Rick Wayne – President and Chief Executive Officer Jean-Pierre Lapointe – Chief Financial Officer.

Alex Twerdahl – Sandler O'Neill.

Good day, everyone, and welcome to the Northeast Bancorp Fiscal Year 2018 Third 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 Jean-Pierre Lapointe, Chief Financial Officer.

Earlier this morning, an investor presentation was uploaded to the company's website, which we'll 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 the 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 that this presentation contains forward-looking statements about Northeast Bancorp.

Forward-looking statements are based upon the current expectations of Northeast Bancorp's management and are subject to risks and uncertainties. Actual results may differ materially from those discussed in the forward-looking statements. Northeast Bancorp does not undertake any obligation to update any forward-looking statements.

At this time, I'd like to turn the call over to Rick Wayne. Please go ahead, sir..

Good morning, and thank you all for joining us today. With me is JP Lapointe, our Chief Financial Officer. After the close of the market yesterday, for the third fiscal quarter of fiscal 2018, we announced net income of $3.9 million or $0.43 per diluted common share, a return of equity of 12.2% and a return of – on assets of 1.4%.

As it'll be discussed in more detail during this call, we had strong growth in our higher yielding LASG portfolio, higher volume in SBA originations, a decline in the delinquent and nonperforming loans and continued disciplined expense management. Turning to Slide 3.

For the quarter, we generated $128.1 million of loans, which included $72.9 million of LASG originated loans and $33 million of LASG purchased loans. Originated LASG loans increased by $35.1 million or 10.1% over the linked quarter.

LASG purchased loans increased by $10.5 million or 4.3% over the linked quarter, for a combined increase in LASG loans of $45.6 million or 7.7% over the linked quarter. The $72.9 million of originated loans had a weighted average yield of 7.58% as of March 31.

Additionally, we generated $8.9 million of loans in our SBA division compared to $4.5 million of SBA originations in the linked quarter. Of note, $8 million of the $8.9 million of SBA originations were loans secured by hotels reflecting a promising start to the build out of our SBA hotel vertical.

We generated a net gain of $560,000 on the sale of $5.8 million of SBA loans. Net interest margin for the third fiscal quarter was 4.9% and our purchased loan return for the quarter was 12.2%, which included $2.6 million of transactional income. Turning to Slide 4.

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 increased to $122.8 million as of March 31, as a result of the growth in the LASG originated portfolio in the quarter.

Loan purchasing capacity increases or decreases depending upon the relative amount of purchased and originated loans on our balance sheet at any given point in time. Now on Slide 5. Under another regulatory commitment, non-owner occupied commercial real estate loans are limited to 300% of total capital.

As of March 31, capacity under this condition was $185.6 million. Moving on to Slide 6. Of the $105.9 million invested by LASG for the quarter, $33 million were purchased loans and $72 million were originated loans. Purchased loans for the quarter have unpaid principal balances of $38.5 million, representing a purchase price of 85.8%.

As frequently mentioned in these investor calls, loan purchasing is transactional and can vary sometimes significantly from quarter-to-quarter. Since 2010, LASG has invested in aggregate of $1.4 billion consisting of approximately $670 million of purchased loans and approximately $740 million of originated loans.

During the past quarter, we reviewed loans with approximately $186.5 million of unpaid principal balances and bid on loans with approximately $45 million of unpaid principal balances. Moving on to Slide 7. At the end of the quarter, the discount on purchased loans was $35.2 million as compared $32.2 million as of December 31.

The change is primarily due to $33 million of purchases, with a related $5.5 million of discount, offset by purchased loan payoffs and pay downs in the quarter. Purchased loan payoffs generated $2.6 million of transactional income, which includes $516,000 on the sale of 2 LASG purchased loans.

Approximately, 85% of the $35.2 million of discount is expected to be realized over the remaining life of the purchased loans through scheduled accretion. The non-accretable portion of the discount represents contractual cash flows that, in our estimation, may not be collectable. Turning to Slide 8. We provide detail on returns from the LASG portfolio.

