##### 



Exhibit 13
 F i n a n c i a l H i g h l i g h t s
 Massbank Corp. and Subsidiaries
Selected Consolidated Financial Data
 (In
thousands)At December 31,
    
    2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002Balance Sheet Data:Total assets
    
    $
    843,522
    
    
    $
    898,679
    
    
    $
    976,168
    
    
    $
    1,010,733
    
    
    $
    1,009,367Mortgage loans
    
    
    199,253
    
    
    
    215,904
    
    
    
    226,197
    
    
    
    241,886
    
    
    
    302,788Other loans
    
    
    9,674
    
    
    
    9,826
    
    
    
    10,001
    
    
    
    11,120
    
    
    
    16,011Allowance for loan losses
    
    
    1,382
    
    
    
    1,253
    
    
    
    1,307
    
    
    
    1,554
    
    
    
    2,271Allowance for loan losses on
off-balance sheet credit exposures
    
    
    345
    
    
    
    517
    
    
    
    588
    
    
    
    626
    
    
    
    384Investments(1)
    
    
    590,646
    
    
    
    637,576
    
    
    
    704,611
    
    
    
    722,079
    
    
    
    669,875Deposits
    
    
    723,332
    
    
    
    784,728
    
    
    
    849,465
    
    
    
    882,508
    
    
    
    883,928Stockholders equity
    
    
    106,885
    
    
    
    105,264
    
    
    
    110,015
    
    
    
    110,927
    
    
    
    117,285
 (In
thousands)Years ended December 31,
    
    2006
    
    2005
    
    2004
    
    2003
    
    2002Operating Data:Interest and dividend income
    
    $
    39,939
    
    
    $
    36,801
    
    
    $
    33,581
    
    
    $
    38,137
    
    
    $
    47,103Interest expense
    
    
    18,951
    
    
    
    15,141
    
    
    
    12,729
    
    
    
    15,854
    
    
    
    22,701Net interest income
    
    
    20,988
    
    
    
    21,660
    
    
    
    20,852
    
    
    
    22,283
    
    
    
    24,402Provision (credit) for loan losses
    
    
    123
    
    
    
    (53
    )
    
    
    (242
    )
    
    
    (502
    )
    
    
    Gains on securities, net
    
    
    797
    
    
    
    679
    
    
    
    1,229
    
    
    
    639
    
    
    
    1,718Other non-interest income
    
    
    1,408
    
    
    
    1,238
    
    
    
    1,307
    
    
    
    1,335
    
    
    
    1,255Non-interest expense
    
    
    12,360
    
    
    
    12,514
    
    
    
    12,352
    
    
    
    12,667
    
    
    
    12,087Income before income taxes
    
    
    10,710
    
    
    
    11,116
    
    
    
    11,278
    
    
    
    12,092
    
    
    
    15,288Income tax expense
    
    
    3,683
    
    
    
    3,793
    
    
    
    3,898
    
    
    
    4,229
    
    
    
    5,474Net income
    
    $
    7,027
    
    
    $
    7,323
    
    
    $
    7,380
    
    
    $
    7,863
    
    
    $
    9,814
 Years
ended December 31,
    
    2006
    
    2005
    
    2004
    
    2003
    
    2002Other Data:Yield on average interest-earning assets
    
    
    4.80
    %
    
    
    4.07
    %
    
    
    3.52
    %
    
    
    3.87
    %
    
    
    4.85
    %Cost of average interest-bearing liabilities
    
    
    2.53
    
    
    
    1.85
    
    
    
    1.48
    
    
    
    1.78
    
    
    
    2.61Interest rate spreadInterest rate spread
    
    
    2.27
    
    
    
    2.22
    
    
    
    2.04
    
    
    
    2.09
    
    
    
    2.24Net interest margin
    
    
    2.53
    
    
    
    2.40
    
    
    
    2.19
    
    
    
    2.26
    
    
    
    2.52Non-interest expense to average assets
    
    
    1.44
    
    
    
    1.35
    
    
    
    1.26
    
    
    
    1.26
    
    
    
    1.22Efficiency ratio(2)
    
    
    53.7
    
    
    
    52.7
    
    
    
    51.6
    
    
    
    50.0
    
    
    
    44.0Return on assets (net income/average assets)
    
    
    0.82
    
    
    
    0.79
    
    
    
    0.75
    
    
    
    0.78
    
    
    
    0.99Return on equity (net income/average
stockholders equity)
    
    
    6.74
    
    
    
    6.84
    
    
    
    6.71
    
    
    
    7.08
    
    
    
    8.39Percent non-performing loans to total loans
    
    
    0.07
    
    
    
    0.11
    
    
    
    0.03
    
    
    
    0.09
    
    
    
    0.13Percent non-performing assets to total assets
    
    
    0.02
    
    
    
    0.03
    
    
    
    0.01
    
    
    
    0.02
    
    
    
    0.04Stockholders equity to assets, at year-end
    
    
    12.67
    
    
    
    11.71
    
    
    
    11.27
    
    
    
    10.97
    
    
    
    11.62Book value per share,at year-end(3)
    
    $
    24.76
    
    
    $
    24.32
    
    
    $
    25.11
    
    
    $
    25.17
    
    
    $
    25.45Market price  close, at year-end(3)
    
    
    32.89
    
    
    
    33.00
    
    
    
    37.45
    
    
    
    43.01
    
    
    
    28.30Earnings per share:(3)Basic
    
    
    1.62
    
    
    
    1.68
    
    
    
    1.67
    
    
    
    1.77
    
    
    
    2.09Diluted
    
    
    1.61
    
    
    
    1.66
    
    
    
    1.64
    
    
    
    1.73
    
    
    
    2.04Cash dividends paid per share(3)
    
    
    1.09
    
    
    
    1.05
    
    
    
    1.00
    
    
    
    0.92
    
    
    
    0.88Dividend payout ratio
    
    
    67
    %
    
    
    63
    %
    
    
    60
    %
    
    
    52
    %
    
    
    42
    %
 (1)
    
    Consist of securities held to maturity and available
for sale, trading securities, short-term investments, term Federal funds sold and interest-bearing deposits in banks.(2)
    
    Determined by dividing non-interest expense (including the
provision (credit) for loan losses) by fully taxable equivalent
net interest income plus non-interest income.(3)
    
    All share information presented has been adjusted to reflect the 3-for-2 split of
the Companys common stock effective April 19, 2002. 3




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##### 



Managements Discussion and Analysis of
Financial Condition and Results of Operations
 General
   Massbank Massbank
   Forward-Looking Statement Disclosure
 Massbank Massbank
 Massbank Massbank
 Massbank
 9




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##### 



Critical Accounting Policies
   Provisions (Credit) for Loan losses
    Investment Securities other than Temporarily Impaired
     10




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##### 



Financial Overview  Comparison of the years 2006 and 2005
 Massbank Massbank
 Massbank
    
    
    The decrease in net interest income of $672 thousand due primarily to a decrease in average
earning assets.
    
    The provision for loan losses of $123 thousand versus a credit for loan losses of $53 thousand
the prior year.
    
    The increase in net securities gains of $118 thousand.
    
    The increase in other non-interest income of $170 thousand.
    
    The decrease in non-interest expense of $154 thousand.
    
    The decrease in income tax expense of $110 thousand due to lower income before taxes partially
offset by an increase in the Companys effective income tax rate.
 Years ended December 31, 2006 compared to 2005:
 (In thousands)Years ended December 31,
    
    2006
    
    2005
    
    changeIncome Statement DataInterest and dividend income:Mortgage and other loans
    
    $
    12,070
    
    
    $
    12,792
    
    
    $
    (722
    )Mortgage-backed securities
    
    
    7,592
    
    
    
    7,217
    
    
    
    375Federal funds sold
    
    
    7,731
    
    
    
    6,116
    
    
    
    1,615Other securities and investments
    
    
    12,546
    
    
    
    10,676
    
    
    
    1,870Total interest and dividend income
    
    
    39,939
    
    
    
    36,801
    
    
    
    3,138Total interest expense
    
    
    18,951
    
    
    
    15,141
    
    
    
    (3,810
    )Net interest income
    
    
    20,988
    
    
    
    21,660
    
    
    
    (672
    )Provision (credit) for loan losses
    
    
    123
    
    
    
    (53
    )
    
    
    (176
    )Gains on securities, net
    
    
    797
    
    
    
    679
    
    
    
    118Other non-interest income
    
    
    1,408
    
    
    
    1,238
    
    
    
    170Non-interest expense
    
    
    12,360
    
    
    
    12,514
    
    
    
    154Income tax expense
    
    
    3,683
    
    
    
    3,793
    
    
    
    110Net income
    
    $
    7,027
    
    
    $
    7,323
    
    
    $
    ( 296
    )Diluted earnings per share (in dollars):
    
    $
    1.61
    
    
    $
    1.66
    
    
    $
    (0.05
    )
 (In thousands)Years ended December 31,
    
    2006
    
    2005
    
    changeAverage Balance Sheet DataTotal average earning assets
    
    $
    833,842
    
    
    $
    904,646
    
    
    $
    (70,804
    )Total average deposits
    
    $
    750,437
    
    
    $
    816,577
    
    
    $
    (66,140
    )
 11




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##### 



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




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##### 



Loans
 Massbank
 Non-Performing Assets
  Deposits
 Massbank
   Stockholders Equity
    13




---



##### 



Results of Operations  Comparison of the years 2006 and 2005
 Net Interest Income
 Massbank
 Massbank
         14




---



##### 



Provisions (Credit) for Loan Losses
    Non-Interest Income
   Non-Interest Expense
     Income Tax Expense
 Massbank
 15




---



##### 



Financial Overview  Comparison of the years 2005 and 2004
 Massbank Massbank
 Massbank
     
    
    The increase in net interest income of $808 thousand due primarily to the higher yield on Federal
funds sold and the resulting increase in interest income on Federal funds.
    
    The credit to the provision for loan losses that was $189 thousand less than the prior year.
    
    The decrease in net securities gains of $550 thousand.
    
    The decrease in other non-interest income of $69 thousand.
    
    The increase in non-interest expense of $162 thousand.
    
    The decrease in income tax expense of $105 thousand due to lower income before taxes and a
reduction in the Companys effective income tax rate.
 16




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##### 



Years
ended December 31, 2005 compared to 2004:
 (In thousands) Years ended December 31,
    
    2005
    
    2004
    
    changeIncome Statement DataInterest and dividend income:Mortgage and other loans
    
    $
    12,792
    
    
    $
    14,247
    
    
    $
    (1,455
    )Mortgage-backed securities
    
    
    7,217
    
    
    
    6,571
    
    
    
    646Federal funds sold
    
    
    6,116
    
    
    
    2,438
    
    
    
    3,678Other securities and investments
    
    
    10,676
    
    
    
    10,325
    
    
    
    351Total interest and dividend income
    
    
    36,801
    
    
    
    33,581
    
    
    
    3,220Total interest expense
    
    
    15,141
    
    
    
    12,729
    
    
    
    (2,412
    )Net interest income
    
    
    21,660
    
    
    
    20,852
    
    
    
    808Provision (credit) for loan losses
    
    
    (53
    )
    
    
    (242
    )
    
    
    (189
    )Gains on securities, net
    
    
    679
    
    
    
    1,229
    
    
    
    (550
    )Other non-interest income
    
    
    1,238
    
    
    
    1,307
    
    
    
    (69
    )Non-interest expense
    
    
    12,514
    
    
    
    12,352
    
    
    
    (162
    )Income tax expense
    
    
    3,793
    
    
    
    3,898
    
    
    
    105Net income
    
    $
    7,323
    
    
    $
    7,380
    
    
    $
    (57
    )Diluted earnings per share (in dollars):
    
    $
    1.66
    
    
    $
    1.64
    
    
    $
    0.02
 (In thousands) Years ended December 31,
    
    2005
    
    2004
    
    changeAverage Balance Sheet DataTotal average earning assets
    
    $
    904,646
    
    
    $
    955,267
    
    
    $
    (50,621
    )Total average deposits
    
    $
    816,577
    
    
    $
    862,691
    
    
    $
    (46,114
    )
 Financial Condition
   Condensed Consolidated Balance Sheets
 (In
thousands) at December 31,
    
    2005
    
    2004
    
    changeShort-term investments
    
    $
    167,787
    
    
    $
    194,250
    
    
    $
    (26,463
    )Interest-bearing deposits in banks
    
    
    898
    
    
    
    2,718
    
    
    
    (1,820
    )Securities available for sale, at market value
    
    
    453,472
    
    
    
    443,753
    
    
    
    9,719Securities held to maturity, at amortized cost
    
    
    6,137
    
    
    
    4,877
    
    
    
    1,260Trading securities, at market value
    
    
    9,282
    
    
    
    59,013
    
    
    
    (49,731
    )Total investments
    
    
    637,576
    
    
    
    704,611
    
    
    
    (67,035
    )Total loans
    
    
    225,730
    
    
    
    236,198
    
    
    
    (10,468
    )Allowance for loan losses
    
    
    (1,253
    )
    
    
    (1,307
    )
    
    
    54Net loans
    
    
    224,477
    
    
    
    234,891
    
    
    
    (10,414
    )Other assets
    
    
    36,626
    
    
    
    36,666
    
    
    
    (40
    )Total assets
    
    $
    898,679
    
    
    $
    976,168
    
    
    $
    (77,489
    )Total deposits
    
    $
    784,728
    
    
    $
    849,465
    
    
    $
    (64,737
    )Escrow deposits of borrowers
    
    
    1,059
    
    
    
    1,074
    
    
    
    (15
    )Other liabilities
    
    
    7,628
    
    
    
    15,614
    
    
    
    (7,986
    )Total liabilities
    
    
    793,415
    
    
    
    866,153
    
    
    
    (72,738
    )Total stockholders equity
    
    
    105,264
    
    
    
    110,015
    
    
    
    (4,751
    )Total liabilities and stockholders equity
    
    $
    898,679
    
    
    $
    976,168
    
    
    $
    (77,489
    )
 17




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##### 



Investments
  Loans
  Non-Performing Assets
  Deposits
    Stockholders Equity
   18




---



##### 



Results of Operations  Comparison of the years 2005 and 2004
 Net Interest Income
          19




---



##### 



Provisions (Credit) for Loan Losses
  Non-Interest Income
  Non-Interest Expense
  Income Tax Expense
 Massbanks
 20




---



##### 



Contractual Obligations
  Payments Due or Commitments Expiring - by PeriodLess than
    
    
    One to
    
    
    Four to
    
    
    More than(In thousands)
    
    Total
    
    
    one year
    
    
    three years
    
    
    five years
    
    
    five yearsContractual cash obligations:Operating lease obligations
    
    $
    1,390
    
    
    $
    295
    
    
    $
    458
    
    
    $
    330
    
    
    $
    307Data processing service obligations(1)
    
    
    1,511
    
    
    
    590
    
    
    
    921
    
    
    
    
    
    
    
    Pension benefit obligations
    
    
    347
    
    
    
    347
    
    
    
    
    
    
    
    
    
    
    
    Supplemental retirement benefit obligations
    
    
    79
    
    
    
    79
    
    
    
    
    
    
    
    
    
    
    
    Total contractual cash obligations
    
    $
    3,327
    
    
    $
    1,311
    
    
    $
    1,379
    
    
    $
    330
    
    
    $
    307Other commitments:Commitments to originate residential
mortgage loans
    
    $
    1,206
    
    
    $
    1,206
    
    
    $
    
    
    
    $
    
    
    
    $
    Unused lines of credit
    
    
    28,779
    
    
    
    842
    
    
    
    7,764
    
    
    
    5,167
    
    
    
    15,006Other loan commitments
    
    
    2,554
    
    
    
    217
    
    
    
    1,882
    
    
    
    26
    
    
    
    429Total other commitments(2)
    
