NBN - NASDAQ

Welcome to the Northeast Bank First Quarter FY 2025 Earnings Call. My name is Brie, and I will be your operator for today's call. This call is being recorded. With us today from the bank is Rick Wayne, President and Chief Executive Officer; Richard Cohen, Chief Financial Officer; and Pat Dignan, Executive Vice President and Chief Operating Officer. Prior to the call, an investor presentation was uploaded to the bank's website, which we will reference 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. [Operator Instructions]. As a remainder, the conference is being recorded. Please note that this presentation contains forward-looking statements about Northeast Bank. Forward-looking statements are based upon the current expectations of Northeast Bank's management and are subject to risks and uncertainties. Actual results may differ materially from those discussed in the forward-looking statements. Northeast Bank does not undertake any obligation to update any forward-looking statements. I will now turn the call over to Rick Wayne. Mr. Wayne, you may begin.

Thank you. Good morning. As indicated, I am Rick Wayne, the Chief Executive Officer of Northeast Bank. And with me are Pat Dignan, our Chief Operating Officer, and Richard Cohen, our Chief Financial Officer. This morning, I will cover some of the highlights on page three of the slide deck. I also want to focus on some points on our asset quality, which are on slides 8 through 10, and for the first time a more comprehensive discussion on our small balance SBA program, which is a slide on slide number 15. Included in the deck are the usual slides on our loan portfolio, including loan to value and other information. That's in the deck for you to review. Of course, it's updated for the quarter ending September 30th, but we won't cover that today unless someone has some questions. Pat will discuss the loan activity for the quarter and Richard will discuss our funding strategy, interest rate risk management, as well including the funding around the loan purchase we made in the quarter. Now, moving on to slide 3, without getting hyperbolic, I would say this was really one great quarter. Our loan production of $942 million was the second best quarter in the bank's history behind only the quarter in December 2022, when we purchased $1 billion of loans in a transaction that most of you are familiar with. This quarter, we had $733 million of purchased loans and $209 million of originated loans. From an earnings perspective, again, another really great quarter, we generated $17.1 million of net income. And except for the quarters in which we had PPP loans that we sold, and those were in Q3 and Q4 of our fiscal year 2021, this quarter was the highest level of net income in the bank's history. So broke a few records. A few other items I'd like to point out on the highlight page. We still have $23 million of availability under the at-the-market offering. Our loan capacity as of September 30th was $462 million. That's after the very large loan activity we had in the quarter. Earnings per share diluted were $2.11. Return on equity was 17.53%. Our return on assets was 2.09%. And tangible book value per share was $47.80. If we now turn to the slides on page 8, first of all, I want to point out that well we had an increase in our allowance of $27 million, which went from 0.97% of loans to 1.25% of loans. So we have a lot more coverage now in our allowance. And while non-performing loans increased by $9 million, it's a few number of loans and we estimate at least $7 million will be resolved in the next six months. So that is obviously good. And I do want to highlight in the bottom chart what happened with the charge-offs, which this quarter were 20 basis points. I'm not really focusing on the light green above that for this quarter or last quarter, because as you may recall from previous conversations, those are just balance sheet items. Those representing the green purchase loans where we had a credit mark. And that under a CECL, you're now required to increase the balance of the loan, set up the allowance, and this is the green mark was just simply charging off part of the balance which we did not pay for. But the blue bar below at 20 basis, that's a real number. And I want to point out of what that was because we don't have that many charge-offs. It was one loan out of a pool that we purchased, 194 loans. The total purchase was – had a UPB of $85 million with $4 million of discount. And of all of those $194 loans, of which only 159 remain because there've been some payoffs, only two loans are non-performing out of that total $85 million or 194 loans, including this one. So the whole pool did really well. And this is one loan that we had a charge of on. If we now go to slide 15. I first want to provide some context to this discussion on our small balance SBA loan activity. In August of 2021, we entered into a loan service provider agreement and a marketing agreement with NEWITY to serve as our loan service provider for 7(a) loans, small balance or not, now we're focused simply on small balance. And the reason we started with them, you may recall also that they were our small P partner in PPP lending in which we originated $3 billion and purchased an additional $8 billion from other banks in a transaction that generated significant income for the bank. And based on that, we thought there would be an opportunity to go market to those borrowers, small balance PPP – small balance 7(a) loans, I'm sorry. And when I say small balance, a lot of what we do is under $150,000 or even under $25,000. We do some that are higher than that, but not that many. And I was very cautious when I discussed this, not to over-promise, because we really did not know at all if there would be demand for this product, whether or not we could get the technology working, what our marketing spend would be and whether it would be a good business line. We're very interested in it working as a way to generate fee income uncorrelated to interest income, but we really didn't know. Well, it took a while to get there. When we started this in fiscal 2022, I mentioned it was August 21 that it started and we're June 30 year end, we did 48 loans total for $6.5 million. And in the following year FY 2023, we did 256 loans for $16 million. And for our last fiscal year 2024, we were starting to get some traction. That's for the whole year. We did 1,039 loans for $92.5 million. And now, and the reason, I'm really excited about it now for the quarter that just ended September 30, we did 766 loans for $82.4 million. And I do want to make sure we're giving appropriate credit, not only to our own team at Northeast Bank, but also to NEWITY as our loan service provider. And so, that has already picked up. We also extended our agreement with NEWITY, which previously was going to expire in August of 2026. It was a five-year contract subject to a lot of technical things that are – we have filed a 8-K where we have posted the two agreements that I'm discussing. But generally speaking, it's another five year contract with an automatic renewal for another five years, unless one party opts out. So we now have the basis of, we believe, a very solid business line platform to generate significant small balance SBA loans, as well as fee income on the portion of the guaranteed loans and the part that is unguaranteed, which for the last year or so has been only about 18% based on the mix of loans, those loans yield prime plus 275. So this is an exciting business and we will now continue to provide information on our SBA business each quarter. And with that, Pat?

