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EBSB > SEC Filings for EBSB > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for MERIDIAN INTERSTATE BANCORP INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for MERIDIAN INTERSTATE BANCORP INC


9-Nov-2012

Quarterly Report


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 Bancorp, Inc. 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, 2011, 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 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:

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

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

increased competitive pressures among financial services companies;

changes in consumer spending, borrowing and savings habits;

our ability to enter new markets successfully and take advantage of growth opportunities, and the possible dilutive effect of potential acquisitions or de novo branches, if any;

legislative or regulatory changes that adversely affect our business;

adverse changes in the securities markets;

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

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

changes in our organization, compensation and benefit plans.

Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. These factors include, but are not limited to, general economic conditions, changes in the interest rate environment, legislative or regulatory changes that may adversely affect our business, changes in accounting policies and practices, changes in competition and demand for financial services, adverse changes in the securities markets and changes in the quality or composition of the Company'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, 2011 filed with the Securities and Exchange Commission on March 15, 2012, under "Risk Factors," which is available through the SEC's website at www.sec.gov, as updated by subsequent filings with the SEC. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, 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.


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Critical Accounting Policies

The Company's summary of significant accounting policies are described in Note 1 to the Consolidated Financial Statements included in the 2011 Annual Report on Form 10-K for the year ended December 31, 2011. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Management has identified accounting for the allowance for loan losses, the valuation of goodwill and analysis for impairment, other-than-temporary impairment of securities and the valuation of deferred tax assets and foreclosed real estate as the Company's critical accounting policies.

Comparison of Financial Condition at September 30, 2012 and December 31, 2011

Assets

Total assets increased $245.0 million, or 12.4%, to $2.219 billion at September 30, 2012 from $1.974 billion at December 31, 2011. Cash and cash equivalents increased $20.8 million, or 13.3%, to $177.5 million at September 30, 2012 from $156.7 million at December 31, 2011. Securities available for sale decreased $60.4 million, or 18.0%, to $274.8 million at September 30, 2012 from $335.2 million at December 31, 2011. Net loans increased $283.8 million, or 21.2%, to $1.625 billion at September 30, 2012 from $1.341 billion at December 31, 2011. The net increase in loans for the nine months ended September 30, 2012 was primarily due to increases of $86.6 million in commercial real estate loans, $97.3 million in construction loans and $64.0 million in commercial business loans.

Asset Quality

Credit Risk Management

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

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

Delinquencies

Total past due loans decreased $12.3 million, or 25.4%, to $36.3 million at September 30, 2012 from $48.7 million at December 31, 2011, reflecting decreases of $4.6 million in loans 90 days or more past due and $7.7 million in loans 30 to 89 days past due. Delinquent loans at September 30, 2012 included $17.6 million of loans acquired in the Mt. Washington merger, including $5.6 million that were 30 to 59 days past due, $1.2 million that were 60 to 89 days past due and $10.9 million that were 90 days or more past due. At September 30, 2012, non-accrual loans exceed loans 90 days or more past due primarily due to loans which were placed on non-accrual status based on a determination that the ultimate collection of all principal and interest due was not expected and certain loans that remain on non-accrual status until they attain a sustained payment history of six months.

Non-performing Assets

Non-performing assets include loans that are 90 or more days past due or on non-accrual status and real estate and other loan collateral acquired through foreclosure and repossession. Loans 90 days or more past due may remain on an accrual basis if adequately collateralized and in the process of collection. At September 30, 2012, the Company did not have any accruing loans past due 90 days or more. For non-accrual loans, interest previously accrued but not collected is reversed and charged against income at the time a loan is placed on non-accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.


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

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

                                               September 30, 2012               December 31, 2011
                                                             (Dollars in thousands)
Loans accounted for on a non-accrual
basis:
Real estate loans:
Residential real estate:
One-to four-family                            $             19,224             $            15,795
Multi-family                                                 1,460                           1,605
Home equity lines of credit                                  2,525                           1,765
Commercial real estate                                       9,230                          11,588
Construction                                                 7,778                          22,434

Total real estate loans                                     40,217                          53,187
Commercial business loans                                      525                             508

Total non-accrual loans                                     40,742                          53,695
Foreclosed assets                                            2,487                           3,853

Total non-performing assets                   $             43,229             $            57,548

