form10q-100758_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 March 31, 2009

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes £     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 T  Non-accelerated Filer £   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 May 1, 2009, the registrant had 22,586,000 shares of no par value common stock outstanding.

 
 

 

MERIDIAN INTERSTATE BANCORP, INC.

FORM 10-Q

INDEX

   
       
 
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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

MERIDIAN INTERSTATE BANCORP, INC.
 
Consolidated Balance Sheets
(Unaudited)
 
             
   
March 31,
   
December 31,
 
(Dollars in thousands)
 
2009
   
2008
 
ASSETS
Cash and due from banks
  $ 11,284     $ 10,354  
Federal funds sold
    18,521       9,911  
          Total cash and cash equivalents
    29,805       20,265  
                 
Certificates of deposit - affiliate bank
    2,000       7,000  
Securities available for sale, at fair value
    278,707       252,529  
Federal Home Loan Bank stock, at cost
    4,303       4,303  
                 
Loans
    745,378       711,016  
Less allowance for loan losses
    (7,456 )     (6,912 )
           Loans, net
    737,922       704,104  
                 
Bank-owned life insurance
    23,045       22,831  
Investment in affiliate bank
    10,349       10,376  
Premises and equipment, net
    22,587       22,710  
Accrued interest receivable
    5,415       6,036  
Foreclosed real estate, net
    2,449       2,604  
Deferred tax asset, net
    10,462       10,057  
Other assets
    1,723       2,537  
              Total assets
  $ 1,128,767     $ 1,065,352  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
               
Noninterest-bearing
  $ 60,560     $ 55,216  
Interest-bearing
    798,700       741,636  
Total deposits
    859,260       796,852  
                 
Short-term borrowings - affiliate bank
    7,546       7,811  
Long-term debt
    57,675       57,675  
Accrued expenses and other liabilities
    17,240       13,174  
              Total liabilities
    941,721       875,512  
                 
Stockholders' equity:
               
   Common stock, no par value 50,000,000 shares authorized;
               
      23,000,000 shares issued; 22,586,000 and 22,750,000 shares
               
      outstanding at March 31, 2009 and December 31, 2008, respectively
    -       -  
   Additional paid-in capital
    100,779       100,684  
   Retained earnings
    104,318       105,426  
   Accumulated other comprehensive loss
    (6,723 )     (6,205 )
   Unearned compensation - ESOP - 776,250 and 786,600 shares
               
      at March 31, 2009 and December 31, 2008, respectively
    (7,762 )     (7,866 )
   Unearned compensation - restricted shares - 414,000
               
       and 250,000 shares at March 31, 2009 and
               
       December 31, 2008, respectively
    (3,566 )     (2,199 )
             Total stockholders' equity
    187,046       189,840  
                Total liabilities and stockholders' equity
  $ 1,128,767     $ 1,065,352  
 
                      See accompanying notes to unaudited consolidated financial statements.

1



MERIDIAN INTERSTATE BANCORP, INC.
Consolidated Statements of Loss
(Unaudited)
             
   
Three Months Ended
March 31
 
(Dollars in thousands, except per share amounts)
 
2009
   
2008
 
Interest and dividend income:
           
    Interest and fees on loans
  $ 10,645     $ 9,183  
    Interest on debt securities
    2,455       2,612  
    Dividends on equity securities
    293       265  
    Interest on certificates of deposit
    42       -  
    Interest on federal funds sold
    12       1,063  
               Total interest and dividend income
    13,447       13,123  
                 
Interest expense:
               
    Interest on deposits
    5,263       6,911  
    Interest on short-term borrowings
    35       62  
    Interest on long-term debt
    497       312  
               Total interest expense
    5,795       7,285  
                 
Net interest income
    7,652       5,838  
Provision for loan losses
    546       131  
               Net interest income, after provision
               
                    for loan losses
    7,106       5,707  
                 
Non-interest income:
               
    Customer service fees
    697       696  
    Loan fees
    150       178  
    Gain on sales of loans, net
    183       19  
    Gain (loss) on securities, net
    (124 )     2,266  
    Income from bank-owned life insurance
    214       185  
    Equity loss on investment in affiliate bank
    (27 )     (168 )
               Total non-interest income
    1,093       3,176  
                 
