form10q-93764_meridian.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
(Mark One)

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

For the quarterly period ended June 30, 2008

OR

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

For the transition period from ______________ to _____________
 
Commission file number:  001-33898
 

                  Meridian Interstate Bancorp, Inc.                  
(Exact name of registrant as specified in its charter)

                           Massachusetts                           
                    20-4652200                    
(State or other jurisdiction of incorporation or
(I.R.S. Employer Identification No.)
organization)
 

10 Meridian Street, East Boston, Massachusetts 02128
(Address of principal executive offices)

                                    (617) 567-1500                                    
(Registrant’s telephone number, including area code)

                                                           Not Applicable                                                           
(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one): Large Accelerated Filer £  Accelerated Filer £  Non-accelerated Filer T   Smaller Reporting Company£

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

At July 31, 2008, the registrant had 23,000,000 shares of no par value common stock outstanding.


 
 

 

MERIDIAN INTERSTATE BANCORP, INC.

FORM 10-Q

INDEX

 
     
Page
     
 
1
     
 
2
     
 
3
     
 
4
     
 
6
     
10
     
21
     
22
     
 
     
23
     
23
     
23
     
23
     
23
     
23
     
24
     
25



 


PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)

             
   
June 30,
   
December 31,
 
(Dollars in thousands)
 
2008
   
2007
 
ASSETS
Cash and due from banks
  $ 11,956     $ 11,821  
Federal funds sold
    31,594       91,272  
          Total cash and cash equivalents
    43,550       103,093  
                 
Certificates of deposit
    7,000       -  
Securities available for sale, at fair value
    341,070       267,058  
Federal Home Loan Bank stock, at cost
    4,303       3,165  
                 
Loans
    622,079       571,741  
Less allowance for loan losses
    (5,961 )     (3,637 )
           Loans, net
    616,118       568,104  
                 
Bank-owned life insurance
    22,418       18,003  
Investment in affiliate bank
    10,518       10,772  
Premises and equipment, net
    22,432       22,816  
Accrued interest receivable
    6,174       5,764  
Other assets
    5,675       4,451  
              Total assets
  $ 1,079,258     $ 1,003,226  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
               
Non interest-bearing
  $ 55,777     $ 51,396  
Interest-bearing
    747,044       723,050  
Total deposits
    802,821       774,446  
                 
Stock subscriptions
    -       62,518  
Short-term borrowings
    -       9,154  
Long-term debt
    62,823       27,373  
Accrued expenses and other liabilities
    14,805       14,051  
              Total liabilities
    880,449       887,542  
                 
Stockholders' equity:
               
   Common stock, no par value 50,000,000 shares
               
    authorized; 23,000,000 and 0 shares issued and
               
     outstanding at June 30, 2008 and December 31, 2007
    -       -  
   Additional paid-in capital
    100,630       -  
   Retained earnings
    104,998       109,177  
   Accumulated other comprehensive income
    1,254       6,507  
   Unearned compensation - ESOP 807,300
               
     shares and 0 shares at June 30, 2008
               
     and December 31, 2007, respectively
    (8,073 )     -  
             Total stockholders' equity
    198,809       115,684  
                Total liabilities and stockholders' equity
  $ 1,079,258     $ 1,003,226  
 
See accompanying notes to unaudited consolidated financial statements.


1



MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
 (Unaudited)

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
(Dollars in thousands, except per share amounts)
 
2008
   
2007
   
2008
   
2007
 
Interest and dividend income:
                       
    Interest and fees on loans
  $ 9,334     $ 8,815     $ 18,517     $ 17,487  
    Interest on debt securities
    2,633       2,792       5,245       5,549  
    Dividends on equity securities
    434       265       691       544  
    Interest on certificates of deposit
    30       -       38       -  
    Interest on federal funds sold
    478       208       1,541       395  
               Total interest and dividend income
    12,909       12,080       26,032       23,975  
                                 
Interest expense:
                               
    Interest on deposits
    6,426       6,307       13,337       12,423  
    Interest on short-term borrowings
    53       102       115       191  
    Interest on long-term debt
    517       391       829       778  
               Total interest expense
    6,996       6,800       14,281       13,392  
                                 
Net interest income
    5,913       5,280       11,751       10,583  
Provision for loan losses
    2,197       71       2,328       143  
               Net interest income, after provision
                               
                    for loan losses
    3,716       5,209       9,423       10,440  
                                 
Non-interest income:
                               
    Customer service fees
    697       710       1,355       1,312  
    Loan fees
    154       128       370       334  
    Gain on sales of loans, net
    8       8       27       25  
    Gain on sales of securities, net
    47       -       2,313       2,032  
    Income from bank-owned life insurance
    230       535       415       697  
    Equity loss on investment in affiliate bank
    (86 )     (128 )     (254 )     (211 )
               Total non-interest income
    1,050       1,253       4,226       4,189  
                                 
Non-interest expenses:
                               
    Salaries and employee benefits
    5,762       3,414       9,784       7,086  
    Occupancy and equipment
    699       622       1,479       1,324  
    Data processing
    406       369       793       732  
    Marketing
    293       203       539       343  
    Professional services
    623       240       967       459  
    Contribution to the Meridian
                               