For the quarter, the purchased portfolio generated a total return of 12.2%, reflecting transactional income of $2.6 million from unscheduled loan payoffs and sales, which was in line with the average of $2.6 million in the prior 4 quarters.

As we have discussed in the past, transactional income realized on the purchased portfolio as well as the amount of loans purchased may not be consistent from quarter-to-quarter. The LASG-originated portfolio generated a return of 6.8% in the quarter. Turning to Slide 9. We provide statistics on the LASG loan portfolio as of March 31.

Of significance, as noted in the chart on the top right, the purchased loan portfolio has a net investment basis of 88% consistent with the linked quarter. On an invested basis, the average loan size is approximately $711,000, an 84% of the portfolio consisted of loans with an investment size less than $6 million.

The loan portfolio has a diverse collateral type, primarily focused on retail and mixed use, industrial hospitality, multifamily and office. By geography, the largest concentrations are in New York and California, with 19% and 18% of the portfolio, respectively. Our collateral is geographically diverse, with collateral in 42 states.

Turning to Slide 10. One of the benefits of the SBA program is the ability to sell a guaranteed portion of a loan, and often at a substantial premium. For a variety of reasons, SBA loans closed in one quarter are sometimes sold in a subsequent quarter. In the current quarter, we closed $8.9 million of loans of which $8.8 million were funded.

Additionally, the company sold $5.8 million of the guaranteed portion of loans in the secondary market of which $4.1 million were originated in the current quarter and $1.7 were originated or purchased in prior quarters. For the quarter ending March 31, the net gain on sale, including the capitalized servicing asset, was $560,000.

On Slide 11, we showed details of the SBA sale pipeline as it stands at March 31. The bank holds $1.9 million in SBA loans held for sale, which represents the guaranteed portion of SBA loans, which have closed and are fully funded as of quarter-end.

Next you will note an additional $3 million in the guaranteed portion of SBA loans that have closed as of March 31, but were not fully funded as of that date. The $3 million consists of 5 loans, with an average guarantee balance of approximately $600,000. These 5 loans have a combined balance of approximately $200,000 that is yet to be disbursed.

In total, this represents an additional $4.9 million in future SBA guarantee loan sales before considering any loan production in our fourth and final quarter of fiscal year 2018. And now I would like to turn it over to JP, who will discuss in more detail our financial results, after which we will be happy to answer your questions.

JP?.

Thanks, Rick, and good morning, everyone. I'm picking up on Slide 12 to provide more information on our financial results. Net income for the quarter was $3.9 million or $0.43 per diluted common share.

Diluted earnings were up $0.07 from the quarter ended December 31, 2017, which I shall refer to as the linked quarter, and up $0.04 from the quarter ended March 31, 2017, which I shall refer to as a comparable prior year quarter.

The increase from the linked quarter is due to higher purchased loan transactional income, which amounted to $2.6 million in the current quarter compared to $1.9 million in the linked quarter and $2.3 million in the comparable prior year quarter.

Additionally, the gain on the sale of SBA loans into the secondary market increased to $560,000 in the current quarter compared to $341,000 in the linked quarter and decreased from $951,000 in the comparable prior year quarter.

We also experienced an increase in interest expense of $546,000 compared to the linked quarter and $848,000 compared to the comparable prior year quarter. Additionally, earnings were impacted by the new tax law signed into effect on December 22, 2017, which reduced our blended federal corporate income tax rate to 28% for fiscal 2018.

As our effective tax rate for the current quarter was 30.7% compared to 29.5% in the linked quarter and 37.5% in the comparable prior year quarter. Turning to Slide 13. Over the past year, we have seen net loan portfolio growth of $75 million.

The majority of the growth over the last 12 months comes from our LASG portfolio, with $342 million of purchases and originations. As shown in the chart, in the trailing 12 months period, we have closed $40 million of SBA loans and sold $37 million of the guaranteed portion of these loans into the secondary market.

