UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K





ý
            Annual
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934


For the Fiscal Year Ended December 31,
2007


OR


o
            Transition
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934





For the transition period from
_______________ to ______________________





Commission
file number 001-33898





Meridian Interstate Bancorp,
Inc.


(Exact
name of registrant as specified in its charter)





Massachusetts
            20-4652200(State
      or other jurisdiction of
            (I.R.S.
      Employerincorporation
      or organization)
            Identification
      No.)10 Meridian Street,
      East Boston, Massachusetts
            02128(Address
      of Principal Executive Offices)
            Zip
      Code


(617)
567-1500


(Registrant’s
telephone number, including area code)





Securities
Registered Pursuant to Section 12(b) of the Act:


Name
      of EachTitle of Each
      Class
            Exchange on Which
      RegisteredCommon
      Stock, .01 par value per share
            The
      NASDAQ Global Select Stock Market,
LLC





Securities
Registered Pursuant to Section 12(g) of the
Act:         None





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes                      o                      No                      x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.


Yes                      o                      No                      x





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 and (2) has been subject to such filing requirements for the
past 90 days.


Yes                      x                      No           o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
form 10-K.    x





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 the definitions 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 oNon Accelerated
Filer x  
  Smaller reporting company  o





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).


Yes                      o                      No                      x





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the Registrant, computed by reference to price at which the
common equity was last sold on June 30, 2007 was $0.  The registrant’s
common stock did not begin trading on the NASDAQ Global Select stock market
until January 23, 2008.As of March 1, 2008,
there were 23,000,000 outstanding shares of the Registrant’s common stock, the
majority of which are owned by the Registrant’s mutual holding company parent,
Meridian Financial Services, Incorporated.


DOCUMENTS
INCORPORATED BY REFERENCE


Proxy
Statement for the 2008 Annual Meeting of Stockholders of the Registrant (Part
III).


1





MERIDIAN
INTERSTATE BANCORP


2007
FORM 10-K ANNUAL REPORT


TABLE
OF CONTENTS





PagePART
      IForward
      Looking Statements
            3Item
      1.
            Business
            4Item
      1A.
            Risk
      Factors
            24Item
      1B.
            Unresolved
      Staff Comments
            24Item
      2.
            Properties
            24Item
      3.
            Legal
      Proceedings
            24Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            24PART
      IIItem
      5.
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            25Item
      6.
            Selected
      Financial Data
            27Item
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            28Item
      7A.
            Quantitative
      and Qualitative Disclosures about Market Risk
            49Item
      8.
            Financial
      Statements and Supplementary Data
            50Item
      9.
            Changes
      and Disagreements with Accountants on Accounting and Financial
      Disclosure
            92Item
      9A.
            Controls
      and Procedures
            92Item
      9AT.
            Controls
      and Procedures
            92Item
      9B.
            Other
      Information
            92PART
      IIIItem
      10.
            Directors
      and Executive Officers and Corporate Governance
            93Item
      11.
            Executive
      Compensation
            93Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            93Item
      13.
            Certain
      Relationships and Related Transactions, and Director
      Independence
            93Item
      14.
            Principal
      Accountant Fees and Services
            93PART
      IVItem
      15.
            Exhibits
      and Financial Statement Schedules.
            94Signatures
            
            95








2








PART
I





Forward
Looking Statements





This Annual Report contains certain
“forward-looking statements,” which can be identified by the use of such words
as estimate, project, believe, intend, anticipate, plan, seek and similar
expressions.  These forward looking statements
include:




·
            statements
      of our goals, intentions and
expectations;




·
            statements
      regarding our business plans, prospects, growth and operating
      strategies;




·
            statements
      regarding the quality of our loan and investment portfolios;
      and




·
            estimates
      of our risks and future costs and
benefits.




These
forward-looking statements are subject to significant risks and
uncertainties.  Actual results may differ materially from those
contemplated by the forward-looking statements due to, among others, the
following factors:





·
            general
      economic conditions, either nationally or in our market area, that are
      worse than expected;





·
            inflation
      and changes in the interest rate environment that reduce our interest
      margins or reduce the fair value of financial
  instruments;





·
            increased
      competitive pressures among financial services
  companies;





·
            changes
      in consumer spending, borrowing and savings
  habits;





·
            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;





·
            legislative
      or regulatory changes that adversely affect our
  business;





·
            adverse
      changes in the securities markets;





·
            changes
      in accounting policies and practices, as may be adopted by the bank
      regulatory agencies, the Financial Accounting Standards Board or the
      Securities and Exchange Commission;





·
            inability
      of third-party providers to perform their obligations to us;
      and





·
            changes
      in our organization, compensation and benefit
  plans.





Any of
the forward-looking statements that we make in this Annual Report and in other
public statements we make may later prove incorrect because of inaccurate
assumptions we might make, the factors illustrated above or other factors that
we cannot foresee.  Because of these and other uncertainties, our
actual future results may be materially different from the results indicated by
these forward-looking statements and you should not rely on such
statements.










3





Item 1.  business





Meridian
Interstate Bancorp, Inc.





Meridian
Interstate Bancorp, Inc. is a Massachusetts mid-tier stock holding company that
was formed in 2006 by East Boston Savings Bank to be its holding
company.  Meridian Interstate Bancorp 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 Bancorp
owns 40% of the capital stock of Hampshire First Bank, a New Hampshire chartered
bank, organized in 2006 and headquartered in Manchester, New
Hampshire.  At December 31, 2007, Hampshire First Bank had assets of
$59.2 million.  In the future, Meridian Interstate Bancorp might also
acquire or organize other operating subsidiaries, including other financial
services companies or their assets, although it currently has no specific plans
or agreements to do so.  At December 31, 2007, Meridian Interstate
Bancorp had total assets of $1.0 billion, deposits of $774.4 million and
retained earnings of $115.7 million.





Meridian
Financial Services, Incorporated





Meridian
Financial Services, Incorporated is our Massachusetts-chartered mutual holding
company parent.  As a mutual holding company, Meridian Financial
Services is a non-stock company.  Meridian Financial Services owns
55.0% of Meridian Interstate Bancorp’s common stock.  So long as
Meridian Financial Services exists, it will own a majority of the voting stock
of Meridian Interstate Bancorp and, through its board of trustees, will be able
to exercise voting control over most matters put to a vote of
stockholders.  All 12 directors of Meridian Interstate Bancorp are
also members of the board of trustees of Meridian Financial Services, which is
composed of 29 members.  Meridian Financial Services does not
currently intend to engage in any business activity other than those relating to
owning a majority of the common stock of Meridian Interstate
Bancorp.








East
Boston Savings Bank





East
Boston Savings Bank is a Massachusetts-chartered stock savings bank that
operates from 11 full-service locations and one loan center in the greater
Boston metropolitan area.  East Boston Savings Bank was originally
founded in 1848.  We offer a variety of deposit and loan products to
individuals and businesses located in our primary market, which consists of
Essex, Middlesex and Suffolk Counties, Massachusetts.





We
operate as a community-oriented financial institution offering financial
services to consumers and businesses in our market area.  We attract
deposits from the general public and use those funds to originate one- to
four-family real estate, multi-family and commercial real estate, construction,
commercial business and consumer loans, which, we primarily hold for
investment.  In addition, a segment of our lending business involves
the purchase and sale of loan participation interests.  We also offer
non-deposit products through a third-party network arrangement.  We
have been successful in growing both deposits and loans.  Since
December 31, 2005, deposits have increased $101.9 million, or 15.2%, and loans
have increased $87.3 million, or 18.1%.  At December 31, 2007, we had
total assets of $989.6 million, deposits of $774.4 million and retained earnings
of $102.3 million.





Available
Information





Meridian
Interstate Bancorp is a public company, and files interim, quarterly and annual
reports with the Securities and Exchange Commission.  These respective
reports are on file and a matter of public record with the Securities and
Exchange Commission and may be read and copied at the Securities and Exchange
Commission’s Public Reference Room at 450 Fifth Street, NW, Washington, DC
20549. The public may obtain information on the operation of the Public
Reference Room by calling the Securities and Exchange Commission at
1-800-SEC-0330. The Securities and Exchange Commission maintains an Internet
site that contains reports, proxy and information statements, and other
information regarding issuers that file electronically with the SEC (http://www.sec.gov).





Our
website address is www.ebsb.com.  Information
on our website should not be considered a part of this annual
report.








4











Market
Area





We
consider the greater Boston metropolitan area, and to a lesser extent eastern
Massachusetts (east of Route 93), to be our primary market
area.  While our primary deposit-gathering area is concentrated in the
greater Boston metropolitan area, our lending area encompasses a broader market
that includes all of Massachusetts east of Route 93, including Cape Cod, and
portions of south-eastern New Hampshire.  We conduct our operations
through our 11 full service offices and one loan center located in Essex (four
offices and one loan center), Middlesex (two offices) and Suffolk (five offices)
Counties, all of which are located in the greater Boston metropolitan
area.  The greater Boston metropolitan area is the 11th largest
metropolitan area in the United States.  Located adjacent to major
transportation corridors, the Boston metropolitan area provides a highly
diversified economic base, with major employment sectors ranging from services,
manufacturing and wholesale retail trade, to finance, technology and medical
care.  Based on census estimates, from 2000 to 2006 the population of
Essex and Middlesex Counties increased 4.5% and 1.3%, respectively, and the
population of Suffolk County decreased 0.8%.  This compares to
population increases of 3.0% for Massachusetts and 7.9% for the United
States.  In addition, 2006 per capita income was $34,287, $42,582 and
$30,099 for Essex, Middlesex and Suffolk Counties, respectively, reflecting
increases of 30.1%, 36.5% and 32.2%, respectively, from 2000.  For
Massachusetts, 2006 per capita income was $34,320, an increase of 32.2%, and for
the United States, 2006 per capital income was $26,228, an increase of 21.5%
from 2000.  Median household income in 2006 was $65,803, $78,854 and
$50,068 for Essex, Middlesex and Suffolk Counties, respectively, reflecting
increases of 27.6%, 29.6% and 27.2%, respectively, from 2000.  For
Massachusetts, 2006 median household income was $63,971; an increase of 26.7%,
and for the United States, 2006 median household income was $48,534, an increase
of 15.6%.  In addition, the median age for Essex, Middlesex and
Suffolk Counties was 39.1, 37.7 and 32.9, respectively, as compared to the state
median of 38.1 and the national median of 36.5.





Competition





We face
significant competition for the attraction of deposits and origination of
loans.  Our most direct competition for deposits has historically come
from the many financial institutions and credit unions operating in our market
area and, to a lesser extent, from other financial service companies such as
brokerage firms and insurance companies.  Several large holding
companies operate banks in our market area, including Bank of America
Corporation, Sovereign Bancorp, Inc., TD Banknorth, Inc., Citizens Financial
Group, Inc. and Eastern Bank.  These institutions are significantly
larger than us and, therefore, have significantly greater
resources.  We also face competition for investors’ funds from money
market funds, mutual funds and other corporate and government
securities.  At June 30, 2007 which is the most recent date for which
data is available from the Federal Deposit Insurance Corporation, we held 0.51%
of the deposits in the Boston metropolitan statistical area, which was the
22nd
largest market share out of 154 financial institutions with offices in that
metropolitan statistical area.





Our
competition for loans comes from financial institutions and credit unions in our
market area and from other financial service providers, such as mortgage
companies and mortgage brokers.  Competition for loans also comes from
the increasing number of non-depository financial service companies entering the
mortgage market, such as insurance companies, securities companies and specialty
finance companies.





We expect
competition to remain intense in the future as a result of legislative,
regulatory and technological changes and the continuing trend of consolidation
in the financial services industry.  Technological advances, for
example, have lowered barriers to entry, allowed banks to expand their
geographic reach by providing services over the Internet and made it possible
for non-depository institutions to offer products and services that
traditionally have been provided by banks.  Changes in federal law
permit affiliation among banks, securities firms and insurance companies, which
promotes a competitive environment in the financial services
industry.  Competition for deposits and the origination of loans could
limit our growth in the future.








5





Lending
Activities





One- to Four-Family Residential
Loans





The
largest segment of our loan portfolio is mortgage loans to enable borrowers to
purchase or refinance existing homes, most of which serve as the primary
residence of the owner.  At December 31, 2007, one- to four-family
residential loans were $224.1 million, or 39.1% of our total loan portfolio,
consisting of $99.3 million and $124.8 million of fixed-rate and adjustable-rate
loans, respectively.  We offer fixed-rate loans with terms up to 30
years and adjustable-rate loans with terms up to 40 years.  Generally,
our fixed-rate loans conform to Fannie Mae and Freddie Mac underwriting
guidelines and those with longer terms (more than fifteen years) are originated
with the intention to sell.  Our adjustable-rate mortgage loans
generally adjust annually or every three years after an initial fixed period
that ranges from three to seven years.  East Boston Savings Bank also
offers fixed-rate bi-weekly loans (loan payments are made every two weeks) and
such loans were $62.4 million at December 31, 2007.  Interest rates
and payments on our adjustable-rate loans generally are adjusted to a rate equal
to a percentage above the one or three year U.S. Treasury
index.  Depending on the loan type, the maximum amount by which the
interest rate may be increased or decreased is generally 2% per adjustment
period and the lifetime interest rate caps range from 2% to 4% over the initial
interest rate of the loan.  Our loans generally do not have prepayment
penalties.





Borrower
demand for adjustable-rate compared to fixed-rate loans is a function of the
level of interest rates, the expectations of changes in the level of interest
rates, and the difference between the interest rates and loan fees offered for
fixed-rate mortgage loans as compared to the interest rates and loan fees for
adjustable-rate loans.  The relative amount of fixed-rate and
adjustable-rate mortgage loans that can be originated at any time is largely
determined by the demand for each in a competitive environment.  The
loan fees, interest rates and other provisions of mortgage loans are determined
by us on the basis of our own pricing criteria and competitive market
conditions.





While
one- to four-family residential real estate loans are normally originated with
up to 30-year terms, such loans typically remain outstanding for substantially
shorter periods because borrowers often prepay their loans in full either upon
sale of the property pledged as security or upon refinancing the original
loan.  Therefore, average loan maturity is a function of, among other
factors, the level of purchase and sale activity in the real estate market,
prevailing interest rates and the interest rates payable on outstanding
loans.  We do not offer loans with negative amortization and generally
do not offer interest-only one- to four-family residential real estate
loans.  Additionally, our current practice is generally (1) to sell to
the secondary market newly originated longer term (more than 15 year terms)
fixed-rate one- to four-family residential real estate loans, and (2) to
hold in our portfolio shorter-term fixed-rate loans and adjustable-rate
loans.  Generally, loans are sold to Fannie Mae and the Federal Home
Loan Bank Mortgage Partnership Finance Program with servicing
retained.  We do not make loans generally known as subprime loans or
Alt-A loans.





We will
make loans with loan-to-value ratios up to 95% (100% for first time home buyers
only); however, we generally require private mortgage insurance for loans with a
loan-to-value ratio over 80%.  We require all properties securing
mortgage loans to be appraised by a licensed real estate
appraiser.  We generally require title insurance on all first mortgage
loans.  Borrowers must obtain hazard insurance, and flood insurance is
required for loans on properties located in a flood zone.





In an
effort to provide financing for first-time buyers, we offer five-year adjustable
rate, bi-weekly and fixed-rate 30-year residential real estate loans through the
Massachusetts Housing Finance Agency First Time Home Buyer
Program.  We offer mortgage loans through this program to qualified
individuals and originate the loans using modified underwriting guidelines,
reduced interest rates and loan conditions.





We also
offer loans secured by one- to four-family properties that are not
owner-occupied (“investment
loans”).  These
loans consist primarily of bi-weekly fixed-rate loans with terms up to 30 years
and adjustable-rate loans which adjust annually after an initial fixed period of
three years or adjust every three years after an initial fixed period of five
years.  Investment loans generally can be made with a loan-to-value
ratio of up to 80%.  At December 31, 2007, investment loans totaled
$13.7 million.





We also
originate land loans primarily to local contractors and developers for making
improvements on approved building lots.  Such loans are generally
written with a maximum 75% loan-to-value ratio based upon the appraised value or
purchase price, whichever is less, for a term of up to three
years.  Interest rates on our land loans are fixed for three
years.  At December 31, 2007, land loans totaled $4.0
million.





6





Commercial and Multi-Family Real
Estate Loans





The
second largest segment of our loan portfolio is fixed- and adjustable-rate
mortgage loans secured by commercial real estate and multi-family real
estate.  At December 31, 2007, commercial real estate and multi-family
real estate loans were $175.1million and $26.9 million, or 30.5% and 4.7%
respectively, of our total loan portfolio.  The commercial real estate
and multi-family loan portfolio consisted of $11.7 million fixed-rate loans and
$190.3 million adjustable rate loans at December 31, 2007.  We
currently target new individual commercial and multi-family real estate loan
originations to small- and mid-size owner occupants and investors in our market
area between $4.0 million and $6.0 million; however, we can, by policy,
originate loans to one borrower up to $10.0 million.  Due to loan
amortizations and lower than targeted size originations, the average size for
loans in this portfolio was $475,000 at December 31, 2007.  Our
commercial real estate and multi-family real estate loans are generally secured
by apartment buildings and properties used for business purposes such as office
buildings, industrial facilities and retail facilities.  We intend to
continue to grow our commercial real estate loan portfolio.  In
addition to originating these loans, we also participate in loans with other
financial institutions located primarily in Massachusetts.





We
originate a variety of fixed- and adjustable-rate commercial real estate and
multi-family real estate loans for terms up to 25 years.  Interest
rates and payments on our adjustable-rate loans adjust every three or five years
and generally are adjusted to a rate equal to a percentage above the
corresponding U.S. Treasury rate or Federal Home Loan Bank borrowing rate. Most of our
adjustable-rate commercial real estate and multi-family real estate loans adjust
every three years and amortize over a 20 year term.  The maximum
amount by which the interest rate may be increased or decreased is generally
2.5% per adjustment period, with a lifetime interest rate cap of 5% over the
initial interest rate of the loan. Loan amounts generally do not exceed 75% to
80% of the property’s appraised value at the time the loan is
originated.





At
December 31, 2007, our largest commercial real estate loan was for $7.7 million
and was secured by an office building located in North Andover,
Massachusetts.  At December 31, 2007, our largest multi-family real
estate loan was for $3.3 million and was secured by an apartment complex located
in Roxbury, Massachusetts.  Both of these loans were performing
according to their original repayment terms at December 31, 2007.





At
December 31, 2007, loan participations purchased totaled $13.1
million.  The properties securing these loans are located primarily in
Massachusetts.  Our underwriting practices with respect to loan
participations generally do not differ from loans that we
originate.





Construction
Loans





At
December 31, 2007, construction loans were $111.8 million, or 19.5% of our total
loan portfolio.  While we expect to continue construction lending, we
expect to decrease the size of the portfolio relative to our entire loan
portfolio with the goal of decreasing the size of the construction loan
portfolio to approximately 15.0% of total loans.





We
primarily make construction loans for commercial development projects, including
apartment buildings, small industrial buildings and retail and office
buildings.  We also originate adjustable and bi-weekly loans to
individuals and to builders to finance the construction of residential
dwellings.  Our construction loans generally are interest-only loans
that provide for the payment of only interest during the construction phase,
which is usually up to 12 to 24 months.  At the end of the
construction phase, the loan may convert to a permanent mortgage loan or the
loan may be paid in full.  Loans generally can be made with a maximum
loan to value ratio of 80% of the appraised market value upon completion of the
project.  As appropriate to the underwriting, a “discounted cash flow
analysis” is utilized.  Before making a commitment to fund a
construction loan, we require an appraisal of the property by an independent
licensed appraiser.  We also will generally require an inspection of
the property before disbursement of funds during the term of the construction
loan.





We also
originate construction and site development loans to contractors and builders to
finance the construction of single-family homes and subdivisions, which homes
typically have an average price ranging from $225,000 to $900,000.  We will
originate these loans whether or not the collateral property underlying the loan
is under contract for sale.  Residential real estate construction loans
include single-family tract construction loans for the construction of entry
level residential homes.  Loans to finance the construction of
single-family homes and subdivisions are generally offered to experienced
builders in our primary market areas.  The maximum loan-to-value limit
applicable to these loans is generally 75% to 80% of the appraised market value
upon completion of the project.  We do not require any cash equity from the
borrower if there is sufficient equity in the land being used as
collateral.  Development plans are required from builders prior to making
the loan. Our loan officers are required to personally


7


visit the
proposed site of the development and the sites of competing developments. 
We require that builders maintain adequate insurance coverage. While maturity
dates for residential construction loans are largely a function of the estimated
construction period of the project, and generally do not exceed one year, land
development loans generally are for 18 to 24 months. Substantially all of our
residential construction loans have adjustable rates of interest based onThe Wall Street Journal
prime rate and during the term of construction, the accumulated interest is
added to the principal of the loan through an interest reserve. 
Construction loan proceeds are disbursed periodically in increments as
construction progresses and as inspection by our approved inspectors
warrant.  Loan commitment amounts for site development loans typically
range from $100,000 to $10.0 million with an average individual loan
commitment at December 31, 2007 of $1.6 million.  We generally target
financing to mid-range $5.0 million to $10.0 million residential development
projects.





At
December 31, 2007, we had $6.9 million, or 1.2% of our total loan portfolio, in
construction loans for one- to four-family properties that convert to permanent
loans.  Also at that date, we had $104.9 million, or 18.3% of our total
loan portfolio, of which $23.5 million will convert to permanent loans, in
construction loans on commercial and multi-family real estate consisting of
mixed-use and non-residential loans.





At
December 31, 2007, our largest outstanding construction loan was for $8.3
million, of which $6.5 million was outstanding.  This loan is secured
by a residential townhouse complex (46 units) in Hingham,
Massachusetts.  This loan was performing according to its original
repayment terms at December 31, 2007.





Home Equity Lines of Credit





We offer
home equity lines of credit, which are secured by owner-occupied one- to
four-family residences.  At December 31, 2007, home equity lines of
credit were $21.5 million, or 3.8% of our total loan portfolio.  Home
equity lines of credit have adjustable rates of interest with ten-year draws
amortized over 15 years that are indexed to the Prime Rate as published by The Wall Street Journal on
the last business day of the month.  Our home equity lines either have
a monthly variable interest rate or an interest rate that is fixed for five
years and that adjusts in years six and eleven.  We offer home equity
lines of credit with cumulative loan-to-value ratios generally up to 80%, when
taking into account both the balance of the home equity loans and first mortgage
loan.





The
procedures for underwriting home equity lines of credit include an assessment of
the applicant’s payment history on other debts and ability to meet existing
obligations and payments on the proposed loan.  Although the
applicant’s creditworthiness is a primary consideration, the underwriting
process also includes a comparison of the value of the collateral to the
proposed loan amount.  The procedures for underwriting one- to
four-family residential real estate loans apply equally to home equity
loans.





Commercial Business
Loans





We make
commercial business loans primarily in our market area to a variety of
professionals, sole proprietorships and small businesses.  At December
31, 2007, commercial business loans were $11.9 million, or 2.1% of our total
loan portfolio.  As part of our strategic plan, we are focusing on
increasing the commercial business loans that we
originate.  Commercial lending products include term loans and
revolving lines of credit.  Commercial loans and lines of credit are
made with either variable or fixed rates of interest.Variable rates are based
on the prime rate as published in The Wall Street Journal, plus
a margin.  Fixed-rate business loans are generally indexed to a
corresponding U.S. Treasury rate, plus a margin.  Commercial business
loans typically have shorter maturity terms and higher interest spreads than
real estate loans, but generally involve more credit risk because of the type
and nature of the collateral.  We are focusing our efforts on small-
to medium-sized, privately-held companies with local or regional businesses that
operate in our market area.





When
making commercial loans, we consider the financial statements of the borrower,
our lending history with the borrower, the debt service capabilities of the
borrower, the projected cash flows of the business and the value of the
collateral, primarily accounts receivable, inventory and equipment, and are
supported by personal guarantees.  Depending on the collateral used to
secure the loans, commercial loans are made in amounts of up to 80% of the value
of the collateral securing the loan.  At December 31, 2007, our
largest commercial business loan was a $1.6 million loan and our largest
commercial line of credit was $1.5 million, of which $165,000 was outstanding at
December 31, 2007.  All of these loans are secured by assets of the
respective borrowers and were performing according to their original terms at
December 31, 2007.











8





Consumer Loans





We
occasionally make fixed rate second mortgage loans, automobile loans, loans
secured by passbook or certificate accounts and overdraft loans.  At
December 31, 2007, consumer loans were $1.6 million, or 0.3% of total
loans.





The
procedures for underwriting consumer loans include an assessment of the
applicant’s payment history on other debts and ability to meet existing
obligations and payments on the proposed loan.  Although the
applicant’s creditworthiness is a primary consideration, the underwriting
process also includes a comparison of the value of the collateral, if any, to
the proposed loan amount.





Loan
Underwriting Risks





Adjustable-Rate
Loans





While we
anticipate that adjustable-rate loans will better offset the adverse effects of
an increase in interest rates as compared to fixed-rate mortgages, an increased
monthly mortgage payment required of adjustable-rate loan borrowers in a rising
interest rate environment could cause an increase in delinquencies and
defaults.  The marketability of the underlying property also may be
adversely affected in a high interest rate environment.  In addition,
although adjustable-rate mortgage loans make our asset base more responsive to
changes in interest rates, the extent of this interest sensitivity is limited by
the annual and lifetime interest rate adjustment limits.





Commercial and Multi-Family Real
Estate Loans





Loans
secured by commercial and multi-family real estate generally have larger
balances and involve a greater degree of risk than one- to four-family
residential mortgage loans.  Of primary concern in commercial and
multi-family real estate lending is the borrower’s creditworthiness and the
feasibility and cash flow potential of the project.  Payments on loans
secured by income properties often depend on successful operation and management
of the properties.  As a result, repayment of such loans may be
subject to a greater extent than residential real estate loans, to adverse
conditions in the real estate market or the economy.  To monitor cash
flows on income properties, we require borrowers and loan guarantors, if any, to
provide annual financial statements on commercial and multi-family real estate
loans.  In reaching a decision on whether to make a commercial or
multi-family real estate loan, we consider and review a global cash flow
analysis of the borrower and consider the net operating income of the property,
the borrower’s expertise, credit history and profitability and the value of the
underlying property.  We have generally required that the properties
securing these real estate loans have debt service coverage ratios (the ratio of
earnings before debt service to debt service) of at least 1.10x.  An
environmental phase one report is obtained when the possibility exists that
hazardous materials may have existed on the site, or the site may have been
impacted by adjoining properties that handled hazardous
materials.  Land loans secured by improved lots generally involve
greater risks than residential mortgage lending because land loans are more
difficult to evaluate.  If the estimate of value proves to be
inaccurate, in the event of default and foreclosure, we may be confronted with a
property the value of which is insufficient to assure full payment.





Construction
Loans





Our
construction loans are based upon estimates of costs and values associated with
the completed project.  These estimates may be inaccurate. 
Construction lending involves additional risks when compared with permanent
residential lending because funds are advanced upon the security of the project,
which is of uncertain value prior to its completion.  Because of the
uncertainties inherent in estimating construction costs, as well as the market
value of the completed project and the effects of governmental regulation of
real property, it is relatively difficult to evaluate accurately the total funds
required to complete a project and the related loan-to-value ratio.  This
type of lending also typically involves higher loan principal amounts and is
often concentrated with a small number of builders.   In
addition, generally during the term of a construction loan, interest may be
funded by the borrower or disbursed from an interest reserve set aside from the
construction loan budget.  These loans often involve the disbursement of
substantial funds with repayment substantially dependent on the success of the
ultimate project and the ability of the borrower to sell or lease the property
or obtain permanent take-out financing, rather than the ability of the borrower
or guarantor to repay principal and interest.  If our appraisal of the
value of a completed project proves to be overstated, we may have inadequate
security for the repayment of the loan upon completion of construction of the
project and may incur a loss.  A “discounted cash flow analysis” is
utilized for determining the value of any construction project of five or more
units.  Our ability to continue to originate a significant amount of
construction loans is dependent on the continued strength of the housing market
in our market areas. Further, if we lost our relationship with one or more of
our larger borrowers building in these areas or there is a decline in the demand
for


9


new
housing in these areas, it is expected that the demand for construction loans
would decline, our liquidity would substantially increase and our net income
would be adversely affected.





Commercial Business
Loans





Unlike
residential mortgage loans, which generally are made on the basis of the
borrower’s ability to make repayment from his or her employment or other income,
and which are secured by real property whose value tends to be more easily
ascertainable, commercial business loans are of higher risk and typically are
made on the basis of the borrower’s ability to make repayment from the cash flow
of the borrower’s business and the collateral securing these loans may fluctuate
in value.  Our commercial business loans are originated primarily
based on the identified cash flow of the borrower and secondarily on the
underlying collateral provided by the borrower.  Most often, this
collateral consists of accounts receivable, inventory or
equipment.  Credit support provided by the borrower for most of these
loans and the probability of repayment is based on the liquidation of the
pledged collateral and enforcement of a personal guarantee, if
any.  As a result, the availability of funds for the repayment of
commercial business loans may depend substantially on the success of the
business itself.  Further, any collateral securing such loans may
depreciate over time, may be difficult to appraise and may fluctuate in
value.





Consumer Loans





Consumer
loans may entail greater risk than do residential mortgage loans, particularly
in the case of consumer loans that are unsecured or secured by assets that
depreciate rapidly, such as motor vehicles.  Repossessed collateral
for a defaulted consumer loan may not provide an adequate source of repayment
for the outstanding loan and a small remaining deficiency often does not warrant
further substantial collection efforts against the borrower.  Consumer
loan collections depend on the borrower’s continuing financial stability, and
therefore are likely to be adversely affected by various factors, including job
loss, divorce, illness or personal bankruptcy.  Furthermore, the
application of various federal and state laws, including federal and state
bankruptcy and insolvency laws, may limit the amount that can be recovered on
such loans.





Loan Originations, Purchase and
Sales





Loan
originations come from a number of sources.  The primary sources of
loan originations are current customers, walk-in traffic, our website,
advertising and referrals from customers as well as our directors, trustees and
corporators.  We advertise in newspapers that are widely circulated
throughout our market area and on local radio.  We occasionally
purchase participation loans to supplement our origination
efforts.  We generally do not purchase whole loans.





We
generally originate loans for our portfolio; however, we generally sell, prior
to funding, to the secondary market all newly originated conforming fixed-rate,
16- to 30-year one- to four-family residential real estate loans.  Our
decision to sell loans is based on prevailing market interest rate conditions
and interest rate risk management.  Generally, loans are sold to
Fannie Mae and the Federal Home Loan Bank Mortgage Partnership Finance Program
with loan servicing retained.  In addition, we sell participation
interests in commercial real estate loans to local financial institutions,
primarily on the portion of loans exceeding our borrowing limits, or as is
prudent in concert with recognition of credit risk.





For the
years ended December 31, 2007 and December 31, 2006, we originated $177.4
million and $175.0 million of loans, and sold $8.3 million and $9.9 million of
loans.  At December 31, 2007, we were servicing $84.2 million of loans
for others.





Loan Approval Procedures and
Authority





Our
lending activities follow written, non-discriminatory, underwriting standards
and loan origination procedures established by our board of directors and
management.  Our board of directors has granted loan approval
authority to certain officers up to prescribed limits, depending on the
officer’s experience, the type of loan and whether the loan is secured or
unsecured.  All loans in excess of $100,000 require a second
authorized officer’s approval.  Loans in excess of $500,000 generally
must be authorized by the Executive Committee.








10





Loans-to-One Borrower Limit and Loan
Category Concentration





The
maximum amount that we may lend to one borrower and the borrower’s related
entities is generally limited, by statute, to 20% of our capital $20.5, which is
defined under Massachusetts law as the sum of our capital stock, surplus account
and undivided profits.  At December 31, 2007, our regulatory limit on
loans-to-one borrower was $20.5 million.  At that date, our largest
lending relationship consisted of three loans totaling $13.1 million and was
secured by commercial real estate.  This loan was performing in
accordance with its original repayment terms at December 31, 2007.  As
a result of the Company’s recent stock offering, our regulatory loans-to-one
borrower limit will increase and we expect to increase our internal loans-to-one
borrower limit.