    $
    32,539
    
    
    $
    2,265
    
    
    $
    9,646
    
    
    $
    5,193
    
    
    $
    15,435
 (1)
    
    The fees charged by our data processing service provider fluctuate based on
the number of deposit and loan accounts serviced and therefore have been estimated.(2)
    
    Commitments to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. These commitments generally have fixed
expiration dates. The total commitment amounts do not necessarily represent future cash
requirements since many of the commitments may expire without being drawn upon.
 21




---



##### 



Liquidity and Capital Resources
    Asset and Liability Management
  22




---



##### 



Interest Rate Risk
          23




---



##### 



Interest rate risk (continued)
    Interest Sensitivity Periods3 Months
    
    
    3 to 6
    
    
    6 Months
    
    
    1 to 5
    
    
    Over(In thousands)
    
    or Less
    
    
    Months
    
    
    to 1 Year
    
    
    Years
    
    
    5 Years
    
    
    TotalInterest-earning assets:Loans(3)
    
    $
    16,053
    
    
    $
    7,696
    
    
    $
    16,465
    
    
    $
    95,536
    
    
    $
    73,177
    
    
    $
    208,927Short-term investments:Federal funds sold
    
    
    117,104
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    117,104Money market investment fund
    
    
    22,133
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22,133Term Federal funds sold
    
    
    41,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,000Interest-bearing deposits in banks
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3Securities available for sale(3) (5)
    
    
    53,881
    
    
    
    26,987
    
    
    
    42,750
    
    
    
    227,568
    
    
    
    56,418
    
    
    
    407,604Securities held to maturity
    
    
    189
    
    
    
    182
    
    
    
    346
    
    
    
    2,033
    
    
    
    2,646
    
    
    
    5,396Trading securities
    
    
    1,931
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,931Total interest-earning assets
    
    $
    252,294
    
    
    $
    34,865
    
    
    $
    59,561
    
    
    $
    325,137
    
    
    $
    132,241
    
    
    $
    804,098Interest-bearing liabilities:Deposits(1) (2) (4)
    
    $
    527,659
    
    
    $
    52,091
    
    
    $
    63,016
    
    
    $
    54,264
    
    
    $
    304
    
    
    $
    697,334Total interest-bearing liabilities
    
    $
    527,659
    
    
    $
    52,091
    
    
    $
    63,016
    
    
    $
    54,264
    
    
    $
    304
    
    
    $
    697,334GAP for period
    
    $
    (275,365
    )
    
    $
    (17,226
    )
    
    $
    (3,455
    )
    
    $
    270,873
    
    
    $
    131,937
    
    
    $
    106,764Cumulative GAP  December 31, 2006
    
    $
    (275,365
    )
    
    $
    (292,591
    )
    
    $
    (296,046
    )
    
    $
    (25,173
    )
    
    $
    106,764Cumulative GAP as a percent of total assets
    
    
    (32.6
    )%
    
    
    (34.7
    )%
    
    
    (35.1
    )%
    
    
    (3.0
    )%
    
    
    12.7
    %Cumulative GAP  December 31, 2005
    
    $
    (297,094
    )
    
    $
    (309,173
    )
    
    $
    (282,412
    )
    
    $
    (41,165
    )
    
    $
    104,845
 (1)
    
    Excludes non-interest bearing demand accounts of $27,004 thousand.(2)
    
    Includes escrow deposits of borrowers of $1,006 thousand.(3)
    
    Loans and mortgage-backed securities reflect regular amortization of
principal and prepayment estimates. Callable U.S. Government agency securities of
$163,743 thousand are shown in the period they are expected to be called or reprice,
otherwise they are shown based on their maturity date. It is assumed that a security
will be called if the coupon rate on the security exceeded market interest rates at
year-end 2006 .(4)
    
    It is assumed that the Banks Savings and NOW account rates will be increased within 3 months or less.(5)
    
    Excludes net unrealized losses on securities available for sale of $(4,525) thousand.
 24




---



##### 



Interest rate risk (continued)
  Expected Maturity Date  At December 31,  2006
 Fair Value(In thousands)
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    Thereafter
    
    
    Total
    
    
    at 12/31/06Interest sensitive assets:Fixed rate securities(5)
    
    $
    112,968
    
    
    $
    101,686
    
    
    $
    50,940
    
    
    $
    36,008
    
    
    $
    23,966
    
    
    $
    56,071
    
    
    $
    381,639
    
    
    $
    377,197Average interest rate(1)
    
    
    4.04
    %
    
    
    3.91
    %
    
    
    4.60
    %
    
    
    4.63
    %
    
    
    5.11
    %
    
    
    6.39
    %
    
    
    4.55
    %Variable rate securities(2)(5)
    
    
    11,366
    
    
    
    
    
    
    
    9,000
    
    
    
    4,000
    
    
    
    4,000
    
    
    
    2,995
    
    
    
    31,361
    
    
    
    31,158Average interest rate(1)
    
    
    3.98
    %
    
    
    
    
    
    
    3.67
    %
    
    
    5.00
    %
    
    
    5.19
    %
    
    
    4.58
    %
    
    
    4.23
    %Trading securities(6)
    
    
    1,931
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,931
    
    
    
    1,931Average interest rate
    
    
    0.57
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.57
    %Fixed rate loans
    
    
    25,632
    
    
    
    21,120
    
    
    
    18,504
    
    
    
    17,158
    
    
    
    17,391
    
    
    
    71,649
    
    
    
    171,454
    
    
    
    165,643Average interest rate
    
    
    5.42
    %
    
    
    5.47
    %
    
    
    5.49
    %
    
    
    5.47
    %
    
    
    5.51
    %
    
    
    5.28
    %
    
    
    5.39
    %Variable rate loans
    
    
    14,583
    
    
    
    5,433
    
    
    
    7,586
    
    
    
    3,573
    
    
    
    4,852
    
    
    
    1,446
    
    
    
    37,473
    
    
    
    36,335Average interest rate
    
    
    7.40
    %
    
    
    5.98
    %
    
    
    5.98
    %
    
    
    6.23
    %
    
    
    6.59
    %
    
    
    5.63
    %
    
    
    6.41
    %Other fixed rate assets(4)
    
    
    41,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,000
    
    
    
    41,000Average interest rate
    
    
    5.29
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5.29
    %Other variable rate assets(3)
    
    
    139,240
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    139,240
    
    
    
    139,240Average interest rate
    
    
    5.14
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5.14
    %Total interest sensitive assets
    
    $
    346,720
    
    
    $
    128,239
    
    
    $
    86,030
    
    
    $
    60,739
    
    
    $
    50,209
    
    
    $
    $132,161
    
    
    $
    804,098
    
    
    $
    792,504Interest sensitive liabilities:Savings and money market
deposit accounts
    
    $
    344,808
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    344,808
    
    
    $
    344,808Average interest rate
    
    
    3.1.96
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.96
    %Fixed rate certificates of deposit
    
    
    176,142
    
    
    
    44,332
    
    
    
    7,831
    
    
    
    1,242
    
    
    
    859
    
    
    
    304
    
    
    
    230,710
    
    
    
    230,348Average interest rate
    
    
    4.30
    %
    
    
    4.62
    %
    
    
    4.52
    %
    
    
    4.36
    %
    
    
    4.48
    %
    
    
    4.93
    %
    
    
    4.38
    %Variable rate certificates of deposit
    
    
    27,106
    
    
    
    15,874
    
    
    
    13,300
    
    
    
    12,674
    
    
    
    
    
    
    
    
    
    
    
    68,954
    
    
    
    68,954Average interest rate
        
    5.50
    %
    
    
    5.51
    %
    
    
    5.69
    %
    
    
    5.69
    %
    
    
    
    
    
    
    
    
    
    
    5.57
    %NOW accounts
    
    
    51,856
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    51,856
    
    
    
    51,856Average interest rate
        
    0.53
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.53
    %Escrow deposits of borrowers
    
    
    1,006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,006
    
    
    
    1,006Average interest rate
    
    
    0.75
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.75
    %Total interest sensitive liabilities
    
    $
    600,918
    
    
    $
    60,206
    
    
    $
    21,131
    
    
    $
    13,916
    
    
    $
    859
    
    
    $
    304
    
    
    $
    697,334
    
    
    $
    696,972
 (1)
    
    Securities rates presented are on a tax equivalent basis.(2)
    
    Includes equity securities.(3)
    
    Consist of Federal funds sold (overnight), money market investment funds and interest-bearing bank money market accounts.(4)
    
    Consist of term Federal funds sold.(5)
    
    Securities presented are at amortized cost.(6)
    
    Securities presented are at market value.
  Other Market Risks
  25




---



##### 



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




---



##### 



Rate/Volume Analysis
  2006 Compared to 2005
    
    
    2005 Compared To 2004(In thousands)
    
    Increase (Decrease)
    
    
    Increase (Decrease)Years ended December 31,
    
    Due To
    
    
    DUE TOVolume
    
    
    Rate
    
    
    Total
    
    
    Volume
    
    
    Rate
    
    
    TotalInterest and dividend income:Federal funds sold
    
    $
    (1,331
    )
    
    $
    2,946
    
    
    $
    1,615
    
    
    $
    75
    
    
    $
    3,603
    
    
    $
    3,678Short-term investments
    
    
    191
    
    
    
    45
    
    
    
    236
    
    
    
    (321
    )
    
    
    135
    
    
    
    (186
    )Investment securities
    
    
    (159
    )
    
    
    2,358
    
    
    
    2,199
    
    
    
    (298
    )
    
    
    1,220
    
    
    
    922Mortgage-backed securities
    
    
    330
    
    
    
    45
    
    
    
    375
    
    
    
    1,032
    
    
    
    (386
    )
    
    
    646Trading securities
    
    
    (812
    )
    
    
    247
    
    
    
    (565
    )
    
    
    (759
    )
    
    
    374
    
    
    
    (385
    )Mortgage loans
    
    
    (675
    )
    
    
    (131
    )
    
    
    (806
    )
    
    
    (720
    )
    
    
    (747
    )
    
    
    (1,467
    )Other loans
    
    
    (31
    )
    
    
    115
    
    
    
    84
    
    
    
    (38
    )
    
    
    50
    
    
    
    12Total interest and dividend income
    
    
    (2,487
    )
    
    
    5,625
    
    
    
    3,138
    
    
    
    (1,029
    )
    
    
    4,249
    
    
    
    3,220Interest expense:Deposits:Demand and NOW
    
    
    (12
    )
    
    
    53
    
    
    
    41
    
    
    
    1
    
    
    
    15
    
    
    
    16Savings
    
    
    (1,907
    )
    
    
    1,001
    
    
    
    (906
    )
    
    
    (1,319
    )
    
    
    705
    
    
    
    (614
    )Time certificates of deposit
    
    
    1,702
    
    
    
    2,973
    
    
    
    4,675
    
    
    
    926
    
    
    
    2,084
    
    
    
    3,010Total interest expense
    
    
    (217
    )
    
    
    4,027
    
    
    
    3,810
    
    
    
    (392
    )
    
    
    2,804
    
    
    
    2,412Net interest income
    
    $
    (2,270
    )
    
    $
    1,598
    
    
    $
    (672
    )
    
    $
    (637
    )
    
    $
    1,445
    
    
    $
    808
 Impact of Inflation and Changing Prices
 Massbank
 27




---



##### 



Recent Accounting Pronouncements
 Interpretation No. 48, Accounting for Uncertainty In Income Taxes, An Interpretation of Sfas No. 109
   SAB No. 108, Considering the Effects of Prior Year Misstatements When Qualifying Misstatements
 In Current Year Financial Statements
 Massbank
 SFAS No. 157, Fair Value Measurements
  SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans,
 an amendment of Sfas Nos. 87, 88, 106 and 132(r)
     28




---



##### 



Massbank Corp.  Managements Annual Report On Internal Control Over Financial Reporting
 Massbank Massbank
 Massbank
  Massbank
 Managements Assessment of Internal Control Over Financial Reporting
 Massbank Massbank Massbank Massbank
 Chairman, President and CEO
 Sr. Vice President, Treasurer and CFO
 29




---



##### 



report of independent registered public accounting firm
 
 The Board of Directors and Stockholder  Massbank Corp.:
 Massbank Massbank Internal Control  Integrated Framework Massbank Massbank
   30




---



##### 



report
of independent registered public accounting firm (continued)
  Massbank Massbank Internal Control 
Integrated Framework Massbank Internal Control  Integrated Framework
 Certified Public Accountants, Inc.
 Boston, Massachusetts
March 6, 2007
 31




---



##### 



Massbank
Corp. and Subsidiaries  Consolidated Balance Sheets
 (In
thousands except share data) At December 31,
    
    2006
    
    
    2005Assets:Cash and due from banks
    
    $
    8,650
    
    
    $
    9,590Short-term investments (Note 2)
    
    
    139,240
    
    
    
    167,787Total cash and cash equivalents
    
    
    147,890
    
    
    
    177,377Interest-bearing deposits in banks
    
    
    
    
    
    
    898Term Federal funds sold
    
    
    41,000
    
    
    
    Securities available for sale, at market value
(amortized cost of $407,604 in 2006 and $458,297 in 2005) (Note 3)
    
    
    403,079
    
    
    
    453,472Securities held to maturity, at amortized cost
(market value of $5,276 in 2006 and $6,022 in 2005) (Note 3)
    
    
    5,396
    
    
    
    6,137Trading securities, at market value (Note 4)
    
    
    1,931
    
    
    
    9,282Loans (Notes 5 and 7):Mortgage loans
    
    
    199,253
    
    
    
    215,904Other loans
    
    
    9,674
    
    
    
    9,826Total loans
    
    
    208,927
    
    
    
    225,730Allowance for loan losses (Note 6)
    
    
    (1,382
    )
    
    
    (1,253
    )Net loans
    
    
    207,545
    
    
    
    224,477Premises and equipment (Note 9)
    
    
    7,085
    
    
    
    6,525Real estate held for resale
    
    
    425
    
    
    
    Accrued interest and income receivable
    
    
    5,083
    
    
    
    3,898Goodwill
    
    
    1,090
    
    
    
    1,090Income tax receivable, net
    
    
    88
    
    
    
    Deferred income tax asset, net (Note 12)
    
    
    3,347
    
    
    
    3,240Other assets
    
    
    19,563
    
    
    
    12,283Total assets
    
    $
    843,522
    
    
    $
    898,679Liabilities and Stockholders Equity:Deposits (Note 10):Demand and NOW
    
    $
    78,860
    
    
    $
    82,250Savings
    
    
    344,808
    
    
    
    441,541Time certificates of deposit
    
    
    299,664
    
    
    
    260,937Total deposits
    
    
    723,332
    
    
    
    784,728Escrow deposits of borrowers
    
    
    1,006
    
    
    
    1,059Accrued income taxes, net
    
    
    
    
    
    
    35Allowance for loan losses on off-balance
sheet credit exposures
    
    
    345
    
    
    
    517Other liabilities
    
    
    11,954
    
    
    
    7,076Total liabilities
    
    
    736,637
    
    
    
    793,415Commitments and contingent liabilities (Notes 8 and 9)Stockholders equity (Notes 12, 14, 15 and 16):Preferred stock, par value $1.00 per share; 2,000,000 shares authorized, none issued
    
    
    
    
    
    
    Common stock, par value $1.00 per share; 10,000,000 shares
authorized, 7,850,317 and 7,811,680 shares issued in 2006 and 2005, respectively
    
    
    7,850
    
    
    
    7,812Additional paid-in capital
    
    
    57,953
    
    
    
    57,067Retained earnings
    
    
    107,055
    
    
    
    104,743172,858
    
    
    
    169,622Treasury stock at cost, 3,532,663 and 3,483,163 shares in 2006 and 2005, respectively
    
    
    (62,902
    )
    
