Edgar Filing: MERIDIAN INTERSTATE BANCORP INC

Form 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2010


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 þ No o

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 o No o

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 o		Accelerated Filer þ		Non-accelerated Filer o		Smaller Reporting Company o

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

At November 2, 2010, the registrant had 22,515,977 shares of no par value common stock outstanding.

MERIDIAN INTERSTATE BANCORP, INC.

FORM 10-Q

INDEX


	Page
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets at September 30, 2010 and December 31, 2009 (Unaudited)		1

Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009 (Unaudited)		2

Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2010 and 2009 (Unaudited)		3

Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009 (Unaudited)		4

Notes to Unaudited Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		16

Item 3. Quantitative and Qualitative Disclosures About Market Risk		29

Item 4. Controls and Procedures		30

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		31

Item 1A. Risk Factors		31

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		31

Item 3. Defaults Upon Senior Securities		31

Item 4. [Removed and Reserved]		31

Item 5. Other Information		31

Item 6. Exhibits		32

Signatures		33

Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)


	September 30,			December 31,
(Dollars in thousands)	2010			2009
ASSETS
Cash and due from banks	$	120,761		$	9,010
Federal funds sold		213			10,956

Total cash and cash equivalents		120,974			19,966

Certificates of deposit — affiliate bank		—			3,000
Securities available for sale, at fair value		348,901			293,367
Federal Home Loan Bank stock, at cost		12,538			4,605
Loans held for sale		6,439			955

Loans		1,203,165			822,542
Less allowance for loan losses		(11,483	)		(9,242	)

Loans, net		1,191,682			813,300

Bank-owned life insurance		33,525			23,721
Foreclosed real estate, net		3,215			2,869
Investment in affiliate bank		11,326			11,005
Premises and equipment, net		33,492			23,195
Accrued interest receivable		6,880			6,231
Prepaid deposit insurance		3,572			5,114
Deferred tax asset, net		9,463			1,523
Goodwill		11,138			—
Other assets		2,399			2,535

Total assets	$	1,795,544		$	1,211,386


LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Non interest-bearing	$	123,099		$	63,606
Interest-bearing		1,285,930			858,869

Total deposits		1,409,029			922,475

Short-term borrowings — affiliate bank		8,616			3,102
Short-term borrowings — other		10,032			22,108
Long-term debt		135,276			50,200
Accrued expenses and other liabilities		20,378			13,086

Total liabilities		1,583,331			1,010,971


Stockholders’ equity:
Common stock, no par value 50,000,000 shares authorized; 23,000,000 shares issued; 22,461,927 and 22,098,565 shares outstanding at September 30, 2010 and December 31, 2009, respectively		—			—
Additional paid-in capital		96,865			100,972
Retained earnings		118,262			109,189
Accumulated other comprehensive income		8,932			5,583
Treasury stock, at cost, 156,758 and 517,500 shares at September 30, 2010 and December 31, 2009, respectively		(1,740	)		(4,535	)
Unearned compensation — ESOP, 714,150 and 745,200 shares at September 30, 2010 and December 31, 2009, respectively		(7,141	)		(7,452	)
Unearned compensation — restricted shares, 381,315 and 383,935 shares at September 30, 2010 and December 31, 2009, respectively		(2,965	)		(3,342	)

Total stockholders’ equity		212,213			200,415

Total liabilities and stockholders’ equity	$	1,795,544		$	1,211,386

See accompanying notes to unaudited consolidated financial statements.

MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(Unaudited)


	Three Months Ended September 30,					Nine Months Ended September 30,
(Dollars in thousands, except per share amounts)	2010		2009			2010		2009
Interest and dividend income:
Interest and fees on loans	$	17,491	$	11,480		$	50,530	$	33,171
Interest on debt securities		3,461		2,673			10,291		7,682
Dividends on equity securities		232		252			665		844
Interest on certificates of deposit		8		16			42		72
Interest on other interest-earning assets		36		5			84		23

Total interest and dividend income		21,228		14,426			61,612		41,792


Interest expense:
Interest on deposits		4,355		4,404			12,864		14,605
Interest on short-term borrowings		11		5			55		47
Interest on long-term debt		868		502			2,649		1,501

Total interest expense		5,234		4,911			15,568		16,153


Net interest income		15,994		9,515			46,044		25,639
Provision for loan losses		77		694			2,245		1,808

Net interest income, after provision for loan losses		15,917		8,821			43,799		23,831


Non-interest income:
Customer service fees		1,555		826			4,459		2,322
Loan fees		238		160			536		437
Gain on sales of loans, net		309		125			1,073		424
Other-than-temporary impairment losses		—		(56	)		—		(429	)
Gain (loss) on sales of securities, net		785		(290	)		785		(290	)
Income from bank-owned life insurance		286		216			865		670
Equity income on investment in affiliate bank		145		117			321		92

Total non-interest income		3,318		1,098			8,039		3,226


Non-interest expenses:
Salaries and employee benefits		6,967		4,084			19,580		14,499
Occupancy and equipment		1,347		754			4,208		2,315
Data processing		779		406			2,282		1,318
Data processing contract termination cost		3,075		—			3,075		—
Marketing and advertising		373		387			1,419		934
Professional services		465		467			1,940		1,535
Foreclosed real estate expense, net		28		15			304		493
Deposit insurance		578		373			1,670		1,513
Other general and administrative		1,033		681			3,253		1,921

Total non-interest expenses		14,645		7,167			37,731		24,528


Income before income taxes		4,590		2,752			14,107		2,529

Provision for income taxes		1,619		864			5,034		787


Net income	$	2,971	$	1,888		$	9,073	$	1,742


Net income per share:
Basic	$	0.13	$	0.09		$	0.41	$	0.08
Diluted	$	0.13	$	0.09		$	0.41	$	0.08

Weighted average shares:
Basic		22,033,643		21,712,292			22,096,747		21,889,813
Diluted		22,037,561		21,712,292			22,103,406		21,889,813

See accompanying notes to unaudited consolidated financial statements.

MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Nine Months Ended September 30, 2010 and 2009


	Shares of No								Accumulated									Unearned
	Par Common			Additional					Other						Unearned			Compensation -
	Stock			Paid-in			Retained		Comprehensive			Treasury			Compensation -			Restricted
(Dollars in thousands)	Outstanding			Capital			Earnings		Income (Loss)			Stock			ESOP			Shares			Total
*Nine Months Ended September 30, 2009*
Balance at December 31, 2008		22,750,000		$	100,684		$	105,426	$	(6,205	)	$	—		$	(7,866	)	$	(2,199	)	$	189,840

Comprehensive income:
Net income		—			—			1,742		—			—			—			—			1,742
Change in net unrealized gain on securities available for sale, net of reclassification adjustment and tax effects		—			—			—		11,133			—			—			—			11,133
Change in prior service costs and actuarial losses, net of tax effects		—			—			—		(18	)		—			—			—			(18	)

Total comprehensive income																						12,857

Purchase of treasury stock		(328,232	)		—			—		—			(2,902	)		—			—			(2,902	)
ESOP shares earned (31,050 shares)		—			(47	)		—		—			—			311			—			264
Purchase of 164,000 shares for restricted share plan		(164,000	)		—			—		—			—			—			(1,468	)		(1,468	)
Share-based compensation expense		—			282			—		—			—			—			259			541

Balance at September 30, 2009		22,257,768		$	100,919		$	107,168	$	4,910		$	(2,902	)	$	(7,555	)	$	(3,408	)	$	199,132


*Nine Months Ended September 30, 2010*
Balance at December 31, 2009		22,098,565		$	100,972		$	109,189	$	5,583		$	(4,535	)	$	(7,452	)	$	(3,342	)	$	200,415

Comprehensive income:
Net income		—			—			9,073		—			—			—			—			9,073
Change in net unrealized gain on securities available for sale, net of reclassification adjustment and tax effects		—			—			—		3,247			—			—			—			3,247
Change in prior service costs and actuarial losses, net of tax effects		—			—			—		102			—			—			—			102

Total comprehensive income																						12,422

ESOP shares earned (31,050 shares)		—			17			—		—			—			311			—			328
Share-based compensation expense		2,620			381			—		—			—			—			377			758
Purchase of treasury stock		(153,367	)		—			—		—			(1,710	)		—			—			(1,710	)
Issuance of 514,109 shares to Meridian Financial Services, Incorporated, the mutual holding company		514,109			(4,505	)		—		—			4,505			—			—			—

Balance at September 30, 2010		22,461,927		$	96,865		$	118,262	$	8,932		$	(1,740	)	$	(7,141	)	$	(2,965	)	$	212,213

See accompanying notes to unaudited consolidated financial statements.

MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)


	Nine Months Ended September 30,
(In thousands)	2010			2009
Cash flows from operating activities:
Net income	$	9,073		$	1,742
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of acquisition fair value adjustments		(1,037	)		—
Earned ESOP shares		328			264
Provision for loan losses		2,245			1,808
Amortization of net deferred loan origination fees		(855	)		(49	)
Net (accretion) amortization of securities available for sale		(113	)		925
Depreciation and amortization expense		1,804			972
(Gain) loss on sales of securities, net		(785	)		290
Other-than-temporary impairment losses		—			429
Gain on sales of loans held in portfolio, net		(352	)		—
(Gain) loss and provision for foreclosed real estate		(125	)		369
Deferred income tax benefit		(2,358	)		(84	)
Income from bank-owned life insurance		(865	)		(670	)
Equity income on investment in affiliate bank		(321	)		(92	)
Share-based compensation expense		758			541
Net changes in:
Loans held for sale		(565	)		(699	)
Accrued interest receivable		724			513
Prepaid deposit insurance		1,542			—
Other assets		3,735			940
Accrued expenses and other liabilities		3,933			4,975

Net cash provided by operating activities		16,766			12,174


Cash flows from investing activities:
Cash provided by business combination		14,422			—
Maturities of certificates of deposit		3,100			4,000
Activity in securities available for sale:
Proceeds from maturities, calls and principal payments		54,336			39,744
(Purchases) proceeds from redemption of mutual funds		(6,130	)		12,116
Proceeds from sales		5,943			392
Purchases		(58,314	)		(102,673	)
Loans originated, net of principal payments received		(70,003	)		(75,526	)
Proceeds from sales of fixed rate loans held in portfolio		34,488			—
Purchases of premises and equipment		(1,396	)		(1,643	)
Purchase of Federal Home Loan Bank stock		—			(151	)
Capitalized costs on foreclosed real estate		(364	)		(1,132	)
Proceeds from sales of foreclosed real estate		3,525			1,549

Net cash used in investing activities		(20,393	)		(123,324	)

(continued)

See accompanying notes to unaudited consolidated financial statements.

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


	Nine Months Ended September 30,
(In thousands)	2010			2009
Cash flows from financing activities:
Net increase in deposits		107,330			125,161
Net change in borrowings with maturities less than three months		(6,410	)		(2,016	)
Proceeds from Federal Home Loan Bank advances with maturities of three months or more		15,475			—
Repayment of Federal Home Loan Bank advances with maturities of three months or more		(10,050	)		(475	)
Purchase of stock for equity incentive plan		—			(1,468	)
Purchase of treasury stock		(1,710	)		(2,902	)

Net cash provided by financing activities		104,635			118,300


Net change in cash and cash equivalents		101,008			7,150

Cash and cash equivalents at beginning of period		19,966			20,265


Cash and cash equivalents at end of period	$	120,974		$	27,415


Supplemental cash flow information:
Interest paid on deposits	$	12,807		$	14,936
Interest paid on borrowings		3,665			1,555
Income taxes paid		5,430			1,315
Non-cash investing and financing activities:
Transfers from loans to foreclosed real estate		1,635			840
In conjunction with the purchase acquisition detailed in Note 6 to the Consolidated Financial Statements, assets were acquired and liabilities were assumed as follows:
Fair value of assets acquired, net of cash acquired		450,648			—
Fair value of liabilities assumed		465,070			—

See accompanying notes to unaudited consolidated financial statements.

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, Incorporated (“Meridian Financial Services”) is the mutual holding company for Meridian Interstate and holds 13,164,109 shares or 59% 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 and nine months ended September 30, 2010 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, 2009 which was filed with the Securities and Exchange Commission (“SEC”) on March 16, 2010, 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 change in the near term relate to the determination of the allowance for loan losses, other than temporary impairment of securities, the valuation of foreclosed real estate, goodwill and income taxes.

2. Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued guidance which changed the accounting principles and disclosures requirements related to securitizations and special-purpose entities. Specifically, this guidance eliminates the concept of a qualifying special-purpose entity, changes the requirements for derecognizing financial assets and changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. This guidance also expands existing disclosure requirements to include more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. This guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The recognition and measurement provisions regarding transfers of financial assets shall be applied to transfers that occur on or after the effective date. The adoption of this guidance on January 1, 2010 did not have a material impact on the Company’s consolidated financial statements.

In July 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-20, “Receivables, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. This ASU requires an entity to provide disclosures that facilitate financial statement users’ evaluation of (1) the nature of credit risk inherent in the entity’s loan portfolio (2) how that risk is analyzed and assessed in arriving at the allowance for loan and lease losses and (3) the changes and reasons for those changes in the allowance for loan and lease losses. For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of this ASU will have a material impact on the disclosures in the Company’s December 31, 2010 consolidated financial statements.

3. Fair Value Hierarchy

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of assets and liabilities 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 assets and liabilities. 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.

The Company groups its assets and 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.

Level 1 — Valuation is based on quoted prices in active markets for identical assets or liabilities. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 — Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 — Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using unobservable inputs to pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The following methods and assumptions were used by the Company in estimating fair value disclosures:

Cash and cash equivalents — The carrying amounts of cash and short-term instruments approximate fair values, based on the short-term nature of the assets.

Certificates of deposit — Fair values of certificates of deposit are estimated using discounted cash flow analyses based on current market rates for similar types of deposits.

Securities available for sale — Securities available for sale are recorded at fair value on a recurring basis. Marketable equity securities are measured at fair value utilizing quoted market prices (Level 1). Corporate bonds, obligations of government-sponsored enterprises, municipal bonds, mortgage-backed securities and other debt securities are 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 (Level 2). The Company does not currently have any securities in its portfolio that are measured using Level 3 inputs. The Company utilizes a third-party pricing service to obtain fair values for securities.

Federal Home Loan Bank stock — The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.

Loans held for sale — The fair value is determined using market prices currently being offered for loans with similar terms to borrowers of similar credit quality.

Loans — For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, using market interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Deposits — The fair values disclosed for non-certificate accounts, by definition, equal to the amount payable on demand at the reporting date which is their carrying amounts. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Borrowings — The fair value is estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Accrued interest — The carrying amounts of accrued interest approximate fair value.

Off-balance sheet credit-related instruments — Fair values for off-balance-sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of these instruments is considered immaterial.

Assets Measured at Fair Value on a Recurring Basis:

Assets measured at fair value on a recurring basis are summarized as follows.:


	September 30, 2010
							Total Fair
(In thousands)	Level 1		Level 2		Level 3		Value
Debt securities:
Corporate bonds	$	—	$	222,468	$	—	$	222,468
Government-sponsored enterprises		—		10,397		—		10,397
Municipal bonds		—		4,432		—		4,432
Residential mortgage-backed securities:
Government-sponsored enterprises		—		37,741		—		37,741
Private label		—		15,224		—		15,224
Other debt securities		—		666		—		666

Total debt securities		—		290,928		—		290,928

Marketable equity securities:
Common stocks		34,820		—		—		34,820
Money market mutual funds		23,153		—		—		23,153

Total marketable equity securities		57,973		—		—		57,973

Total securities available for sale	$	57,973	$	290,928	$	—	$	348,901


	December 31, 2009
							Total Fair
(In thousands)	Level 1		Level 2		Level 3		Value
Debt securities:
Corporate bonds	$	—	$	220,007	$	—	$	220,007
Government-sponsored residential rmortgage-backed securities		—		23,778		—		23,778

Total debt securities		—		243,785		—		243,785

Marketable equity securities:
Common stocks		28,878		—		—		28,878
Money market mutual funds		20,704		—		—		20,704

Total marketable equity securities		49,582		—		—		49,582

Total securities available for sale	$	49,582	$	243,785	$	—	$	293,367

There were no transfers in or out of Levels 1 and 2 for the nine months ended September 30, 2010. There were no liabilities measured at fair value on a recurring basis.

Assets Measured at Fair Value on a Non-recurring Basis:

The Company may also be required, from time to time, to measure certain other 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.

The following tables summarize the fair value hierarchy used to determine each adjustment and the carrying value of the related individual assets. The gain/loss represents the amount of write-down recorded during the periods noted on the assets held at period end. There were no liabilities measured at fair value on a non-recurring basis.


							Three Months Ended		Nine Months Ended
	September 30, 2010						September 30, 2010		September 30, 2010
(In thousands)	Level 1		Level 2		Level 3		Total Losses		Total Losses
Impaired loans	$	—	$	—	$	10,762	$	27	$	943
Foreclosed real esate		—		—		3,215		51		51

	$	—	$	—	$	13,977	$	78	$	994


							Three Months Ended		Nine Months Ended
	December 31, 2009						September 30, 2009		September 30, 2009
(In thousands)	Level 1		Level 2		Level 3		Total Losses		Total Losses
Impaired loans	$	—	$	—	$	1,700	$	536	$	874
Foreclosed real esate		—		—		2,869		150		350

	$	—	$	—	$	4,569	$	686	$	1,224

At September 30, 2010 and December 31, 2009, the fair value of foreclosed real estate is based on appraised value of the collateral, considering discounting factors and adjusted for selling costs. The losses on foreclosed real estate represent the adjustment in valuation recorded during the time periods indicated, and not for losses incurred on the sale of the property. At September 30, 2010 and December 31, 2009, the amount of impaired loans represents the carrying value and related 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 losses on impaired loans are 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.

