UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q


(Mark
One)





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





For the
quarterly period ended September 30, 2008





OR





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





For the
transition period from ______________ to _____________




Commission
file number:  001-33898







Meridian Interstate Bancorp,
Inc.


(Exact
name of registrant as specified in its charter)





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





10 Meridian Street, East
Boston, Massachusetts 02128


(Address
of principal executive offices)





(617)
567-1500


(Registrant’s
telephone number, including area code)





Not
Applicable


(Former
name, former address and former fiscal year, if changed since last
report)





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





Indicate by check
mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company.  See
definition of “large accelerated filer” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.


(Check
one): Large Accelerated Filer o  Accelerated
Filer £  Non-accelerated
Filer T   Smaller
Reporting Company£





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





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


Index


MERIDIAN
INTERSTATE BANCORP, INC.





FORM
10-Q





INDEX





PART I.
            FINANCIAL INFORMATIONItem 1.
            Financial Statements
            PageConsolidated Balance Sheets at September 30, 2008 and December
      31, 2007 (Unaudited)
            1Consolidated Statements of Operations for the three and nine
      months ended September 30, 2008 and 2007 (Unaudited)
            2Consolidated Statements of Changes in Stockholders’ Equity for
      the nine months ended September 30, 2008 and 2007
      (Unaudited)
            3Consolidated Statements of Cash Flows for the nine months ended
      September 30, 2008 and 2007 (Unaudited)
            4Notes to Unaudited Consolidated Financial
      Statements
            6Item 2.
            Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
            10Item 3.
            Quantitative and Qualitative Disclosures About Market
      Risk
            22Item 4.
            Controls and Procedures
            23PART II.
            OTHER INFORMATIONItem 1.
            Legal Proceedings
            24Item 1A.
            Risk Factors
            24Item 2.
            Unregistered Sales of Equity Securities and Use of
      Proceeds
            25Item 3.
            Defaults Upon Senior Securities
            25Item 4.
            Submission of Matters to a Vote of Security
      Holders
            25Item 5.
            Other Information
            25Item 6.
            Exhibits
            26Signatures
            
            27








Index


PART
I – FINANCIAL INFORMATION





Item
1. Financial Statements





MERIDIAN INTERSTATE BANCORP, INC. AND SUBSIDIARIES


Consolidated
Balance Sheets


(Unaudited)





September
      30,
              
              
              December
      31,(Dollars
      in thousands)
              
              2008
              
              
              2007ASSETSCash
      and due from banks
              
              $
              15,934
              
              
              $
              11,821Federal
      funds sold
              
              
              23,550
              
              
              
              91,272Total
      cash and cash equivalents
              
              
              39,484
              
              
              
              103,093Certificates
      of deposit
              
              
              7,000
              
              
              
              -Securities
      available for sale, at fair value
              
              
              288,941
              
              
              
              267,058Federal
      Home Loan Bank stock, at cost
              
              
              4,303
              
              
              
              3,165Loans
              
              
              667,608
              
              
              
              571,741Less
      allowance for loan losses
              
              
              (5,718
              )
              
              
              (3,637
              )Loans,
      net
              
              
              661,890
              
              
              
              568,104Bank-owned
      life insurance
              
              
              22,627
              
              
              
              18,003Investment
      in affiliate bank
              
              
              10,449
              
              
              
              10,772Premises
      and equipment, net
              
              
              22,575
              
              
              
              22,816Accrued
      interest receivable
              
              
              5,627
              
              
              
              5,764Foreclosed
      real estate
              
              
              2,045
              
              
              
              560Other
      assets
              
              
              8,742
              
              
              
              3,891Total
      assets
              
              $
              1,073,683
              
              
              $
              1,003,226LIABILITIES
      AND STOCKHOLDERS' EQUITYDeposits:Non
      interest-bearing
              
              $
              56,805
              
              
              $
              51,396Interest-bearing
              
              
              748,279
              
              
              
              723,050Total
      deposits
              
              
              805,084
              
              
              
              774,446Stock
      subscriptions
              
              
              -
              
              
              
              62,518Short-term
      borrowings
              
              
              -
              
              
              
              9,154Long-term
      debt
              
              
              57,675
              
              
              
              27,373Accrued
      expenses and other liabilities
              
              
              15,870
              
              
              
              14,051Total
      liabilities
              
              
              878,629
              
              
              
              887,542Stockholders'
      equity:Common
      stock, no par value 50,000,000 shares authorized;23,000,000
      and 0 shares issued and outstandingat
      September 30, 2008 and December 31, 2007
              
              
              -
              
              
              
              -Additional
      paid-in capital
              
              
              100,628
              
              
              
              -Retained
      earnings
              
              
              107,141
              
              
              
              109,177Accumulated
      other comprehensive income (loss)
              
              
              (4,745
              )
              
              
              6,507Unearned
      compensation - ESOP, 796,950 shares and 0 sharesat
      September 30, 2008 and December 31, 2007, respectively
              
              
              (7,970
              )
              
              
              -Total
      stockholders' equity
              
              
              195,054
              
              
              
              115,684Total
      liabilities and stockholders' equity
              
              $
              1,073,683
              
              
              $
              1,003,226


See
accompanying notes to unaudited consolidated financial
statements.


1
 Index





MERIDIAN
INTERSTATE BANCORP, INC. AND SUBSIDIARIES


Consolidated
Statements of Operations


(Unaudited)





Three
      Months EndedSeptember 30,
              
              
              Nine
      Months EndedSeptember 30,(Dollars
      in thousands, except share amounts)
              
              2008
              
              
              2007
              
              
              2008
              
              
              2007Interest
      and dividend income:Interest
      and fees on loans
              
              $
              9,938
              
              
              $
              9,073
              
              
              $
              28,455
              
              
              $
              26,560Interest
      on debt securities
              
              
              2,674
              
              
              
              2,715
              
              
              
              7,919
              
              
              
              8,264Dividends
      on equity securities
              
              
              573
              
              
              
              271
              
              
              
              1,264
              
              
              
              815Interest
      on certificates of deposit
              
              
              60
              
              
              
              -
              
              
              
              98
              
              
              
              -Interest
      on federal funds sold
              
              
              99
              
              
              
              331
              
              
              
              1,640
              
              
              
              726Total
      interest and dividend income
              
              
              13,344
              
              
              
              12,390
              
              
              
              39,376
              
              
              
              36,365Interest
      expense:Interest
      on deposits
              
              
              6,045
              
              
              
              6,736
              
              
              
              19,382
              
              
              
              19,159Interest
      on short-term borrowings
              
              
              -
              
              
              
              97
              
              
              
              115
              
              
              
              288Interest
      on long-term debt
              
              
              534
              
              
              
              370
              
              
              
              1,363
              
              
              
              1,148Total
      interest expense
              
              
              6,579
              
              
              
              7,203
              
              
              
              20,860
              
              
              
              20,595Net
      interest income
              
              
              6,765
              
              
              
              5,187
              
              
              
              18,516
              
              
              
              15,770Provision
      for loan losses
              
              
              403
              
              
              
              117
              
              
              
              2,731
              
              
              
              260Net
      interest income, after provisionfor
      loan losses
              
              
              6,362
              
              
              
              5,070
              
              
              
              15,785
              
              
              
              15,510Non-interest
      income:Customer
      service fees
              
              
              718
              
              
              
              710
              
              
              
              2,073
              
              
              
              2,022Loan
      fees
              
              
              181
              
              
              
              152
              
              
              
              551
              
              
              
              486Gain
      (loss) on sales of loans, net
              
              
              (10
              )
              
              
              (6
              )
              
              
              17
              
              
              
              19Gain
      (loss) on sales of securities, net
              
              
              2,779
              
              
              
              (860
              )
              
              
              5,092
              
              
              
              1,172Income
      from bank-owned life insurance
              
              
              209
              
              
              
              153
              
              
              
              624
              
              
              
              850Equity
      loss on investment in affiliate bank
              
              
              (69
              )
              
              
              (138
              )
              
              
              (323
              )
              
              
              (349
              )Total
      non-interest income
              
              
              3,808
              
              
              
              11
              
              
              
              8,034
              
              
              
              4,200Non-interest
      expenses:Salaries
      and employee benefits
              
              
              4,009
              
              
              
              3,618
              
              
              
              13,793
              
              
              
              10,704Occupancy
      and equipment
              
              
              719
              
              
              
              608
              
              
              
              2,198
              
              
              
              1,932Data
      processing
              
              
              450
              
              
              
              368
              
              
              
              1,243
              
              
              
              1,100Marketing
              
              
              293
              
              
              
              282
              
              
              
              832
              
              
              
              625Professional
      services
              
              
              595
              
              
              
              278
              
              
              
              1,562
              
              
              
              737Contribution
      to the MeridianCharitable
      Foundation
              
              
              -
              
              
              
              -
              
              
              
              3,000
              
              
              
              -Other
      general and administrative
              
              
              733
              
              
              
              553
              
              
              
              1,959
              
              
              
              1,382Total
      non-interest expenses
              
              
              6,799
              
              
              
              5,707
              
              
              
              24,587
              
              
              
              16,480Income
      (loss) before income taxes
              
              
              3,371
              
              
              
              (626
              )
              
              
              (768
              )
              
              
              3,230Provision
      (benefit) for income taxes
              
              
              1,228
              
              
              
              (323
              )
              
              
              (374
              )
              
              
              942Net
      income (loss)
              
              $
              2,143
              
              
              $
              (303
              )
              
              $
              (394
              )
              
              $
              2,288Income
      per share:Basic
              
              $
              0.10
              
              
              
              N/A
              
              
              
              N/A
              
              
              
              N/ADiluted
              
              $
              0.10
              
              
              
              N/A
              
              
              
              N/A
              
              
              
              N/AWeighted
      Average Shares:Basic
              
              
              22,196,225
              
              
              
              N/A
              
              
              
              N/A
              
              
              
              N/ADiluted
              
              
              22,196,225
              
              
              
              N/A
              
              
              
              N/A
              
              
              
              N/A




See
accompanying notes to unaudited consolidated financial
statements.