    
    (61,281
    )Accumulated other comprehensive income (loss)
    
    
    (3,071
    )
    
    
    (3,077
    )Shares held in rabbi trust at cost, 17,944 and 15,644 shares in 2006 and 2005, respectively
    
    
    (426
    )
    
    
    (351
    )Deferred compensation obligation
    
    
    426
    
    
    
    351Total stockholders equity
    
    
    106,885
    
    
    
    105,264Total liabilities and stockholders equity
    
    $
    843,522
    
    
    $
    898,679
 See accompanying notes to consolidated financial statements.
 32




---



##### 



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




---



##### 



Massbank
Corp. and Subsidiaries  Consolidated Statements of Cash Flows
 (In thousands) Years ended December 31,
    
    2006
    
    
    2005
    
    
    2004Cash flows from operating activities:Net income
    
    $
    7,027
    
    
    $
    7,323
    
    
    $
    7,380Adjustments to reconcile net income to net cash provided
by operating activities:Depreciation and amortization
    
    
    669
    
    
    
    642
    
    
    
    676Share-based payment compensation
    
    
    60
    
    
    
    
    
    
    
    Loan interest capitalized
    
    
    (11
    )
    
    
    (9
    )
    
    
    (8
    )(Increase) decrease in accrued interest and income receivable
    
    
    (1,185
    )
    
    
    (482
    )
    
    
    438Increase (decrease) in other liabilities
    
    
    554
    
    
    
    (22
    )
    
    
    276(Increase) decrease in income tax receivable, net
    
    
    (88
    )
    
    
    164
    
    
    
    161Amortization of premiums (accretion of discounts)
on securities, net
    
    
    (79
    )
    
    
    (48
    )
    
    
    566Net trading securities activity
    
    
    7,412
    
    
    
    49,895
    
    
    
    13,488Gains on securities available for sale, net
    
    
    (736
    )
    
    
    (515
    )
    
    
    (1,361
    )Appreciation on donated equity securities
    
    
    5
    
    
    
    
    
    
    
    (Gains) losses on trading securities, net
    
    
    (61
    )
    
    
    (164
    )
    
    
    132Decrease in deferred mortgage loan origination fees,
net of amortization
    
    
    (27
    )
    
    
    (113
    )
    
    
    (231
    )(Decrease) increase in accrued income taxes, net
    
    
    (35
    )
    
    
    35
    
    
    
    Deferred income tax expense (benefit)
    
    
    (56
    )
    
    
    250
    
    
    
    28(Increase) decrease in other assets
    
    
    (3,301
    )
    
    
    (5,088
    )
    
    
    847Provision (credit) for loan losses
    
    
    123
    
    
    
    (53
    )
    
    
    (242
    )Provision (credit) for loan losses on off-balance
sheet credit exposures
    
    
    (172
    )
    
    
    (71
    )
    
    
    (38
    )Gains on sales of premises and equipment
    
    
    (3
    )
    
    
    
    
    
    
    (4
    )Net cash provided by operating activities
    
    
    10,096
    
    
    
    51,744
    
    
    
    22,108Cash flows from investing activities:Purchases of term Federal funds
    
    
    (41,000
    )
    
    
    (15,000
    )
    
    
    Proceeds from maturities of term Federal funds
    
    
    
    
    
    
    15,000
    
    
    
    Net decrease in interest-bearing bank deposits
    
    
    898
    
    
    
    1,820
    
    
    
    2,967Proceeds from sales of investment securities available for sale
    
    
    20,405
    
    
    
    28,252
    
    
    
    28,942Proceeds from maturities and redemption of investment securities
held to maturity and available for sale
    
    
    122,250
    
    
    
    103,961
    
    
    
    207,509Purchases of investment securities available for sale
    
    
    (91,205
    )
    
    
    (132,546
    )
    
    
    (225,318
    )Purchases of mortgage-backed securities available for sale
    
    
    (25,943
    )
    
    
    (47,696
    )
    
    
    (63,922
    )Purchases of mortgage-backed securities held to maturity
    
    
    
    
    
    
    (1,581
    )
    
    
    (4,925
    )Principal repayments of mortgage-backed securities
    
    
    26,730
    
    
    
    31,450
    
    
    
    35,671Principal repayments of securities available for sale
    
    
    2
    
    
    
    
    
    
    
    1Donated equity securities
    
    
    5
    
    
    
    
    
    
    
    Loans originated
    
    
    (21,736
    )
    
    
    (48,874
    )
    
    
    (60,332
    )Loan principal payments received
    
    
    38,583
    
    
    
    59,460
    
    
    
    77,369Purchases of premises and equipment
    
    
    (1,654
    )
    
    
    (700
    )
    
    
    (193
    )Proceeds from sales of premises and equipment
    
    
    3
    
    
    
    
    
    
    
    4Net cash provided by (used in) investing activities
    
    
    27,338
    
    
    
    (6,454
    )
    
    
    (2,227
    )
 (Continued)
 34




---



##### 



Massbank Corp. and Subsidiaries  Consolidated Statements of Cash Flows (Continued)
 (In thousands) Years ended December 31,
    
    2006
    
    
    2005
    
    
    2004Cash flows from financing activities:Net decrease in deposits
    
    
    (61,396
    )
    
    
    (64,737
    )
    
    
    (33,043
    )Decrease in escrow deposits of borrowers
    
    
    (53
    )
    
    
    (15
    )
    
    
    (65
    )Payments to acquire treasury stock
    
    
    (1,621
    )
    
    
    (4,487
    )
    
    
    (2,617
    )Purchase of company stock for deferred compensation plan,
net of distributions
    
    
    (75
    )
    
    
    (30
    )
    
    
    (38
    )Increase in deferred compensation obligation
    
    
    75
    
    
    
    30
    
    
    
    38Options exercised, including tax benefit
    
    
    864
    
    
    
    1,830
    
    
    
    944Cash dividends paid on common stock
    
    
    (4,715
    )
    
    
    (4,583
    )
    
    
    (4,415
    )Net cash used in financing activities
    
    
    (66,921
    )
    
    
    (71,992
    )
    
    
    (39,196
    )Net decrease in cash and cash equivalents
    
    
    (29,487
    )
    
    
    (26,702
    )
    
    
    (19,315
    )Cash and cash equivalents at beginning of year
    
    
    177,377
    
    
    
    204,079
    
    
    
    223,394Cash and cash equivalents at end of year
    
    $
    147,890
    
    
    $
    177,377
    
    
    $
    204,079Supplemental cash flow disclosures:Cash transactions:Cash paid during the year for interest
    
    $
    18,950
    
    
    $
    15,203
    
    
    $
    12,769Cash paid during the year for taxes, net of refunds
    
    
    3,745
    
    
    
    3,002
    
    
    
    3,401Non-cash transactions:Transfer of property from premises and equipment
to real estate held for resale
    
    $
    425
    
    
    $
    
    
    
    $
    
 See accompanying notes to consolidated financial statements.
 35




---



##### 



Massbank Corp. and Subsidiaries  Consolidated Statements of Changes in Stockholders Equity
 (In
thousands except share data) Years ended December 31, 2006,
2005 and 2004Accumulated
    
    
    SharesAdditional
    
    
    
    
    
    
    
    
    
    
    other
    
    
    held in
    
    
    DeferredCommon
    
    
    paid-in
    
    
    Retained
    
    
    Treasury
    
    
    comprehensive
    
    
    Rabbi
    
    
    compensationstock
    
    
    capital
    
    
    earnings
    
    
    stock
    
    
    income
    
    
    Trust
    
    
    obligation
    
    
    TotalBalance at December 31, 2003
    
    $
    7,688
    
    
    $
    54,417
    
    
    $
    99,038
    
    
    $
    (54,177
    )
    
    $
    3,961
    
    
    $
    (515
    )
    
    $
    515
    
    
    $
    110,927Net Income
    
    
    
    
    
    
    
    
    
    
    7,380
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,380Other comprehensive loss, net of tax:Unrealized losses on securities, net of
reclassification adjustment (Note 1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,204
    )
    
    
    
    
    
    
    
    
    
    
    (2,204
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,176Cash dividends paid ($1.00 per share)
    
    
    
    
    
    
    
    
    
    
    (4,415
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,415
    )Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,617
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,617
    )Purchase of company stock for
deferred compensation plan,
net of distributions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (38
    )
    
    
    38
    
    
    
    Exercise of stock options
    
    
    48
    
    
    
    588
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    636Tax benefit on stock options exercised
    
    
    
    
    
    
    308
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    308Balance at December 31, 2004
    
    
    7,736
    
    
    
    55,313
    
    
    
    102,003
    
    
    
    (56,794
    )
    
    
    1,757
    
    
    
    (553
    )
    
    
    553
    
    
    
    110,015Net Income
    
    
    
    
    
    
    
    
    
    
    7,323
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,323Other comprehensive loss, net of tax:Unrealized losses on securities, net of
reclassification adjustment (Note 1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,834
    )
    
    
    
    
    
    
    
    
    
    
    (4,834
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,489Cash dividends paid ($1.05 per share)
    
    
    
    
    
    
    
    
    
    
    (4,583
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,583
    )Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,487
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,487
    )Purchase of company stock for
deferred compensation plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (30
    )
    
    
    30
    
    
    
    Distribution of company stock from
deferred compensation plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    232
    
    
    
    (232
    )
    
    
    Exercise of stock options
    
    
    76
    
    
    
    1,412
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,488Tax benefit on stock options exercised
    
    
    
    
    
    
    342
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    342Balance at December 31, 2005
    
    
    7,812
    
    
    
    57,067
    
    
    
    104,743
    
    
    
    (61,281
    )
    
    
    (3,077
    )
    
    
    (351
    )
    
    
    351
    
    
    
    105,264Net Income
    
    
    
    
    
    
    
    
    
    
    7,027
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,027Other comprehensive income, net of tax:Unrealized gains on securities, net of
reclassification adjustment (Note 1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    202
    
    
    
    
    
    
    
    
    
    
    
    202Pension liability adjustment to
initially apply SFAS No. 158, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (196
    )
    
    
    
    
    
    
    
    
    
    
    (196
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,033Share-based payment compensation
    
    
    
    
    
    
    60
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    60Cash dividends paid ($1.09 per share)
    
    
    
    
    
    
    
    
    
    
    (4,715
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,715
    )Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,621
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,621
    )Purchase of company stock for
deferred compensation plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (75
    )
    
    
    75
    
    
    
    Exercise of stock options
    
    
    38
    
    
    
    712
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    750Tax benefit on stock options exercised
    
    
    
    
    
    
    114
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    114Balance at December 31, 2006
    
    $
    7,850
    
    
    $
    57,953
    
    
    $
    107,055
    
    
    $
    (62,902
    )
    
    $
    (3,071
    )
    
    $
    (426
    )
    
    $
    426
    
    
    $
    106,885
 See accompanying notes to consolidated financial statements.
 36




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##### 



Massbank Corp. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31,
2006, 2005 and 2004
 1.
    
    Summary of
Significant Accounting PoliciesMassbank Corp. (the Company) is a Delaware chartered holding company whose
principal subsidiary is Massbank (the Bank). The Bank operates fifteen full
service banking offices in Reading, Melrose, Stoneham, Wilmington, Medford, Chelmsford,
Tewksbury, Westford, Dracut, Lowell and Everett, Massachusetts providing a variety of deposit,
lending and trust services. As a Massachusetts chartered savings bank whose deposits are insured
by the Federal Deposit Insurance Corporation (FDIC) and the Depositors Insurance Fund (DIF),
the activities of the Bank are subject to regulation, supervision and examination by federal and
state regulatory authorities, including, but not limited to the FDIC, the Massachusetts
Commissioner of Banks and the DIF. In addition, as a bank holding company, the Company is subject
to supervision, examination and regulation by the Board of Governors of the Federal Reserve
System.Basis of
PresentationThe consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries Knabssam LLC and Massbank and its subsidiaries:
Readibank Properties, Inc., Readibank Investment Corporation and Melbank Investment
Corporation.The Company has one reportable operating segment. All significant intercompany balances and
transactions have been eliminated in consolidation. The accounting and reporting policies of the
Company conform to U.S. generally accepted accounting principles and to general practices within
the banking industry. In preparing the consolidated financial statements, management is required
to make estimates and assumptions that affect the reported amounts of assets and liabilities at
the balance sheet date and income and expenses for the period. Material estimates that are
particularly susceptible to change in the near term relate to the determination of the allowance
for loan losses, the allowance for loan losses on off-balance sheet credit exposures and other
than temporary declines in value of investment securities requiring impairment write downs due
to general market conditions or other factors.Certain amounts in the prior years consolidated financial statements were reclassified to
facilitate comparison with the current fiscal year.Investments in Debt
and Equity SecuritiesUnder its investment policy, management determines the appropriate classification of
securities at the time of purchase. Those debt securities that the Company has the intent and
the ability to hold to maturity are classified as securities held to maturity and are carried
at amortized historical cost.Those securities held for indefinite periods of time and not intended to be held to maturity
are classified as available for sale. Securities held for indefinite periods of time include
securities that management intends to use as part of its asset/liability management strategy and
that may be sold in response to changes in market conditions, interest rates, prepayment risk,
the need to increase regulatory capital and other factors. The Company records investment
securities available for sale at aggregate market value with the net unrealized holding gains or
losses reported, net of tax effect, as a separate component of stockholders equity until
realized. As of December 31, 2006, stockholders equity included approximately $2.9 million of
accumulated other comprehensive loss, representing the net unrealized losses on securities
available for sale, less applicable income tax benefits.Securities that are bought and held
principally for the purpose of sale in the near term are classified as trading securities.
Trading generally reflects active and frequent buying and selling, and trading securities are
generally used with the objective of generating profits on short-term differences in price caused
by market volatility. Investments classified as trading securities are stated at market value
with unrealized gains and losses included in earnings.Income on debt securities is accrued and included in interest and dividend income. The
specific identification method is used to determine realized gains or losses on sales of
securities available for sale which are also reported in non-interest income under the caption
gains on securities available for sale, net. When a security suffers a loss in value which is
considered other than temporary, such loss is recognized by a charge to earnings.
 37




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##### 



1.
    