      Charitable Foundation
    -       -       3,000       -  
    Other general and administrative
    693       389       1,226       829  
               Total non-interest expenses
    8,476       5,237       17,788       10,773  
                                 
Income (loss) before income taxes
    (3,710 )     1,225       (4,139 )     3,856  
                                 
Provision (benefit) for income taxes
    (1,494 )     429       (1,602 )     1,265  
                                 
               Net income (loss)
  $ (2,216 )   $ 796     $ (2,537 )   $ 2,591  
                                 
Loss per share:
                               
                Basic
  $ (0.10 )     N/A       N/A       N/A  
                Diluted
  $ (0.10 )     N/A       N/A       N/A  
                                 
Weighted Average Shares:
                               
                Basic
    22,185,914       N/A       N/A       N/A  
                Diluted
    22,185,914       N/A       N/A       N/A  
 
See accompanying notes to unaudited consolidated financial statements.


2


MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity
 (Unaudited)
Six Months Ended June 30, 2008 and 2007
 
(Dollars in thousands)
 
Shares of
Common
Stock
   
Common
Stock
   
Additional
Paid-in
Capital
   
Retained
Earnings
 
  Accumulated
Other
Comprehensive 
Income
  Unearned
Compensation 
ESOP
 
Total
 
Six months ended June 30, 2007
                                         
Balance at December 31, 2006
    -     $ -     $ -     $ 106,911     $ 3,364     $ -     $ 110,275  
Comprehensive income:
                                                       
   Net income
    -       -       -       2,591       -       -       2,591  
   Change in net unrealized gain on securities available for
                                                       
      sale, net of reclassification adjustment and tax effects
    -       -       -       -       (164 )     -       (164 )
        Total comprehensive income
                                                    2,427  
Balance at June 30, 2007
    -     $ -     $ -     $ 109,502     $ 3,200     $ -     $ 112,702  
Six months ended June 30, 2008
                                                       
Balance at December 31, 2007
    -     $ -     $ -     $ 109,177     $ 6,507     $ -     $ 115,684  
Comprehensive loss:
                                                       
   Net loss
    -       -       -       (2,537 )     -       -       (2,537 )
   Change in net unrealized gain on securities available for
                                                       
      sale, net of reclassification adjustment and tax effects
    -       -       -       -       (4,909 )     -       (4,909 )
   Amortization of prior service cost, net of tax effects
    -       -       -       -       9       -       9  
          Total comprehensive loss
                                                    (7,437 )
    Adjustment to initially apply EITF 06-4
    -       -       -       (1,642 )     -       -       (1,642 )
Adjustment to initially apply FAS 158 for long-term health care plan 
     -        -        -        -        (353      -        (353
    Issuance of 12,650,000 shares to the mutual holding company
  12,650,000       -       -       -       -       -       -  
   Issuance of 10,050,000 shares in the initial public
                                                       
      offering, net of expenses of $2,867
    10,050,000       -       97,633       -       -       -       97,633  
   Contribution of common stock to the Meridian Charitable Foundation, Inc.
300,000       -       3,000       -       -       -       3,000  
   Purchase of common stock by the ESOP
    -       -       -       -       -       (8,280 )     (8,280 )
   Unallocated ESOP shares earned (20,700 shares)
    -       -       (3 )     -       -       207       204  
Balance at June 30, 2008
    23,000,000     $ -     $ 100,630     $ 104,998     $ 1,254     $ (8,073 )   $ 198,809  

See accompanying notes to unaudited consolidated financial statements.


3


MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)


             
   
Six Months Ended June 30,
 
(In thousands)
2008
 
2007
 
Cash flows from operating activities:
           
    Net income (loss)
  $ (2,537 )   $ 2,591  
    Adjustments to reconcile net income (loss) to net cash
               
        provided by operating activities:
               
            Contribution of stock to charitable foundation
    3,000       -  
            Earned ESOP shares
    204       -  
            Provision for loan losses
    2,328       143  
            Amortization of net deferred loan origination fees
    (146 )     (270 )
            Net amortization of securities available for sale
    544       408  
            Depreciation and amortization expense
    642       574  
            Gain on sales of securities, net
    (2,313 )     (2,032 )
            Loss on sale of foreclosed real estate
    5       -  
            Deferred income tax benefit
    (1,338 )     (110 )
            Income from bank-owned life insurance
    (415 )     (697 )
            Equity loss on investment in affiliate bank
    254       211  
            Net changes in:
               
                 Accrued interest receivable
    (410 )     (17 )
                 Other assets
    3,087       471  
                 Accrued expenses and other liabilities
    (1,227 )     557  
                       Net cash provided by operating activities
    1,678       1,829  
                 
Cash flows from investing activities:
               
    Purchases of certificates of deposit
    (7,000 )     -  
    Activity in securities available for sale:
               