Loan Commitments





We issue
commitments for fixed- and adjustable-rate mortgage loans conditioned upon the
occurrence of certain events.  Commitments to originate mortgage loans
are legally binding agreements to lend to our customers.  Generally,
our loan commitments expire after 30 days.





Investment
Activities





We have
legal authority to invest in various types of liquid assets, including U.S.
Treasury obligations, securities of various government-sponsored enterprises and
municipal governments, deposits at the Federal Home Loan Bank of Boston,
certificates of deposit of federally insured institutions, investment grade
corporate bonds and investment grade marketable equity
securities.  Our equity securities generally pay
dividends.  We also are required to maintain an investment in Federal
Home Loan Bank of Boston stock.  While we have the authority under
applicable law to invest in derivative securities, we had no investments in
derivative securities at December 31, 2007.





At
December 31, 2007, our investment portfolio consisted primarily of corporate
bonds, investment-grade marketable equity securities, short-term
government-sponsored enterprises and mortgage-backed securities.





Our
investment objectives are to provide and maintain liquidity, to establish an
acceptable level of interest rate and credit risk, to provide an alternate
source of low-risk investments when demand for loans is weak and to generate a
favorable return.  Our board of directors has the overall
responsibility for the investment portfolio, including approval of our
investment policy.  The Executive Committee of the Board of Directors
and management are responsible for implementation of the investment policy and
monitoring our investment performance.OurExecutive Committee
reviews the status of our investment portfolio on a quarterly basis, or more
frequently if warranted.





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.




At each
balance sheet date, management has concluded that the declines in value of the
Company’s debt securities are temporary, whereby management expects to collect
the full amount of principal and interest payments within the contractual
period.  Further, at each balance sheet date and in all material
respects, management has the intent and ability to hold depreciated debt
securities to the earlier of recovery or maturity.  From time to time,
management’s intent to hold depreciated debt securities to recovery or maturity
may change as a result of prudent portfolio management.  If
management’s intent changes, unrealized losses are recognized either as
impairment charges to the consolidated income statement or as realized losses if
a sale has been executed.  In most instances, management sells the
securities at the time their intent changes.





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.  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.





11


Deposit
Activities and Other Sources of Funds





General





Deposits,
borrowings and loan repayments are the major sources of our funds for lending
and other investment purposes.  Scheduled loan repayments are a
relatively stable source of funds, while deposit inflows and outflows and loan
prepayments are significantly influenced by general interest rates and money
market conditions.





Deposit Accounts





Deposits
are attracted, by advertising and through our website, from within our market
area through the offering of a broad selection of deposit instruments, including
non-interest-bearing demand deposits (such as checking accounts),
interest-bearing demand accounts (such as NOW and money market accounts),
savings accounts and certificates of deposit.  In addition to accounts
for individuals, we also offer several commercial checking accounts designed for
the businesses operating in our market area. At December 31, 2007, we
had $897,000 of brokered deposits.





Deposit
account terms vary according to the minimum balance required, the time period
that funds must remain on deposit, and the interest rate, among other
factors.  In determining the terms of our deposit accounts, we
consider the rates offered by our competition, our liquidity needs,
profitability, and customer preferences and concerns.  We generally
review our deposit mix and pricing on a weekly basis.  Our deposit
pricing strategy has generally been to offer competitive rates and to
periodically offer special rates in order to attract deposits of a specific type
or term.





Borrowings





We may
utilize advances from the Federal Home Loan Bank of Boston to supplement our
supply of investable funds.  The Federal Home Loan Bank functions as a
central reserve bank providing credit for its member financial
institutions.  As a member, we are required to own capital stock in
the Federal Home Loan Bank and are authorized to apply for advances on the
security of such stock and certain of our whole first mortgage loans and other
assets (principally securities which are obligations of, or guaranteed by, the
United States), provided certain standards related to creditworthiness have been
met.  Advances are made under several different programs, each having
its own interest rate and range of maturities.  Depending on the
program, limitations on the amount of advances are based either on a fixed
percentage of an institution’s net worth or on the Federal Home Loan Bank’s
assessment of the institution’s creditworthiness.  As of December 31,
2007, we also had an available line of credit of $9.4 million with the Federal
Home Loan Bank of Boston at an interest rate that adjusts daily.  All
of our borrowings from the Federal Home Loan Bank are secured by a blanket lien
on qualified collateral, defined principally as 75% of the carrying value of
certain first mortgage loans on owner-occupied residential
property.





Financial
Services





We offer
customers a range of non-deposit products, including mutual funds, annuities,
stocks and bonds which are cleared by a third party broker-dealer.  We
receive a portion of the commissions generated by our sales to our
customers.  We also offer customers long-term care insurance through a
third-party insurance company which generates commissions for us.  Our
non-deposit products generated $118,000, $43,000 and $97,000 of non-interest
income during the years ended December 31, 2007, 2006 and 2005,
respectively.





Personnel





As of
December 31, 2007, we had 161 full-time and 33 part-time employees, none of whom
is represented by a collective bargaining unit.  We believe our
relationship with our employees is excellent.





Subsidiaries





The only
subsidiary of Meridian Interstate Bancorp is East Boston Savings
Bank.





In
addition, Meridian Interstate Bancorp owns 40% of the capital stock of Hampshire
First Bank, a New Hampshire chartered bank, organized in 2006 and headquartered
in Manchester, New Hampshire.  In connection with the organization of
Hampshire First Bank, Meridian Interstate Bancorp also received non-voting
warrants to purchase an additional 60,000 shares of capital stock of Hampshire
First Bank (currently representing 2.0% of the outstanding shares of Hampshire
First Bank).  At December 31, 2007, our directors and executive
officers also own an additional 1.2% in the aggregate of the capital stock of
Hampshire First Bank and owned non-voting warrants to purchase in the aggregate
less than 1.0% of the capital stock.  None of our directors and
executive officers has any agreements


12


or
contracts with each other or with Meridian Interstate Bancorp regarding voting
their shares of Hampshire First Bank stock.  We also have no
additional agreements or contracts to purchase shares of voting securities of
Hampshire First Bank.  In addition, any future acquisition by Meridian
Interstate Bancorp of the voting securities of Hampshire First Bank, either
common stock or warrants, would require prior approval of the Federal Reserve
Board and the Massachusetts Commissioner of Banks.





Hampshire
First Bank bylaws provide that Meridian Interstate Bancorp may nominate or
appoint 40% of the directors of Hampshire First Bank for as long as it holds 40%
or more of the outstanding common stock of Hampshire First Bank.  In
addition, the Hampshire First Bank bylaws require that all matters requiring a
vote of the board of directors be approved by a two-thirds vote.  The
members of the Hampshire First Bank board appointed by Meridian Interstate
Bancorp also will appoint the Chairman of the Board.  As a result,
four of the 10 current directors of Hampshire First Bank also currently serve as
directors of Meridian Interstate Bancorp (Messrs. Del Rossi, Gavegnano, Lynch
and Verdonck) and Mr. Gavegnano, our Chairman of the Board and Chief Executive
Officer, also serves as Chairman of the Board of Hampshire First
Bank.  None of these four individuals has any agreements or contracts
with Meridian Interstate Bancorp regarding their duties or actions as directors
of Hampshire First Bank.





In the
future, we may realize gains from our investment in Hampshire First Bank from
the net income generated by the business of Hampshire First Bank and, possibly,
by the sale of this investment, although we have no current intention to sell
our investment.  In addition, we believe Hampshire First Bank will
provide us with a source of loans via loan participations.  Due to the
consolidation of financial institutions in New Hampshire and in Hampshire First
Bank’s primary market, Hillsborough County, New Hampshire, we believe there is a
significant opportunity for a community-focused bank to provide a full range of
financial services to small and middle-market commercial and retail
customers.  In addition, we believe Hampshire First Bank is led by a
qualified and experienced executive management team.  Because it is a
new enterprise with no operating history, however, we do not expect to record
substantial benefits from our investment in the near future.  As a
result of the start-up expenditures that a new bank must incur in relation to
total revenue generated, we expect that Hampshire First Bank will likely incur
operating losses during its initial years of operations.





Hampshire
First Bank’s loan portfolio consists primarily of multi-family and commercial
real estate, commercial business and construction loans.  At December
31, 2007, Hampshire First Bank had assets of $59.2 million, deposits of $32.1
million and equity of $26.7 million.  Meridian Interstate Bancorp
accounts for its investment in Hampshire First Bank by the equity method of
accounting under which Meridian Interstate Bancorp’s share of the net income or
loss of Hampshire First Bank is recognized as income or loss in Meridian
Interstate Bancorp’s consolidated financial statements.  At December
31, 2007, Meridian Interstate Bancorp had a $10.8 million investment in
Hampshire First Bank and during the years ended December 31, 2007 and 2006,
Meridian Interstate Bancorp recorded losses of $541,000 and $578,000,
respectively, from this investment.





East
Boston Savings Bank has one active wholly-owned subsidiary, Prospect, Inc., a
Massachusetts corporation.  Prospect was formed in 2000 to engage in
buying, selling and holding securities on its own behalf.  As a
Massachusetts securities corporation, the income earned on Prospect’s investment
securities is subject to a lower state tax rate than that assessed on income
earned on investment securities maintained at East Boston Savings
Bank.  At December 31, 2007, Prospect had total assets of $96.7
million and total equity of $96.4 million.





General
Regulation and Supervision





East
Boston Savings Bank is currently a Massachusetts-charted stock savings bank, and
is the wholly-owned subsidiary of Meridian Interstate Bancorp, a Massachusetts
corporation and registered bank holding company, which is a wholly-owned
subsidiary of Meridian Financial Services, a Massachusetts mutual holding
company and registered bank holding company. East Boston Savings Bank’s deposits
are insured up to applicable limits by the Federal Deposit Insurance Corporation
and by the Depositors Insurance Fund for amounts in excess of the Federal
Deposit Insurance Corporation insurance limits. East Boston Savings Bank is
subject to extensive regulation by the Massachusetts Commissioner of Banks, as
its chartering agency, and by the Federal Deposit Insurance Corporation, as its
deposit insurer. East Boston Savings Bank is required to file reports with, and
is periodically examined by, the Federal Deposit Insurance Corporation and the
Massachusetts Commissioner of Banks concerning its activities and financial
condition and must obtain regulatory approvals prior to entering into certain
transactions, including, but not limited to, mergers with or acquisitions of
other financial institutions.





The
regulation and supervision of East Boston Savings Bank establish a comprehensive
framework of activities in which an institution can engage and is intended
primarily for the protection of depositors and borrowers and, for purposes of
the Federal Deposit Insurance Corporation, the protection of the insurance
fund.  The regulatory


13


structure
also gives the regulatory authorities extensive discretion in connection with
their supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes.  Any change in
such regulatory requirements and policies, whether by the applicable state
legislature, the Federal Deposit Insurance Corporation or Congress, could have a
material adverse impact on Meridian Financial Services, Meridian Interstate
Bancorp or East Boston Savings Bank and their operations.  East Boston
Savings Bank is a member of the Federal Home Loan Bank of
Boston.  Meridian Interstate Bancorp and Meridian Financial Services
are regulated as bank holding companies by the Federal Reserve Board and the
Massachusetts Commissioner of Banks.





Certain
regulatory requirements applicable to East Boston Savings Bank, Meridian
Interstate Bancorp and Meridian Financial Services are referred to below or
elsewhere herein.  The description of statutory provisions and
regulations applicable to savings banks and their holding companies set forth
below and elsewhere in this document does not purport to be a complete
description of such statutes and regulations and their effects on East Boston
Savings Bank, Meridian Interstate Bancorp and Meridian Financial Services and is
qualified in its entirety by reference to the actual laws and regulations
involved.





State
Bank Regulation





General





As a
Massachusetts-chartered savings bank, East Boston Savings Bank is subject to
supervision, regulation and examination by the Massachusetts Commissioner of
Banks and to various Massachusetts statutes and regulations which govern, among
other things, investment powers, lending and deposit-taking activities,
borrowings, maintenance of surplus and reserve accounts, distribution of
earnings and payment of dividends. In addition, East Boston Savings Bank is
subject to Massachusetts consumer protection and civil rights laws and
regulations. The approval of the Massachusetts Commissioner of Banks or the
Board of Bank Incorporation is required for a Massachusetts-chartered bank to
establish or close branches, merge with other financial institutions, organize a
holding company, issue stock and undertake certain other
activities.





In
response to Massachusetts laws enacted in the last few years, the Massachusetts
Commissioner of Banks adopted rules that generally allow Massachusetts banks to
engage in activities permissible for federally chartered banks or banks
chartered by another state. The Commissioner also has adopted procedures
reducing regulatory burdens and expense and expediting branching by
well-capitalized and well-managed banks.





Investment
Activities





In
general, Massachusetts-chartered savings banks may invest in preferred and
common stock of any corporation organized under the laws of the United States or
any state provided such investments do not involve control of any corporation
and do not, in the aggregate, exceed 4.0% of the bank’s deposits.
Massachusetts-chartered savings banks may in addition invest an amount equal to
1.0% of their deposits in stocks of Massachusetts corporations or companies with
substantial employment in Massachusetts which have pledged to the Massachusetts
Commissioner of Banks that such monies will be used for further development
within the Commonwealth.  However, these powers are constrained by
federal law.  See “—Federal Bank Regulation—Investment
Activities” for federal restrictions on equity investments.





Loans to One Borrower
Limitations





Massachusetts
banking law grants broad lending authority. However, with certain limited
exceptions, total obligations of one borrower to a bank may not exceed 20.0% of
the total of the bank’s capital, which is defined under Massachusetts law as the
sum of the bank’s capital stock, surplus account and undivided
profits.





Loans to a Bank’s
Insiders





The
Massachusetts banking laws prohibit any executive officer, director or trustee
from borrowing, otherwise becoming indebted, or becoming liable for a loan or
other extension of credit by such bank to any other person, except for any of
the following loans or extensions of credit:  (i) loans or extension
of credit, secured or unsecured, to an officer of the bank in an amount not
exceeding $100,000; (ii) loans or extensions of credit intended or secured for
educational purposes to an officer of the bank in an amount not exceeding
$200,000; (iii) loans or extensions of credit secured by a mortgage on
residential real estate to be occupied in whole or in part by the officer to
whom the loan or extension of credit is made, in an amount not exceeding
$750,000; and (iv) loans or extensions of credit to a director or trustee of the
bank who is not also an officer of the bank in an amount permissible under the
bank’s loan


14


to one
borrower limit.  Massachusetts banking laws also prohibit officers and
directors from receiving a preferential interest rate or terms on loans or
extensions of credit.





The loans
listed above require approval of the majority of the members of East Boston
Savings Bank’s board of directors, excluding any member involved in the loan or
extension of credit. No such loan or extension of credit may be granted with an
interest rate or other terms that are preferential in comparison to loans
granted to persons not affiliated with the savings bank.





Dividends





A
Massachusetts stock bank may declare from net profits cash dividends not more
frequently than quarterly and non-cash dividends at any time. No dividends may
be declared, credited or paid if the bank’s capital stock is impaired. The
approval of the Massachusetts Commissioner of Banks is required if the total of
all dividends declared in any calendar year exceeds the total of its net profits
for that year combined with its retained net profits of the preceding two years.
Net profits for this purpose means the remainder of all earnings from current
operations plus actual recoveries on loans and investments and other assets
after deducting from the total thereof all current operating expenses, actual
losses, accrued dividends on preferred stock, if any, and all federal and state
taxes.





Regulatory
Enforcement Authority





Any
Massachusetts bank that does not operate in accordance with the regulations,
policies and directives of the Massachusetts Commissioner of Banks may be
subject to sanctions for non-compliance, including seizure of the property and
business of the bank and suspension or revocation of its charter. The
Massachusetts Commissioner of Banks may under certain circumstances suspend or
remove officers or directors who have violated the law, conducted the bank’s
business in a manner which is unsafe, unsound or contrary to the depositors
interests or been negligent in the performance of their duties. In addition,
upon finding that a bank has engaged in an unfair or deceptive act or practice,
the Massachusetts Commissioner of Banks may issue an order to cease and desist
and impose a fine on the bank concerned. Finally, Massachusetts consumer
protection and civil rights statutes applicable to East Boston Savings Bank
permit private individual and class action law suits and provide for the
rescission of consumer transactions, including loans, and the recovery of
statutory and punitive damage and attorney’s fees in the case of certain
violations of those statutes.





Depositors Insurance
Fund





All
Massachusetts-chartered savings banks are required to be members of the
Depositors Insurance Fund, a corporation that insures savings bank deposits in
excess of federal deposit insurance coverage. The Depositors Insurance Fund is
authorized to charge savings banks an annual assessment of up to 1/50th of 1.0%
of a savings bank’s deposit balances in excess of amounts insured by the Federal
Deposit Insurance Corporation.





Massachusetts
has other statutes and regulations that are similar to the federal provisions
discussed below.





Federal
Bank Regulation





Capital Requirements





Under
Federal Deposit Insurance Corporation’s regulations, federally insured
state-chartered banks that are not members of the Federal Reserve System (“state
non-member banks”), such as East Boston Savings Bank, are required to comply
with minimum leverage capital requirements. For an institution determined by the
Federal Deposit Insurance Corporation to not be anticipating or experiencing
significant growth and to be, in general, a strong banking organization rated
composite 1 under Uniform Financial Institutions Ranking System established by
the Federal Financial Institutions Examination Council, the minimum capital
leverage requirement is a ratio of Tier 1 capital to total assets of 3.0%. For
all other institutions, the minimum leverage capital ratio is not less than
4.0%. Tier 1 capital is the sum of common stockholder’s equity, non-cumulative
perpetual preferred stock (including any related surplus) and minority
investments in certain subsidiaries, less intangible assets (except for certain
servicing rights and credit card relationships) and certain other specified
items.





The
Federal Deposit Insurance Corporation regulations require state non-member banks
to maintain certain levels of regulatory capital in relation to regulatory
risk-weighted assets. The ratio of regulatory capital to regulatory
risk-weighted assets is referred to as a bank’s “risk-based capital ratio.”
Risk-based capital ratios are determined by allocating assets and specified
off-balance sheet items (including recourse obligations, direct credit
substitutes and residual interests) to four risk-weighted categories ranging
from 0.0% to 100.0%, with higher levels of capital being


15


required
for the categories perceived as representing greater risk. For example, under
the Federal Deposit Insurance Corporation’s risk-weighting system, cash and
securities backed by the full faith and credit of the U.S. government are given
a 0.0% risk weight, loans secured by one- to four-family residential properties
generally have a 50.0% risk weight, and commercial loans have a risk weighting
of 100.0%.





State
non-member banks must maintain a minimum ratio of total capital to risk-weighted
assets of at least 8.0%, of which at least one-half must be Tier 1 capital.
Total capital consists of Tier 1 capital plus Tier 2 or supplementary capital
items, which include allowances for loan losses in an amount of up to 1.25% of
risk-weighted assets, cumulative preferred stock and certain other capital
instruments, and a portion of the net unrealized gain on equity
securities.  The includable amount of Tier 2 capital cannot exceed the
amount of the institution’s Tier 1 capital. Banks that engage in specified
levels of trading activities are subject to adjustments in their risk based
capital calculation to ensure the maintenance of sufficient capital to support
market risk.





The
Federal Deposit Insurance Corporation Improvement Act  required each
federal banking agency to revise its risk-based capital standards for insured
institutions to ensure that those standards take adequate account of
interest-rate risk, concentration of credit risk, and the risk of nontraditional
activities, as well as to reflect the actual performance and expected risk of
loss on multi-family residential loans. The Federal Deposit Insurance
Corporation, along with the other federal banking agencies, has adopted a
regulation providing that the agencies will take into account the exposure of a
bank’s capital and economic value to changes in interest rate risk in assessing
a bank’s capital adequacy. The Federal Deposit Insurance Corporation also has
authority to establish individual minimum capital requirements in appropriate
cases upon determination that an institution’s capital level is, or is likely to
become, inadequate in light of the particular circumstances.





As bank
holding companies, Meridian Financial Services and Meridian Interstate Bancorp
are subject to capital adequacy guidelines for bank holding companies
substantially similar to those of the Federal Deposit Insurance Corporation for
state-chartered savings banks.  On a pro forma consolidated basis,
Meridian Financial Services and Meridian Interstate Bancorp exceed those
requirements.





Standards for
Safety and Soundness





As
required by statute, the federal banking agencies adopted final regulations and
Interagency Guidelines Establishing Standards for Safety and Soundness to
implement safety and soundness standards. The guidelines set forth the safety
and soundness standards that the federal banking agencies use to identify and
address problems at insured depository institutions before capital becomes
impaired. The guidelines address internal controls and information systems,
internal audit system, credit underwriting, loan documentation, interest rate
exposure, asset growth, asset quality, earnings and compensation, fees and
benefits. Most recently, the agencies have established standards for
safeguarding customer information. If the appropriate federal banking agency
determines that an institution fails to meet any standard prescribed by the
guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard.





Investment
Activities





Since the
enactment of Federal Deposit Insurance Corporation Improvement Act, all
state-chartered Federal Deposit Insurance Corporation-insured banks and savings
banks have generally been limited in their investment activities to principal
and equity investments of the type and in the amount authorized for national
banks, notwithstanding state law. Federal Deposit Insurance Corporation
Improvement Act and the Federal Deposit Insurance Corporation regulations permit
exceptions to these limitations. For example, state chartered banks may, with
Federal Deposit Insurance Corporation approval, continue to exercise state
authority to invest in common or preferred stocks listed on a national
securities exchange or the NASDAQ National Market and in the shares of an
investment company registered under the Investment Company Act of 1940, as
amended. The maximum permissible investment is 100.0% of Tier 1 Capital, as
specified by the Federal Deposit Insurance Corporation’s regulations, or the
maximum amount permitted by Massachusetts law, whichever is less. East Boston
Savings Bank received approval from the Federal Deposit Insurance Corporation to
retain and acquire such equity instruments equal to the lesser of 100.0% of East
Boston Savings Banks’ Tier 1 capital or the maximum permissible amount specified
by Massachusetts law.  Any such grandfathered authority may be
terminated upon the Federal Deposit Insurance Corporation’s determination that
such investments pose a safety and soundness risk or upon the occurrence of
certain events such as the savings bank’s conversion to a different charter. In
addition, the Federal Deposit Insurance Corporation is authorized to permit such
institutions to engage in state authorized activities or investments not
permissible for national banks (other than non-subsidiary equity investments) if
they meet all applicable capital requirements and it is determined that such
activities or investments do not pose a significant risk to the deposit
insurance fund. The Federal Deposit Insurance Corporation has adopted
regulations governing the procedures for institutions seeking


16


approval
to engage in such activities or investments. The Gramm-Leach-Bliley Act of 1999
specifies that a non-member bank may control a subsidiary that engages in
activities as principal that would only be permitted for a national bank to
conduct in a “financial subsidiary” if a bank meets specified conditions and
deducts its investment in the subsidiary for regulatory capital
purposes.





Interstate Banking and
Branching





The
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, or the
Interstate Banking Act, permits adequately capitalized and managed bank holding
companies to acquire banks in any state subject to specified concentration
limits and other conditions. The Interstate Banking Act also authorizes the
interstate merger of banks. In addition, among other things, the Interstate
Banking Act permits banks to establish new branches on an interstate basis
provided that such action is specifically authorized by the law of the host
state.





Prompt Corrective Regulatory
Action





Federal
law requires, among other things, that federal bank regulatory authorities take
“prompt corrective action” with respect to banks that do not meet minimum
capital requirements. For these purposes, the law establishes five capital
categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized.





The
Federal Deposit Insurance Corporation has adopted regulations to implement the
prompt corrective action legislation. An institution is deemed to be “well
capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a
Tier 1 risk-based capital ratio of 6.0% or greater and a leverage ratio of 5.0%
or greater. An institution is “adequately capitalized” if it has a total
risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio
of 4.0% or greater, and generally a leverage ratio of 4.0% or greater. An
institution is “undercapitalized” if it has a total risk-based capital ratio of
less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or
generally a leverage ratio of less than 4.0%. An institution is deemed to be
“significantly undercapitalized” if it has a total risk-based capital ratio of
less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0%, or a
leverage ratio of less than 3.0%. An institution is considered to be “critically
undercapitalized” if it has a ratio of tangible equity (as defined in the
regulations) to total assets that is equal to or less than 2.0%.





“Undercapitalized”
banks must adhere to growth, capital distribution (including dividend) and other
limitations and are required to submit a capital restoration plan. A bank’s
compliance with such a plan is required to be guaranteed by any company that
controls the undercapitalized institution in an amount equal to the lesser of
5.0% of the institution’s total assets when deemed undercapitalized or the
amount necessary to achieve the status of adequately capitalized. If an
“undercapitalized” bank fails to submit an acceptable plan, it is treated as if
it is “significantly undercapitalized.” “Significantly undercapitalized” banks
must comply with one or more of a number of additional restrictions, including
but not limited to an order by the Federal Deposit Insurance Corporation to sell
sufficient voting stock to become adequately capitalized, requirements to reduce
total assets, cease receipt of deposits from correspondent banks or dismiss
directors or officers, and restrictions on interest rates paid on deposits,
compensation of executive officers and capital distributions by the parent
holding company. “Critically undercapitalized” institutions are subject to
additional measures including, subject to a narrow exception, the appointment of
a receiver or conservator within 270 days after it obtains such
status.  No institution may make any capital distribution if it would
be undercapitalized on a pro forma basis.





Transactions
with Affiliates





Transactions
between banks and their affiliates are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a bank is any company or entity that
controls, is controlled by or is under common control with the bank. In a
holding company context, the parent bank holding company and any companies that
are controlled by such parent holding company are affiliates of the subsidiary
bank. Generally, Sections 23A and 23B of the Federal Reserve Act and Regulation
W (i) limit the extent to which the bank or its subsidiaries may engage in
“covered transactions” with any one affiliate to an amount equal to 10.0% of
such institution’s capital stock and surplus, and contain an aggregate limit on
all such transactions with all affiliates to an amount equal to 20.0% of such
institution’s capital stock and surplus and (ii) require that all such
transactions be on terms substantially the same, or at least as favorable, to
the institution or subsidiary as those provided to a non-affiliate. The term
“covered transaction” includes the making of loans, purchase of assets, issuance
of a guarantee and other similar transactions. Loans or other extensions of
credit by the financial institution to the affiliate are required to be
collateralized in accordance with the requirements set forth in Section 23A of
the Federal Reserve Act and no low quality assets may generally be purchased
from affiliates.


17


The
Sarbanes-Oxley Act of 2002 generally prohibits loans by a company to its
executive officers and directors.  However, the law contains a
specific exception for loans by a depository institution to its executive
officers and directors in compliance with federal banking laws.  Under
such laws, East Boston Savings Bank’s authority to extend credit to executive
officers, directors and 10% shareholders (“insiders”), as well as entities such
persons control, is limited.  The law limits both the individual and
aggregate amount of loans East Boston Savings Bank may make to insiders based,
in part, on East Boston Savings Bank’s capital position and requires certain
board approval procedures to be followed.  Such loans are required to
be made on terms substantially the same as those offered to unaffiliated
individuals and not involve more than the normal risk of
repayment.  There is an exception for loans made pursuant to a benefit
or compensation program that is widely available to all employees of the
institution and does not give preference to insiders over other
employees.  Loans to executive officers are further limited by
specific categories of loans that may be made.  The federal
restrictions on insider lending are in addition to those imposed by state
law.





Enforcement





The
Federal Deposit Insurance Corporation has extensive enforcement authority over
insured nonmember banks, including East Boston Savings Bank. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, issue cease and desist orders and remove directors and officers. In
general, these enforcement actions may be initiated in response to violations of
laws and regulations and unsafe or unsound practices. The Federal Deposit
Insurance Corporation has authority under federal law to appoint a conservator
or receiver for an insured bank under limited circumstances. The Federal Deposit
Insurance Corporation is required, with certain exceptions, to appoint a
receiver or conservator for an insured state non-member bank if that bank was
“critically undercapitalized” on average during the calendar quarter beginning
270 days after the date on which the institution became “critically
undercapitalized.” The Federal Deposit Insurance Corporation may also appoint
itself as conservator or receiver for an insured state non-member institution
under specific circumstances on the basis of the institution’s financial
condition or upon the occurrence of other events, including: (1) insolvency; (2)
substantial dissipation of assets or earnings through violations of law or
unsafe or unsound practices; (3) existence of an unsafe or unsound condition to
transact business; and (4) insufficient capital, or the incurring of losses that
will deplete substantially all of the institution’s capital with no reasonable
prospect of replenishment without federal assistance.





Insurance
of Deposit Accounts





The
deposits of East Boston Savings Bank are insured up to applicable limits by the
Deposit Insurance Fund of the Federal Deposit Insurance
Corporation.  The Deposit Insurance Fund is the successor to the Bank
Insurance Fund and the Savings Association Insurance Fund, which were merged in
2006.  The Federal Deposit Insurance Corporation recently amended its
risk-based assessment system for 2007 to implement authority granted by the
Federal Deposit Insurance Reform Act of 2005 (“Reform Act”).  Under
the revised system, insured institutions are assigned to one of four risk
categories based on supervisory evaluations, regulatory capital levels and
certain other factors.  An institution’s assessment rate depends upon
the category to which it is assigned.  Risk category I, which contains
the least risky depository institutions, is expected to include more than 90% of
all institutions.  Unlike the other categories, Risk Category I
contains further risk differentiation based on the Federal Deposit Insurance
Corporation’s analysis of financial ratios, examination component ratings and
other information.  Assessment rates are determined by the Federal
Deposit Insurance Corporation and currently range from five to seven basis
points for the healthiest institutions (Risk Category I) to 43 basis points of
assessable deposits for the riskiest (Risk Category IV).  The Federal
Deposit Insurance Corporation may adjust rates uniformly from one quarter to the
next, except that no single adjustment can exceed three basis
points.  No insured institution may make a capital distribution if in
default of its Federal Deposit Insurance Corporation assessment.





The
Reform Act also provided for a one-time credit for eligible institutions based
on their assessment base as of December 31, 1996.  Subject to certain
limitations with respect to institutions that are exhibiting weaknesses, credits
can be used to offset assessments until exhausted.  East Boston
Savings Bank’s one-time credit approximated $539,000, with $130,000 remaining at
December 31, 2007.  The Reform Act also provided for the possibility
that the Federal Deposit Insurance Corporation may pay dividends to insured
institutions once the Deposit Insurance fund reserve ratio equals or exceeds
1.35% of estimated insured deposits.





In
addition to the assessment for deposit insurance, institutions are required to
make payments on bonds issued in the late 1980s by the Financing Corporation to
recapitalize a predecessor deposit insurance fund.  This payment is
established quarterly and during the year ending December 31, 2007 averaged 5.67
basis points of assessable deposits.


18





The
Reform Act provided the Federal Deposit Insurance Corporation with authority to
adjust the Deposit Insurance Fund ratio to insured deposits within a range of
1.15% and 1.50%, in contrast to the prior statutorily fixed ratio of
1.25%.  The ratio, which is viewed by the Federal Deposit Insurance
Corporation as the level that the fund should achieve, was established by the
agency at 1.25% for 2007.





The
Federal Deposit Insurance Corporation has authority to increase insurance
assessments.  A significant increase in insurance premiums would
likely have an adverse effect on the operating expenses and results of
operations of East Boston Savings Bank.  Management cannot predict
what insurance assessment rates will be in the future.





The
Federal Deposit Insurance Corporation may terminate insurance of deposits if it
finds that the institution is in an unsafe or unsound condition to continue
operations, has engaged in unsafe or unsound practices, or has violated any
applicable law, regulation, rule, order or condition imposed by the Federal
Deposit Insurance Corporation. The management of East Boston Savings Bank does
not know of any practice, condition or violation that might lead to termination
of deposit insurance.





Privacy
Regulations





Pursuant
to the Gramm-Leach-Bliley Act, the Federal Deposit Insurance Corporation has
published final regulations implementing the privacy protection provisions of
the Gramm-Leach-Bliley Act. The regulations generally require that insured banks
disclose their privacy policies, including identifying with whom a customer’s
“non-public personal information” is shared, to customers at the time of
establishing the customer relationship and annually thereafter. In addition,
customers are required to be given the ability to “opt-out” of having their
personal information shared with unaffiliated third parties.