Carrying amounts and fair value of financial assets and liabilities are as follows:


	September 30, 2010				December 31, 2009
	Carrying		Fair		Carrying		Fair
(In thousands)	Amount		Value		Amount		Value
Financial assets:
Cash and cash equivalents	$	120,974	$	120,974	$	19,966	$	19,966
Certificates of deposit — affiliate bank		—		—		3,000		3,028
Securities available for sale		348,901		348,901		293,367		293,367
Federal Home Loan Bank stock		12,538		12,538		4,605		4,605
Loans and loans held for sale, net		1,198,121		1,211,911		814,255		813,393
Accrued interest receivable		6,880		6,880		6,231		6,231

Financial liabilities:
Deposits		1,409,029		1,416,172		922,475		927,385
Borrowings		153,924		161,070		75,410		76,782
Accrued interest payable		1,066		1,066		728		728

4. 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. If rights to dividends on unvested awards are non-forfeitable, these unvested awards are considered outstanding in the computation of basic earnings per share. 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) were issued during the period. 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 EPS calculations. At September 30, 2010 and 2009, options for 502,572 and 587,600 shares, respectively, were not included in the calculation of diluted EPS because to do so would have been antidilutive.

The following table is the reconciliation of basic and diluted earnings per share for the three and nine month periods ended September 30, 2010 and 2009:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(Dollars in thousands, except per share amounts)	2010		2009		2010		2009

Net income available to common stockholders	$	2,971	$	1,888	$	9,073	$	1,742


Average number of common shares outstanding		21,766,532		21,542,287		21,830,598		21,704,968
Effect of dilutive unvested stock awards		267,111		170,005		266,149		184,845

Basic weighted average shares outstanding		22,033,643		21,712,292		22,096,747		21,889,813
Effect of dilutive stock options		3,918		—		6,659		—

Diluted weighted average shares outstanding		22,037,561		21,712,292		22,103,406		21,889,813


Earnings per share:
Basic	$	0.13	$	0.09	$	0.41	$	0.08
Diluted	$	0.13	$	0.09	$	0.41	$	0.08

5. Securities

All securities held by the Company as of September 30, 2010 and December 31, 2009 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.

At September 30, 2010, the securities portfolio was $348.9 million, or 19.4% of total assets. At that date, 63.8% of the securities portfolio, or $222.5 million, was invested in corporate bonds. The amortized cost and fair value of corporate bonds in the financial services sector was $69.2 million and $71.7 million, respectively. The remainder of the corporate bond portfolio includes companies from a variety of industries. The portfolio also includes debt securities issued by government-sponsored enterprises, municipal bonds, mortgage backed securities issued by government-sponsored enterprises and private companies, other debt securities and marketable equity securities. Included in marketable equity securities are money market mutual funds and common stocks.

The amortized cost and fair values of securities available for sale, with gross unrealized gains and losses follows:


			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(In thousands)	Cost		Gains		Losses			Value
September 30, 2010
Debt securities:
Corporate bonds:
Financial services	$	69,195	$	2,711	$	(180	)	$	71,726
Industry and manufacturing		40,935		2,281		—			43,216
Consumer products and services		39,214		2,518		—			41,732
Other		62,767		3,027		—			65,794

Total corporate bonds		212,111		10,537		(180	)		222,468
Government-sponsored enterprises		10,334		74		(11	)		10,397
Municipal bonds		4,380		52		—			4,432
Residential mortgage-backed securities:
Government-sponsored enterprises		36,562		1,186		(7	)		37,741
Private label		14,168		1,166		(110	)		15,224
Other debt securities		666		—		—			666

Total debt securities		278,221		13,015		(308	)		290,928

Marketable equity securities:
Common stocks		32,048		3,463		(691	)		34,820
Money market mutual funds		23,153		—		—			23,153

Total marketable equity securities		55,201		3,463		(691	)		57,973

Total securities available for sale	$	333,422	$	16,478	$	(999	)	$	348,901


December 31, 2009
Debt securities:
Corporate bonds:
Financial services	$	59,219	$	1,786	$	(282	)	$	60,723
Industry and manufacturing		54,522		2,106		(481	)		56,147
Consumer products and services		50,402		2,205		—			52,607
Other		48,136		2,394		—			50,530

Total corporate bonds		212,279		8,491		(763	)		220,007
Government-sponsored residential rmortgage-backed securities		23,659		148		(29	)		23,778

Total debt securities		235,938		8,639		(792	)		243,785

Marketable equity securities:
Common stocks		26,698		3,001		(821	)		28,878
Money market mutual funds		20,704		—		—			20,704

Total marketable equity securities		47,402		3,001		(821	)		49,582

Total securities available for sale	$	283,340	$	11,640	$	(1,613	)	$	293,367

The amortized cost and fair value of debt securities by contractual maturity at September 30, 2010 are as follows. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without prepayment penalties.


	Within 1 year				Over 1 year to 5 years				Over 5 years				Total
	Amortized		Fair		Amortized		Fair		Amortized		Fair		Amortized		Fair
(In thousands)	Cost		Value		Cost		Value		Cost		Value		Cost		Value
Corporate bonds:
Financial services	$	9,497	$	9,484	$	48,547	$	50,953	$	11,151	$	11,289	$	69,195	$	71,726
Industry and manufacturing		5,002		5,006		35,933		38,210		—		—		40,935		43,216
Consumer products and services		7,736		7,889		31,478		33,843		—		—		39,214		41,732
Other		22,135		22,486		40,632		43,308		—		—		62,767		65,794

Total corporate bonds		44,370		44,865		156,590		166,314		11,151		11,289		212,111		222,468
Government-sponsored enterprises		—		—		4,339		4,367		5,995		6,030		10,334		10,397
Municipal bonds		1,366		1,371		500		505		2,514		2,556		4,380		4,432
Residential mortgage- backed securities:
Government-sponsored enterprises		—		—		8		8		36,554		37,733		36,562		37,741
Private label		—		—		—		—		14,168		15,224		14,168		15,224
Other debt securities		—		—		140		140		526		526		666		666


Total	$	45,736	$	46,236	$	161,577	$	171,334	$	70,908	$	73,358	$	278,221	$	290,928

Information pertaining to securities available for sale, with gross unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:


	Less Than Twelve Months				Over Twelve Months
	Gross				Gross
	Unrealized		Fair		Unrealized		Fair
(In thousands)	Losses		Value		Losses		Value
September 30, 2010
Debt securities:
Corporate bonds — financial services	$	80	$	4,918	$	100	$	5,900
Government-sponsored enterprises		11		207		—		—
Residential mortgage-backed securities:
Government-sponsored enterprises		7		443		—		—
Private label		110		2,063		—		—

Total debt securities		208		7,631		100		5,900
Common stocks		274		5,307		417		3,340

Total	$	482	$	12,938	$	517	$	9,240


	Less Than Twelve Months				Over Twelve Months
	Gross				Gross
	Unrealized		Fair		Unrealized		Fair
(In thousands)	Losses		Value		Losses		Value
December 31, 2009
Debt securities:
Corporate bonds:
Financial services	$	24	$	6,059	$	258	$	6,736
Industry and manufacturing		—		—		481		5,519

Total corporate bonds		24		6,059		739		12,255
Government-sponsored residential rmortgage-backed securities		26		8,163		3		9

Total debt securities		50		14,222		742		12,264
Common stock		—		—		821		6,890

Total	$	50	$	14,222	$	1,563	$	19,154

The Company determined no securities were other-than-temporarily impaired during the nine months ended September 30, 2010. Management evaluates securities for other-than-temporary impairment on a quarterly basis, with more frequent evaluation for selected issuers or when economic or market concerns warrant such evaluations.

As of September 30, 2010, the net unrealized gain on the total debt securities portfolio was $12.7 million. At September 30, 2010, 13 debt securities had unrealized losses with an aggregate depreciation of 2.2% from the Company’s cost basis. In analyzing a debt issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, industry analysts’ reports and, to a lesser extent given the relatively insignificant levels of depreciation in the Company’s debt portfolio, spread differentials between the effective rates on instruments in the portfolio compared to risk-free rates. The unrealized losses are primarily caused by (a) recent declines in profitability and near-term profit forecasts by industry analysts resulting from a decline in the level of business activity and (b) recent downgrades by several industry analysts. The contractual terms of these investments do not permit the companies to settle the security at a price less than the par value of the investment. The Company currently does not believe it is probable that it will be unable to collect all amounts due according to the contractual terms of the investments. Therefore, it is expected that the bonds would not be settled at a price less than the par value of the investment. Because (1) the Company does not intend to sell the securities; (2) the Company does not believe it is “more likely than not” that the Company will be required to sell the securities before recovery of its amortized cost basis; and (3) the present value of expected cash flows is sufficient to recover the entire amortized cost basis of the securities, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2010.