         Proceeds from maturities, calls and principal payments
    61,207       67,364  
         Proceeds from sales
    9,804       4,290  
         Purchases
    (151,701 )     (60,583 )
    (Purchase) redemption of Federal Home Loan Bank stock
    (1,138 )     206  
    Loans originated, net of principal payments received
    (51,104 )     (14,543 )
    Purchase of bank-owned life insurance
    (4,000 )     -  
    Proceeds from bank-owned life insurance
    -       1,793  
    Purchases of premises and equipment
    (258 )     (3,249 )
    Proceeds from sales of foreclosed real estate
    1,463       -  
                       Net cash used in investing activities
    (142,727 )     (4,722 )

(continued)

4



MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)

   
Six Months Ended June 30,
 
(In thousands)
2008
 
2007
 
Cash flows from financing activities:
           
    Net increase in deposits
    28,375       8,624  
    Proceeds from sale of common stock
    97,633       -  
    Common stock purchased by ESOP
    (8,280 )     -  
    Decrease in stock subscriptions
    (62,518 )     -  
    Net change in Federal Home Loan Bank advances
               
         with maturities of less than three months
    (9,154 )     238  
    Proceeds from Federal Home Loan Bank advances
               
         with maturities of three months or more
    45,000       -  
    Repayment of Federal Home Loan Bank advances
               
         with maturities of three months or more
    (9,550 )     (1,570 )
                    Net cash provided by financing activities
    81,506       7,292  
                 
Net change in cash and cash equivalents
    (59,543 )     4,399  
                 
Cash and cash equivalents at beginning of period
    103,093       23,494  
                 
Cash and cash equivalents at end of period
  $ 43,550     $ 27,893  
                 
Supplemental cash flow information:
               
    Interest paid on deposits
    13,472       12,454  
    Interest paid on borrowings
    843       974  
    Income taxes paid
    60       87  
Non-cash investing and financing activities:
               
    Transfers from loans to foreclosed real estate
    908       -  

See accompanying notes to unaudited consolidated financial statements
.

5


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.
Basis of Presentation

Meridian Interstate Bancorp, Inc.  (the “Company” or “Meridian Interstate”) is a Massachusetts mid-tier stock holding company that was formed in 2006 by East Boston Savings Bank (“the Bank”) to be its holding company.  Meridian Interstate owns all of East Boston Savings Bank’s capital stock and directs, plans and coordinates East Boston Savings Bank’s business activities.  In addition, Meridian Interstate owns 40% of the capital stock of Hampshire First Bank, a New Hampshire chartered bank, organized in 2006 and headquartered in Manchester, New Hampshire.  Meridian Financial Services, Inc. (“Meridian Financial Services”) is the mutual holding company for Meridian Interstate and holds 12,650,000 shares or 55% of Meridian Interstate’s outstanding common stock.

The accompanying unaudited interim consolidated financial statements of Meridian Interstate Bancorp, Inc. have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included.  Such adjustments were of a normal recurring nature.  The results of operations for the three and six months ended June 30, 2008 are not necessarily indicative of the results that may be expected for the entire year or any other interim period.  For additional information, refer to the financial statements and footnotes thereto of Meridian Interstate included in Meridian Interstate’s Form 10-K for the year ended December 31, 2007 which was filed with the Securities and Exchange Commission (“SEC”) on March 31, 2008, and is available through the SEC’s website at www.sec.gov.   

In preparing financial statements in conformity with U. S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and income and expenses during the reporting period. Actual results could differ significantly from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to determination of the allowance for loan losses and the fair values of financial instruments.

2.
Stock Offering

The Company completed its initial public stock offering on January 22, 2008 and sold 10,050,000 shares of its outstanding common stock to subscribers in the offering at a price of $10.00 per share, including 828,000 shares sold to the company’s employee stock ownership plan.  Concurrent with the initial public offering, Meridian Financial Services was issued 12,650,000 shares, or 55.0% of the Company’s outstanding common stock.   Because Meridian Interstate did not have outstanding public shares of common stock for the entire six months ended June 30, 2008, per share earnings data is not meaningful for this period or prior comparative periods and is therefore not presented.
 
Net investable proceeds from the initial public offering were $89.4 million.   In connection with the initial public offering, the Company also contributed 300,000 shares of common stock to the Meridian Charitable Foundation, resulting in a pre-tax non-interest expense charge of $3.0 million, in the quarter ended March 31, 2008.

As part of the offering, Meridian Interstate established a liquidation account of $114,216,000, which is equal to the net worth of Meridian Interstate as of the date of the latest consolidated balance sheet appearing in the final prospectus distributed in connection with the offering.  The liquidation account will be maintained for the benefit of the eligible account holders and supplemental eligible account holders who maintain their accounts at East Boston Savings Bank after the offering.  The liquidation account will be reduced annually to the extent that such account holders have reduced their qualifying deposits as of each anniversary date.  Subsequent increases will not restore an account holder’s interest in the liquidation account.  In the event of a complete liquidation, each eligible account holder will be entitled to receive balances for accounts held then.


6



Meridian Interstate may not declare or pay dividends on, and may not repurchase, any of its shares of common stock if the effect thereof would cause stockholders’ equity to be reduced below applicable regulatory capital maintenance requirements or if such declaration, payment or repurchase would otherwise violate regulatory requirements.