    Summary of Significant Accounting Policies (continued)LoansLoans are reported at the principal amount outstanding, net of unearned fees. Loan
origination fees and related direct incremental loan origination costs are offset and the
resulting net amount is deferred and amortized over the life of the loan using the level-yield
method.The Bank generally does not accrue interest on loans which are 90 days or more past due.
When a loan is placed on nonaccrual status, all interest previously accrued but not collected is
reversed from income and all amortization of deferred loan fees is discontinued. Interest
received on nonaccrual loans is either applied against principal or reported as income according
to managements judgment as to the collectibility of principal. Interest accruals are resumed
on such loans only when they are brought current with respect to interest and principal and
when, in the judgment of management, the loans are estimated to be fully collectible as to both
principal and interest.Impairment on loans for which it is probable that the Bank will be unable to collect all
amounts due according to the contractual terms of the loan agreement are measured on a discounted
cash flow method, or at the loans observable market price, or at the fair value of the
collateral if the loan is collateral dependent. However, impairment must be measured based on the
fair value of the collateral if it is determined that foreclosure is probable. Impaired loans
consist of all nonaccrual commercial loans.Allowance for Loan Losses and Allowance for Loan Losses on Off-Balance Sheet Credit ExposuresThe Company maintains an allowance for possible losses that are inherent in the Companys
loan portfolio. The allowance for loan losses is increased by provisions charged to operations
based on the estimated loan loss exposure inherent in the portfolio. Management uses a
methodology to systematically measure the amount of estimated loan loss exposure inherent in the
portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology
includes three elements: an analysis of individual loans deemed to be impaired, general loss
allocations for various loan types based on historical loss experience factors and an unallocated
allowance which is maintained based on managements assessment of many factors including the risk
characteristics of the portfolio, concentrations of credit, current and anticipated economic
conditions that may affect borrowers ability to pay, and trends in loan delinquencies and
charge-offs. Realized losses, net of recoveries, are charged directly to the allowance. While
management uses the information available in establishing the allowance for loan losses, future
adjustments to the allowance may be necessary if economic conditions differ from the assumptions
used in making the evaluation. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Banks allowance for loan losses. Such
agencies may require the Bank to recognize additions to the allowance based on judgments
different from those of management.The Company also maintains an allowance for possible losses on its outstanding loan
commitments. The allowance for loan losses on off-balance sheet credit exposures (shown
separately on the balance sheet) is maintained based on expected drawdowns of committed loans and
their loss experience factors and managements assessment of various other factors including
current and anticipated economic conditions that may effect the borrowers ability to pay, and
trends in loan delinquencies and charge-offs.
 38




---



##### 



Premises and EquipmentLand is carried at cost. Premises, equipment and leasehold improvements are stated at cost,
less accumulated depreciation and amortization computed primarily by use of the straight-line
method over the estimated useful lives of the related assets or terms of the related leases.Real Estate Held for ResaleReal estate held for resale consists of a parcel of land owned by the Companys subsidiary,
Knabssam LLC that is not being used for operations purposes. The land is carried at cost. The
Company, through its subsidiary, has granted a local developer an option purchase the land. As
consideration for this option, the developer will make quarterly option payments to Knabssam LLC
until the option is either exercised and the closing transaction for the purchase occurs or the
option is allowed to lapse. The closing is expected to take place in the third quarter of 2007.
Option payments received prior to the expiration of the option period in August 2007 are not
applied towards the purchase price and are not refundable. Under the option agreement, the option
period may be extended in accordance with the terms of the agreement.Impairment of the Long-lived Assets  Except GoodwillThe Company reviews long-lived assets for impairment at least annually or whenever events or
changes in business circumstances indicate that the remaining useful life may warrant revision or
that the carrying amount of the long-lived asset may not be fully recoverable. The Company performs
undiscounted cash flow analyses to determine if impairment exists. If impairment is determined to
exist, any related impairment loss is calculated based on the fair value. Impairment losses on
assets to be disposed of, if any, are based on the estimated proceeds to be received, less any
cost of disposal.Share-based PaymentEffective January 1, 2006, the Company adopted Statement of Financial Accounting Standards
No. 123 (revised 2004), Share-Based Payment (SFAS 123R) which requires the measurement and
recognition of compensation expense for all stock-based awards made to employees and directors,
including stock option grants, based on estimated fair values. SFAS 123(R) supersedes previous
accounting under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25) for periods beginning in fiscal year 2006.SFAS 123(R) requires companies to estimate the fair value of stock-based awards on the date
of grant using an option-pricing model. The value of the portion of the award that is ultimately
expected to vest is recognized as expense over the requisite service periods in the Consolidated
Statements of Income. The Company adopted SFAS 123(R) using the modified prospective transition
method that requires the application of the accounting standard starting the first day of the
fiscal year, January 1, 2006 for the Company. Under this method, compensation expense is also
recognized for stock based awards that are modified after December 31, 2005. The Companys
Consolidated Financial Statements, as of and for the year ended December 31, 2006, reflect the
impact of SFAS 123(R). Stock-based compensation expense for the year ended December 31, 2006
totaled $60,000. This stock-based compensation expense is related to the 34,250 stock options
granted to employees and directors in 2006, net of any forfeitures, accounted for under SFAS
123(R) and to the modification of 11,250 stock options in 2006, due to the retirement of a Company
director. Typically, when a director ceases to be a director by reason of the directors
retirement after reaching the mandatory retirement age of 72, the Board has voted to extend the
date that the directors outstanding options shall become fully exercisable from a period of
three months from the date of termination to a period of five years from the date of retirement or
until the expiration date, if earlier. As required by SFAS 123(R), the change in fair value
resulting from this modification has been included in expense. The stock options that were
granted in 2006 were granted at an exercise price equal to the Companys closing stock price at
the date of grant. The stock options issued vest at 20% per year over 5 years and have a
contractual term of ten years.Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to
employees and directors using the intrinsic value method in accordance with APB 25 as allowed
under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS 123). Under the intrinsic value based method, no stock-based compensation
expense for employee stock options was recognized in the Companys Consolidated Financial
Statements, because the exercise price of the stock options granted to the Companys employees and
directors equaled the fair market value of the underlying stock at the date of grant. In
accordance with the modified prospective transition method the Company used in adopting SFAS
123(R), the Companys earnings results prior to fiscal year 2006 have not been restated to
reflect, and do not include, the possible impact of SFAS 123(R). Prior to 2006, the stock options
issued by the Company had a contractual term of ten years and vested immediately at the time of
issuance.Upon adoption of SFAS 123(R), the Company selected the Black-Scholes option-pricing model
as the most appropriate method for determining the estimated fair value for stock-based awards.
 39




---



##### 



1.
    
    Summary of
Significant Accounting Policies (continued)The following table illustrates the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of SFAS No. 123 in 2005 and 2004.
 (In
thousands except per share data) Years Ended December 31,
    
    2005
    
    
    2004Net income, as reported
    
    $
    7,323
    
    
    $
    7,380Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects(1)
    
    
    (161
    )
    
    
    (170
    )Pro forma net income
    
    $
    7,162
    
    
    $
    7,210Earnings per share:Basic  as reported
    
    $
    1.68
    
    
    $
    1.67Basic  pro forma
    
    
    1.64
    
    
    
    1.64Diluted  as reported
    
    $
    1.66
    
    
    $
    1.64Diluted  pro forma
    
    
    1.62
    
    
    
    1.60Weighted average fair value per share
    
    $
    8.11
    
    
    $
    9.55Expected term (years)
    
    7.3 years
    
    7.3 yearsRisk-free interest rate
    
    
    3.97
    %
    
    
    3.49
    %Volatility
    
    
    21.2
    %
    
    
    21.9
    %Dividend yield
    
    
    2.8
    %
    
    
    2.3
    %
 (1)
    
    A Black-Scholes option pricing model was used to determine the fair values of
the options granted.
 Goodwill ImpairmentThe Company adopted SFAS No. 142, Goodwill and Other Intangibles, effective January 1,
2002. The statement addresses the method of identifying and measuring goodwill and other
intangible assets acquired in a business combination, eliminates further amortization of
goodwill, and requires periodic impairment evaluations of goodwill. Impairment evaluations are
required to be performed annually and may be required more frequently if certain conditions
indicating potential impairment exists. In the event that the Company were to determine that
its goodwill were impaired, the recognition of an impairment charge could have an adverse
impact on its results of operations in the period that the impairment occurred or on its
financial position.Pension PlanThe Bank accounts for pension benefits on the net periodic pension cost method for
financial reporting purposes. This method recognizes the compensation cost of an employees
pension benefit over that employees approximate service period. Pension costs are funded in
the year of accrual using the aggregate cost method.Earnings per Common ShareBasic EPS is computed by dividing net income by the weighted average number of shares of
common stock outstanding during the year. Diluted EPS reflects the effect on the weighted
average shares outstanding of the number of additional shares outstanding if dilutive stock
options were converted into common stock using the treasury stock method.The treasury shares acquired in connection with the Companys directors deferred
compensation plan are considered outstanding in the computation of earnings per share and
book value per share.A reconciliation of the weighted average shares outstanding for the years ended December
31, 2006, 2005 and 2004 follows:
 (In thousands) Years ended December 31,
    
    2006
    
    
    2005
    
    
    2004Basic shares
    
    
    4,326
    
    
    
    4,366
    
    
    
    4,408Dilutive impact of stock options
    
    
    35
    
    
    
    57
    
    
    
    94Diluted shares
    
    
    4,361
    
    
    
    4,423
    
    
    
    4,502
 40




---



##### 



1.
    
    Summary of Significant Accounting Policies (continued)Comprehensive IncomeAccounting principles generally require that recognized revenue, expenses, gains and
losses be included in net income. Although certain changes in assets and liabilities, such as
unrealized gains and losses on available for sale securities, are reported as separate
component of the equity section of the balance sheet, such items, along with net income, are
components of comprehensive income.The components of other comprehensive income and related tax effects at December 31 are as
follows:
 (In thousands)Years ended December 31,
    
    2006
    
    
    2005
    
    
    2004Unrealized holding gains (losses) on available for sale securities
and when issued securities contracts arising during period
    
    $
    1,027
    
    
    $
    (7,221
    )
    
    $
    (2,242
    )Less: reclassification adjustment for gains realized in income
    
    
    735
    
    
    
    515
    
    
    
    1,361Net unrealized gains (losses)
    
    
    292
    
    
    
    (7,736
    )
    
    
    (3,603
    )Tax (expense) or benefit
    
    
    (90
    )
    
    
    2,902
    
    
    
    1,399Net unrealized gains (losses), net of tax
    
    
    202
    
    
    
    (4,834
    )
    
    
    (2,204
    )Pension liability adjustment
to initially apply SFAS No. 158
    
    
    (337
    )
    
    
    
    
    
    
    Tax benefit
    
    
    141
    
    
    
    
    
    
    
    Pension liability adjustment, net of tax
    
    
    (196
    )
    
    
    
    
    
    
    Other comprehensive income (loss)
    
    $
    6
    
    
    $
    (4,834
    )
    
    $
    (2,204
    )
 Cash and Cash EquivalentsFor purposes of reporting cash flows, cash and cash equivalents consist of cash and due
from banks, and short-term investments with original maturities of less than 90 days.As a regulated financial institution, the Bank is required to maintain certain reserve
requirements of vault cash and/or deposits with the Federal Reserve Bank of Boston. The
amount of this reserve requirement, included in Cash and Due from Banks, was $4.6 million
and $7.6 million at December 31, 2006 and 2005, respectively.Income TaxesThe Bank recognizes income taxes under the asset and liability method. Under this
method, deferred tax assets and liabilities are established for the temporary differences
between the accounting basis and the tax basis of the Banks assets and liabilities at enacted
tax rates expected to be in effect when the amounts related to such temporary differences are
realized or settled. The Banks deferred tax asset is reviewed and adjustments to such asset
are recognized as deferred income tax expense or benefit based upon managements judgment
relating to the realizability of such asset. Based on the Banks historical and current
pre-tax earnings, management believes it is more likely than not that the Bank will realize
its existing gross deferred tax asset.2.
    
    Short-Term InvestmentsShort-term investments consist of the following:
 (In thousands)At December 31,
    
    2006
    
    
    2005Federal funds sold (overnight)
    
    $
    117,104
    
    
    $
    152,785Term Federal funds sold
    
    
    
    
    
    
    15,000Money market investment funds
    
    
    22,133
    
    
    
    Interest-bearing bank money market accounts
    
    
    3
    
    
    
    2Total short-term investments
    
    $
    139,240
    
    
    $
    167,787
 The investments above are stated at cost which approximates market value.
 41




---



##### 



3.
    
    Investment SecuritiesThe amortized cost and market value of investment securities follows:
 Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Market(In thousands) At December 31, 2006
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueSecurities held to maturity:Mortgage-backed securities:Federal National Mortgage Association
    
    $
    5,396
    
    
    $
    
    
    
    $
    (120
    )
    
    $
    5,276Total
    
    $
    5,396
    
    
    $
    
    
    
    $
    (120
    )
    
    $
    5,276Securities available for sale:Debt securities:U.S. Treasury obligations
    
    $
    22,018
    
    
    $
    
    
    
    $
    (309
    )
    
    $
    21,709U.S. Government agency obligations
    
    
    242,775
    
    
    
    10
    
    
    
    (3,238
    )
    
    
    239,547Total
    
    
    264,793
    
    
    
    10
    
    
    
    (3,547
    )
    
    
    261,256Mortgage-backed securities:Government National Mortgage Association
    
    
    1,554
    
    
    
    19
    
    
    
    
    
    
    
    1,573Federal Home Loan Mortgage Corporation
    
    
    131,399
    
    
    
    602
    
    
    
    (1,555
    )
    
    
    130,446Federal National Mortgage Association
    
    
    2,418
    
    
    
    
    
    
    
    (40
    )
    
    
    2,378Collateralized mortgage obligations
    
    
    74
    
    
    
    
    
    
    
    
    
    
    
    74Total mortgage-backed securities
    
    
    135,445
    
    
    
    621
    
    
    
    (1,595
    )
    
    
    134,471Total debt securities
    
    
    400,238
    
    
    
    631
    
    
    
    (5,142
    )
    
    
    395,727Equity securities
    
    
    7,366
    
    
    
    589
    
    
    
    (603
    )
    
    
    7,352Total securities available for sale
    
    
    407,604
    
    
    $
    1,220
    
    
    $
    (5,745
    )
    
    $
    403,079Net unrealized losses on securities
available for sale
    
    
    (4,525
    )Total securities available for sale, net
    
    
    403,079Total investment securities, net
    
    $
    408,475
 The amortized cost and market value of investment securities follows:
 Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Market(In thousands) At December 31, 2005
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueSecurities held to maturity:Mortgage-backed securities:Federal National Mortgage Association
    
    $
    6,137
    
    
    $
    
    
    
    $
    (115
    )
    
    $
    6,022Total
    
    $
    6,137
    
    
    $
    
    
    
    $
    (115
    )
    
    $
    6,022Securities available for sale:Debt securities:U.S. Treasury obligations
    
    $
    77,051
    
    
    $
    
    
    
    $
    (935
    )
    
    $
    76,116U.S. Government agency obligations
    
    
    239,024
    
    
    
    10
    
    
    
    (4,497
    )
    
    
    234,537Total
    
    
    316,075
    
    
    
    10
    
    
    
    (5,432
    )
    
    
    310,653Mortgage-backed securities:Government National Mortgage Association
    
    
    3,262
    
    
    
    89
    
    
    
    
    
    
    
    3,351Federal Home Loan Mortgage Corporation
    
    
    128,942
    
    
    
    1,003
    
    
    
    (1,058
    )
    
    
    128,887Federal National Mortgage Association
    
    
    3,138
    
    
    
    2
    
    
    
    (37
    )
    
    
    3,103Collateralized mortgage obligations
    
    
    92
    
    
    
    
    
    
    
    (1
    )
    
    
    91Total mortgage-backed securities
    
    
    135,434
    
    
    
    1,094
    
    
    
    (1,096
    )
    
    
    135,432Total debt securities
    
    
    451,509
    
    
    
    1,104
    
    
    
    (6,528
    )
    
    
    446,085Equity securities
    
    
    6,788
    
    
    
    722
    
    
    
    (123
    )
    
    
    7,387Total securities available for sale
    
    
    458,297
    
    
    $
    1,826
    
    
    $
    (6,651
    )
    
    $
    453,472Net unrealized losses on securities
available for sale
    
    
    (4,825
    )Total securities available for sale, net
    
    
    453,472Total investment securities, net
    
    $
    459,609
 42




---



##### 



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

2006
    
    
    2005
    
    
    2004Realized
    
    
    Realized
    
    
    RealizedGains
    
    
    Losses
    
    
    Gains
    
    
    Losses
    
    
    Gains
    
    
    LossesSales:U.S. Treasury obligations
    
    $
    
    
    
    $
    (105
    )
    
    $
    29
    
    
    $
    (55
    )
    
    $
    35
    
    
    $
    (68
    )Marketable equity securities
    
    
    1,083
    
    
    
    (248
    )
    
    
    761
    
    
    
    (220
    )
    
    
    1,720
    
    
    
    (326
    )Securities donated to Massbank
Charitable Foundation:Marketable equity securities
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total realized gains (losses)
    
    $
    1,088
    
    
    $
    (353
    )
    
    $
    790
    
    
    $
    (275
    )
    