2
 Index


MERIDIAN
INTERSTATE BANCORP, INC. AND SUBSIDIARIES


Consolidated
Statements of Changes in Stockholders’ Equity


(Unaudited)


Nine
Months Ended September 30, 2008 and 2007




(Dollars
      in thousands)
              
              Shares
      of Common Stock
              
              
              Common
      Stock
              
              
              Additional
      Paid-in Capital
              
              
              Retained
      Earnings
              
              
              Accumulated
      OtherComprehensive Income (Loss)
              
              
              Unearned
      Compensation ESOP
              
              
              TotalNine
      months ended September 30, 2007Balance
      at December 31, 2006
              
              
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              106,911
              
              
              $
              3,364
              
              
              $
              -
              
              
              $
              110,275Comprehensive
      income:Net
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              2,288
              
              
              
              -
              
              
              
              -
              
              
              
              2,288Net
      unrealized gain on securities available for sale, net ofreclassification
      adjustment and tax effects
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,653
              
              
              
              -
              
              
              
              1,653Total
      comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              3,941Balance
      at September 30, 2007
              
              
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              109,199
              
              
              $
              5,017
              
              
              $
              -
              
              
              $
              114,216Nine
      months ended September 30, 2008Balance
      at December 31, 2007
              
              
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              109,177
              
              
              $
              6,507
              
              
              $
              -
              
              
              $
              115,684Adjustment
      to initially apply EITF 06-4
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (1,642
              )
              
              
              -
              
              
              
              -
              
              
              
              (1,642
              )Balance,
      as adjusted
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              114,042Comprehensive
      loss:Net
      loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (394
              )
              
              
              -
              
              
              
              -
              
              
              
              (394
              )Net
      unrealized loss on securities available for sale, net ofreclassification
      adjustment and tax effects
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (10,914
              )
              
              
              -
              
              
              
              (10,914
              )Amortization
      of prior service cost, net of tax effects
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              15
              
              
              
              -
              
              
              
              15Total
      comprehensive loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (11,293
              )Adjustment
      to initially apply FAS 158 forlong-term
      health care plan
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (353
              )
              
              
              -
              
              
              
              (353
              )Issuance
      of 12,650,000 shares to the mutual holding company
              12,650,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Issuance
      of 10,050,000 shares in the initial publicoffering,
      net of expenses of $2,867
              
              
              10,050,000
              
              
              
              -
              
              
              
              97,633
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              97,633Issuance
      and contribution of common stock tothe
      Meridian Charitable Foundation, Inc.
              
              
              300,000
              
              
              
              -
              
              
              
              3,000
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              3,000Purchase
      of common stock by the ESOP
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (8,280
              )
              
              
              (8,280
              )Unallocated
      ESOP shares earned (31,050 shares)
              
              
              -
              
              
              
              -
              
              
              
              (5
              )
              
              
              -
              
              
              
              -
              
              
              
              310
              
              
              
              305Balance
      at September 30, 2008
              
              
              23,000,000
              
              
              $
              -
              
              
              $
              100,628
              
              
              $
              107,141
              
              
              $
              (4,745
              )
              
              $
              (7,970
              )
              
              $
              195,054


See
accompanying notes to unaudited consolidated financial statements.





3
 Index


MERIDIAN
INTERSTATE BANCORP, INC. AND SUBSIDIARIES


Consolidated
Statements of Cash Flows


(Unaudited)








Nine
      Months Ended September 30,(In
      thousands)
                
                2008
                
                2007Cash
      flows from operating activities:Net
      income (loss)
                
                $
                (394
                )
                
                $
                2,288Adjustments
      to reconcile net income (loss) to net cashprovided
      by operating activities:Contribution
      of stock to charitable foundation
                
                
                3,000
                
                
                
                -Earned
      ESOP shares
                
                
                305
                
                
                
                -Provision
      for loan losses
                
                
                2,731
                
                
                
                260Amortization
      of net deferred loan origination fees
                
                
                (242
                )
                
                
                (380
                )Net
      amortization of securities available for sale
                
                
                828
                
                
                
                521Depreciation
      and amortization expense
                
                
                950
                
                
                
                855Gain
      on sales of securities, net
                
                
                (5,092
                )
                
                
                (1,172
                )Loss
      on sale of foreclosed real estate
                
                
                5
                
                
                
                -Deferred
      income tax benefit
                
                
                (1,522
                )
                
                
                (2,181
                )Income
      from bank-owned life insurance
                
                
                (624
                )
                
                
                (850
                )Equity
      loss on investment in affiliate bank
                
                
                323
                
                
                
                349Net
      changes in:Accrued
      interest receivable
                
                
                137
                
                
                
                218Other
      assets
                
                
                2,808
                
                
                
                1,371Accrued
      expenses and other liabilities
                
                
                1,438
                
                
                
                1,552Net
      cash provided by operating activities
                
                
                4,651
                
                
                
                2,831Cash
      flows from investing activities:Purchases
      of certificates of deposit
                
                
                (7,000
                )
                
                
                -Activity
      in securities available for sale:Proceeds
      from maturities, calls and principal payments
                
                
                90,363
                
                
                
                79,442Proceeds
      from redemption of mutual funds
                
                
                25,000
                
                
                
                -Proceeds
      from sales
                
                
                16,947
                
                
                
                40,944Purchases
                
                
                (168,579
                )
                
                
                (104,630
                )(Purchase)
      redemption of Federal Home Loan Bank stock
                
                
                (1,138
                )
                
                
                206Loans
      originated, net of principal payments received
                
                
                (99,228
                )
                
                
                (16,645
                )Purchase
      of bank-owned life insurance
                
                
                (4,000
                )
                
                
                -Proceeds
      from bank-owned life insurance
                
                
                -
                
                
                
                1,793Purchases
      of premises and equipment
                
                
                (709
                )
                
                
                (4,050
                )Proceeds
      from sales of foreclosed real estate
                
                
                1,463
                
                
                
                -Net
      cash used in investing activities
                
                
                (146,881
                )
                
                
                (2,940
                )





(continued)





4
 Index











MERIDIAN
INTERSTATE BANCORP, INC. AND SUBSIDIARY


Consolidated
Statements of Cash Flows


(Unaudited)





Nine
      Months Ended September 30,(In
      thousands)
              
              2008
              
              2007Cash
      flows from financing activities:Net
      increase in deposits
              
              
              30,638
              
              
              
              28,238Proceeds
      from sale of common stock
              
              
              35,115
              
              
              
              -Loan
      to ESOP for purchase of common stock
              
              
              (8,280
              )
              
              
              -Net
      change in Federal Home Loan Bank advanceswith
      maturities of less than three months
              
              
              (9,154
              )
              
              
              8,925Proceeds
      from Federal Home Loan Bank advanceswith
      maturities of three months or more
              
              
              45,000
              
              
              
              -Repayment
      of Federal Home Loan Bank advanceswith
      maturities of three months or more
              
              
              (14,698
              )
              
              
              (4,450
              )Net
      cash provided by financing activities
              
              
              78,621
              
              
              
              32,713Net
      change in cash and cash equivalents
              
              
              (63,609
              )
              
              
              32,604Cash
      and cash equivalents at beginning of period
              
              
              103,093
              
              
              
              23,494Cash
      and cash equivalents at end of period
              
              $
              39,484
              
              
              $
              56,098Supplemental
      cash flow information:Interest
      paid on deposits
              
              
              19,583
              
              
              
              19,139Interest
      paid on borrowings
              
              
              1,427
              
              
              
              1,450Income
      taxes paid
              
              
              180
              
              
              
              377Non-cash
      investing and financing activities:Transfers
      from loans to foreclosed real estate
              
              
              2,953
              
              
              
              -





See
accompanying notes to unaudited consolidated financial
statements.