As of September 30, 2010, the net unrealized gain on the total equity portfolio was $2.8 million. At September 30, 2010, 21 marketable equity securities had unrealized losses with an aggregate depreciation of 7.4% from the Company’s cost basis. Five equity securities had market value declines of 15.0% or more, with net unrealized losses of $382,000. 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 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. A decline of 10% or more in the value of an acquired equity security is generally the triggering event for management to review individual securities for liquidation and/or classification as other-than-temporarily impaired. Impairment losses are recognized when management concludes that declines in the value of equity securities are other than temporary, or when they can no longer assert that they have the intent and ability to hold depreciated equity securities for a period of time sufficient to allow for any anticipated recovery in fair value. Unrealized losses on marketable equity securities that are in excess of 25% of cost and that have been sustained for more than twelve months are generally considered-other-than temporary and charged to earnings as impairment losses, or realized through sale of the security.

6. Acquisition

In an effort to expand and diversify its market area, the Company completed its acquisition of Mt. Washington Cooperative Bank, a Massachusetts-chartered mutual co-operative bank (“Mt. Washington”), on January 4, 2010 through the merger of Mt. Washington with and into the Bank. Each Mt. Washington branch office has become a branch office of East Boston Savings Bank, and such branch offices now operate under the name “Mt. Washington Bank, A Division of East Boston Savings Bank.” Pursuant to the merger agreement, Meridian Interstate issued 514,109 shares of its common stock to Meridian Financial Services, Incorporated, Meridian Interstate’s top-tier mutual holding company. The shares issued reflect the value of Mt. Washington as determined by the average of two independent appraisals. The shares were issued in a private placement exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. In addition, Meridian Interstate contributed $15 million of capital to East Boston Savings Bank in connection with the acquisition.

The Company accounted for the acquisition using the acquisition method. Accordingly, the Company recorded merger and acquisition expenses of $269,000 during the nine months ended September 30, 2010 and $449,000 during the year ended December 31, 2009. The acquisition method also requires an acquirer to recognize the assets acquired and the liabilities assumed at their fair values as of the acquisition date.

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed as of the date of the acquisition:


	(In thousands)
Assets acquired and liabilities assumed:
Cash and cash equivalents	$	14,422
Certificates of deposit		100
Securities available for sale		45,516
Federal Home Loan Bank Stock, at cost		7,933
Loans held for sale		4,919
Loans, net		345,917
Bank -owned life insurance		8,939
Foreclosed real estate, net		1,747
Premises and equipment, net		10,618
Accrued interest receivable		1,373
Deferred tax asset, net		8,849
Goodwill		11,138
Other assets		3,599

Total assets acquired	$	465,070


Deposits	$	380,550
FHLB Borrowings		80,932
Accrued expenses and other liabilities		3,588

Total liabilities assumed	$	465,070

As noted above, the Company acquired loans at fair value of $345.9 million. Included in this amount was $20.4 million of loans with evidence of deterioration of credit quality since origination for which it was probable, at the time of the acquisition, that the Company would be unable to collect all contractually required payments receivable. The Company’s evaluation of loans with evidence of credit deterioration as of the acquisition date resulted in a nonaccretable difference of $7.1 million, which is defined as the loan’s contractually required payments receivable in excess of the amount of its cash flows expected to be collected. The Company considered factors such as payment history, collateral values, and accrual status when determining whether there was evidence of deterioration of the loan’s credit quality at the acquisition date. As of September 30, 2010, the carrying amount of these loans with evidence of credit deterioration at the acquisition date was $19.2 million, and the remaining nonaccretable difference was $4.9 million.

The following table summarizes the unaudited pro forma financial results of operations as if the Company acquired Mt. Washington on January 1, 2009 (2009 amounts represent combined results for the Company and Mt. Washington):


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(In thousands, except per share amounts)	2010		2009		2010		2009

Net interest income	$	15,994	$	13,368	$	46,201	$	37,341
Net income		2,971		1,494		9,282		608
Net income per share — Basic	$	0.13	$	0.07	$	0.42	$	0.03
Net income per share — Diluted		0.13		0.07		0.42		0.03

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, 2009, 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:

	•		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 recent legislation restructuring of 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, 2009 filed with the Securities and Exchange Commission on March 16, 2010, under “Risk Factors,” which is available through the SEC’s website at www.sec.gov, as updated by subsequent filings with the SEC. 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.

Critical Accounting Policies

The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements included in the 2009 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, the valuation of foreclosed real estate, goodwill and income taxes as the Company’s most critical accounting policies. The only changes to the Company’s critical accounting policies since December 31, 2009 involved the accounting for the acquisition of Mt. Washington and the resulting goodwill.

Comparison of Financial Condition at September 30, 2010 and December 31, 2009

Total assets increased $584.2 million, or 48.2%, to $1.8 billion at September 30, 2010 from $1.2 billion at December 31, 2009, reflecting $465.1 million of assets acquired in the Mt. Washington merger. Cash and cash equivalents increased $101.0 million to $121.0 million at September 30, 2010 from $20.0 million at December 31, 2009, including $14.4 million of cash acquired in the Mt. Washington merger. Securities available for sale increased $55.5 million, or 18.9%, to $348.9 million at September 30, 2010 from $293.4 million at December 31, 2009, including $45.5 million of securities acquired in the Mt. Washington merger. Net loans increased $378.4 million, or 46.5%, to $1.2 billion at September 30, 2010 from $813.3 million at December 31, 2009, primarily due to $345.9 million of loans acquired in the Mt. Washington merger and organic loan growth of $68.8 million, partially offset by sales of fixed-rate bi-weekly mortgage loans totaling $34.1 million in the first quarter of 2010.

Total deposits increased $486.6 million, or 52.7%, to $1.4 billion at September 30, 2010 from $922.5 million at December 31, 2009, reflecting $380.6 million of deposits acquired in the Mt. Washington merger along with organic deposit growth of $106.0 million. Total borrowings increased $78.5 million, or 104.1%, to $153.9 million at September 30, 2010 from $75.4 million at December 31, 2009, reflecting $80.9 million of Federal Home Loan Bank advances acquired in the Mt. Washington merger.

Total stockholders’ equity increased $11.8 million, or 5.9%, to $212.2 million at September 30, 2010, from $200.4 million at December 31, 2009. The increase was due primarily to $9.1 million in net income and a $3.3 million increase in accumulated other comprehensive income reflecting an increase in the fair value of available for sale securities, net of tax. Stockholders’ equity to assets was 11.82% at September 30, 2010, compared to 16.54% at December 31, 2009, reflecting the increase in assets resulting from the Mt. Washington merger. Book value per share increased to $9.45 at September 30, 2010 from $9.07 at December 31, 2009. Tangible book value per share decreased to $8.95 at September 30, 2010 from $9.07 at December 31, 2009, primarily due to goodwill resulting from the Mt. Washington merger.

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 September 30, 2010 and December 31, 2009 was as follows:


	September 30, 2010						December 31, 2009
(Dollars in thousands)	Amount			%			Amount			%
Real estate loans:
One-to four-family	$	428,549			35.6	%	$	276,122			33.5	%
Multi-family		128,168			10.7			53,402			6.5
Commercial real estate		408,898			33.9			350,648			42.6
Construction		127,629			10.6			94,102			11.4
Home equity lines of credit		73,580			6.1			29,979			3.6

Total real estate loans		1,166,824			96.9			804,253			97.6

Commercial business loans		29,522			2.5			18,029			2.2
Consumer loans		6,909			0.6			1,205			0.2

Total loans		1,203,255			100.0	%		823,487			100.0	%

Net deferred loan origination fees		(90	)					(945	)
Allowance for loan losses		(11,483	)					(9,242	)

Loans, net	$	1,191,682					$	813,300

Asset Quality

Non-Performing Assets. 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. At September 30, 2010, the Company did not have any accruing loans past due 90 days or more. 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. 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 September 30, 2010 and December 31, 2009:


	September 30,			December 31,
(Dollars in thousands)	2010			2009
Loans accounted for on a non-accrual basis:
Real estate loans:
One-to four-family	$	11,476		$	4,098
Multi-family		3,128			850
Commercial real estate		6,104			7,388
Home equity lines of credit		2,155			—
Construction		14,220			9,224

Total real estate loans		37,083			21,560

Commercial business loans		228			—
Consumer loans		3			138

Total non-accrual loans		37,314			21,698

Foreclosed assets		3,215			2,869

Total nonperforming assets	$	40,529		$	24,567


Non-accrual loans to total loans		3.10	%		2.63	%
Non-accrual loans to total assets		2.08	%		1.79	%
Non-performing assets to total assets		2.26	%		2.03	%

Non-performing loans increased to $37.3 million, or 3.10% of total loans outstanding at September 30, 2010, from $21.7 million, or 2.63% of total loans outstanding at December 31, 2009. Non-performing assets increased to $40.5 million, or 2.26% of total assets, at September 30, 2010, from $24.6 million, or 2.03% of total assets, at December 31, 2009. Non-performing assets at September 30, 2010 were comprised of $14.2 million of construction loans, $6.1 million of commercial real estate loans, $11.5 million of one-to four-family mortgage loans, $3.1 million of multi-family mortgage loans, $2.2 million of home equity loans and foreclosed real estate of $3.2 million. Non-performing assets at September 30, 2010 included $17.4 million acquired in the Mt. Washington merger, comprised of $16.5 million of non-performing loans and $924,000 of foreclosed real estate. Interest income that would have been recorded for the nine months ended September 30, 2010 had nonaccruing loans and accruing loans past due 90 days or more been current according to their original terms amounted to $1.7 million.