Community
Reinvestment Act





Pursuant
to the Community Reinvestment Act, (“CRA”), and similar provision of
Massachusetts law, a bank has a continuing and affirmative obligation,
consistent with its safe and sound operation, to help meet the credit needs of
its entire community, including low and moderate income neighborhoods. The CRA
does not establish specific lending requirements or programs for financial
institutions nor does it limit an institution’s discretion to develop the types
of products and services that it believes are best suited to its particular
community, consistent with the CRA. The CRA does require the Federal Deposit
Insurance Corporation, in connection with its examination of a bank, to assess
the institution’s record of meeting the credit needs of its community and to
take such record into account in its evaluation of certain applications by such
institution, including applications to acquire branches and other financial
institutions. The CRA requires the Federal Deposit Insurance Corporation to
provide a written evaluation of an institution’s CRA performance utilizing a
four-tiered descriptive rating system. East Boston Savings Bank’s latest Federal
Deposit Insurance Corporation CRA rating was “Outstanding.”


The
Massachusetts version is generally similar to the CRA but utilizes a five-tiered
descriptive rating system. Massachusetts law requires the Massachusetts
Commissioner of Banks to consider, but not be limited to, a bank’s record of
performance under Massachusetts law in considering any application by the bank
to establish a branch or other deposit-taking facility, to relocate an office or
to merge or consolidate with or acquire the assets and assume the liabilities of
any other banking institution. East Boston Savings Bank’s most recent rating
under Massachusetts law was “Outstanding.”


Consumer Protection and Fair Lending
Regulations





Massachusetts
savings banks are subject to a variety of federal and Massachusetts statutes and
regulations that are intended to protect consumers and prohibit discrimination
in the granting of credit. These statutes and regulations provide for a range of
sanctions for non-compliance with their terms, including imposition of
administrative fines and remedial orders, and referral to the Attorney General
for prosecution of a civil action for actual and punitive damages and injunctive
relief. Certain of these statutes authorize private individual and class action
lawsuits and the award of actual, statutory and punitive damages and
attorney’s
fees for certain types of violations.





Anti-Money
Laundering





USA Patriot Act of
2001





The
Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT
Act”) significantly expanded the responsibilities of


19


financial
institutions, including banks, in preventing the use of the U.S. financial
system to fund terrorist activities.  Title III of the USA PATRIOT Act
provides for a significant overhaul of the U.S. anti-money laundering
regime.  Among other provisions, Title III of the USA PATRIOT Act
requires financial institutions operating in the United States to develop new
anti-money laundering compliance programs, due diligence policies and controls
to ensure the detection and reporting of money laundering.  Such
required compliance programs are intended to supplement existing compliance
requirements, also applicable to financial institutions, under the Bank Secrecy
Act and the Office of Foreign Assets Control Regulations.





Other
Regulations





Interest
and other charges collected or contracted for by East Boston Savings Bank are
subject to state usury laws and federal laws concerning interest
rates.  Loan operations are also subject to state and federal laws
applicable to credit transactions, such as the:




·
            Home
      Mortgage Disclosure Act of 1975, requiring financial institutions to
      provide information to enable the public and public officials to determine
      whether a financial institution is fulfilling its obligation to help meet
      the housing needs of the community it
serves;





·
            Equal
      Credit Opportunity Act, prohibiting discrimination on the basis of race,
      creed or other prohibited factors in extending
  credit;





·
            Fair
      Credit Reporting Act of 1978, governing the use and provision of
      information to credit reporting
agencies;





·
            Massachusetts
      Debt Collection Regulations, establishing standards, by defining unfair or
      deceptive acts or practices, for the collection of debts from persons
      within the Commonwealth of Massachusetts and the General Laws of
      Massachusetts, Chapter 167E, which governs East Boston Savings Bank’s
      lending powers; and





·
            Rules
      and regulations of the various federal and state agencies charged with the
      responsibility of implementing such federal and state
  laws.







The
deposit operations of East Boston Savings Bank also are subject to, among
others, the:




·
            Right
      to Financial Privacy Act, which imposes a duty to maintain confidentiality
      of consumer financial records and prescribes procedures for complying with
      administrative subpoenas of financial
records;





·
            Check
      Clearing for the 21st Century Act (also known as “Check 21”), which gives
      “substitute checks,” such as digital check images and copies made from
      that image, the same legal standing as the original paper check;
      and





·
            Electronic
      Funds Transfer Act and Regulation E promulgated thereunder, and, as to
      East Boston Savings Bank Chapter 167B of the General Laws of
      Massachusetts, which govern automatic deposits to and withdrawals from
      deposit accounts and customers’ rights and liabilities arising from the
      use of automated teller machines and other electronic banking
      services;





·
            General
      Laws of Massachusetts, Chapter 167D, which governs East Boston Savings
      Bank’s deposit powers.





Federal
Reserve System





The
Federal Reserve Board regulations require depository institutions to maintain
non-interest-earning reserves against their transaction accounts (primarily NOW
and regular checking accounts). East Boston Savings Bank is in compliance with
these requirements.





Federal
Home Loan Bank System





East
Boston Savings Bank is a member of the Federal Home Loan Bank System, which
consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank
provides a central credit facility primarily for member institutions. Members of
the Federal Home Loan Bank are required to acquire and hold shares of capital
stock in the Federal Home Loan Bank. East Boston Savings Bank was in compliance
with this requirement with an investment in stock of the Federal Home Loan Bank
of Boston at December 31, 2007 of $3.2 million.


20





The
Federal Home Loan Banks are required to provide funds for certain purposes
including the resolution of insolvent thrifts in the late 1980s and to
contributing funds for affordable housing programs. These requirements could
reduce the amount of dividends that the Federal Home Loan Banks pay to their
members and result in the Federal Home Loan Banks imposing a higher rate of
interest on advances to their members.  If dividends were reduced, or
interest on future Federal Home Loan Bank advances increased, a member bank
affected by such reduction or increase would likely experience a reduction in
its net interest income. There can be no assurance that such dividends will
continue in the future. Further, there can be no assurance that the impact of
recent or future legislation on the Federal Home Loan Banks also will not cause
a decrease in the value of the Federal Home Loan Bank of Boston stock held by
East Boston Savings Bank.





Holding
Company Regulation





Meridian
Interstate Bancorp and Meridian Financial Services are subject to examination,
regulation, and periodic reporting under the Bank Holding Company Act of 1956,
as amended, as administered by the Federal Reserve Board.  Meridian
Interstate Bancorp and Meridian Financial Services are required to obtain the
prior approval of the Federal Reserve Board to acquire all, or substantially
all, of the assets of any bank or bank holding company. Prior Federal Reserve
Board approval would be required for Meridian Interstate Bancorp or Meridian
Financial Services to acquire direct or indirect ownership or control of any
voting securities of any bank or bank holding company if, after such
acquisition, it would, directly or indirectly, own or control more than 5% of
any class of voting shares of the bank or bank holding company. In addition to
the approval of the Federal Reserve Board, prior approval may also be necessary
from other agencies having supervisory jurisdiction over the bank to be acquired
before any bank acquisition can be completed.





A bank
holding company is generally prohibited from engaging in non-banking activities,
or acquiring, direct or indirect control of more than 5% of the voting
securities of any company engaged in non-banking activities. One of the
principal exceptions to this prohibition is for activities found by the Federal
Reserve Board to be so closely related to banking or managing or controlling
banks as to be a proper incident thereto. Some of the principal activities that
the Federal Reserve Board has determined by regulation to be so closely related
to banking are: (i) making or servicing loans; (ii) performing certain data
processing services; (iii) providing discount brokerage services; (iv) acting as
fiduciary, investment or financial advisor; (v) leasing personal or real
property; (vi) making investments in corporations or projects designed primarily
to promote community welfare; and (vii) acquiring a savings and loan association
whose direct and indirect activities are limited to those permitted for bank
holding companies.




The
Gramm-Leach-Bliley Act of 1999 authorizes a bank holding company that meets
specified conditions, including being “well capitalized” and “well managed,” to
opt to become a “financial holding company” and thereby engage in a broader
array of financial activities than previously permitted. Such activities can
include insurance underwriting and investment banking.




Meridian
Interstate Bancorp and Meridian Financial Services are subject to the Federal
Reserve Board’s capital adequacy guidelines for bank holding companies (on a
consolidated basis) substantially similar to those of the Federal Deposit
Insurance Corporation for East Boston Savings Bank.




A bank
holding company is generally required to give the Federal Reserve Board prior
written notice of any purchase or redemption of then outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, is equal to 10% or more of the company’s
consolidated net worth. The Federal Reserve Board may disapprove such a purchase
or redemption if it determines that the proposal would constitute an unsafe and
unsound practice, or would violate any law, regulation, Federal Reserve Board
order or directive, or any condition imposed by, or written agreement with, the
Federal Reserve Board. The Federal Reserve Board has adopted an exception to
this approval requirement for well-capitalized bank holding companies that meet
certain other conditions.




The
Federal Reserve Board has issued a policy statement regarding the payment of
dividends by bank holding companies. In general, the Federal Reserve Board’s
policies provide that dividends should be paid only out of current earnings and
only if the prospective rate of earnings retention by the bank holding company
appears consistent with the organization’s capital needs, asset quality and
overall financial condition. The Federal Reserve Board’s policies also require
that a bank holding company serve as a source of financial strength to its
subsidiary banks by standing ready to use available resources to provide
adequate capital funds to those banks during periods of financial stress or
adversity and by maintaining the financial flexibility and capital-raising
capacity to obtain additional resources for assisting its subsidiary banks where
necessary. Under the prompt corrective action laws, the ability of a bank
holding company to pay dividends may be restricted if a subsidiary bank becomes
undercapitalized.




21


These
regulatory policies could affect the ability of Meridian Interstate Bancorp or
Meridian Financial Services to pay dividends or otherwise engage in capital
distributions.




Under the
Federal Deposit Insurance Act, depository institutions are liable to the Federal
Deposit Insurance Corporation for losses suffered or anticipated by the Federal
Deposit Insurance Corporation in connection with the default of a commonly
controlled depository institution or any assistance provided by the Federal
Deposit Insurance Corporation to such an institution in danger of
default.




The
status of Meridian Interstate Bancorp and Meridian Financial Services as
registered bank holding companies under the Bank Holding Company Act does not
exempt them from certain federal and state laws and regulations applicable to
corporations generally, including, without limitation, certain provisions of the
federal securities laws.




Meridian
Interstate Bancorp, Meridian Financial Services and East Boston Savings Bank
will be affected by the monetary and fiscal policies of various agencies of the
United States Government, including the Federal Reserve System. In view of
changing conditions in the national economy and in the money markets, it is
impossible for management to accurately predict future changes in monetary
policy or the effect of such changes on the business or financial condition of
Meridian Interstate Bancorp, Meridian Financial Services or East Boston Savings
Bank.




Massachusetts
Holding Company Regulation




Under the
Massachusetts banking laws, a company owning or controlling two or more banking
institutions, including a savings bank, is regulated as a bank holding company.
The term “company” is defined by the Massachusetts banking laws similarly to the
definition of “company” under the Bank Holding Company Act. Each Massachusetts
bank holding company: (i) must obtain the approval of the Massachusetts Board of
Bank Incorporation before engaging in certain transactions, such as the
acquisition of more than 5% of the voting stock of another banking institution;
(ii) must register, and file reports, with the Division; and (iii) is subject to
examination by the Division.  In addition, a Massachusetts mutual
holding company: (i) may invest in the stock of one or more banking
institutions; (ii) may merge with or acquire a mutual banking institution; (iii)
may merge with or acquire another bank holding company provided that any such
holding company has a subsidiary banking institution; (iv) may invest in a
corporation; (v) must register, and file reports, with the Division; (vi) may
engage directly or indirectly only in activities permitted by law for a
Massachusetts bank holding company; and (vii) may take any action with respect
to any securities of any subsidiary banking institution which are held by such
mutual holding company.  Meridian Interstate Bancorp and Meridian
Financial Services are registered Massachusetts bank holding
companies.




Federal
Securities Laws




Our
common stock is registered with the Securities and Exchange Commission under
Section 12(b) of the Securities Exchange Act of 1934, as amended.  We
are subject to information, proxy solicitation, insider trading restrictions,
and other requirements under the Exchange Act.




Sarbanes-Oxley
Act of 2002




The
Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance,
auditing and accounting, executive compensation, and enhanced and timely
disclosure of corporate information. As directed by the Sarbanes-Oxley Act of
2002, Meridian Interstate Bancorp’s and Meridian Financial Services’ Chief
Executive Officer and Chief Financial Officer each will be required to certify
that Meridian Interstate Bancorp’s and Meridian Financial Services’ quarterly
and annual reports do not contain any untrue statement of a material
fact.  The rules adopted by the Securities and Exchange Commission
under the Sarbanes-Oxley Act of 2002 have several requirements, including having
these officers certify that: they are responsible for establishing, maintaining
and regularly evaluating the effectiveness of our internal controls; they have
made certain disclosures to our auditors and the audit committee of the board of
directors about our internal controls; and they have included information in our
quarterly and annual reports about their evaluation and whether there have been
significant changes in our internal controls or in other factors that could
significantly affect internal controls.  Meridian Interstate Bancorp
and Meridian Financial Services will be subject to further reporting and audit
requirements beginning with the year ending December 31, 2008 under the
requirements of the Sarbanes-Oxley Act.  Meridian Interstate Bancorp
and Meridian Financial Services will prepare policies, procedures, and systems
designed to ensure the Company achieves compliance with these
regulations.




22


Federal
Income Taxation




General




East
Boston Savings Bank reports its income on a calendar year basis using the
accrual method of accounting.  The federal income tax laws apply to
East Boston Savings Bank in the same manner as to other corporations with some
exceptions, including the reserve for bad debts discussed below.  The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to East
Boston Savings Bank.  East Boston Savings Bank’s federal income tax
returns have been either audited or closed under the statute of limitations
through December 31, 2001.  For its 2007 tax year, East Boston Savings
Bank’s maximum federal income tax rate was 34%.




Bad Debt
Reserves




For
taxable years beginning before January 1, 1996, thrift institutions that
qualified under certain definitional tests and other conditions of the Internal
Revenue Code were permitted to use certain favorable provisions to calculate
their deductions from taxable income for annual additions to their bad debt
reserve. A reserve could be established for bad debts on qualifying real
property loans, generally secured by interests in real property improved or to
be improved, under the percentage of taxable income method or the experience
method.  The reserve for non-qualifying loans was computed using the
experience method.  Federal legislation enacted in 1996 repealed the
reserve method of accounting for bad debts and the percentage of taxable income
method for tax years beginning after 1995 and required savings institutions to
recapture or take into income certain portions of their accumulated bad debt
reserves.  However, those bad debt reserves accumulated prior to 1988
(“Base Year Reserves”) were not required to be recaptured unless the savings
institution failed certain tests.  Approximately $7.5 million of East
Boston Savings Bank’s accumulated bad debt reserves would not be recaptured into
taxable income unless East Boston Savings Bank makes a “non-dividend
distribution” to Meridian Interstate Bancorp as described below.




Distributions




If East
Boston Savings Bank makes “non-dividend distributions” to Meridian Interstate
Bancorp, the distributions will be considered to have been made from East Boston
Savings Bank’s un-recaptured tax bad debt reserves, including the balance of its
Base Year Reserves as of December 31, 1987, to the extent of the “non-dividend
distributions,” and then from East Boston Savings Bank’s supplemental reserve
for losses on loans, to the extent of those reserves, and an amount based on the
amount distributed, but not more than the amount of those reserves, will be
included in East Boston Savings Bank’s taxable income. Non-dividend
distributions include distributions in excess of East Boston Savings Bank’s
current and accumulated earnings and profits, as calculated for federal income
tax purposes, distributions in redemption of stock and distributions in partial
or complete liquidation.  Dividends paid out of East Boston Savings
Bank’s current or accumulated earnings and profits will not be so included in
Meridian Interstate Bancorp’s taxable income.




The
amount of additional taxable income triggered by a non-dividend is an amount
that, when reduced by the tax attributable to the income, is equal to the amount
of the distribution.  Therefore, if East Boston Savings Bank makes a
non-dividend distribution to Meridian Interstate Bancorp, approximately one and
one-half times the amount of the distribution not in excess of the amount of the
reserves would be includable in income for federal income tax purposes, assuming
a 34% federal corporate income tax rate.  East Boston Savings Bank
does not intend to pay dividends that would result in a recapture of any portion
of its bad debt reserves.




State
Taxation





Financial
institutions in Massachusetts are not allowed to file consolidated income tax
returns.  Instead, each entity in the consolidated group files a
separate annual income tax return.  The Massachusetts excise tax rate
for savings banks is currently 10.5% of federal taxable income, adjusted for
certain items.  Taxable income includes gross income as defined under
the Internal Revenue Code, plus interest from bonds, notes and evidences of
indebtedness of any state, including Massachusetts, less deductions, but not the
credits, allowable under the provisions of the Internal Revenue Code, except for
those deductions relating to dividends received and income or franchise taxes
imposed by a state or political subdivision.  Carryforwards and
carrybacks of net operating losses and capital losses are not allowed. East
Boston Savings Bank’s state tax returns, as well as those of its subsidiary, are
not currently under audit.




A
financial institution or business corporation is generally entitled to special
tax treatment as a “security corporation” under Massachusetts law provided that:
(a) its activities are limited to buying, selling, dealing in or holding
securities on its own behalf and not as a broker; and (b) it has applied for,
and received, classification as a “security corporation” by the Commissioner of
the Massachusetts Department of Revenue.  A security corporation that
is also a bank holding company under the Internal Revenue Code must pay a tax
equal to 0.33% of its gross income.  A security corporation that is
not a bank holding company under the Internal Revenue Code must pay a
tax


23


equal to
1.32% of its gross income.  Meridian Interstate Bancorp is considering
whether to seek to qualify as a security corporation.  To do so, it
would need to (a) apply for, and receive, security corporation classification by
the Massachusetts Department of Revenue; and (b) not conduct any activities
deemed impermissible under the governing statutes and the various regulations,
directives, letter rulings and administrative pronouncements issued by the
Massachusetts Department of Revenue.  In order to qualify as a
security corporation, it would need to establish a subsidiary for the purpose of
making the loan to the employee stock ownership plan, since making such a loan
directly could disqualify it from classification as a security
corporation.





Item 1a.  risk
factors





There
have been no material changes to the Risk Factors disclosed in our Prospectus
filed with the Securities and Exchange Commission on November 27, 2007 (File No.
333-146373) pursuant to Rule 424(b)(3) of the Securities Act of 1933, as
amended.







Item 1b.  unresolved staff
comments





Not
applicable.








Item 2.  properties





At
December 31, 2007, we conducted business through our eleven full service offices
and one loan center located in East Boston, Everett, Lynnfield, Melrose,
Peabody, Revere, Saugus and Winthrop, Massachusetts.  In July 2007 we
opened a branch office in Lynn, Massachusetts.  We own all of our
offices except our Saugus (Village Park) office (subject to a renewable lease
that expires in 2012).  At December 31, 2007, the total net book value
of our land, buildings, furniture, fixtures and equipment was $22.8
million.  In 2008, the Bank entered into an agreement to lease
property in Wakefield, Massachusetts with the intent of establishing a new
branch location.








Item
3.  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
4.  submission of matters to a
vote of security holders





During
the fourth quarter of the fiscal year covered by this report, we did not submit
any matters to the vote of security holders.








24


part
ii





Item
5.  market
for registrant’s common equity, related stockholder matters and issuer purchases
of equity securities





(a)           Our
shares of common stock are traded on the NASDAQ Global Select Market under the
symbol “EBSB”.  The approximate number of holders of record of
Meridian Interstate Bancorp, Inc.’s common stock as of March 31, 2008 was
703.  Certain shares of Meridian Interstate Bancorp, Inc. are held in
“nominee” or “street” name and accordingly, the number of beneficial owners of
such shares is not known or included in the foregoing number. Meridian
Interstate Bancorp, Inc. common stock began trading on the NASDAQ Global Select
Market on January 23, 2008. Accordingly, no information prior to this date is
available.




Meridian
Interstate Bancorp has not yet determined whether it will pay a dividend on the
common stock.  The board of directors will consider a policy of paying
regular cash dividends.  The board of directors may declare and pay
periodic special cash dividends in addition to, or in lieu of, regular cash
dividends.  In determining whether to declare or pay any dividends,
whether regular or special, the board of directors will take into account our
financial condition and results of operations, tax considerations, capital
requirements, industry standards, and economic conditions.  The
regulatory restrictions that affect the payment of dividends by East Boston
Savings Bank to us discussed below also will be considered.  We cannot
guarantee that we will pay dividends or that, if paid, we will not reduce or
eliminate dividends in the future.





If
Meridian Interstate Bancorp pays dividends to its shareholders, it will be
required to pay dividends to Meridian Financial Services. The Federal Reserve
Board’s current policy prohibits the waiver of dividends by mutual holding
companies.  In addition, Massachusetts banking regulations prohibit
Meridian Financial Services from waiving dividends declared and paid by Meridian
Interstate Bancorp unless the Massachusetts Commissioner of Banks does not
object to the waiver and provided the waiver is not detrimental to the safe and
sound operation of East Boston Savings Bank.  Accordingly, we do not
currently anticipate that Meridian Financial Services will be permitted to waive
dividends paid by Meridian Interstate Bancorp.





Meridian
Interstate Bancorp is subject to Massachusetts law, which prohibits
distributions to stockholders if, after giving effect to the distribution, the
corporation would not be able to pay its debts as they become due in the usual
course of business or the corporation’s total assets would be less than the sum
of its total liabilities plus the amount that would be needed, if the
corporation were to be dissolved at the time of the distribution, to satisfy the
preferential rights upon dissolution of stockholders whose preferential rights
are superior to those receiving the distribution.





Dividends
from Meridian Interstate Bancorp may depend, in part, upon receipt of dividends
from East Boston Savings Bank because Meridian Interstate Bancorp will have no
source of income other than dividends from East Boston Savings Bank and earnings
from investment of net proceeds from the offering retained by Meridian
Interstate Bancorp.  Massachusetts banking law and Federal Deposit
Insurance Corporation regulations limit distributions from East Boston Savings
Bank to Meridian Interstate Bancorp.  For example, East Boston Savings
Bank could not pay dividends if it were not in compliance with applicable
regulatory capital requirements.  See “Regulation and Supervision–State
Bank Regulation–Dividends”and “–Federal Bank Regulation–Prompt
Corrective Regulatory Action.”  In addition, Meridian
Interstate Bancorp is subject to the Federal Reserve Board’s policy that
dividends should be paid only out of current earnings and only if the
prospective rate of earnings retention by Meridian Interstate Bancorp appears
consistent with its capital needs, asset quality and overall financial
condition.  See “Regulation and Supervision–Holding
Company Regulation.”





Any
payment of dividends by East Boston Savings Bank to Meridian Interstate Bancorp
that would be deemed to be drawn out of East Boston Savings Bank’s bad debt
reserves would require East Boston Savings Bank to pay federal income taxes at
the then-current income tax rate on the amount deemed
distributed.  See “Federal and State Taxation—Federal
Income Taxation” and note 10 of the notes to consolidated financial
statements included in this annual report.  Meridian Interstate
Bancorp does not contemplate any distribution by East Boston Savings Bank that
would result in this type of tax liability.





(b)           On
July 2, 2007, the Board of Directors of Meridian Interstate Bancorp, Inc.
adopted a Stock Issuance Plan whereby Meridian Interstate Bancorp, Inc. would
sell 43% of its to-be outstanding shares of common stock to the public in a
stock offering and issue 2% of its to-be outstanding shares to Meridian
Charitable Foundation, Inc.  The remaining 55% of the to-be
outstanding shares would be held by Meridian Financial Services, Incorporated,
Meridian Interstate Bancorp, Inc.’s mutual holding company.




Meridian
Interstate Bancorp, Inc. filed a Registration Statement on Form S-1 with the
Securities and Exchange Commission in connection with the stock offering (File
No. 333-146373).  The Registration Statement was declared




25


effective
by the Securities and Exchange Commission on November 13,
2007.  Meridian Interstate Bancorp, Inc. registered 13,591,125 shares
on the Registration Statement, including up to 13,291,125 shares for sale to the
public.  The stock offering commenced on November 27, 2007, and closed
on January 22, 2008.




Keefe,
Bruyette & Woods, Inc. was engaged to assist in the marketing of the shares
of common stock. For their services, Keefe, Bruyette & Woods, Inc. received
a success fee of 0.75% of the aggregate dollar amount of the shares of common
stock sold in the Subscription and Community offering excluding shares sold to
our employee stock ownership plan and to our officers, employees, corporators
and directors and their immediate family members and contributed to Meridian
Charitable Foundation, Inc.   For shares of common stock sold
through a group of broker-dealers in a syndicated community offering, the total
fees payable to the selected dealers (which included Keefe, Bruyette &
Woods, Inc.) for the shares sold totaled 0.50% of the aggregate dollar amount of
shares sold in the syndicated offering. Keefe, Bruyette & Woods, Inc. was
also reimbursed $10,750 for its reasonable out-of-pocket expenses and $25,000
for its legal fees and expenses.




The stock
offering resulted in gross proceeds of $100.5 million, through the sale of
10,050,000 shares at a price of $10.00 per share. Expenses related to the
offering were approximately $2.9 million, including $1.5 million paid to Keefe,
Bruyette & Woods, Inc.  No underwriting discounts, commissions or
finders fees were paid in connection with the stock offering. Net investable
proceeds of the offering were approximately $89.4 million.




$44.7
million of the net proceeds of the offering were retained by Meridian Interstate
Bancorp, Inc. and $44.7 million were contributed to East Boston Savings
Bank.  The proceeds were invested in federal funds sold in the interim
period.  Meridian Interstate Bancorp, Inc. may use the proceeds from
the stock offering as described in the section entitled “Use of Proceeds” in
Prospectus.




(c)
            There
      was no issuer repurchases of equity securities during the quarter ended
      December 31, 2007.




(d)           Other
than the Employee Stock Ownership Plan, Meridian Interstate Bancorp, Inc. has no
equity compensation plan that was not approved by
stockholders.




(e)           Our
shares of common stock began trading on the NASDAQ Global Select Market on
January 23, 2008.  Accordingly, no comparative stock performance
information is available for periods ending prior to this date.




26


ITEM
      6.  SELECTED FINANCIAL
      DATAAt
      or for the Year Ended December 31,(Dollars
      in thousands)
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004
              
              
              2003Financial
      Condition DataTotal
      assets
              
              $
              1,003,226
              
              
              $
              899,563
              
              
              $
              824,500
              
              
              $
              794,008
              
              
              $
              766,169Securities
              
              
              267,058
              
              
              
              281,662
              
              
              
              264,174
              
              
              
              298,492
              
              
              
              301,314Loans
      receivable, net
              
              
              568,104
              
              
              
              529,650
              
              
              
              480,833
              
              
              
              424,418
              
              
              
              400,513Deposits
              
              
              774,446
              
              
              
              736,989
              
              
              
              672,544
              
              
              
              642,714
              
              
              
              628,570Federal
      Home Loan Bank advances
              
              
              36,527
              
              
              
              40,589
              
              
              
              37,108
              
              
              
              38,482
              
              
              
              29,152Total
      retained earnings
              
              
              115,684
              
              
              
              110,275
              
              
              
              104,243
              
              
              
              102,076
              
              
              
              97,778Operating
      DataInterest
      and dividend income
              
              $
              49,175
              
              
              $
              45,235
              
              
              $
              40,186
              
              
              $
              38,260
              
              
              $
              40,388Interest
      expense
              
              
              28,096
              
              
              
              21,828
              
              
              
              14,545
              
              
              
              11,937
              
              
              
              13,039Net
      interest income
              
              
              21,079
              
              
              
              23,407
              
              
              
              25,641
              
              
              
              26,323
              
              
              
              27,349Provision
      (credit) for loan losses
              
              
              465
              
              
              
              434
              
              
              
              456
              
              
              
              (113
              )
              
              
              375Net
      interest income after provision (credit)
              
              
              20,614
              
              
              
              22,973
              
              
              
              25,185
              
              
              
              26,436
              
              
              
              26,974for
      loan lossesNon-interest
      income
              
              
              4,652
              
              
              
              3,342
              
              
              
              3,555
              
              
              
              4,331
              
              
              
              5,276Non-interest
      expenses
              
              
              22,620
              
              
              
              21,894
              
              
              
              20,637
              
              
              
              20,104
              
              
              
              20,164Income
      before income taxes
              
              
              2,646
              
              
              
              4,421
              
              
              
              8,103
              
              
              
              10,663
              
              
              
              12,086Income
      taxes
              
              
              380
              
              
              
              1,127
              
              
              
              2,700
              
              
              
              3,894
              
              
              
              4,250Net
      income
              
              $
              2,266
              
              
              $
              3,294
              
              
              $
              5,403
              
              
              $
              6,769
              
              
              $
              7,836Key
      Performance RatiosReturn
      on average assets
              
              
              0.25
              %
              
              
              0.38
              %
              
              
              0.68
              %
              
              
              0.88
              %
              
              
              1.05
              %Return
      on average equity
              
              
              2.01
              
              
              
              3.12
              
              
              
              5.31
              
              
              
              6.85
              
              
              
              8.55Interest
      rate spread  (1)
              
              
              1.97
              
              
              
              2.60
              
              
              
              3.23
              
              
              
              3.48
              
              
              
              3.76Net
      interest margin (2)
              
              
              2.47
              
              
              
              2.92
              
              
              
              3.47
              
              
              
              3.67
              
              
              
              3.97Noninterest
      expense to average assets
              
              
              2.47
              
              
              
              2.55
              
              
              
              2.58
              
              
              
              2.60
              
              
              
              2.71Efficiency
      ratio (3)
              
              
              88.94
              
              
              
              81.72
              
              
              
              70.97
              
              
              
              66.75
              
              
              
              61.78Average
      interest-earning assets to
              
              
              115.31
              
              
              
              111.47
              
              
              
              111.97
              
              
              
              111.68
              
              
              
              110.69average
      interest-bearing liabilitiesCapital
      RatiosAverage
      equity to average assets
              
              
              12.32
              %
              
              
              12.26
              %
              
              
              12.72
              %
              
              
              12.80
              %
              
              
              12.31
              %Total
      capital to risk weighted assets (4)
              
              
              12.97
              
              
              
              13.44
              
              
              
              15.49
              
              
              
              15.05
              
              
              
              14.71Tier
      I capital to risk weighted assets (4)
              
              
              11.93
              
              
              
              12.39
              
              
              
              14.77
              
              
              
              14.35
              
              
              
              14.10Tier
      I capital to average assets (4)
              
              
              10.21
              
              
              
              10.46
              
              
              
              12.77
              
              
              
              12.53
              
              
              
              12.03Asset
      Quality RatiosAllowance
      for loan losses/total loans
              
              
              0.63
              %
              
              
              0.63
              %
              
              
              0.61
              %
              
              
              0.58
              %
              
              
              0.65
              %Allowance
      for loan losses/nonperforming loans
              
              
              73.00
              
              
              
              126.06
              
              
              
              926.50
              
              
              
              1,301.05
              
              
              
              81.28Net
      charge-offs/average loans outstanding
              
              
              0.03
              
              
              
              0.00
              
              
              
              0.00
              
              
              
              0.01
              
              
              
              0.00Non-performing
      loans/total loans
              
              
              0.87
              
              
              
              0.50
              
              
              
              0.07
              
              
              
              0.04
              
              
              
              0.80Non-performing
      assets/total assets
              
              
              0.55
              
              
              
              0.30
              
              
              
              0.04
              
              
              
              0.02
              
              
              
              0.42Other data: Number of
      offices
              
              
              11
              
              
              
              11
              
              
              
              10
              
              
              
              10
              
              
              
              9
  (1)
      Represents the difference between the weighted average yield on average
      interest-earning assets and the weighted averagecost
      of interest-bearing liabilities.(2)
      Represents net interest income as a percent of average interest-earning
      assets.(3)
      Represents non-interest expense divided by the sum of net interest income
      and non-interest income, excluding gainsor
      losses on the sale of securities.(4)
      Ratios are for East Boston Savings Bank
only.