5
 Index


NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.
            Basis
      of Presentation





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





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





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





2.
            Stock
      Offering





The Company completed its initial
public stock offering on January 22, 2008 and sold 10,050,000 shares of its
outstanding common stock to subscribers in the offering at a price of $10.00 per
share, including 828,000 shares sold to the company’s employee stock ownership
plan.  Concurrent with the initial public offering, Meridian Financial
Services was issued 12,650,000 shares, or 55.0% of the Company’s outstanding
common stock.   Because Meridian Interstate did not have
outstanding public shares of common stock for the entire nine months ended
September 30, 2008, per share earnings data is not meaningful for this period or
prior comparative periods and is therefore not presented.




Net
investable proceeds from the initial public offering were $89.4
million.   In connection with the initial public offering, the
Company also issued and contributed 300,000 shares of common stock to the
Meridian Charitable Foundation, resulting in a pre-tax, non-interest expense
charge of $3.0 million, in the quarter ended March 31, 2008.





As part
of the offering, Meridian Interstate established a liquidation account of $114.2
million, which is equal to the net worth of Meridian Interstate as of the date
of the latest consolidated balance sheet appearing in the final prospectus
distributed in connection with the offering.  The liquidation account
will be maintained for the benefit of the eligible account holders and
supplemental eligible account holders who maintain their accounts at East Boston
Savings Bank after the offering.  The liquidation account will be
reduced annually to the extent that such account holders have reduced their
qualifying deposits as of each anniversary date.  Subsequent increases
will not restore an account holder’s interest in the liquidation
account.  In the event of a complete liquidation, each eligible
account holder will be entitled to receive balances for accounts held
then.





6
 Index





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





3.
            Recent
      Accounting Pronouncements





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





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





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





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





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








7
 Index


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





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





In
October, 2008, the FASB issued FSP No. 157-3,“Determining the Fair
Value of a Financial Asset When the Market for that Asset Is Not Active.” The
FSP clarifies the application of SFAS No. 157 in a market that is not active and
provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial asset is not
active.  FSP 157-3 was effective immediately upon issuance, and
includes prior periods for which financial statements have not been
issued.  The Company applied the guidance contained in FSP 157-3 in
determining fair values as of September 30, 2008, and it did not have a material
impact on the consolidated financial statements.





4.
            Fair
      Value Measurement





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





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





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





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





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





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





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


8
 Index


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





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





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





Quoted
      Prices in
              
              SignificantActive
      Markets for
              
              OtherAssets
      at Fair Value
              
              Identical
      Assets
              
              Observable
      Inputs(Level
      1)
              
              (Level
      2)(In
      thousands)Securities
      available for sale
              $
              288,941
              
              $
              73,544
              
              $
              215,397





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





SignificantUnobservable
              
              Total
      GainsAssets
      at Fair Value
              
              
              Inputs
              
              (Losses)(Level
      3)(In
      thousands)Impaired loans(1)
              
              $
              6,578
              
              
              $
              6,578
              
              $
              (1,488)





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





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





5.
            Employee
      Benefits





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


9
 Index


of shares
to be released will be based on the fair value of the shares at that date
required to settle the liability.  As shares are released from
collateral, the shares become outstanding for EPS computations.





Employment
Agreement - Consistent with the terms of his employment agreement, the
Bank entered into a Separation Agreement with its President upon his retirement
during the quarter ended June 30, 2008.  The Separation Agreement
provided for the payment of any accrued compensation, 24 months of salary
continuation payments at his rate of salary of  $30,961
per  month, the lump sum  payment of benefits under his
existing supplemental executive retirement plan totaling $2,351,591 to be paid
on December 7, 2008, the continuation of an existing
split-dollar  life  insurance  policy and a
bank-owned life  insurance policy, both of which  had been
fully paid, and the  maintenance  of  existing
long-term care insurance policies for the President and his spouse at a current
annual premium of $2,723.  During the quarter ended June 30, 2008, the
Company recorded pre-tax charges of $1.5 million as a result of the Separation
Agreement.





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





Share Based
Compensation–On August 19, 2008, stockholders of the Company approved the 2008 Equity
Incentive Plan (the "Equity Incentive Plan").  The Equity Incentive
Plan provides for the award of up to 1,449,000 shares of common stock pursuant
to grants of restricted stock awards, incentive stock options, non-qualified
stock options, and stock appreciation rights; provided, however, that no more
than 1,035,000 shares may be issued or delivered in the aggregate pursuant to
the exercise of stock options or stock appreciation rights, and no more than
414,000 shares may be issued or delivered pursuant to restricted stock
awards.  Pursuant to terms of the Equity Incentive Plan, the Board of
Directors granted stock options and restricted shares to employees and directors
on October 6, 2008.  A total of 637,000 stock options were
granted, and 185,625 restricted shares were granted, both with vesting
dates evenly over a period of five years.





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





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





Forward-Looking
Statements





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





Management’s ability to predict results
or the effect of future plans or strategies is inherently
uncertain.  These factors include, but are not limited to, general
economic conditions, changes in the interest rate environment, legislative or
regulatory changes that may adversely affect our business, changes in accounting
policies and practices, changes in competition and demand for financial
services, adverse changes in the securities markets and


10
 Index


changes
in the quality or composition of Meridian Interstate Bancorp’s loan or
investment portfolios.  Additional factors that may affect our results
are discussed in our Annual Report on Form 10-K
for the fiscal year ended December 31, 2007filed with the
Securities and Exchange Commission on March 31, 2008, under “Risk Factors,” as
subsequently amended, which is available through the SEC’s website at www.sec.gov.  These
risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such
statements.  Except as required by applicable law or regulation,
Meridian Interstate Bancorp does not undertake, and specifically disclaims any
obligation, to release publicly the result of any revisions that may be made to
any forward-looking statements to reflect events or circumstances after the date
of the statements or to reflect the occurrence of anticipated or unanticipated
events.




Critical
Accounting Policies




The
Company’s significant accounting policies are described in Note 1 to the
consolidated financial statements included in the 2007 Annual Report on Form
10-K.  Management has identified accounting for the allowance for
credit losses, other than temporary impairment of investment securities and
income taxes as the Company’s most critical accounting estimates.





General





Selected
Financial Data





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










Financial
      Condition AtSeptember
      30,
              
              
              December
      31,(In
      thousands)
              
              2008
              
              
              2007Total
      assets
              
              $
              1,073,683
              
              
              $
              1,003,226Secuities
      available for sale
              
              
              288,941
              
              
              
              267,058Net
      loans
              
              
              661,890
              
              
              
              568,104Deposits
              
              
              805,084
              
              
              
              774,446Borrowed
      funds
              
              
              57,675
              
              
              
              36,527Stockholders'
      equity
              
              
              195,054
              
              
              
              115,684
  Results
      of OperationsThree
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,(Dollars
      in thousands)
              
              2008
              
              
              2007
              
              
              2008
              
              
              2007Net
      interest income
              
              $
              6,765
              
              
              $
              5,187
              
              
              $
              18,516
              
              
              $
              15,770Provision
      for loan losses
              
              
              403
              
              
              
              117
              
              
              
              2,731
              
              
              
              260Non-interest
      income
              
              
              3,808
              
              
              
              11
              
              
              
              8,034
              
              
              
              4,200Non-interest
      expenses
              
              
              6,799
              
              
              
              5,707
              
              
              
              24,587
              
              
              
              16,480Provision
      (benefit) for income taxes
              
              
              1,228
              
              
              
              (323
              )
              
              
              (374
              )
              
              
              942Net
      income (loss)
              
              
              2,143
              
              
              
              (303
              )
              
              
              (394
              )
              
              
              2,288Interest
      rate spread
              
              
              2.10
              %
              
              
              2.18
              %
              
              
              1.87
              %
              
              
              2.23
              %Net
      interest margin
              
              
              2.70
              %
              
              
              2.48
              %
              
              
              2.50
              %
              
              
              2.53
              %





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





The
Company’s total assets increased by $70.5 million, or 7.0%, to $1.1 billion at
September 30, 2008 from December 31, 2007.  Cash and cash equivalents
decreased by $63.6 million, as cash received for the stock offering was used for
general corporate activities, including loan originations and investment
purchases.  Net loans increased by $93.8 million, or 16.5%, and
securities available for sale increased $21.9 million, or 8.2%.  For
the nine months


11
 Index


ended
September 30, 2008, the Company increased outstanding loans in all categories
except construction and consumer lending.





Deposits
increased by $30.6 million, or 4.0%, for the nine months ended September 30,
2008.  Demand deposit and money market balances increased by $13.6
million and $17.6 million, respectively, during this time.