Non-interest expenses:
               
    Salaries and employee benefits
    6,314       4,092  
    Occupancy and equipment
    864       780  
    Data processing
    438       387  
    Marketing and advertising
    234       246  
    Professional services
    652       309  
    Contribution to the Meridian
               
      Charitable Foundation
    -       3,000  
    Foreclosed real estate expense
    255       29  
    Other general and administrative
    920       469  
               Total non-interest expenses
    9,677       9,312  
                 
    Loss before income taxes
    (1,478 )     (429 )
                 
    Benefit for income taxes
    (370 )     (108 )
                 
               Net loss
  $ (1,108 )   $ (321 )
                 
Loss per share:
               
                Basic
  $ (0.05 )     N/A  
                Diluted
  $ (0.05 )     N/A  
                 
Weighted Average Shares:
               
                Basic
    21,868,565       N/A  
                Diluted
    22,050,960       N/A  

 
See accompanying notes to unaudited consolidated financial statements.

2

 
MERIDIAN INTERSTATE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Three Months Ended March 31, 2009 and 2008
 
(Dollars in thousands)
 
Shares of
No Par
Common
Stock
Outstanding
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive 
Income (Loss)
   
Unearned
Compensation
ESOP
   
Unearned
Compensation
Restricted
Shares
   
Total
 
Three Months Ended March 31, 2008
                                         
Balance at December 31, 2007
    -     $ -     $ 109,177     $ 6,507     $ -     $ -     $ 115,684  
    Adjustment to initially apply EITF 06-4
    -       -       (1,642 )     -       -               (1,642 )
Comprehensive loss:
                                                       
   Net loss
    -       -       (321 )     -       -       -       (321 )
   Change in net unrealized gain on securities available for
                                                       
      sale, net of reclassification adjustment and tax effects
    -       -       -       (2,713 )     -       -       (2,713 )
    Change in prior service costs and
                                                       
      actuarial losses, net of tax effects
    -       -       -       5       -       -       5  
          Total comprehensive loss
                                                    (3,029 )
    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  
    Issuance and contribution of 300,000 shares
                                                       
      to the Meridian Charitable Foundation
    300,000       3,000       -       -       -       -       3,000  
   Purchase of common stock by the ESOP
    -       -       -       -       (8,280 )     -       -  
   ESOP shares earned (10,350 shares)
    -       (5 )     -       -       104       -       (8,280 )
Balance at March 31, 2008
    23,000,000     $ 100,628     $ 107,214     $ 3,799     $ (8,176 )   $ -     $ 203,465  
Three Months Ended March 31, 2009
                                                       
Balance at December 31, 2008
    22,750,000     $ 100,684     $ 105,426     $ (6,205 )   $ (7,866 )   $ (2,199 )   $ 189,840  
Comprehensive loss:
                                                       
   Net loss
    -       -       (1,108 )     -       -       -       (1,108 )
   Change in net unrealized loss on securities available for
                                                       
      sale, net of reclassification adjustment and tax effects
    -       -       -       (518 )     -       -       (518 )
          Total comprehensive loss
                                                    (1,626 )
   ESOP shares earned (10,350 shares)
    -       (17 )     -       -       104       -       87  
   Purchase of 164,000 shares
                                                       
      for restricted share plan
         (164,000 )      -       -       -       -       (1,468 )     (1,468 )
   Share-based compensation expense
     -       112       -       -               101       213  
Balance at March 31, 2009
    22,586,000     $ 100,779     $ 104,318     $ (6,723 )   $ (7,762 )   $ (3,566 )   $ 187,046  
 
See accompanying notes to unaudited consolidated financial statements.