27


Item
7.  management’s discussion and
analysis of financial condition and results of
operations





The
objective of this section is to help readers understand our views on our results
of operations and financial condition.  You should read this
discussion in conjunction with the consolidated financial statements and notes
to the consolidated financial statements that appear elsewhere in the annual
report.




Overview


Our
primary source of income is net interest income.  Net interest income
is the difference between interest income, which is the income that we earn on
our loans and investments, and interest expense, which is the interest that we
pay on our deposits and borrowings.  Changes in levels of interest
rates affect our net interest income.  In recent periods, short-term
interest rates (which influence the rates we pay on deposits) have increased,
while longer-term interest rates (which influence the rates we earn on loans)
have not.  The narrowing of the spread between the interest we earn on
loans and investments and the interest we pay on deposits has negatively
affected our net interest income.





A
secondary source of income is non-interest income, which includes revenue that
we receive from providing products and services.  The majority of our
non-interest income generally comes from customer service fees, loan fees,
bank-owned life insurance and gains on sales of securities.







Recent Decline in
Net Income




Our net
income has decreased steadily in recent years.  Net income, which in
2003 was $7.8 million, has decreased each year since, and in 2007 was $2.3
million.  The primary reason for the decline in net income was the
decrease in our net interest income.  Our net interest income
decreased from $27.3 million in 2003 to $21.1 million in 2007.  In
addition, from 2003 to 2007, our return on average assets and return on average
equity decreased each year, from 1.05% and 8.55%, respectively, in 2003, to
0.25% and 2.01%, respectively, in 2007.  Our most significant
challenge that hinders our ability to generate competitive returns has been our
low interest rate spread and margin.  Our interest rate spread has
declined steadily from 3.76% in 2003 to 1.97% in 2007.  Similarly, our
net interest margin has decreased during this time period from 3.97% to
2.47%.




Allowance
for Loan Losses





The
allowance for loan losses is a valuation allowance for possible losses inherent
in the loan portfolio.  We evaluate the need to establish allowances
against losses on loans on a regular basis.  When additional
allowances are necessary, a provision for loan losses is charged to
earnings.





Expenses





The
non-interest expenses we incur in operating our business consist of expenses for
salaries and employee benefits, occupancy and equipment, data processing,
marketing and advertising, professional services and various other general and
administrative expenses.





Our
largest non-interest expense is salaries and employee benefits, which consist
primarily of salaries and wages paid to our employees, payroll taxes, and
expenses for health insurance, retirement plans and other employee
benefits.  As a result of the completion of the offering, we will
recognize additional annual employee compensation expenses stemming from the
adoption of new equity benefit plans.  We cannot determine the actual
amount of these new stock-related compensation and benefit expenses at this time
because applicable accounting practices require that they be based on the fair
market value of the shares of common stock at specific points in the
future.  In addition, the Board of Directors voted to
enter into a supplemental executive retirement agreement with Mr. Gavegnano
in lieu of the agreement that was in place for Mr. Gavegnano as a
director.  The Board of Directors has also voted to amend the vesting
terms of the supplemental executive retirement agreements with Messrs. Verdonck,
Freehan and Siuda.  As a result, we expect to incur increased annual
expenses relating to the new and amended agreements.  The additional
charge to salaries and employee benefits expense in 2007 was $202,000 and we
expect the additional charge in 2008 to be approximately $303,000.





Effective
at the beginning of 2007, the Federal Deposit Insurance Corporation began
assessing most insured depository institutions for deposit insurance at a rate
between five cents and seven cents for every $100 of
deposits.  Assessment credits have been provided to institutions that
paid high premiums in the past.  East Boston Savings Bank has a
remaining assessment credit of approximately $130,000 as of December 31,
2007.  We expect that this credit will offset some of our deposit
insurance premiums in 2008.


28


As a
result of the stock offering, we will incur additional non-interest expenses as
a result of operating as a public company in 2008.  These additional
expenses will consist primarily of legal and accounting fees, compliance with
the provisions of Sarbanes Oxley and expenses of stockholder communications and
meetings.





In
addition, our contribution to Meridian Charitable Foundation resulted in an
additional operating expense of $3.0 million during the quarter ending March 31,
2008.





Critical
Accounting Policies





Critical
accounting estimates are necessary in the application of certain accounting
policies and procedures and are particularly susceptible to significant
change.  Critical accounting policies are defined as those involving
significant judgments and assumptions by management that could have a material
impact on the carrying value of certain assets or on income under different
assumptions or conditions.  Management believes that the most critical
accounting policy, which involves the most complex or subjective decisions or
assessments, is as follows:





Allowance for
Loan Losses





The
allowance for loan losses is utilized to absorb losses inherent in the loan
portfolio. The allowance represents management’s estimate of losses as of the
date of the financial statements. The allowance includes a specific component
for impaired loans and a general component for pools of non-impaired
loans.





The loan
portfolio is reviewed on a regular basis by management and the adequacy of the
allowance for loan losses is adjusted monthly. The methodology for assessing the
appropriateness of the allowance includes comparison to actual losses,
comparisons to peer groups, industry data, and economic
conditions.  The regulatory agencies also review the allowance for
loan losses. Such agencies may require that additional provisions be made based
upon judgments that differ from those of management.





While
management believes that it uses the best information available to establish the
allowance for loan losses, future adjustments to the allowance may be necessary
and results of operations could be adversely affected if circumstances differ
substantially from the assumptions used in making its determinations. Because
the estimation of inherent losses cannot be made with certainty, there can be no
assurance that the existing allowance for loan losses is adequate or that
increases will not be necessary should the quality of any loan deteriorate as a
result of the factors noted above. Any material increase in the allowance for
loan losses may adversely affect the financial condition and results of
operations and will be recorded in the period in which the circumstances become
known.  See note 1 of the notes to the consolidated financial
statements included in this annual report.





Operating
Strategies





Our
mission is to operate and grow a profitable community-oriented financial
institution.  We plan to achieve this by executing our strategies
of:





1.
            Continuing
      to emphasize our commercial real estate, commercial business and
      construction loans, as well as increase our commercial business
      relationships in our expanding market
area;





2.
            Managing
      credit risk to maintain a low level of nonperforming assets, and interest
      rate risk to optimize our net interest
margin;





3.
            Expanding
      our franchise through the opening of additional branch offices and the
      possible acquisition of existing financial service companies or their
      assets;





4.
            Increasing
      core deposits through aggressive marketing and offering new deposit
      products; and





5.
            Continuing to grow and diversify
      our sources of non-interest
income.





Continuing
to emphasize our commercial real estate, commercial business and construction
loans, as well as increase our commercial business relationships in our
expanding market area;





Recently,
we have worked to increase our commercial relationships by diversifying our loan
portfolio beyond residential mortgage loans and offering business deposit and
checking products.  Since December 31, 2003, our commercial real
estate and construction loan portfolio has increased $116.5 million, or 68.3%,
and at December 31,


29


2007 was
50.0% of our total loan portfolio. The increase in this commercial real estate
and construction loan portfolio represented 69.3% of the total increase in our
entire loan portfolio during the same period. In particular, since December 31,
2003, our construction loan portfolio increased $77.8 million, or 229.3%, and at
December 31, 2007 was 19.5% of our total loan portfolio.  East Boston
Savings Bank’s commercial lending team seeks opportunities to provide financing
for $5.0 million to $10.0 million residential development
projects.  Since December 31, 2003, we have taken advantage of the
significant growth in both residential and commercial real estate development in
our market area.  Finally, since December 31, 2003, we have increased
the number of our commercial real estate lenders and commercial lending support
staff.





We intend
to increase the size of our commercial business loan portfolio as a percentage
of our total loan portfolio.  In order to support this increase, we
expect to increase the number of our commercial business lenders and
staff.  In connection with the increase in our commercial business
loan portfolio, we expect an increase in our business checking
accounts.  Business checking accounts were $25.9 million, or 3.3% of
our total deposits at December 31, 2007.





With the
additional capital raised in the offering, we expect to continue to emphasize
the larger lending relationships associated with commercial real estate and
construction lending.  In addition, we intend to expand and develop
our commercial business loan portfolio, as well as our business deposit and
checking products to better serve our commercial customers.





Managing
credit risk to maintain a low level of nonperforming assets, and interest rate
risk to optimize our net interest margin;





Managing
risk is an essential part of successfully managing a financial
institution.  Credit risk and interest rate risk are two prominent
risk exposures that we face. Credit risk is the risk of not collecting the
interest and/or the principal balance of a loan or investment when it is
due.  Our strategy for credit risk management focuses on having
well-defined credit policies and uniform underwriting criteria and providing
prompt attention to potential problem loans.  We believe that high
asset quality is a key to long-term financial success. We have sought to grow
and diversify the loan portfolio, while maintaining a high level of asset
quality and moderate credit risk, using underwriting standards that we believe
are conservative, as well as diligent monitoring of the portfolio and loans in
non-accrual status and on-going collection efforts. At December 31, 2007, our
nonperforming loans (loans which are 90 or more days delinquent) were 0.87% of
our total loan portfolio.  Although we intend to continue our efforts
to originate commercial real estate, commercial business and construction loans,
we intend to continue our philosophy of managing large loan exposures through
our experienced, risk-based approach to lending.





Interest
rate risk is the potential reduction of net interest income as a result of
changes in interest rates. 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.  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.





In order
to improve our risk management, in 2006 we hired a Risk Management Specialist to
oversee the bank-wide risk management process.  These responsibilities
include the implementation of an overall risk program and strategy, determining
risks and implementing risk mitigation strategies in the following
areas:  interest rates, operational/compliance, liquidity, strategic,
reputation, credit and legal/regulatory.  This position provides
counsel to members of our senior management team on all issues that effect our
risk positions.





Expanding
our franchise through the opening of additional branch offices and the possible
acquisition of existing financial service companies or their
assets;





We are
always looking to expand our franchise in the greater Boston metropolitan
area.  Since 2001, we have opened four de novo branches, the most
recent in July 2007.  We intend to continue our geographic expansion
in the greater Boston metropolitan area by opening de novo branches in
communities contiguous to those currently served by East Boston Savings
Bank.  We currently anticipate that we will establish one additional
branch in 2008 and another by the end of 2012, if market conditions are
favorable.  We entered into a lease agreement that commenced in March
2008 for the establishment of a branch at 381 Main Street in Wakefield,
Massachusetts.  We expect the branch to open in the second half of
2008.  In addition to branching, we are focusing on upgrading existing
facilities in an effort to better serve our customers.  The new
branches and the renovations to our existing


30


branches
are expected to be funded by cash generated by our
business.  Consequently, we do not expect to borrow funds for these
expansion projects.





We have
also diversified our market area through our acquisition in 2006 of 40% of the
capital stock of Hampshire First Bank, a de novo New Hampshire chartered bank,
organized in 2006 and headquartered in Manchester, New Hampshire.  Due
to the consolidation of financial institutions in New Hampshire and in Hampshire
First Bank’s primary market, Hillsborough County, New Hampshire, we believe
there is a significant opportunity for a community-focused bank to provide a
full range of financial services to small and middle-market commercial and
retail customers.  We account for our investment in Hampshire First
Bank by the equity method of accounting under which our share of the net income
or loss of Hampshire First Bank is recognized as non-interest income or
non-interest loss in our consolidated financial statements.  However,
as a new financial institution, Hampshire First Bank will likely incur operating
losses during its initial years of operations.  During the years ended
December 31, 2007 and 2006, Meridian Interstate Bancorp recorded losses of
$541,000 and $578,000, respectively, from this investment.  We hope to
continue to increase our franchise by pursuing expansion through the acquisition
of existing financial service companies or their assets, although we currently
have no specific plans or agreements regarding any acquisitions.





Increasing
core deposits through aggressive marketing and the offering of new deposit
products;





Retail
deposits are our primary source of funds for investing and
lending.  Core deposits, which include all deposit account types
except certificates of deposit, comprised 44.2% of our total deposits at
December 31, 2007.  We value our core deposits because they represent
a lower cost of funding and are generally less sensitive to withdrawal when
interest rates fluctuate as compared to certificate of deposit
accounts.  We market core deposits through the internet, in-branch and
local mail, print and television advertising, as well as programs that link
various accounts and services together, minimizing service fees.  We
will continue to customize existing deposit products and introduce new products
to meet the needs of our customers.  We believe that offering new
deposit and savings products will contribute to increasing core
deposits.





Continuing
to grow and diversify our sources of non-interest income.





Our
profits rely heavily on the spread between the interest earned on loans and
securities and interest paid on deposits and borrowings.  In order to
decrease our reliance on interest rate spread income we have pursued initiatives
to increase non-interest income.  In 2006, we introduced a courtesy
overdraft protection program that generated fee income of $970,000 and $746,000
in 2007 and 2006, respectively.  In addition during 2005, we began
originating reverse mortgages for sale which generated approximately $233,000,
$348,000 and $121,000 of non-interest income in 2007, 2006 and 2005,
respectively.  We offer non-deposit investment products, including
mutual funds, annuities, stocks, bonds, life insurance and long-term
care.  Our non-deposit products generated $118,000, $43,000 and
$97,000 of non-interest income during the years ended December 31, 2007, 2006
and 2005, respectively.  We intend to increase our sale of non-deposit
products to further expand our revenue sources.











31


Balance
Sheet Analysis





Assets





At
December 31, 2007, our assets were $1.0.billion, an increase of $103.7 million,
or 11.5%, from $899.6 million at December 31, 2006.  The increase was
due primarily to a $38.5 million increase, or 7.3%, in our loan portfolio, and
an increase in federal funds sold of $80.9 million, partially offset by a $14.6
million decrease, or 5.2%, in our securities portfolio.





Loans





At
December 31, 2007, total loans, net, were $568.1 million, or 56.6% of total
assets.  In the year ended December 31, 2007, the loan portfolio grew
$38.5 million, or 7.3%.  Growth in total real estate loans was $36.5
million, or 7.0%, and included increases of $19.6 million, or 9.6% in one-to
four-family real estate, $5.6 million, or 3.3%, in commercial real estate and
$10.3 million, or 10.1%, in construction loans.  Commercial business
loans increased by $1.6 million, or 16.0%, and consumer loans increased by
$246,000, or 18.5%.  One- to four-family real estate, multi-family and
commercial real estate and construction loans increased as a result of the
growth in the residential and commercial real estate market and our continuing
emphasis on commercial real estate lending.





Loan
Portfolio Analysis





Loan
      Portfolio Composition at December 31,2007
              
              
              2006
              
              
              2005
              
              
              2004
              
              
              2003(Dollars
      in thousands)
              
              Amount
              
              
              %
              
              
              Amount
              
              
              %
              
              
              Amount
              
              
              %
              
              
              Amount
              
              
              %
              
              
              Amount
              
              
              %Real
      estate loans:One-
      to four-family
              
              $
              224,109
              
              
              
              39.1
              %
              
              $
              204,559
              
              
              
              38.3
              %
              
              $
              205,044
              
              
              
              42.2
              %
              
              $
              189,586
              
              
              
              44.2
              %
              
              $
              194,889
              
              
              
              48.1
              %Multi-family
              
              
              26,855
              
              
              
              4.7
              
              
              
              26,781
              
              
              
              5.0
              
              
              
              19,392
              
              
              
              4.0
              
              
              
              20,633
              
              
              
              4.8
              
              
              
              21,400
              
              
              
              5.3Commercial
      real estate
              
              
              175,072
              
              
              
              30.5
              
              
              
              169,422
              
              
              
              31.7
              
              
              
              156,995
              
              
              
              32.3
              
              
              
              150,181
              
              
              
              35.1
              
              
              
              136,456
              
              
              
              33.7Home
      equity linesof
      credit
              
              
              21,541
              
              
              
              3.8
              
              
              
              20,663
              
              
              
              3.9
              
              
              
              16,794
              
              
              
              3.5
              
              
              
              13,305
              
              
              
              3.1
              
              
              
              9,985
              
              
              
              2.5Construction
              
              
              111,796
              
              
              
              19.5
              
              
              
              101,495
              
              
              
              19.0
              
              
              
              76,041
              
              
              
              15.7
              
              
              
              44,106
              
              
              
              10.3
              
              
              
              33,953
              
              
              
              8.4Total
      real estate loans
              
              
              559,373
              
              
              
              97.6
              
              
              
              522,920
              
              
              
              97.9
              
              
              
              474,266
              
              
              
              97.7
              
              
              
              417,811
              
              
              
              97.5
              
              
              
              396,683
              
              
              
              98.0Commercial
      business loans
              
              
              11,859
              
              
              
              2.1
              
              
              
              10,220
              
              
              
              1.9
              
              
              
              10,149
              
              
              
              2.1
              
              
              
              9,695
              
              
              
              2.3
              
              
              
              6,610
              
              
              
              1.6Consumer
      loans
              
              
              1,576
              
              
              
              0.3
              
              
              
              1,330
              
              
              
              0.2
              
              
              
              999
              
              
              
              0.2
              
              
              
              1,034
              
              
              
              0.2
              
              
              
              1,537
              
              
              
              0.4Total
      loans
              
              
              572,808
              
              
              
              100.0
              %
              
              
              534,470
              
              
              
              100.0
              %
              
              
              485,414
              
              
              
              100.0
              %
              
              
              428,540
              
              
              
              100.0
              %
              
              
              404,830
              
              
              
              100.0
              %Net
      deferred loan origination fees
              
              
              (1,067
              )
              
              
              
              
              
              
              (1,458
              )
              
              
              
              
              
              
              (1,644
              )
              
              
              
              
              
              
              (1,637
              )
              
              
              
              
              
              
              (1,696
              )Allowance
      for loan losses
              
              
              (3,637
              )
              
              
              
              
              
              
              (3,362
              )
              
              
              
              
              
              
              (2,937
              )
              
              
              
              
              
              
              (2,485
              )
              
              
              
              
              
              
              (2,619
              )Loans,
      net
              
              $
              568,104
              
              
              
              
              
              
              $
              529,650
              
              
              
              
              
              
              $
              480,833
              
              
              
              
              
              
              $
              424,418
              
              
              
              
              
              
              $
              400,515








32


Loan
Maturity





The
following tables set forth certain information at December 31, 2007 regarding
the dollar amount of loan principal repayments becoming due during the periods
indicated.  The tables do not include any estimate of prepayments
which significantly shorten the average life of all loans and may cause our
actual repayment experience to differ from that shown below.  Demand
loans having no stated schedule of repayments and no stated maturity are
reported as due in one year or less.  The amounts shown below exclude
net deferred loan origination fees.Our adjustable-rate
mortgage loans generally do not provide for downward adjustments below the
initial discounted contract rate, other than declines due to a decline in the
index rate.





Contractual
      Maturities and Interest Rate Sensitivity At December 31,
    2007Real
      Estate
                  Loans
                
                
                Commercial
                  Business
                  Loans
                
                
                Consumer
                  Loans
                
                
                Total
                  Loans(Dollars
      in thousands)Amounts
      due in:One
      year or less
                
                $
                133,060
                
                
                $
                5,089
                
                
                $
                225
                
                
                $
                138,374More
      than one to five years
                
                
                299,264
                
                
                
                4,488
                
                
                
                1,351
                
                
                
                305,103More
      than five to ten years
                
                
                39,209
                
                
                
                438
                
                
                
                -
                
                
                
                39,647More
      than ten years
                
                
                87,840
                
                
                
                1,844
                
                
                
                -
                
                
                
                89,684Total
                
                $
                559,373
                
                
                $
                11,859
                
                
                $
                1,576
                
                
                $
                572,808Interest
      rate terms on amountsdue
      after one year:Fixed-rate
      loans
                
                $
                130,571
                
                
                $
                5,832
                
                
                $
                1,351
                
                
                $
                137,754Adjustable-rate
      loans
                
                
                295,742
                
                
                
                938
                
                
                
                -
                
                
                
                296,680Total
                
                $
                426,313
                
                
                $
                6,770
                
                
                $
                1,351
                
                
                $
                434,434





At
December 31, 2007, our loan portfolio consisted of $198.6 million of fixed-rate
loans and $374.3 million of adjustable-rate loans.





Credit
Risk Management





Our
strategy for credit risk management focuses on having well-defined credit
policies and uniform underwriting criteria and providing prompt attention to
potential problem loans.





When a
borrower fails to make a required loan payment, we take a number of steps to
have the borrower cure the delinquency and restore the loan to current status,
including contacting the borrower by letter and phone at regular
intervals.  When the borrower is in default, we may commence
collection proceedings.  If a foreclosure action is instituted and the
loan is not brought current, paid in full, or refinanced before the foreclosure
sale, the real property securing the loan generally is sold at
foreclosure.  Management informs the Executive Committee monthly of
the amount of loans delinquent more than 30 days.  Management provides
detailed information to the board of directors on loans 60 or more days past due
and all loans in foreclosure and repossessed property that we own.





Analysis
of Nonperforming and Classified Assets





We
consider repossessed assets and loans that are 90 days or more past due to be
non-performing assets.  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.  A loan may remain on accrual status if it is in the
process of collection and is either guaranteed or well secured.  When
a loan is placed on non-accrual status, unpaid interest is reversed against
interest income.  Interest received on non-accrual loans generally is
either applied against principal or reported as interest income, according to
management’s judgment as to the collectibility of
principal.  Generally, loans are restored to accrual status when the
obligation is brought current, has performed in accordance with the contractual
terms for a reasonable period of time, and the ultimate collectibility of the
total contractual principal and interest in no longer in doubt.


33


Real
estate that we acquire as a result of foreclosure or by deed-in-lieu of
foreclosure is classified as foreclosed real estate until it is
sold.  When property is acquired, it is initially recorded at the fair
market value at the date of foreclosure. Holding costs and declines in fair
value after acquisition of the property results in charges against
income.





The
following table provides information with respect to our non-performing assets
at the dates indicated.





Non-performing
      AssetsAt
      December 31,(In
      thousands)
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004
              
              
              2003Loans
      accounted for on a non-accrual basis:Real
      estate loans:One-to
      four-family
              
              $
              2,059
              
              
              $
              824
              
              
              $
              167
              
              
              $
              168
              
              
              $
              277Multi-family
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,560Commercial
      real estate
              
              
              1,561
              
              
              
              -
              
              
              
              123
              
              
              
              -
              
              
              
              -Home
      equity lines of credit
              
              
              98
              
              
              
              29
              
              
              
              27
              
              
              
              14
              
              
              
              47Construction
              
              
              1,218
              
              
              
              1,814
              
              
              
              -
              
              
              
              -
              
              
              
              1,323Total
      real estate loans
              
              
              4,936
              
              
              
              2,667
              
              
              
              317
              
              
              
              182
              
              
              
              3,207Commercial
      business loans
              
              
              45
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              12Consumer
      loans
              
              
              1
              
              
              
              -
              
              
              
              -
              
              
              
              8
              
              
              
              3Total
      non-accrual loans
              
              
              4,982
              
              
              
              2,667
              
              
              
              317
              
              
              
              190
              
              
              
              3,222Accruing
      loans past due 90 days or more:Real
      estate loans
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Commercial
      business loans
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Consumer
      loans
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      accruing past due 90 days or more
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      non-performing loans
              
              
              4,982
              
              
              
              2,667
              
              
              
              317
              
              
              
              190
              
              
              
              3,222Foreclosed
      assets
              
              
              560
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Other
      nonperforming assets
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      non-performing assets
              
              $
              5,542
              
              
              
              2,667
              
              
              
              317
              
              
              
              190
              
              
              
              3,222Non-performing
      loans to total loans
              
              
              0.87
              %
              
              
              0.50
              %
              
              
              0.07
              %
              
              
              0.04
              %
              
              
              0.80
              %Non-performing
      loans to total assets
              
              
              0.50
              %
              
              
              0.30
              %
              
              
              0.04
              %
              
              
              0.02
              %
              
              
              0.42
              %





We did
not have any troubled debt restructurings or accruing loans past due 90 days or
more at the dates presented.





Interest
income that would have been recorded for the year ended December 31, 2007 had
nonaccruing loans been current according to their original repayment terms
amounted to $409,000.  Income related to non-accrual loans included in
interest income for the year ended December 31, 2007 was $227,000.





Total
non-accrual loans increased during the year ended December 31, 2007 due
primarily to the increase in one -to four-family residential
loans.  Management monitors these delinquent loans carefully, and
considers the increase to be reflective of general market conditions in our
lending area.  In addition, $884,000 of the non-accrual loans
represents one matured construction loan, $400,000 represents one matured land
loan and $45,000 represents one matured commercial business loan.  The
loans have become due, and while the customers continue to make payments, we are
working with the customers to modify or extend the loans. These loans will
continue to be reported as non-accrual until such time as documentation is
executed to modify or extend the loans, or the loans are paid in
full.





34


Delinquencies





The
following table provides information become about delinquencies in our loan
portfolio at the dates indicated.  Loans delinquent 90 days or more
are less than total non-accrual loans due to matured loans on non-accrual status
that have not become 90 days delinquent on payments, since the borrower
continues to make payments in accordance with the original loan
term.  These loans will be removed from non-accrual status upon payoff
or loan modification and maturity extension.





Selected
      Loan DelinquenciesThe
      following table sets forth a summary of certain delinquency information as
      of Deember 31.2007
              
              
              2006
              
              
              200530-59
              
              
              60-89
              
              
              90
      days
              
              
              30-59
              
              
              60-89
              
              
              90
      days
              
              
              30-59
              
              
              60-89
              
              
              90
      days(In
      thousands)
              
              Days
              
              
              Days
              
              
              or
      more
              
              
              Days
              
              
              Days
              
              
              or
      more
              
              
              Days
              
              
              Days
              
              
              or
      morePast
      Due
              
              
              Past
      Due
              
              
              Past
      Due
              
              
              Past
      Due
              
              
              Past
      Due
              
              
              Past
      Due
              
              
              Past
      Due
              
              
              Past
      Due
              
              
              Past
      DueReal
      estate loans :One-to
      four-family
              
              $
              1,489
              
              
              $
              856
              
              
              $
              1,036
              
              
              $
              313
              
              
              $
              284
              
              
              $
              540
              
              
              $
              1,441
              
              
              $
              167
              
              
              $
              -Multi
      family
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Commercial
      real estate
              
              
              526
              
              
              
              -
              
              
              
              623
              
              
              
              992
              
              
              
              -
              
              
              
              -
              
              
              
              386
              
              
              
              -
              
              
              
              123Home
      equity lines of credit
              
              
              41
              
              
              
              -
              
              
              
              70
              
              
              
              153
              
              
              
              -
              
              
              
              29
              
              
              
              -
              
              
              
              -
              
              
              
              27Construction
              
              
              4,576
              
              
              
              -
              
              
              
              -
              
              
              
              335
              
              
              
              760
              
              
              
              1,054
              
              
              
              708
              
              
              
              -
              
              
              
              -Total
      real estate loans
              
              
              6,632
              
              
              
              856
              
              
              
              1,729
              
              
              
              1,793
              
              
              
              1,044
              
              
              
              1,623
              
              
              
              2,535
              
              
              
              167
              
              
              
              150Commercial
      business loans
              
              
              25
              
              
              
              
              
              
              
              250
              
              
              
              116
              
              
              
              -
              
              
              
              -
              
              
              
              50
              
              
              
              -
              
              
              
              -Consumer
      loans
              
              
              1
              
              
              
              -
              
              
              
              1
              
              
              
              3
              
              
              
              5
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
              
              $
              6,658
              
              
              $
              856
              
              
              $
              1,980
              
              
              $
              1,912
              
              
              $
              1,049
              
              
              $
              1,623
              
              
              $
              2,585
              
              
              $
              167
              
              
              $
              150





Analysis
and Determination of the Allowance for Loan Losses





The
allowance for loan losses is a valuation allowance that represents our estimate
of the probable losses inherent in the loan portfolio.  We evaluate
the need to establish allowances against losses on loans on a quarterly
basis.  We review previously classified assets and any new non-accrual
loans and other loans where collectibility may be in question as part of
determining whether additional allowances are necessary.  When
additional allowances are necessary, a provision for loan losses is charged to
earnings.





The
allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to
earnings.  Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is
confirmed.  Subsequent recoveries, if any, are credited to the
allowance.





The
adequacy of the allowance for loan losses is evaluated on a regular basis by
management and is based upon management’s periodic review of the collectibility
of the loans in light of historical experience, the nature and volume of the
loan portfolio, adverse situations that may affect the borrower’s ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions.  This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available.





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.





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.


35


Large
groups of smaller balance homogeneous loans are collectively evaluated for
impairment.  Accordingly, we do not separately identify individual
consumer loans for impairment disclosures.





We
identify loans that may need to be charged off as a loss by reviewing all
delinquent loans, watch list loans and other loans that management may have
concerns about collectibility.  For individually reviewed loans, the
borrower’s inability to make payments under the terms of the loan or a shortfall
in collateral value would result in our charging off the loan or the portion of
the loan that was impaired.





The
following table sets forth an analysis of the allowance for loan losses for the
periods indicated.





Analysis
      of Loan Loss ExperienceAt
      December 31,(Dollars
      in thousands)
              2007
              
              
              2006
              
              
              2005
              
              
              2004
              
              
              2003Beginning
      Balance
              
              $
              3,362
              
              
              $
              2,937
              
              
              $
              2,485
              
              
              $
              2,619
              
              
              $
              2,250Provision
      for loan losses
              
              
              465
              
              
              
              434
              
              
              
              456
              
              
              
              (113
              )
              
              
              375Charge
      offs:Real
      estate loans
              
              
              207
              
              
              
              -
              
              
              
              -
              
              
              
              12
              
              
              
              -Commercial
      business loans
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Consumer
      loans
              
              
              63
              
              
              
              12
              
              
              
              11
              
              
              
              18
              
              
              
              24Total
      charge-offs
              
              
              270
              
              
              
              12
              
              
              
              11
              
              
              
              30
              
              
              
              24Recoveries:Real
      estate loans
              
              
              16
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1Commercial
      business
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Consumer
      loans
              
              
              64
              
              
              
              3
              
              
              
              7
              
              
              
              9
              
              
              
              17Total
      recoveries
              
              
              80
              
              
              
              3
              
              
              
              7
              
              
              
              9
              
              
              
              18Net
      charge-offs
              
              
              (190
              )
              
              
              (9
              )
              
              
              (4
              )
              
              
              (21
              )
              
              
              (6
              )Allowance
      at end of year
              
              $
              3,637
              
              
              $
              3,362
              
              
              $
              2,937
              
              
              $
              2,485
              
              
              $
              2,619Allowance
      to nonperforming loans
              
              
              73.00
              %
              
              
              126.06
              %
              
              
              926.50
              %
              
              
              1301.05
              %
              
              
              81.28
              %Allowance
      to total loans outstanding
              
              
              0.63
              %
              
              
              0.63
              %
              
              
              0.61
              %
              
              
              0.58
              %
              
              
              0.65
              %Net
      charge-offs to averageloans
      outstanding
              
              
              0.03
              %
              
              
              0.00
              %
              
              
              0.00
              %
              
              
              0.01
              %
              
              
              0.00
              %





At both
December 31, 2007 and 2006, our allowance for loan losses represented 0.63% of
total gross loans. The allowance for loan losses increased 8.2% from December
31, 2006 to December 31, 2007, representing a provision for loan losses of
$465,000 and net charge-offs of $190,000. The increase in the allowance results
primarily from an increase in the commercial real estate, construction, and
commercial portfolios, as well as an increase in the level of specific reserves
for impaired loans.





At
December 31, 2007, the level of specific reserve for impaired loans was $89,000,
compared to no specific reserve at December 31, 2006.  The
balance of the impaired loans increased by $3.3 million fromDecember 31, 2006 to
$5.1 million December 31, 2007 mainly due to an increase in the residential real
estate portfolio impaired loan balance.  $1.3 million of the impaired
loan balance at both December 31, 2007 and December 31, 2006 represented loans
that had passed their maturity date and were in the process of modification,
extension, or being re-financed at another lender. These loans, until paid off
or modified, were reported as non-accrual.