Borrowed
funds also increased $21.1 million, to $57.7 million.  In April 2008,
the Company obtained new advances totaling $45.0 million from the Federal Home
Loan Bank of Boston (“FHLB”) as part of its leveraging strategy and to take
advantage of favorable interest rates.  The advances mature from 2011
to 2013, with rates ranging from 2.99% to 3.54%.   The average
borrowing rate is 3.27% and the average term is four years.





Stockholders’ equity increased by $79.4
million, to $195.1 million at September 30, 2008 from $115.7 million at December
31, 2007, mainly due to the Company’s first quarter stock
offering.  During the third quarter of 2008, accumulated other
comprehensive income decreased by $11.3 million primarily due to the change in
net unrealized losses on securities available for sale.





Securities





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





At
      September 30, 2008
              
              
              At
      December 31, 2007Amortized
              
              
              Fair
              
              
              Amortized
              
              
              Fair(In
      thousands)
              
              Cost
              
              
              Value
              
              
              Cost
              
              
              ValueSecurities
      available for sale:U.S.
      Government – sponsored enterprises
              
              $
              19,268
              
              
              $
              19,267
              
              
              $
              7,002
              
              
              $
              6,975Corporate
      bonds
              
              
              204,262
              
              
              
              196,089
              
              
              
              219,626
              
              
              
              220,629Mortgage-backed
      securities
              
              
              41
              
              
              
              41
              
              
              
              43
              
              
              
              43Total
      debt securities
              
              
              223,571
              
              
              
              215,397
              
              
              
              226,671
              
              
              
              227,647Marketable
      equity securities
              
              
              72,476
              
              
              
              73,544
              
              
              
              28,843
              
              
              
              39,411Total
      securities available for sale
              
              $
              296,047
              
              
              $
              288,941
              
              
              $
              255,514
              
              
              $
              267,058





The
available-for-sale securities portfolio increased $21.9 million, or 8.2% to
$288.9 million at September 30, 2008 from $267.1 million December 31,
2007.   Money market mutual funds included in the marketable
equity securities portfolio totaled $46.6 million and $1.3 million at September
30, 2008 and December 31, 2007, respectively.   Management
continues to hold the money market mutual funds and monitor available investment
opportunities in light of the current issues in the debt and equity
markets.





Management evaluates securities for
other-than-temporary impairment on a monthly basis, with more frequent
evaluation for selected issues.  Consideration is given to (1) the
length of time and the extent to which the fair value has been less than cost,
(2) the financial condition and near-term prospects of the issuer, and (3) the
intent and ability of the Company to retain its investment in the issuer for a
period of time sufficient to allow for any anticipated recovery in fair
value.  At September 30, 2008, unrealized losses in our debt portfolio
ranged from 0% to 52%, and unrealized losses in our equity portfolio ranged from
0% to 27%.





Included in the decrease in the
market value of the equity portfolio year to date is almost all of the net gain
on sales of securities of $5.1 million.  As of September 30, 2008 the
net unrealized gain of the total equity portfolio was $1.1
million.  Seven equity securities had market value declines of 20% or
more, with net unrealized losses of $701,000.  The most significant
market valuation decrease related to any one equity security at September 30,
2008 is $183,000.   As of June 30, 2008, three equity securities
had a market value declineof 20% or more,
with


12
 Index


net unrealized losses of
$428,000.  No equity security had a market valuation decrease
of 20% or more as of December 31, 2007.





At September 30, 2008, the aggregate
amortized cost of debt obligations owned by the Company was $223.6 million and
the aggregate market value was $215.4 million.Eight
corporate bonds, from five issuers, had a market decline of greater
than 20% of book value, with declines ranging from 23.1% to
51.7%.   All of these bonds were issued by financial
companies.  The aggregate unrealized loss on these eight bonds
is $6.9 million and is presently considered to be temporary.





Five of the securities, from three
issuers, had been impaired greater than 20% for approximately one month,
reflecting the rapid changes in the market during the third
quarter.   The aggregate unrealized loss on these five bonds was
$3.6 million at September 30, 2008.  These bonds have maturity dates
ranging from May 2010 to May 2012.  Due to the very recent impairment
of these securities, with no indication that the issuers will be unable to
continue to service the obligations based on ongoing operations, and
management’s ability and intent to hold the obligations until the earlier of
recovery or maturity, management considers the decline in market valuation to be
temporary.





The remaining three bonds, from two
issuers, had been impaired greater than 20% for less than six
months.  The aggregate unrealized loss on these three bonds was $3.3
million at September 30, 2008.  Included in this group is the bond
with the most significant market decline ($2.1 million), issued by a regional
bank considered to be “well-capitalized” as of September 30,
2008.  This bond matures in December 2011.  In October 2008,
the issuer announced it will be acquired by PNC Bank.  PNC Bank has
thus far mainly avoided many of the credit problems affecting regional and
national banks, and announced that it will receive $7.7 billion from the
Treasury Department TARP Capital Purchase Program as part of the
acquisition.





The
remaining two bonds in this group, maturing in July 2011 and February 2012, were
issued by a commercial finance and lease company.  The aggregate
unrealized loss on these bonds was $1.2 million as of September 30, 2008.
According to the issuer’s third quarter press
releases, the company has obtained $11.0 billion of additional liquidity during
2008 and continues to have stable cash balances and an adequate funding plan to
meet all obligations in the next 12 months. The third quarter earnings
announcement also includes a statement that the issuer is reviewing its funding
model, including deposit taking capabilities, which would help alleviate funding
issues long term by providing a deposit base to support
lending.





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




















13
 Index


Loan
Portfolio Analysis





Our loan portfolio consists primarily
of residential, multi-family and commercial real estate loans, construction and
land development loans, commercial and consumer loans and home equity lines of
credit originated primarily in our market area. There are no foreign loans
outstanding.  The Company does not originate or purchase
non-traditional loans, such as negative amortization or payment option
adjustable rate mortgages or subprime or Alt-A loans.  Interest rates
charged on loans are affected principally by the demand for such loans, the
supply of money available for lending purposes and the rates offered by our
competitors.  Loan detail by category as
of September 30, 2008 and December 31, 2007 were as
follows:





At
      September 30, 2008
                
                
                At
      December 31, 2007(Dollars
      in thousands)
                
                Amount
                
                
                %
                
                
                Amount
                
                
                %Real
      estate loans:One-to
      four-family
                
                $
                266,327
                
                
                
                39.8
                %
                
                $
                224,109
                
                
                
                39.1
                %Multi-family
                
                
                31,407
                
                
                
                4.7
                
                
                
                26,855
                
                
                
                4.7Commercial
      real estate
                
                
                223,867
                
                
                
                33.4
                
                
                
                175,072
                
                
                
                30.5Construction
                
                
                104,321
                
                
                
                15.6
                
                
                
                111,796
                
                
                
                19.5Home
      equity linesof
      credit
                
                
                27,078
                
                
                
                4.1
                
                
                
                21,541
                
                
                
                3.8Total
      real estate loans
                
                
                653,000
                
                
                
                97.6
                
                
                
                559,373
                
                
                
                97.6Commercial
      business loans
                
                
                14,355
                
                
                
                2.2
                
                
                
                11,859
                
                
                
                2.1Consumer
      loans
                
                
                1,274
                
                
                
                0.2
                
                
                
                1,576
                
                
                
                0.3Total
      loans
                
                
                668,629
                
                
                
                100.0
                %
                
                
                572,808
                
                
                
                100.0
                %Net
      deferred origination fees
                
                
                (1,021
                )
                
                
                
                
                
                
                (1,067
                )Allowance
      for loan losses
                
                
                (5,718
                )
                
                
                
                
                
                
                (3,637
                )Loans,
      net
                
                $
                661,890
                
                
                
                
                
                
                $
                568,104





Analysis
of Loan Loss Experience





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




Three
      Months Ended September 30,
              
              
              Nine
      Months Ended September 30,(Dollars
      in thousands)
              
              2008
              
              
              2007
              
              
              2008
              
              
              2007Beginning
      balance
              
              $
              5,961
              
              
              $
              3,503
              
              
              $
              3,637
              
              
              $
              3,362Provision
      for loan losses
              
              
              403
              
              
              
              117
              
              
              
              2,731
              
              
              
              260Charge
      offs:Real
      estate loans
              
              
              647
              
              
              
              -
              
              
              
              650
              
              
              
              16Commercial
      business loans
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Consumer
      loans
              
              
              -
              
              
              
              1
              
              
              
              2
              
              
              
              14Total
      charge-offs
              
              
              647
              
              
              
              1
              
              
              
              652
              
              
              
              30Recoveries:Real
      estate loans
              
              
              -
              
              
              
              -
              
              
              
              1
              
              
              
              16Commercial
      business
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Consumer
      loans
              
              
              1
              
              
              
              1
              
              
              
              1
              
              
              
              12Total
      recoveries
              
              
              1
              
              
              
              1
              
              
              
