Summary of CENTRAL BANCORP INC /MA/

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 Central Bancorp, Inc. (the "Company" or "Central Bancorp"). The information contained in this section should be read in conjunction with the unaudited consolidated financial statements and footnotes appearing in Part I, Item 1 of this Form 10-Q. Forward-Looking Statements
This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project" or similar expressions. The Company'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 the Company 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 the Bank's market area, changes in real estate market values in the Bank's market area, and changes in relevant accounting principles and guidelines. Additionally, other risks and uncertainties may be described in the Company's Annual Report on Form 10-K for the year ended March 31, 2008, as filed with the Securities and Exchange Commission on June 20, 2008, which is available through the SEC's website at www.sec.gov, as well as under "Part II-Item 1A. Risk Factors" of this Form 10-Q. 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, the Company 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.
General
The Company is a Massachusetts holding company established in 1998 to be the holding company for Central Co-operative Bank (the "Bank"). The Company's primary business activity is the ownership of all of the outstanding capital stock of the Bank. Accordingly, the information set forth in this report, including the consolidated financial statements and related data, relates primarily to the Bank.
The Bank is a Massachusetts co-operative bank headquartered in Somerville, Massachusetts with nine full-service facilities, a limited service high school branch in suburban Boston, and a stand-alone 24-hour automated teller machine in Somerville. The Company primarily generates funds in the form of deposits and uses the funds to make mortgage loans for the construction, purchase and refinancing of residential properties and to make loans on commercial real estate in its market area.
The operations of the Company and its subsidiary are generally influenced by overall economic conditions, the related monetary and fiscal policies of the federal government and the regulatory policies of financial institution regulatory authorities, including the Massachusetts Commissioner of Banks, the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") and the Federal Deposit Insurance Corporation.
The Bank monitors its exposure to earnings fluctuations resulting from market interest rate changes. Historically, the Bank's earnings have been vulnerable to changing interest rates due to differences in the terms to maturity or repricing of its assets and liabilities. For example, in a declining interest rate environment, the Bank's net interest income and net income could be positively impacted as interest-sensitive liabilities (deposits and borrowings) could adjust more quickly to declining interest rates than the Bank's interest-sensitive assets (loans and investments). Conversely, in a rising interest rate environment, the Bank's net interest income and net income could be negatively affected as interest-sensitive liabilities (deposits and borrowings) could adjust more quickly to rising interest rates than the Bank's interest-sensitive assets (loans and investments).

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The following is a discussion and analysis of the Company's results of operations for the three and six months ended September 30, 2008 and 2007 and its financial condition at September 30, 2008 compared to March 31, 2008. Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the consolidated financial statements and accompanying notes.
Critical Accounting Policies
Accounting policies involving significant judgments and assumptions by management, which have, or could have, a material impact on the carrying value of certain assets and impact income, are considered critical accounting policies. The Company considers the allowance for loan losses and the fair value of investments to be its critical accounting policies. There have been no significant changes in the methods or assumptions used in the accounting policies that require material estimates and assumptions.
Allowance for Loan Losses. Arriving at an appropriate level of allowance for loan losses necessarily involves a high degree of judgment. The ongoing evaluation process includes a formal analysis of the allowance each quarter, which considers, among other factors, the character and size of the loan portfolio, business and economic conditions, loan growth, delinquency trends, nonperforming loan trends, charge-off experience and other asset quality factors. The Company evaluates specific loan status reports on commercial and commercial real estate loans rated "substandard" or worse. Estimated reserves for each of these credits is determined by reviewing current collateral value, financial information, cash flow, payment history and trends and other relevant facts surrounding the particular credit. Provisions for losses on the remaining commercial and commercial real estate loans are based on pools of similar loans using a combination of historical loss experience, loan to value ratios and qualitative adjustments. For the residential real estate and consumer loan portfolios, the range of reserves is calculated by applying historical charge-off and recovery experience and other pertinent data to the current outstanding balance in each loan category. Although management uses available information to establish the appropriate level of the allowance for loan losses, future additions or reductions to the allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination.
Fair Value of Investments. Debt securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at cost, adjusted for amortization of premiums and accretion of discounts, both computed by a method that approximates the effective yield method. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and reported at fair value, with unrealized gains and losses included in earnings. Debt and equity securities not classified as either held-to-maturity or trading are classified as available-for-sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity and comprehensive income.
Gains and losses on sales of securities are recognized when realized with the cost basis of investments sold determined on a specific-identification basis. Premiums and discounts on investment and mortgage-backed securities are amortized or accreted to interest income over the actual or expected lives of the securities using the level-yield method.
If a decline in fair value below the amortized cost basis of an investment is judged to be other-than-temporary, the cost basis of the investment is written down to fair value as a new cost basis and the amount of the write-down is included in the results of operations.
The Company's investments in the Federal Home Loan Bank of Boston and the Co-operative Central Bank Reserve Fund are accounted for at cost.