Troubled Debt Restructurings. The following table summarizes the Company’s troubled debt restructurings (“TDRs”) at September 30, 2010 and December 31, 2009:


	September 30,		December 31,
(In thousands)	2010		2009
TDRs on accrual status:
One-to four-family real estate	$	1,103	$	189
Commercial real estate		4,797		—

		5,900		189

TDRs on non-accrual status:
One-to four-family real estate		566		1,148
Construction		—		591

		566		1,739

Total TDRs	$	6,466	$	1,928

The increase in commercial real estate TDRs was due to a $4.8 million loan which was modified to grant an interest rate reduction of 300 basis points on an interest-only basis for two years. Modifications of other TDRs consist of either rate reductions of 160 basis points on average or provisions for interest-only payments for specified periods up to 12 months. The Company has generally been successful with the concessions it has offered to borrowers to date. The Company generally returns TDRs to accrual status when they have sustained payments for six months based on the restructured terms.

Potential Problem Loans. Certain loans are identified during the Company’s loan review process that are currently performing in accordance with their contractual terms and we expect to receive payment in full of principal and interest, but it is deemed probable that we will be unable to collect all the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. This may result from deteriorating conditions such as cash flows, collateral values or creditworthiness of the borrower. These loans are classified as impaired but are not accounted for on a non-accrual basis. There were no potential problem loans identified at September 30, 2010 or December 31, 2009 other than those already classified as non-performing, impaired or troubled debt restructurings as of those dates.

Allowance for Loan Losses. The allowance for loan losses is maintained at levels considered adequate by management to provide for probable loan losses inherent in the loan portfolio 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 and nine months ended September 30, 2010 and 2009 were as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in thousands)	2010			2009			2010			2009
Beginning balance	$	11,265		$	8,120		$	9,242		$	6,912

Provision for loan losses		77			694			2,245			1,808

Charge offs:
Real estate loans		105			51			263			216
Commercial business loans		—			—			—			—
Consumer loans		33			57			83			58

Total charge-offs		138			108			346			274

Recoveries:
Real estate loans		268			—			314			260
Commercial business		—			—			—			—
Consumer loans		11			5			28			5

Total recoveries		279			5			342			265

Net (charge-offs) recoveries		141			(103	)		(4	)		(9	)

Ending balance	$	11,483		$	8,711		$	11,483		$	8,711


Allowance to non-accrual loans		30.77	%		45.14	%		30.77	%		45.14	%
Allowance to total loans outstanding		0.95	%		1.11	%		0.95	%		1.11	%
Net (charge-offs) recoveries to average loans outstanding (annualized)		0.05	%		(0.01	)%		0.00	%		0.00	%

The Company’s provision for loan losses was $77,000 for the quarter ended September 30, 2010 compared to $694,000 for the quarter ended September 30, 2009. For the nine months ended September 30, 2010, the provision for loan losses was $2.2 million compared to $1.8 million for the nine months ended September 30, 2009. These changes were based primarily on management’s assessment of loan portfolio growth and composition changes, an ongoing evaluation of credit quality and current economic conditions. The allowance for loan losses was $11.5 million or 0.95% of total loans outstanding at September 30, 2010, compared to $9.2 million, or 1.12% of total loans outstanding at December 31, 2009. The decrease in the ratio of the allowance for loan losses to total loans outstanding was primarily due to $345.9 million of loans acquired in the Mt. Washington merger at fair value on the date of acquisition, pursuant to current accounting guidance that precludes the combination of allowance for loan loss amounts associated with such loans acquired. The Company continues to assess the adequacy of its allowance for loan losses in accordance with established policies.

The following table sets forth the breakdown of the allowance for loan losses by loan category at September 30, 2010 and December 31, 2009:


	September 30, 2010								December 31, 2009
						% of								% of
			% of			Loans in					% of			Loans in
			Allowance			Category					Allowance			Category
			to Total			to Total					to Total			to Total
(Dollars in thousands)	Amount		Allowance			Loans			Amount		Allowance			Loans
Real estate loans:
One- to four-family	$	2,054		17.9	%		35.6	%	$	1,730		18.7	%		33.5	%
Multi-family		1,078		9.4			10.7			467		5.1			6.5
Commercial real estate		5,106		44.5			33.9			4,435		48.0			42.6
Home equity lines of credit		133		1.2			6.1			128		1.4			3.6
Construction		2,624		22.8			10.6			1,859		20.1			11.4

Total real estate loans		10,995		95.8			96.9			8,619		93.3			97.6


Commercial business loans		356		3.1			2.5			586		6.3			2.2
Consumer loans		132		1.1			0.6			37		0.4			0.2

Total	$	11,483		100.0	%		100.0	%	$	9,242		100.0	%		100.0	%

The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired, whereby an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component relates to pools of non-impaired loans and is based on historical loss experience adjusted for qualitative factors.

The Company had impaired loans totaling $38.3 million and $29.3 million as of September 30, 2010 and December 31, 2009, respectively. At September 30, 2010, impaired loans totaling $11.9 million had a valuation allowance of $1.2 million. Impaired loans totaling $2.2 million had a valuation allowance of $472,000 at December 31, 2009. The Company’s average investment in impaired loans was $32.3 million and $17.0 million for the nine months ended September 30, 2010 and 2009, respectively.

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, we do not separately identify individual one-to four-family residential and consumer loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring. The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a TDR. All TDRs are initially classified as impaired.

We review residential and commercial loans for impairment based on the fair value of collateral, if collateral-dependent, or expected cash flows. Management has reviewed the collateral value for all impaired and non-accrual loans that were collateral-dependent as of September 30, 2010 and considered any probable loss in determining the allowance for loan losses. For loans measured for impairment based on the collateral value, we will do the following:

		Residential loans:

•		When a loan becomes seriously delinquent, generally 60 days past due, internal valuations are completed by the Company’s in-house appraiser who is a Massachusetts certified residential appraiser. The Company obtains third party appraisals, which are generally the basis for charge-offs when a loss is indicated, prior to the foreclosure sale. The Company generally is able to complete the foreclosure process within nine to 12 months from receipt of the internal valuation.

•		The Company makes adjustments to appraisals based on updated economic information, if necessary, prior to the foreclosure sale. The Company reviews current market factors to determine whether, in management’s opinion, downward adjustments to the most recent appraised values may be warranted. If so, management uses their best estimate to apply an estimated discount rate to the appraised values to reflect current market factors.

•		Appraisals received by the Company are based on comparable property sales.

•		Loans that are partially charged off generally remain on non-accrual status until foreclosure or such time that they are performing in accordance with the terms of the loan and have a sustained payment history of at least six months.

•		The accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. Loan losses are charged against the allowance when we believe the uncollectibility of a loan balance is confirmed; generally when third party appraised values, less estimated costs to sell, are less than the Company’s carrying values.

		Commercial loans:

•		The Company obtains a third party appraisal at the time a loan is deemed to be in a workout situation and there is no indication that the loan will return to performing status, generally when the loan is 90 days or more past due. One or more updated third party appraisals are obtained prior to foreclosure depending on the foreclosure timeline. In general the Company orders new appraisals every 180 days on loans in the process of foreclosure.

•		The Company makes downward adjustments to appraisals when conditions warrant. Adjustments are made by applying a discount to the appraised value based on occupancy, recent changes in condition to the property and certain other factors. Adjustments are also made to appraisals for construction projects involving residential properties based on recent sales of units. Losses are recognized if the appraised value less estimated costs to sell is less than the Company’s carrying value of the loan.

•		Appraisals received by the Company are generally based on a reconciliation of comparable property sales and income capitalization approaches. For loans on construction projects involving residential properties, appraisals are generally based on a discounted cash flow analysis assuming a bulk sale to a single buyer.

•		Loans that are partially charged off generally remain on non-accrual status until foreclosure or such time that they are performing in accordance with the terms of the loan and have a sustained payment history of at least six months.

•		The accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. Loan losses are charged against the allowance when we believe the uncollectibility of a loan balance is confirmed, generally when appraised values (as adjusted values, if applicable) less estimated costs to sell, are less than the Company’s carrying values.

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:


	September 30, 2010					December 31, 2009
(Dollars in thousands)	Amount		Percent			Amount		Percent
NOW and demand deposits	$	247,431		17.6	%	$	102,386		11.1	%
Money market deposits		314,772		22.3			247,006		26.8
Regular and other deposits		184,129		13.1			128,016		13.9
Certificates of deposit		662,697		47.0			445,067		48.2

Total	$	1,409,029		100.0	%	$	922,475		100.0	%

Borrowings

Total borrowings increased $78.5 million, or 104.1%, to $153.9 million at September 30, 2010 from $75.4 million at December 31, 2009, reflecting $80.9 million of Federal Home Loan Bank advances acquired in the Mt. Washington merger. At September 30, 2010 and December 31, 2009, FHLB advances totaled $135.3 million and $62.3 million, respectively, with a weighted average rate of 2.52% and 2.77%, respectively. At September 30, 2010 and December 31, 2009, federal funds purchased totaled $18.6 million and $13.1 million, respectively, with a weighted average rate of 0.20% and 0.35%, respectively.