              2
              
              
              
              28Net
      charge-offs
              
              
              (646
              )
              
              
              -
              
              
              
              (650
              )
              
              
              (2
              )Ending
      balance
              
              $
              5,718
              
              
              $
              3,620
              
              
              $
              5,718
              
              
              $
              3,620Allowance
      to non-accrual loans
              
              
              92.51
              %
              
              
              72.49
              %
              
              
              92.51
              %
              
              
              72.49
              %Allowance
      to total loans outstanding
              
              
              0.86
              %
              
              
              0.66
              %
              
              
              0.86
              %
              
              
              0.66
              %Net
      charge-offs/average loans outstanding
              
              
              0.10
              %
              
              
              0.00
              %
              
              
              0.11
              %
              
              
              0.00
              %


14
 Index


Provision
for Loan Losses




The
Company’s loan loss provision was $403,000 and $2.7 million for the quarter and
nine months ended September 30, 2008, compared to $117,000 and $260,000 for the
same periods in 2007.  The increase in the provision relates to
specific reserves established during the second quarter for two impaired
construction loans, as well as growth in the loan portfolio and management’s
assessment of various factors affecting the portfolio, including, among others,
an ongoing evaluation of credit quality, local real estate market conditions,
and general economic factors.  The Company had two loan charge-offs
totaling $647,000 during the current quarter.  Both loans charged-off
had specific reserves established in the second quarter.  The
collateral for both loans, a residential construction loan and a residential
real estate loan, became foreclosed real estate.




The
allowance for loan losses was $5.7 million, or 0.86% of total loans outstanding
as of September 30, 2008, compared to $3.6 million, or 0.63% as of December 31,
2007, and $3.6 million, or 0.66% at September 30, 2007.





Management’s
Assessment of Asset Quality





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




The
following table summarizes the non-performing assets at September 30, 2008
and December 31, 2007.





At
      September 30,
              
              
              At
      December 31,(In
      thousands)
              
              2008
              
              
              2007Loans
      accounted for on a non-accrual basis:Real
      estate loans:One-to
      four-family
              
              $
              3,068
              
              
              $
              2,059Multi-family
              
              
              -
              
              
              
              -Commercial
      real estate
              
              
              2,679
              
              
              
              1,561Home
      equity lines of credit
              
              
              -
              
              
              
              98Construction
              
              
              335
              
              
              
              1,218Total
      real estate loans
              
              
              6,082
              
              
              
              4,936Commercial
      business loans
              
              
              99
              
              
              
              45Consumer
      loans
              
              
              -
              
              
              
              1Total
      non-accrual loans
              
              
              6,181
              
              
              
              4,982Foreclosed
      assets
              
              
              2,045
              
              
              
              560Total
      nonperforming assets
              
              $
              8,226
              
              
              $
              5,542Non-accrual
      loans to total loans
              
              
              0.92
              %
              
              
              0.87
              %Non-accrual
      loans to total assets
              
              
              0.58
              %
              
              
              0.50
              %Non-performing
      assets to total assets
              
              
              0.77
              %
              
              
              0.55
              %





Non-performing
assets (non-accrual loans and property acquired through foreclosure) were $8.2
million, or 0.77% of total assets at September 30, 2008, compared to $5.5
million, or 0.55% at December 31, 2007, and $5.2 million, or 0.56% at September
30, 2007.  The increase in non-performing assets from December
resulted primarily from one construction lending relationship that was
transferred to property acquired through foreclosure during the third
quarter.  The balance of the relationship was $2.4 million at the time
of foreclosure, and a charge-off of $596,000 was recorded against the
allowance.  The charge-off had been identified as a specific reserve
prior to June 30, 2008.


15
 Index


The
Company’s credit quality is a reflection of the current environment, with
increased levels of non-performing residential loans and commercial real estate
loans compared to December 31, 2007 due mainly to softening in local primary
real estate markets.  The Company cannot predict when the level of
non-performing assets might return to the lower end of the historic basis point
range; however management continues to monitor delinquency and non-performing
asset trends.




Total
property acquired through foreclosure was $2.0 million at September 30, 2008,
compared to $560,000 and $220,000 at December 31 and September 30,
2007.  The Company recorded a $5,000 loss on the sale of foreclosed
real estate for the nine months ending September 30, 2008.




Foregone
interest income that would have been recorded for the nine months ended
September 30, 2008 had nonaccruing loans and accruing loans past due 90 days or
more been current according to their original terms amounted to
$152,000.





The Bank
individually reviews classified residential and commercial loans for impairment,
and establishes reserves, if necessary, based on the fair value of collateral or
expected cash flows.  The Bank considers a loan to be impaired when
collection of all amounts due according to the original loan term, including
interest, is doubtful.  At September 30, 2008, there are $10.4 million
of impaired loans, including loans of $8.1 million with an impairment allowance
of $1.5 million.  The September 30, 2008 impaired loan balance
includes two troubled debt restructings totaling $6.2 million that are on
accrual due to their continued payment performance.   A
modification of loan terms constitutes a troubled debt restructuring if, for
reasons related to the debtor’s financial difficulties, a concession is granted
to the debtor that would not otherwise be considered.  At December 31,
2007, there was $5.1 million of impaired loans, including loans of $621,000 with
an impairment allowance of $89,000.  The Company’s average investment
in impaired loans was $6.4 million and $4.0 million for the nine months ended
September 30, 2008 and 2007, respectively.





Deposits





Deposits
are a major source of our funds for lending and other investment
purposes.  Deposit inflows and outflows are significantly influenced
by general interest rates and money market conditions.




The
following table summarizes the balance and the composition of
deposits:





At
      September 30, 2008
              
              
              At
      December 31, 2007(Dollars
      in thousands)
              
              Amount
              
              
              Percent
              
              
              Amount
              
              
              PercentNOW
      and demand deposits
              
              $
              98,635
              
              
              
              12.3
              %
              
              $
              85,045
              
              
              
              11.0
              %Money
      market deposits
              
              
              156,238
              
              
              
              19.4
              
              
              
              138,688
              
              
              
              17.9Regular
      and other deposits
              
              
              118,806
              
              
              
              14.7
              
              
              
              118,837
              
              
              
              15.3Certificates
      of deposit
              
              
              431,405
              
              
              
              53.6
              
              
              
              431,876
              
              
              
              55.8Total
              
              $
              805,084
              
              
              
              100.0
              %
              
              $
              774,446
              
              
              
              100.0
              %





Borrowings





Federal
Home Loan Bank (“FHLB”) advances maturing within one year totaled $9.2 million
at December 31, 2007, at a weighted average rate of 4.52%.  No short
term advances were outstanding at September 30, 2008.




At
September 30, 2008, long-term FHLB advances totaling $57.7 million mature
through April 2013, with a weighted average yield of 3.45%.  As of
December 31, 2007, long-term FHLB advances totaling $27.4 million were
outstanding, with a weighted average yield of 4.48%.





16
 Index





Results
of Operations for the Three and Nine months ended September 30, 2008 and
September 30, 2007





Average
Balance Table




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




For
      The Three Months Ended September 30,2008
              
              
              2007(Dollars
      in thousands)
              
              Average
      Balance
              
              
              Interest
      Earned/Paid
              
              
              Yield/ Cost
      (4)
              
              
              AverageBalance
              
              
              InterestEarned/Paid
              
              
              Yield/ Cost
      (4)Assets:Interest-earning
      assets:Loans
      (1)
              
              $
              641,094
              
              
              $
              9,938
              
              
              
              6.17
              %
              
              $
              545,808
              
              
              $
              9,073
              
              
              
              6.63
              %Securities
      and certificates of deposit
              
              
              333,900
              
              
              
              3,307
              
              
              
              3.94
              
              
              
              262,927
              
              
              
              2,986
              
              
              
              4.54Other
      interest-earning assets
              
              
              21,478
              
              
              
              99
              
              
              
              1.83
              
              
              
              26,153
              
              
              
              331
              
              
              
              5.02Total
      interest-earning assets
              
              
              996,472
              
              
              
              13,344
              
              
              
              5.33
              
              
              
              834,888
              
              
              
              12,390
              
              
              
              5.94Noninterest-earning
      assets
              
              
              79,296
              
              
              
              
              
              
              
              
              
              
              
              77,934Total
      assets
              
              $
              1,075,768
              
              
              
              
              
              
              
              
              
              
              $
              912,822Liabilities
      and stockholders' equity:Interest-bearing
      liabilities:NOW  deposits
              
              $
              42,078
              
              
              
              92
              
              
              
              0.87
              
              
              $
              61,909
              
              
              
              31
              
              
              
              0.20Money
      market deposits
              
              
              150,501
              
              
              
              929
              
              
              
              2.46
              
              
              
              119,184
              
              
              
              1,144
              
              
              
              3.81Savings
      and other deposits
              
              
              123,236
              
              
              