3. 
Recent Accounting Pronouncements

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157 (“SFAS 157”), "Fair Value Measurements," which provides a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. Statement No. 157 does not require any new fair value measurements.  The Company’s disclosures relating to SFAS No. 157 are set forth in Note 4.  In February 2008, the FASB issued FASB Staff Position (FSP) FAS 157-2, which defers the effective date of SFAS No. 157 until January 1, 2009 for nonfinancial assets and nonfinancial liabilities except those items recognized or disclosed at fair value on an annual or more frequently recurring basis.  The adoption of the SFAS No. 157 did not have a material affect on the Company's consolidated financial statements.

Effective January 1, 2008, the Company also adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115.”   SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis.  The Company did not elect fair value treatment for any financial assets or liabilities upon adoption.

Effective January 1, 2008, the Company adopted EITF 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.”  The Company is the sole owner of life insurance policies pertaining to certain of the Company’s employees.  The Company has entered into agreements with these individuals whereby the Company will pay to the individual’s estate or beneficiaries a portion of the death benefit that the Company will receive as beneficiary of such policies.  EITF 06-4 addresses accounting for split-dollar life insurance arrangements whereby the employer purchases a policy to insure the life of an employee, and separately enters into an agreement to split the policy benefits between the employer and the employee.  This EITF states that an obligation arises as a result of a substantive agreement with an employee to provide future postretirement benefits.  Under EITF 06-4, the obligation is not settled upon entering into an insurance arrangement.  Since the obligation is not settled, a liability should be recognized in accordance with applicable authoritative guidance.  The implementation of this guidance on January 1, 2008 resulted in other liabilities increasing by $1.6 million with a corresponding decrease in retained earnings on the consolidated balance sheet.

In December 2007, the FASB issued Statement No. 141 (revised), “Business Combinations,” which replaces FASB Statement No. 141, and applies to all business entities, including mutual entities that previously used the pooling-of-interests method of accounting for certain business combinations, which makes significant amendments to other Statements and other authoritative guidance, and applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  An entity may not apply it before that date.

In December 2007, the FASB issued Statement No. 160, “Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB No. 51,” which establishes accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years beginning on or after December 15, 2008 and is not expected to have a material impact on the consolidated financial statements of the Company.



7

 

In March of 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133,” which changes the disclosure requirements for derivative instruments and hedging activities.  Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  This Statement is effective for fiscal years and interim periods beginning after November 15, 2008 and is not expected to have a material impact on the consolidated financial statements of the Company.

In May 2008, the FASB issued Statement No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162), which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP in the United States (the GAAP Hierarchy). The Board issued this Statement because it is the entity (not its auditor) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP.  Accordingly, the Board concluded that the GAAP hierarchy should reside in the accounting literature established by the FASB as opposed to auditing literature established by the American Institute of Certified Public Accountants and Public Company Accounting Oversight Board (PCAOB).  SFAS 162 is effective 60 days following the SEC’s approval of the PCAOB’s amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles”.  The Company does not expect the adoption to have a material impact on its consolidated financial statements.


4. 
Fair Value Measurement

As discussed in Note 3, SFAS No. 157 was implemented by the Company effective January 1, 2008.  SFAS No. 157 establishes a hierarchy that prioritizes the use of fair value inputs used in valuation methodologies into the following three levels:

Level 1:  Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2:  Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means for substantially the full term of the asset.

Level 3:  Significant unobservable inputs that reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The following is a description of the Company's valuation methodologies used to measure and disclose the fair values of its financial assets and liabilities on a recurring or nonrecurring basis:

Securities available for sale:  Securities available for sale are recorded at fair value on a recurring basis.  Fair value measurement is based on quoted prices, when available.  If quoted prices are not available, fair values are measured using pricing models.  

The Company utilizes a third-party pricing service to obtain fair values for investment securities.  The pricing service utilizes the following method to value the security portfolio.

The securities measured at fair value utilizing Level 1 inputs are marketable equity securities and utilizing Level 2 inputs are corporate obligations, obligations of the U.S. Treasury, agencies and corporations of the U.S. government, including mortgage-backed securities.  The fair values represent either quoted market prices for the identical securities (Level 1 inputs) or fair values determined by pricing models that consider standard input factors such as observable market data, benchmark yields, reported trades, broker/dealer quotes, credit spreads, benchmark securities, as well as new issue data, monthly payment information, and collateral performance, among others.   The Company does not currently have any Level 3 securities in its portfolio.

8



Loans:  The Company does not record loans at fair value on a recurring basis.  However, from time to time, non-recurring fair value adjustments to collateral dependent loans are recorded to reflect partial write-downs based on the observable market price or current appraised value of the collateral.

