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Northeast Bank

NBN US

Northeast BankUnited States Composite

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Q2 2015 · Earnings Call Transcript

Jan 30, 2015

Executives

Richard Wayne - President and Chief Executive Officer Claire Bean - Chief Operating Officer

Analysts

David Minkoff - DCM Asset Management Alexander Twerdahl - Sandler O'Neill and Partners, L.P.

Operator

Good day, everyone, and welcome to the Northeast Bancorp Fiscal Year 2015 Second Quarter Earnings Results conference call. This call is being recorded.

With us today from the company is Rick Wayne, President and Chief Executive Officer; and Claire Bean, Chief Operating Officer; and Brian Shaughnessy, Chief Financial Officer. Earlier this morning an investor presentation was uploaded to the company’s website, which we will be referenced in this morning’s call.

The presentation can be accessed at the investor relations’ section of northeastbank.com under events and presentations. You may find it helpful to download this investor presentation and follow along during the call.

Also this call will be available for rebroadcast on the website for future use. The question-and-answer session for this call will be conducted electronically following the presentation.

Please note this presentation contains forward-looking information for Northeast Bancorp. Such information contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which involves significant risks and uncertainties.

Actual results may differ materially from the results discussed in the forward-looking statements. At this time, I would like to turn the call over to Rick Wayne.

Please go ahead sir.

Richard Wayne

Thank you. Good morning and thank you all for joining us today.

With me is Claire Bean, our Chief Operating Officer who will discuss our financial results following my comments. Also with us today is Brian Shaughnessy, our new Chief Financial Officer.

Brian joined us recently out of KPMG, where he worked since 2005 in the financial services practice. His very impressive background and experience in financial services makes him a great fit for our company.

Following our presentation we will be happy to answer your questions. Please turn to Slide 3.

For the quarter we closed $93 million of loans, including $68 million of LASG commercial loan purchases and originations and $25 million of residential loan originations. With $2.8 million of transactional income the purchased loan portfolio generated a return of 13.7% and bank-wide net interest margin of 4.87%.

With respect to the stock repurchase plan during the quarter we purchased 434,286 shares at an average share price of $9.14. Cumulatively, we have purchased 739,886 shares at an average price of $9.36.

In the prior quarter, I commented on our SBA program and the significant investment we are making in this line of business. In the current quarter, we have added seven new business development officers across the country and we are excited about the experience and opportunity that they bring to Northeast Bank.

Moving on to Slide 4 and 5, of the approximately $68 million invested by LASG for the quarter, $39.7 million were purchased loans and $28.6 million were originated loans. Purchased loans for the quarter had unpaid principal balances of $46.3 million, representing a purchase price of 85.7%.

Since June of 2011 when LASG purchased its first loan it has invested an aggregate of $534 million consisting of $357 million of purchased loans and $177 million of originated loans. In addition, we originated $2.8 million of loans with SBA guarantees of which $2.6 million were sold to the secondary market for $445,000 gain.

I would like to briefly comment on what we saw in this small balance performing commercial loan purchase market during the past quarter. As I noted, we purchased loans at an invested amount of $39.7 million and with unpaid principal balances of $46.3 million.

During the past quarter we reviewed loans with approximately $338 million of unpaid principal balances and bid our loans with approximately $54 million of unpaid principal balances. We remain disciplined in our selection underwriting and bidding on reviewed loan pools and singularly focused on building a quality portfolio.

While we bid our relatively low percentage of loans reviewed, principally due to differences in perceptions of collateral value from that of the sellers we continue to remain optimistic about the purchased loan business and expect to continue to grow our purchased loan book. Turning to Slide 6, as we have discussed in the past under a regulatory commitment made in connection with the 2010 merger, purchased loans are limited to 40% of total loans.

Loan purchasing capacity was $24 million at September 30 and $19.7 million at December 31 reflecting loan purchases of $39.7 million and balance sheet loan originations of $30 million and pay-downs in our purchased and originated loan books. Loan purchase capacity increases or decreases depending upon the relative amount of purchase and originated loans on our balance sheet at any point in time.

Now on Slide 7, under another regulatory commitment, commercial real estate loans are limited to 300% of total risk-based capital. Capacity under this commitment was $162 million at September 30 and $133 million at December 31 reflecting non-owner occupied purchases of $24 million.

CRE pay-downs of $1 million and a $6 million impact of reduction in our regulatory capital, principally due to our repurchase program. Moving on to Slide 8, at the end of the quarter, the discount on purchased loans was $42 million.