              354
              
              
              
              1.14
              
              
              
              127,363
              
              
              
              371
              
              
              
              1.15Certificates
      of deposit
              
              
              435,022
              
              
              
              4,670
              
              
              
              4.27
              
              
              
              419,575
              
              
              
              5,190
              
              
              
              4.91Total
      interest-bearing deposits
              
              
              750,837
              
              
              
              6,045
              
              
              
              3.20
              
              
              
              728,031
              
              
              
              6,736
              
              
              
              3.70FHLB
      advances
              
              
              60,316
              
              
              
              534
              
              
              
              3.52
              
              
              
              38,663
              
              
              
              467
              
              
              
              4.83Total
      interest-bearing liabilities
              
              
              811,153
              
              
              
              6,579
              
              
              
              3.23
              
              
              
              766,694
              
              
              
              7,203
              
              
              
              3.76Noninterest-bearing
      demand deposits
              
              
              54,711
              
              
              
              
              
              
              
              
              
              
              
              25,111Other
      noninterest-bearing liabilities
              
              
              10,509
              
              
              
              
              
              
              
              
              
              
              
              8,232Total
      liabilities
              
              
              876,373
              
              
              
              
              
              
              
              
              
              
              
              800,037Total
      stockholders' equity
              
              
              199,395
              
              
              
              
              
              
              
              
              
              
              
              112,785Total
      liabilities and stockholders' equity
              
              $
              1,075,768
              
              
              
              
              
              
              
              
              
              
              $
              912,822Net
      interest income
              
              
              
              
              
              $
              6,765
              
              
              
              
              
              
              
              
              
              
              $
              5,187Interest
      rate spread  (2)
              
              
              
              
              
              
              
              
              
              
              2.10
              %
              
              
              
              
              
              
              
              
              
              
              2.18
              %Net
      interest margin  (3)
              
              
              
              
              
              
              
              
              
              
              2.70
              %
              
              
              
              
              
              
              
              
              
              
              2.48
              %Average
      interest-earning assets to
              
              
              
              
              
              
              122.85
              %
              
              
              
              
              
              
              
              
              
              
              108.89
              %average
      interest-bearing liabilities




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


17
 Index
  For
      The Nine Months Ended September 30,2008
              
              
              2007(Dollars
      in thousands)
              
              AverageBalance
              
              
              Interest
      Earned/Paid
              
              
              Yield/ Cost
      (4)
              
              
              Average
      Balance
              
              
              InterestEarned/Paid
              
              
              Yield/ Cost
      (4)Assets:Interest-earning
      assets:Loans
      (1)
              
              $
              604,157
              
              
              $
              28,455
              
              
              
              6.29
              %
              
              $
              541,108
              
              
              $
              26,560
              
              
              
              6.55
              %Securities
      and certificates of deposit
              
              
              301,477
              
              
              
              9,281
              
              
              
              4.11
              
              
              
              269,448
              
              
              
              9,079
              
              
              
              4.49Other
      interest-earning assets
              
              
              85,350
              
              
              
              1,640
              
              
              
              2.57
              
              
              
              18,900
              
              
              
              726
              
              
              
              5.14Total
      interest-earning assets
              
              
              990,984
              
              
              
              39,376
              
              
              
              5.31
              
              
              
              829,456
              
              
              
              36,365
              
              
              
              5.85Noninterest-earning
      assets
              
              
              76,733
              
              
              
              
              
              
              
              
              
              
              
              74,542Total
      assets
              
              $
              1,067,717
              
              
              
              
              
              
              
              
              
              
              $
              903,998Liabilities
      and stockholders' equity:Interest-bearing
      liabilities:NOW  deposits
              
              $
              38,855
              
              
              
              236
              
              
              
              0.81
              
              
              $
              63,322
              
              
              
              79
              
              
              
              0.17Money
      market deposits
              
              
              144,751
              
              
              
              2,967
              
              
              
              2.74
              
              
              
              107,266
              
              
              
              2,852
              
              
              
              3.55Savings
      and other deposits
              
              
              129,138
              
              
              
              1,103
              
              
              
              1.14
              
              
              
              131,199
              
              
              
              1,142
              
              
              
              1.16Certificates
      of deposit
              
              
              443,140
              
              
              
              15,076
              
              
              
              4.54
              
              
              
              418,279
              
              
              
              15,086
              
              
              
              4.82Total
      interest-bearing deposits
              
              
              755,884
              
              
              
              19,382
              
              
              
              3.43
              
              
              
              720,066
              
              
              
              19,159
              
              
              
              3.56FHLB
      advances
              
              
              53,458
              
              
              
              1,478
              
              
              
              3.69
              
              
              
              40,095
              
              
              
              1,436
              
              
              
              4.79Total
      interest-bearing liabilities
              
              
              809,342
              
              
              
              20,860
              
              
              
              3.44
              
              
              
              760,161
              
              
              
              20,595
              
              
              
              3.62Noninterest-bearing
      demand deposits
              
              
              53,867
              
              
              
              
              
              
              
              
              
              
              
              24,275Other
      noninterest-bearing liabilities
              
              
              9,854
              
              
              
              
              
              
              
              
              
              
              
              7,417Total
      liabilities
              
              
              873,063
              
              
              
              
              
              
              
              
              
              
              
              791,853Total
      stockholders' equity
              
              
              194,654
              
              
              
              
              
              
              
              
              
              
              
              112,145Total
      liabilities and stockholders' equity
              
              $
              1,067,717
              
              
              
              
              
              
              
              
              
              
              $
              903,998Net
      interest income
              
              
              
              
              
              $
              18,516
              
              
              
              
              
              
              
              
              
              
              $
              15,770Interest
      rate spread  (2)
              
              
              
              
              
              
              
              
              
              
              1.87
              %
              
              
              
              
              
              
              
              
              
              
              2.23
              %Net
      interest margin  (3)
              
              
              
              
              
              
              
              
              
              
              2.50
              %
              
              
              
              
              
              
              
              
              
              
              2.53
              %Average
      interest-earning assets to
              
              
              
              
              
              
              122.44
              %
              
              
              
              
              
              
              
              
              
              
              109.12
              %average
      interest-bearing liabilities




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


18
 Index


Financial
Summary





The
Company recorded net income of $2.1 million for the quarter ended September 30,
2008, compared to a net loss of $303,000 for the quarter ended September 30,
2007.  Net income per basic and diluted share for the third quarter of
2008 was $.10.  The Company recorded a net pre-tax gain on sale of
securities of $2.8 million for the 2008 third quarter, compared to a pre-tax
loss on sale of securities of $860,000 during the comparable 2007
period.





For the
nine months ended September 30, 2008, the Company recorded a net loss of
$394,000, compared to net income of $2.3 million for the nine months ended
September 30, 2007.  The 2008 net loss includes a $3.0 million pre-tax
contribution of stock to the Company’s charitable foundation, and pre-tax
compensation charges of $1.5 million as a result of the retirement of the Bank’s
president.





Earnings
per share is not applicable for the nine months ended September 30, 2008 and
prior periods, as shares were not outstanding for the entire
periods.





Analysis
of Net Interest Income





Net interest income for the quarter
ended September 30, 2008 was $6.8 million, an increase of $1.6 million, or
30.4%, from the quarter ended September 30, 2007, due to an increase in interest
income earned on loans of $865,000, or 9.5%, and a reduction in deposit interest
expense of $691,000, or 10.3%.   Net interest income for the nine
months ended September 30, 2008 was $18.5 million, an increase of $2.7 million,
or 17.4%, from the nine months ended September 30, 2007, due primarily to an
increase in loan interest income of $1.9 million, or 7.1%.





The Company’s net interest margin was
2.70% and 2.48% for the quarters ended September 30, 2008 and 2007,
respectively.  The margin increase from the prior period is due to a
decrease in the overall rate paid on deposits and borrowings.  For the
nine months ended September 30, 2008 the net interest margin was 2.50%, compared
to 2.53% for the same period in 2007.  The decline in the nine-month
net interest margin is due to faster repricing of prime-related assets compared
to interest-bearing liabilities in a period of declining market interest rates.





Growth in the loan portfolio resulted
in increased loan interest income in 2008, from $9.1 million for the quarter
ended September 30, 2007, to $9.9 million for the quarter ended September 30,
2008.  For the nine months ended September 30, 2008, total loan
interest income was $28.5 million, compared to $26.6 million for the nine months
ended September 30, 2007.





The average balance of interest-bearing
deposits increased from $728.0 million to $750.8 million for the quarters ended
September 30, 2007 and 2008, respectively, while deposit interest expense
decreased $691,000, or 10.3%, due to lower average rates paid, particularly on
money market accounts and certificates of deposit.  For the nine
months ended September 30, 2008, deposit interest expense increased $223,000, or
1.2%, from the same period in 2007 due to higher average balances.