The balances of assets and liabilities measured at fair value on a recurring basis as of June 30, 2008 were as follows:

   
Assets at Fair Value
   
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   
Significant
Other
Observable Inputs
(Level 2)
(In thousands)
               
Securities available for sale
 
$
341,070
   
$
89,481
   
$
     251,589
 
The balances of assets and liabilities measured at fair value on a nonrecurring basis as of June 30, 2008 were as follows:

   
Assets at Fair Value
   
Significant
Unobservable
Inputs
(Level 3)
   
Total Gains
(Losses)
(In thousands)
             
Impaired loans (1)
 
$
3,310
   
$
3,310
   
$
        (1,069)

(1) Represents carrying value and related write-downs for which adjustments are based on the appraised value of the collateral.

The Company did not have any significant changes in valuation methodology during the quarters ended June 30, 2008 or 2007.  The Company will apply the fair value measurement and disclosure provisions of SFAS No. 157 effective January 1, 2009 to nonfinancial assets and liabilities measured on a nonrecurring basis.  The Company measures the fair value of the following on a nonrecurring basis:  (1) long-lived assets and (2) foreclosed assets.


5.
Employee Benefits

Employee Stock Ownership Plan (“ESOP”)—The Company established an ESOP for its eligible employees effective January 1, 2008.  Employees are eligible to participate in the ESOP after attainment of age 18 and completion of three months of employment.  The ESOP acquired 828,000 shares in the stock offering with the proceeds of a loan totaling $8.3 million from the Company’s subsidiary, Meridian Funding Corporation. Company contributions to the ESOP are at the discretion of the Company’s Board of Directors but at a minimum will be sufficient to service the annual debt of the ESOP.  The Company accounts for its ESOP in accordance with Statement of Position 93-6 “Employers’ Accounting for Employee Stock Ownership Plans”.  Accordingly, the shares pledged as collateral are reported as unallocated ESOP shares in the consolidated balance sheets.  Shares will be released from collateral to settle the Company’s obligation under the ESOP at the ESOP’s year end.  The number of shares to be released will be based on the fair value of the shares at that date required to settle the liability.  As shares are released from collateral, the shares become outstanding for EPS computations.

Consistent with the terms of his employment agreement, the Bank entered into a Separation Agreement with its President upon his retirement during the quarter ended June 30, 2008.  The Separation Agreement provided for the payment of any accrued  compensation,  24 months salary continuation payments at his rate of salary of  $30,961  per  month,  the lump sum  payment  of benefits  under his existing  supplemental  executive  retirement  plan totaling $2,351,591 to be paid on December 7, 2008, the continuation of an existing split-dollar  life  insurance  policy and a bank-owned life  insurance  policy, both of which  had been  fully  paid, and the  maintenance  of

9


existing  long-term care insurance  policies for the President and his spouse at a current annual premium of $2,723.  During the quarter ended June 30, 2008, the Company recorded pre-tax charges of $1.5 million as a result of the Separation Agreement.

Upon reviewing the long-term health care policies paid by the Company’s mutual holding company for the retiring President, as well as certain directors and executives, the Bank was determined to be a party to the agreement to pay the policies.  The policies will thus be paid by the Bank in the future.  In accordance with SFAS No. 158, “Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R),” the Bank established a liability for the present value of the premiums due for the long-term care policies during the quarter.  The adjustment to stockholders’ equity was an after-tax reduction of $353,000.


Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of the financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of Meridian Interstate.  The following discussion should be read in conjunction with the consolidated financial statements, notes and tables included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007, filed with the Securities and Exchange Commission.

Forward-Looking Statements

This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of Meridian Interstate Bancorp.  These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions.  Meridian Interstate Bancorp’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain.  Factors which could have a material adverse effect on the operations of Meridian Interstate Bancorp and its subsidiaries include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in East Boston Savings Bank’s market area, changes in real estate market values in East Boston Savings Bank’s market area, and changes in relevant accounting principles and guidelines.

Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain.  These factors include, but are not limited to, general economic conditions, changes in the interest rate environment, legislative or regulatory changes that may adversely affect our business, changes in accounting policies and practices, changes in competition and demand for financial services, adverse changes in the securities markets and changes in the quality or composition of Meridian Interstate Bancorp’s loan or investment portfolios.  Additional factors that may affect our results are discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 filed with the Securities and Exchange Commission on March 31, 2008, under “Risk Factors,” which is available through the SEC’s website at www.sec.gov.  These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.  Except as required by applicable law or regulation, Meridian Interstate Bancorp does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.  

10



Critical Accounting Policies
 
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements included in the 2007 Annual Report on Form 10-K.  Management has identified accounting for the allowance for credit losses and income taxes as the Company’s most critical accounting policies.  The Company’s critical accounting policies have not changed since December 31, 2007.