Results of Operations for the Three and Nine Months Ended September 30, 2010 and September 30, 2009

Overview

We recorded net income of $3.0 million, or $0.13 per share (basic and diluted), for the quarter ended September 30, 2010, compared to $1.9 million, or $0.09 per share (basic and diluted), for the quarter ended September 30, 2009. Income before income tax expense increased $1.8 million to $4.6 million, the net result of increases in net interest income of $6.5 million and non-interest income of $2.2 million and a decrease in provision for loan losses of $617,000, partially offset by an increase in non-interest expense of $7.5 million.

For the nine months ended September 30, 2010, net income was $9.1 million, or $0.41 per share (basic and diluted) compared to net income of $1.7 million, or $0.08 per share (basic and diluted), for the nine months ended September 30, 2009. Income before income tax expense increased $11.6 million to $14.1 million, the net result of increases in net interest income of $20.4 million and non-interest income of $4.8 million, partially offset by increases in provision for loan losses of $437,000 and non-interest expense of $13.2 million. The three and nine month periods ended September 30, 2010 reflect combined results following the acquisition of Mt. Washington Cooperative Bank on January 4, 2010.

The Company recorded a pre-tax charge of $3.1 million during the quarter ended September 30, 2010 for costs related to termination of the contract with Mt. Washington’s data processing services provider in October 2010. The after tax impact of this charge was a reduction to net income of $1.8 million, or $0.08 per share (basic and diluted), for the quarter and nine months ended September 30, 2010.

Return on average stockholders’ equity increased to 5.64% for the quarter ended September 30, 2010 and 5.83% for the nine months ended September 30, 2010, compared to 3.86% and 1.22% for the respective periods of 2009. Return on average assets was 0.68% for the quarter ended September 30, 2010 and 0.71% for the nine months ended September 30, 2010, compared to 0.63% and 0.20% for the respective periods of 2009.

Net Interest Income

Net interest income increased $6.5 million, or 68.1%, to $16.0 million for the quarter ended September 30, 2010 from $9.5 million for the quarter ended September 30, 2009. The net interest rate spread and net interest margin were 3.75% and 3.93%, respectively, for the quarter ended September 30, 2010 compared to 3.00% and 3.35%, respectively, for the quarter ended September 30, 2009. For the nine months ended September 30, 2010, net interest income increased $20.4 million, or 79.6%, to $46.0 million from $25.6 million for the nine months ended September 30, 2009. The net interest rate spread and net interest margin were 3.72% and 3.90%, respectively, for the nine months ended September 30, 2010 compared to 2.80% and 3.21%, respectively, for the nine months ended September 30, 2009. The increases in net interest income were due primarily to the Mt. Washington merger and organic loan growth, along with continuing declines in interest costs of deposits and borrowings.

The average balance of the Company’s loan portfolio, which is principally comprised of real estate loans, increased $423.3 million, or 54.4%, to $1.2 billion, which was partially offset by the decline in the yield on loans of eight basis points to 5.78% for the quarter ended September 30, 2010 compared to the quarter ended September 30, 2009. For the nine months ended September 30, 2010, the average balance of the loan portfolio increased $420.6 million, or 55.7%, to $1.2 billion, which was partially offset by the decline in the yield on loans of 15 basis points to 5.75% compared to the nine months ended September 30, 2009.

The Company’s cost of deposits declined 63 basis points to 1.37%, which was partially offset by the increase in the average balance of interest-bearing deposits of $384.5 million, or 44.0%, to $1.3 billion for the quarter ended September 30, 2010 compared to the quarter ended September 30, 2009. For the nine months ended September 30, 2010, the cost of deposits declined 98 basis points to 1.40%, which was partially offset by the increase in the average balance of interest-bearing deposits of $409.0 million, or 49.7%, to $1.2 billion compared to the nine months ended September 30, 2009.

The Company’s yield on interest-earning assets increased 14 basis points to 5.22% for the quarter ended September 30, 2010 compared to 5.08% for the quarter ended September 30, 2009, while the cost of interest-bearing liabilities declined 61 basis points to 1.47% for the quarter ended September 30, 2010 compared to 2.08% for the quarter ended September 30, 2009. For the nine months ended September 30, 2010, the yield on interest-earning assets declined two basis points to 5.22% compared to 5.24% for the nine months ended September 30, 2009, while the cost of interest-bearing liabilities declined 94 basis points to 1.50% compared to 2.44% for the nine months ended September 30, 2009.

The following tables present information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. For purposes of these tables, average balances have been calculated using daily average balances, and non-accrual loans are included in average balances but are not deemed material. Loan fees are included in interest income on loans but are not material. None of the income reflected in the following table is tax-exempt income:


	Three Months Ended September 30,
	2010								2009
	Average		Interest			Yield/			Average		Interest			Yield/
(Dollars in thousands)	Balance		Earned/Paid			Cost (4)			Balance		Earned/Paid			Cost (4)
Assets:
Interest-earning assets:
Loans (1)	$	1,200,946	$	17,491			5.78	%	$	777,674	$	11,480			5.86	%
Securities and certificates of deposit		349,691		3,701			4.20			314,130		2,941			3.71
Other interest-earning assets		62,513		36			0.23			35,346		5			0.06

Total interest-earning assets		1,613,150		21,228			5.22			1,127,150		14,426			5.08


Noninterest-earning assets		130,999								77,101

Total assets	$	1,744,149							$	1,204,251


Liabilities and stockholders’ equity:
Interest-bearing liabilities:
NOW deposits	$	116,282		129			0.44	%	$	37,912		22			0.23	%
Money market deposits		309,486		837			1.07			267,049		1,084			1.61
Savings and other deposits		184,920		254			0.54			128,816		238			0.73
Certificates of deposit		647,554		3,135			1.92			439,967		3,060			2.76

Total interest-bearing deposits		1,258,242		4,355			1.37			873,744		4,404			2.00

FHLB advances and other borrowings		151,071		879			2.31			62,612		507			3.21


Total interest-bearing liabilities		1,409,313		5,234			1.47			936,356		4,911			2.08

Noninterest-bearing demand deposits		110,210								61,203
Other noninterest-bearing liabilities		13,916								11,260

Total liabilities		1,533,439								1,008,819

Total stockholders’ equity		210,710								195,432

Total liabilities and stockholders’ equity	$	1,744,149							$	1,204,251

Net interest-earning assets	$	203,837							$	190,794

Net interest income			$	15,994							$	9,515

Interest rate spread (2)							3.75	%							3.00	%
Net interest margin (3)							3.93	%							3.35	%
Average interest-earning assets to average interest-bearing liabilities				114.46	%							120.38	%


(1)		Loans on non-accrual status are included in average balances.

(2)		Interest rate spread represents the difference between 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.


	Nine Months Ended September 30,
	2010								2009
	Average		Interest			Yield/			Average		Interest			Yield/
(Dollars in thousands)	Balance		Earned/Paid			Cost (4)			Balance		Earned/Paid			Cost (4)
Assets:
Interest-earning assets:
Loans (1)	$	1,175,322	$	50,530			5.75	%	$	754,770	$	33,171			5.90	%
Securities and certificates of deposit		347,711		10,998			4.23			286,433		8,598			4.03
Other interest-earning assets		55,549		84			0.20			29,295		23			0.11

Total interest-earning assets		1,578,582		61,612			5.22			1,070,498		41,792			5.24


Noninterest-earning assets		134,497								80,603

Total assets	$	1,713,079							$	1,151,101


Liabilities and stockholders’ equity:
Interest-bearing liabilities:
NOW deposits	$	112,462		394			0.47	%	$	37,483		105			0.38	%
Money market deposits		305,669		2,617			1.14			225,982		3,184			1.89
Savings and other deposits		183,406		756			0.55			126,673		833			0.88
Certificates of deposit		631,157		9,097			1.93			433,512		10,483			3.24

Total interest-bearing deposits		1,232,694		12,864			1.40			823,650		14,605			2.38

FHLB advances and other borrowings		154,384		2,704			2.34			64,840		1,548			3.20


Total interest-bearing liabilities		1,387,078		15,568			1.50			888,490		16,153			2.44

Noninterest-bearing demand deposits		102,880								60,569
Other noninterest-bearing liabilities		15,665								10,412

Total liabilities		1,505,623								959,471

Total stockholders’ equity		207,456								191,630

Total liabilities and stockholders’ equity	$	1,713,079							$	1,151,101


Net interest-earning assets	$	191,504							$	182,008

Net interest income			$	46,044							$	25,639

Interest rate spread (2)							3.72	%							2.80	%
Net interest margin (3)							3.90	%							3.21	%
Average interest-earning assets to average interest-bearing liabilities				113.81	%							120.49	%


(1)		Loans on non-accrual status are included in average balances.