Borrowing expense increased $67,000, or
14.3%, for the quarter ended September 30, 2008 compared to the same period in
2007 due to higher average outstanding borrowings, which increased from $38.7
million to $60.3 million.





Non-interest
Income




Non-interest
income for the third quarter of 2008 was $3.8 million, compared to $11,000 in
the third quarter of 2007.    A loss on sale of securities
of $860,000 in the third quarter of 2007 offset other income earned, as the
Company sold debt securities with exposure to the subprime mortgage
market.  The Company recorded gains on sales of securities of $2.8
million during the third quarter of 2008, as management opted to sell equity
securities with appreciable gains.  Bank-owned life insurance income
increased from $153,000 to $209,000 due to an increase in policy balances
owned.  The Company’s equity loss from its investment in Hampshire
First Bank decreased from $138,000 to $69,000, as Hampshire First Bank continues
to implement its business growth plans.




Non-interest
income increased from $4.2 million for the nine months ended September 30, 2007
to $8.0 million for the nine months ended September 30, 2008, primarily due to
increased net gains on sales of securities.  The Company also recorded
bank-owned life insurance income of $624,000 for the nine months ended
September




19
 Index


30, 2008
compared to $850,000 for the comparable 2007 period due to policy proceeds of
$383,000 received during 2007.   No policy proceeds were received
during 2008.




Non-interest Expenses




Non-interest
expenses increased from $5.7 million for the quarter ended September 30, 2007 to
$6.8 million for the quarter ended September 30, 2008.  Salary and
employee benefit costs increased from $3.6 million to $4.0 million, primarily as
a result of additional expense incurred in connection with the Company’s
Employee Stock Ownership Plan (ESOP) and bank-owned life insurance
policies.  The Company also incurred an increase in professional
service fees of $317,000 due mainly to legal and audit expenses related to being
a public company.  Other expenses increased $180,000 due to an
increase in deposit insurance expense and annual meeting
expenses.  The Company benefited from a one-time deposit insurance
credit in 2007 and the first quarter of 2008.




Non-interest
expenses increased $8.1 million, from $16.5 million to $24.6 million for the
nine months ended September 30, 2007, and 2008, respectively, primarily as a
result of the $1.5 million retirement charge (see Note 5 to interim financial
statements), the contribution expense of $3.0 million for the contribution to
the Meridian Charitable Foundation, and increased professional service fees and
deposit insurance expense.




Income Tax
Expense





The
Company recorded a tax expense of $1.2 million, or a 36.4% effective tax rate,
for the quarter ended September 30, 2008 compared to a tax benefit of $323,000,
or a 51.6% effective tax rate, for the same 2007 period.  The Company
recorded a tax benefit of $374,000, or a 48.7% effective tax
rate,  for the nine months ended September 30, 2008 compared to a tax
expense of $942,000, or a 29.2% effective tax rate,  for the same 2007
period.   The change in the effective tax rate is due to changes
in the components of non-taxable income and non-deductible expense as a
percentage of pre-tax income or loss, including net gains and losses on the sale
of securities and the Company’s 2008 contribution to the Meridian Charitable
Foundation.





The
Company contributed 300,000 shares of common stock to the Meridian Charitable
Foundation, resulting in a pre-tax non-interest expense charge of $3.0 million
in the first quarter of 2008.  Under current Federal income tax
regulations, charitable contribution deductions are limited to 10% of taxable
income.   Accordingly, the $3.0 million contribution created a
carry-forward for income tax purposes and a deferred tax asset for financial
statement purposes.





Liquidity and
Capital Management





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





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





Our most liquid assets are cash and
cash equivalents.  The levels of these assets depend on our operating,
financing, lending and investing activities during any given
period.  At September 30, 2008, cash and cash equivalents totaled
$39.5 million.  In addition, at September 30, 2008, we had $108.0
million of available borrowing capacity with the Federal Home Loan Bank of
Boston, including a $9.4 million line of credit.  On September 30,
2008, we had $57.7 million of advances outstanding.





A significant use of our liquidity is
the funding of loan originations.  At September 30, 2008, we had
$170.1 million in total loan commitments outstanding.  Historically,
some of the commitments expire without being fully drawn; therefore the total
amount of commitment does not necessarily represent future cash
requirements.  Unused portions of existing loans include $83.2 million
in unadvanced portions of construction loans, $26.1 million in unused home
equity lines of credit, $2.1 million in unused business lines of credit, $1.2
million in unused commercial letters of credit, and $557,000 in unadvanced
revolving lines of credit. Commitments to fund new loans


20
 Index


include
$5.1 million in commitments to fund one- to four-family residential real estate
loans, $32.7 million in commitments to fund commercial real estate loans, $15.7
million in commitments to originate commercial construction loans, $1.3 million
in commitments to originate commercial lines of credit, $1.3 million in
commitments to originate home equity lines of credit, and $761,000 in
commitments to originate residential construction loans.  We also have
a seven year contract with our core data processing provider with an outstanding
commitment of approximately $6.4 million as of September 30, 2008, and an annual
payment of approximately $1.3 million.  In 2008, the Company entered
into an agreement for design and renovation services for the new Wakefield,
Massachusetts branch, which opened for business in October.  The
outstanding commitment for the project at September 30, 2008 is
$126,000.





Another significant use of our
liquidity is the funding of deposit withdrawals.  Certificates of
deposit due within one year of September 30, 2008 totaled $356.6 million,
or 83% of certificates of deposit.   If these maturing deposits
do not remain with us, we will be required to utilize other sources of
funds.  Historically, a significant portion of certificates of deposit
that mature have remained at the Company.   We have the ability
to attract and retain deposits by adjusting the interest rates
offered.





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





Capital
Management.Both Meridian
Interstate Bancorp and East Boston Savings Bank are subject to various
regulatory capital requirements administered by the Federal Reserve Board and
Federal Deposit Insurance Corporation, respectively, including a risk-based
capital measure.  The risk-based capital guidelines include both a
definition of capital and a framework for calculating risk-weighted assets by
assigning balance sheet assets and off-balance sheet items to broad risk
categories.  At September 30, 2008, both Meridian Interstate Bancorp
and East Boston Savings Bank exceeded all of their respective regulatory capital
requirements.





The proceeds from the stock offering
significantly increased our liquidity and capital resources.  The
initial level of liquidity is being reduced as net proceeds are used for general
corporate purposes, including the funding of loan originations.  Due
to the increase in equity that resulted from the net proceeds of the stock
offering, our return on equity ratios have been adversely affected.





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 stock 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 nontax-qualified employee stock benefit plan of
Meridian Interstate Bancorp or East Boston Savings Bank in an amount reasonable
and appropriate to fund the plan; or (iv) is limited to stock repurchases of no
greater than 5% of the outstanding capital stock of Meridian Interstate Bancorp
where compelling and valid business reasons are established to the satisfaction
of the Commissioner of Banks.  In addition, pursuant to Federal
Reserve Board approval conditions imposed in connection with the formation of
Meridian Interstate Bancorp, Meridian Interstate Bancorp has committed (i) to
seek the Federal Reserve Board’s prior approval before repurchasing any equity
securities from Meridian Financial Services and (ii) that any repurchases of
equity securities from stockholders other than Meridian Financial Services will
be at the current market price for such stock repurchases.  Meridian
Interstate Bancorp will also be subject to the Federal Reserve Board’s notice
provisions for stock repurchases.





Off-Balance
Sheet Arrangements.In the normal course of operations, we
engage in a variety of financial transactions that, in accordance with generally
accepted accounting principles are not recorded in our financial
statements.  These transactions involve, to varying degrees, elements
of credit, interest rate and liquidity risk. Such transactions are used
primarily to manage customers’ requests for funding and take the form of loan
commitments and lines of credit.  We had no investment in derivative
securities at September 30, 2008.


21
 Index


For the nine months ended September 30,
2008, we engaged in no off-balance sheet transactions reasonably likely to have
a material effect on our financial condition, results of operations or cash
flows.





Item
3.  Quantitative and Qualitative Disclosures about
Market Risk





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





We have an Asset/Liability Management
Committee to coordinate all aspects 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.





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





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





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





The simulation uses projected repricing
of assets and liabilities at September 30, 2008 on the basis of contractual
maturities, anticipated repayments and scheduled rate adjustments. Prepayment
rates can have a significant impact on interest income simulation. Because of
the large percentage of loans we hold, rising or falling interest rates have a
significant impact on the prepayment speeds of our earning assets that in turn
affect the rate sensitivity position.





When
interest rates rise, prepayments tend to slow. When interest rates fall,
prepayments tend to rise. Our asset sensitivity would be reduced if prepayments
slow and vice versa. While we believe such assumptions to be reasonable, there
can be no assurance that assumed prepayment rates will approximate actual future
mortgage-backed security and loan repayment activity.