General

Selected Financial Data

 
The following is a summary of operating and financial condition highlights as of and for the periods indicated:


   
Financial Condition At
 
   
June 30,
   
December 31,
 
(In thousands)
 
2008
   
2007
 
             
Total assets
  $ 1,079,258     $ 1,003,226  
Secuities available for sale
    341,070       267,058  
Net loans
    616,118       568,104  
Deposits
    802,821       774,446  
Borrowed funds
    62,823       36,527  
Stockholders' equity
    198,809       115,684  
 
             
             
             
             
   
Six Months Ended
 
   
June 30,
 
(Dollars in thousands)
 
2008
   
2007
 
             
Net interest income
  $ 11,751     $ 10,583  
Provision for loan losses
    2,328       143  
Non-interest income
    4,226       4,189  
Non-interest expenses
    17,788       10,773  
Provision (benefit) for income taxes
    (1,602 )     1,265  
Net income (loss)
    (2,537 )     2,591  
                 
Interest rate spread
    1.70 %     2.07 %
Net interest margin
    2.35 %     2.54 %



11



Comparison of Financial Condition at June 30, 2008 and December 31, 2007

The Company’s total assets increased by $76.0 million, or 7.6%, to $1.1 billion at June 30, 2008 from December 31, 2007.  Net loans increased by $48.0 million, or 8.5%, and securities available for sale increased $74.0 million, or 27.7%.  For the six months ended June 30, 2008, growth in one- to four-family real estate loans was $30.4 million, or 13.6%.  An increase in commercial real estate loans of $25.0 million, or 14.3%, was offset by a decrease in the balance of construction loans of $11.9 million, or 10.6%.

Deposits increased by $28.4 million, or 3.7%, for the six months ended June 30, 2008, with increases in all deposit categories.   Federal Home Loan Bank of Boston borrowings also increased $26.3 million, to $62.8 million, as the Company opted to replace some higher rate maturing advances with lower cost borrowings.

Stockholders’ equity increased by $83.1 million, to $198.8 million at June 30, 2008 from $115.7 million at December 31, 2007, mainly due to the stock offering.  As a result of the offering, the Company has 23,000,000 shares outstanding, including 10,050,000 shares of common stock sold in the offering, (including shares sold to the Company’s employee stock ownership plan), 300,000 shares contributed to the Meridian Charitable Foundation, Inc. and 12,650,000 shares issued to the Company's mutual holding company parent, Meridian Financial Services, Incorporated.  


Securities

All securities held by the Company as of June 30, 2008 and December 31, 2007 were classified as available-for-sale and are carried at fair value. Unrealized gains and losses, net of tax, are excluded from earnings and reported as a separate component of stockholders’ equity. Gains or losses on the sale of available-for-sale securities are determined using the specific identification method. Premiums and discounts are recognized in interest income using the effective interest method over the period to maturity. Carrying amounts and fair values at June 30, 2008 and December 31, 2007 were as follows:

 
At June 30, 2008
   
At December 31, 2007
 
 
 
Amortized
   
Fair
   
Amortized
   
Fair
 
(In thousands) 
Cost
   
Value
   
Cost
   
Value
 
Securities available for sale:
                       
   U.S. Government – sponsored enterprises
  $ 40,466     $ 40,430     $ 7,002     $ 6,975  
   Corporate bonds
    212,300       211,117       219,626       220,629  
   Mortgage-backed securities
    42       42       43       43  
                                 
      Total debt securities
    252,808       251,589       226,671       227,647  
   Marketable equity securities
    85,161       89,481       28,843       39,411  
      Total securities available for sale
$ 337,969     $ 341,070     $ 255,514     $ 267,058  

The available for sale securities portfolio increased $74.0 million, or 27.7%, as the Company replaced some federal funds sold with mutual fund investments and agency securities.   At June 30, 2008, unrealized losses in our debt portfolio ranged from 0% to 22%, and unrealized losses in our equity portfolio ranged from 0% to 29%.  Management continues to monitor the securities that have been determined to have temporary market declines.

Management evaluates securities for other-than-temporary impairment on a semi-monthly basis.  Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

12


 
Loan Portfolio Analysis

Our loan portfolio consists primarily of residential, multi-family and commercial real estate, construction and land development, commercial, and consumer loans and home equity lines of credit originated primarily in our market area. There are no foreign loans outstanding. Interest rates charged on loans are affected principally by the demand for such loans, the supply of money available for lending purposes and the rates offered by our competitors.  Loan detail by category as of June 30, 2008 and December 31, 2007 were as follows:

                         
   
At June 30, 2008
   
At December 31, 2007
 
(Dollars in thousands)
Amount
   
%
   
Amount
   
%
 
Real estate loans:
                       
   One-to four-family
  $ 254,492       40.8 %   $ 224,109       39.1 %
   Multi-family
    29,045       4.8       26,855       4.7  
   Commercial real estate
    200,064       32.1       175,072       30.5  
   Construction
    99,900       16.0       111,796       19.5  
   Home equity lines
                               
     of credit
  24,576       3.9       21,541       3.8  
        Total real estate loans
  608,077       97.6       559,373       97.6  
                                 
Commercial business loans
    13,603       2.2       11,859       2.1  
Consumer loans
  1,444       0.2       1,576       0.3  
         Total loans
  623,124       100.0 %     572,808       100.0 %
Net deferred origination fees
    (1,045 )             (1,067 )        
Allowance for loan losses
  (5,961 )             (3,637 )        
         Loans, net
$ 616,118             $ 568,104          
  