    $
    1,755
    
    
    $
    (394
    )
 Proceeds from sales of debt securities available for sale during 2006, 2005 and 2004 were $9.9
million, $22.0 million and $18.3 million, respectively. Proceeds from sales of equity
securities available for sale during 2006, 2005 and 2004, were $10.5 million, $6.3 million and
$10.6 million, respectively.There were no sales of investment securities held to maturity during 2006, 2005 and 2004.The amortized cost and market value of debt securities available for sale by contractual maturity
are as follows:
 (In thousands) At December 31,
    
    2006
    
    
    2005Amortized
    
    
    Market
    
    
    Amortized
    
    
    MarketCost
    
    
    Value
    
    
    Cost
    
    
    ValueInvestment securities available for sale:U.S. Treasury obligations:Maturing within 1 year
    
    $
    14,019
    
    
    $
    13,911
    
    
    $
    50,950
    
    
    $
    50,595Maturing after 1 year but within 5 years
    
    
    7,999
    
    
    
    7,798
    
    
    
    26,101
    
    
    
    25,521Total
    
    
    22,018
    
    
    
    21,709
    
    
    
    77,051
    
    
    
    76,116U.S. Government agency obligations:Maturing within 1 year
    
    
    75,000
    
    
    
    74,594
    
    
    
    45,999
    
    
    
    45,612Maturing after 1 year but within 5 years
    
    
    150,745
    
    
    
    148,246
    
    
    
    171,992
    
    
    
    168,254Maturing after 5 years but within 10 years
    
    
    15,995
    
    
    
    15,706
    
    
    
    19,996
    
    
    
    19,665Maturing after 10 years but within 15 years
    
    
    1,035
    
    
    
    1,001
    
    
    
    1,037
    
    
    
    1,006Total
    
    
    242,775
    
    
    
    239,547
    
    
    
    239,024
    
    
    
    234,537Mortgage-backed securities:Maturing within 1 year
    
    
    100
    
    
    
    101
    
    
    
    19
    
    
    
    20Maturing after 1 year but within 5 years
    
    
    7,508
    
    
    
    7,666
    
    
    
    7,238
    
    
    
    7,451Maturing after 5 years but within 10 years
    
    
    17,155
    
    
    
    17,473
    
    
    
    22,333
    
    
    
    22,955Maturing after 10 years but within 15 years
    
    
    110,608
    
    
    
    109,157
    
    
    
    105,779
    
    
    
    104,940Maturing after 15 years
    
    
    74
    
    
    
    74
    
    
    
    65
    
    
    
    66Total
    
    
    135,445
    
    
    
    134,471
    
    
    
    135,434
    
    
    
    135,432Total debt securities available for sale
    
    
    400,238
    
    
    
    395,727
    
    
    
    451,509
    
    
    
    446,085Net unrealized losses on debt securities
available for sale
    
    
    (4,511
    )
    
    
    
    
    
    
    (5,424
    )
    
    
    Total debt securities available for sale,
net carrying value
    
    $
    395,727
    
    
    $
    395,727
    
    
    $
    446,085
    
    
    $
    446,085
 Maturities of mortgage-backed securities are shown at final contractual maturity and do not
reflect any principal amortization or prepayments.Included in U.S. Government agency obligations are investments that can be called prior to
final maturity with an amortized cost of $163.7 million and a market value of $161.3 million at
December 31, 2006 and an amortized cost of $193.0 million and a market value of $189.3 million
at December 31, 2005.
 43




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##### 



3.
    
    Investment
Securities (continued)The fair value and unrealized losses of temporarily impaired investments aggregated by
category of investments is as follows:
 (In
thousands) At December 31, 2006
    
    Less Than 12 months
    
    
    12 Months or longer
    
    
    TotalUnrealized
    
    
    
    
    
    
    Unrealized
    
    
    
    
    
    
    UnrealizedDescription of Securities
    
    Fair value
    
    
    Losses
    
    
    Fair Value
    
    
    Losses
    
    
    Fair Value
    
    
    LossesDebt securities available for sale and held to maturity:U.S. Treasury obligations
    
    $
    
    
    
    $
    
    
    
    $
    21,709
    
    
    $
    (309
    )
    
    $
    21,709
    
    
    $
    (309
    )U.S. Government agency obligations
    
    
    48,670
    
    
    
    (79
    )
    
    
    178,832
    
    
    
    (3,159
    )
    
    
    227,502
    
    
    
    (3,238
    )Mortgage-backed securities
    
    
    38,135
    
    
    
    (203
    )
    
    
    68,953
    
    
    
    (1,512
    )
    
    
    107,088
    
    
    
    (1,715
    )Total debt securities
    
    
    86,805
    
    
    
    (282
    )
    
    
    269,494
    
    
    
    (4,980
    )
    
    
    356,299
    
    
    
    (5,262
    )Equity securities
    
    
    3,292
    
    
    
    (603
    )
    
    
    
    
    
    
    
    
    
    
    3,292
    
    
    
    (603
    )Total temporarily impaired securities
    
    $
    90,097
    
    
    $
    (885
    )
    
    $
    269,494
    
    
    $
    (4,980
    )
    
    $
    359,591
    
    
    $
    (5,865
    )
 As of December 31, 2006, management concluded that the unrealized losses above are temporary
in nature since they are not related to the underlying credit quality of the issuers, and the
Company has the intent and ability to hold these investments for a time necessary to recover
its cost. The losses above (with the exception of the equity securities) are on securities
that have contractual maturity dates and are primarily related to market interest rates.
The fair value and unrealized losses of temporarily impaired investments aggregated by category of
investments is as follows:
 (In thousands) At December 31, 2005
    
    Less than 12 months
    
    
    12 months or longer
    
    
    TotalUnrealized
    
    
    
    
    
    
    Unrealized
    
    
    
    
    
    
    UnrealizedDescription of Securities
    
    Fair value
    
    
    Losses
    
    
    Fair Value
    
    
    Losses
    
    
    Fair Value
    
    
    LossesDebt securities available for sale and held to maturity:U.S. Treasury obligations
    
    $
    42,489
    
    
    $
    (279
    )
    
    $
    32,625
    
    
    $
    (656
    )
    
    $
    75,114
    
    
    $
    (935
    )U.S. Government agency obligations
    
    
    107,529
    
    
    
    (1,458
    )
    
    
    120,960
    
    
    
    (3,039
    )
    
    
    228,489
    
    
    
    (4,497
    )Mortgage-backed securities
    
    
    96,160
    
    
    
    (1,084
    )
    
    
    3,050
    
    
    
    (127
    )
    
    
    99,210
    
    
    
    (1,211
    )Total debt securities
    
    
    246,178
    
    
    
    (2,821
    )
    
    
    156,635
    
    
    
    (3,822
    )
    
    
    402,813
    
    
    
    (6,643
    )Equity securities
    
    
    1,856
    
    
    
    (117
    )
    
    
    59
    
    
    
    (6
    )
    
    
    1,915
    
    
    
    (123
    )Total temporarily impaired securities
    
    $
    248,034
    
    
    $
    (2,938
    )
    
    $
    156,694
    
    
    $
    (3,828
    )
    
    $
    404,728
    
    
    $
    (6,766
    )
 As of December 31, 2005, management concluded that the unrealized losses above are temporary
in nature since they are not related to the underlying credit quality of the issuers, and the
Company has the intent and ability to hold these investments for a time necessary to recover
its cost. The losses above (with the exception of the equity securities) are on securities
that have contractual maturity dates and are primarily related to market interest rates.
 44




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##### 



3.
    
    Investment
Securities (continued)The amortized cost and market value of U.S. Government agency securities available for
sale that can be called prior to maturity by scheduled maturity and next call date are as
follows:
 (In thousands) At December 31,
    

2006
    
    
    2005Amortized
    
    
    Market
    
    
    Amortized
    
    
    MarketBased on Scheduled Maturity
    
    Cost
    
    
    Value
    
    
    Cost
    
    
    ValueInvestment securities available for saleU.S. Government agency obligations:Maturing within 1 year
    
    $
    32,000
    
    
    $
    31,735
    
    
    $
    19,999
    
    
    $
    19,775Maturing after 1 but within 2 years
    
    
    46,750
    
    
    
    45,824
    
    
    
    47,000
    
    
    
    46,122Maturing after 2 but within 3 years
    
    
    36,000
    
    
    
    35,418
    
    
    
    51,000
    
    
    
    49,758Maturing after 3 but within 4 years
    
    
    18,000
    
    
    
    17,704
    
    
    
    32,000
    
    
    
    31,299Maturing after 4 but within 5 years
    
    
    16,000
    
    
    
    15,974
    
    
    
    22,000
    
    
    
    21,688Maturing after 5 but within 10 years
    
    
    13,994
    
    
    
    13,710
    
    
    
    19,996
    
    
    
    19,665Maturing after 10 but within 15 years
    
    
    1,000
    
    
    
    966
    
    
    
    1,000
    
    
    
    969Total
    
    $
    163,744
    
    
    $
    161,331
    
    
    $
    192,995
    
    
    $
    189,276
 Amortized
    
    
    Market
    
    
    Amortized
    
    
    MarketBased on Next Call Date
    
    Cost
    
    
    Value
    
    
    Cost
    
    
    ValueInvestment securities available for saleU.S. Government agency obligations:Callable within 1 year
    
    $
    157,744
    
    
    $
    155,391
    
    
    $
    182,995
    
    
    $
    179,365Callable after 1 but within 2 years
    
    
    6,000
    
    
    
    5,940
    
    
    
    7,000
    
    
    
    6,945Callable after 2 but within 3 years
    
    
    
    
    
    
    
    
    
    
    3,000
    
    
    
    2,966Total
    
    $
    163,744
    
    
    $
    161,331
    
    
    $
    192,995
    
    
    $
    189,276
 4.
    
    Trading SecuritiesThe carrying amount and market value of trading securities are as follows:
 (In Thousands) At December 31,
    
    2006
    
    
    2005Market
    
    
    MarketValue
    
    
    ValueU.S. Treasury obligations
    
    $
    
    
    
    $
    7,896Marketable equity securities
    
    
    1,926
    
    
    
    1,382Investments in mutual funds
    
    
    5
    
    
    
    4Total trading securities
    
    $
    1,931
    
    
    $
    9,282
 During the years ended December 31, 2006, 2005 and 2004, the Company realized gains and losses
on sales of trading securities as follows:
 (In Thousands) Years Ended December 31,
    
    2006
    
    
    2005
    
    
    2004Realized
    
    
    Realized
    
    
    RealizedGains
    
    
    Losses
    
    
    Gains
    
    
    Losses
    
    
    Gains
    
    
    LossesU.S. Treasury obligations
    
    $
    
    
    
    $
    (29
    )
    
    $
    1
    
    
    $
    (119
    )
    
    $
    101
    
    
    $
    (40
    )Marketable equity securities
    
    
    224
    
    
    
    
    
    
    
    99
    
    
    
    (3
    )
    
    
    72
    
    
    
    (19
    )Total realized gains (losses)
    
    $
    224
    
    
    $
    (29
    )
    
    $
    100
    
    
    $
    (122
    )
    
    $
    173
    
    
    $
    (59
    )
 Proceeds from sales of trading securities during 2006, 2005 and 2004 were $21.2 million, $24.4
million and $46.4 million, respectively. Mark-to-market adjustments included in income in
2006, 2005 and 2004 were $(134) thousand, $186 thousand and $(246) thousand, respectively.
 45




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##### 



5.
    
    LoansThe Banks lending activities are conducted principally in the local communities in
which it operates banking offices, and to a lesser extent, in selected areas of Massachusetts
and southern New Hampshire.
   (In
thousands) At December 31,
    
    2006
    
    
    2005Mortgage loans:Residential:Conventional:Fixed rate
    
    $
    169,036
    
    
    $
    189,736Variable rate
    
    
    23,941
    
    
    
    22,948FHA and VA
    
    
    13
    
    
    
    27Construction
    
    
    1,217
    
    
    
    845Commercial:Fixed rate
    
    
    367
    
    
    
    191Variable rate
    
    
    4,076
    
    
    
    2,144Construction
    
    
    563
    
    
    
    Total mortgage loans
    
    
    199,213
    
    
    
    215,891Premium on loans
    
    
    2
    
    
    
    2Deferred mortgage loan origination costs, net
    
    
    38
    
    
    
    11Mortgage loans, net
    
    
    199,253
    
    
    
    215,904Other loans:Consumer:Second mortgage loans
    
    
    751
    
    
    
    34Installment
    
    
    211
    
    
    
    211Guaranteed education
    
    
    635
    
    
    
    1,094Other secured
    
    
    408
    
    
    
    499Home equity lines of credit
    
    
    7,460
    
    
    
    7,722Unsecured
    
    
    128
    
    
    
    148Total consumer loans
    
    
    9,593
    
    
    
    9,708Commercial
    
    
    81
    
    
    
    118Total other loans
    
    
    9,674
    
    
    
    9,826Total loans
    
    $
    208,927
    
    
    $
    225,730
 In the ordinary course of business, the Bank makes loans to its directors, officers and their
associates and affiliated companies (related parties) at substantially the same terms as
those prevailing at the time of origination for comparable transactions with unrelated
borrowers. An analysis of total related party loans for the year ended December 31, 2006
follows:
 (In thousands)Balance at December 31, 2005
    
    $
    1,489Additions
    
    
    76Repayments
    
    
    (162
    )Balance at December 31, 2006
    
    $
    1,403
 46




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##### 



6.
    
    Allowance for Loan LossesAn analysis of the activity in the allowance for loan losses is as follows:
 (In thousands) Years ended December 31,
    
    2006
    
    
    2005
    
    
    2004Balance at beginning of year
    
    $
    1,253
    
    
    $
    1,307
    
    
    $
    1,554Provision (credit) for loan losses
    
    
    123
    
    
    
    (53
    )
    
    
    (242
    )Recoveries of loans previously charged-off
    
    
    19
    
    
    
    
    
    
    
    Total
    
    
    1,395
    
    
    
    1,254
    
    
    
    1,312Charge-offs:Mortgage loans
    
    
    
    
    
    
    
    
    
    
    Other loans
    
    
    (13
    )
    
    
    (1
    )
    
    
    (5
    )Balance at end of year
    
    $
    1,382
    
    
    $
    1,253
    
    
    $
    1,307
 The following table shows the allocation of the allowance for loan losses by category of
loans at December 31, 2006, 2005 and 2004.
 (In thousands) At December 31,
    
    2006
    
    
    2005
    
    
    2004Percentage
    
    
    
    
    
    
    Percentage
    
    
    
    
    
    
    Percentageof Loans
    
    
    
    
    
    
    of Loans
    
    
    
    
    
    
    of LoansAmount
    
    
    to Total
    
    
    Amount
    
    
    to Total
    
    
    Amount
    
    
    to TotalMortgage loans:Residential
    
    $
    795
    
    
    
    93
    %
    
    $
    770
    
    
    
    95
    %
    
    $
    767
    
    
    
    95
    %Commercial
    
    
    324
    
    
    
    2
    
    
    
    111
    
    
    
    1
    
    
    
    79
    
    
    
    1Consumer loans
    
    
    98
    
    
    
    5
    
    
    
    139
    
    
    
    4
    
    
    
    154
    
    
    
    4Commercial loans
    
    
    40
    
    
    
    
    
    
    
    46
    
    
    
    
    
    
    
    46
    
    
    
    Unallocated
    
    
    125
    
    
    
    
    
    
    
    187
    
    
    
    
    
    
    
    261
    
    
    
    Total
    
    $
    1,382
    
    
    
    100
    %
    
    $
    1,253
    
    
    
    100
    %
    
    $
    1,307
    
    
    
    100
    %
 An integral component of the Companys risk management process is to ensure the proper
allocation of the allowance for loan losses based upon an analysis of risk characteristics,
demonstrated losses and other factors. The unallocated component of the allowance for loan
losses represents managements view that there are possible losses that have been incurred
within the portfolio but have not yet been specifically identified. The unallocated portion of
the allowance for loan losses is based on managements assessment of many factors including
the risk characteristics of the loan portfolio, concentrations of credit, current and
anticipated economic conditions that may affect borrowers ability to pay, and trends in loan
delinquencies and charge-offs. The unallocated portion of the allowance for loan losses may
change periodically after evaluating factors impacting assumptions utilized in the calculation
of the allocated portion of the allowance for loan losses. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review the Banks
allowance for loan losses. Such agencies may require the Bank to recognize additions to the
allowance based on judgments different from those of management.7.
    
