Good day, everyone, and welcome to the Northeast Bancorp Fiscal Year 2018 Fourth 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 JP Lapointe, Chief Financial Officer..

Earlier this morning, an investor presentation was uploaded to the company'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 & 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 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 risk 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 on the call is JP Lapointe, our Chief Financial Officer..

After the close of the market yesterday, for the fourth quarter of fiscal 2018, we announced quarterly net income of $4.3 million or $0.48 per diluted common share, 13% return on equity, 1.5% return on assets and an efficiency ratio of 57.9%..

For the fiscal year ended June 30, 2018, we earned $16.2 million or $1.77 per diluted common share compared to $1.38 for the prior fiscal year, representing a 28% increase.

As will be discussed in more detail this morning, we had significant growth in our higher-yielding LASG portfolio, higher volume in SBA originations and a decline in delinquent and nonperforming loans with continued disciplined expense management..

Turning to Slide 3. During the fourth quarter, bank wide we generated $155.8 million of loans, including $119.2 million in our Loan Acquisition and Servicing Group. LASG loan production included $66.6 million of originated loans and $52.6 million of purchased loans.

Of the $62.6 million (sic) [ $66.6 million ] of originated loans, 91% were variable, indexed to prime with a weighted average yield of 7.53% as of June 30. The LASG portfolio had net growth of $51.6 million or 8.1% over the linked quarter and net growth of $111.4 million or 19.3% over the prior fiscal year.

Additionally, we generated $23.9 million of loans in our SBA division compared to $8.9 million of SBA originations in the linked quarter. $16.3 million of the $23.9 million of the SBA originations were loans secured by hotels, demonstrating the continued build-out of our SBA hotel vertical.

We generated a net gain of $1 million on the sale of $10.9 million of SBA loans. Net interest margin for the third fiscal quarter (sic) [ fourth fiscal quarter ] was 5.3% and our total return on purchased loans for the quarter was 11.5%, which included $2.4 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 decreased to $101 million as of June 30 as a result of the growth in the LASG purchased portfolio during 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..

On Slide 5. Under another regulatory commitment, nonowner occupied commercial real estate loans are limited to 300% of total capital. As of June 30, capacity under this condition was $166.3 million..

Moving on to Slide 6. Of the $119.2 million invested by LASG for the quarter, $52.6 million were purchased loans and $66.6 million were originated loans. Purchased loans for the quarter have unpaid principal balances of $56.2 million, representing a purchase price of 93.6%.

As mentioned in these investor calls, loan purchasing is transactional and can vary significantly -- sometimes significantly from quarter to quarter. Since the merger in 2010, LASG has invested an aggregate of $1.5 billion, consisting of approximately $727 million of purchased loans and approximately $809 million of originated loans.

During the past quarter, we reviewed loans with $244 million of unpaid principal balance and bid on loans with $92.5 million of unpaid principal balances and repurchased, as previously mentioned, $56.2 million at 93.6% or $52.6 million invested. The $52.6 million invested consisted of 83 loans acquired in 12 separate transactions.

As I've said before, we remain disciplined in our selection, underwriting and bidding on loan pools, singularly focused on building a quality portfolio. I would like to highlight that we had a record volume of purchases this quarter, demonstrating our ability to grow our loan book through our purchased business..

Moving on to Slide 7. At the end of the quarter, the discount on purchased loans was $37.1 million as compared to $35.2 million for the linked quarter. The change is primarily due to $52.6 million of purchases with a related discount of $3.6 million. This was offset by loan payoffs and paydowns in the quarter.

Purchased loan payoffs generated $2.4 million of transactional income, including $402,000 gain on the sale of 2 purchased loans. Approximately 85% of the $37.1 million discount is expected to be realized over the remaining life of the purchased loans through scheduled accretion.

The nonaccretable portion of the discount represents contractual cash loans that, in our estimation, may not be collectible..

Turning to Slide 8. We provide detail on returns from the LASG portfolio. For the quarter, the purchased portfolio generated a total return of 11.5%, reflecting transactional income of $2.4 million from unscheduled loan payoffs and sales. This was relatively in line with the average of $2.7 million of transactional income for the prior four quarters.

As we've 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 7.5% in the quarter..

Turning to Slide 9. We provide statistics on the LASG loan portfolio as of June 30 of significance. As noted in the chart in the top right, the purchased loan portfolio has a net investment basis of 89%, a slight increase from 88% in the linked quarter. On an invested basis, the average loan size is approximately $735,000.