Management
has reviewed the collateral for all impaired and non-accrual loans as of
December 31, 2007 and considered any potential loss in determining the allowance
for loan losses.  To ensure the valuations of the collateral are
accurate, our in-house appraiser has updated the property value using current
market conditions.  For more complex loans, we utilize the expertise
of outside appraisers that have more experience with the collateral in
question.  All impaired and non-accrual loans were adequately
collateralized or reserved for at December 31, 2007.


36


Management
views the activity in the impaired and non-performing assets during this period
to be indicative of the local real estate market.  The activity in the
matured category does occur from time to time as documentation is not always
executed before the maturity date.  The following table sets forth the
breakdown of the allowance for loan losses by loan category at the dates
indicated.





Allocation
      of the Allowance for Loan LossesAt
      December 31,2007
              
              
              2006
              
              
              2005(Dollars
      in thousands)
              
              Amount
              
              
              %
      of
                Allowance
                to
      Total
                Allowance
              
              
              %
      of
                Loans
      in
                Category
                to
      Total
                Loans
              
              
              Amount
              
              
              %
      of
                Allowance
                toTotal
                Allowance
              
              
              %
      of
                Loans
      in
                Category
                to
      Total
                Loans
              
              
              Amount
              
              
              %
      of
                Allowance
                toTotal
                Allowance
              
              
              %
      of
                Loans
      in
                Category
                to
      Total
                LoansReal
      estate loans:One-
      to four-family
              
              $
              668
              
              
              
              18.4
              %
              
              
              39.1
              %
              
              $
              550
              
              
              
              16.4
              %
              
              
              38.3
              %
              
              $
              542
              
              
              
              18.5
              %
              
              
              42.2
              %Multi-family
              
              
              201
              
              
              
              5.5
              
              
              
              4.7
              
              
              
              201
              
              
              
              6.0
              
              
              
              5.0
              
              
              
              145
              
              
              
              4.9
              
              
              
              4.0Commercial
      real estate
              
              
              1,313
              
              
              
              36.1
              
              
              
              30.5
              
              
              
              1,271
              
              
              
              37.8
              
              
              
              31.7
              
              
              
              1,178
              
              
              
              40.1
              
              
              
              32.3Home
      equity lines of credit
              
              
              82
              
              
              
              2.2
              
              
              
              3.8
              
              
              
              52
              
              
              
              1.5
              
              
              
              3.9
              
              
              
              42
              
              
              
              1.4
              
              
              
              3.5Construction
              
              
              1,007
              
              
              
              27.7
              
              
              
              19.5
              
              
              
              974
              
              
              
              29.0
              
              
              
              19.0
              
              
              
              721
              
              
              
              24.6
              
              
              
              15.7Total
      real estate loans
              
              
              3,271
              
              
              
              89.9
              
              
              
              97.6
              
              
              
              3,048
              
              
              
              90.7
              
              
              
              97.9
              
              
              
              2,628
              
              
              
              89.5
              
              
              
              97.7Commercial
      business loans
              
              
              355
              
              
              
              9.8
              
              
              
              2.1
              
              
              
              306
              
              
              
              9.1
              
              
              
              1.9
              
              
              
              304
              
              
              
              10.3
              
              
              
              2.1Consumer
      loans
              
              
              11
              
              
              
              0.3
              
              
              
              0.3
              
              
              
              8
              
              
              
              0.2
              
              
              
              0.2
              
              
              
              5
              
              
              
              0.2
              
              
              
              0.2Total
              
              $
              3,637
              
              
              
              100.0
              %
              
              
              100.0
              %
              
              $
              3,362
              
              
              
              100.0
              %
              
              
              100.0
              %
              
              $
              2,937
              
              
              
              100.0
              %
              
              
              100.0
              %





Although
we believe that we use the best information available to establish the allowance
for loan losses, future adjustments to the allowance for loan losses may be
necessary and our results of operations could be adversely affected if
circumstances differ substantially from the assumptions used in making the
determinations.  Furthermore, while we believe we have established our
allowance for loan losses in conformity with United States generally accepted
accounting principles, there can be no assurance that regulators, in reviewing
our loan portfolio, will not require us to increase our allowance for loan
losses.  In addition, because future events affecting borrowers and
collateral cannot be predicted with certainty, there can be no assurance that
the existing allowance for loan losses is adequate or that increases will not be
necessary should the quality of any loans deteriorate as a result of the factors
discussed above.  Any material increase in the allowance for loan
losses may adversely affect our financial condition and results of
operations.











37





Securities
Portfolio





At
December 31, 2007, the securities portfolio was $267.1 million, or 26.6% of
total assets.  At that date, 82.6% of the securities portfolio was
invested in corporate bonds.  The remainder was invested primarily in
debt securities issued by government-sponsored enterprises and marketable equity
securities.  The following table sets forth the amortized cost and
fair value of our securities, all of which at the dates indicated were available
for sale.





SecuritiesAt
      December 31,2007
              
              
              2006
              
              
              2005Amortized
              
              
              Fair
              
              
              Amortized
              
              
              Fair
              
              
              Amortized
              
              
              Fair(Dollars
      in thousands)
              
              Cost
              
              
              Value
              
              
              Cost
              
              
              Value
              
              
              Cost
              
              
              ValueSecurities
      available for sale:Government
      – sponsoredenterprises
              
              $
              7,002
              
              
              $
              6,975
              
              
              $
              9,005
              
              
              $
              8,831
              
              
              $
              15,944
              
              
              $
              15,740Corporate
      bonds
              
              
              219,626
              
              
              
              220,629
              
              
              
              235,823
              
              
              
              233,142
              
              
              
              217,620
              
              
              
              214,399Mortgage-backed
      securities
              
              
              43
              
              
              
              43
              
              
              
              46
              
              
              
              46
              
              
              
              50
              
              
              
              50Total
      debt securities
              
              
              226,671
              
              
              
              227,647
              
              
              
              244,874
              
              
              
              242,019
              
              
              
              233,614
              
              
              
              230,189Marketable
      equity securities
              
              
              28,843
              
              
              
              39,411
              
              
              
              29,759
              
              
              
              39,643
              
              
              
              29,216
              
              
              
              33,985Total
              
              $
              255,514
              
              
              $
              267,058
              
              
              $
              274,633
              
              
              $
              281,662
              
              
              $
              262,830
              
              
              $
              264,174





At
December 31, 2007, we had no investments in a single company or entity that had
an aggregate book value in excess of 10% of our equity.





The
following table sets forth the stated maturities and weighted average yields of
the securities at December 31, 2007.  All of the securities listed
have fixed rates.








Investment
      Maturities ScheduleOne
      Year or Less
                
                
                More
      than One Year
                  to
      Five Years
                
                
                More
      than Five Years
                  to
      Ten Years
                
                
                More
      than Ten
                  Years
                
                
                Total(Dollars
      in thousands)
                
                Amortized
                  Cost
                
                
                Weighted
                  Average
                  Yield
                
                
                Amortized
                  Cost
                
                
                Weighted
                  Average
                  Yield
                
                
                Amortized
                  Cost
                
                
                Weighted
                  Average
                  Yield
                
                
                Amortized
                  Cost
                
                
                Weighted
                  Average
                  Yield
                
                
                Amortized
                  Cost
                
                
                Weighted
                  Average
                  YieldGovernment
      – sponsoredenterprises
                
                $
                6,003
                
                
                
                3.71
                %
                
                $
                999
                
                
                
                3.31
                %
                
                $
                -
                
                
                
                -
                %
                
                $
                -
                
                
                
                -
                %
                
                $
                7,002
                
                
                
                3.66
                %Corporate
      bonds
                
                
                71,867
                
                
                
                4.31
                
                
                
                147,759
                
                
                
                5.04
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                219,626
                
                
                
                4.80Mortgage-backed
      securities
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                17
                
                
                
                7.67
                
                
                
                26
                
                
                
                9.18
                
                
                
                43
                
                
                
                8.59Total
      debt securities
                
                $
                77,870
                
                
                
                4.26
                %
                
                $
                148,758
                
                
                
                5.02
                %
                
                $
                17
                
                
                
                7.67
                %
                
                $
                26
                
                
                
                9.18
                %
                
                $
                226,671
                
                
                
                4.76
                %





38


Deposits Our deposit base is
comprised of NOW and demand deposits, money market deposits, regular and other
deposits and certificates of deposit.  We consider NOW and demand
deposits, money market deposits, regular and other deposits to be core
deposits.  At December 31, 2007, core deposits were 44.2% of total
deposits.  Deposits increased $37.5 million, or 5.1%, in the year
ended December 31, 2007, as a result of a $41.9 million, or 43.4%, increase in
money market deposits resulting from the movement of customer funds from
longer-term to shorter-term deposits. The following table sets forth the average
balances of deposits for the periods indicated.





DepositsYear
      Ended December 31,2007
              
              
              2006
              
              
              2005(Dollars
      in thousands)
              
              Average
                Balance
              
              
              Percent
                of
      Total
                Deposits
              
              Average
                Balance
              
              
              Percent
                of
      Total
                Deposits
              
              Average
                Balance
              
              
              Percent
                of
      Total
                DepositsDemand
      deposits
              
              $
              54,051
              
              
              
              7.2
              %
              
              $
              25,358
              
              
              
              3.6
              %
              
              $
              25,432
              
              
              
              3.9
              %NOW
      deposits
              
              
              34,355
              
              
              
              4.6
              
              
              
              67,228
              
              
              
              9.6
              
              
              
              66,653
              
              
              
              10.2Money
      market deposits
              
              
              113,392
              
              
              
              15.0
              
              
              
              105,071
              
              
              
              14.9
              
              
              
              120,074
              
              
              
              18.5Regular
      and other deposits
              
              
              129,153
              
              
              
              17.1
              
              
              
              142,698
              
              
              
              20.3
              
              
              
              165,747
              
              
              
              25.5Certificates
      of deposit
              
              
              422,588
              
              
              
              56.1
              
              
              
              362,990
              
              
              
              51.6
              
              
              
              272,733
              
              
              
              41.9Total
              
              $
              753,539
              
              
              
              100.0
              %
              
              $
              703,345
              
              
              
              100.0
              %
              
              $
              650,639
              
              
              
              100.0
              %




The
following table indicates the amount of certificates of deposit of $100,000 or
more by time remaining until maturity as of December 31, 2007.





Time
      Deposit Maturities of $100,000 or moreCertificates(Dollars
      in thousands)
              
              of
      DepositMaturity
      Period:Three
      months or less
              
              $
              15,449Over
      three through six months
              
              
              21,878Over
      six through twelve months
              
              
              58,384Over
      twelve months
              
              
              70,070Total
              
              $
              165,781





39


Borrowings





We use
borrowings from the Federal Home Loan Bank of Boston to supplement our supply of
funds for loans and investments.




Borrowings
              
              Year
      EndedDecember
      31,(Dollars
      in thousands)
              
              2007
              
              
              2006
              
              
              2005Balance
      outstanding at end of year
              
              $
              36,527
              
              
              $
              40,589
              
              
              $
              37,108Average
      amount outstanding during the year
              
              $
              39,193
              
              
              $
              41,039
              
              
              $
              35,665Weighted
      average interest rate during the year
              
              
              4.74
              %
              
              
              4.43
              %
              
              
              3.76
              %Maximum
      outstanding at any month end
              
              $
              49,188
              
              
              $
              52,649
              
              
              $
              56,030Weighted
      average interest rate at end of year
              
              
              4.49
              %
              
              
              4.69
              %
              
              
              4.00
              %




At
December 31, 2007, we also had an available line of credit of $9.4 million with
the Federal Home Loan Bank of Boston at an interest rate that adjusts daily,
none of which was outstanding at that date.





Retained Earnings





Retained
earnings were $115.7 million at December 31, 2007, an increase of $5.4 million,
or 4.9%, during 2007.  This increase is due to net income as well as
an increase in the net unrealized gain on securities available for
sale.





40


Average
Balance Sheets and Related Yields and Rates





The
following tables presents 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.




Average
      Balance TableAt
      or For theYear
      Ended December 31,2007
              
              
              2006
              
              
              2005Average
                Balance
              
              
              Interest
              
              
              Average
                Yield
              
              
              Average
                Balance
              
              
              Interest
              
              
              Average
                Yield
              
              
              Average
                Balance
              
              
              Interest
              
              
              Average
                YieldAssets:Interest-earning
      assets:Loans
              
              $
              550,494
              
              
              $
              35,745
              
              
              
              6.49
              %
              
              $
              507,143
              
              
              $
              32,661
              
              
              
              6.44
              %
              
              $
              457,841
              
              
              $
              28,708
              
              
              
              6.27Securities
              
              
              275,055
              
              
              
              12,170
              
              
              
              4.42
              
              
              
              278,621
              
              
              
              11,781
              
              
              
              4.23
              
              
              
              274,005
              
              
              
              11,201
              
              
              
              4.09Other
      interest-earning assets
              
              
              26,244
              
              
              
              1,260
              
              
              
              4.80
              
              
              
              15,753
              
              
              
              793
              
              
              
              5.03
              
              
              
              8,149
              
              
              
              277
              
              
              
              3.40Total
      interest-earning assets
              
              
              851,793
              
              
              
              49,175
              
              
              
              5.77
              
              
              
              801,517
              
              
              
              45,235
              
              
              
              5.64
              
              
              
              739,995
              
              
              
              40,186
              
              
              
              5.43Noninterest-earning
      assets
              
              
              65,348
              
              
              
              
              
              
              
              
              
              
              
              58,643
              
              
              
              
              
              
              
              
              
              
              
              59,754Total
      assets
              
              $
              917,141
              
              
              
              
              
              
              
              
              
              
              $
              860,160
              
              
              
              
              
              
              
              
              
              
              $
              799,749Liabilities
      and equity:Interest-bearing
      liabilities:NOW
      deposits
              
              $
              34,355
              
              
              $
              123
              
              
              
              0.36
              %
              
              $
              67,228
              
              
              $
              96
              
              
              
              0.14
              %
              
              $
              66,653
              
              
              $
              90
              
              
              
              0.14
              %Money
      market deposits
              
              
              113,392
              
              
              
              4,164
              
              
              
              3.67
              
              
              
              105,071
              
              
              
              3,188
              
              
              
              3.03
              
              
              
              120,074
              
              
              
              2,788
              
              
              
              2.32Regular
      and other deposits
              
              
              129,153
              
              
              
              1,500
              
              
              
              1.16
              
              
              
              142,698
              
              
              
              1,673
              
              
              
              1.17
              
              
              
              165,747
              
              
              
              2,064
              
              
              
              1.25Certificates
      of deposit
              
              
              422,588
              
              
              
              20,452
              
              
              
              4.84
              
              
              
              362,990
              
              
              
              15,052
              
              
              
              4.15
              
              
              
              272,733
              
              
              
              8,260
              
              
              
              3.03Total
      interest-bearing deposits
              
              
              699,488
              
              
              
              26,239
              
              
              
              3.75
              
              
              
              677,987
              
              
              
              20,009
              
              
              
              2.95
              
              
              
              625,207
              
              
              
              13,202
              
              
              
              2.11FHLB
      advances
              
              
              39,193
              
              
              
              1,857
              
              
              
              4.74
              
              
              
              41,039
              
              
              
              1,819
              
              
              
              4.43
              
              
              
              35,665
              
              
              
              1,343
              
              
              
              3.76Total
      interest-bearing liabilities
              
              
              738,681
              
              
              
              28,096
              
              
              
              3.80
              
              
              
              719,026
              
              
              
              21,828
              
              
              
              3.04
              
              
              
              660,872
              
              
              
              14,545
              
              
              
              2.20Noninterest-bearing
      demand deposits
              
              
              54,051
              
              
              
              
              
              
              
              
              
              
              
              25,358
              
              
              
              
              
              
              
              
              
              
              
              25,432Other
      noninterest-bearing liabilities
              
              
              11,429
              
              
              
              
              
              
              
              
              
              
              
              10,358
              
              
              
              
              
              
              
              
              
              
              
              11,691Total
      liabilities
              
              
              804,161
              
              
              
              
              
              
              
              
              
              
              
              754,742
              
              
              
              
              
              
              
              
              
              
              
              697,995Total
      equity
              
              
              112,980
              
              
              
              
              
              
              
              
              
              
              
              105,418
              
              
              
              
              
              
              
              
              
              
              
              101,754Total
      liabilities and equity
              
              $
              917,141
              
              
              
              
              
              
              
              
              
              
              $
              860,160
              
              
              
              
              
              
              
              
              
              
              $
              799,749Net
      interest income
              
              
              
              
              
              $
              21,079
              
              
              
              
              
              
              
              
              
              
              $
              23,407
              
              
              
              
              
              
              
              
              
              
              $
              25,641Interest
      rate spread
              
              
              
              
              
              
              
              
              
              
              1.97
              %
              
              
              
              
              
              
              
              
              
              
              2.60
              %
              
              
              
              
              
              
              
              
              
              
              3.23
              %Net
      interest margin
              
              
              
              
              
              
              
              
              
              
              2.47
              %
              
              
              
              
              
              
              
              
              
              
              2.92
              %
              
              
              
              
              
              
              
              
              
              
              3.47
              %Average
      interest-earning assets to
                average
      interest-bearing liabilities
              
              
              
              
              
              
              115.31
              %
              
              
              
              
              
              
              
              
              
              
              111.47
              %
              
              
              
              
              
              
              
              
              
              
              111.97
              %




41




Rate/Volume
Analysis




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.




Analysis
      of Net Interest IncomeYears
      ended December 31,
              
              
              Years
      ended December 31,2007
      Compared to 2006
              
              
              2006
      Compared to 2005Increase
      (Decrease) Due to
              
              
              Increase
      (Decrease) Due to(Dollars
      in thousands)
              
              Volume
              
              
              Rate
              
              
              Net
              
              
              Volume
              
              
              Rate
              
              
              NetInterest
      income:Loans
              
              $
              2,670
              
              
              $
              414
              
              
              $
              3,084
              
              
              $
              3,158
              
              
              $
              795
              
              
              $
              3,953Securities
              
              
              (340
              )
              
              
              729
              
              
              
              389
              
              
              
              191
              
              
              
              389
              
              
              
              580Other
      interest-earningassets
              
              
              502
              
              
              
              (35
              )
              
              
              467
              
              
              
              341
              
              
              
              175
              
              
              
              516Total
              
              
              2,832
              
              
              
              1,108
              
              
              
              3,940
              
              
              
              3,690
              
              
              
              1,359
              
              
              
              5,049Interest
      expense:Deposits
              
              
              2,767
              
              
              
              3,463
              
              
              
              6,230
              
              
              
              2,557
              
              
              
              4,250
              
              
              
              6,807FHLB
      advances
              
              
              (71
              )
              
              
              109
              
              
              
              38
              
              
              
              219
              
              
              
              257
              
              
              
              476Total
              
              
              2,696
              
              
              
              3,572
              
              
              
              6,268
              
              
              
              2,776
              
              
              
              4,507
              
              
              
              7,283Change
      in interest income
              
              $
              136
              
              
              $
              (2,464
              )
              
              $
              (2,328
              )
              
              $
              914
              
              
              $
              (3,148
              )
              
              $
              (2,234
              )





Results
of Operations for the Years Ended December 31, 2007, 2006 and 2005





Financial
Highlights





Net
income decreased during 2007 and 2006 due to a decrease in net interest income,
primarily resulting from increases in the average balance and average cost of
certificates of deposit. The increase in interest expense was partially offset
in both years by an increase in the average balance of loans.  Net
income was $2.3 million for the year ended December 31, 2007 compared to $3.3
million for the year ended December 31, 2006.  Return on average
assets and return on average equity was 0.25% and 2.01%, respectively, for the
year ended December 31, 2007 compared to 0.38% and 3.12% for the year ended
December 31, 2006.





Net
income was $3.3 million for the year ended December 31, 2006 compared to $5.4
million for the year ended December 31, 2005.  Return on average
assets and return on average equity was 0.38% and 3.12%, respectively for the
year ended December 31, 2006 compared to 0.68% and 5.31% for the year ended
December 31, 2005.




Summary
      Income StatementsYear
      Ended December 31,
              
              
              Change
      2007/2006
              
              
              Change
      2006/2005(Dollars
      in thousands)
              
              2007
              
              
              2006
              
              
              2005
              
              
              Amount
              
              
              Percent
              
              
              Amount
              
              
              PercentNet
      interest income
              
              $
              21,079
              
              
              $
              23,407
              
              
              $
              25,641
              
              
              $
              (2,328
              )
              
              
              (9.95
              )
      %
              
              $
              (2,234
              )
              
              
              (8.71
              )
      %Provision
      for loan losses
              
              
              465
              
              
              
              434
              
              
              
              456
              
              
              
              31
              
              
              
              7.14
              
              
              
              (22
              )
              
              
              (4.82
              )Non-interest
      income
              
              
              4,652
              
              
              
              3,342
              
              
              
              3,555
              
              
              
              1,310
              
              
              
              39.20
              
              
              
              (213
              )
              
              
              (5.99
              )Non-interest
      expenses
              
              
              22,620
              
              
              
              21,894
              
              
              
              20,637
              
              
              
              726
              
              
              
              3.32
              
              
              
              1,257
              
              
              
              6.09Net
      income
              
              
              2,266
              
              
              
              3,294
              
              
              
              5,403
              
              
              
              (1,028
              )
              
              
              (31.21
              )
              
              
              (2,109
              )
              
              
              (39.03
              )Return
      on average equity
              
              
              2.01
              %
              
              
              3.12
              %
              
              
              5.31
              %
              
              
              
              
              
              
              (35.58
              )
              
              
              
              
              
              
              (41.24
              )Return
      on average assets
              
              
              0.25
              %
              
              
              0.38
              %
              
              
              0.68
              %
              
              
              
              
              
              
              (34.21
              )
              
              
              
              
              
              
              (44.12
              )





42





Net
Interest Income





Net
interest income for 2007 was $21.1 million, a decrease of $2.3 million, or
10.0%, from $23.4 million for 2006.  Net interest income decreased
primarily due to the increase in the average balance and average costs of
deposits, particularly certificates of deposit and money market accounts.
Certificates of deposit balances increased as we promoted competitive higher
rates starting in October 2006.  These deposits began to mature in
October 2007 and will continue to mature through the first quarter of
2008.  In addition, the introduction of an aggressive money market
campaign in the second quarter of 2007 motivated some customers to transfer
funds from lower cost savings accounts to the higher yielding money market
instrument.  The promotion has ended, but the higher yields were
guaranteed through the end of 2007.  The average rate paid on
certificates of deposit and money market deposits increased due to these
promotions, and the average rate paid on borrowings increased due to an increase
in long-term rates.





The
increase in deposit expense was partially offset by an increase in the interest
earned on loans, due to an increase in the average balance of loans
outstanding.  The average outstanding loan balance increased 8.5%, to
$550.5 million in 2007, from $507.1 million in 2006.





In 2006,
net interest income decreased from 2005 primarily due to the increase in the
average balance and average cost of certificates of deposit and Federal Home
Loan Bank advances and an increase in the average cost of money market deposits.
Certificates of deposit increased due in part to our efforts to attract deposits
to fund loan growth and Federal Home Loan Bank advances also increased to fund
loan growth.  In addition, the increasing rate environment resulted in
the movement of customer funds from non-maturity deposit accounts, such as
savings deposits and money market accounts, into higher costing certificates of
deposit.  The average rate paid on certificates of deposit, money
market deposits and borrowings increased due to the increasing rate environment.
Partially offsetting the increase in interest expense was an increase in
interest income on loans.  Average loans increased principally in
construction and multi-family and commercial real estate loans as a result of
our continuing emphasis on this expanding loan portfolio.  The
increasing rate environment and the growth in the higher yielding construction
and multi-family and commercial real estate loan portfolio helped to increase
the average yield on loans.  Income from securities increased due
primarily to an increase in the average yield on securities and an increase in
the average balance of securities.  Income from other interest-earning
assets increased due to increases in rates paid on overnight funds.





Provision for
Loan Losses





Based on
our evaluation of loan loss factors, management made a provision of $465,000,
$434,000, and $456,000 for the years ended December 31, 2007, 2006, and 2005,
respectively.  This was based on management’s estimate of the losses
inherent in our total loan portfolio combined with the changes in our loan
portfolio.  Management assesses a number of factors in determining the
level of provision, including changes to the composition of the loan portfolio
and trends in delinquencies and charge-offs.  The loan portfolio
continued to grow in 2007, with increases of $19.6 million, or 9.6% in one to
four family real estate, $5.6 million, or 3.3%, in commercial real estate and
$10.3 million, or 10.1%, in construction loans from 2006.  Non-accrual
loans increased from $2.7 million at December 31, 2006 to $5.0 million at
December 31, 2007. Charge-offs increased from $12,000 during 2006 to $270,000
during 2007.





At
December 31, 2006, nonperforming loans increased to $2.7 million, from $317,000
at December 31, 2005.  Delinquencies greater than 30 days increased to
$4.6 million at December 31, 2006 from $2.9 million at December 31,
2005.  In addition, our loan portfolio experienced growth during 2006
and 2005, particularly in construction and commercial real estate loans, which
tend to be riskier than one- to four-family residential mortgage
loans.





The
allowance for loan losses was $3.6 million, 0.63%, of total loans outstanding as
of December 31, 2007, as compared with $3.4 million, 0.63% of total loans as of
December 31, 2006.  As of December 31, 2005, the allowance for loan
losses was $2.9 million, or 0.61% of total loans.  An analysis of the
changes in the allowance for loan losses is presented under “Risk Management – Analysis and
Determination of the Allowance for Loan Losses.”








43


Non-interest
      Income SummaryYear
      Ended December 31,
              
              
              Change
      2007/2006
              
              
              Change
      2006/2005(Dollars
      in thousands)
              
              2007
              
              
              2006
              
              
              2005
              
              
              Amount
              
              
              Percent
              
              
              Amount
              
              
              PercentCustomer
      service fees
              
              $
              2,810
              
              
              $
              2,444
              
              
              $
              2,271
              
              
              $
              366
              
              
              
              14.98
              %
              
              $
              173
              
              
              
              7.62
              %Loan
      fees
              
              
              569
              
              
              
              606
              
              
              
              443
              
              
              
              (37
              )
              
              
              (6.11
              )
              
              
              163
              
              
              
              36.79Gain
      on sales of loans, net
              
              
              49
              
              
              
              69
              
              
              
              190
              
              
              
              (20
              )
              
              
              (28.99
              )
              
              
              (121
              )
              
              
              (63.68
              )Gain
      (loss) on securities, net
              
              
              299
              
              
              
              (44
              )
              
              
              117
              
              
              
              343
              
              
              
              (779.55
              )
              
              
              (161
              )
              
              
              (137.61
              )Income
      from bank-owned life insurance
              
              
              1,143
              
              
              
              796
              
              
              
              564
              
              
              
              347
              
              
              
              43.59
              
              
              
              232
              
              
              
              41.13Equity
      loss on investment in affiliate bank
              
              
              (541
              )
              
              
              (578
              )
              
              
              (109
              )
              
              
              37
              
              
              
              (6.40
              )
              
              
              (469
              )
              
              
              (430.28
              )Other
              
              
              323
              
              
              
              49
              
              
              
              79
              
              
              
              274
              
              
              
              559.18
              
              
              
              (30
              )
              
              
              (37.97
              )Total  non-interest
      income
              
              $
              4,652
              
              
              $
              3,342
              
              
              $
              3,555
              
              
              $
              1,310
              
              
              
              39.20
              %
              
              $
              (213
              )
              
              
              (5.99
              )
      %





Non-interest
income increased by 39.2%, to $4.7 million in 2007, from $3.3 million in
2006.  In addition to an increase in gains on securities of $343,000,
customer service fees increased by $366,000, or 15.0%, to $2.8 million,
primarily as a result of the introduction of a courtesy overdraft
program.  Loan fee income includes reverse mortgage fees of $233,000
in 2007, compared to $348,000 in 2006, reflecting less demand for this product
in 2007.  Income from bank-owned life insurance increased $347,000, or
43.6%, primarily due to the receipt of proceeds from life insurance for two
insured individuals which resulted in $501,000 of income in
2007.  Excluding the life insurance death benefit proceeds, bank-owned
life insurance income decreased from 2006 due to lower rates earned on the
policies.  Other income includes the recovery of $305,000 of insurance
proceeds from a prior year litigation settlement in 2007.  For the
years ended December 31, 2007 and 2006, we realized losses of $541,000 and
$578,000, respectively, on our investment in our affiliate bank, Hampshire First
Bank.




Comparing
2006 to 2005, customer service fees increased by $173,000, or
7.6%.  In 2006 we introduced a courtesy overdraft protection program
that generated additional fee income.  The changes in loan fees are
due to reverse mortgage fees.  In 2005, we began brokering reverse
mortgages for a third-party lender, generating approximately $348,000 in fees in
2006, compared to $121,000 in 2005.  Income from sale of residential
mortgage loans declined in 2006 due to changes in interest
rates.  Income from bank-owned life insurance increased in 2006 due to
changes in the rates earned on the various policies.  The equity loss
on investment in affiliate bank represents our 40% share of the net loss
incurred by Hampshire First Bank.  Hampshire First Bank completed its
organization in November 2006.  As a result, these losses represent
primarily start up costs associated with the establishment of Hampshire First
Bank.




Non-interest
      Expense SummaryYear
      Ended December 31,
              
              
              Change
      2007/2006
              
              
              Change
      2006/2005(Dollars
      in thousands)
              
              2007
              
              
              2006
              
              
              2005
              
              
              Amount
              
              
              Percent
              
              
              Amount
              
              
              PercentSalaries
      and employee benefits
              
              $
              14,708
              
              
              $
              13,225
              
              
              $
              13,325
              
              
              $
              1,483
              
              
              
              11.21
              %
              
              $
              (100
              )
              
              
              (0.75
              )
      %Occupancy
      and equipment
              
              
              2,602
              
              
              
              2,630
              
              
              
              2,575
              
              
              
              (28
              )
              
              
              (1.06
              )
              
              
              55
              
              
              
              2.14Data
      processing
              
              
              1,588
              
              
              
              1,578
              
              
              
              1,361
              
              
              
              10
              
              
              
              0.63
              
              
              
              217
              
              
              
              15.94Marketing
      and advertising
              
              
              987
              
              
              
              1,017
              
              
              
              899
              
              
              
              (30
              )
              
              
              (2.95
              )
              
              
              118
              
              
              
              13.13Professional
      services
              
              
              847
              
              
              
              1,036
              
              
              
              753
              
              
              
              (189
              )
              
              
              (18.24
              )
              
              
              283
              
              
              
              37.58Litigation
      settlement
              
              
              -
              
              
              
              575
              
              
              
              -
              
              
              
              (575
              )
              
              
              (100.00
              )
              
              
              575
              
              
              
              100.00Other
      general and administrative
              
              
              1,888
              
              
              
              1,833
              
              
              
              1,724
              
              
              
              55
              
              
              
              3.00
              
              
              
              109
              
              
              
              6.32Total  non-interest
      expense
              
              $
              22,620
              
              
              $
              21,894
              
              
              $
              20,637
              
              
              $
              726
              
              
              
              3.32
              %
              
              $
              1,257
              
              
              
              6.09
              %




For 2007,
non-interest expense increased by $726,000, or 3.3%.  The increase was
primarily due to increases in salaries and employee benefits expense of $1.5
million, or 11.2%.  We opened new branch offices in late 2006 and
mid-2007, which increased staff levels and occupancy costs.  Increases
in health care costs, as well as modest salary increases and new staff additions
reflect the remaining increases.  Partially offsetting the
compensation increase were decreases in expenses of $189,000 for professional
services and $30,000 for marketing expense, as management has instituted various
budget initiatives aimed at reducing expenses, as well as a non-recurring
litigation settlement charge of $575,000 in 2006.




44


Salaries
and employee benefits expense declined slightly in 2006 from 2005 primarily due
to a reduction in our bonus accrual, as well as no accrual for the employee
Equity Appreciation Plan in 2006.  The Equity Appreciation Plan was
terminated in early 2007 and will be paid out during the second quarter of
2008.  Occupancy and equipment expenses increased during 2006 due to
increases in utility costs and maintenance expenses.  Professional
services increased due to increases in legal expenses and audit
fees.  East Boston Savings Bank was engaged in litigation with a
commercial borrower during both 2005 and 2006 and the case was settled in late
2006 to avoid continued costs of litigation.  Marketing and
advertising expenses increased due to the addition of a branch in 2006, as well
as other marketing initiatives and promotions.  Other general and
administrative expenses increased in 2006 primarily due to increased
expenditures for charitable contributions.