The
following table reflects changes in estimated net interest income for the
Company for the twelve-month period beginning October 1, 2008 and ending
September 30, 2009:


22
 Index


Increase
      (Decrease)in
      Market Interest
              
              Net
      Interest Income
              
              
              Net
      Portfolio Value EstimateRates
      (Rate Shock)
              
              Amount
              
              
              Change
              
              
              Percent
              
              
              Amount
              
              
              Change
              
              
              Percent(Dollars
      in thousands)200
              
              
              $
              32,402
              
              
              $
              1,869
              
              
              
              6.12
              %
              
              $
              152,395
              
              
              $
              (39,748
              )
              
              
              (20.69
              )
      %100
              
              
              
              31,636
              
              
              
              1,103
              
              
              
              3.61
              
              
              
              173,421
              
              
              
              (18,722
              )
              
              
              (9.74
              )0
              
              
              
              30,533
              
              
              
              
              
              
              
              
              
              
              
              192,143(100
              )
              
              
              28,729
              
              
              
              (1,804
              )
              
              
              (5.91
              )
              
              
              203,078
              
              
              
              10,935
              
              
              
              5.69(200
              )
              
              
              26,158
              
              
              
              (4,375
              )
              
              
              (14.33
              )
              
              
              208,054
              
              
              
              15,911
              
              
              
              8.28





The basis
point changes in rates in the above table are assumed to occur evenly over the
following 12 months.





Item
4.  Controls and Procedures





(a)
            Disclosure
      Controls and Procedures





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





(b)
            Changes
      in Internal Control over Financial
Reporting





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





23
 Index


PARTII – OTHER INFORMATION





Item
1.  Legal Proceedings





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





Item
1A.  Risk Factors





For
information regarding our risk factors, see “Risk Factors,” in our 2007 Annual
Report on Form 10-K, filed with the SEC on March 31, 2008, which is available
through the SEC’s website at www.sec.gov.   As
of September 30, 2008, the risk factors of Meridian Interstate Bancorp have not
changed materially from those reported in the prospectus.  The risks
described in Meridian Interstate Bancorp’s prospectus are not the only risks
that we face.  Additional risks and uncertainties not currently known
to us or that we currently deem to be immaterial also may materially adversely
affect our business, financial condition and/or operating results.





In
addition to the previously noted risk factors, the Company will experience an
increased level of Federal Deposit Insurance Corporation (“FDIC”) insurance
expense.  The FDIC imposes an assessment based on the risk category of
the institution that ranges from 5 to 43 basis points of the institution’s
deposits.  The Company received a one-time credit that decreased the
amount of deposit insurance expense in 2007 and the first quarter of
2008.  This credit was depleted during the second quarter of
2008.





Federal
law requires that the reserve ratio for the deposit insurance fund be
established by the FDIC at 1.15% to 1.50% of estimated insured
deposits.  If this reserve ratio drops below 1.15% or the FDIC expects
that it will do so within six months, the FDIC must, within ninety days,
establish and implement a plan to restore the designated reserve ratio to 1.15%
of estimated insured deposits within five years (absent extraordinary
circumstances.)





Recent
bank failures coupled with deteriorating economic conditions have significantly
reduced the deposit insurance fund’s reserve ratio.  As of June 30,
2008, the designated reserve ratio was 1.01% of estimated insured deposits at
March 31, 2008.  As a result of this reduced reserve ratio, on October
16, 2008, the FDIC published a proposed rule that would restore the reserve
ratio to the required level.  The proposed rule would raise the
current deposit insurance assessment rate uniformly for all institutions by 7
basis points (to a range from 12 to 50 basis points) for the first quarter of
2009.  The proposed rule would also alter the way the FDIC calculates
federal deposit insurance assessment rates beginning in the second quarter of
2009 and thereafter.





Under the
proposed rule, the FDIC would first establish an institution’s initial base
assessment rate.  This initial assessment rate would range, depending
on the risk category of the institution, from 10 to 45 basis
points.  The FDIC would then adjust the initial base assessment
(higher or lower) to obtain the total base assessment rate.  The
adjustments to the initial base assessment rate would be based upon an
institution’s levels of unsecured debt, secured liabilities, and brokered
deposits.  The total base assessment rate would range from 8 to 77.5
basis points of the institution’s deposits.  There can be no assurance
that the proposed rule will be implemented by the FDIC or implemented in its
present form.





In
addition, the Emergency Economic Stabilization Act of 2008 (EESA) temporarily
increased the limit on FDIC insurance coverage for deposits to $250,0000 through
December 31, 2009, and the FDIC took action to provide coverage for newly-issued
senior unsecured debt and non-interest bearing transaction account in excess of
the $250,000 limit, for which institutions will be assessed additional
premiums.





These
actions will significantly increase the Company’s non-interest expense in 2009
and in future years as long as the increased premiums are in
place.


24
 Index


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





(a.) –
(c.) Not applicable.








Item
3.  Defaults Upon Senior Securities





Not
applicable.





Item
4.  Submission of Matters to a Vote of Security
Holders





(a)
            The
      annual meeting of shareholders was held on August 19,
  2008.





(b)
            The
      following individuals were re-elected as directors for a three-year term
      at the annual meeting: Vincent D. Basile, James P. DelRossi, James G.
      Sartori and Paul T. Sullivan.





(c)
            The
      following matters were voted upon and approved by the Company’s
      shareholders at the 2008 Annual Meeting of Shareholders held on August 19
      2008: (i) election of four directors to serve for three-year terms
      (Proposal 1); (ii) approval of the Company’s 2008 Equity Incentive
      Compensation Plan (Proposal 2); and (iii) ratification of the
      appointment of Wolf & Company, P.C. as the independent registered
      public accounting firm for the Company for the fiscal year ending
      December 31, 2008. (Proposal
3).





The votes
tabulated by an independent inspector of election for the above-listed proposals
were as follows:




Proposal
1


Vincent
D. Basile received 21,491,240 votes for election and 400,326 votes were
withheld; James P. DelRossi received 21,619,728 votes for election and 271,838
votes were withheld; and James G. Sartori received 21,626,762 votes for election
and 264,804 votes were withheld; Paul T. Sullivan received 21,613,070 votes for
election and 278,496 votes were withheld. There were no abstentions or broker
non-votes for any of the nominees.





Proposal
2


Shareholders
cast 18,662,920 votes for, 920,457 votes against and 84,318 abstentions, and
2,223,871 broker non-votes.





Proposal
3


Shareholders
cast 21,769,020 votes for, 88,303 votes against and 34,243
abstentions.





(d)
            Not
      applicable.





Item
5.  Other Information





None.








25
 Index


Item
6.  Exhibits





3.1
            Amended
      and Restated Articles of Organization of Meridian Interstate Bancorp,
      Inc.*3.2
            Amended
      and Restated Bylaws of Meridian Interstate Bancorp,
  Inc.*4
            Form
      of Common Stock Certificate of Meridian Interstate Bancorp,
      Inc.*10.1
            Form
      of East Boston Savings Bank Employee Stock Ownership
  Plan*10.2
            Form
      of East Boston Savings Bank Employee Stock Ownership Plan Trust
      Agreement*10.3
            East
      Boston Savings Bank Employee Stock Ownership Plan Loan Agreement, Pledge
      Agreement and Promissory Note*10.4
            Form
      of Amended and Restated Employment Agreement*10.5
            Form
      of East Boston Savings Bank Employee Severance Compensation
      Plan*10.6
            Form
      of Supplemental Executive Retirement Agreements with certain
      directors*10.7
            Form
      of Separation Agreement with Robert F. Verdonck incorporated by reference
      to the Form 8-K filed on September11, 2008.10.8
            Form
      of Amended and Restated Supplemental Executive Retirement Agreement with
      Leonard V. Siuda filed as an exhibit to Form 10-Q filed on May 14,
      2008.10.9
            Form
      of Amended and Restated Supplemental Executive Retirement Agreement with
      Philip F. Freehan filed as an exhibit to Form 10-Q filed on May 14,
      2008.10.10
            Form
      of Supplemental Executive Retirement Agreement with Richard J. Gavegnano
      filed as an exhibit to Form 10-Q filed on May 14, 2008.10.11
            2008
      Equity Incentive Plan**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.**
            Incorporated by
      reference toAppendix A to theCompany’s Definitive
      Proxy Statement for its 2008 Annual Meeting, as filed with the Securities
      and Exchange Commission on July
      11, 2008.


























26
 Index


SIGNATURES





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








MERIDIAN INTERSTATE
      BANCORP, INC.(Registrant)Dated:  November
      10, 2008
            
            /s/
      Richard J. GavegnanoRichard
      J. GavegnanoChairman
      and Chief Executive Officer(Principal
      Executive Officer)Dated:  November
      10, 2008
            
            /s/
      Leonard V. SiudaLeonard
      V. SiudaChief
      Financial Officer and Treasurer(Principal
      Financial and Accounting Officer)






27