3


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


             
   
Three Months Ended March 31,
 
(In thousands)
 
2009
 
2008
 
Cash flows from operating activities:
           
    Net loss
  $ (1,108 )   $ (321 )
    Adjustments to reconcile net loss to net cash
               
        provided by operating activities:
               
            Contribution of stock to charitable foundation
    -       3,000  
            Earned ESOP shares
    87       99  
            Provision for loan losses
    546       131  
            Amortization of net deferred loan origination fees
    (57 )     (78 )
            Net amortization of securities available for sale
    302       150  
            Depreciation and amortization expense
    329       324  
            Loss (gain) on securities, net
    124       (2,266 )
            Loss and provision for foreclosed real estate
    148       5  
            Deferred income tax provision (benefit)
    14       (1,152 )
            Income from bank-owned life insurance
    (214 )     (185 )
            Equity loss on investment in affiliate bank
    27       168  
            Share-based compensation expense
    213       -  
            Net changes in:
               
                 Accrued interest receivable
    621       514  
                 Other assets
    814       3,666  
                 Accrued expenses and other liabilities
    4,066       (1,131 )
                     Net cash provided by operating activities
    5,912       2,924  
                 
Cash flows from investing activities:
               
    Maturities (purchases) of certifictes of deposit
    5,000       (2,000 )
    Activity in securities available for sale:
               
         Proceeds from maturities, calls and principal payments
    17,751       25,750  
         Proceeds from sales
    -       9,804  
         Purchases
    (45,292 )     (22,203 )
    Loans originated, net of principal payments received
    (34,632 )     (12,257 )
    Purchase of bank-owned life insurance
    -       (4,000 )
    Purchases of premises and equipment
    (206 )     (137 )
    Capitalized cost on foreclosed real estate
    (180 )     -  
    Proceeds from sales of foreclosed real estate
    512       290  
                     Net cash used in investing activities
    (57,047 )     (4,753 )

(continued)

4




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

   
Three Months Ended March 31,
 
(In thousands)
 
2009
 
2008
 
Cash flows from financing activities:
           
    Net increase in deposits
    62,408       31,148  
    Proceeds from sale of common stock
    -       97,633  
    Common stock purchased by ESOP
    -       (8,280 )
    Decrease in stock subscriptions
    -       (62,518 )
    Purchase of stock for equity incentive plan
    (1,468 )     -  
    Net change in borrowings with maturities
               
         less than three months
    (265 )     -  
    Repayment of Federal Home Loan Bank advances
               
         with maturities of three months or more
    -       (6,300 )
                    Net cash provided by financing activities
    60,675       51,683  
                 
Net change in cash and cash equivalents
    9,540       49,854  
                 
Cash and cash equivalents at beginning of period
    20,265       103,093  
                 
Cash and cash equivalents at end of period
  $ 29,805     $ 152,947  
                 
Supplemental cash flow information:
               
    Interest paid on deposits
  $ 5,332     $ 6,917  
    Interest paid on borrowings
    532       404  
    Income taxes paid
    170       20  
Non-cash investing and financing activities:
               
    Transfers from loans to foreclosed real estate
    325       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 56% 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 considered necessary for a fair presentation have been included.  Such adjustments were of a normal recurring nature.  The results of operations for the three months ended March 31, 2009 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, 2008 which was filed with the Securities and Exchange Commission (“SEC”) on March 15, 2009, as subsequently amended, 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, other-than-temporary impairment of securities, foreclosed real estate, income taxes and the fair values of financial instruments.

2.             Recent Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards SFAS No. 141 (revised), ‘‘Business Combinations’’, which replaces SFAS 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. This Statement 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. 

In April 2009, the FASB issued FASB Staff Position (FSP) No. 141(R)-1 ("FSP 141(R)-1"), Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.  FSP 141(R)-1 amends and clarifies FASB Statement No. 141 (revised 2007), Business Combinations, to address application issues raised by preparers, auditors, and members of the legal profession on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination.  FSP 141(R)-1 is effective for assets or liabilities arising from contingencies in 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.  The adoption of this FSP by the Company on January 1, 2009 did not have an impact on the Company’s consolidated financial statements.

Effective January 1, 2008, the Company adopted EITF 06-04, “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

6


portion of the death benefit that the Company will receive as beneficiary of such policies.  EITF 06-04 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 06-04, 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. 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. The adoption of this Statement by the Company on January 1, 2009 did not have an impact on the Company’s consolidated financial statements.

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.  The adoption of this Statement by the Company on January 1, 2009 did not have an impact on the Company’s consolidated financial statements.