The $42 million balance at December 31, representing a discount of 16% from the outstanding loan balances consists of $30 million of accretable discount and $12 million of non-accretable discount. Approximately 70% of the $42 million discount is expected to be realized over the remaining life of the purchased loans through scheduled accretion or early pay-off.

The non-accretable portion of the discount represents contractual cash flows that in their estimation may not be collectable. If you could turn on to Slide 9, which provides detail on returns from the LASG portfolio.

For the quarter, the purchased portfolio generated a return of approximately 13.7%, including transactional income of $2.8 million from unscheduled loan payoffs and asset sales. While the returns on our purchased portfolio are strong, it is important to emphasize that both the amount of loans purchased and the transactional income realized on the purchase portfolio may not be consistent from quarter-to-quarter.

With respect to the LASG originated portfolio, which does not benefit from purchased discount, it generated returns of 7.4% in the quarter benefiting from $178,000 of exit and prepayment fees. In addition, you will note a yield of 7 basis points on loans secured by securities.

Turning to Slide 10, which provide some statistics on the LASG loan portfolio of as of September 30 - December 31, pardon me, of significance. The overall LASG portfolio consists of 64% of purchased loans and 36% originated loans.

On an investment basis, the average loan size is approximately $782,000 with the largest individual loan of $12 and was 67% of the portfolio consistent with loans of less than $4 million. The loan portfolio has a diverse collateral type focused on retail, industrial, office, hospitality, and multifamily, and by geography with the largest concentrations in California 20% and New York at 15%, those percentages referring to the percentage of the portfolio.

Our collateral is geographically diverse with collateral in 36 different states. In addition, as noted in the chart, in the top right of the slide, the purchased loan portfolio had a weighted average net investment of 84%.

And now, I would like to turn it over to Claire, who will discuss in more detail our financial results.

Claire Bean

Thank you, Rick, and good morning, everyone. I’m picking it up on Slide 11.

As Rick noted, it was a solid quarter with net income of $1.6 million, or $0.16 per share that was flat compared to last quarter and up from $0.13 in the comparable fiscal 2014 period. A $2.8 million transactional income for the quarter was strong, as with the net interest margin coming in at 4.87% for the three months.

Operating expenses shipped up when compared to the linked-quarter, the reasons, which I’ll discuss in a moment. Turning to Slide 12, we have a strong - we had strong loan growth this past quarter pleasing the portfolio by $33.5 million, or 6%, which is coming primarily on the strength of $68 million in LASG purchases and loan originations.

And over the past four quarters, we’ve achieved $73 million of net growth on approximately $200 million of combined purchases and originations. These results are detailed further on Slide 13, which shows the composition of net loan growth over the past four quarters, much of it coming in production by the LASG, which on a net basis increased as originated loan book by approximately 17% and purchase loans by approximately 7%.

And as we noted last quarter, we’ve invested in additional Maine based commercial lending resources and saw some favorable preliminary results this quarter, increasing the Community Bank commercial real estate book by about $3 million. Turning to funding, we grew deposits by 6.4% or $38 million over the last three months.

That was entirely made up of increases in non-maturity accounts and in our ableBanking division’s money market accounts in particular. Since the inception of the ableBanking division in 2012, money market balances we’ve attracted have proven to be quite sticky even when our rates are not at top of market.

On Slide 15, I’ll quickly note the variability and transactional income, which as we’ve seen this before– noted in the green bars on the first two graphs in which we’ve discussed quite a bit on previous calls. Also the slight decline in what we characterized in our - as our base interest income and the increase in operating expenses compared to the linked-quarter.

Slide 16, just very briefly also provides another look at operating expense trends. Turning to Slide 17, we provided here some additional color behind the variances in operating expenses and in base interest income.

And for the purposes of this slide we’re comparing fiscal Q2 to the linked-quarter. Turning first to interest income, the main reasons for the quarter-over-quarter decline are, the fact that prepayment fees on originated loans, originated in the prior quarter were $270,000 higher than in Q2.

It also - also affected by NPAs and the one new purchased loan in particular, which caused the period-over-period reduction of approximately $140,000. And lastly, decreases in yield on both the LASG originated and community bank portfolios were responsible for most of the remainder of that variance.

With regard to operating expenses, approximately $200,000 of the increase came in compensation expense, largely due to recruitment costs, and the compensation associated with the hiring of seven new Business Development Officers in our SBA division. There was $150,000 increase in professional fees in the quarter, most of that costs are the results of temporary consulting services.