While bank-wide loan production has been strong over the trailing 12 months, increases have been significantly offset by pay downs and amortization in the LASG purchased and originated portfolios, which amounted to $273 million over the trailing 12 months.

These results are further detailed on Slide 14, which shows the composition of the loan portfolio over the most recent 5 quarters. The net loan growth over this time is primarily driven by the strength of LASG originations, which had net growth of $83 million or 28% since March 31, 2017.

In the current quarter, LASG originated $72.9 million of loans and purchased loans with a recorded investment amounting to $33 million. Turning to Slide 15. In order to fund loan growth, we have had net deposit growth of approximately $127 million or 15% over the trailing 12 months period.

Over the past year, all of the growth is within our money market product. The growth in these products has strengthened our overall deposit mix, where nonmaturity accounts, which include money market, savings and demand deposit products, represents 68% of total deposits as of March 31, 2018, as compared to 62% of total deposits at March 31, 2017.

Compared to the linked quarter deposits are also up $127 million or 15%. Slide 16, shows trends in the main components of our income.

Compared to the linked quarter, base net interest income increased $478,000 due to higher average balances in the LASG portfolio along with higher rates earned on our loans, as the majority of our LASG portfolio is tied to the prime interest rate.

Additionally, transactional interest income from the purchased loan portfolio increased by $199,000 compared to the linked quarter. The purchased portfolio had a yield of 11.29% in the current quarter compared to 11% in the linked quarter.

The increase in net interest income before loan loss provision from the comparable prior year quarter is largely attributable to an increase in base net interest income of $843,000 due to higher average balances in the LASG portfolio and higher rates earned on the loans in this portfolio, partially offset by lower transactional interest income from the purchased portfolio.

The 11.29% yield in the purchased portfolio is down from 11.89% in the comparable prior year quarter due to higher transactional interest income amount in the comparable prior year quarter. The lower purchased loan yield was more than offset by the higher average originated balances in the current quarter from the comparable prior year quarter.

Noninterest income increased by $654,000 over the linked quarter, primarily due to the $516,000 gain on the sale of other loans in the current quarter and the $219,000 increase in gain on the sale of SBA loans.

Noninterest income is down $426,000 from the comparable prior year quarter, primarily due to the $391,000 decrease in gains on the sale of SBA loans due to fewer SBA loan sales in the current quarter. These results are further detailed on Slide 17, which shows trends in total revenue and noninterest expense over the past 5 quarters.

Compared to the linked quarter, total revenue has increased by $1.3 million, while noninterest expenses has increased by $412,000.

The increase in revenue is primarily due to an increase in base net interest income due to a higher average balance in the LASG originated loans, along with increased purchased loan transactional interest income, an increase from the gains on sale of other loans and an increase in gains from the sale of SBA loans.

The increase in noninterest expense compared to the linked quarter is primarily due to an increase in other noninterest expense due to impairment charges incurred on the SBA servicing asset portfolio as compared to a recovery recorded on this portfolio during the linked quarter.

Additionally, there was an increase in salaries and benefits expense due to an increase in payroll taxes and an increase in marketing expenses due to increased costs associated with marketing efforts.

Compared to the prior year – compared to the comparable prior year quarter, total revenue has increased by $249,000, while noninterest expense has increased by $133,000.

The increase in revenues primarily due to an increase in net interest income of $675,000, partially offset by a decrease in the gain on sales of SBA loans of $391,000 from the comparable prior year quarter. The impact of the increase in revenue in the current quarter was reduced by higher noninterest expense.

The revenue has helped us achieve an annualized return on equity of 12.2% and a return on assets of 1.4% and an efficiency ratio of 59.8% in the current quarter. Slide 18 shows originations and the associated gains in the residential portfolio over the past 5 quarters. These gains continue to be a positive contribution to noninterest income.

We sell substantially all residential loan production into the secondary market. Slide 19 provides additional information on trends in yield, average balances and our net interest margin, which was 4.94% in the current quarter as compared to 4.93% in the linked quarter and 5.11% in the comparable prior year quarter.