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Market Events
The Company's financial results were significantly impacted by the September 2008 conservatorship of Fannie Mae and Freddie Mac. The conservatorship and elimination of Fannie Mae and Freddie Mac dividends significantly reduced the value of the Company's preferred stock investment in these companies, resulting in impairment write downs of these investments totaling $9.4 million during the three months ended September 30, 2008. The remaining value of these investments was $707 thousand at September 30, 2008. The Company invested in these quality investments known as Government Sponsored Enterprises ("GSE's") that had carried an implied government backing which was not fulfilled by the actions taken in early September by the U.S. Treasury. Net loss for the quarter ended September 30, 2008 was $9.5 million, or $6.80 per diluted share, as compared to net income of $465,000, or $0.33 per diluted share, for the comparable prior year quarter. The Company's net loss for the six months ended September 30, 2008 was $9.1 million, or $6.53 per diluted share, as compared to net income of $690,000, or $0.49 per diluted share, for the corresponding period in 2007.
The non-cash charges to record the other than temporary impairment of the Company's Fannie Mae and Freddie Mac preferred stock investments reduced earnings by $9.4 million or $6.75 and $6.77 per diluted share for the quarter and year-to-date periods ending September 30, 2008, respectively. No tax benefit was recorded during the periods as the losses were considered capital losses and there were no available capital gains to offset such losses. However, in the quarter ending December 31, 2008, the Company will recognize a tax benefit of approximately $3.2 million or $2.34 per share on the Fannie Mae and Freddie Mac impairment charges due to the October 3, 2008 enactment of the Emergency Economic Stabilization Act of 2008, which permits the Company to treat losses incurred on the Fannie Mae and Freddie Mac preferred stock as ordinary losses for federal income tax purposes. Note that the $2.34 per share tax benefit discussed above is based upon management's estimate of the number of shares that will be outstanding during the quarter ended December 31, 2008.
Regulatory reporting guidance issued by the FFIEC subsequent to the October 3, 2008 passage of the Emergency Economic Stabilization Act of 2008 permits financial institutions to reflect the tax benefits in September 30, 2008 regulatory reports. Therefore, the following table presents the Company's and the Bank's September 30, 2008 capital ratios after the impairment write downs and their associated tax benefits have been taken:

                                                  At September 30, 2008
                                                    Regulatory        Regulatory
                                                     Threshold        Threshold
                                                     For Well       For Adequately
                                        Actual      Capitalized      Capitalized

         Central Bancorp:
         Tier 1 Leverage                  6.44 %           5.0 %             4.0 %
         Tier 1 Risk-Based Ratio          9.32 %           6.0 %             4.0 %
         Total Risk-Based Ratio          10.54 %          10.0 %             8.0 %