This is a big quarter for us. We purchased 191 loans in seven transactions with gross balances of $808 million at a purchase price of $733 million or $0.91. These were mostly bank-originated term loans sold for a variety of reasons, but mainly liquidity. The loans are secured mostly with retail, industrial, and mixed-use collateral, and located primarily in New York, New Jersey, and California. The weighted average loan to value on these loans was around 55% at our purchase price, with no loans above 65%. Generally, these loans were purchased at credit and yield levels consistent with what you've seen from us previously. Looking forward, we think they'll continue to be purchase opportunities for us. M&A activity appears to be picking up, and historically that's been our biggest source of loan purchasing opportunity. In our real estate origination business, we closed $127 million for the quarter, a level we believe to be core. These included 17 loans, with an average balance of $7.5 million. Lateral types include multifamily, hospitality, retail, and industrial and generally located in New York, California, and Florida. At origination, the weighted average LTV for these loans was just over 50%, and average rates were just under 9%. Interestingly, about 40% of these loans were direct and 60% lender finance, which is a return to a more historically normal mix between these two loan products. Recall that in the last fiscal year, over 90% of our loan originations were lender finance. We think we became more competitive in the direct lending space as the year went on, because an increase in real estate transactions led to a more confidence around valuation. Others are sharing that confidence. While many banks remain on the sidelines with respect to commercial real estate lending, there's a lot of new capital in the non-bank lender space, and we're starting to see some very aggressive lending as they chase yield. Fortunately, there remains plenty of opportunity in our lending niche. And based on our current pipeline, we're optimistic we can maintain the current level of originations with loans that meet both our credit and yield requirements. Now I'll turn it over to Richard.