As previously discussed, the net interest margin, which was consistent with the linked quarter, is largely driven by an increase in base net interest income, offset by lower transactional interest income amount from the purchased portfolio and higher funding costs.

Additionally, the average balance of loans for the current quarter was $783 million, as we originated and purchased a large amount of loans near the end of the quarter.

So looking forward, we are starting the fourth quarter of fiscal 2018 with the beginning balance of the $816 million, which should result in a higher average balance for the fourth quarter. Slide 20 provides a snapshot of our asset quality metrics. Compared to the linked quarter, nonperforming loans to total loans has increased to 1.67% from 2.34%.

And nonperforming assets to total assets has decreased to 1.25% from 1.84%. These metrics have also decreased compared to the June 30, 2017. In the top right-hand corner, classified commercial loans were $10.5 million as of March 31, 2018, which decreased from $13 million in the linked quarter.

Finally, as noted in the chart on the bottom right-hand corner of the slide, annualized net charge-offs to average loan balances have remained at very low levels over the past several years and there were three basis points in the current quarter down from four basis points in the linked quarter.

Overall, our allowance coverage has continued to increase and appears appropriate to address the risk in our loan portfolio. That concludes our prepared remarks. At this time, we would like to open up the call to Q&A..

[Operator Instructions] And our first question comes from the line of Alex Twerdahl from Sandler O'Neill. Your line is open..

Hey, good morning, guys..

Good morning..

Good morning..

First off, just wanted to ask a little bit more about the originated LASG loan book had another very active quarter, this quarter, that's getting to be a larger percentage of your overall loan portfolio.

Are there any limitations, either in terms of capital restrictions or as a percentage of the overall portfolio from where you stand, as to how big that piece of the pie can be?.

The general answer – this is Alex, not Jeff, I just want to make sure, correct, Alex?.

Yes, no, this is Alex, for sure this time..

No, there is not really any limits on that. Generally speaking, and I'll narrow it down a little bit where there might be. We have overall leverage limits, of course. So like any bank related to our level of capital, there are limits on how big the banking can get.

But with respect to that category of loans, they are really – they are kind of in two categories, one is our portfolio finance business, which – those are C&I loans, not commercial real estate loans. And so therefore, not subject to the 300% commercial real estate limit. Other than that, I don't want to get too granular.

Well, I'm happy to but may put people to sleep. Other than to the extent that they're – they get reclassed on the call report as substantively commercial real estate loans. But the general answer is, not with respect to those.

To the extent that in the origination business, we're doing direct bridge lending, secured by investor commercial real estate that's subject to the 300% limit.

But to kind of give the practical answer based on our capacity and the breakdown between those kinds of loans, I don't see the conditions that we operate under practically limiting us in that business line..

Okay.

And then, can you just remind me, if I'm not mistaken the portfolio finance piece is at least is a prime-based product, is that right? Can just remind us, kind of, in that piece as well as the overall portfolio kind of what percentage of loans are prime or LIBOR-based that are floating with rising rates and which pieces are not?.

I can. Indeed, you are correct that it is primarily a prime-based product. In our investors slide on Page 3, we indicate that in the quarter on the originated loans for this quarter, they were a little bit around here, we originated $73 million. And of that number, 96% of them were prime-based. Well, I think there was one loan that was fixed.

It was kind of a one – maybe an 18-month or a two-year loan at 10%, other than that it's all floating. And we indicated March 31, the rate on those originations was 7.58%. And today, of course, it's 25 basis points higher. And so we love that product because it's floating rate – it's – the loans are typically prime plus 2.5% or so, in that range.

And when it's in the case of – particularly in the case of portfolio finance, the relationship between our loan – of course, our collateral is assignment of a note mortgage from our borrower, whose is another lender.

But if you go one level deeper than that to the underlying real estate, if you look at our loan to the underlying real estate, it's in the low 50s. So it's a very attractive low LTV, high yield floating rate. And there seems to be a good size market for us to continue to grow that business.