         Central Co-operative Bank:
         Tier 1 Leverage                  5.45 %           5.0 %             4.0 %
         Tier 1 Risk-Based Ratio          7.90 %           6.0 %             4.0 %
         Total Risk-Based Ratio           9.12 %          10.0 %             8.0 %

The Company remained well capitalized in all such measures and the Bank remained well capitalized except in regard to its total risk based capital ratio which is considered to be adequately capitalized.
Comparison of Financial Condition at September 30, 2008 and March 31, 2008 Total assets were $541.8 million at September 30, 2008 compared to $571.2 million at March 31, 2008, representing a decrease of $29.5 million, or 5.2%. Total loans (excluding loans held for sale) were $462.8 million at

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September 30, 2008 compared to $474.9 million at March 31, 2008, representing a decrease of $12.2 million, or 2.6%. This decrease was primarily due to decreases in commercial real estate loans of $2.1 million, commercial and industrial loans of $7.2 million, and construction loans of $8.4 million, partially offset by an increase in residential loans of $4.9 million. Construction loans declined as management de-emphasized this type of lending in the current economic environment. Commercial real estate and commercial and industrial loans decreased primarily due to payoffs during the period.
Management regularly assesses the desirability of holding newly originated residential mortgage loans in the Bank's portfolio or selling such loans in the secondary market. A number of factors are evaluated to determine whether or not to hold such loans in portfolio including current and projected liquidity, current and projected interest rates, projected growth in other interest-earning assets and the current and projected interest rate risk profile. Based on its consideration of these factors, management determined that most long-term residential mortgage loans originated during the six months ended September 30, 2008 should be retained, rather than being sold in the secondary market. The decision to sell or hold loans is made at the time the loan commitment is issued and the Bank simultaneously enters into a best efforts forward commitment to sell the loan to manage the interest rate risk associated with the decision to sell the loan. Loans are sold servicing released.
Cash and cash equivalents totaled $16.3 million at September 30, 2008 compared to $17.7 million at March 31, 2008, representing a decrease of $1.4 million, or 8.2%, comprised of a $4.5 million decrease in short-term investments and a $3.0 million increase in cash and due from banks. Investment securities totaled $46.5 million at September 30, 2008 compared to $63.1 million at March 31, 2008, representing a decrease of $16.5 million, or 26.2%. Regarding cash flows, cash and cash equivalents, investment securities, and loans decreased as the result of the redeployment of these funds to fund deposit withdrawals and maturing FHLB advances. Stock in the Federal Home Loan Bank of Boston remained unchanged and totaled $8.5 million at both September 30, 2008 and March 31, 2008. The allowance for loan losses totaled $4.7 million at September 30, 2008 compared to $3.6 million at March 31, 2008, representing an increase of $1.1 million, or 29.4%. This increase was primarily related to one customer relationship and such increase was the result of management's regular analysis of the adequacy of the allowance for loan losses (see "Provision for Loan Losses"). Management considered the allowance for loan losses to be adequate at both September 30, 2008 and March 31, 2008. Banking premises and equipment, net, totaled $3.7 million at September 30, 2008 compared to $4.0 million at March 31, 2008, primarily reflecting amortization of leasehold improvements and depreciation for the period.
During the quarter ended September 30, 2008, one residential loan was foreclosed upon and it is recorded on the balance sheet as an asset titled "Other Real Estate Owned" with a balance of $89 thousand as of September 30, 2008, compared to $0 as of March 30, 2008.
During the quarter ended December 31, 2007, the Bank purchased life insurance policies on one executive which totaled $6.0 million. The cash surrender value of these policies is carried as an asset titled "Bank-Owned Life Insurance" and totaled $6.2 million at September 30, 2008 as compared to $6.1 as of March 31, 2008.
Total deposits amounted to $354.1 million at September 30, 2008 compared to $361.1 million at March 31, 2008, representing a decrease of $7.0 million or 1.9%, reflecting the combined effect of a $7.7 million, or 4.5%, decrease in certificates of deposit, and a $648 thousand or 0.4% increase in core deposits (consisting of all noncertificate accounts). Deposits declined primarily due to continued strong competition for deposits in our market area.
Federal Home Loan Bank advances amounted to $144.6 million at September 30, 2008 compared to $156.7 million at March 31, 2008, representing a decrease of $12.1 million, or 7.7%, as maturing Federal Home Loan Bank advances were paid with available cash on hand.
Accrued expenses and other liabilities totaled $1.4 million at September 30, 2008 and $1.9 million at March 31, 2008.
Total stockholders' equity amounted to $28.6 million at September 30, 2008 compared to $38.8 million at March 31, 2008, representing a decrease of $10.2 million, or 26.4%. Decreases due to net loss of $9.1 million, other comprehensive loss of $962 thousand, and dividends paid to stockholders of $513 thousand, were partially offset by

