Nine Months Ended September 30,
	2007			2006
	(In thousands)
Balance at December 31, 2006 and 2005	$	1,382		$	1,253
Provision (credit) for loan losses		(10	)		132
Recoveries of loans previously charged-off		—			19
Charge-offs		(2	)		(9	)
Balance at September 30,	$	1,370		$	1,395

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

At September 30, 2007 the balance of the allowance for loan losses was $1,370,000 representing 0.71% of total loans compared to $1,395,000 representing 0.65% of total loans at September 30, 2006. Management believes that the allowance for loan losses is adequate to cover the risks inherent in the portfolio under current conditions.

The Company also maintains an allowance for possible losses on its outstanding loan commitments that totaled $345,000 and $336,000 at September 30, 2007 and 2006, respectively. The allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) is maintained based on expected drawdowns of committed loans and their loss experience factors and management’s assessment of various other factors including current and anticipated economic conditions that may effect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.

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DEPOSITS

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

The Bank’s total deposits decreased $29.9 million to $693.4 million at September 30, 2007 from $723.3 million at December 31, 2006. This decrease in deposits is due in part to intense competition for short-term deposits, more attractive returns in the equity securities markets and management’s decision to seek to protect the Company’s net interest margin.

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

	September 30, 2007		December 31, 2006
	(In thousands)
Demand and NOW	$	72,606	$	78,860
Savings and money market accounts		311,725		344,808
Time certificates of deposit		309,031		299,664
Total deposits	$	693,362	$	723,332

45

PART I. ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices. The Company’s balance sheet at September 30, 2007 included trading securities consisting of debt and equity securities with a fair value of $234.0 million and equity securities available for sale with a fair value of $6.0 million. Broad market movements such as changes in the general level of interest rates and equity prices affect the value of these portfolios. Trading securities are measured at fair value with changes in fair value recognized in earnings. Changes in the general level of interest rates will cause volatility in Company earnings. Movements in equity prices affect the value of the Company’s equity securities and the amount of securities gains or losses that the Company realizes from the sale of these securities.

Interest Rate Risk

Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change the interest income and expense streams associated with the Company’s financial instruments also change, which impacts net interest income, the primary component of the Company’s earnings. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process. For additional information about the Company’s asset/liability management and interest rate risk, see the Management Discussion and Analysis section of the Company’s Form 10-K for the year ended December 31, 2006.

Liquidity and Capital Resources

The Bank must maintain a sufficient amount of cash and assets which can readily be converted into cash in order to meet cash outflows from normal depositor requirements and loan demands. The Bank’s primary sources of funds are deposits, loan and mortgage-backed securities amortization and prepayments, sales or maturities of investment securities, investment securities called before maturity and income on earning assets. In addition to loan payments and maturing investment securities, which are relatively predictable sources of funds, the Bank maintains a high percentage of its assets invested in overnight federal funds sold and money market funds, which can be immediately converted into cash and United States Treasury and Government agency securities, which can be sold or pledged to raise funds. At September 30, 2007 the Bank had $162.5 million or 20.0% of total assets and $231.2 million or 28.3% of total assets invested, respectively, in overnight federal funds sold and money market funds, and United States Treasury and Government agency obligations.

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

46

Liquidity and Capital Resources (continued)

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

The capital ratios of the Bank and the Company currently exceed the minimum regulatory requirements. At September 30, 2007, the Bank had a leverage Tier I capital to average assets ratio of 12.58%, a Tier I capital to risk- weighted assets ratio of 33.08% and a total capital to risk-weighted assets ratio of 33.76%. The Company, on a consolidated basis, had ratios of leverage Tier I capital to average assets of 13.20%, Tier I capital to risk-weighted assets of 34.55% and total capital to risk-weighted assets of 35.24% at

September 30, 2007.

PART I. ITEM 4

Controls and Procedures

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

evaluation, such officers have concluded that our disclosure controls and procedures are effective as of the end of such period.

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

47

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, MASSBANK Corp. and/or the Bank are involved as a plaintiff or defendant in various legal actions incident to their business. As of September 30, 2007, none of these actions individually or in the aggregate is believed by management to be material to the financial condition of MASSBANK Corp. or the Bank.

Item 1A. Risk Factors

There have been no material changes to the Risk Factors previously disclosed in Item 1A of the Company’s Annual Report on Form 10-K for the period ended December 31, 2006.

Item 2(c). Share Repurchases

Issuer Purchases of Equity Securities

The following table sets forth the maximum number of shares of the Company’s common stock that may yet be purchased under the Company’s stock repurchase program.

Period	Total Number of Shares Purchased	Average Price Paid Per Share		Total Number of Shares Purchased as Part of a Publicly Announced Repurchase Program (1)	Maximum Number of Shares That May Yet Be Purchased Under the Repurchase Program
June 30, 2007	—		—	—	104,417	(1)
July 1-31, 2007	—		—	—	104,417
August 1-31, 2007	41,900	$	34.01	41,900	62,517
September 1-30, 2007	12,000	$	36.77	12,000	50,517
	53,900	$	34.62	53,900

(1) On October 18, 2006 the Registrant’s Board of Directors extended for another year the stock repurchase program previously authorized.

In addition, the following number of shares were purchased for the Company’s Directors’ Deferred Compensation Plan and Trust during the quarter ended September 30, 2007.

Period	Total Number of Shares Purchased	Average Price Paid Per Share		Total Number of Shares Purchased as Part of a Publicly Announced Repurchase Program	Maximum Number of Shares That May Yet Be Purchased Under the Repurchase Program
July 1-31, 2007	—	$	—	—	—
August 1-31, 2007	—	$	—	—	—
September 1-30, 2007	500	$	34.00	—	—
	500	$	34.00

48

Item 2(c). Share Repurchases (continued)

The following number of shares were also purchased for the Bank’s Employees’ Stock Ownership Plan (ESOP) during the quarter ended September 30, 2007.

Period	Total Number of Shares Purchased	Average Price Paid Per Share		Total Number of Shares Purchased as Part of a Publicly Announced Repurchase Program	Maximum Number of Shares That May Yet Be Purchased Under the Repurchase Program
July 1-31, 2007	—	$	—	—	—
August 1-31, 2007	—	$	—	—	—
September 1-30, 2007	7,885	$	35.64	—	—
	7,885	$	35.64

Item 3. Defaults Upon Senior Securities

Not Applicable.

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

Not Applicable.

Item 5. Other Information

None.

Item 6. Exhibits

a. Exhibit Index

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

49

SIGNATURES

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

	MASSBANK Corp. & Subsidiaries
	(Registrant)
Date: November 9, 2007	/s/ Gerard H. Brandi
	(Signature)
	Gerard H. Brandi
	President and CEO
Date: November 9, 2007	/s/ Reginald E. Cormier
	(Signature)
	Reginald E. Cormier
	Sr. V.P., Treasurer and CFO

50