In December 2008, the FASB issued FASB Staff Position No. FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP 132(R)-1”), which amends FASB Statement No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan.  This staff position requires disclosure of information about how investment allocation decisions are made, the fair value of each major category of plan assets and the inputs and valuation techniques used to develop fair value measurements.  Also, an employer shall provide users of financial statements with an understanding of significant concentrations of risk in plan assets. The disclosures about plan assets are required for years ending after December 15, 2009.  Upon initial adoption of FSP 132(R)-1, disclosures are not required for earlier periods that are presented for comparative purposes.

In January  2009, the FASB issued a FASB Staff Position on the Emerging Issues Task Force (“EITF”) Issue No. 03-06-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” (FSP EITF 03-06-1). Under FSP EITF 03-06-1, unvested share-based awards which include the right to receive nonforfeitable dividends or dividend equivalents are considered to participate with common stock in undistributed earnings. Companies that issue share-based awards considered to be participating securities under FSP EITF 03-06-1 are required to calculate basic and diluted earnings per common share amounts under the two-class method. The two-class method excludes from earnings per common share calculations any dividends paid or owed to participating securities and any undistributed earnings considered to be attributable to participating securities. FSP EITF 03-06-1 requires retrospective application to all prior-period earnings per share data presented.   The adoption of this EITF by the Company on January 1, 2009 did not have an impact on the Company’s consolidated financial statements.

On January 12, 2009, FASB issued FSP Emerging Issues Task Force (EITF) 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20”. FSP EITF 99-20-1 addresses certain practice issues in EITF No. 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, by making its other-than-temporary impairment assessment guidance consistent with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. FSP EITF 99-20-1 removes the reference to the consideration of a market participant's estimates

7


of cash flows in EITF 99-20, and instead requires an assessment of whether it is probable, based on current information and events, that the holder of the security will be unable to collect all amounts due according to the contractual terms.  If it is probable that there has been an adverse change in estimated cash flows, an other-than-temporary impairment is deemed to exist, and a corresponding loss shall be recognized in earnings equal to the entire difference between the investment’s carrying value and its fair value at the balance sheet date of the reporting period for which the assessment is made.  This FSP is effective for interim and annual reporting periods ending after December 15, 2008, and shall be applied prospectively.  The adoption of this Statement by the Company on January 1, 2009 did not have an impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued the following three FSPs intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities:
 
FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability have decreased significantly.  FSP FAS 157-4 also provides guidance on identifying circumstances that indicate a transaction is not orderly.  The provisions of FSP FAS 157-4 are effective for the Company’s interim period ending on June 30, 2009.  Management is currently evaluating the effect that the provisions of FSP FAS 157-4 may have on the Company’s consolidated financial statements.
 
FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” requires disclosures about fair value of financial instruments in interim reporting periods of publicly traded companies that were previously only required to be disclosed in annual financial statements.  The provisions of FSP FAS 107-1 and APB 28-1 are effective for the Company’s interim period ending on June 30, 2009.  The adoption of this EITF by the Company is not expected to have a material impact on the Company’s consolidated financial statements.
 
FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” amends current other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements.  This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities.  The provisions of FSP FAS 115-2 and FAS 124-2 are effective for the Company’s interim period ending on June 30, 2009.  Management is currently evaluating the effect that the provisions of FSP FAS 115-2 and FAS 124-2 may have on the Company’s consolidated financial statements.

3.             Fair Value Measurement

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  In accordance with FASB Statement No. 157, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company’s various financial instruments.   In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

Fair Value Hierarchy

In accordance with Statement No. 157, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

8


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.

Assets Measured at Fair Value on a Recurring Basis:

Assets measured at fair value on a recurring basis are summarized as follows.  There were no liabilities measured at fair value on a recurring basis.
 
 
March 31, 2009
   
 
 
(In thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Securities available for sale
  $ 73,589     $ 205,118       -     $ 278,707  
                                 
                                 
 
December 31, 2008
   
 
 
(In thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Securities available for sale
  $ 47,799     $ 204,730       -     $ 252,529  

The Company may also be required, from time to time, to measure certain other financial assets and non-financial assets on a non-recurring basis in accordance with generally accepted accounting principles.  These adjustments to fair value usually result from the application of lower-of-cost-or market accounting or write-downs of individual assets.
 

9


The following tables summarize the fair value hierarchy used to determine each adjustment and the carrying value of the related individual assets.
 