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increases due to stock-based compensation of $161 thousand, amortization of unearned compensation regarding the ESOP of $(193) thousand, and unearned ESOP compensation of $344 thousand.
Comparison of Operating Results for the Quarters Ended September 30, 2008 and 2007
As mentioned in the "Market Events" section of this document, earnings for the quarter ended September 30, 2008 were significantly impacted by the impairment of our Fannie Mae and Freddie Mac preferred stock investments. Net loss for the quarter ended September 30, 2008 was $9.5 million or $6.80 per diluted share, as compared to net income of $465 thousand, or $0.33 per diluted share, for the comparable prior year quarter. In addition to the aforementioned Fannie Mae and Freddie Mac preferred stock losses, other items contributing to the operating results for the quarter ended September 30, 2008 as compared to the quarter ended September 30, 2007 were a $945 thousand increase in net interest and dividend income, a $1.2 million increase in the provision for loan losses, a $234 thousand decrease in noninterest income, an increase in noninterest expenses of $223 thousand and a decrease of $175 thousand in the provision for income taxes.
Interest and Dividend Income. Interest and dividend income decreased by $133 thousand, or 1.7%, to $7.8 million for the quarter ended September 30, 2008 as compared to $7.9 million during the same period of 2007. Although the average balance of loans for the quarter ended September 30, 2008 increased by $7.4 million as compared to the quarter ended September 30, 2007, the yield on loans remained unchanged at 6.03%. The average balance of loans increased primarily due to increases in the average balances of commercial real estate and residential loans as the Bank continued to focus on originating these types of loans during the period. The average balance on investment securities declined as maturities and principal repayments were used to fund loan growth and deposit withdrawals. The yield on short-term investments was 1.92% during the quarter ended September 30, 2008 as compared to 5.22% during the quarter ended September 30, 2007 as the average yields on these investments are closely tied to the federal funds target rate, which averaged approximately 2.0% during the quarter ended September 30, 2008, and 5.25% during the quarter ended September 30, 2007.
Interest Expense. Interest expense decreased by $1.1 million, or 23.0%, to $3.6 million for the quarter ended September 30, 2008 as compared to $4.7 million during the same period of 2007 due to decreases the average rates paid on deposits, FHLB borrowings, and other borrowings. The cost of deposits decreased by 117 basis points from 3.35% during quarter ended September 30, 2007 to 2.18% during the quarter ended September 30, 2008, as some high-cost certificates of deposit were replaced by more cost-effective FHLB borrowings and lower-costing deposits. The average balance of certificates of deposit totaled $171.8 million during the quarter ended September 30, 2008, compared to $187.1 million for the same period in 2007, a decline of $15.3 million. The average balance of FHLB borrowings increased by $14.5 million, from $131.7 million during the quarter ended September 30, 2007 to $146.2 million during the same period of 2008. The decrease in the average cost of these funds was the result of a decrease in market interest rates. The average balance of lower-costing nonmaturity deposits increased by $8.9 million to $185.9 million for the quarter ended September 30, 2008, as compared to an average balance of $177.0 million during the same period of 2007. The average cost of other borrowings decreased as a portion of these borrowings are adjustable and the average rate paid during the quarter ended September 30, 2008 was 5.98%, compared to an average rate of 7.08% during the quarter ended September 30, 2007.