And lastly, an increase in loan expense. And this is the category that tends to fluctuate from quarter-to-quarter, and in this particular period, much of the increase was due to a loss on a residential loan that we sold in the secondary market back in 2007.

Turning to Slide 18, we show here trends in loan yields and purchased loan total returns, which was discussed earlier. Our net interest margin this quarter at 4.87% was down from 5.18% last quarter, is a strong result nonetheless.

Baseline NIM with all transactional income stripped out of it, came in at 3.55%, down from 4.10% last quarter. The decline as we just noted is mainly due to lower yields on both the LASG and community bank originated portfolios, as well as the significant decline in prepayment fees realized on originated loans compared to last quarter.

Average balances are shown in the upper right, well up $23 million from the prior three months period. This is in large measure reflecting the low yielding securities loans that we originated late last quarter.

Net growth this quarter was also predominantly booked late in the period, and we’ll therefore benefit us more in Q3. Turning to Slide 19, our residential lending group produced solid results generating total originations of approximately $25 million and net gains on sale of $450,000.

Slide 20, is the snapshot of our asset quality metrics, the uptick in NPAs of about 50 basis points is the result of one fairly recently purchased loan and as you’ve heard us say in the past, this is not uncommon in the transition period post purchase. So the good classified loans are down compared to year-end and charge-offs have remained fairly insignificant.

That concludes our prepared remarks. We’d like at this time to open up the call for Q&A.

Operator

[Operator Instructions] Our first question comes from David Minkoff with DCM Asset Management.

David Minkoff

Good morning, ladies and gentlemen; Claire is the lady, and two gentlemen.

Claire Bean

Good morning, David.

David Minkoff

Congratulations on a pretty decent quarter overall, I would say. But the question I had was the non-performing assets have been hovering around $9 million for last few quarters and jump to $14 million, which Claire touched on due to one recent loan.

But the provision for loan losses looks like, it was only $113,000 in the income statement this quarter. I think at the last conference call, you touched on where you provide for those non-performers, is it encompassed in the loan portfolio or something, but how was it broken out, I don’t recall.

Claire Bean

You hit on it David. For purchased loans, the losses that that maybe inherent in that portfolio are not really reflected in our allowance.

They’re instead reflected in the discount that we achieved when we buy those loans. And to the extent, we think, we may not collect all of the cash flows on a purchased loans.

There is a portion of the discount that’s called non-accretable. And that –it’s not brought into income, and may, in fact, reflect the potential for credit loss on a loan.

As you know, over time, we’ve had good success in collecting a lot of non-accretable discounts, but there are certainly no guarantee that we might and that’s really the fundamental reasons that we characterize it that way as to allow for the potential for credit losses on a given purchased loans.

David Minkoff

Understood. So of the $5 million, approximately that the total non-performers went up in the quarter.

How much of that the $5 million would you say, you - was an enhanced discount on the loan portfolio due to that, was it the $4 million, $5 million, or is it a portion of it or how could we could read that?

Richard Wayne

Let me answer your - hi, David. First of all, thank you for your complement and your introductory comment.

The - and I’m aware that you asked the question about the level of non-performers, because we did have a jump this quarter as compared to the linked-quarter and generally. And as Claire alluded to very briefly in her comment, it’s basically it went up because of one purchased loan that was purchased recently.

The borrower decided, thinking that maybe what we said at discount might be cut their costs, not to pay us for a while, that ultimately is not a - never a good strategy. But borrowers and then it’s a nature of the purchased loan business, where occasionally borrowers do that.

And so, it went up for that reason, which we did a - we’re very familiar with that credit, did a big underwriting, and don’t believe we need any reserve against that or, of course, we would have one.

David Minkoff

Okay. So I understand that.

But would you say the $5 million went up, would you say, you got that $5 million discount in the purchase of that loan or not?

Richard Wayne

I’m trying to be responsive for your question, but I’m not sure, I can answer it, I mean, perhaps, I don’t have it exactly. But - so let me try and answer it in this way and maybe you could follow-up with the further question, if it’s not…

David Minkoff

Okay.

Richard Wayne

…clear enough. When we buy a loan, we know, we go through an underwriting process, we buy it at a typically at a discount.

David Minkoff

Right.

Richard Wayne

And way the accounting works for the - for purchased loans, when you buy it, it’s not like an originated loan, you don’t setup any discount against that loan unless the cash flows change. Claire, do you want to?