Income Tax
Expense





Income
taxes were $380,000 for 2007, reflecting an effective tax rate of 14.4% compared
to $1.1 million for 2006, reflecting an effective tax rate of
25.5%.  The decline in our effective tax rate from 2006 to 2007 was
primarily attributable to the benefits derived from the receipt of dividends
from equity securities and income from bank-owned life insurance.  In
2007, we received the proceeds from two bank owned life insurance policies due
to the death of covered individuals of $501,000.  In addition, because
of the decrease in both the net interest margin and net income in 2007, these
income sources with lower tax rates represented a greater percentage of our net
taxable income than in 2006.





Income
taxes were $1.1 million for 2006, reflecting an effective tax rate of 25.5%
compared to $2.7 million for 2005, reflecting an effective tax rate of
33.3%.  The decline in our effective tax rate from 2005 to 2006 was
primarily attributable to the benefits derived from the receipt of dividends
from equity securities, as well as income from bank-owned life
insurance.  While these amounts fluctuate, they have represented a
greater percentage of our net taxable income as our net interest margin has
declined over the same period.





Risk
Management





Overview





Managing
risk is an essential part of successfully managing a financial
institution.  Our most prominent risk exposures are credit risk,
interest rate risk and market risk.  Credit risk is the risk of not
collecting the interest and/or the principal balance of a loan or investment
when it is due.  Interest rate risk is the potential reduction of net
interest income as a result of changes in interest rates.  Market risk
arises from fluctuations in interest rates that may result in changes in the
values of financial instruments, such as available-for-sale securities that are
accounted for on a mark-to-market basis.  Other risks that we face are
operational risks, liquidity risks and reputation risk.  Operational
risks include risks related to fraud, regulatory compliance, processing errors,
and technology and disaster recovery.  Liquidity risk is the possible
inability to fund obligations to depositors, lenders or
borrowers.  Reputation risk is the risk that negative publicity or
press, whether true or not, could cause a decline in our customer base or
revenue.





We hired
a Risk Management Specialist in 2006 to oversee the bank-wide risk management
process.  These responsibilities include the implementation of an
overall risk program and strategy, determining risks and implementing risk
mitigation strategies in the following areas:  interest rates,
operational/compliance, liquidity, strategic, reputation, credit and
legal/regulatory.  This position provides counsel to members of our
senior management team on all issues that effect our risk
positions.  In addition, this position is responsible for the
following:





·
            Develops,
      implements and maintains a risk management program for the entire bank to
      withstand regulatory scrutiny and provides operational safety and
      efficiency;





·
            Recommends
      policy to the board of directors;





·
            Chairs
      the Risk Management Committee;





·
            Participates
      in developing long-term strategic risk objectives for East Boston Savings
      Bank;





·
            Coordinates
      and reviews risk assessments and provides recommendations on risk
      controls, testing and mitigation
strategies;





·
            Reviews
      and provides recommendations and approvals for all proposed business
      initiatives;


45





·
            Implements
      and maintains the Vendor Management
Program;





·
            Acts
      as our Information Security Officer and provides comments and
      recommendations in accordance with Gramm-Leach Bliley Act requirements;
      and





·
            Maintains
      leading edge knowledge of risk management and regulatory trends and
      mitigation strategies.





Asset/Liability
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 involving
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.





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 table
below sets forth an approximation of our exposure as a percentage of estimated
net interest income for the next 12-month period using interest income
simulation. The simulation uses projected repricing of assets and liabilities at
December 31, 2007 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.








46





The
following table reflects changes in estimated net interest income for East
Boston Savings Bank at December 31, 2007 through December 31, 2008.





Interest
      Rate SensitivityIncrease
      (Decrease)in
      Market Interest
              
              Net
      Interest Income
              
              
              Net
      Portfolio Value EstimateRates
      (Rate Shock)
              
              Amount
              
              
              Change
              
              
              Percent
              
              Amount
              
              
              Change
              
              
              Percent(Dollars
      in Thousands)300
      bp
              
              $
              25,871
              
              
              $
              1,820
              
              
              
              7.57
              %
              
              $
              57,636
              
              
              $
              (43,179
              )
              
              
              (42.83
              )
      %200
              
              
              25,287
              
              
              
              1,236
              
              
              
              5.14
              
              
              
              72,263
              
              
              
              (28,552
              )
              
              
              (28.32
              )100
              
              
              24,684
              
              
              
              633
              
              
              
              2.63
              
              
              
              86,823
              
              
              
              (13,992
              )
              
              
              (13.88
              )0
              
              
              24,051
              
              
              
              
              
              
              
              
              
              
              
              100,815(100)
              
              
              23,351
              
              
              
              (700
              )
              
              
              (2.91
              )
              
              
              113,135
              
              
              
              12,320
              
              
              
              12.22(200)
              
              
              22,484
              
              
              
              (1,567
              )
              
              
              (6.52
              )
              
              
              122,354
              
              
              
              21,539
              
              
              
              21.36(300)
              
              
              21,398
              
              
              
              (2,653
              )
              
              
              (11.03
              )
              
              
              129,786
              
              
              
              28,971
              
              
              
              28.74





The basis
point changes in rates in the above table are assumed to occur evenly over the
following 12 months.  The projected increase in our net interest
income resulting from an increase in rates, as reflected in the table above, is
due primarily to our October 2006 promotion of highly competitive higher rate
certificates of deposit.  The deposits relating to this promotion
mature prior to June 30, 2008 and are expected to roll over into lower rate
deposit products.





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 December 31, 2007, cash and cash
equivalents totaled $103.1 million, comprised of $91.3 million of federal funds
sold and $11.8 million of cash and due from banks.  The federal funds
sold balance is due to the receipt of stock subscription deposits in the fourth
quarter of 2007 for the Company’s recently completed stock
offering.  In addition, at December 31, 2007, we had $91.4 million of
available borrowing capacity with the Federal Home Loan Bank of Boston,
including a $9.4 million line of credit.  On December 31, 2007, we had
$36.5 million of advances outstanding.





A
significant use of our liquidity is the funding of loan
originations.  At December 31, 2007, we had $122.0 million in loan
commitments outstanding, which primarily consisted of $6.4 million in
commitments to fund one- to four-family residential real estate loans, $12.5
million in commitments to fund commercial real estate loans, $16.9 million in
commitments to fund construction loans, and $1.8 million in commitments to fund
commercial lines of credit, plus $35.3 million in unadvanced portions of
construction loans, $20.5 million in unused home equity lines of credit and
$1.6 million in unused commercial letters of credit, and $27.0 million in
unadvanced revolving lines of credit.  Historically, many of the
commitments expire without being fully drawn; therefore, the total amount of
commitments does not necessarily represent future cash
requirements.  Another significant use of our liquidity is the funding
of deposit withdrawals.  Certificates of deposit due within one year
of December 31, 2007 totaled $261.2 million, or 60.5% of certificates of
deposit.  The large percentage of certificates of deposit that mature
within one year reflects our October 2006 promotion and customers’ hesitancy to
invest their funds for long periods in the recent low interest rate
environment.  If these maturing deposits do not remain with us, we
will be required to seek


47


other
sources of funds, including other certificates of deposit and
borrowings.  Depending on market conditions, we may be required to pay
higher rates on such deposits or other borrowings than we currently pay on the
certificates of deposit that mature on or before June 30, 2008.  We
believe, however, based on past experience that a significant portion of our
certificates of deposit will remain with us.  We have the ability to
attract and retain deposits by adjusting the interest rates
offered.





The
following table presents certain of our contractual obligations as of December
31, 2007.





Contractual
Obligations





Contractual
      ObligationsPayments
      Due by Period(Dollars
      in thousands)
              
              Total
              
              
              Less
      than One Year
              
              
              1-3
      Years
              
              
              3-5
      Years
              
              
              More
      Than
                5
      YearsContractual
      obligations:Long-term
      debt obligations
              
              $
              27,373
              
              
              $
              14,848
              
              
              $
              12,525
              
              
              $
              -
              
              
              $
              -Operating
      lease obligations
              
              
              259
              
              
              
              69
              
              
              
              122
              
              
              
              68
              
              
              
              -Other
      long-term obligations (1)
              
              
              7,395
              
              
              
              1,305
              
              
              
              2,610
              
              
              
              2,610
              
              
              
              870Total
              
              $
              35,027
              
              
              $
              16,222
              
              
              $
              15,257
              
              
              $
              2,678
              
              
              $
              870(1)
      Consists entirely of expenses related to obligations under a data
      processing agreement.





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 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 December 31, 2007, both Meridian Interstate and East
Boston Savings Bank exceeded all of their respective regulatory capital
requirements.  East Boston Saving Bank is considered “well
capitalized” under regulatory guidelines.  See “Regulation and Supervision—Federal
Bank Regulation—Capital Requirements,” “Regulatory Capital
Compliance” and note 13 of the notes to the consolidated financial
statements.





The
capital raised in our offering has significantly increased our liquidity and
capital resources.  Over time, the initial level of liquidity will be
reduced as net proceeds from the stock offering are used for general corporate
purposes, including the funding of lending activities.  Our financial
condition and results of operations will be enhanced by the capital from the
offering, resulting in increased net interest-earning assets and net
income.  However, the large increase in equity resulting from the
capital raised in the offering will, initially, have an adverse impact on our
return on equity.  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 the offering 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 non tax-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




48


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.







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.  For
information about our loan commitments and unused lines of credit, see
note 11 of the notes to the consolidated financial
statements.  We had no investment in derivative securities at December
31, 2007.





For the
year ended December 31, 2007, we did not engage in any off-balance sheet
transactions reasonably likely to have a material effect on our financial
condition, results of operations or cash flows.





Impact
of Recent Accounting Pronouncements







For a
discussion of the impact of recent accounting pronouncements, see note 1 of
the notes to the consolidated financial statements included in this annual
report.







Effect
of Inflation and Changing Prices





The
financial statements and related financial data presented in this annual report
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the change in the relative
purchasing power of money over time due to inflation.  The primary
impact of inflation on our operations is reflected in increased operating
costs.  Unlike most industrial companies, virtually all the assets and
liabilities of a financial institution are monetary in nature.  As a
result, interest rates generally have a more significant impact on a financial
institution’s performance than do general levels of
inflation.  Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and
services.  Refer to note 15 of the notes to the consolidated financial
statements for additional information.







Item
7a.  quantitative and qualitative
disclosures about market risk





Information
regarding quantitative and qualitative disclosures about market risk appears
under Item 7, “Management’s Discussion and Analysis of Financial Condition and
Results of Operations,” under the caption “Asset/Liability
Management”.





49





Item
8.  financial statements and supplementary
data











Index
to Consolidated Financial Statements








PageReport
      of Independent Registered Public Accounting Firm
            51Consolidated
      Balance Sheets as of December 31, 2007 and 2006
            52Consolidated
      Statements of Income for the years ended December 31, 2007, 2006 and
      2005
            53Consolidated
      Statements of Changes in Retained Earnings for the years ended December
      31, 2007, 2006 and 2005
            54Consolidated
      Statements of Cash Flows for the years ended December 31, 2007, 2006 and
      2005
            55Notes
      to Consolidated Financial Statements
            57


50





REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM











The Audit
Committee


Meridian
Interstate Bancorp, Inc.


East
Boston, Massachusetts








We have
audited the accompanying consolidated balance sheets of Meridian Interstate
Bancorp, Inc., successor, following the corporate reorganization described in
Note 1 to the consolidated financial statements, to Meridian Financial Services,
Incorporated, as of December 31, 2007 and 2006 and the related consolidated
statements of income, changes in retained earnings and cash flows for each of
the years in the three-year period ended December 31, 2007  These
consolidated financial statements are the responsibility of the Company’s
management.  Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.





We
conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Meridian Interstate Bancorp,
Inc. and subsidiary as of December 31, 2007 and 2006, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2007 in conformity with accounting principles
generally accepted in the United States of America.








/s/
Wolf
& Company, P.C.




Boston,
Massachusetts


March 28,
2008





51


MERIDIAN
INTERSTATE BANCORP, INC. AND SUBSIDIARY


CONSOLIDATED
BALANCE SHEETS


December
      31,(In
      thousands)
              2007
              
              2006ASSETSCash
      and due from banks
              
              $
              11,821
              
              
              $
              13,162Federal
      funds sold
              
              
              91,272
              
              
              
              10,332Total
      cash and cash equivalents
              
              
              103,093
              
              
              
              23,494Securities
      available for sale, at fair value
              
              
              267,058
              
              
              
              281,662Federal
      Home Loan Bank stock, at cost
              
              
              3,165
              
              
              
              3,371Loans
      held for sale
              
              
              -
              
              
              
              3,594Loans
              
              
              571,741
              
              
              
              533,012Less
      allowance for loan losses
              
              
              (3,637
              )
              
              
              (3,362
              )Loans,
      net
              
              
              568,104
              
              
              
              529,650Bank-owned
      life insurance
              
              
              18,003
              
              
              
              19,029Investment
      in affiliate bank
              
              
              10,772
              
              
              
              11,313Premises
      and equipment, net
              
              
              22,816
              
              
              
              19,700Accrued
      interest receivable
              
              
              5,764
              
              
              
              5,502Other
      assets
              
              
              4,451
              
              
              
              2,248Total
      assets
              
              $
              1,003,226
              
              
              $
              899,563LIABILITIES
      AND RETAINED EARNINGSDeposits:Non
      interest-bearing
              
              $
              51,396
              
              
              $
              52,491Interest-bearing
              
              
              723,050
              
              
              
              684,498Total
      deposits
              
              
              774,446
              
              
              
              736,989Stock
      subscriptions
              
              
              62,518
              
              
              
              -Short-term
      borrowings
              
              
              9,154
              
              
              
              8,916Long-term
      debt
              
              
              27,373
              
              
              
              31,673Accrued
      expenses and other liabilities
              
              
              14,051
              
              
              
              11,710Total
      liabilities
              
              
              887,542
              
              
              
              789,288Commitments
      and contingencies (Notes 6, 7 and 11)Retained
      earnings
              
              
              109,177
              
              
              
              106,911Accumulated
      other comprehensive income
              
              
              6,507
              
              
              
              3,364Total
      retained earnings
              
              
              115,684
              
              
              
              110,275Total
      liabilities and retained earnings
              
              $
              1,003,226
              
              
              $
              899,563





See
accompanying notes to consolidated financial statements.


52


MERIDIAN
INTERSTATE BANCORP, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF INCOME





Years Ended
      December 31,(In
      thousands)
              
              2007
              
              
              2006
              
              
              2005Interest
      and dividend income:Interest
      and fees on loans
              
              $
              35,745
              
              
              $
              32,661
              
              
              $
              28,708Interest
      on debt securities
              
              
              11,039
              
              
              
              10,577
              
              
              
              10,454Dividends
      on equity securities
              
              
              1,131
              
              
              
              1,204
              
              
              
              747Interest
      on federal funds sold
              
              
              1,260
              
              
              
              793
              
              
              
              277Total
      interest and dividend income
              
              
              49,175
              
              
              
              45,235
              
              
              
              40,186Interest
      expense:Interest
      on deposits
              
              
              26,239
              
              
              
              20,009
              
              
              
              13,202Interest
      on short-term borrowings
              
              
              370
              
              
              
              392
              
              
              
              279Interest
      on long-term debt
              
              
              1,487
              
              
              
              1,427
              
              
              
              1,064Total
      interest expense
              
              
              28,096
              
              
              
              21,828
              
              
              
              14,545Net
      interest income
              
              
              21,079
              
              
              
              23,407
              
              
              
              25,641Provision
      for loan losses
              
              
              465
              
              
              
              434
              
              
              
              456Net
      interest income, after provisionfor
      loan losses
              
              
              20,614
              
              
              
              22,973
              
              
              
              25,185Non-interest
      income:Customer
      service fees
              
              
              2,810
              
              
              
              2,444
              
              
              
              2,271Loan
      fees
              
              
              569
              
              
              
              606
              
              
              
              443Gain
      on sales of loans, net
              
              
              49
              
              
              
              69
              
              
              
              190Gain
      (loss) on sales of securities, net
              
              
              299
              
              
              
              (44
              )
              
              
              117Income
      from bank-owned life insurance
              
              
              1,143
              
              
              
              796
              
              
              
              564Equity
      loss on investment in affiliate bank
              
              
              (541
              )
              
              
              (578
              )
              
              
              (109
              )Other
              
              
              323
              
              
              
              49
              
              
              
              79Total
      non-interest income
              
              
              4,652
              
              
              
              3,342
              
              
              
              3,555Non-interest
      expenses:Salaries
      and employee benefits
              
              
              14,708
              
              
              
              13,225
              
              
              
              13,325Occupancy
      and equipment
              
              
              2,602
              
              
              
              2,630
              
              
              
              2,575Data
      processing
              
              
              1,588
              
              
              
              1,578
              
              
              
              1,361Marketing
      and advertising
              
              
              987
              
              
              
              1,017
              
              
              
              899Professional
      services
              
              
              847
              
              
              
              1,036
              
              
              
              753Litigation
      settlement
              
              
              -
              
              
              
              575
              
              
              
              -Other
      general and administrative
              
              
              1,888
              
              
              
              1,833
              
              
              
              1,724Total
      non-interest expenses
              
              
              22,620
              
              
              
              21,894
              
              
              
              20,637Income
      before income taxes
              
              
              2,646
              
              
              
              4,421
              
              
              
              8,103Provision
      for income taxes
              
              
              380
              
              
              
              1,127
              
              
              
              2,700Net
      income
              
              $
              2,266
              
              
              $
              3,294
              
              
              $
              5,403




See
accompanying notes to consolidated financial statements.


53


MERIDIAN
INTERSTATE BANCORP, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CHANGES IN RETAINED EARNINGS







Years
Ended December 31, 2007, 2006 and 2005




AccumulatedOther
              
              
              TotalRetained
              
              
              Comprehensive
              
              
              Retained(In
      thousands)
              
              Earnings
              
              
              Income
              
              
              EarningsBalance
      at December 31, 2004
              
              $
              98,214
              
              
              $
              3,862
              
              
              $
              102,076Comprehensive
      income:Net
      income
              
              
              5,403
              
              
              
              -
              
              
              
              5,403Change
      in net unrealized gain onsecurities
      available for sale, net ofreclassification
      adjustment and tax effects
              
              
              -
              
              
              
              (3,236
              )
              
              
              (3,236
              )Total
      comprehensive income
              
              
              
              
              
              
              
              
              
              
              2,167Balance
      at December 31, 2005
              
              
              103,617
              
              
              
              626
              
              
              
              104,243Comprehensive
      income:Net
      income
              
              
              3,294
              
              
              
              -
              
              
              
              3,294Change
      in net unrealized gain onsecurities
      available for sale, net ofreclassification
      adjustment and tax effects
              
              
              -
              
              
              
              3,323
              
              
              
              3,323Total
      comprehensive income
              
              
              
              
              
              
              
              
              
              
              6,617Adjustment
      to initially apply SFASNo.
      158, net of tax effect
              
              
              -
              
              
              
              (585
              )
              
              
              (585
              )Balance
      at December 31, 2006
              
              
              106,911
              
              
              
              3,364
              
              
              
              110,275Comprehensive
      income:Net
      income
              
              
              2,266
              
              
              
              -
              
              
              
              2,266Change
      in net unrealized gain onsecurities
      available for sale, net ofreclassification
      adjustment and tax effects
              
              
              -
              
              
              
              2,720
              
              
              
              2,720Amortization
      of net actuarial loss and priorservice
      cost, net of tax effect
              
              
              -
              
              
              
              94
              
              
              
              94Termination
      of supplemental executive retirementplan,
      net of tax effect (see Note 12)
              
              
              -
              
              
              
              329
              
              
              
              329Total
      comprehensive income
              
              
              
              
              
              
              
              
              
              
              5,409Balance
      at December 31, 2007
              
              $
              109,177
              
              
              $
              6,507
              
              
              $
              115,684




See
accompanying notes to consolidated financial statements.


54


MERIDIAN
INTERSTATE BANCORP, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CASH FLOWS








Years Ended
      December 31,(In
      thousands)
              
              2007
              
              
              2006
              
              
              2005Change
      flows from operating activities:Net
      income
              
              $
              2,266
              
              
              $
              3,294
              
              
              $
              5,403Adjustments
      to reconcile net income to net cashprovided
      by operating activities:Provision
      for loan losses
              
              
              465
              
              
              
              434
              
              
              
              456Amortization
      of net deferred loan origination fees
              
              
              (464
              )
              
              
              (608
              )
              
              
              (738
              )Gain
      on sale of loans held in portfolio
              
              
              -
              
              
              
              (14
              )
              
              
              -Net
      amortization of securities available for sale
              
              
              649
              
              
              
              1,017
              
              
              
              1,584Depreciation
      and amortization expense
              
              
              1,200
              
              
              
              1,178
              
              
              
              1,131Loss
      (gain) on securities, net
              
              
              (299
              )
              
              
              44
              
              
              
              (117
              )Deferred
      income tax benefit
              
              
              (316
              )
              
              
              (390
              )
              
              
              (1,751
              )Income
      from bank-owned life insurance
              
              
              (1,143
              )
              
              
              (796
              )
              
              
              (564
              )Equity
      loss on investment in affiliate bank
              
              
              541
              
              
              
              578
              
              
              
              109Net
      changes in:Loans
      held for sale
              
              
              745
              
              
              
              -
              
              
              
              -Accrued
      interest receivable
              
              
              (262
              )
              
              
              (832
              )
              
              
              281Other
      assets
              
              
              (2,005
              )
              
              
              (780
              )
              
              
              1,999Accrued
      expenses and other liabilities
              
              
              1,647
              
              
              
              113
              
              
              
              1,816Net
      cash provided by operating activities
              
              
              3,024
              
              
              
              3,238
              
              
              
              9,609Cash
      flows from investing activities:Activity
      in securities available for sale:Proceeds
      from maturities, calls and principal payments
              
              
              97,441
              
              
              
              91,909
              
              
              
              10,817Proceeds
      from sales
              
              
              44,091
              
              
              
              14,975
              
              
              
              37,817Purchases
              
              
              (122,763
              )
              
              
              (119,748
              )
              
              
              (21,142
              )Investment
      in affiliate bank
              
              
              -
              
              
              
              (11,400
              )
              
              
              (600
              )Redemption
      (purchase) of Federal Home Loan Bank stock
              
              
              206
              
              
              
              99
              
              
              
              (755
              )Loans
      originated, net of principal payments received
              
              
              (36,386
              )
              
              
              (55,540
              )
              
              
              (56,133
              )Proceeds
      from sales of loans held in portfolio
              
              
              -
              
              
              
              3,317
              
              
              
              -Decrease
      in cash surrender value from life insurance proceeds
              
              
              2,169
              
              
              
              -
              
              
              
              -Purchases
      of premises and equipment
              
              
              (4,316
              )
              
              
              (2,949
              )
              
              
              (2,051
              )Proceeds
      from sales of foreclosed real estate
              
              
              220
              
              
              
              -
              
              
              
              -Net
      cash used in investing activities
              
              
              (19,338
              )
              
              
              (79,337
              )
              
              
              (32,047
              )







(continued)





See
accompanying notes to consolidated financial statements.





55


MERIDIAN
INTERSTATE BANCORP, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CASH FLOWS (Concluded)








Years Ended
      December 31,(In
      thousands)
              
              2007
              
              
              2006
              
              
              2005Cash
      flows from financing activities:Net
      increase in deposits
              
              
              37,457
              
              
              
              64,445
              
              
              
              29,830Proceeds
      from stock subscriptions
              
              
              62,518
              
              
              
              -
              
              
              
              -Net
      change in Federal Home Loan Bank advanceswith
      maturities less than three months
              
              
              (212
              )
              
              
              1,983
              
              
              
              (12,497
              )Proceeds
      from Federal Home Loan Bank advanceswith
      maturities of three months or more
              
              
              150
              
              
              
              14,013
              
              
              
              12,823Repayment
      of Federal Home Loan Bank advanceswith
      maturities of three months or more
              
              
              (4,000
              )
              
              
              (12,515
              )
              
              
              (1,700
              )Net
      cash provided by financing activities
              
              
              95,913
              
              
              
              67,926
              
              
              
              28,456Net
      change in cash and cash equivalents
              
              
              79,599
              
              
              
              (8,173
              )
              
              
              6,018Cash
      and cash equivalents at beginning of year
              
              
              23,494
              
              
              
              31,667
              
              
              
              25,649Cash
      and cash equivalents at end of year
              
              $
              103,093
              
              
              $
              23,494
              
              
              $
              31,667Supplemental
      cash flow information:Interest
      paid on deposits
              
              $
              26,171
              
              
              $
              19,631
              
              
              $
              13,011Interest
      paid on Federal Home Loan Bank advances
              
              
              1,872
              
              
              
              1,798
              
              
              
              1,320Income
      taxes paid, net of refunds
              
              
              455
              
              
              
              2,497
              
              
              
              2,401Non-cash
      investing and financing activities:Transfers
      from loans to loans held for sale
              
              
              -
              
              
              
              3,594
              
              
              
              -Transfers
      from loans held for sale to loans
              
              
              2,849
              
              
              
              -
              
              
              
              -Transfers
      from loans to foreclosed real estate
              
              
              780
              
              
              
              -
              
              
              
              -





See
accompanying notes to consolidated financial statements.


56


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





1.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES




Basis
of Presentation and Consolidation




The
consolidated financial statements include the accounts of Meridian Interstate
Bancorp, Inc. (the “Company”), a wholly-owned subsidiary of Meridian Financial
Services, Incorporated (“Meridian”), a mutual holding company.  The
Company was formed in a corporate reorganization in July 2006 to invest in
Hampshire First Bank, and to own East Boston Savings Bank and its subsidiary
(the “Bank”).  Following the corporate reorganization, the Company
became the mid-tier holding company subsidiary of Meridian and succeeded it as
the Bank’s direct parent.  The corporate reorganization constituted a
change in reporting entity under Statement of Financial Accounting Standards No.
154 “Accounting Changes and
Error Corrections; a Replacement of APB No. 20 and FASB Statement No. 3”(“SFAS No. 154”).  In accordance with the guidance in SFAS No.
154, the change in reporting entity to reflect the new holding company structure
has been retrospectively applied to the financial statements of all periods
presented.  The change in reporting entity resulted in increases
(decreases) as compared to Meridian’s historic 2006 and 2005 net income and
retained earnings of $163,000 and $35,000 and $(2,940,000) and $(3,095,000) or
5.2% and 0.6%, and (2.6%) and (2.9%), respectively.




The
Company is accounting for its investment in Hampshire First Bank, a 40% owned
de novo bank affiliate, by the equity method of accounting under which the
Company’s share of the net income or loss of the affiliate is recognized as
income or loss in the Company’s consolidated statement of income.  The
Bank’s subsidiary is Prospect, Inc., which engages in the buying, selling and
holding of securities on its own behalf.  All significant intercompany
balances and transactions have been eliminated in consolidation.




Business
and Operating Segments




The Bank
provides loan and deposit services to its customers through banking offices in
Peabody, Lynnfield, Melrose, Revere, Saugus, Winthrop, Everett and Lynn, as well
as branches in East Boston.  The Bank is subject to competition from
other financial institutions including commercial banks, other savings banks,
credit unions, mortgage banking companies, and other financial service
providers.




Statement
of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures about Segments
of an Enterprise and Related Information,” establishes standards for the way
that public business enterprises report information about operating segments in
annual and interim financial statements. It also establishes standards for
related disclosures about products and services, geographical areas, and major
customers. Generally, financial information is to be reported on the basis that
it is used internally for evaluating segment performance and deciding how to
allocate resources to segments. Management evaluates the Company’s performance
and allocates resources based on a single segment concept. Accordingly, there
are no separately identified material operating segments for which discrete
financial information is available.  The Company does not derive
revenues from, or have assets located in foreign countries, nor does it derive
revenues from any single customer that represents 10% or more of the Company’s
total revenues.




Use
of Estimates




In
preparing consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the date of the consolidated balance sheet and
reported amounts of revenues and expenses during the reporting
period.  Actual results could differ from those
estimates.  A material estimate that is particularly susceptible to
significant change in the near term relates to the determination of the
allowance for loan losses.




57


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









Reclassification




Certain
amounts in the 2006 and 2005 consolidated financial statements have been
reclassified to conform to the 2007 presentation.




Significant
Concentrations of Credit Risk




Most of
the Company’s activities are with customers located within
Massachusetts.  Note 4 includes the types of securities in which the
Company invests.  Note 5 includes the types of lending in which the
Company engages.  The Company believes that it does not have any
significant concentration in any one industry or customer.




Cash
and Cash Equivalents




For
purposes of the consolidated statements of cash flows, cash and cash equivalents
include amounts due from banks and federal funds sold on a daily basis, which
mature overnight or on demand.




Securities
Available for Sale




Securities
are classified as “available for sale” and recorded at fair value, with
unrealized gains and losses excluded from earnings and reported in other
comprehensive income, net of tax effects.




Purchase
premiums and discounts are recognized in interest income using the interest
method over the terms of the securities.  Declines in the fair value
of securities below their cost that are deemed to be other than temporary are
reflected in earnings as realized losses.  Gains and losses on the
sale of securities are recorded on the trade date and are determined using the
specific identification method.




Federal
Home Loan Bank Stock




The Bank
is a member of the Federal Home Loan Bank (“FHLB”).  As such, it is
required to invest in $100 par value stock of the FHLB in an amount at least
equal to the greater of one percent of assets secured by residential housing or
five percent of outstanding advances.  If the stock is redeemed, the
Bank would receive from the FHLB an amount equal to the par value of the
stock.




Loans
Held For Sale




Loans
originated and intended for sale in the secondary market are carried at the
lower of cost or estimated fair value in the aggregate.  Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income.  Loan origination fees, net of certain direct
origination costs, are deferred, and, upon sale, included in the determination
of the gain on sale of loans.




Loans




The Bank
grants mortgage, commercial and consumer loans to customers.  A
substantial portion of the loan portfolio is represented by mortgage loans
throughout eastern Massachusetts.  The ability of the Bank’s debtors
to honor their contracts is dependent upon the real estate and general economic
conditions in this area.




Loans
that management has the intent and ability to hold for the foreseeable future or
until maturity or pay-off generally are reported at their outstanding unpaid
principal balances adjusted for charge-offs, the allowance for loan losses, and
net deferred loan origination fees.  Interest income is accrued on the
unpaid principal balance.  Loan origination fees, net of certain
direct origination costs, are deferred and recognized as an adjustment of the
related loan yield using the interest method over the terms of the
loans.




58


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









The
accrual of interest on mortgage and commercial loans is discontinued at the time
the loan is 90 days past due, unless the credit is well-secured and in process
of collection.  Past due status is based on contractual terms of the
loan.  In all cases, loans are placed on non-accrual or charged-off at
an earlier date if collection of principal or interest is considered
doubtful.




All
interest accrued but not collected for loans that are placed on non-accrual or
charged off is reversed against interest income.  The interest on
these loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual.  Loans are returned to accrual
status when all the principal and interest amounts contractually due are brought
current and future payments are reasonably assured.




Allowance
for Loan Losses




The
allowance for loan losses represents management’s estimate of the probable
losses inherent in the loan portfolio and is established as losses are estimated
to have occurred through a provision for loan losses charged to
earnings.  Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is
confirmed.  Subsequent recoveries, if any, are credited to the
allowance.




The
adequacy of the allowance for loan losses is evaluated on a regular basis by
management and is based upon management’s periodic review of the collectibility
of the loans in light of historical experience, the nature and volume of the
loan portfolio, adverse situations that may affect the borrower’s ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions.  This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available.




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.




A loan is
considered impaired when, based on current information and events, it is
probable that the Bank 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, the
Bank does not separately identify individual consumer loans for impairment
disclosures.