And something we're going to focus on trying, I would point you to the forward-looking statement part of the next comment. But something we are focusing on to try and grow that quite a bit, if we can. And just to finish, on that table, you can see for the – for nine months, we did $158 million of which 97% of it was floating.

So it's mostly doing a little rounding, it's all prime-based floating paper..

If I look at the first page of the press release, and you have the LASG originated portfolio sitting at about $382 million.

Is it applying that same kind of high 90% prime-based? Is that an appropriate extrapolation?.

I don't know exactly what that number – I don't think it would be as high as that. And I will for the next call, we'll provide that number on the portfolio. But because there are some loans in there that in the earlier days we did that were maybe three-year adjustable. So the rate got adjusted at three years.

There could have been a couple in there that were five-year fixed. It's not the business that we're doing now. But I – and so – but by a long shot most of it's floating. Or if it's not floating, its paper that was written for a year or 18 months at a fixed rate that was appropriately priced to reflect that..

Okay. So that will be something I look forward to as rates rise, I guess.

Can I just ask the SBA impairment charge that you had this quarter, that you sighted JP, is that something that it gets adjusted every quarter? Or is that specific to this quarter?.

That's something that gets adjusted every quarter, Alex. So last quarter we actually had a recovery in that portfolio of about $110,000. And this quarter was a impairment charge of $140,000. So in that other noninterest expense line item, it's about a $250,000 swing compared to the linked quarter based on that.

And that's due to different assumptions and payoffs in that portfolio. One of the significant assumptions that seems to be having a big drive in that valuation is prepayment speeds. And we have a third party, who values up for us on a quarterly basis. So....

Okay.

And then, Rick, in your prepared remarks you mentioned some portion of the SBA originations this quarter being in the hospitality sector, I missed that number, can you just repeat what that was?.

It was $8 million out of the $9 million was in the hotel space..

Okay. And maybe....

You may recall that – I'm sorry, go on Alex..

Yes. No, I was just going to ask, I know you hired someone that has a speciality in that last quarter. But I was just going to ask, it's certainly outlook on SBA.

I know that it's been in a little bit of a transition over the last couple of quarters for you guys, just wondering where we are on the upswing here?.

Thank you. I'm glad you asked that because I wanted to comment on that. First, it was noted – in your report this morning, you had indicated that expenses you noted went up against the linked quarter, $250,000 of it. JP just talked about it in the change and the servicing rights. And then there was another piece having to do with payroll number.

This is our first – even though it's our third quarter, it's the first calendar quarter, where payroll taxes go up because you restart FICA, et cetera. But now to the relevant point about – I'm going to get to your point about that hotel. We're going to spend about another $100,000 in marketing. It all had to do with the SBA.

And we're really trying to build that. We've really been focusing on the hotel vertical space. At first, we hired a fellow you are referring to was formally the Head of the Asian American Hotel Owners Association, which is a trade group representing half of the hotel owners in the country. He is well known there.

And as part of our marketing plan to do that, we'll be going to – and he has in particular, he's probably going to go to 30 or 35 conferences this year to meet with hotel owners.

We've invested in – we've hired a marketing firm that provides branding and help us build technology where we can do a much better job with – when we send out emails, tracking them, building a micro site for our web page for the hotel space booked.

We've had – we have two people in the bank that are on the calls all day, calling up and following up on that. So we're making a big investment in people, technology and marketing to grow that. And we're doing better with it. I'd like – $9 million is not satisfactory to be clear.

I mean that's where we wind up, then I would say we did not do well with this. But we believe we're building something that's going to grow and grow. And I would expect that next quarter those numbers are going to look better than they did this quarter.

And when kind of compare that with – well, we used to have with the BDO models, with BDOs that their homes calling brokers to try and find business. We think this is a much more valuable business. And it's more franchise value to the company, more sustainable, more focused. So it takes a while though. So I don't want to overstate.