 
March 31, 2009
   
Quarter
Ended
March 31,
2009
 
(In thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
Losses
 
Impaired loans
    -       -       2,156       109  
Foreclosed real esate
    -       -       2,449       60  
    $ -     $ -     $ 4,605     $ 169  
                                 
 
December 31, 2008
   
Quarter
Ended
March 31,
2008
 
(In thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
Losses
 
Impaired loans
    -       -       1,511       59  
Foreclosed real esate
    -       -       2,604       -  
    $ -     $ -     $ 4,115     $ 59  
 
At March 31, 2009 and December 31, 2008, the amount of foreclosed real estate in Level 3 represents the carrying value and related charge-offs for which adjustments are based on appraised value of the collateral, considering discounting factors and adjusted for selling costs. The loss on foreclosed real estate represents the adjustment in valuation recorded during the time periods indicated, and not for losses incurred on the sale of the property.  At March 31, 2009 and December 31, 2008, the amount of impaired loans in Level 3 represents the carrying value and related FASB Statement No. 114 allocated reserves on impaired loans for which adjustments are based on the appraised value of the underlying collateral, considering discounting factors and adjusted for selling costs.  The loss on impaired loans is not recorded directly as an adjustment to current earnings or comprehensive income, but rather as a component in determining the overall adequacy of the allowance for loan losses.  Adjustments to the estimated fair value of impaired loans may result in increases or decreases to the provision for loan losses.  There were no liabilities measured at fair value on a non-recurring basis.
 
4.             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.
 
Net investable proceeds from the initial public offering were $89.4 million.   In connection with the initial public offering, the Company also issued and 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.

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.


10

 
5.         Earnings Per Share

Basic earnings per share (“EPS”) excludes dilution and is calculated by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding during the period.  Diluted EPS is computed in a manner similar to that of basic EPS except that the weighted-average number of common shares outstanding is increased to include the number of incremental common shares (computed using the treasury stock method) that would have been outstanding if all potentially dilutive common stock equivalents (such as stock options and unvested restricted stock) were issued during the period. 
 
For the quarter ended March 31, 2009, potentially dilutive common stock equivalents totaled 182,395 shares, representing the dilutive effect of the restricted stock.  Earnings per share are not applicable for year to date and quarterly periods prior to June 30, 2008 as the Company did not issue stock until January 23, 2008.  Unallocated common shares held by the ESOP are shown as a reduction in stockholders’ equity and are not included in the weighted-average number of common shares outstanding for either basic or diluted earnings per share calculations.
  
The following table is the reconciliation of basic and diluted earnings per share for the three months ended March 31, 2009.
       
(Dollars in thousands, except per share amounts)
 
Basic
   
Diluted
 
Net Loss
  $ (1,108 )   $ (1,108 )
Weighted average shares outstanding
    21,868,565       21,868,565  
Effect of dilutive securities
    -       182,395  
Adjusted weighted average shares outstanding
    21,868,565       22,050,960  
    Loss Per Share
  $ (0.05 )   $ (0.05 )
 

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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, 2008, filed with the Securities and Exchange Commission.

Forward-Looking Statements

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:

 
·
significantly increased competition among depository and other financial institutions;
 
·
inflation and changes in the interest rate environment or other changes that reduce our interest margins or reduce the fair value of financial instruments;
 
·
general economic conditions, either nationally or in our market areas, that are worse than expected;
 
·
adverse changes in the securities markets;
 
·
legislative or regulatory changes that adversely affect our business;
 
·
our ability to enter new markets successfully and take advantage of growth opportunities, and the possible dilutive effect of potential acquisitions or de novo branches, if any;
 
·
changes in consumer spending, borrowing and savings habits;
 
·
changes in accounting policies and practices, as may be adopted by bank regulatory agencies, the Financial Accounting Standards Board, the Public Company Accounting Oversight Board and other promulgating authorities;
 
·
inability of third-party providers to perform their obligations to us;
 
·
changes in our organization, compensation and benefit plans;
 
·
changes in real estate values in our market areas;
 
·
the effect of the current governmental effort to restructure the U.S. financial and regulatory system;
 
·
the effect of developments in the secondary market affecting our loan pricing;
 
·
the level of future deposit premiums; and
 
·
the effect of the current financial crisis on our loan portfolio and our investment portfolio, and our deposit and other customers.