Foreclosed
Assets




Assets
acquired through, or in lieu of, loan foreclosure, included in other
assets, are held for sale and are initially recorded at fair value at the
date of foreclosure, establishing a new cost basis.  The excess, if
any, of the loan balance over the fair value of the asset at the time of
transfer from loans to foreclosed assets is charged to the allowance for loan
losses.  Subsequent to foreclosure, valuations are periodically
performed by management and the assets are carried at the lower of carrying
amount or fair value less costs to sell.  Revenue and expenses from
operations and changes in the valuation allowance are included in other general
and administrative expenses.









59







NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)







Premises
and Equipment




Land is
carried at cost.  Buildings, equipment and leasehold improvements are
stated at cost, less accumulated depreciation and amortization, computed on the
straight-line method over the estimated useful lives of the assets or the
expected terms of the leases, if shorter.  Expected terms include
lease option periods to the extent that the exercise of such options is
reasonably assured.  It is general practice to charge the cost of
maintenance and repairs to earnings when incurred; major expenditures for
improvements are capitalized and depreciated.




Bank-Owned
Life Insurance




The Bank
has purchased insurance policies on the lives of certain directors, executive
officers and employees.  Bank-owned life insurance policies are
reflected on the consolidated balance sheet at cash surrender
value.  Changes in surrender value are reflected in non-interest
income on the consolidated statement of income.




Transfers
of Financial Assets




Transfers
of financial assets are accounted for as sales when control over the assets has
been surrendered.  Control over financial assets is deemed to be
surrendered when (1) the assets have been isolated from the Bank, (2) the
transferee obtains the right to pledge or exchange the transferred assets, and
(3) the Bank does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.




Advertising




Advertising
costs are expenses when incurred.




Supplemental
Executive Retirement Plans




The Bank
accounts for supplemental executive retirement benefits on the net periodic
pension cost method for financial reporting purposes.  This method
recognizes the compensation cost of an employee’s pension benefit over the
employee’s approximate service period.




On
December 31, 2006, the Company adopted Financial Accounting Standards Board
(“FASB”) Statement No. 158, “Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans” (“SFAS No. 158”), which requires an employer to
(a) recognize in its consolidated balance sheets the funded status of a
benefit plan, (b) measure a plan’s assets and its obligations that
determine its funded status as of the end of the employer’s fiscal year,
(c) recognize, through other comprehensive income, net of tax, changes in
the funded status of the benefit plan that are not recognized as net periodic
benefit cost, and (d) disclose additional information about certain effects
on net periodic benefit cost for the next fiscal year that relate to the delayed
recognition of certain benefit cost elements.




60


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)







The
following table illustrates the incremental effect of applying
SFAS No. 158 on individual line items in the consolidated balance
sheet as of December 31, 2006.




Before
              
              
              
              
              
              AfterApplication
      of
              
              
              
              
              
              Application
      of(In
      thousands)
              SFAS
      No.158
              
              
              Adjustments
              
              
              SFAS
      No.158Accrued
      pension benefit
              
              $
              3,201
              
              
              $
              992
              
              
              $
              4,193Net
      deferred tax asset (liability)
              
              
              (45
              )
              
              
              407
              
              
              
              362Total
      assets
              
              
              899,201
              
              
              
              362
              
              
              
              899,563Total
      liabilities
              
              
              788,926
              
              
              
              362
              
              
              
              789,288Accumulated
      other comprehensive income
              
              
              3,949
              
              
              
              (585
              )
              
              
              3,364Total
      retained earnings
              
              
              110,860
              
              
              
              (585
              )
              
              
              110,275





Income
Taxes




Deferred
tax assets and liabilities are reflected at currently enacted income tax rates
applicable to the period in which the deferred tax assets or liabilities are
expected to be realized or settled.  As changes in tax laws or rates
are enacted, deferred tax assets and liabilities are adjusted accordingly
through the provision for income taxes.  The Bank’s base amount of its
federal income tax reserve for loan losses is a permanent difference for which
there is no recognition of a deferred tax liability.  However, the
loan loss allowance maintained for financial reporting purposes is a temporary
difference with allowable recognition of a related deferred tax asset, if deemed
realizable.




On
January 1, 2007, the Company adopted FASB Financial Accounting Standards
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”)
which clarifies the accounting for uncertainty in income taxes recognized in an
entity’s financial statements in accordance with FASB Statement No. 109,
“Accounting for Income Taxes.”  FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return.  FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosures and transitions.  The adoption of FIN 48 did not have a
material impact on the Company’s consolidated financial statements.














61


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









Comprehensive
Income




Accounting
principles generally require that recognized revenue, expenses, gains and losses
be included in net income.  Although certain changes in assets and
liabilities are reported as a separate component of the retained earnings
section of the consolidated balance sheets, such items, along with net income,
are components of comprehensive income (loss).




The
components of other comprehensive income (loss) and related tax effects are as
follows:





Years
      Ended December 31,(In
      thousands)
              2007
              
              
              2006
              
              
              2005Unrealized
      holding gains/losses onsecurities
      available for sale
              
              $
              4,814
              
              
              $
              5,641
              
              
              $
              (5,242
              )Reclassification
      adjustments for losses (gains)realized
      in income
              
              
              (299
              )
              
              
              44
              
              
              
              (117
              )Unrealized
      gains (losses)
              
              
              4,515
              
              
              
              5,685
              
              
              
              (5,359
              )Tax
      effect
              
              
              (1,795
              )
              
              
              (2,362
              )
              
              
              2,123Net-of-tax
      amount
              
              
              2,720
              
              
              
              3,323
              
              
              
              (3,236
              )Amortization
      of net actuarial loss and priorservice
      cost
              
              
              159
              
              
              
              -
              
              
              
              -Tax
      effect
              
              
              (65
              )
              
              
              -
              
              
              
              -Net
      of tax amount
              
              
              94
              
              
              
              -
              
              
              
              -Termination
      of supplemental executiveretirement
      plan
              
              
              557
              
              
              
              -
              
              
              
              -Tax
      effect
              
              
              (228
              )
              
              
              -
              
              
              
              -Net
      of tax amount
              
              
              329
              
              
              
              -
              
              
              
              -$
              3,143
              
              
              $
              3,323
              
              
              $
              (3,236
              )








62




NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)









The
components of accumulated other comprehensive income, included in total retained
earnings, are as follows:







December
      31,(In
      thousands)
              2007
              
              
              2006Net
      unrealized gain on securitiesavailable
      for sale
              
              $
              11,544
              
              
              $
              7,029Tax
      effect
              
              
              (4,875
              )
              
              
              (3,080
              )Net-of-tax
      amount
              
              
              6,669
              
              
              
              3,949Unrecognized
      net actuarial loss pertainingto
      supplemental executive retirement plans
              
              
              (47
              )
              
              
              (736
              )Unrecognized
      prior service cost pertainingto
      supplemental executive retirement plans
              
              
              (229
              )
              
              
              (256
              )Total
              
              
              (276
              )
              
              
              (992
              )Tax
      effect
              
              
              114
              
              
              
              407Net-of-tax
      amount
              
              
              (162
              )
              
              
              (585
              )$
              6,507
              
              
              $
              3,364




Unrecognized
prior service cost amounting to $28,000, included in accumulated other
comprehensive income at December 31, 2007, is expected to be recognized as a
component of net periodic pension cost for the year ended December 31,
2008.









63


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









Recent
Accounting Pronouncements




In
September 2006, the FASB issued Statement No. 157, "Fair Value Measurements,"
which defines fair value, establishes a framework for measuring fair value in
accordance with generally accepted accounting principles, and expands
disclosures about fair value measurements. The definition of fair value retains
the exchange price notion in earlier definitions of fair value. This Statement
clarifies that the exchange price is the price in an orderly transaction between
market participants to sell the asset or transfer the liability in the market in
which the reporting entity would transact for the asset or liability, that is,
the principal or most advantageous market for the asset or liability. Emphasis
is placed on fair value being a market-based measurement, not an entity-specific
measurement, and therefore a fair value measurement should be determined based
on the assumptions that market participants would use in pricing the asset or
liability. As a basis for considering these market participant assumptions, a
fair value hierarchy has been established to distinguish between (1) market
participant assumptions developed based on market data obtained from sources
independent of the reporting entity (observable inputs) and (2) the reporting
entity's own assumptions about market participant assumptions developed based on
the best information available in the circumstances (unobservable
inputs).  This Statement is effective for the Company on January 1,
2008, except for certain non-financial assets and liabilities, for which the
effective date is January 1, 2009, and is not expected to have a material impact
on the Company’s consolidated financial statements.





In
February 2007, the FASB issued Statement No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an amendment of FASB
Statement No. 115.” This Statement permits entities to choose to measure many
financial instruments and certain other items at fair value, with the objective
of improving financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions, and is expected to expand the use of fair value measurement. An
entity will report unrealized gains and losses on items for which the fair value
option has been elected in earnings at each subsequent reporting date. The fair
value option may generally be applied instrument by instrument and is
irrevocable. This Statement is effective for the Company on January 1, 2008 and
is not expected to have a material impact on the Company’s consolidated
financial statements.





The
Company is the sole owner of life insurance policies pertaining to certain of
the Company’s employees.  The Company has entered into agreements with
these individuals whereby the Company will pay to the individual’s estate or
beneficiaries a portion of the death benefit that the Company will receive as
beneficiary of such policies.  No liability has been recognized on the
consolidated balance sheet for such death benefits.  In September
2006, the FASB ratified EITF 06-4, “Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements.”  This issue addresses accounting for split-dollar life
insurance arrangements whereby the employer purchases a policy to insure the
life of an employee, and separately enters into an agreement to split the policy
benefits between the employer and the employee.  This EITF states that
an obligation arises as a result of a substantive agreement with an employee to
provide future postretirement benefits.  Under EITF 06-4, the
obligation is not settled upon entering into an insurance
arrangement.  Since the obligation is not settled, a liability should
be recognized in accordance with applicable authoritative
guidance.  EITF 06-4 is effective for the Company on January 1,
2008.  The Company recorded a decrease to retained earnings and an
increase in other liabilities of approximately $1.6 million during the first
quarter of 2008 as a result of adoption of EITF 06-4.





In
December 2007, the FASB issued Statement No. 141 (revised), “Business
Combinations,” which replaces FASB Statement No. 141, and applies to all
business entities, including mutual entities that previously used the
pooling-of-interests method of accounting for certain business combinations.
Under Statement No. 141 (revised) an acquirer is required to recognize at fair
value the assets acquired, liabilities assumed, and any non-controlling interest
in the acquiree at the acquisition date.  This Statement requires that
acquisition costs and expected restructuring costs be recognized separately from
the acquisition, and that the acquirer in a business combination achieved in
stages


64


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





recognize
the identifiable assets and liabilities, as well as the non-controlling interest
in the acquiree, at the full amounts of their fair values.  This
Statement also requires an acquirer to recognize assets acquired and liabilities
assumed arising from contractual contingencies as of the acquisition date, and
to recognize contingent consideration at the acquisition
date.  Further, this Statement eliminates the concept of negative
goodwill and requires gain recognition in instances in which the total
acquisition-date fair value of the identifiable net assets acquired exceeds the
fair value of the consideration transferred plus any non-controlling interest in
the acquiree.  This Statement makes significant amendments to other
Statements and other authoritative guidance, and applies prospectively to
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008.  An entity may not apply it before that date.





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





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







65


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









2.
            STOCK
      OFFERING




On July
2, 2007, the Board of Directors of the Company and the Board of Directors of the
Bank unanimously adopted the Plan of Stock Issuance (the “Plan”) pursuant to
which the Company would sell common stock representing a minority ownership of
the estimated pro forma market value of the Company, as determined by an
independent appraisal, to eligible depositors of the Bank and the Company’s
qualified employee benefit plans in a stock subscription offering and, if
necessary, to the general public in a community and/or syndicated community
offering.  The majority of the common stock will be owned by the
Company’s parent company, Meridian Financial Services, Incorporated (a mutual
holding company).




The
minority stock offering was completed on January 22, 2008 at the midpoint of the
stock offering range and 10,050,000 shares of common stock were issued
in the offering at a price of $10.00 per share, including 828,000 shares sold to
the employee stock ownership plan and 300,000 shares contributed to the Meridian
Charitable Foundation, Inc.  Net investable proceeds from the
offering after the charitable foundation contribution amounted to approximately
$89,353,000.





Part of
the offering included the establishment of an employee stock ownership plan
(“the ESOP”) which acquired 828,000 shares of stock in the
offering.  The ESOP borrowed the funds to acquire these shares from
the net offering proceeds retained by Meridian Interstate
Bancorp.  The borrowing will have an interest rate equal to the prime
rate as published in The Wall
Street Journal, and a term of 20 years.  East Boston Savings
Bank intends to make contributions to the employee stock ownership plan in
amounts at least equal to the principal and interest requirement of the
debt.  As the debt is paid down, shares will be released for
allocation to participants’ accounts and stockholders’ equity will be
increased.  The amount of this borrowing has been reflected as a
reduction from gross proceeds to determine estimated net investable
proceeds.





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





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





Offering
costs have been deferred and have reduced the proceeds from the shares sold in
the offering.  As of December 31, 2007, offering costs amounting to
$1,186,000 had been incurred and are included in other assets in the
accompanying balance sheet.








66


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)








The
following table shows the Company’s unaudited proforma summary consolidated
balance sheet as of December 31, 2007 as if the stock offering had closed at
that date.





(In
      Thousands)AssetsCash
      and cash equivalents
              
              $
              139,394Investments
              
              
              270,223Loans,
      net
              
              
              568,104Other
      assets
              
              
              60,620Total
      assets
              
              $
              1,038,341Liabilities and
      Stockholders' EquityDeposits
              
              $
              774,446Other
      liabilities
              
              
              57,838Total
      liabilities
              
              
              832,284Stockholders'
      equity
              
              
              206,057Total
      liabilities and stockholders' equity
              
              $
              1,038,341





3.
            RESTRICTIONS
      ON CASH AND AMOUNTS DUE FROM BANKS




The Bank
is required to maintain average balances on hand or with the Federal Reserve
Bank.  At both December 31, 2007 and 2006, these reserve balances
amounted to $400,000.













67


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





4.
            SECURITIES
      AVAILABLE FOR SALE




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




Gross
              
              
              GrossAmortized
              
              
              Unrealized
              
              
              Unrealized
              
              
              Fair(In
      thousands)
              Cost
              
              
              Gains
              
              
              Losses
              
              
              ValueDecember 31,
      2007Debt
      securities:Government-sponsored
      enterprises
              
              $
              7,002
              
              
              $
              -
              
              
              $
              (27
              )
              
              $
              6,975Corporate
      bonds
              
              
              219,626
              
              
              
              1,697
              
              
              
              (694
              )
              
              
              220,629Mortgage-backed
      securities
              
              
              43
              
              
              
              3
              
              
              
              (3
              )
              
              
              43Total
      debt securities
              
              
              226,671
              
              
              
              1,700
              
              
              
              (724
              )
              
              
              227,647Marketable
      equity securities
              
              
              28,843
              
              
              
              10,819
              
              
              
              (251
              )
              
              
              39,411Total
      securities availablefor
      sale
              
              $
              255,514
              
              
              $
              12,519
              
              
              $
              (975
              )
              
              $
              267,058December 31,
      2006Debt
      securities:Government-sponsored
      enterprises
              
              $
              9,005
              
              
              $
              -
              
              
              $
              (174
              )
              
              $
              8,831Corporate
      bonds
              
              
              235,823
              
              
              
              21
              
              
              
              (2,702
              )
              
              
              233,142Mortgage-backed
      securities
              
              
              46
              
              
              
              3
              
              
              
              (3
              )
              
              
              46Total
      debt securities
              
              
              244,874
              
              
              
              24
              
              
              
              (2,879
              )
              
              
              242,019Marketable
      equity securities
              
              
              29,759
              
              
              
              9,894
              
              
              
              (10
              )
              
              
              39,643Total
      securities availablefor
      sale
              
              $
              274,633
              
              
              $
              9,918
              
              
              $
              (2,889
              )
              
              $
              281,662








68


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









The
amortized cost and fair value of debt securities by contractual maturity at
December 31, 2007 and 2006 follows.  Expected maturities may
differ from contractual maturities because issuers may have the right to call or
prepay obligations with or without prepayment penalties.




December
      31, 2007
              
              
              December
      31, 2006Amortized
              
              
              Fair
              
              
              Amortized
              
              
              Fair(In
      thousands)
              Cost
              
              
              Value
              
              
              Cost
              
              
              ValueWithin
      1 year
              
              $
              77,870
              
              
              $
              77,669
              
              
              $
              93,153
              
              
              $
              92,838Over
      1 year to 5 years
              
              
              148,758
              
              
              
              149,935
              
              
              
              151,675
              
              
              
              149,135Mortgage-backed
      securities
              
              
              43
              
              
              
              43
              
              
              
              46
              
              
              
              46$
              226,671
              
              
              $
              227,647
              
              
              $
              244,874
              
              
              $
              242,019




For the
years ended December 31, 2007, 2006, and 2005, proceeds from sales of
securities available for sale amounted to $44,091,000 $14,975,000 and
$37,817,000 respectively.  Gross gains of $2,493,000, $1,243,000 and
$951,000 and gross losses of $2,194,000, $1,287,000 and $834,000, respectively,
were realized on those sales.




Information
pertaining to securities available for sale as of December 31, 2007, 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 MonthsGross
              
              
              
              
              
              GrossUnrealized
              
              
              Fair
              
              
              Unrealized
              
              
              Fair(In
      thousands)
              Losses
              
              
              Value
              
              
              Losses
              
              
              ValueDecember 31,
      2007Debt
      securities:Government-sponsored
      enterprises
              
              $
              -
              
              
              $
              -
              
              
              $
              27
              
              
              $
              6,975Corporate
      bonds
              
              
              160
              
              
              
              30,256
              
              
              
              534
              
              
              
              77,576Mortgage-backed
      securities
              
              
              -
              
              
              
              -
              
              
              
              3
              
              
              
              12Total
      debt securities
              
              
              160
              
              
              
              30,256
              
              
              
              564
              
              
              
              84,563Marketable
      equity securities
              
              
              221
              
              
              
              3,931
              
              
              
              30
              
              
              
              285Total
      temporarily impairedsecurities
              
              $
              381
              
              
              $
              34,187
              
              
              $
              594
              
              
              $
              84,848


69


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









Information
pertaining to securities available for sale as of December 31, 2006 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 MonthsGross
              
              
              
              
              
              GrossUnrealized
              
              
              Fair
              
              
              Unrealized
              
              
              Fair(In
      thousands)
              Losses
              
              
              Value
              
              
              Losses
              
              
              ValueDecember 31,
      2006Debt
      securities:Government-sponsored
      enterprises
              
              $
              1
              
              
              $
              1,999
              
              
              $
              173
              
              
              $
              6,832Corporate
      bonds
              
              
              381
              
              
              
              88,661
              
              
              
              2,321
              
              
              
              115,561Mortgage-backed
      securities
              
              
              -
              
              
              
              -
              
              
              
              3
              
              
              
              12Total
      debt securities
              
              
              382
              
              
              
              90,660
              
              
              
              2,497
              
              
              
              122,405Marketable
      equity securities
              
              
              10
              
              
              
              304
              
              
              
              -
              
              
              
              -Total
      temporarily impairedsecurities
              
              $
              392
              
              
              $
              90,964
              
              
              $
              2,497
              
              
              $
              122,405








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


70


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









At
December 31, 2007, sixty-four debt securities have unrealized losses with
aggregate depreciation of less than 1% from the Company’s amortized cost
basis.  These unrealized losses relate principally to deterioration in
value attributable to changes in market conditions and not to deterioration in
credit quality of the issuer.  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.  At each balance sheet date, management has
concluded that the declines in value of the Company’s debt securities are
temporary, whereby management expects to collect the full amount of principal
and interest payments within the contractual period.  Further, at each
balance sheet date and in all material respects, management has the intent and
ability to hold depreciated debt securities to the earlier of recovery or
maturity.  At December 31, 2007, the average time to maturity of the
Company’s depreciated debt securities was 26 months.  From time to
time, management’s intent to hold depreciated debt securities to recovery or
maturity may change as a result of prudent portfolio management.  If
management’s intent changes, unrealized losses are recognized either as
impairment charges to the consolidated income statement or as realized losses if
a sale has been executed.  In most instances, management sells the
securities at the time their intent changes.




At
December 31, 2007, eleven marketable equity securities have unrealized losses
with aggregate depreciation of 6% from the Company’s cost basis.  No
credit issues have been identified that cause management to believe the decline
in market value is other than temporary.  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.  In
any event, 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
considered other than temporary and charged to earnings as impairment losses, or
realized through sale of the security.




71


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









5.           LOANS




A summary
of loans follows:




December
      31,(In
      thousands)
              2007
              
              
              2006Mortgage
      loans on real estate:Residential
      real estate
              
              $
              224,109
              
              
              $
              204,559Commercial
      real estate
              
              
              175,072
              
              
              
              169,422Construction
              
              
              111,796
              
              
              
              101,495Multi-family
              
              
              26,855
              
              
              
              26,781Home
      equity lines of credit
              
              
              21,541
              
              
              
              20,663559,373
              
              
              
              522,920Other
      loans:Commercial
      non-real estate
              
              
              11,859
              
              
              
              10,220Passbook
      and stock secured
              
              
              440
              
              
              
              506Personal
              
              
              1,136
              
              
              
              82413,435
              
              
              
              11,550Total
      loans
              
              
              572,808
              
              
              
              534,470Less:Allowance
      for loan losses
              
              
              (3,637
              )
              
              
              (3,362
              )Net
      deferred loan origination fees
              
              
              (1,067
              )
              
              
              (1,458
              )Loans,
      net
              
              $
              568,104
              
              
              $
              529,650




An
analysis of the allowance for loan losses follows:




Years
      Ended December 31,(In
      thousands)
              
              2007
              
              
              2006
              
              
              2005Balance
      at beginning of year
              
              $
              3,362
              
              
              $
              2,937
              
              
              $
              2,485Provision
      for loan losses
              
              
              465
              
              
              
              434
              
              
              
              456Recoveries
              
              
              80
              
              
              
              3
              
              
              
              7Loans
      charged-off
              
              
              (270
              )
              
              
              (12
              )
              
              
              (11
              )Balance
      at end of year
              
              $
              3,637
              
              
              $
              3,362
              
              
              $
              2,937




72


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









The
following is a summary of information pertaining to impaired and non-accrual
loans:




December
      31,(In
      thousands)
              2007
              
              
              2006Impaired
      loans without a valuation allowance
              
              $
              4,495
              
              
              $
              1,814Impaired
      loans with a valuation allowance
              
              
              621
              
              
              
              -Total
      impaired loans
              
              $
              5,116
              
              
              $
              1,814Valuation
      allowance related to impaired loans
              
              $
              89
              
              
              $
              -Total
      non-accrual loans
              
              $
              4,982
              
              
              $
              2,667Total
      loans past-due ninety days or more and still accruing
              
              $
              -
              
              
              $
              -




Years
      Ended December 31,(In
      thousands)
              2007
              
              
              2006
              
              
              2005Average
      investment in impaired loans
              
              $
              4,605
              
              
              $
              701
              
              
              $
              -Interest
      income recognized onimpaired
      loans
              
              $
              227
              
              
              $
              -
              
              
              $
              -Interest
      income recognized on a cash basison
      impaired loans
              
              $
              227
              
              
              $
              -
              
              
              $
              -


No
additional funds are committed to be advanced in connection with impaired
loans.




73


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









6.
            SERVICING




Loans
serviced for others by the Bank are not included in the accompanying
consolidated balance sheets.  The Bank retains servicing on most loan
sales and generally earns a fee of 0.25% per annum based on the monthly
outstanding balances of the loans serviced.  The unpaid principal
balances of mortgage loans serviced for others amounted to $84,234,000 and
$85,254,000 at December 31, 2007 and 2006, respectively.




Included
in loans serviced for others at December 31, 2007 and 2006 is $72,578,000 and
$71,505,000 respectively, of loans serviced for the Federal Home Loan Bank with
a recourse provision whereby the Bank may be obligated to participate in
potential losses on a limited basis when a realized loss on foreclosure
occurs.  Losses are borne in priority order by the borrower, PMI
insurance, the Federal Home Loan Bank and the Bank.  As December 31,
2007 and 2006, the maximum contingent liability associated with loans sold with
recourse is $1,450,000 and $1,362,000 respectively, which is not recorded in the
consolidated financial statements.  The Bank has never repurchased any
loans or incurred any losses under these recourse provisions.









7.
            PREMISES
      AND EQUIPMENT




A summary
of the cost and accumulated depreciation and amortization of premises and
equipment follows:




EstimatedDecember
      31,
              
              
              Useful(In
      thousands)
              2007
              
              
              2006
              
              
              LivesLand
      and land improvements
              
              $
              5,007
              
              
              $
              3,082
              
              
              -Buildings
              
              
              18,435
              
              
              
              12,221
              
              
              40
      yearsLeasehold
      improvements
              
              
              411
              
              
              
              623
              
              
              5
      yearsEquipment
              
              
              6,633
              
              
              
              5,699
              
              
              3-10
      yearsConstruction
      in process
              
              
              -
              
              
              
              4,58730,486
              
              
              
              26,212Less
      accumulated depreciationand
      amortization
              
              
              (7,670
              )
              
              
              (6,512
              )$
              22,816
              
              
              $
              19,700







Depreciation
and amortization expense for the years ended December 31, 2007, 2006 and 2005
amounted to $1,200,000, $1,178,000 and $1,131,000 respectively.




At
December 31, 2006, construction in process represented costs capitalized in
connection with branches in Lynn, Everett and East Boston which were completed
and opened in 2007.  The Company has no firm commitments related to
construction as of December 31, 2007.









74


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









Lease
Commitments




The Bank
is obligated under non-cancelable operating lease agreements for banking offices
and facilities.  These leases have terms with renewal options, the
cost of which is not included below.  The leases generally provide
that real estate taxes, insurance, maintenance and other related costs are to be
paid by the Bank.  At December 31, 2007, future minimum lease
payments are as follows:




Year
      EndingDecember
      31,
              
              Amount(In
      thousands)2008
              
              $
              692009
              
              
              612010
              
              
              612011
              
              
              612012
              
              
              7$
              259




Total
rent expense for all operating leases amounted to $100,000 $153,000 and $169,000
for the years ended December 31, 2007, 2006 and 2005,
respectively.




75


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









8.
            DEPOSITS




A summary
of deposit balances, by type, follows:




December
      31,(In
      thousands)
              2007
              
              
              2006Demand
      deposits
              
              $
              51,396
              
              
              $
              52,491NOW
      deposits
              
              
              33,649
              
              
              
              36,627Money
      market deposits
              
              
              138,688
              
              
              
              96,744Regular
      and other deposits
              
              
              118,837
              
              
              
              130,878Total
      non-certificate accounts
              
              
              342,570
              
              
              
              316,740Term
      certificates less than $100,000
              
              
              266,095
              
              
              
              256,251Term
      certificates $100,000 and greater
              
              
              165,781
              
              
              
              163,998Total
      term certificates
              
              
              431,876
              
              
              
              420,249Total
      deposits
              
              $
              774,446
              
              
              $
              736,989







A summary
of term certificates, by maturity, follows:




(Dollars
      In thousands)
              December
      31, 2007
              
              
              December
      31, 2006Weighted
              
              
              
              
              
              WeightedAverage
              
              
              
              
              
              AverageAmount
              
              
              Rate
              
              
              Amount
              
              
              RateWithin
      1 year
              
              $
              261,209
              
              
              
              4.82
              %
              
              $
              286,883
              
              
              
              4.60
              %Over
      1 year to 2 years
              
              
              156,602
              
              
              
              4.97
              
              
              
              75,942
              
              
              
              4.89Over
      2 years to 3 years
              
              
              9,114
              
              
              
              4.26
              
              
              
              47,364
              
              
              
              5.16Over
      3 years to 4 years
              
              
              2,363
              
              
              
              4.02
              
              
              
              7,808
              
              
              
              4.05Over
      4 years to 5 years
              
              
              2,588
              
              
              
              4.46
              
              
              
              2,252
              
              
              
              4.48$
              431,876
              
              
              
              4.86
              %
              
              $
              420,249
              
              
              
              4.70
              %








Brokered
certificates of deposit, included in the above table, amounted to $897,000 and
$1,215,000 at December 31, 2007 and 2006, respectively.


76


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









9.
            BORROWINGS




Federal
Home Loan Bank (“FHLB”) advances amounting to $9,154,000 and $8,916,000 at
December 31, 2007 and 2006, respectively, mature within one year at a weighted
average rate of 4.52% and 5.33%, respectively.




Long-term
FHLB advances outstanding are as follows:




(Dollars
      In thousands)
              
              December
      31, 2007
              
              
              December
      31, 2006Weighted
              
              
              
              
              
              WeightedMaturing
      During the
              
              
              
              
              Average
              
              
              
              
              
              AverageYear Ending December
      31,
              
              Amount
              
              
              Rate
              
              
              Amount
              
              
              Rate2007
              
              
              -
              
              
              
              -
              %
              
              $
              4,450
              
              
              
              4.69
              %2008
              
              
              14,848
              
              
              
              4.80
              
              
              
              14,698
              
              
              
              4.812009
              
              
              7,475
              
              
              
              4.00
              
              
              
              7,475
              
              
              
              4.002010
              
              
              5,050
              
              
              
              4.22
              
              
              
              5,050
              
              
              
              4.22$
              27,373
              
              
              
              4.48
              %
              
              $
              31,673
              
              
              
              4.51
              %








As of
December 31, 2007, the Bank also has an available line of credit of $9,430,000
with the Federal Home Loan Bank of Boston at an interest rate that adjusts
daily.  No amounts were drawn on the line of credit as of December 31,
2007 and 2006.





All
borrowings from the FHLB are secured by a blanket lien on qualified collateral,
defined principally as 75% of the carrying value of certain first mortgage loans
on owner-occupied residential property.




77


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









10.
            INCOME
      TAXES




Allocation
of federal and state income taxes between current and deferred portions is as
follows:




Years
      Ended December 31,(In
      thousands)
              2007
              
              
              2006
              
              
              2005Current
      tax provision:Federal
              
              $
              625
              
              
              $
              1,314
              
              
              $
              3,440State
              
              
              71
              
              
              
              203
              
              
              
              1,011Total
      current provision
              
              
              696
              
              
              
              1,517
              
              
              
              4,451Deferred
      tax benefit:Federal
              
              
              (281
              )
              
              
              (350
              )
              
              
              (1,302
              )State
              
              
              (35
              )
              
              
              (40
              )
              
              
              (449
              )Total
      deferred benefit
              
              
              (316
              )
              
              
              (390
              )
              
              
              (1,751
              )Total
      provision
              
              $
              380
              
              
              $
              1,127
              
              
              $
              2,700








The
reasons for the differences between the statutory federal income tax rate and
the effective tax rates are summarized as follows:





Years
      Ended December 31,(In
      thousands)
              2007
              
              
              2006
              
              
              2005Statutory
      federal tax rate
              
              
              34.0
              %
              
              
              34.0
              %
              
              
              34.0
              %Increase
      (decrease) resulting from:State
      taxes, net of federal tax benefit
              
              
              0.9
              
              
              
              2.4
              
              
              
              4.6Dividends
      received deduction
              
              
              (7.0
              )
              
              
              (5.0
              )
              
              
              (1.9
              )Bank-owned
      life insurance
              
              
              (14.7
              )
              
              
              (6.2
              )
              
              
              (2.3
              )Other,
      net
              
              
              1.2
              
              
              
              0.3
              
              
              
              (1.1
              )Effective
      tax rates
              
              
              14.4
              %
              
              
              25.5
              %
              
              
              33.3
              %


78


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









The
components of the net deferred tax asset (liability) are as
follows:




December
      31,(In
      thousands)
              2007
              
              
              2006Deferred
      tax asset:Federal
              
              $
              3,146
              
              
              $
              3,168State
              
              
              942
              
              
              
              1,0094,088
              
              
              
              4,177Deferred
      tax liability:Federal
              
              
              (3,975
              )
              
              
              (2,629
              )State
              
              
              (1,523
              )
              
              
              (1,186
              )(5,498
              )
              
              
              (3,815
              )Net
      deferred tax asset (liability)
              
              $
              (1,410
              )
              
              $
              362








The tax
effects of each item that give rise to deferred tax assets (liabilities) are as
follows:





December
      31,(In
      thousands)
              2007
              
              
              2006Net
      unrealized gain on securities available for sale
              
              $
              (4,875
              )
              
              $
              (3,080
              )Depreciation
      and amortization
              
              
              (360
              )
              
              
              (304
              )Allowance
      for loan losses
              
              
              1,488
              
              
              
              1,376Employee
      benefit plans
              
              
              2,002
              
              
              
              2,186Equity
      loss on investment in affiliate bank
              
              
              417
              
              
              
              234Deferred
      income
              
              
              -
              
              
              
              104Other,
      net
              
              
              (82
              )
              
              
              (154
              )Net
      deferred tax asset (liability)
              
              $
              (1,410
              )
              
              $
              362




79


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









A summary
of the change in the net deferred tax asset (liability) is as
follows:





Years
      Ended December 31,(In
      thousands)
              2007
              
              
              2006
              
              
              2005Balance
      at beginning of year
              
              $
              362
              
              
              $
              1,927
              
              
              $
              (1,947
              )Deferred
      tax benefit
              
              
              316
              
              
              
              390
              
              
              
              1,751Change
      in net unrealized gain onsecurities
      available for sale
              
              
              (1,795
              )
              
              
              (2,362
              )
              
              
              2,123Adjustment
      to initially applySFAS
      No. 158
              
              
              -
              
              
              
              407
              
              
              
              -Termination
      of supplementalexecutive
      retirement plan
              
              
              (228
              )
              
              
              -
              
              
              
              -Amotization
      of net actuarial loss andprior
      service cost
              
              
              (65
              )
              
              
              -
              
              
              
              -Balance
      at end of year
              
              $
              (1,410
              )
              
              $
              362
              
              
              $
              1,927








The
federal income tax reserve for loan losses at the Bank’s base year is
$7,500,000.  If any portion of the reserve is used for purposes other
than to absorb loan losses, approximately 150% of the amount actually used
(limited to the amount of the reserve) would be subject to taxation in the year
in which used.  As the Bank intends to use the reserve to absorb only
loan losses, a deferred tax liability of $3,000,000 has not been
provided.