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The following table presents average balances and average rates earned/paid by the Company for the quarter ended September 30, 2008 compared to the quarter ended September 30, 2007:

                                                                    Three Months Ended September 30,
                                                     2008                                                     2007
                                Average                                                  Average
                                Balance          Interest          Average Rate          Balance          Interest          Average Rate
                                                                      (Dollars in thousands)

Interest-earning assets:
Mortgage loans                 $ 457,339        $    6,884                  6.03 %      $ 447,721        $    6,753                  6.03 %
Other loans                        8,804               140                  6.36           10,991               235                  8.55
Investment securities             52,210               723                  5.06           72,753               880                  4.84
Short-term investments            11,025                53                  1.92            4,978                65                  5.22

Total interest-earning
assets                           534,378             7,800                  5.85          536,443             7,933                  5.92


Allowance for loan losses         (3,982 )                                                 (3,844 )
Noninterest-earning
assets                            25,563                                                   18,734

Total assets                   $ 555,959                                                $ 551,333


Interest-bearing
liabilities:
Deposits                       $ 318,915             1,737                  2.18        $ 328,204             2,746                  3.35
Advances from FHLB of
Boston                           146,223             1,691                  4.63          131,736             1,727                  5.24
Other borrowings                  11,998               174                  5.80           12,028               207                  6.88

Total interest-bearing
liabilities                      477,136             3,602                  3.02          471,968             4,680                  3.97


Noninterest-bearing
liabilities                       40,939                                                   41,229

Total liabilities                518,075                                                  513,197

Stockholders' equity              37,884                                                   38,136

Total liabilities and
stockholders' equity           $ 555,959                                                $ 551,333


Net interest and dividend
income                                          $    4,198                                               $    3,253

Net interest spread                                                         2.82 %                                                   1.95 %

Net interest margin                                                         3.14 %                                                   2.43 %

Provision for Loan Losses. The Company provides for loan losses in order to maintain the allowance for loan losses at a level that management estimates is adequate to absorb probable losses based on an evaluation of known and inherent risks in the portfolio. In determining the appropriate level of the allowance for loan losses, management considers past and anticipated loss experience, evaluations of underlying collateral, financial condition of the borrower, prevailing economic conditions, the nature and volume of the loan portfolio and the levels of non-performing and other classified loans. The amount of the allowance is based on estimates and ultimate losses may vary from such estimates. Management assesses the allowance for loan losses on a quarterly basis and provides for loan losses monthly when appropriate to maintain the adequacy of the allowance. The Company uses a process of portfolio segmentation to calculate the appropriate reserve level at the end of each quarter. Periodically, the Company evaluates the allocations used in these calculations. During the quarter ended September 30, 2008, management performed a thorough analysis of the loan portfolio as well as the required reserve allocations for loans considered impaired under SFAS No 114 and the allocation percentages used when calculating potential losses under SFAS No. 5. Based on this analysis, the Company recorded a $900 thousand provision for loan losses, which primarily relates to one customer relationship, during the quarter ended September 30, 2008.
Senior management continued to give high priority to monitoring and managing the Company's asset quality. At September 30, 2008, nonperforming loans totaled $10.3 million as compared to $9.6 million on March 31, 2008. The ten loans constituting this category are all secured by real estate collateral located almost exclusively in the Greater Boston area. Nine of these loans have an active plan for resolution in place from either the sale of the

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real estate directly by the borrower or through foreclosure. The other nonperforming loan has entered into a bankruptcy court approved resolution program with the ongoing net cash flow generated from apartment rents from the property collateral being paid to the Bank. While bankruptcy filings have extended the time required to resolve some nonperforming assets, management . . .