Analysis of Loan Loss Experience

The allowance for loan losses is maintained at a level adequate to absorb possible losses inherent in the loan portfolio.  The allowance for loan losses is based on management’s assessment of various factors affecting the loan portfolio, including portfolio composition, delinquency and non-accrual levels, economic conditions, loss experience, and an evaluation of underlying collateral quality.  Changes in the allowance for loan losses during the six months ended June 30, 2008 and 2007 were as follows:

 
Six Months Ended June 30,
 
(Dollars in thousands)
2008
   
2007
 
Beginning balance
  $ 3,637     $ 3,362  
Provision for loan losses
    2,328       143  
Charge offs:
               
Real estate loans
    5       16  
Commercial business loans
    -       -  
Consumer loans
    -       61  
        Total charge-offs
    5       77  
Recoveries:
               
Real estate loans
    1       16  
Commercial business loans
    -       -  
Consumer loans
    -       59  
Total recoveries
    1       75  
Net charge-offs
    (4 )     (2 )
     Ending balance
  $ 5,961     $ 3,503  
Allowance to non-accrual loans
    78.64 %     49.95 %
Allowance to total loans outstanding
    0.96 %     0.64 %
Net charge-offs/average loans outstanding
  0.00 %     0.00 %

13



Provision for Loan Losses
 
The Company’s loan loss provision amounted to $2.2 million and $2.3 million for the three and six months ended June 30, 2008, compared to $71,000 and $143,000 for the same periods in 2007. Most of the increase in the provision related to specific impairment reserves taken for two residential construction projects determined to be impaired during the second quarter, as well as growth in the loan portfolio and management’s assessment of various factors affecting the portfolio, including, among others, an ongoing evaluation of credit quality, local real estate market conditions, and general economic factors.  As a result of the increased provision taken during the second quarter, the allowance for loan losses was $6.0 million, or 0.96% of total loans outstanding as of June 30, 2008, as compared to $3.6 million, or 0.63% of total loans outstanding as of December 31, 2007.   We recorded net charge-offs of $4,000 and $2,000 in the six months ending June 30, 2008 and 2007, respectively.
 
Management’s Assessment of Asset Quality

Non-performing assets include loans that are 90 or more days past due or on non-accrual status and real estate and other loan collateral acquired through foreclosure and repossession.  Loans 90 days or more past due may remain on an accrual basis if adequately collateralized and in the process of collection.  For non-accrual loans, interest previously accrued but not collected is reversed and charged against income at the time a loan is placed on non-accrual status.  Payments received at the time a loan is on non-accrual status are applied to principal.  Interest income is not recognized until the loan is returned to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
The following table summarizes the non-performing assets at June 30, 2008 and December 31, 2007.

 
At June 30,
   
At December 31,
 
(In thousands)
2008
   
2007
 
Loans accounted for on a non-accrual basis:
       
Real estate loans:
           
   One-to four-family
  $ 1,465     $ 2,059  
   Multi-family
    -       -  
   Commercial real estate
    2,986       1,561  
  Home equity lines of credit
    -       98  
  Construction
    3,124       1,218  
        Total real estate loans
    7,575       4,936  
Commercial business loans
    -       45  
Consumer loans
    5       1  
    Total non-accrual loans
    7,580       4,982  
                 
Foreclosed assets
    -       560  
          Total nonperforming assets
  $ 7,580     $ 5,542  
                 
Non-accrual loans to total loans
    1.22 %     0.87 %
Non-accrual loans to total assets
    0.70 %     0.50 %
Non-performing assets to total assets
  0.70 %     0.55 %

Non-performing assets (non-accrual loans and property acquired through foreclosure) were $7.6 million, or 0.70% of total assets at June 30, 2008, compared to $5.5 million, or 0.55% at December 31, 2007, and $7.0 million, or 0.77% at June 30, 2007.  The increase in non-performing assets from December resulted primarily from one $2.4 million residential construction lending relationship.  We held no property acquired through foreclosure at June 30, 2008 or 2007, compared to $560,000 of such property at December 31, 2007.  Interest income that would have been recorded for the six months ended June 30, 2008 had nonaccruing loans and accruing loans past due 90 days or more been current according to their original terms amounted to $397,000.  The Company recorded a $5,000 loss on the sale of foreclosed real estate for the six months ending June 30, 2008.

14



At June 30, 2008, there was $14.4 million of impaired loans, including loans of $11.9 million with an impairment allowance of $2.2 million.  Impaired loans totaling $621,000 had a valuation allowance of $89,000 at December 31, 2007.    The June 30, 2008 impaired loan balance includes a $7.5 million troubled debt restructuring.  A modification of loan terms constitutes a troubled debt restructuring if, for reasons related to the debtor’s financial difficulties, a concession is granted to the debtor that would not otherwise be considered.    The Company’s average investment in impaired loans was $7.7 million and $2.8 million for the six months ended June 30, 2008 and 2007, respectively.