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, 2008 filed with the Securities and Exchange Commission on March 15, 2009, under “Risk Factors,” as subsequently amended, 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.  

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Critical Accounting Policies
 
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements included in the 2008 Annual Report on Form 10-K. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.  Management has identified accounting for the allowance for loan losses, other-than-temporary impairment of securities, foreclosed real estate and income taxes as the Company’s most critical accounting policies.  The Company’s critical accounting policies have not changed since December 31, 2008.

Selected Financial Data

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

   
Financial Condition Highlights
 
   
At
   
At
 
   
March 31,
   
December 31,
 
(In thousands)
 
2009
   
2008
 
             
             
Total assets
  $ 1,128,767     $ 1,065,352  
Secuities available for sale
    278,707       252,529  
Net loans
    737,922       704,104  
Deposits
    859,260       796,852  
Borrowed funds
    65,221       65,486  
Stockholders' equity
    187,046       189,840  
                 
                 
                 
                 
   
Three Months Ended
 
   
March 31,
 
(Dollars in thousands)
 
2009
   
2008
 
                 
Net interest income
  $ 7,652     $ 5,838  
Provision for loan losses
    546       131  
Non-interest income
    1,093       3,176  
Non-interest expenses
    9,677       9,312  
Benefit for income taxes
    (370 )     (108 )
Net loss
    (1,108 )     (321 )
                 
Interest rate spread
    2.55 %     1.82 %
Net interest margin
    3.04 %     2.43 %

 
Comparison of Financial Condition at March 31, 2009 and December 31, 2008

Total assets increased by $63.4 million, or 6.0%, to $1.1 billion at March 31, 2009.  Securities available for sale increased $26.2 million, or 10.4%, from December 31, 2008, as the Company invested excess funds in money market mutual funds as an alternative to federal funds sold.
 
Loan growth continued in the first quarter of 2009, with total loans increasing by $34.4 million, or 4.8%.  Multi-family loans increased by $15.3 million, or 49.2%, while the one- to four-family residential loan and
 

13


commercial real estate loan portfolios increased by $9.8 million and $8.4 million, respectively.  Rate decreases have contributed to higher originations for these products, with increased interest in both purchase and refinance activity.
 
Deposits increased by $62.4 million, or 7.8%, from December 31, 2008, with increases in all deposit types, as local deposit competition has lessened.  Money market deposits increased by $31.9 million, or 18.4%, to $204.7 million at March 31, 2009.  Certificates of deposit also increased by $20.2 million, or 4.9%, to $434.2 million.

Stockholders’ equity decreased by $2.8 million, to $187.0 million at March 31, 2009 from $189.8 million at December 31, 2008, mainly due to in the net operating loss of $1.1 million and a $1.5 million repurchase of the Company’s common stock, for the Equity Incentive Plan.

Securities
 
All securities held by the Company as of March 31, 2009 and December 31, 2008 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 March 31, 2009 and December 31, 2008 were as follows:

   
At March 31,
   
At December 31,
 
   
2009
   
2008
 
(In thousands)
 
Amortized
   
Fair
   
Amortized
   
Fair
 
   
Cost
   
Value
   
Cost
   
Value
 
Debt securities:
                       
   U.S. Government – sponsored enterprises
  $ -     $ -     $ 1,000     $ 1,003  
   Corporate bonds
    209,970       205,079       210,079       203,687  
   Mortgage-backed securities
    40       39       40       40  
                                 
      Total debt securities
    210,010       205,118       211,119       204,730  
Marketable equity securities :
                               
   Common stocks
    27,276       21,554       26,142       22,854  
   Money market mutual funds
    52,035       52,035       24,945       24,945  
      Total marketable equity securities
    79,311       73,589       51,087       47,799  
                                 
      Total securities available for sale
  $ 289,321     $ 278,707     $ 262,206     $ 252,529  

Securities available for sale increased $26.2 million, or 10.4%, from $252.5 million at December 31, 2008, as the Company invested excess funds in money market mutual funds as an alternative to federal funds sold.  Management continues to hold the money market mutual funds and monitor available investment opportunities in light of the current issues in the debt and equity markets.