80


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









11.
            OTHER
      COMMITMENTS AND CONTINGENCIES




In the
normal course of business, there are outstanding commitments which are not
reflected in the accompanying consolidated financial statements.




Loan
Commitments




The Bank
is party to financial instruments with off-balance sheet risk in the normal
course of business to meet the financing needs of its customers and to reduce
its own exposure to fluctuations in interest rates.  The instruments
involve, to varying degrees, elements of credit and interest rate risk in excess
of the amount recognized in the accompanying consolidated balance
sheets.  The contract amounts of those instruments reflect the extent
of involvement the Bank has in particular classes of financial
instruments.




The
Bank’s exposure to credit loss in the event of nonperformance by the other party
to the financial instrument for loan commitments is represented by the
contractual amount of those instruments.  The Bank uses the same
credit policies in making commitments as it does for on-balance sheet
instruments.  A summary of outstanding financial instruments whose
contract amounts represent credit risk is as follows:




December
      31,(In
      thousands)
              2007
              
              
              2006Commitments
      to originate loans
              
              $
              37,674
              
              
              $
              28,218Unadvanced
      funds on construction loans
              
              
              35,293
              
              
              
              37,617Unadvanced
      funds on home equity lines of credit
              
              
              20,475
              
              
              
              19,673Unadvanced
      funds on revolving lines of credit
              
              
              26,985
              
              
              
              25,374Commercial
      letters of credit
              
              
              1,574
              
              
              
              1,306




Commitments
to originate loans are agreements to lend to a customer provided there is no
violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee.  Since a portion of the commitments are
expected to expire without being drawn upon, the total commitments do not
necessarily represent future cash requirements.  The Bank evaluates
each customer’s credit worthiness on a case by case basis.  The amount
of collateral obtained, if deemed necessary by the Bank for the extension of
credit, is based upon management’s credit evaluation of the
borrower.  Collateral held includes, but is not limited to,
residential real estate and deposit accounts.




Unfunded
commitments under lines of credit are commitments for possible future extensions
of credit to existing customers.  These lines of credit are
collateralized if deemed necessary and usually do not contain a specified
maturity date and may not be drawn upon to the total extent to which the Bank is
committed.




Letters
of credit are conditional commitments issued by the Bank to guarantee the
performance of a customer to a third-party.  Those letters of credit
are primarily issued to support borrowing arrangements.  The credit
risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers.




Employment
Agreements




The Bank
has entered into employment agreements with certain senior
executives.  The agreements provide for a minimum annual salary,
subject to increase at the discretion of the Board of Directors, and other
benefits.  The agreements may be terminated for cause by the Bank
without further liability on the part of the Bank, or by the executives with
prior written notice to the Board of Directors.




Legal
Claims




Various
legal claims may arise from time to time in the normal course of business, but
in the opinion of management, these claims are not expected to have a material
effect on the Company’s consolidated financial statements.




81


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









12.
            EMPLOYEE
      BENEFIT PLANS




401(k)
Plan




The Bank
has a 401(k) plan to provide basic and supplemental retirement benefits for
eligible employees.  Under this plan, each employee reaching the age
of eighteen and having completed at least three months of service in any one
twelve-month period, beginning with such employee’s date of employment, can
elect to be a participant in the retirement plan.  All participants
are fully vested upon entrance to the plan.  The Bank contributes
three percent of an employee’s compensation regardless of the employee’s
contributions and makes matching contributions equal to fifty percent of the
first six percent of an employee’s compensation contributed to the
Plan.  For the years ended December 31, 2007, 2006 and 2005, expense
attributable to the plan amounted to $522,000, $484,000, and $501,000,
respectively.




Supplemental
Executive Retirement Benefits – Officers and Directors




The Bank
has Supplemental Executive Retirement Plans for certain senior officers and
directors which provide for a defined benefit obligation, based on the
executive’s or director’s final average compensation. The plans
are unfunded and have no assets.  The Bank does not expect to contribute
assets to the plan in 2008.  Information pertaining to the activity in the
plans is as follows:





Years
      Ended December 31,2007
              
              
              2006
              
              
              2005(In
      thousands)
              Officers
              
              
              Directors
              
              
              Officers
              
              
              Directors
              
              
              Officers
              
              
              DirectorsChange
      in plan assets:Fair
      value of plan assets at beginningof
      year
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -Employer
      contribution
              
              
              -
              
              
              
              -
              
              
              
              784
              
              
              
              -
              
              
              
              -
              
              
              
              -Benefits
      payments
              
              
              -
              
              
              
              -
              
              
              
              (784
              )
              
              
              -
              
              
              
              -
              
              
              
              -Fair
      value of plan assets at end of year
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Change
      in benefit obligation:Benefit
      obligation at beginning of year
              
              
              3,547
              
              
              
              646
              
              
              
              3,922
              
              
              
              386
              
              
              
              4,161
              
              
              
              -Service
      cost
              
              
              39
              
              
              
              103
              
              
              
              63
              
              
              
              59
              
              
              
              88
              
              
              
              56Interest
      cost
              
              
              155
              
              
              
              37
              
              
              
              226
              
              
              
              22
              
              
              
              208
              
              
              
              18Benefit
      payments
              
              
              -
              
              
              
              -
              
              
              
              (784
              )
              
              
              -
              
              
              
              -
              
              
              
              -Plan
      amendment
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              312Actuarial
      loss (gain)
              
              
              16
              
              
              
              (118
              )
              
              
              120
              
              
              
              179
              
              
              
              (535
              )
              
              
              -Plan
      termination
              
              
              (3,757
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Benefit
      obligation at end of year
              
              
              -
              
              
              
              668
              
              
              
              3,547
              
              
              
              646
              
              
              
              3,922
              
              
              
              386Funded
      status
              
              
              -
              
              
              
              (668
              )
              
              
              (3,547
              )
              
              
              (646
              )
              
              
              (3,922
              )
              
              
              (386
              )Unrecognized
      net loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              442
              
              
              
              -Unrecognized
      net transition obligation
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              284Accrued
      benefit obligation
              
              $
              -
              
              
              $
              (668
              )
              
              $
              (3,547
              )
              
              $
              (646
              )
              
              $
              (3,480
              )
              
              $
              (102
              )Accumulated
      benefit obligation
              
              $
              -
              
              
              $
              567
              
              
              $
              2,905
              
              
              $
              517
              
              
              $
              2,860
              
              
              $
              271




82







NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)







The
components of net periodic pension cost are as follows:




(In
      thousands)
              2007
              
              
              2006
              
              
              2005Officers
              
              
              Directors
              
              
              Officers
              
              
              Directors
              
              
              Officers
              
              
              DirectorsService
      cost
              
              $
              39
              
              
              $
              103
              
              
              $
              63
              
              
              $
              59
              
              
              $
              88
              
              
              $
              56Interest
      cost
              
              
              155
              
              
              
              37
              
              
              
              226
              
              
              
              22
              
              
              
              208
              
              
              
              18Recognized
      net actuarial loss
              
              
              16
              
              
              
              13
              
              
              
              5
              
              
              
              -
              
              
              
              10
              
              
              
              -Recognition
      of prior service cost
              
              
              -
              
              
              
              28
              
              
              
              -
              
              
              
              28
              
              
              
              -
              
              
              
              28$
              210
              
              
              $
              181
              
              
              $
              294
              
              
              $
              109
              
              
              $
              306
              
              
              $
              102





The
assumptions used to determine benefit obligations and net periodic pension costs
are as follows:




2007
              
              2006
              
              2005Officers
              
              Directors
              
              Officers
              
              Directors
              
              Officers
              
              DirectorsDiscount
      rate
              5.75%
              
              5.75%
              
              5.75%
              
              5.75%
              
              5.75%
              
              5.75%Rate
      of compensation increase
              4.00%
              
              3.00%
              
              4.00%
              
              3.00%
              
              4.00%
              
              3.00%Expected
      return on plan assets
              N/A
              
              N/A
              
              N/A
              
              N/A
              
              N/A
              
              N/ARetirement
      age
              65
              
              72
              
              65
              
              72
              
              65
              
              72





The
expected future benefit payments for the Director’s plan are as
follows:





Year
      Ending December 31,
                
                Amount(In
      thousands)2008
                
                $
                -2009
                
                
                2262010
                
                
                -2011
                
                
                -2012
                
                
                1932013-2017
                
                
                466




Supplemental
Executive Retirement Agreements – Officers




In 2007,
in anticipation of the minority stock offering, the Bank revised the agreements
for the senior officers. This resulted in the termination of the officer’s Plan which had
been accounted for under SFAS No. 158, and the establishment of a liability for
individual contracts. The present value of the estimated future benefits is
accrued over the required service periods. At December 31, 2007 the accrued
liability for these agreements amounted to $3,563,600.




Supplemental executive
retirement benefit expense for officers and directors amounted to $713,000,
$403,000 and $408,000 for the year ended December 31, 2007, 2006 and 2005,
respectively.




Equity
Appreciation Plan




The Bank
previously had an equity appreciation plan to attract, retain and motivate
directors and officers and other key managerial employees.  On
February 10, 2005, the Bank’s Executive Committee voted to freeze the Equity
Appreciation Plan at the current level of shares, and on January 25, 2007, voted
to terminate the Plan with payout to occur in 2008.  The accrued
liability for this plan as of both December 31, 2007 and 2006 amounted to
$1,723,000.  The expense for the year ended December 31, 2005 amounted
to $488,000.




83







NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









Incentive
Compensation Plan




Eligible
officers and employees of the Bank participate in an incentive compensation plan
which is based on various factors as set forth by the Executive
Committee.  Incentive compensation plan expense for the years ended
December 31, 2007, 2006 and 2005 amounted to $710,000, $573,000, and $828,000,
respectively.




13.
            RELATED
      PARTY TRANSACTIONS




The
following summarizes the activity with respect to loans made to officers and
directors of the Company, their affiliates, and members of their immediate
families.





Years
      Ended December 31,(In
      thousands)
              
              2007
              
              
              2006Balance
      at beginning of year
              
              $
              12,294
              
              
              $
              12,129Additions
              
              
              1,771
              
              
              
              3,123Reductions
              
              
              (2,117
              )
              
              
              (2,958
              )Balance
      at end of year
              
              $
              11,948
              
              
              $
              12,294





Such
loans are made in the normal course of business at the Bank’s normal credit
terms, including interest rate and collateral requirements, and do not represent
more than a normal risk of collection.




Deposits
from these related parties totaled $4,588,000 and $7,080,000 at
December 31, 2007 and 2006, respectively.  All such deposits were
accepted in the ordinary course of business on substantially the same terms as
those prevailing at the time for comparable transactions with other
persons.




In
connection with the Company’s investment in Hampshire First Bank (“HFB”), East
Boston Savings Bank has entered into a Master Services Agreement whereby certain
services are provided to HFB.  During the years ended December 31,
2007 and 2006, revenue recorded by the Company for providing such services
amounted to $8,000 and $12,000 respectively.  Additionally, four out
of ten of the directors of HFB also serve as directors of the Company, including
one who serves as the Chairman of the Board of both entities.




84


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









14.
            MINIMUM
      REGULATORY CAPITAL REQUIREMENTS




The
Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies.  Failure to meet minimum
capital requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company’s and Bank’s consolidated financial
statements.  Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and the Bank must meet
specific capital guidelines that involve quantitative measures of their assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices.  The capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.  Prompt corrective action provisions
are not applicable to mutual holding companies.




Quantitative
measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios (set forth in the
table) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined) and of Tier 1 capital (as defined) to
average assets (as defined).  Management believes, as of
December 31, 2007 and 2006, that the Company and the Bank meet all capital
adequacy requirements to which they are subject.




As of
December 31, 2007, the most recent notification from the Federal Deposit
Insurance Company categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action.  To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the following
table.  There are no conditions or events since that notification that
management believes have changed the Bank’s category.




85


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









The
Company’s and the Bank’s actual capital amounts and ratios follow:




MinimumTo
      Be WellMinimum
              
              
              Capitalized
      UnderCapital
              
              
              Prompt
      CorrectiveActual
              
              
              Requirement
              
              
              Action
      Provisions(Dollars
      in thousands)
              Amount
              
              
              Ratio
              
              
              Amount
              
              
              Ratio
              
              
              Amount
              
              
              RatioDecember 31,
      2007Total
      Capital (to Risk WeightedAssets):Company
              
              $
              117,546
              
              
              
              14.4
              %
              
              $
              65,236
              
              
              
              8.0
              %
              
              
              N/A
              
              
              
              N/ABank
              
              
              104,156
              
              
              
              13.0
              
              
              
              64,221
              
              
              
              8.0
              
              
              $
              80,276
              
              
              
              10.0
              %Tier
      1 Capital (to Risk WeightedAssets):Company
              
              
              109,154
              
              
              
              13.4
              
              
              
              32,618
              
              
              
              4.0
              
              
              
              N/A
              
              
              
              N/ABank
              
              
              95,764
              
              
              
              11.9
              
              
              
              32,110
              
              
              
              4.0
              
              
              
              48,165
              
              
              
              6.0Tier
      1 Capital (to Average Assets):Company
              
              
              109,154
              
              
              
              11.5
              
              
              
              38,013
              
              
              
              4.0
              
              
              
              N/A
              
              
              
              N/ABank
              
              
              95,764
              
              
              
              10.2
              
              
              
              37,505
              
              
              
              4.0
              
              
              
              46,881
              
              
              
              5.0December 31,
      2006Total
      Capital (to Risk WeightedAssets):Company
              
              $
              114,684
              
              
              
              15.1
              %
              
              $
              60,688
              
              
              
              8.0
              %
              
              
              N/A
              
              
              
              N/ABank
              
              
              100,187
              
              
              
              13.4
              
              
              
              59,638
              
              
              
              8.0
              
              
              $
              74,548
              
              
              
              10.0
              %Tier
      1 Capital (to Risk WeightedAssets):Company
              
              
              106,882
              
              
              
              14.1
              
              
              
              30,344
              
              
              
              4.0
              
              
              
              N/A
              
              
              
              N/ABank
              
              
              92,385
              
              
              
              12.4
              
              
              
              29,819
              
              
              
              4.0
              
              
              
              44,729
              
              
              
              6.0Tier
      1 Capital (to Average Assets):Company
              
              
              106,882
              
              
              
              12.4
              
              
              
              34,402
              
              
              
              4.0
              
              
              
              N/A
              
              
              
              N/ABank
              
              
              92,385
              
              
              
              10.5
              
              
              
              35,335
              
              
              
              4.0
              
              
              
              44,168
              
              
              
              5.0







86


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









A
reconciliation of the Company’s and Bank’s retained earnings to regulatory
capital follows:




December
      31, 2007
              
              
              December
      31, 2006(In
      Thousands)
              Consolidated
              
              
              Bank
              
              
              Consolidated
              
              
              BankTotal
      retained earnings per financial statements
              
              $
              115,684
              
              
              $
              102,294
              
              
              $
              110,275
              
              
              $
              95,778Adjustments
      to Tier 1 capital:Accumulated
      other comprehensive income
              
              
              (6,507
              )
              
              
              (6,507
              )
              
              
              (3,364
              )
              
              
              (3,364
              )Servicing
      assets
              
              
              (23
              )
              
              
              (23
              )
              
              
              (29
              )
              
              
              (29
              )Total
      Tier 1 capital
              
              
              109,154
              
              
              
              95,764
              
              
              
              106,882
              
              
              
              92,385Adjustments
      for total capital:Allowance
      for loan losses
              
              
              3,637
              
              
              
              3,637
              
              
              
              3,354
              
              
              
              3,35445%
      of net unrealized gains onmarketable
      equity securities
              
              
              4,755
              
              
              
              4,755
              
              
              
              4,448
              
              
              
              4,448Total
      capital per regulatory reporting
              
              $
              117,546
              
              
              $
              104,156
              
              
              $
              114,684
              
              
              $
              100,187




15.
            FAIR
      VALUE OF FINANCIAL INSTRUMENTS




The fair
value of a financial instrument is the current amount that would be exchanged
between willing parties, other than in a forced liquidation.  Fair
value is best determined based upon quoted market prices.  However, in
many instances, there are no quoted market prices for the Company’s various
financial instruments.  In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques.  Those techniques are significantly affected by
the assumptions used, including the discount rate and estimates of future cash
flows.  Accordingly, the fair value estimates may not be realized in
an immediate settlement of the instrument.  Disclosure is not required
for certain financial instruments and all nonfinancial
instruments.  Accordingly, the aggregate fair value amounts presented
may not necessarily represent the underlying fair value of the
Company.




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




Cash and cash
equivalents - The carrying amounts of cash and short-term instruments
approximate fair values.




Securities available for
sale - Fair values for securities are based on quoted market prices,
where available.  If quoted market values are not available, fair
values are based on quoted market prices of comparable instruments.




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 -
Fair values of loans held for sale are based on commitments on hand from
investors or prevailing market prices.




87


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









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
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 interest rates currently being
offered on certificates to a schedule of aggregated expected monthly maturities
on time deposits.




Stock subscriptions–The carrying amount of stock subscriptions approximates fair
value.




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.




The
carrying amounts and estimated fair values of the Company’s financial
instruments are as follows:




December
      31,2007
              
              
              2006Carrying
              
              
              Fair
              
              
              Carrying
              
              
              Fair(In
      thousands)
              Amount
              
              
              Value
              
              
              Amount
              
              
              ValueFinancial
      assets:Cash
      and cash equivalents
              
              $
              103,093
              
              
              $
              103,093
              
              
              $
              23,494
              
              
              $
              23,494Securities
      available for sale
              
              
              267,058
              
              
              
              267,058
              
              
              
              281,662
              
              
              
              281,662Federal
      Home Loan Bank stock
              
              
              3,165
              
              
              
              3,165
              
              
              
              3,371
              
              
              
              3,371Loans
      held for sale
              
              
              -
              
              
              
              -
              
              
              
              3,594
              
              
              
              3,594Loans
              
              
              568,104
              
              
              
              572,820
              
              
              
              529,650
              
              
              
              532,484Accrued
      interest receivable
              
              
              5,764
              
              
              
              5,764
              
              
              
              5,502
              
              
              
              5,502Financial
      liabilities:Deposits
              
              
              774,446
              
              
              
              776,037
              
              
              
              736,989
              
              
              
              738,422Stock
      subscriptions
              
              
              62,518
              
              
              
              62,518
              
              
              
              -
              
              
              
              -Borrowings
              
              
              36,527
              
              
              
              36,556
              
              
              
              40,589
              
              
              
              40,042Accrued
      interest payable
              
              
              1,222
              
              
              
              1,222
              
              
              
              1,169
              
              
              
              1,169




88




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)









16.
            CONDENSED
      FINANCIAL STATEMENTS OF PARENT
COMPANY




Financial
information pertaining only to Meridian Interstate Bancorp, funded in July 2006,
is as follows:




December
      31,(In
      Thousands)
              2007
              
              
              2006BALANCE
      SHEETAssetsCash
      and cash equivalents
              
              $
              177
              
              
              $
              26Securities
      available for sale at fair value
              
              
              1,093
              
              
              
              2,506Investment
      in subsidiary
              
              
              102,294
              
              
              
              96,227Investment
      in affiliate bank
              
              
              10,772
              
              
              
              11,313Other
      assets
              
              
              1,577
              
              
              
              203Total
      assets
              
              $
              115,913
              
              
              $
              110,275Liabilities and
      Stockholder's EquityAccrued
      expenses and other liabilities
              
              $
              229
              
              
              $
              -Stockholder's
      equity
              
              
              115,684
              
              
              
              110,275Total
      liabilities and stockholder's equity
              
              $
              115,913
              
              
              $
              110,275




89


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)




Year
      Ended December 31,(In
      Thousands)
              2007
              
              
              2006STATEMENTS OF
      INCOMEIncome:Interest
      and dividends on securities
              
              $
              113
              
              
              $
              180Equity
      loss on investment in affliate bank
              
              
              (541
              )
              
              
              (578
              )Total
      loss
              
              
              (428
              )
              
              
              (398
              )Operating
      expenses
              
              
              412
              
              
              
              58Loss
      before income taxes and equity in undistributedearnings
      of subsidiary
              
              
              (840
              )
              
              
              (456
              )Applicable
      income tax benefit
              
              
              (184
              )
              
              
              (113
              )(656
              )
              
              
              (343
              )Equity
      in undistributed earnings of subsidiary
              
              
              2,922
              
              
              
              3,637Net
      income
              
              $
              2,266
              
              
              $
              3,294STATEMENTS OF CASH
      FLOWSCash
      flows from operating activities:Net
      income
              
              $
              2,266
              
              
              $
              3,294Adjustments
      to reconcile net income to netcash
      used by operating activities:Equity
      in undistributed earnings of subsidiary
              
              
              (2,922
              )
              
              
              (3,637
              )Equity
      loss on investment in affliate bank
              
              
              541
              
              
              
              578Net
      amortization of securities available for sale
              
              
              -
              
              
              
              (125
              )Increase
      in other assets
              
              
              (1,374
              )
              
              
              (203
              )Increase
      in other liabilities
              
              
              229
              
              
              
              -Net
      cash used by operating activities
              
              
              (1,260
              )
              
              
              (93
              )Cash
      flows from investing activities:Sales
      and maturities of securities available for sale
              
              
              1,523
              
              
              
              23,050Purchase
      of securities available for sale
              
              
              (112
              )
              
              
              (25,431
              )Investment
      in affiliate bank
              
              
              -
              
              
              
              (12,000
              )Dividend
      from subsidiary
              
              
              -
              
              
              
              14,500Net
      cash provided by investing activities
              
              
              1,411
              
              
              
              119Net
      increase in cash and cash equivalents
              
              
              151
              
              
              
              26Cash
      and cash equivalents at beginning of year
              
              
              26
              
              
              
              -Cash
      and cash equivalents at end of year
              
              $
              177
              
              
              $
              26




90


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)







17.
            SELECTED
      QUARTERLY CONSOLIDATED FINANCIAL INFORMATION
  (Unaudited)




The
selected quarterly financial data presented below should be read in conjunction
with the Consolidated Financial Statements and related notes.




Years
      Ended December 31,(Dollars in
      Thousands)
              
              2007
              
              
              2006Fourth
              
              
              Third
              
              
              Second
              
              
              First
              
              
              Fourth
              
              
              Third
              
              
              Second
              
              
              FirstQuarter
              
              
              Quarter
              
              
              Quarter
              
              
              Quarter
              
              
              Quarter
              
              
              Quarter
              
              
              Quarter
              
              
              QuarterInterest
      and dividend income
              
              $
              12,810
              
              
              $
              12,390
              
              
              $
              12,080
              
              
              $
              11,895
              
              
              $
              12,090
              
              
              $
              11,464
              
              
              $
              10,982
              
              
              $
              10,699Interest
      expense
              
              
              7,501
              
              
              
              7,203
              
              
              
              6,800
              
              
              
              6,592
              
              
              
              6,550
              
              
              
              5,688
              
              
              
              4,994
              
              
              
              4,596Net
      interest income
              
              
              5,309
              
              
              
              5,187
              
              
              
              5,280
              
              
              
              5,303
              
              
              
              5,540
              
              
              
              5,776
              
              
              
              5,988
              
              
              
              6,103Provision
      for loan losses
              
              
              205
              
              
              
              117
              
              
              
              71
              
              
              
              72
              
              
              
              31
              
              
              
              223
              
              
              
              111
              
              
              
              69Net
      interest income, after provision for  loan
losses
              
              
              5,104
              
              
              
              5,070
              
              
              
              5,209
              
              
              
              5,231
              
              
              
              5,509
              
              
              
              5,553
              
              
              
              5,877
              
              
              
              6,034Non-interest
      income
              
              
              452
              
              
              
              11
              
              
              
              1,253
              
              
              
              2,936
              
              
              
              232
              
              
              
              234
              
              
              
              934
              
              
              
              1,942Non-interest
      expenses
              
              
              6,140
              
              
              
              5,707
              
              
              
              5,237
              
              
              
              5,536
              
              
              
              6,096
              
              
              
              5,220
              
              
              
              5,305
              
              
              
              5,273Income
      (loss) beforeincome
      taxes
              
              
              (584
              )
              
              
              (626
              )
              
              
              1,225
              
              
              
              2,631
              
              
              
              (355
              )
              
              
              567
              
              
              
              1,506
              
              
              
              2,703Provision
      (benefit) forincome
      taxes
              
              
              (562
              )
              
              
              (323
              )
              
              
              429
              
              
              
              836
              
              
              
              (64
              )
              
              
              128
              
              
              
              279
              
              
              
              784Net
      income (loss)
              
              $
              (22
              )
              
              $
              (303
              )
              
              $
              796
              
              
              $
              1,795
              
              
              $
              (291
              )
              
              $
              439
              
              
              $
              1,227
              
              
              $
              1,919
















91


Item 9.  Changes in and disagreements
with accountants on accounting and financial disclosure





None.





Item 9a.  Controls and Procedures





Not
applicable.





Item 9a(t).  Controls and
Procedures





An
evaluation was performed under the supervision and with the participation of our
management, including the Chief Executive Officer and the Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)
promulgated under the Securities and Exchange Act of 1934, as amended) as of
December 31, 2007. Based on that evaluation, our management, including the Chief
Executive Officer and the Chief Financial Officer, concluded that our disclosure
controls and procedures were effective.





During
the quarter ended December 31, 2007, there were no changes in our internal
control over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.





See the
Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.





This
annual report does not include a report of management’s assessment regarding
internal control over financial reporting or an attestation report
of Meridian Interstate Bancorp, Inc.’s registered public accounting
firm due to a transition period established by rules of the Securities and
Exchange Commission for newly public companies.








Item 9b.  other
information





Not
applicable.

















92


PART
III








Item 10.  Directors and Executive
Officers of the Registrant and Corporate Governance





The
“Proposal I—Election of Directors” section of the Company’s definitive proxy
statement for our 2008 Annual Meeting of Stockholders (the “2008 Proxy
Statement”) will be incorporated herein by reference or filed by an amendment to
this annual report.




Item 11.  Executive
Compensation





The
“Proposal I—Election of Directors” section of the Company’s 2008 Proxy Statement
will be incorporated herein by reference or filed by an amendment to this annual
report.




Item 12.  Security Ownership of
Certain Beneficial Owners and Management and Related Stockholder
Matters





The “Proposal I—Election of Directors” section of the 2008 Proxy
Statement will be incorporated herein by reference or filed by an amendment to
this annual report.




We do not
have any equity compensation program that was not approved by stockholders,
other than our employee stock ownership plan.





Item 13. Certain Relationships and
Related Transactions, and Director Independence





The
“Transactions with Certain Related Persons” section of the 2008 Proxy Statement
will be incorporated herein by reference or filed by an amendment to this annual
report.




Item 14.  Principal Accountant Fees
and Services





The
“Proposal II – Ratification of Appointment of Independent Registered Public
Accounting Firm” Section of the 2008 Proxy Statement will be incorporated herein
by reference or filed by an amendment to this annual report.












93




PART IV









Item 15. Exhibits and Financial
Statement Schedules





(a)(1)  Financial
Statements





The following documents are filed as
part of this Form 10-K.





(A)
            Report
      of Independent Registered Public Accounting
Firm





(B)
            Consolidated
      Balance Sheets - at December 31, 2007 and
2006





(C)
            Consolidated
      Statements of Income - Years ended December 31, 2007, 2006 and
      2005





(D)
            Consolidated
      Statements of Changes in Retained Earnings - Years ended December 31,
      2007, 2006 and 2005





(E)
            Consolidated
      Statements of Cash Flows - Years ended December 31, 2007, 2006 and
      2005





(F)
            Notes
      to Consolidated Financial
Statements.





(a)(2)  Financial Statement
Schedules





None.





(a)(3)    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.*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 Amended and Restated Supplemental Executive Retirement Agreements with
      certain officers*10.7
              Form
      of Supplemental Executive Retirement Agreements with certain
      directors*21
              Subsidiaries
      of Registrant*31.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200231.2
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200232
              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.


94


SIGNATURES





Pursuant to the requirements of Section
13 or 15(d) 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.Date:
            March 28,
      2008
            
            By:
            /s/
      Richard J. GavegnanoRichard
      J. GavegnanoChairman
      of the Board and Chief Executive Officer(Duly
      Authorized Representative)





Pursuant to the requirements of the
Securities Exchange of 1934, this report has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated.





Signatures
            
            Title
            
            Date/s/
      Richard J. Gavegnano
              Richard
      J. Gavegnano
            
            Chairman
      of the Board and Chief Executive Officer (Principal Executive
      Officer)
            
            March
      28, 2008/s/
      Leonard V. Siuda
              Leonard
      V. Siuda
            
            Chief
      Financial Officer and Treasurer (Principal Financial and Accounting
      Officer)
            
            March
      28, 2008/s/
      Robert F. Verdonck
              Robert
      F. Verdonck
            
            President
      and Director
            
            March
      28, 2008/s/
      Philip F. Freehan
              Philip
      F. Freehan
            
            Executive
      Vice President and Director
            
            March
      28, 2008/s/
      Vincent D. Basile
              Vincent
      D. Basile
            
            Director
            
            March
      28, 2008/s/
      James P. DelRossi
              James
      P. DelRossi
            
            Director
            
            March
      28, 2008/s/
      Anna R. DiMaria
              Anna
      R. DiMaria
            
            Director
            
            March
      28, 2008/s/
      Domenic A. Gambardella
              Domenic
      A. Gambardella
            
            Director
            
            March
      28, 2008/s/
      Edward L. Lynch
              Edward
      L. Lynch
            
            Director
            
            March
      28, 2008/s/
      Gregory F. Natalucci
              Gregory
      F. Natalucci
            
            Director
            
            March
      28, 2008


95





Signatures
            
            Title
            
            Date/s/
      James G. Sartori
              James
      G. Sartori
            
            Director
            
            March
      28, 2008/s/
      Paul T. Sullivan
              Paul
      T. Sullivan
            
            Director
            
            March
      28, 2008/s/
      Marilyn A. Censullo
              Marilyn
      A. Censullo
            
            Director
            
            March
      28, 2008




96