(2)		Interest rate spread represents the difference between 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.

The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume:


	Three Months Ended September 30,								Nine Months Ended September 30,
	2010 Compared to 2009								2010 Compared to 2009
	Increase (Decrease) Due to								Increase (Decrease) Due to
(In thousands)	Volume		Rate			Net			Volume		Rate			Net
Interest income:
Loans	$	6,167	$	(156	)	$	6,011		$	18,213	$	(854	)	$	17,359
Securities		353		407			760			1,964		436			2,400
Other interest-earning assets		6		25			31			34		27			61

Total		6,526		276			6,802			20,211		(391	)		19,820


Interest expense:
Deposits		1,492		(1,541	)		(49	)		5,290		(7,031	)		(1,741	)
Borrowings		548		(176	)		372			1,667		(511	)		1,156

Total		2,040		(1,717	)		323			6,957		(7,542	)		(585	)

Change in net interest income	$	4,486	$	1,993		$	6,479		$	13,254	$	7,151		$	20,405

Non-interest Income

Non-interest income increased $2.2 million, or 202.2%, to $3.3 million for the quarter ended September 30, 2010 from $1.1 million for the quarter ended September 30, 2009, primarily due to increases of $1.1 million in gain on sale of securities, $729,000 in customer service fees and $184,000 in gain on sale of loans. For the nine months ended September 30, 2010, non-interest income increased $4.8 million, or 149.2%, to $8.0 million from $3.2 million for the nine months ended September 30, 2009, primarily due to increases of $2.1 million in customer service fees, $1.1 million in gain on sale of securities, $649,000 in gain on sales of loans, $429,000 from other-than-temporary impairment losses recorded in the prior year period and $229,000 in equity income from the Company’s Hampshire First Bank affiliate. The increases in customer service fees were primarily due to service charges on deposit relationships acquired in the Mt. Washington merger and additional growth in deposits. The increases in gain on sales of securities reflected gains totaling $518,000 from equity securities and $267,000 from corporate bonds during the quarter ended September 30, 2010. The increases in gain on sales of loans reflected higher sales of loans originated for sale during the first nine months of 2010 and gains totaling $352,000 on sales of fixed-rate bi-weekly mortgage loans during the first quarter of 2010.

Non-interest Expense

Non-interest expense increased $7.5 million, or 104.3%, to $14.6 million for the quarter ended September 30, 2010 from $7.2 million for the quarter ended September 30, 2009, primarily due to the $3.1 million charge related to termination of the contract with Mt. Washington’s data processing services provider and increases of $373,000 in recurring data processing costs, $2.9 million in salaries and employee benefits and $593,000 in occupancy and equipment expenses. For the nine months ended September 30, 2010, non-interest expense increased $13.2 million, or 53.8%, to $37.7 million from $24.5 million for the nine months ended September 30, 2009, primarily due to the $3.1 million charge related to termination of the contract with Mt. Washington’s data processing services provider and increases of $964,000 in recurring data processing costs, $5.1 million in salaries and employee benefits, $1.9 million in occupancy and equipment expenses, $485,000 in marketing and advertising, $405,000 in professional services and $1.3 million in other general and administrative expenses. The increases in non-interest expenses were primarily due to higher expense levels following the Mt. Washington merger. The Company’s efficiency ratio improved to 62.45% for the quarter ended September 30, 2010, excluding the charge to terminate Mt. Washington’s data processing contract, from 65.73% for the quarter ended September 30, 2009. For the nine months ended September 30, 2010, the efficiency ratio improved to 65.02%, excluding the charge to terminate Mt. Washington’s data processing contract, from 84.13% for the nine months ended September 30, 2009.

The Company agreed to revised contract terms with its current data processing services provider during the quarter ended September 30, 2010 that included provisions for the conversion of Mt. Washington’s accounts from their data processing services provider in October 2010. As a result of these revised contract terms and the termination of Mt. Washington’s prior data processing services contract, the Company expects to realize significant data processing cost savings in subsequent periods.

Income Tax

The Company recorded a provision for income taxes of $1.6 million for the quarter ended September 30, 2010, reflecting an effective tax rate of 35.3%, compared to $864,000, or 31.4%, for the quarter ended September 30, 2009. For the nine months ended September 30, 2010, the provision for income taxes was $5.0 million, reflecting an effective tax rate of 35.7%, compared to $787,000, or 31.1%, for the nine months ended September 30, 2009. The increase in the income tax provision was primarily due to taxable income that was higher than tax preference items. After an analysis of the components of the deferred tax asset, the Company recorded a decrease of $331,000 to the valuation allowance against the deferred tax asset during the nine months ended September 30, 2010. As of September 30, 2010, the total valuation allowance against the deferred tax asset was $110,000.

Liquidity and Capital Management

Liquidity Management. Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities of and payments on investment securities and borrowings from the Federal Home Loan Bank of Boston. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management policy.

Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At September 30, 2010, cash and cash equivalents totaled $121.0 million. In addition, at September 30, 2010, we had $164.5 million of available borrowing capacity with the Federal Home Loan Bank of Boston, including a $9.4 million line of credit. On September 30, 2010, we had $132.6 million of advances outstanding.

A significant use of our liquidity is the funding of loan originations. At September 30, 2010 and December 31, 2009, we had total loan commitments outstanding, as follows:


	September 30,		December 31,
(In thousands)	2010		2009
Unadvanced portion of existing loans:
Construction	$	45,477	$	72,218
Home equity line of credit		42,294		25,623
Other lines and letters of credit		9,032		4,038
Commitments to originate:
One- to four-family		19,700		1,844
Commercial real estate		60,494		18,711
Construction		19,519		27,460
Other loans		3,946		4,457

Total loan commitments outstanding	$	200,462	$	154,351

Historically, many of the commitments expire without being fully drawn; therefore, the total amount of commitments does not necessarily represent future cash requirements. The Bank provided participating checking accounts with overdraft account protection covering $7.8 million of balances as of September 30, 2010.

In July 2010, we extended the contract with our core data processing provider through December 2017. This contract extension resulted in an outstanding commitment of $16.2 million as of September 30, 2010, with total annual payments of $2.2 million. On August 5, 2010, we terminated Mt. Washington’s contract with its core data processing provider in preparation for the conversion to the Company’s core data processing provider during October 2010. This contract termination and related systems conversion costs resulted in a charge to operations of $3.1 million during the quarter ending September 30, 2010. In addition, we had outstanding commitments as of September 30, 2010 totaling $2.0 million for the construction of two new branches in Revere and the West Roxbury area of Boston, Massachusetts, and $487,000 for renovations of several existing branch locations.

Another significant use of our liquidity is the funding of deposit withdrawals. Certificates of deposit due within one year of September 30, 2010 totaled $375.2 million, or 56.6% of total certificates of deposit. If these maturing deposits do not remain with us, we will be required to utilize other sources of funds. Historically, a significant portion of certificates of deposit that mature have remained at the Company. We have the ability to attract and retain deposits by adjusting the interest rates offered, and total certificates of deposit have increased in 2010 in addition to those acquired in the Mt. Washington merger.

Our primary investing activities are the origination of loans and the purchase of securities. Our primary financing activities consist of activity in deposit accounts and Federal Home Loan Bank advances. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive. Occasionally, we offer promotional rates on certain deposit products to attract deposits.

Capital Management. Both Meridian Interstate Bancorp and East Boston Savings Bank are subject to various regulatory capital requirements administered by the Federal Reserve Board and Federal Deposit Insurance Corporation, respectively, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At September 30, 2010, both Meridian Interstate Bancorp and East Boston Savings Bank exceeded all of their respective regulatory capital requirements. East Boston Savings Bank is considered “well capitalized” under regulatory guidelines.

We may use capital management tools such as cash dividends and common share repurchases. However, Massachusetts Commissioner of Banks regulations restrict stock repurchases by Meridian Interstate Bancorp within three years of its initial stock offering completed in January 2008 unless the repurchase: (i) is part of a general repurchase made on a pro rata basis pursuant to an offering approved by the Commissioner of the Banks and made to all stockholders of Meridian Interstate Bancorp (other than Meridian Financial Services with the approval of the Commissioner of Banks); (ii) is limited to the repurchase of qualifying shares of a director; (iii) is purchased in the open market by a tax-qualified or nontax-qualified employee stock benefit plan of Meridian Interstate Bancorp or East Boston Savings Bank in an amount reasonable and appropriate to fund the plan; or (iv) is limited to stock repurchases of no greater than 5% of the outstanding capital stock of Meridian Interstate Bancorp where compelling and valid business reasons are established to the satisfaction of the Commissioner of Banks. In addition, pursuant to Federal Reserve Board approval conditions imposed in connection with the formation of Meridian Interstate Bancorp, Meridian Interstate Bancorp has committed (i) to seek the Federal Reserve Board’s prior approval before repurchasing any equity securities from Meridian Financial Services and (ii) that any repurchases of equity securities from stockholders other than Meridian Financial Services will be at the current market price for such stock repurchases. Meridian Interstate Bancorp will also be subject to the Federal Reserve Board’s notice provisions for stock repurchases.