Claire Bean

Don’t setup any allowance.

Richard Wayne

Allowance, I’m sorry.

Claire Bean

Yes.

Richard Wayne

Again, so that was a loan that and this is true for all the purchased loans, and that’s the loan when we buy it, we believe, we’re carrying it on a net basis at the right value. If it turns out over time, which doesn’t happen a lot, not - without getting overly arrogant, we’re pretty good at it, but sometimes the world changes.

But if over time the credit deteriorated, it would be at that point that we would have a setup reserve for it. With respect to your specific question, now going back to the increase it’s - of the kind of loan I described in the beginning, we bought it.

We paid the price for it. We believe, we’re carrying it at the right value and we don’t need to have any additional reserve for that.

David Minkoff

Okay, I understand that, I do. And second question I had was, I think, originally when you setup the stock buyback, it was for approximately 800,000 shares, you can correct me if I’m wrong.

And I think, you said you already did 700,000 something. So you practically done on the buyback and maybe by now it’s a monthly, and for the next quarter, you may have even completed the buyback, is that correct?

Richard Wayne

Well, the amount of the - I couldn’t comment, of course, on what happened in the - this current quarter. But the buyback 8.70 [ph], Claire, was repurchased and at the end of the quarter we had how many left?

Claire Bean

About $130,000 left.

Richard Wayne

About $130,000 left at the end of the quarter. I would - I assume you and other investors are pleased with that the - we after the last - the quarter ended September 30, the - for whatever reason, we didn’t have an opportunity to buy so much of it but something like 14,000 shares.

So this was a pretty big quarter for the repurchase.

David Minkoff

Right now I’m pleased with it, because a lot of companies announced buybacks and they never really act on it, it’s just a window-dressing type of thing. But you’re showing how compelling you think the stock is, and I agree, it’s at a 20% discount from the book value equity, it is compelling, and I can’t agree with you.

So I applaud you for acting so quickly and buying it back. I guess, my next question would be, are you planning on announcing a further one?

Richard Wayne

And now unfortunately, I have to give you one of those answers that aren’t going to tell you anything, which is our board looks at that and makes decisions on the best use of our capital.

David Minkoff

All right, I’ll look to [indiscernible] that one, that’s okay. That’s fair enough.

Richard Wayne

I gave you the disclaimer. I was going to tell you something that isn’t going to be helpful, but you understand, of course, that’s all I can say.

David Minkoff

I do understand. And okay, we’ll continue watching keep up the good work.

Richard Wayne

Thank you, David.

David Minkoff

Bye now.

Operator

Our next question comes from Alexander Twerdahl with Sandler O’Neill and Partners.

Alexander Twerdahl

Hey, good morning.

Richard Wayne

Good morning, Alex.

Claire Bean

Good morning, Alex.

Alexander Twerdahl

First, I was wondering if you can elaborate a little bit on the SBA division, some of the loans that you’re the, I guess the new business we got into during the quarter. Can you just talk about what volume of loans needed to be originated to make that $445,000 gain on sale?

Richard Wayne

I’m sorry, asked the question again. We - I think, we reported that we originated $2.8 million and we sold $2.6 million and that generated the $4.45 [ph].

Alexander Twerdahl

Okay.

Richard Wayne

Do you have a different - was that a different - do you have a different question?

Alexander Twerdahl

I must have a missed that earlier, that’s what I’m looking for. And you guys keep, so you sell off the 75% as guaranteed by the SBA and you keep 25% generally, I mean…

Richard Wayne

Well, that’s what we did then, I mean, that may or may not be what we do all the time. But the - when you do sell your sell-up of guaranteed piece, so that’s correct, and that’s what we did in the quarter.

Alexander Twerdahl

Okay. And the compensation for the guys that do that business, is that kind of in lock step with the loan sales, or is there a little bit of a lag behind?

Richard Wayne

Claire, do you want to talk about the accounting for the - without putting - kind of talking about what the dollars are obviously on anyone’s comp. The - you want to talk about why we have an expense of one quarter and then when you sell, how it works?

Claire Bean

Sure. When we put the loan on the books, we record sort of the net cost against this carrying value of that loan, and that’s based on - mostly that bad cost is based on what we pair our BDOs.

But when we sell the loan to 75% piece of the loan, with that goes the portion of the costs that relate that. And so that is netted against the gain that we’ve realized.

Alexander Twerdahl

Okay. So the comp and expenses would be netted against the gain, and so be kind of like everything that was done in the last quarter of the year is already accounted for as of the last quarter of the year?