Non-performing loans to total loans                           2.48 %                          3.97 %
Non-performing loans to total assets                          1.84 %                          2.72 %
Non-performing assets to total
assets                                                        1.95 %                          2.91 %

Non-performing loans declined $13.0 million to $40.7 million, or 2.48% of total loans outstanding at September 30, 2012, from $53.7 million, or 3.97% of total loans outstanding at December 31, 2011. Non-performing assets declined $14.3 million to $43.2 million, or 1.95% of total assets, at September 30, 2012, from $57.5 million, or 2.91% of total assets, at December 31, 2011. Non-performing assets at September 30, 2012 included $20.0 million of assets acquired in the Mt. Washington merger, comprised of $19.2 million of non-performing loans and $769,000 of foreclosed real estate. Interest income that would have been recorded for the nine months ended September 30, 2012 had nonaccruing loans been current according to their original terms amounted to $1.1 million.

Troubled Debt Restructurings

In the course of resolving non-performing loans, the Bank may choose to restructure the contractual terms of certain loans, with terms modified to fit the ability of the borrower to repay in line with its current financial status. A loan is considered 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.


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The following table summarizes the Company's troubled debt restructurings ("TDRs") at the dates indicated.

                                            September 30,       December 31,
                                                2012                2011
                                                     (In thousands)
        TDRs on accrual status:
        One-to four-family                 $         1,784     $        1,269
        Home equity lines of credit                     22                 -
        Construction                                 3,562                 -

        Total TDRs on accrual status                 5,368              1,269

        TDRs on non-accrual status:
        One-to four-family                           2,715              2,052
        Commercial real estate                       4,506              4,663
        Construction                                 3,937              7,715

        Total TDRs on non-accrual status            11,158             14,430

        Total TDRs                         $        16,526     $       15,699

The increase in one-to four-family TDRs on accrual was due to one residential loan modification and three one-to four-family TDRs that were returned to accrual status during the nine months ended September 30, 2012. Modifications of one-to four-family TDRs consist of rate reductions, loan term extensions or provisions for interest-only payments for a specified period up to 12 months. The Company has generally been successful with the concessions it has offered to borrowers to date. The increase in construction TDRs was due to one construction TDR which was returned to accrual status. The Company generally returns TDRs to accrual status when they have sustained payments for six months based on the restructured terms.

Potential Problem Loans

Certain loans are identified during the Company's loan review process that are currently performing in accordance with their contractual terms and we expect to receive payment in full of principal and interest, but it is deemed probable that we will be unable to collect all the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. This may result from deteriorating conditions, such as cash flows, collateral values or creditworthiness of the borrower. These loans are classified as impaired but are not accounted for on a non-accrual basis. There were no potential problem loans identified at September 30, 2012 other than those already classified as non-performing, impaired or troubled debt restructurings.

Allowance for Loan Losses

The allowance for loan losses is maintained at levels considered adequate by management to provide for probable loan losses inherent in the loan portfolio as of the consolidated balance sheet reporting dates. The allowance for loan losses is based on management's assessment of various factors affecting the loan portfolio, including portfolio composition, delinquent and non-accrual loans, national and local business conditions and loss experience and an overall evaluation of the quality of the underlying collateral.


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The following table sets forth the breakdown of the allowance for loan losses by loan category at the periods indicated:

                                                September 30, 2012                              December 31, 2011
                                                                       % of                                           % of
                                                      % of           Loans in                        % of           Loans in
                                                    Allowance        Category                      Allowance        Category
                                                    to Total         of Total                      to Total         of Total
                                      Amount        Allowance         Loans          Amount        Allowance         Loans
                                                                      (Dollars in thousands)
Real estate loans:
Residential real estate:
One-to four-family                   $  2,611             13.9 %          27.4 %    $  1,861             14.3 %          30.9 %
Multi-family                            1,537              8.3            11.3         1,361             10.4            13.0
Home equity lines of credit               256              1.4             3.7           245              1.9             4.5
Commercial real estate                  7,423             39.9            37.4         6,980             53.4            39.0
Construction                            4,540             24.4            11.6         1,430             11.0             6.9

Total real estate loans                16,367             87.9            91.4        11,877             91.0            94.3
Commercial business loans               2,144             11.5             8.2         1,061              8.1             5.3
Consumer                                  111              0.6             0.4           115              0.9             0.4

Total loans                          $ 18,622            100.0 %         100.0 %    $ 13,053            100.0 %         100.0 %