Thanks very much, Pat. So I want to just quickly recap what we discussed in the previous earnings call where we spoke about interest rate risk and what might happen to us and how we're positioned in a rates-down environment. I'm going to speak to you quickly as well about prepayments and to remind you of the position the bank is in from a prepayment perspective. I'll speak about how we funded the purchases that Pat just spoke about. I'll speak about our general approach to interest rate risk management, and then I'll speak about what happened in practice once rates fell. A recap on the Q4 investor call. I said at that stage that we would benefit from interest rates falling. And the reasons for those that I gave was because of the floors we have in place over our variable rate loans, the tendency of loans to prepay in a rates down environment, which I'll expand on in a short while, and the repricing of our liabilities, which to some extent is a lag factor. What I also said on that call is that we do not position ourselves for excessive exposure to changes in interest rates in either direction. Our analysis at that stage had said to us that with rates down, we would expect to initially have a compression of our net interest income, thereafter followed by an expansion, resulting on a net basis in a slightly positive effect over the year and in fact the subsequent two years in a rates down environment. One of the reasons that I've just spoken about is prepayment, and I'll speak quickly about that and then I'll tell you what in fact has happened. As you'll see if you look at slide number 22 is we have a $223.5 million rate mark discount. To remind you what that represents, the rate mark is the rate at which we have received a discount off the face value when we purchase the loans. And the reason we receive that is not for credit reasons. It's because the loan was originated at what is now a below market rate, and we purchased the loan such as to produce the return that we are targeting. That $223.5 million will enter our income statement in two different ways. The first way is as an accretion. In other words, with the passage of time, we bleed that discount into our interest income and we earn it over the period of the loan. On the assumption that these loans do not default, these loans would either accrete, or in the event that they prepay, we would take that discount in respect to the loan upfront. The reason why I'm focusing on that is that discount would be a benefit to us in a rates down environment because, everything else equal we expect when rates fall, prepayments increase. In our current approach, the way that we approach interest rate risk is as follows. We have a system in place which forecasts our balance sheet into the future, and it takes into account a number of different scenarios, both rates up and rates down by different amounts, and it also considers both a shock as well as a ramp. A shock being a sudden and significant change in rates and a ramp being a slow progression of rates either rising or falling. That system that we use and run scenarios through had told us that a rates down environment would be favorable to us, but only marginally, which is exactly what we want. If the results said that we would be significantly favorably affected by rates down, that implies we've taken an interest rate position, which we do not do. Our objective in funding is to make sure that we match the best of our ability, the asset side of the book, to make sure that when rates change, there's a commensurate change in the cost of funding. And it's also to ensure liquidity is managed. In other words, for the maturity of the liabilities to match as closely as possible, the maturity or the repricing of the assets. Turning to the purchases that Pat spoke about, that's exactly what we did. We looked at the repricing profile of the book that was purchased, and we matched that profile with brokered CDs and had a laddered approach taking out broken CDs with different maturities to approximately match that of the book. What is interesting for us is to then, in light of the fact that rates fell 50 basis points on the 18th of September, we ran an analysis to see what actually happened to our income and interest expense over that period of time and what that might imply for the remainder of the year. Recall, as I said a short while ago, we expected that initially negative impacts and for that to reverse over the subsequent three quarters. What in fact happened was a pleasant surprise, is that given the rate at which we were able to reprice our liabilities which was better than we had modeled, the net effect in the first 18 days plus the subsequent – the next 12 days plus the subsequent 18 was the quicker repricing of the liabilities. The net effect on net interest income just for that month was relatively flat. So I reiterate what I'd said in the previous earnings call that given the way that we are positioned, we would expect that NII would be positively affected by a rate down environment, but not significantly so due to our approach to interest rate risk. We are attempting wherever possible to be as neutral as possible and not to take a position wherever we can avoid it. I'll turn back to Rick.

Thank you, Richard. And I will turn it back to our listeners to see if there are any questions about what we have covered or otherwise.

[Operator Instructions]. Our first question comes from Mark Fitzgibbon of Piper Sandler, is on the line with a question.

First question I had, Richard, could you just follow up on the margin discussion a little bit? I heard your comments and they were helpful. Would you be able to share with us what the margin looked like for the month of October? Since we're, well, thus far for the month of October?

No, we don't have that information available for October yet.

But it sounds like on balance you expect the net interest margin to be down a little bit in the fourth quarter and then start to sort of flatten out. Is that a fair characterization?

Well, with respect to the large purchase, Pat had indicated that we would expect that to behave as like other purchases in the past. If we go back and look at other purchases, yield on our purchase loan book, in recent vintage, it's been between 8.5% and 9%, roughly. We would expect that to be the case with our loans that we purchased. We don't have a number out for the funding costs, but actually you could easily figure it out. It was about 420, 425 to fund those purchases. So I'm describing now a spread on that between probably 3.5% and 4%, I think is a reasonable number for the spread we would expect to earn on the large purchase volume. On our originated loans that we put on the balance sheet, our originated loan portfolio for – it is on page 3. It's almost 9%, 8.85% on what we originated. And you can do this same analysis with respect to the cost of funds on that.