We're not going to go from $9 million to $40 million. Hopefully, we're going to keep growing each quarter. And while I'm not saying we will do this, you can – just for your reference, I guess, if you go from $9 million, let's say, to $16 million, $7 million that's another new salvos, that's another $500,000 of gains.

So we can keep growing this quarter by quarter, I believe we'll have something valuable..

All right. That's a lot of good additional color. So there – and as you look out, it's going to take a couple of quarters, if not years. But if I look at like the calendar second quarter of 2017, I guess your fourth quarter of 2017 is being kind of a high point of the old SBA model.

There is no reason why a couple quarters from now or however long it takes, you can't get back there given the infrastructure and given what kind of like your outlook is for that segment, is that correct thinking?.

It's correct. And I would say, we don't do better than that openly. I'm saying, I – we have a whole team here, we will be disappointed. No, we made the transition to this model with the view that we can do better than we did before that's why we did it.

I'm not saying reliable on our – in our SBA business that – and the numbers, obviously, don't line up. But as a model focusing on verticals and developing a reputation and our brand in certain areas starting with hotels and adding to them over time, we believe is a very good model for us..

Okay. And then, just a final question from me. It looks like the end of period share count went down very slightly from the end of the last quarter. And your share price has kind of come down a little bit over the last couple of months.

I mean you still have the buy back in place, correct? And is there any change in your thoughts on using that? Have you been using it? Will you use it at some point in the future? Or is that is really growth or is the best use of capital, as you look toward?.

Well, first, let me just comment on, and I'm going to ask JP to comment on the share count is – JP, will you look – you are saying on the linked quarter? Alex, just want to make sure we're working with the same....

I have in my mind the end of December, are you having 8.94 million shares and then it's going down to 8.93 million at the end of March?.

We're just taking a look at that to make sure. We – I assume you have the right number. But let's....

If not, I've to get Jeff back on the call..

We went down by 3,000 shares, you're saying?.

14,000 shares..

I think it was like 14,000 shares. It was a small – it's a small number..

Yes, my – what we haven't brought back any share back. If it goes down, it probably went down because there was an employee that had restricted shares that left the bank that forfeited his shares.

That would – JP, would there be another reason the share count would go down?.

No, we're just following up right now to make sure that....

I'm sure it's that. But to answer your question, Alex, on the use of the buy back. The board and management, we think about use of capital to make sure we have – we're using it wisely, the possible – the two obvious possibilities are, using it for growth or returning it to shareholders either through a repurchase or through a dividend.

And the board values that. We – the conclusion to date has been so far that – and, of course, this – the price of the stock drives that decision. But the choice – the decision so far has been that, it's not – it wouldn't be wise for us to use capital to buy back stock. We are disappointed what's happened to the stock price.

But when you see how much growth we had in our loan book with the linked quarter, it's particularly in the LASG. What's happening, the LASG is growing and the lower yielding community bank portfolio is shrinking. It is our hope and expectation we'll continue to grow the LASG. And we're probably going to want to use that capital.

But if sadly the stock price went down to a level where it makes sense to buy back that's a tool that's certainly available to us..

And Alex, the answer to your question is, what Rick said, forfeitures and then share cancellations for vested restricted stock awards. It's what caused the change in the shares during the quarter..

Okay, all right. Well, thank you very much for taking my questions..

Thank you, Alex..

[Operator Instructions] There are no further questions at this time. I would now like to turn the call over to Rick Wayne for closing remarks..

Thank you. Well, I hope that was, I mean, good conversation with Alex that – between that and the material that we provided. We were able to answer all of your questions and describe the activity of the bank during the quarter. Our goal is to be as transparent as possible.

I always say in these calls, if there is additional information that you think would be helpful in future calls, I mean, we are able to provide that information. We would be happy to. So feel free to let JP or me know. And thank you for listening to the call and reading our material, supporting us, we appreciate it.

It's Thursday, so I can't wish you good weekend, but hope you have a good weekend. Thank you..

This concludes today's conference. You may now disconnect..