    Non-performing AssetsThe following schedule summarizes non-performing assets at the dates shown:
 (In thousands) At December 31,
    
    2006
    
    
    2005
    
    
    2004Total nonaccrual loans
    
    $
    137
    
    
    $
    257
    
    
    $
    74Total non-performing assets
    
    $
    137
    
    
    $
    257
    
    
    $
    74Percent of non-performing loans to total loans
    
    
    0.07
    %
    
    
    0.11
    %
    
    
    0.03
    %Percent of non-performing assets to total assets
    
    
    0.02
    %
    
    
    0.03
    %
    
    
    0.01
    %
 47




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##### 



7.
    
    Non-performing
Assets(continued)The reduction in interest income associated with nonaccrual loans is as follows:
 (In thousands) Years ended December 31,
    
    2006
    
    
    2005
    
    
    2004Interest income that would have been recorded under original terms
    
    $
    8
    
    
    $
    16
    
    
    $
    4Interest income actually recorded
    
    
    5
    
    
    
    9
    
    
    
    1Reduction in interest income
    
    $
    3
    
    
    $
    7
    
    
    $
    3
 During 2006, 2005 and 2004 the Company had no impaired loans.8.
    
    Financial Instruments with Off-Balance Sheet RiskThe Bank is party to financial instruments with off-balance sheet risk in the normal
course of business to meet the financing needs of its customers and to reduce its own exposure
to fluctuations in interest rates. These financial instruments include commitments to extend
credit and involve, to varying degrees, elements of credit risk in excess of the amount
recognized in the consolidated balance sheet. The contract or notional amounts reflect the
extent of involvement the Bank has in particular classes of these instruments. The Banks
exposure to credit loss in the event of nonperformance by the other party to the financial
instru ment is represented by the contractual or notional amount of those instruments. The Bank
uses the same credit policies in making commitments and conditional obligations as it does for
on-balance sheet instruments.
 Contract or Notional Amount(In thousands) At December 31,
    
    2006
    
    
    2005Financial instruments whose contract amounts represent credit risk:Commitments to originate residential mortgage loans
    
    $
    1,206
    
    
    $
    1,257Unadvanced portions of construction loans
    
    
    217
    
    
    
    530Unused credit lines, including unused portions of equity lines of credit
    
    
    28,779
    
    
    
    31,413Other loan commitments
    
    
    2,337
    
    
    
    2,451
 Commitments to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee by the
customer. Since many of the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash requirements. The Bank
evaluates each customers credit-worthiness on a case-by-case basis. The amount of collateral
obtained, if any, is based on managements credit evaluation of the borrower.9.
    
    Premises and EquipmentA summary of premises and equipment and their estimated useful lives used for depreciation
purposes is as follows:
 EstimatedUseful Life(In thousands) At December 31,
    
    2006
    
    
    2005
    
    
    (In Years)Premises:Land
    
    $
    1,967
    
    
    $
    2,392
    
    
    
    Buildings
    
    
    7,438
    
    
    
    6,204
    
    
    
    25-45Building and leasehold improvements
    
    
    2,862
    
    
    
    2,723
    
    
    
    2-30Equipment
    
    
    5,591
    
    
    
    5,309
    
    
    
    1-1517,858
    
    
    
    16,628Less: accumulated depreciation and amortization
    
    
    10,773
    
    
    
    10,103Total premises and equipment, net
    
    $
    7,085
    
    
    $
    6,525
 The Bank is obligated under a number of noncancelable operating leases for various banking
offices. These operating leases expire at various dates through 2016 with options for renewal.
Rent expense for the years ended December 31, 2006, 2005 and 2004 amounted to $312 thousand,
$298 thousand, and $294 thousand, respectively.
 48




---



##### 



9.
    
    Premises and
Equipment (continued)The minimum rental commitments, with initial or remaining terms of one year or more
exclusive of operating costs and real estate taxes to be paid by the Bank under these leases, as
of December 31, 2006, are as follows:
 (In
thousands)Years ending December 31,
    
    PAYMENTS2007
    
    $
    2952008
    
    
    2672009
    
    
    1912010
    
    
    1652011
    
    
    165Later
years
    
    
    307Total
    
    $
    1,390
 10.
    
    DepositsDeposits are summarized as follows:
 (In
Thousands) AT December 31,
    
    2006
    
    
    2005Amount
    
    
    Rate
    
    
    Amount
    
    
    RateDemand and NOW:NOW accounts
    
    $
    51,856
    
    
    
    0.53
    %
    
    $
    54,924
    
    
    
    0.37
    %Demand accounts
    
    
    27,004
    
    
    
    
    
    
    
    27,326
    
    
    
    Total demand and NOW
    
    
    78,860
    
    
    
    0.35
    
    
    
    82,250
    
    
    
    0.25Savings:Savings accounts
    
    
    335,142
    
    
    
    1.96
    
    
    
    430,771
    
    
    
    1.75Money market accounts
    
    
    9,666
    
    
    
    1.99
    
    
    
    10,770
    
    
    
    1.73Total savings
    
    
    344,808
    
    
    
    1.96
    
    
    
    441,541
    
    
    
    1.75Time certificates of deposit:Fixed rate certificates
    
    
    230,710
    
    
    
    4.38
    
    
    
    197,743
    
    
    
    3.19Variable rate certificates
    
    
    68,954
    
    
    
    5.57
    
    
    
    63,194
    
    
    
    4.80Total time certificates of deposit
    
    
    299,664
    
    
    
    4.65
    
    
    
    260,937
    
    
    
    3.58Total deposits
    
    $
    723,332
    
    
    
    2.90
    %
    
    $
    784,728
    
    
    
    2.20
    %
 The maturity distribution and related rate structure of the Banks time certificates of deposit at
December 31, 2006 follows:
 (In Thousands) AT December 31,
    
    2006AverageAmount
    
    
    Interest RateDue within 3 months
    
    $
    74,084
    
    
    
    4.44
    %Due within 36 months
    
    
    57,942
    
    
    
    4.44Due within 612 months
    
    
    71,222
    
    
    
    4.50Due within 12 years
    
    
    60,206
    
    
    
    4.86Due within 23 years
    
    
    21,131
    
    
    
    5.26Due within 35 years
    
    
    14,775
    
    
    
    5.50Thereafter
    
    
    304
    
    
    
    4.93Total
    
    $
    299,664
    
    
    
    4.65
    %
 49




---



##### 



10.
    
    Deposits(continued)At December 31, 2006 and 2005, the Bank had individual time certificates of deposit of
$100 thousand or more maturing as follows:
 (In
Thousands) At December 31,
    
    2006
    
    
    2005Due within 3 months
    
    $
    33,060
    
    
    $
    17,824Due within 36 months
    
    
    21,323
    
    
    
    21,777Due within 612 months
    
    
    26,980
    
    
    
    22,174Due within 12 years
    
    
    22,322
    
    
    
    21,363Due within 23 years
    
    
    10,050
    
    
    
    3,381Due within 35 years
    
    
    5,021
    
    
    
    7,736Thereafter
    
    
    155
    
    
    
    200Total
    
    $
    118,911
    
    
    $
    94,455
 11.
    
    Fair Value of Financial InstrumentsThe Bank is required to disclose estimated fair values for its financial instruments.
Fair value estimates, methods, and assumptions are set forth below for the Banks financial
instruments.Cash and Due from
Banks, Short-Term Investments and Accrued Interest and Income Receivable
The carrying amounts for these financial instruments approximate fair value because of
the short-term nature of these financial instruments.Interest-bearing Deposits in Banks and Term Federal Funds Sold
The carrying amounts of the interest-bearing deposits in banks and term Federal funds
sold reported in the balance sheet at December 31, 2006 and 2005 approximate fair value.Securities
The fair value of investment securities is based principally on quoted market prices and
dealer quotes.
   (In Thousands) At December 31,
    
    2006
    
    
    2005Carrying
    
    
    Calculated
    
    
    Carrying
    
    
    CalculatedAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair ValueSecurities available for sale
    
    $
    403,079
    
    
    $
    403,079
    
    
    $
    453,472
    
    
    $
    453,472Securities held to maturity
    
    
    5,396
    
    
    
    5,276
    
    
    
    6,137
    
    
    
    6,022Trading securities
    
    
    1,931
    
    
    
    1,931
    
    
    
    9,282
    
    
    
    9,282Total securities
    
    $
    410,406
    
    
    $
    410,286
    
    
    $
    468,891
    
    
    $
    468,776
 LoansFair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as residential mortgage, commercial real
estate, consumer and commercial.
  50




---



##### 



11.
    
    Fair Value of Financial Instruments (continued)The following table presents information for loans:
 (In thousands) At December 31,
    
    2006
    
    
    2005Carrying
    
    
    Calculated
    
    
    Carrying
    
    
    CalculatedAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair ValueReal estate:Residential:Variable
    
    $
    25,168
    
    
    $
    24,171
    
    
    $
    23,113
    
    
    $
    22,202Fixed
    
    
    169,112
    
    
    
    163,378
    
    
    
    190,471
    
    
    
    186,377Commercial:Fixed
    
    
    367
    
    
    
    347
    
    
    
    192
    
    
    
    175Variable
    
    
    4,606
    
    
    
    4,445
    
    
    
    2,128
    
    
    
    2,057Consumer
    
    
    9,593
    
    
    
    9,569
    
    
    
    9,708
    
    
    
    9,709Commercial
    
    
    81
    
    
    
    68
    
    
    
    118
    
    
    
    94Total loans
    
    
    208,927
    
    
    
    201,978
    
    
    
    225,730
    
    
    
    220,614Allowance for loan losses
    
    
    (1,382
    )
    
    
    
    
    
    
    (1,253
    )
    
    
    Net loans
    
    $
    207,545
    
    
    $
    201,978
    
    
    $
    224,477
    
    
    $
    220,614
 DepositsThe fair value of deposits with no stated maturity, such as demand deposits, NOW
accounts, savings accounts, and money market accounts for purposes of this disclosure, is
equal to the amount payable on demand as of December 31, 2006 and 2005. The fair value of
certificates of deposit is based on the discounted value of contractual cash flows. The
discount rate is estimated using the rates currently offered for deposits of similar remaining
maturities.
 (In thousands) At December 31,
    
    2006
    
    
    2005Carrying
    
    
    Estimated
    
    
    Carrying
    
    
    EstimatedAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair ValueDemand accounts
    
    $
    27,004
    
    
    $
    27,004
    
    
    $
    27,326
    
    
    $
    27,326NOW accounts
    
    
    51,856
    
    
    
    51,856
    
    
    
    54,924
    
    
    
    54,924Savings accounts
    
    
    335,142
    
    
    
    335,142
    
    
    
    430,771
    
    
    
    430,771Money market accounts
    
    
    9,666
    
    
    
    9,666
    
    
    
    10,770
    
    
    
    10,770Time certificates of deposit
    
    
    299,664
    
    
    
    299,302
    
    
    
    260,937
    
    
    
    259,755Total deposits
    
    
    723,332
    
    
    
    722,970
    
    
    
    784,728
    
    
    
    783,546Escrow deposits of borrowers
    
    
    1,006
    
    
    
    1,006
    
    
    
    1,059
    
    
    
    1,059Total
    
    $
    724,338
    
    
    $
    723,976
    
    
    $
    785,787
    
    
    $
    784,605
 The fair value estimates and the carrying amounts above do not include the benefit that
results from the low-cost funding provided by the deposit liabilities compared to the cost of
borrowing funds in the market.Commitments to Extend CreditThe fair value of commitments to extend credit is estimated using the fees currently
charged to enter into similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. For fixed rate loan
commitments, fair value also considers the difference between current levels of interest rates
and the committed rates.
  51




---



##### 



11.
    
    Fair Value Of Financial Instruments (continued)LimitationsFair value estimates are made at a specific point in time, based on relevant market
information and information about the financial instrument. These estimates do not reflect any
premium or discount that could result from offering for sale at one time the Banks entire
holdings of a particular financial instrument. Because no active market exists for a portion of
the Banks financial instruments, fair value estimates are based on judgments regarding future
expected loss experience, current economic conditions, risk characteristics of various
financial instruments and other factors. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and therefore cannot be determined with
precision. Changes in assumptions could significantly affect the estimates.
  12.
    
    Income TaxesIncome tax expense was allocated as follows:
 (In
Thousands) Years ended december 31,
    
    2006
    
    
    2005
    
    
    2004Current income tax expense:Federal
    
    $
    3,507
    
    
    $
    3,430
    
    
    $
    3,606State
    
    
    232
    
    
    
    113
    
    
    
    264Total current tax expense
    
    
    3,739
    
    
    
    3,543
    
    
    
    3,870Deferred income tax (benefit) expense:Federal
    
    
    (44
    )
    
    
    186
    
    
    
    23State
    
    
    (12
    )
    
    
    64
    
    
    
    5Total deferred tax (benefit) expense:
    
    
    (56
    )
    
    
    250
    
    
    
    28Total income tax expense
    
    $
    3,683
    
    
    $
    3,793
    
    
    $
    3,898
 Income tax expense attributable to income from operations for the years ended December
31, differed from the amounts computed by applying the federal income tax rate of 35
percent as a result of the following:
 (In
Thousands) Years ended december 31,
    
    2006
    
    
    2005
    
    
    2004Computed expected income tax expense at statutory rate
    
    $
    3,749
    
    
    $
    3,891
    
    
    $
    3,947Increase (reduction) in income taxes resulting from:Reduction in federal income tax rate
    
    
    (100
    )
    
    
    (91
    )
    
    
    (98
    )State and local income taxes, net of federal benefit
    
    
    143
    
    
    
    115
    
    
    
    175Dividends received deduction
    
    
    (40
    )
    
    
    (42
    )
    
    
    (40
    )Dividends paid to ESOP deduction
    
    
    (70
    )
    
    
    (72
    )
    
    
    (73
    )Other
    
    
    1
    
    
    
    (8
    )
    
    
    (13
    )Income tax expense
    
    $
    3,683
    
    
    $
    3,793
    
    
    $
    3,898Effective income tax rate
    
    
    34.39
    %
    
    
    34.12
    %
    
    
    34.56
    %
 52




---



##### 



12.
    
    Income Taxes (continued)At December 31, 2006 and 2005, the Bank had gross deferred tax assets and gross deferred
tax liabilities as follows:
 (In
Thousands) Years ended december 31,
    
    2006
    
    
    2005Deferred tax assets:Unrealized losses on securities available for sale
    
    $
    1,656
    
    
    $
    1,746Loan losses
    
    
    722
    
    
    
    740Deferred compensation and pension cost
    
    
    889
    
    
    
    672Depreciation
    
    
    166
    
    
    
    147Purchase accounting
    
    
    11
    
    
    
    95Deferred loan fees, net
    
    
    3
    
    
    
    4Other
    
    
    19
    
    
    
    11Gross deferred tax asset
    
    
    3,466
    
    
    
    3,415Deferred tax liabilities:Other unrealized securities gains
    
    
    111
    
    
    
    167Other
    
    
    8
    
    
    
    8Gross deferred tax liability
    
    
    119
    
    
    
    175Net deferred tax asset
    
    $
    3,347
    
    
    $
    3,240
   13.
    