Management evaluates securities for other-than-temporary impairment on a monthly basis, with more frequent evaluation for selected issues.  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.  The Company recorded an impairment loss of $124,000 on equity securities determined to be other-than-temporarily impaired during the first quarter of 2009.

As of March 31, 2009, the net unrealized loss on the total equity portfolio was $5.7 million.  Twenty-seven equity securities had market value declines of 20% or more.  The most significant market valuation decrease related to any one equity security at March 31, 2009 is $517,000.  Although the issuers have shown declines in earnings as a result of the weakened economy, no credit issues have been identified that cause management to

14


believe the decline in market value is other than temporary, and the Company has the ability and intent to hold these investments until a recovery of fair value.  In analyzing an equity issuer’s financial condition, management considers industry analysts’ reports, financial performance and projected target prices of investment analysts within a one-year time frame.

At March 31, 2009, the aggregate amortized cost of debt obligations owned by the Company was $210.0 million and the aggregate market value was $205.1 million.  Eleven corporate bonds, from six issuers, had a market decline of greater than 20% of amortized cost, with declines ranging from 22% to 50%.  The aggregate unrealized loss on these bonds at March 31, 2009 was $6.8 million and is presently considered to be temporary.

Three bonds, from two issuers, had been impaired greater than 20% for approximately seven months.   The issuers are consumer finance and commercial finance subsidiaries of a major insurance company.  The bonds had an amortized cost of $7.0 million and unrealized losses of $3.3 million at March 31, 2009.  These bonds have maturity dates of May 2010 to May 2012.

Two bonds, from one issuer, had been impaired greater than 20% for approximately three months.  The amortized cost and aggregate unrealized loss on these bonds at March 31, 2009 was $2.4 million and $813,000, respectively.  These bonds were issued by a national media company with a significant revenue decline in 2008.  These bonds mature in June of 2011.

Another bond, with a decline of $665,000, was issued by a national insurance company, and has been impaired for approximately four months.  At March 31, 2009, the amortized cost of this bond, which matures in July of 2012, was $3.0 million.

Three bonds, from one issuer, had been impaired greater than 20% for approximately one month.  The amortized cost and aggregate unrealized loss on these bonds at March 31, 2009 was $4.0 million and $1.1 million, respectively.  These bonds were issued by a national insurance company.  These bonds mature in September 2011 and June 2012.

Due to the relatively short length of time of the impairment of these securities, with no indication that the issuers will be unable to continue to service the obligations based on ongoing operations, and management’s ability and intent to hold the obligations until the earlier of recovery or maturity, management considers the decline in market valuation to be temporary.




15


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 March 31, 2009 and December 31, 2008 was as follows:

                         
   
At March 31, 2009
   
At December 31, 2008
 
(Dollars in thousands)
 
Amount
   
%
   
Amount
   
%
 
Real estate loans:
                       
   One-to four-family
  $ 284,565       38.1 %   $ 274,716       38.6 %
   Multi-family
    46,560       6.2       31,212       4.4  
   Commercial real estate
    277,825       37.2       269,454       37.7  
   Construction
    91,794       12.3       91,652       12.9  
   Home equity lines
                               
     of credit
    29,466       4.0       28,253       4.0  
        Total real estate loans
    730,210       97.8       695,287       97.6  
                                 
Commercial business loans
    14,851       2.0       15,355       2.2  
Consumer loans
    1,303       0.2       1,379       0.2  
         Total loans
    746,364       100.0 %     712,021       100.0 %
Net deferred loan origination fees
    (986 )             (1,005 )        
Allowance for loan losses
    (7,456 )             (6,912 )        
         Loans, net
  $ 737,922             $ 704,104          

16


Analysis of Loan Loss Experience

The allowance for loan losses is maintained at levels considered adequate by management to provide for possible loan losses as of the consolidated balance sheet reporting dates.  The allowance for loan losses is based on management’s assessment of various factors affecting the loan portfolio, including portfolio composition, delinquent and non-accrual loans, national and local business conditions and loss experience, and an overall evaluation of the quality of the underlying collateral.  Changes in the allowance for loan losses during the three months ended March 31, 2009 and 2008 were as follows:

   
Three Months Ended
 
   
March 31,
 
(Dollars in thousands)
 
2009
   
2008
 
Beginning balance
  $