Deposits

Deposits are a major source of our funds for lending and other investment purposes.  Deposit inflows and outflows are significantly influenced by general interest rates and money market conditions.
The following table summarizes the period end balance and the composition of deposits:

   
At June 30, 2008
   
At December 31, 2007
 
(Dollars in thousands)
Amount
   
Percent
   
Amount
   
Percent
 
NOW and demand deposits
  $ 96,117       12.0
% 
  $ 85,045       11.0  %
Money market deposits
    144,571       18.0       138,688       17.9  
Regular and other deposits
    121,071       15.1       118,837       15.3  
Certificates of deposit
    441,062       54.9       431,876       55.8  
         Total
$ 802,821       100.0 %   $ 774,446       100.0 %

Borrowings

Federal Home Loan Bank (“FHLB”) advances maturing within one year totaled $9.2 million at December 31, 2007, at a weighted average rate of 4.52%.  No short term advances were outstanding at June 30, 2008.
 
At June 30, 2008, long-term FHLB advances totaling $62.8 million mature through April 2013, with a weighted average yield of 3.56%.  As of December 31, 2007, long-term FHLB advances totaling $27.4 million were outstanding, with a weighted average yield of 4.48%.
 



15




Results of Operations for the Three and Six Months Ended June 30, 2008 and June 30, 2007

Average Balance Table
The following table sets forth average balance sheets, average yields and costs, and certain other information at and for the periods indicated.

MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES
Net Interest Income Analysis
(Unaudited)
                                     
   
For The Three Months Ended June 30,
 
 
2008
2007
(Dollars in thousands)
 
Average
Balance
 
Interest
Earned/Paid
 
Yield/ 
Cost (4)
Average
Balance
 
Interest
Earned/Paid
 
Yield/ 
Cost (4)
Assets:
                                   
Interest-earning assets:
                                   
   Loans (1)
  $ 604,227     $ 9,334       6.21 %   $ 538,720     $ 8,815       6.56 %
   Securities and certificates of deposit
    310,094       3,097       4.02       278,410       3,057       4.40  
   Other interest-earning assets
    96,801     478       1.99       16,076     208       5.19  
         Total interest-earning assets
    1,011,122       12,909       5.13       833,206       12,080       5.82  
                                                 
Noninterest-earning assets
    76,288                       68,230                  
         Total assets
  $ 1,087,410                     $ 901,436                  
                                                 
Liabilities and stockholders' equity:
                                               
Interest-bearing liabilities:
                                               
   NOW  deposits
  $ 39,530       79       0.80     $ 34,289       33       0.39  
   Money market deposits
    143,566       885       2.48       103,936       891       3.44  
   Savings and other deposits
    123,801       351       1.14       132,958       380       1.15  
   Certificates of deposit
    448,618     5,111       4.58       414,495     5,003       4.84  
      Total interest-bearing deposits
    755,515       6,426       3.42       685,678       6,307       3.69  
                                                 
   FHLB advances
    64,070     570       3.58       41,263     493       4.79  
                                                 
      Total interest-bearing liabilities
    819,585       6,996       3.43       726,941       6,800       3.75  
                                                 
   Non-interest-bearing demand deposits
    55,299                       53,890                  
   Other non-interest-bearing liabilities
    9,647                       7,598                  
         Total liabilities
    884,531                       788,429                  
                                                 
      Total stockholders' equity
    202,879                       113,007                  
      Total liabilities and stockholders' equity
  $ 1,087,410                     $ 901,436                  
                                                 
   Net interest income
          $ 5,913                     $ 5,280          
   Interest rate spread  (2)
                    1.70 %                     2.07 %
   Net interest margin  (3)
                    2.35 %                     2.54 %
   Average interest-earning assets to average interest-bearing liabilities
          123.37 %                     114.62 %        

(1) Loans on non accrual status are included in average balances.
         
               
(2) Interest rate spread represents the difference betweent the yield on interest-earning assets and the cost of interest-bearing liabilities.
 
               
(3) Net interest margin represents net interest income divided by average interest-earning assets.
 
               
(4) Annualized.
             

16



MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES
Net Interest Income Analysis
(Unaudited)
                                     
   
For The Six Months Ended June 30,
 
2008
2007
(Dollars in thousands)
 
Average
Balance
 
Interest
Earned/Paid
 
Yield/ 
Cost (4)
Average
Balance
 
Interest
Earned/Paid
 
Yield/ 
Cost (4)
Assets:
                                   
Interest-earning assets:
                                   
   Loans (1)
  $ 585,481     $ 18,517       6.36 %   $ 538,719     $ 17,487       6.49 %
   Securities and certificates of deposit
    285,088       5,974       4.21       279,757       6,093       4.36  
   Other interest-earning assets
    117,636     1,541       2.63       15,214     395       5.23  
         Total interest-earning assets
    988,205       26,032       5.30       833,690       23,975       5.75  
                                                 
Noninterest-earning assets
    75,438                       65,911                  
         Total assets
  $ 1,063,643                     $ 899,601                  
                                                 
Liabilities and stockholders' equity:
                                               
Interest-bearing liabilities:
                                               
   NOW  deposits
  $ 37,225       147       0.79     $ 64,040       47       0.15  
   Money market deposits
    141,844       2,038       2.89       101,208       1,709       3.40  
   Savings and other deposits
    132,122       746       1.14       133,149       771       1.17  
   Certificates of deposit
    447,243     10,406       4.68       417,620     9,896