    Earnings Per ShareThe following is a calculation of earnings per share for the years indicated:
 Years Ended December 31,
    
    2006
    
    
    2005
    
    
    2004(In
thousands except share data)
    
    Basic
    
    
    Diluted
    
    
    Basic
    
    
    Diluted
    
    
    Basic
    
    
    DilutedNet income
    
    $
    7,027
    
    
    $
    7,027
    
    
    $
    7,323
    
    
    $
    7,323
    
    
    $
    7,380
    
    
    $
    7,380Average shares outstanding
    
    
    4,325,879
    
    
    
    4,325,879
    
    
    
    4,365,932
    
    
    
    4,365,932
    
    
    
    4,408,293
    
    
    
    4,408,293Dilutive stock options
    
    
    
    
    
    
    34,809
    
    
    
    
    
    
    
    56,597
    
    
    
    
    
    
    
    93,244Weighted average shares outstanding
    
    
    4,325,879
    
    
    
    4,360,688
    
    
    
    4,365,932
    
    
    
    4,422,529
    
    
    
    4,408,293
    
    
    
    4,501,537Earnings per share (in dollars)
    
    $
    1.62
    
    
    $
    1.61
    
    
    $
    1.68
    
    
    $
    1.66
    
    
    $
    1.67
    
    
    $
    1.64
 53




---



##### 



14.
    
    Stockholders EquityThe Company may not declare or pay cash dividends on its shares of common stock if the
effect thereof would cause its stockholders equity to be reduced below or to otherwise
violate legal or regulatory requirements. Substantially all of the Companys retained earnings
are unrestricted at December 31, 2006.
    (IN THOUSANDS)
    
    
    
    
    
    
    
    
    
    For Capital
    
    TO BE WELLAt December 31, 2006
    
    Actual
    
    Adequacy Purposes
    
    Capitalized(1)Amount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    RatioTier I Capital (to Average Assets):MASSBANK Corp. (consolidated)
    
    $
    108,852
    
    
    
    12.78
    %
    
    $
    25,547
    
    
    
    3.00
    %
    
    
    N/A
    
    
    
    MASSBANK (the Bank)
    
    
    103,245
    
    
    
    12.39
    
    
    
    24,992
    
    
    
    3.00
    
    
    $
    41,653
    
    
    
    5.00
    %Tier I Capital (to Risk-Weighted Assets):MASSBANK Corp. (consolidated)
    
    
    108,852
    
    
    
    36.58
    
    
    
    11,901
    
    
    
    4.00
    
    
    
    N/A
    
    
    
    MASSBANK (the Bank)
    
    
    103,245
    
    
    
    34.77
    
    
    
    11,876
    
    
    
    4.00
    
    
    
    17,815
    
    
    
    6.00Total Capital (to Risk-Weighted Assets):MASSBANK Corp. (consolidated)
    
    
    110,579
    
    
    
    37.17
    
    
    
    23,803
    
    
    
    8.00
    
    
    
    N/A
    
    
    
    MASSBANK (the Bank)
    
    
    104,972
    
    
    
    35.35
    
    
    
    23,753
    
    
    
    8.00
    
    
    
    29,691
    
    
    
    10.00
 
 (1)
    
    This column presents the minimum amounts and ratios that a financial institution
must have to be categorized as well capitalized. (In thousands)
    
    
    
    
    
    
    
    
    
    For Capital
    
    To Be WellAt December 31, 2005
    
    Actual
    
    Adequacy Purposes
    
    Capitalized(1)Amount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    RatioTier I Capital (to Average Assets):MASSBANK Corp. (consolidated)
    
    $
    107,251
    
    
    
    11.94
    %
    
    $
    26,942
    
    
    
    3.00
    %
    
    
    N/A
    
    
    
    MASSBANK (the Bank)
    
    
    103,122
    
    
    
    11.48
    
    
    
    26,940
    
    
    
    3.00
    
    
    $
    44,900
    
    
    
    5.00
    %Tier I Capital (to Risk-Weighted Assets):MASSBANK Corp. (consolidated)
    
    
    107,251
    
    
    
    39.03
    
    
    
    10,990
    
    
    
    4.00
    
    
    
    N/A
    
    
    
    MASSBANK (the Bank)
    
    
    103,122
    
    
    
    37.54
    
    
    
    10,989
    
    
    
    4.00
    
    
    
    16,484
    
    
    
    6.00Total Capital (to Risk-Weighted Assets):MASSBANK Corp. (consolidated)
    
    
    109,290
    
    
    
    39.78
    
    
    
    21,981
    
    
    
    8.00
    
    
    
    N/A
    
    
    
    MASSBANK (the Bank)
    
    
    105,161
    
    
    
    38.28
    
    
    
    21,978
    
    
    
    8.00
    
    
    
    27,473
    
    
    
    10.00
 
 1)
    
    This column presents the minimum amounts and ratios that a financial institution
must have to be categorized as well capitalized. 54




---



##### 



15.
    
    Employee BenefitsPension PlanThe Bank sponsors a noncontributory defined benefit pension plan that covers all
employees who meet specified age and length of service requirements, which is administered by
the Savings Banks Employees Retirement Association (SBERA). The Plan provides for benefits to
be paid to eligible employees at retirement based primarily upon their years of service with
the Bank and compensation levels near retirement. Contributions to the Plan reflect benefits
attributed to employees service to date, as well as service expected to be earned in the
future. Pension plan assets consist principally of equity securities; mutual funds  bonds,
mutual funds  equities, and all assets mutual funds; and money market funds and cash.
  (In
thousands) Years ended december 31,
    
    2006
    
    
    2005Accumulated benefit obligation
    
    $
    8,837
    
    
    $
    7,842Change in benefit obligation:Benefit obligation at beginning of year
    
    $
    9,994
    
    
    $
    9,488Service cost
    
    
    413
    
    
    
    459Interest cost
    
    
    575
    
    
    
    546Actuarial loss (gain)
    
    
    326
    
    
    
    (52
    )Benefits paid
    
    
    (646
    )
    
    
    (447
    )Benefit obligation at end of year
    
    $
    10,662
    
    
    $
    9,994Change in plan assets:Fair value of plan assets at beginning of year
    
    $
    8,443
    
    
    $
    7,834Actual return on plan assets
    
    
    1,242
    
    
    
    691Employer contribution
    
    
    141
    
    
    
    364Benefits paid
    
    
    (646
    )
    
    
    (447
    )Other
    
    
    1
    
    
    
    1Fair value of plan assets at end of year
    
    $
    9,181
    
    
    $
    8,443Funded status
    
    $
    (1,481
    )
    
    $
    (1,551
    )
  Defined Benefit(In Thousands) At December 31, 2006
    
    Pension PlanOther liabilities (accrued pension liability)
    
    $
    337Deferred income tax asset, net
    
    
    (141
    )Other comprehensive loss
    
    
    (196
    )
  Defined BenefitPension Plan(In thousands) At December 31,
    
    2006
    
    
    2005Accrued pension liability
    
    $
    1,481
    
    
    $
    959Unrecognized net actuarial loss
    
    
    
    
    
    
    528Unrecognized transition asset
    
    
    
    
    
    
    (42
    )Unrecognized past service cost
    
    
    
    
    
    
    106Funded status of pension plan  net under-funded amount
    
    $
    1,481
    
    
    $
    1,551
 55




---



##### 



15.
    
    Employee benefits(continued)The amounts in accumulated other comprehensive loss that have not yet been recognized as components
of net periodic benefit expense at December 31, 2006 are as follows:
 Defined benefit(In thousands)
    
    Pension planPrior service cost, net of tax of $41
    
    $
    57Actuarial loss, net of tax of $109
    
    
    151Transition asset, net of tax of $9
    
    
    (12
    )Total
    
    $
    196
 The following table reflects the amortization of amounts in accumulated other comprehensive loss
that is expected to be recognized as components of net periodic benefit expense during 2007:
 Defined benefit(In thousands)
    
    Pension planAmortization of net prior service cost (credit)
    
    $
    8Amortization of actuarial loss
    
    
    Amortization of transition asset
    
    
    (21
    )
 Assumptions used in determining the actuarial present value of the Companys benefit obligation
were as follows:
 (In thousands) years ende december 31,
    
    2006
    
    
    2005
    
    
    2004Discount rate
    
    
    5.75
    %
    
    
    5.75
    %
    
    
    5.75
    %Rate of compensation increase
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    4.00
    %Assumptions used to develop the net periodic benefit
cost data were:Discount rate
    
    
    5.75
    %
    
    
    5.75
    %
    
    
    6.25
    %Expected return on plan assets
    
    
    7.75
    %
    
    
    7.75
    %
    
    
    7.75
    %Rate of compensation increase
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    4.00
    %Components of net periodic pension expense:Service cost
    
    $
    413
    
    
    $
    459
    
    
    $
    430Interest cost
    
    
    575
    
    
    
    546
    
    
    
    524Expected return on plan assets
    
    
    (654
    )
    
    
    (607
    )
    
    
    (545
    )Amortization of transition obligation
    
    
    (21
    )
    
    
    (21
    )
    
    
    (21
    )Amortization of prior service cost
    
    
    7
    
    
    
    7
    
    
    
    7Amortization of unrecognized net actuarial (gain) loss
    
    
    6
    
    
    
    48
    
    
    
    8Net periodic pension expense
    
    $
    326
    
    
    $
    432
    
    
    $
    403
 The approximate composition of pension plan assets as of the end of the plan years ended October
31, 2006 and 2005 is as follows:
 Years ended october 31,
    
    2006
    
    
    2005Asset Category:Fixed Income Securities (including money market funds)
    
    
    36.5
    %
    
    
    35.1
    %Domestic Equity Securities
    
    
    48.5
    
    
    
    50.5International Equity Securities
    
    
    15.0
    
    
    
    14.4100.0
    %
    
    
    100.0
    %
 56




---



##### 



15. Employee benefits (continued)
   Massbank
  (In thousands) Years ending October 31,
    
    Payments2007
    
    $
    9072008
    
    
    1,6542009
    
    
    5012010
    
    
    5692011
    
    
    1,5842012
    
    
    6852013
    
    

    1,3472014
    
    

    2,3632015
    
    

    8482016
    
    

    1,0432017
    

    
    1,065
 Profit Sharing And Incentive Compensation Bonus Plans
   Employee Stock Ownership Plan
      Employee Agreements
  Executive Supplemental Retirement Agreements
  57




---



##### 



15.
Employee Benefits (continued)
 Directors Deferred Compensation Plan
 Massbank
 Stock Option Plan
     Years Ended December 31,
    
    2006
    
    
    2005
    
    
    2004Weighted

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


    Options Outstanding
    
    
    Options exercisableWeighted Avg.
    
    
    Weighted Avg.
    
    
    
    
    
    
    Weighted Avg.RANGE OF
    
    Number
    
    
    Remaining
    
    
    Exercise
    
    
    Number
    
    
    ExerciseEXERCISE PRICES
    
    Outstanding
    
    
    Contractual Life
    
    
    Price
    
    
    Exercisable
    
    
    Price$19.00 to $20.67
    
    
    65,875
    
    
    2.3 years
    
    $
    19.76
    
    
    
    65,875
    
    
    $
    19.7625.00 to 27.63
    
    
    47,250
    
    
    3.1 years
    
    
    26.09
    
    
    
    47,250
    
    
    
    26.0928.44 to 29.60
    
    
    43,325
    
    
    2.7 years
    
    
    29.14
    
    
    
    43,325
    
    
    
    29.1432.50 to 32.80
    
    
    34,250
    
    
    8.9 years
    
    
    32.79
    
    
    
    
    
    
    
    36.70 to 42.90
    
    
    54,150
    
    
    7.0 years
    
    
    39.52
    
    
    
    54,150
    
    
    
    39.52$19.00 to $42.90
    
    
    244,850
    
    
    4.5 years
    
    $
    28.83
    
    
    
    210,600
    
    
    $
    28.19
 58




---



##### 



15. Employee Benefits (continued)
  Years
ended December 31,
    
    2006
    
    
    2005Weighted average fair value per share
    
    $
    6.58
    
    
    $
    8.11Expected term (years)
    

7.3 years
    
    7.3 yearsRisk free interest rate
    
    
    4.31
    %
    
    
    3.97
    %Dividend Yield
    
    
    3.29
    %
    
    
    2.80
    %Volatility
    
    
    21.5
    %
    
    
    21.2
    %
    16. Shareholder Rights Plan
 Massbank Massbank
 59




---



##### 



17. Parent Company Financial Statements
 assbank
 Balance Sheets
 (In thousands except share data) At December 31,
    
    2006
    
    
    2005Assets:Cash
    
    $
    5,087
    
    
    $
    12Interest-bearing deposits in banks
    
    
    
    
    
    
    3,894Total cash and cash equivalents
    
    
    5,087
    
    
    
    3,906Investment in subsidiaries
    
    
    101,789
    
    
    
    101,135Income tax receivable, net
    
    
    155
    
    
    
    210Deferred income tax asset, net
    
    
    32
    
    
    
    25Other assets
    
    
    1
    
    
    
    Total assets
    
    $
    107,064
    
    
    $
    105,276Liabilities:Other liabilities
    
    $
    179
    
    
    $
    12Total liabilities
    
    
    179
    
    
    
    12Stockholders Equity (Notes 12, 14, 15 and 16):Preferred stock, par value $1.00 per share; 2,000,000 shares authorized, none issuedCommon stock, par value $1.00 per share; 10,000,000 shares
authorized, 7,850,317 and 7,811,680 shares issued in 2006 and 2005, respectively
    
    
    7,850
    
    
    
    7,812Additional paid-in capital
    
    
    57,953
    
    
    
    57,067Retained earnings
    
    
    107,055
    
    
    
    104,743172,858
    
    
    
    169,622Treasury stock at cost, 3,532,663 and 3,483,163 shares in 2006 and 2005, respectively
    
    
    (62,902
    )
    
    
    (61,281
    )Accumulated other comprehensive income (loss)
    
    
    (3,071
    )
    
    
    (3,077
    )Shares held in rabbi trust at cost
3,004 and 2,479 shares in 2006 and 2005, respectively
    
    
    (84
    )
    
    
    (67
    )Deferred compensation obligation
    
    
    84
    
    
    
    67Total stockholders equity
    
    
    106,885
    
    
    
    105,264Total liabilities and stockholders equity
    
    $
    107,064
    
    
    $
    105,276
 Statements of Income(In thousands) Years ended December 31,
    
    2006
    
    
    2005
    
    
    2004Income:Dividends received from subsidiaries
    
    $
    7,055
    
    
    $
    7,000
    
    
    $
    7,100Interest and dividend income
    
    
    14
    
    
    
    31
    
    
    
    18Total interest and dividend income
    
    
    7,069
    
    
    
    7,031
    
    
    
    7,118Non-interest expense
    
    
    186
    
    
    
    170
    
    
    
    179Income before income taxes
    
    
    6,883
    
    
    
    6,861
    
    
    
    6,939Income tax benefit
    
    
    110
    
    
    
    99
    
    
    
    108Income before equity in undistributed earnings of
subsidiaries
    
    
    6,993
    
    
    
    6,960
    
    
    
    7,047Equity in undistributed earnings of subsidiaries
    
    
    34
    
    
    
    363
    
    
    
    333Net income
    
    $
    7,027
    
    
    $
    7,323
    
    
    $
    7,380
  60




---



##### 



17.Parent Company Financial Statements (continued)
 Statements Of Cash Flows(In Thousands) Years Ended December 31,
    
    2006
    
    
    2005
    
    
    2004Cash
flows from operating activities:Net income
    
    $
    7,027
    
    
    $
    7,323
    
    
    $
    7,380Adjustments to reconcile net income to net cash provided by
operating activities:Equity in undistributed earnings of subsidiaries
    