Allowance to non-accrual loans          45.71 %                                        24.31 %
Allowance to total loans
outstanding                              1.13 %                                         0.96 %
Net charge-offs to average loans
outstanding (annualized)                 0.02 %                                         0.06 %

The Company's provision for loan losses was $2.3 million for the quarter ended September 30, 2012 compared to $1.6 million for the quarter ended September 30, 2011. For the nine months ended September 30, 2012, the provision for loan losses was $5.8 million compared to $2.4 million for the nine months ended September 30, 2011. The changes were based primarily on management's assessment of loan portfolio growth and composition changes, an ongoing evaluation of credit quality and current economic conditions. In addition, increases in the provision for loan losses were primarily due to growth in the commercial real estate, construction and commercial business loan categories for the third quarter and nine months ended September 30, 2012 compared to the same periods in 2011. Loans in the commercial real estate, construction and commercial business categories have higher inherent credit risk than loans in the residential real estate loan categories. The allowance for loan losses was $18.6 million or 1.13% of total loans outstanding at September 30, 2012, compared to $13.1 million or 0.96% of total loans outstanding at December 31, 2011. The Company continues to assess the adequacy of its allowance for loan losses in accordance with established policies.

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

The Company had impaired loans totaling $42.7 million and $58.9 million as of September 30, 2012 and December 31, 2011, respectively. At September 30, 2012, impaired loans totaling $10.0 million had an allocated allowance of $1.2 million. Impaired loans totaling $9.1 million had an allocated allowance of $490,000 at December 31, 2011. The Company's average investment in impaired loans was $50.9 million and $38.7 million for the nine months ended September 30, 2012 and 2011, respectively.

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


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

We review residential and commercial loans for impairment based on the fair value of collateral, if collateral-dependent, or the present value of expected cash flows. Management has reviewed the collateral value for all impaired and non-accrual loans that were collateral-dependent as of September 30, 2012 and considered any probable loss in determining the allowance for loan losses.

For residential loans measured for impairment based on the collateral value, we will do the following:

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

We make adjustments to appraisals based on updated economic information, if necessary, prior to the foreclosure sale. We review current market factors to determine whether, in management's opinion, downward adjustments to the most recent appraised values may be warranted. If so, we use our best estimate to apply an estimated discount rate to the appraised values to reflect current market factors.

Appraisals we receive are based on comparable property sales.

For commercial loans measured for impairment based on the collateral value, we will do the following:

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

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

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

Loans that are partially charged off generally remain on non-accrual status until foreclosure or such time that they are performing in accordance with the terms of the loan and have a sustained payment history of at least six months. The accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. Loan losses are charged against the allowance when we believe the uncollectibility of a loan balance is confirmed, generally when appraised values (as adjusted values, if applicable) less estimated costs to sell, are less than the Company's carrying values.

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


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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. Our deposit base is comprised of demand, NOW, money market, regular savings and other deposits, and certificates of deposit. We consider demand, NOW, money market, and regular and other deposits to be core deposits. Total deposits increased $192.4 million, or 12.0%, to $1.797 billion at September 30, 2012 from $1.604 billion at December 31, 2011. Our continuing focus on the acquisition and expansion of core deposit relationships resulted in net growth in those non-term balances of $204.4 million to $1.162 billion, or 64.7% of total deposits, at September 30, 2012. The net deposit growth also reflects $85.7 million of new deposits in the two branches opened since September 2011.

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

                                           September 30, 2012                        December 31, 2011
                                                        Percent of                                Percent of
                                     Balance          Total Deposits           Balance          Total Deposits
                                                           (Dollars in thousands)
Demand deposits                    $   192,019                   10.8 %      $   145,274                    9.1 %
NOW deposits                           167,950                    9.3            153,651                    9.6
Money market deposits                  565,011                   31.4            445,868                   27.8
Regular and other deposits             237,519                   13.2            213,266                   13.3
Certificates of deposit                634,352                   35.3            646,429                   40.2

Total                              $ 1,796,851                  100.0 %      $ 1,604,488                  100.0 %

Borrowings

We use borrowings from the Federal Home Loan Bank of Boston to supplement our supply of funds for loans and investments. In addition, we also purchase federal funds from local banking institutions as an additional short-term funding source for the Bank. Total borrowings increased $40.4 million, or 30.7%, to . . .

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