Can I add one more thing there quickly, Mark? Turn to slide 16, that may also give you some insight in terms of your question. So slide 16 talks about the impact of the cost of funds for the first quarter being 4.34% and dropping to 4.18%, which is a point estimate at the end of the month. Remembering that 16 basis point drop does not reflect all the other liabilities that will be priced. So merely in those 12 days, there was a 16 basis point reduction in our cost of funding. As I said, that would take some time to come through with some lags and would not reflect the impact of brokered CDs as those roll and reprice.

Changing gears a little bit on the loan front, I guess I was curious, are you seeing a lot more loan pools today than you have in the past? Has the volume of that picked up? And in that same vein, I was curious if it's likely we'll see another big loan pool purchase, say, in the next couple quarters or do you think it's more likely that you'll sort of digest what you just put on?

Well, the volume of loans for purchase is quite typical. There've been periods going up, we've been at this for a long time. There are periods when there's a lot of activity and there's periods where there has not been. We're seeing a lot of activity in the market, but that's not to say we're necessarily going to have a lot more in our balance sheet. We're optimistic, but it's binary, as you know. You bid, you win, you don't win. But it's been pretty busy for quite a while. As to whether or not we could expect another very large purchase, very hard to say. There are certainly large pools out there. But whether we bid on them, whether we win on them, I don't want to provide a false hope we'll see. Certainly looking at a lot.

I would just add that the loan sale advisors that we speak with frequently are all slammed. They're very busy. Again, that doesn't necessarily mean it will translate to actual opportunities because there's a lot of tire kicking in this business. But they're as busy as they've ever been. And I'd say one thing that is new and interesting is the number of single loan. There seems to be a growing number of banks/non-banks selling single loans, which we haven't seen in a while, has been pooled for quite a while. This is interesting, in that it's a different kind of opportunity where we think we can be competitive on the size. So whether or not there's more whales out there, we hope so, but you never know.

In that same vein, I guess I'm curious what your thoughts are on adding to the ATM or doing sort of a spot capital raise to take advantage of some of these loan purchase opportunities and what you might be targeting for capital ratio.

That is a very good question. We have $23 million remaining in the existing ATM. It's a facility we like very much. I know you know this, Mark. But for other listeners, it has the benefit for us of being able to raise capital when we need it and not raising a lot of capital for working capital purposes and then not being able to use it. In 2012, we raised $55 million in a transaction that we thought there'd be a lot of loan purchasing opportunities and there were not. Kind of the good side, we wound up over time buying back a third of our bank stock at about 16 bucks as it turned out. And I digress, as they say. But with respect to the ATM we have now, that's why we put out the information. What is our loan capacity? And as we need the capital, we will sell stock out of the ATM to do it. And of course, where our stock is now trading, it's much more attractive to sell stock than when we were trading below tangible book. Now our tangible book is about 48 bucks and we're trading in the 90s now. As to whether we will do another one, to answer your question, the board will evaluate that and make a decision as to how much, although it's not – it's a relatively inexpensive way to raise capital. So there's no guarantee, but not be surprised if we wind up adding to the ATM and allowing ourselves more flexibility going into the future. I think it's a good sign for investors that we have confidence in the business when we're increasing the ATM.

One of the optics or metrics that stands out for you guys relative to a lot of other banks is that CRE concentration. And I think it was over 600%. And many banks are telling their investors that they're pushing down toward that 300% guidance that the regulators had given a while back. And I know you all feel differently about where you ought to sit on that. I wondered if you could just at a high level share with us a couple thoughts on why you think your company is different and justifies being able to have a much higher level than other banks.