Claire Bean

Yes, but it tracks loan volume. So when you got a start-up business, of course, we got comp in this quarter just closed for seven BDOs, but very little volume, because the pipeline is just building up.

So most of that comp in this quarter fell to the bottom line, but once we were up at full, sort of full speed, a lot of that would be netted against the gain.

Richard Wayne

And if we didn’t sell it, what?

Claire Bean

Or recorded as of - essentially against the carrying value that we carry on the balance sheet.

Alexander Twerdahl

Okay. And so $2.8 million that you did during the quarter is - and I saw a taste of what is possible out there, but you expect that business to get much better over the course of 2015, is that fair?

Richard Wayne

Yes, we do. We mentioned in the last call, but just to remind others that, the BDOs that joined us started on November 2.

And you can imagine when one comes in, and just starts by the time you get this whole process to be able to get the pipeline going. And now we are starting to see a lot more activity from those seven BDOs as they are - they’ve been here now for, kind of three or, three months already.

So I’m going to expect that volume without putting a number on it to be higher on a go-forward basis.

Alexander Twerdahl

Okay. Thank you.

And then I apologies if you’ve addressed this already, I jumped on a little bit late. But in terms of the LASG purchases, you had some really nice volume during the fourth quarter, generally, I think, I recall you saying that the first quarter is may be a little bit, that kind of puts us volume gets more attractive as the year goes on for you guys, maybe is a good way to put it.

So is that, it would be fair to assume that that the first quarter - the march quarter coming up would be a little bit, I mean, all things being equal would be a little lighter than the fourth quarter?

Richard Wayne

Yes, I think, that’s a fair statement. And I would underscore your phrase of things being considered, it’s a transactional business and that get always change, but it’s a general rule what you said is true.

Alexander Twerdahl

Okay. And then just my final question, it’s now been, I think 2.5 years since the LASG business has really been up and running and is again closer to a full tilt, and we are also 2.5 years further out in the financial crisis from what you said this swing up, and you continue to operate quite well underneath your financial constraints the guidelines that are put in place for you to have to abide by.

I mean, do you think it is at any point and I know how you are probably going to answer this question, but I mean, is there any point we think that could be reassessed those guidelines?

Richard Wayne

I would - as you are thinking about this notion [ph], I would not assume, I mean, under the exception anything is possible almost I would not assume that’s a likely result. We have - as I’m sure, we’ve said it’s - we’ve said, we’ve elected to withdraw as a Fed member, which doesn’t mean we don’t have a holding company.

It means our primary regulator is the FDIC, not the federal reserve, those are commitments with the federal reserve. You can imagine the Fed has a lot of things on their plate other than our conditions.

I don’t - I would not hold that out as high probability, I would assume for modeling that we are going to work within the constraints that we have. But let me say a few positive things about that that we’ve realized now that frankly we didn’t realize when we started all of this is, we are making a real effort to build our origination business, both around the SBA, which we think has got significant potential as you can see from the amount of gain that one could recognize, when you book loans and you can sell them.

And also in the community bank in Maine, where we have hired some really good people to originate loans there. And thirdly, we have hired more in Boston in the LASG to originate nationally both - sometimes opportunistically, where we get particularly high rates and sometimes kind of a more traditionally.

And so, the limit of the 40%, I mean, it’s a limit, but we’re now focused on also not only the purchase business, but the origination business. And we believe that’s going to - at some point add franchise value towards being able to have an origination business.

And you didn’t ask this, but it’s just a follow-up. And on the purchase business, we - while the fourth quarter is, as you did mention is typically stronger.

There is a lot of activity out there. There - and so, we are optimistic about that as well.

Alexander Twerdahl

That’s great. Thanks for taking my questions.

Richard Wayne

Thank you, Alex.

Operator

[Operator Instructions] And I’m not showing any further questions at this time. I’d like to turn the conference back over to Rick Wayne for closing remarks.

Richard Wayne

Thank you. And thank you all for listening, for paying attention, and for following us, David and Alex, thank you for your very thoughtful questions.

As you may have noticed from this slide deck, we’ve added a few more slides to provide greater visibility into our company, the SBA most likely next quarter, gross will add some slide - will add a slide or slides about our SBA business, so that we can provide some greater visibility into that business. And, again, we appreciate your support and thank you for dialing in.

And with that now I’ll say goodbye.

Operator

Ladies and gentlemen, that concludes today’s presentation. You may now disconnect and have a wonderful day.

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