    
    (34
    )
    
    
    (363
    )
    
    
    (333
    )Dividend from subsidiary in the form of land
    
    
    (480
    )
    
    
    
    
    
    
    Decrease (increase) in current income tax receivable, net
    
    
    55
    
    
    
    (23
    )
    
    
    22Decrease (increase) in deferred income tax asset, net
    
    
    (7
    )
    
    
    (4
    )
    
    
    7Decrease (increase) in other assets
    
    
    (1
    )
    
    
    29
    
    
    
    (28
    )Increase (decrease) in other liabilities
    
    
    167
    
    
    
    (1
    )
    
    
    (4
    )Decrease (increase) in amount due from subsidiaries
    
    
    
    
    
    
    196
    
    
    
    (196
    )Share-based payment compensation
    
    
    5
    
    
    
    
    
    
    
    Net cash provided by operating activities
    
    
    6,732
    
    
    
    7,157
    
    
    
    6,848Cash flow from financing activities:Payments to acquire treasury stock
    
    
    (1,621
    )
    
    
    (4,487
    )
    
    
    (2,617
    )Purchase of company stock for deferred compensation plan,
net of distributions
    
    
    (17
    )
    
    
    (8
    )
    
    
    (13
    )Increase in deferred compensation obligation
    
    
    17
    
    
    
    8
    
    
    
    13Options exercised, including tax benefits
    
    
    785
    
    
    
    1,572
    
    
    
    684Dividends paid on common stock
    
    
    (4,715
    )
    
    
    (4,583
    )
    
    
    (4,415
    )Net cash used in financing activities
    
    
    (5,551
    )
    
    
    (7,498
    )
    
    
    (6,348
    )Net increase (decrease) in cash and cash equivalents
    
    
    1,181
    
    
    
    (341
    )
    
    
    500Cash and cash equivalents at beginning of year
    
    
    3,906
    
    
    
    4,247
    
    
    
    3,747Cash and cash equivalents at end of year
    
    $
    5,087
    
    
    $
    3,906
    
    
    $
    4,247
   18. Ten-Year Statistical Summary (Unaudited)
 (In thousands except per share data)Years ended December 31,
    
    2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    1999
    
    
    1998
    
    
    1997Net income
    
    $
    7,027
    
    
    $
    7,323
    
    
    $
    7,380
    
    
    $
    7,863
    
    
    $
    9,814
    
    
    $
    10,759
    
    
    $
    11,111
    
    
    $
    11,311
    
    
    $
    10,914
    
    
    $
    10,167Diluted earnings per share
    
    
    1.61
    
    
    
    1.66
    
    
    
    1.64
    
    
    
    1.73
    
    
    
    2.04
    
    
    
    2.24
    
    
    
    2.25
    
    
    
    2.17
    
    
    
    1.98
    
    
    
    1.85Cash dividends paid per share
    
    
    1.09
    
    
    
    1.05
    
    
    
    1.00
    
    
    
    0.92
    
    
    
    0.88
    
    
    
    0.84
    
    
    
    0.79
    
    
    
    0.74
    
    
    
    0.68
    
    
    
    0.59Book value per share, at year-end
    
    
    24.76
    
    
    
    24.32
    
    
    
    25.11
    
    
    
    25.17
    
    
    
    25.45
    
    
    
    24.34
    
    
    
    22.83
    
    
    
    20.43
    
    
    
    21.05
    
    
    
    19.38Return on average assets
    
    
    0.82
    %
    
    
    0.79
    %
    
    
    0.75
    %
    
    
    0.78
    %
    
    
    0.99
    %
    
    
    1.13
    %
    
    
    1.20
    %
    
    
    1.20
    %
    
    
    1.17
    %
    
    
    1.12
    %Return on average equity
    
    
    6.74
    %
    
    
    6.84
    %
    
    
    6.71
    %
    
    
    7.08
    %
    
    
    8.39
    %
    
    
    9.53
    %
    
    
    10.93
    %
    
    
    10.66
    %
    
    
    10.05
    %
    
    
    10.51
    %
 61




---



##### 



19. Quarterly Data (Unaudited)
 Years ended december 31,
    
    2006
    
    
    2005(In thousands except
    
    4th
    
    
    3rd
    
    
    2nd
    
    
    1st
    
    
    4th
    
    
    3rd
    
    
    2nd
    
    
    1stPer share data)
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    QuarterInterest and dividend income
    
    $
    10,085
    
    
    $
    10,052
    
    
    $
    10,001
    
    
    $
    9,801
    
    
    $
    9,621
    
    
    $
    9,346
    
    
    $
    9,069
    
    
    $
    8,765Interest expense
    
    
    5,106
    
    
    
    4,872
    
    
    
    4,613
    
    
    
    4,360
    
    
    
    4,128
    
    
    
    3,878
    
    
    
    3,674
    
    
    
    3,461Net interest income
    
    
    4,979
    
    
    
    5,180
    
    
    
    5,388
    
    
    
    5,441
    
    
    
    5,493
    
    
    
    5,468
    
    
    
    5,395
    
    
    
    5,304Provision (credit) for loan losses
    
    
    (9
    )
    
    
    82
    
    
    
    50
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (53
    )Net interest income after
provision (credit) for loan losses
    
    
    4,988
    
    
    
    5,098
    
    
    
    5,338
    
    
    
    5,441
    
    
    
    5,493
    
    
    
    5,468
    
    
    
    5,395
    
    
    
    5,357Gains (losses) on securities, net
    
    
    259
    
    
    
    168
    
    
    
    119
    
    
    
    251
    
    
    
    253
    
    
    
    238
    
    
    
    244
    
    
    
    (56
    )Other non-interest income
    
    
    477
    
    
    
    292
    
    
    
    279
    
    
    
    360
    
    
    
    290
    
    
    
    329
    
    
    
    354
    
    
    
    265Non-interest expense
    
    
    3,053
    
    
    
    2,942
    
    
    
    3,058
    
    
    
    3,307
    
    
    
    3,097
    
    
    
    3,189
    
    
    
    3,185
    
    
    
    3,043Income before income taxes
    
    
    2,671
    
    
    
    2,616
    
    
    
    2,678
    
    
    
    2,745
    
    
    
    2,939
    
    
    
    2,846
    
    
    
    2,808
    
    
    
    2,523Income tax expense
    
    
    940
    
    
    
    885
    
    
    
    923
    
    
    
    935
    
    
    
    1,051
    
    
    
    962
    
    
    
    951
    
    
    
    829Net income
    
    $
    1,731
    
    
    $
    1,731
    
    
    $
    1,755
    
    
    $
    1,810
    
    
    $
    1,888
    
    
    $
    1,884
    
    
    $
    1,857
    
    
    $
    1,694Earnings per share (in dollars):(1)Basic
    
    $
    0.40
    
    
    $
    0.40
    
    
    $
    0.41
    
    
    $
    0.42
    
    
    $
    0.44
    
    
    $
    0.43
    
    
    $
    0.42
    
    
    $
    0.39Diluted
    
    
    0.40
    
    
    
    0.40
    
    
    
    0.40
    
    
    
    0.41
    
    
    
    0.43
    
    
    
    0.43
    
    
    
    0.42
    
    
    
    0.38Weighted average common
shares outstanding:(1)Basic
    
    
    4,320
    
    
    
    4,315
    
    
    
    4,329
    
    
    
    4,340
    
    
    
    4,332
    
    
    
    4,343
    
    
    
    4,390
    
    
    
    4,400Diluted
    
    
    4,353
    
    
    
    4,349
    
    
    
    4,364
    
    
    
    4,377
    
    
    
    4,371
    
    
    
    4,398
    
    
    
    4,452
    
    
    
    4,470
 
 (1)
    
    Computation of earnings per share is further described in
Note 1. 62




---



##### 



Massbank Corp. And Subsidiaries Stockholder Data
 Years ended D ecember 31, 2006 and 2005
 Massbank
  Price per Share
    
    
    CashDividendsHigh
    
    
    Low
    
    
    DeclaredYear ended december 31,
    
    2006Fourth Quarter
    
    $
    33.63
    
    
    $
    32.33
    
    
    $
    0.28Third Quarter
    
    
    33.94
    
    
    
    32.44
    
    
    
    0.27Second Quarter
    
    
    33.29
    
    
    
    32.32
    
    
    
    0.27First Quarter
    
    
    34.692
    
    
    
    31.77
    
    
    
    0.27
 Year ended december 31,
    
    2005Fourth Quarter
    
    $
    33.48
    
    
    $
    28.567
    
    
    $
    0.27Third Quarter
    
    
    35.12
    
    
    
    33.13
    
    
    
    0.26Second Quarter
    
    
    37.84
    
    
    
    34.25
    
    
    
    0.26First Quarter
    
    
    38.52
    
    
    
    36.94
    
    
    
    0.26
 Comparative Massbank Corp. Stock Performance Data
  Comparative
cumulative Return Totals (years ended december 31,)
 Comparative 5 year cumulative total return
 2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005
    
    
    2006Massbank Corp.
    
    $
    100.00
    
    
    $
    122.26
    
    
    $
    189.79
    
    
    $
    169.67
    
    
    $
    154.26
    
    
    $
    158.84S&P500 Index
    
    $
    100.00
    
    
    $
    78.03
    
    
    $
    100.16
    
    
    $
    110.92
    
    
    $
    116.28
    
    
    $
    134.43
 Comparative 10 Year Cumulative Total Return
 1996
    
    
    1997
    
    
    1998
    
    
    1999
    
    
    2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005
    
    
    2006Massbank Corp.
    
    $
    100.00
    
    
    $
    169.65
    
    
    $
    143.01
    
    
    $
    111.88
    
    
    $
    115.43
    
    
    $
    146.25
    
    
    $
    178.81
    
    
    $
    277.56
    
    
    $
    248.14
    
    
    $
    225.61
    
    
    $
    232.31S&P500 Index
    
    $
    100.00
    
    
    $
    133.10
    
    
    $
    170.82
    
    
    $
    206.49
    
    
    $
    187.84
    
    
    $
    165.58
    
    
    $
    129.21
    
    
    $
    165.85
    
    
    $
    183.66
    
    
    $
    192.54
    
    
    $
    222.59
 Comparative 15 Year Cumulative Total Return
 1991
    
    
    1992
    
    
    1993
    
    
    1994
    
    
    1995
    
    
    1996
    
    
    1997
    
    
    1998
    
    
    1999
    
    
    2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005
    
    
    2006Massbank Corp.
    
    $
    100.00
    
    
    $
    195.10
    
    
    $
    211.62
    
    
    $
    211.40
    
    
    $
    300.16
    
    
    $
    369.13
    
    
    $
    626.23
    
    
    $
    527.88
    
    
    $
    412.99
    
    
    $
    426.08
    
    
    $
    539.85
    
    
    $
    660.03
    
    
    $
    1,024.57
    
    
    $
    915.94
    
    
    $
    832.79
    
    
    $
    857.52S&P500 Index
    
    $
    100.00
    
    
    $
    107.43
    
    
    $
    118.09
    
    
    $
    119.61
    
    
    $
    164.01
    
    
    $
    201.21
    
    
    $
    267.81
    
    
    $
    343.70
    
    
    $
    415.48
    
    
    $
    377.95
    
    
    $
    333.16
    
    
    $
    259.98
    
    
    $
    333.70
    
    
    $
    369.53
    
    
    $
    387.39
    
    
    $
    447.87
 Comparative 20 year cumulative total return
 1986
    
    
    1987
    
    
    1988
    
    
    1989
    
    
    1990
    
    
    1991
    
    
    1992
    
    
    1993
    
    
    1994
    
    
    1995
    
    
    1996Massbank Corp.
    
    $
    100.00
    
    
    $
    98.10
    
    
    $
    136.05
    
    
    $
    126.27
    
    
    $
    96.66
    
    
    $
    125.60
    
    
    $
    245.05
    
    
    $
    265.80
    
    
    $
    265.51
    
    
    $
    377.00
    
    
    $
    463.62S&P500 Index
    
    $
    100.00
    
    
    $
    105.67
    
    
    $
    122.94
    
    
    $
    161.31
    
    
    $
    156.27
    
    
    $
    203.15
    
    
    $
    218.25
    
    
    $
    239.91
    
    
    $
    242.99
    
    
    $
    333.18
    
    
    $
    408.75
 1997
    
    
    1998
    
    
    1999
    
    
    2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005
    
    
    2006Massbank Corp.
    
    $
    786.54
    
    
    $
    663.01
    
    
    $
    518.71
    
    
    $
    535.15
    
    
    $
    678.05
    
    
    $
    829.00
    
    
    $
    1,286.85
    
    
    $
    1,150.41
    
    
    $
    1,045.97
    
    
    $
    1,077.03S&P500 Index
    
    $
    544.05
    
    
    $
    698.22
    
    
    $
    844.05
    
    
    $
    767.81
    
    
    $
    676.82
    
    
    $
    528.16
    
    
    $
    677.92
    
    
    $
    750.71
    
    
    $
    786.99
    
    
    $
    909.86
 Refer to page 7 of this report for performance graphs.
 63




---



##### 



Officers
and directors  Massbank Corp.
  Chairman, President and
Chief Executive Officer
 Senior Vice President, Treasurer and
Chief Financial Officer
 Secretary
 Assistant Secretary
 Board
of Directors
 Retired, Bedell Brothers Insurance  Agency, Inc.
 Chairman, President and  Chief Executive Officer,  Massbank Corp.
 Treasurer Emeritus,  Massachusetts Institute of Technology
 President  Camilli Economics, LLC
 Retired Partner, Attorney  Goodwin Procter LLP
 Teacher, Brooks School
 Attorney, Principal  Latham, Latham & Lamond, P.C.
 Retired, C.H. Cleaves Insurance  Agency, Inc.
 Executive Director,  Visiting Nurse Association  of Greater Lowell, Inc.
 Certified Public Accountant, Partner  Rucci, Bardaro & Barrett, PC
   Officers
and Directors  Massbank
   Chairman, President and
Chief Executive Officer
 Senior Vice President, Lending
 Senior Vice President,
Community Banking and
Chief Operating Officer
 Senior Vice President, Treasurer
and Chief Financial Officer
 Vice President, Operations
 Vice President and
Senior Trust Officer
 Vice President and
Senior Trust Officer
 Vice President and Director,
Information Technology
 Loan Origination Officer
 Assistant Treasurer
 Assistant Treasurer
 Collections Officer
 Director, Human Resources
 Trust Operations Officer and
Executive Administrator
 Assistant Vice President
 Mortgage Origination Officer
 Assistant Vice President
 Assistant Controller
 Assistant Vice President,
Loan Operations
 Security/BSA Officer
 Director of Audit
 Assistant Vice President,
Marketing
 Assistant Treasurer
 Controller
 Information Technology Officer
 Assistant Treasurer
 Assistant Treasurer
 Assistant Treasurer
 Assistant Vice President,
Operations
 Board
of Directors  and  Executive Committee
 Chairman    Clerk
   64




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Corporate Information
  Massbank Corp.
 Savings and Mortgage
24-Hour-Rate Lines
 
 Notice of Shareholders Meeting
 Massbank
 Trademark
 
 Form 10-K
 Massbank
 Dividend Reinvestment and
Stock Purchase Plan
 Massbank
 Transfer Agent
  
 Independent Registered
Public Accounting Firm
 
 Legal Counsel
   Massbank Branch Offices
  Massbank of Reading*
 *Main Office
 Massbank of Chelmsford
 
 
 Massbank of Dracut
 
 Massbank of Everett
 Massbank of Lowell
 
 
 Massbank of Medford
 
 Massbank of Melrose
 Massbank of Stoneham
 
 Massbank of Tewksbury
 
 Massbank of Westford
 
 Massbank of Wilmington