Well, first of all, the only kind of lending we do is commercial real estate and, of course, the small balance SBA lending, which is – our balance sheet is 97%, I'm rounding here, commercial real estate. We've been doing this for quite a while. We're having a lot of controls in place. We have an excellent, experienced team. I'll remind listeners that Pat and I were doing this at Capital Crossing Bank, which was a bank my former partner and I started 30 years ago. We have a bunch of folks in the national lending business that came from Capital Crossing Bank and a bunch more that have joined us. We have an incredible record around asset quality. The charge-offs, really, really small. I think, overall, on a weighted average basis, the charge-offs on our purchase loan book have been 5 or 6 basis points with returns that have been, call it, 975 or so. And on the originated side, charge-offs have been really, really small. I'm probably over $4 billion of originations. Some of the things that we focus on, not only risk management, risk control, and all the things that one would expect, we have very low LTVs. In the low 50s overall on our loan book, and that gives us a lot of protection. We structure loans. If it's an originated loan into bankruptcy remote entities with the highest default rate permitted under state law, typically with advances in our lender finance that are cross collateralized, cross defaulted, often even with the LTV set up with interest reserves and, with – on our part, because – on the loan on loan, for example, so we have very good counterparts. And we've been successful at it for a very long time. And we have in place a protocol for how many real estate loans we could have in buckets relating to the risk rating. So that, for example, in the highest risk rating, what we would call one through three. we could have 850% of capital in those, but in the substandard loans, kind of rated eight and above, it's 30% in that bucket. And so, there's a relationship between how much we will have on our balance sheet and the quality of our loans, all structured to cause a level of very high quality commercial real estate loans. I could go on much longer on all the things that make us great, but I think that's a great answer. I'm bragging about the team, not me, but we have a great team.

I think that's a great answer. Sorry, just got two more quick ones. Are there any plans to grow sort of the core deposits with either new branches, products or anything to try to bring down that broker deposit number over time?

Yes, but growing deposit is kind of brick by brick. In some respects – well, this is a transaction. I'd say in Maine now, we have seven branches, and we have now $900 million of deposits in those branches, which for us is the highest number in quite some time. On top of that, we have government deposits in Maine for another $400 million. That's about $1.3 billion I've just described. And then of course, as you point out, we have a lot of broker deposits, which we actually like quite a bit. It was very efficient. We ordered up the money for that loan pool in a couple of weeks and brought in $750 million of deposits at good pricing. And with respect to growing it in a massive way in a transaction, of course, we see them from time to time and we're open to the idea, but so far, it's just that they have not been attractive in terms of the economics.

Just a couple of little modeling things. I assume professional expenses were a little bit elevated due to the loan purchases and we should see those start to come back down. Is that fair?

No, I don't think it was that. Becca Jones is – Becca Rand, just got married. Becca, do you want to answer that question?

Just general legal expenses, audit expenses as we grow, those just continue to increase slightly.

Lastly, the effective tax rate, you feel like that probably stays in that 32-ish percent range going forward?

Yes.

No, I was just going to say, we do think so.

Our next caller comes from David Minkoff of DCM Asset Management.

Congratulations on another nice quarter. Actually, the quarter was even nicer than it appeared because, as you pointed out, those loans were purchased at the high level were done late in the quarter and really didn't work its way into the quarterly numbers yet. And we'll see that in the ensuing quarters. So, the report was even better than it looks. The $805 million loan purchase, which was kind of outstanding, what would the normal loan purchases have been in the last couple of quarters? I don't have those numbers in front of me. How were they running?

We do have it. It's a slide on that which we could go over. Let's see. What page is that on?

Well, I'm not on the slide. I'm on the phone call in, so I don't have access to the slides at that moment.

No, I know. That was actually a question for ourselves to find it. On page 6, well, this is not just the – this is the total. Oh, we have both here. On the purchase side, this was significantly larger than the last four quarters. If we go back a year ago, we purchased $52 million. The following quarter was $186 million. The following quarter was zero. The following one, which was June 30th, was $143 million. And then this, of course, was $732 million.

So that's an incredible increase. Now, I'm assuming that those numbers and those purchases was done at the same stringency that you've used in the past. You haven't lowered your standards to get those numbers up to that number, correct?

Correct.

You may look at – to get $732 million in purchase loans, what do you look at, $7 billion perhaps or something to come up with that number?

No, it wasn't that because the $732 million, a big chunk of that was in one transaction, so we were pretty busy with that one transaction. So it wasn't $7 billion.

So it's somewhat of an aberration then because of that one large transaction, is that right?