In April 2010, the Commonwealth of Massachusetts Office of the Commissioner of Banks approved the Company’s application to repurchase up to 5% of its outstanding common stock not held by its mutual holding company parent, or 472,428 shares of its common stock. As of September 30, 2010, the Company had repurchased 153,367 shares of its stock at an average price of $11.15 per share, or 32.5% of the shares authorized for repurchase under the Company’s third stock repurchase program. The Company has repurchased 1,084,867 shares since December 2008.

Off-Balance Sheet Arrangements. In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. We had no investment in derivative securities at September 30, 2010.

For the nine months ended September 30, 2010, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk Management. Our earnings and the market value of our assets and liabilities are subject to fluctuations caused by changes in the level of interest rates. We manage the interest rate sensitivity of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits. As a result, sharp increases in interest rates may adversely affect our earnings while decreases in interest rates may beneficially affect our earnings. To reduce the potential volatility of our earnings, we have sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Our strategy for managing interest rate risk emphasizes: originating loans with adjustable interest rates; selling the residential real estate fixed-rate loans with terms greater than 15 years that we originate; and promoting core deposit products and short-term time deposits.

We have an Asset/Liability Management Committee to coordinate all aspects of asset/liability management. The committee establishes and monitors the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources to provide results that are consistent with liquidity, growth, risk limits and profitability goals.

Net Interest Income Simulation Analysis. We analyze our interest rate sensitivity position to manage the risk associated with interest rate movements through the use of interest income simulation. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest sensitive.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period.

Our goal is to manage asset and liability positions to moderate the effects of interest rate fluctuations on net interest income. Interest income simulations are completed quarterly and presented to the Asset/Liability Committee and the board of directors. The simulations provide an estimate of the impact of changes in interest rates on net interest income under a range of assumptions. The numerous assumptions used in the simulation process are reviewed by the Asset/Liability Committee and the Executive Committee on a quarterly basis. Changes to these assumptions can significantly affect the results of the simulation. The simulation incorporates assumptions regarding the potential timing in the repricing of certain assets and liabilities when market rates change and the changes in spreads between different market rates. The simulation analysis incorporates management’s current assessment of the risk that pricing margins will change adversely over time due to competition or other factors.

Simulation analysis is only an estimate of our interest rate risk exposure at a particular point in time. We continually review the potential effect changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities.

The simulation uses projected repricing of assets and liabilities on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rates can have a significant impact on interest income simulation. Because of the large percentage of loans we hold, rising or falling interest rates have a significant impact on the prepayment speeds of our earning assets that in turn affect the rate sensitivity position. When interest rates rise, prepayments tend to slow. When interest rates fall, prepayments tend to rise. Our asset sensitivity would be reduced if prepayments slow and vice versa. While we believe such assumptions to be reasonable, there can be no assurance that assumed prepayment rates will approximate actual future mortgage-backed security and loan repayment activity.

The following table reflects changes in estimated net interest income for the Company at October 1, 2010 through September 30, 2011.


Interest Rate Sensitivity
Increase (Decrease)
in Market Interest	Net Interest Income
Rates (Rate Shock)	Amount		Change			Percent
	(Dollars in Thousands)
300	$	55,950	$	(5,362	)		(8.75	)%
Flat		61,312
-50		61,856		544			0.89

Item 4. Controls and Procedures

(a) Disclosure Controls and Procedures

Meridian Interstate Bancorp’s management, including Meridian Interstate Bancorp’s principal executive officer and principal financial officer, have evaluated the effectiveness of Meridian Interstate Bancorp’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, Meridian Interstate Bancorp’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that Meridian Interstate Bancorp files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (2) is accumulated and communicated to Meridian Interstate Bancorp’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

(b) Internal Control over Financial Reporting

There have not been any changes in Meridian Interstate Bancorp’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, Meridian Interstate Bancorp’s internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. We are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.

Item 1A. Risk Factors

Other than with respect to information contained in this and other Quarterly Reports on Form 10-Q we have filed with the Securities and Exchange Commission during 2010, there have been no material updates or additions to the risk factors previously disclosed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 16, 2010. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

		(a.) — (b.) Not applicable.

		(c.) The following table sets forth information with respect to any purchase made by or on behalf of the Company during the indicated periods:


							(d)
							Maximum Number
					(c)		(or Approximate
					Total Number of		Dollar Value) of
					Shares (or Units)		Shares (or Units)
	(a)		(b)		Purchased as Part		that May Yet Be
	Total Number of		Average Price		of Publicly		Purchased Under
	Shares (or Units)		Paid Per Share (or		Announced Plans		the Plans or
Period	Purchased		Unit)		or Programs (1)		Programs
July 1 – 31, 2010		400	$	10.78		400		362,328
August 1 – 31, 2010		31,615	$	10.83		31,615		330,713
September 1 – 30, 2010		11,652	$	10.86		11,652		319,061

Total		43,667	$	10.84		43,667		319,061


(1)		In April 2010, the Commonwealth of Massachusetts Office of the Commissioner of Banks approved the Company’s application to repurchase up to 5% of its outstanding common stock not held by its mutual holding company parent, or 472,428 shares of its common stock.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. [Removed and Reserved]

Item 5. Other Information

None.

Item 6. Exhibits


	3.1			Amended and Restated Articles of Organization of Meridian Interstate Bancorp, Inc.*
	3.2			Amended and Restated Bylaws of Meridian Interstate Bancorp, Inc.*
	3.3			Articles of Correction of Meridian Interstate Bancorp, Inc.***
	4			Form of Common Stock Certificate of Meridian Interstate Bancorp, Inc.*
	10.1			Form of East Boston Savings Bank Employee Stock Ownership Plan*
	10.2			Form of East Boston Savings Bank Employee Stock Ownership Plan Trust Agreement*
	10.3			East Boston Savings Bank Employee Stock Ownership Plan Loan Agreement, Pledge Agreement and Promissory Note*
	10.4			Form of Amended and Restated Employment Agreement*
	10.5			Form of East Boston Savings Bank Employee Severance Compensation Plan*
	10.6			Form of Supplemental Executive Retirement Agreements with certain directors*
	10.7			Form of Separation Agreement with Robert F. Verdonck incorporated by reference to the Form 8-K filed on June 11, 2008
	10.8			Form of Separation Agreement with Leonard V. Siuda incorporated by reference to the Form 8-K filed on April 7, 2009
	10.9			Form of Separation Agreement with Philip F. Freehan incorporated by reference to the Form 8-K filed on April 7, 2009
	10.10			Form of Supplemental Executive Retirement Agreement with Richard J. Gavegnano filed as an exhibit to Form 10-Q filed on May 14, 2008
	10.11			Form of Employment Agreement with Richard J. Gavegnano incorporated by reference to the Form 8-K filed on January 12, 2009
	10.12			Form of Employment Agreement with Deborah J. Jackson incorporated by reference to the Form 8-K filed on January 22, 2009
	10.13			Form of Supplemental Executive Retirement Agreement with Deborah J. Jackson incorporated by reference to the Form 8-K filed on January 22, 2009
	10.14			2008 Equity Incentive Plan**
	10.15			Amendment to Supplemental Executive Retirement Agreements with Certain Directors incorporated by reference to the Form 10-K/A filed on April 8, 2009
	10.16			Agreement and Plan of Merger incorporated by reference to the Form 8-K filed on July 24, 2009
	10.17			Employment Agreement between Edward J. Merritt and East Boston Savings Bank***
	10.18			Supplemental Executive Retirement Agreement between East Boston Savings Bank and Edward J. Merritt***
	10.19			Joint Beneficiary Designation Agreement between Edward J. Merritt and Mt. Washington Cooperative Bank***
	10.20			First Amendment to Joint Beneficiary Designation Agreement between Edward J. Merritt and Mt. Washington Cooperative Bank***
	10.21			Change in Control Agreement between Mark Abbate and East Boston Savings Bank incorporated by reference to the Form 8-K filed on December 15, 2009
	21			Subsidiaries of Registrant*
	31.1			Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2			Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32			Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


*		Incorporated by reference to the Registration Statement on Form S-1 of Meridian Interstate Bancorp, Inc. (File No. 333-146373), originally filed with the Securities and Exchange Commission on September 28, 2007.

**		Incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement for its 2008 Annual Meeting, as filed with the Securities and Exchange Commission on July 11, 2008.

***		Incorporated by reference to the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 16, 2010.

SIGNATURES

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


	MERIDIAN INTERSTATE BANCORP, INC. (Registrant)
Dated: November 9, 2010	/s/ Richard J. Gavegnano
	Richard J. Gavegnano
	Chairman and Chief Executive Officer (Principal Executive Officer)

Dated: November 9, 2010	/s/ Mark L. Abbate
	Mark L. Abbate Senior Vice President, Treasurer and Chief Financial Officer
	(Principal Financial and Accounting Officer)

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