Well, I have in front of me what our market funnel looks like. So for the quarter, we looked at total 20 pools for $2.7 billion. And then out of those – that means those are transactions that we came across. We took a more in-depth look on $2 billion, which means that was 11 pools that we looked at and we did a fair amount of work on those. And of those, we wound up bidding on $839 million. And we wound up closing on $807 million, which is a very high rate. It's not typically that high, the rate, but a lot of those were negotiated transactions. And so, the likelihood of closing was higher.

Understood. So it's a good number, and it should translate into better earnings, I guess, going forward. You first announced this. You pre-announced this, I guess you might say, on September 24th, when you came out and said you purchased $805 million, I think the number was. $805 million, right, that was the number. And the next day, on the 25th, Piper Sandler came out and increased your target price from $82 to $95 a share. So, that was a pretty happy increase. What was the earnings estimate that they have for the ensuing year, for the year ending June 2025 that gave them that $95 price target. I didn't see the report in depth.

Oh, for the fiscal year we're in now?

The fiscal year that just began. Yeah, that ends next in June 2025.

It's in the range of $10.

$10, okay.

I don't have it exactly in front of me, David, but give or take a little bit. It's in that range.

And as you mentioned, we did $211 million this quarter, and that does not include the spread on all of the loans that we've booked late in September. So, as you said, that's going to – you'll see that in the ensuing quarters.

Right. So, in other words – hypothetically, you might say that had you increase [Technical Difficulty] July 1st, the earnings for the quarter might have been in the $2.50 range or something like that, $2.60. And I would stand to reason when Piper has an estimate of $10 a share. So I think that's – okay, we'll see that as things go forward. You don't usually give projections, so I'm not going to ask you to comment on that. So, again, congratulations on a great quarter, and we're looking forward for this to continue.

David, before you go, I would say you were a legend for your comments on the last call.

Congratulations. It's been a great quarter and I'm glad to be a legend.

Our next caller is Adam Wilkie of Pacific Ridge Capital.

I think I was one of those folks that mentioned David's comments. Yeah, great job, guys. Happy to see the loan purchase. I was going to ask actually about the 7(a) business. How big would you like to grow that on your balance sheet? I know it's pretty small right now. And what should we expect the charge-off rate to be on the total originated loan balance on average through the cycle and then maybe at the peak?

Just to remind everyone else, you probably know that. So the guaranteed portion has been roughly – unguaranteed portion has been roughly 18%. And the reason for that is loans under $150,000 have an 85% guarantee. And over $150,000 is a 75% guarantee. We're doing a lot of small ones. And so, we have 18% on our – we wound up putting on our balance sheet. From the business perspective, it's very profitable because you can sell off the guaranteed portion for premiums now between 10.5% and 11%. Roughly, we think that – and so, therefore, I think we'll keep running with this on our balance sheet. Our balance sheet is getting much bigger, and it's not a lot that we're putting on. I think the real question as to that is how comfortable are we with the credit quality around these. And to answer part of your question, there's a lot of data from the SBA about charge-offs for these kinds of loans. And we think that – if you look at historically over a lot of information in this category, it would be about 3% on the unguaranteed portion. But so far, probably we may have a tighter credit box than those averages that we've been using. But everything we've booked, we've had something like $150,000 of charge-offs on a couple hundred million of originations. That's $100,000, not much, much less than 3%, but we now have a 3% reserve against our SBA loans. We increased it by about a million dollars or so this quarter, so now our unguaranteed SBA portfolio is a little bit less than $50 million. And we have 3% of that in the allowance, which we believe will be – is the appropriate coverage. As to your question, what are the peaks and the – it's knowable. I don't know that offhand, though.

All right, that's fine. And so, if I understand correctly, on the purchase business, a lot of potential opportunities right now. You could – you might do something, you might not. And if you do, the ATM is there to fund it and you would probably – sorry, the ATM is there for the capital, if necessary. And then, you would do probably again some sort of laddered activity to help fund it if those possibilities come through. Is that fair to say?

Yes. Well said.

That's all I have and keep up the great work.

Thank you. We have no further questions at this time. Now I will turn the call over to Rick Wayne for closing remarks.

Thank you. Thank you all for listening and those that asked questions – for your questions. It'd be interesting when we have our next call to see how some of these things play out that we've discussed today. If you have any suggestions on ways we can provide more relevant information on our slides and the information we provide, let us know. If we can do it, we will. And with that, I thank you and we will sign off now.