And 84% of the portfolio consisted of loans with an investment size less than $6 million. The loan portfolio has a diverse collateral type, focused on retail and mixed use, industrial, hospitality, multifamily and office. By geography, the largest concentrations are in California and in New York with 19% and 18% of the portfolio, respectively.

Our collateral is geographically diverse, with collateral in 41 states..

Turning to Slide 10. One of the benefits of the SBA program is the ability to sell the guaranteed portion of a loan and often at a substantial premium. For a variety of reasons, SBA loans closed in 1 quarter are sometimes sold in a subsequent quarter. In the current quarter, we closed $23.9 million of SBA loans, of which $21.3 million was funded.

Additionally, the company sold $10.9 million of the guaranteed portion of loans in the secondary market, of which $7.5 million were originated in the current quarter and $3.4 million were originated or purchased in prior quarters. For the quarter ending June 30, the net gain on sale, including the capitalized servicing asset, was $1 million..

On Slide 11, we show detail of the SBA sale pipeline as it stands at June 30. The bank holds $3.8 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.

There is also an additional $9.1 million in the guaranteed portion of SBA loans that have closed and will be fully funded in subsequent quarters. In total, this represents an additional $12.9 million in future SBA guarantee loan sales before considering any additional loan production in future quarters..

And now, I'd 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. Thank you. .

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 $4.3 million or $0.48 per diluted common share.

Diluted earnings per share were up $0.05 from the quarter ended March 31, 2018, which I shall refer to as the linked quarter, and up $0.03 from the quarter ended June 30, 2017, which I shall refer to as the comparable prior year quarter.

The increases are due to higher base net interest income amounts during the quarter, which amounted to $12.4 million in the current quarter compared to $11 million in the linked quarter and $10.2 million in the comparable prior year quarter.

Additionally, the gains on the sale of SBA loans into the secondary market increased to $1 million in the current quarter compared to $560,000 in the linked quarter and decreased from $1.9 million in the comparable prior year quarter..

We also experienced an increase in interest expense of $215,000 compared to the linked quarter and $950,000 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 34.5% compared to 30.7% in the linked quarter and 41.6% in the comparable prior year quarter.

The increase in the effective tax rate during the quarter compared to the linked quarter is due to increased state income tax expense due to updated state apportionments as our income shifts into higher taxing states, along with additional expenses related to the year-end true-up of our tax provision.

However, going forward, our federal corporate income tax rate will decrease to 21%, and we expect our effective tax rate to be around 27%..

Turning to Slide 13. Over the past year, we have seen net loan portfolio growth of $92.6 million. The majority of the growth over the last 12 months comes from our LASG portfolio, with $348.7 million of purchases and originations.

As shown in the chart, in the trailing 12 months period, we have closed $45 million of SBA loans and sold $29 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 paydowns and the amortization in the LASG purchased and originated portfolios, which amounted to $275 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 the LASG portfolio, which had net growth of $111 million or 19% since June 30, 2017.

In the current quarter, LASG originated $66.6 million of loans and purchased loans with a recorded investment amounting to $52.6 million..

Turning to funding on Slide 15. In order to fund loan growth, we've had net deposit growth of $65 million or 7% over the trailing 12-month period. Over the past year, all of the deposit types have seen increases or primarily all of the growth is within our money market products.

The growth in these products has strengthened our overall deposit mix, where nonmaturity accounts, which include money market, savings and demand deposit products, represent 63% of total deposits as of June 30, 2018, as compared to 62% of total deposits at June 30, 2017. Compared to the linked quarter, deposits are down $21 million or 2%..

Slide 16 shows trends in the main components of our income. Compared to the linked quarter, base net interest income increased $1.4 million due to higher average balances in the LASG portfolio, along with higher rates earned on our loans as a majority of our LASG portfolio is tied to the prime interest rate.

Additionally, transactional interest income from the purchased loan portfolio decreased by $124,000 as compared to the linked quarter. The purchased portfolio had a yield of 10.9% in the current quarter compared to 11.3% 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 $2.2 million 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 10.9% yield in the purchased portfolio is down from 13.6% in the comparable prior year quarter due to higher transactional interest income amounts in the comparable prior year quarter. The lower purchased loan yield was more than offset by the higher average balances in the current quarter from the comparable prior year quarter.

Noninterest income increased by $77,000 over the linked quarter, primarily due to the $473,000 increase in gain on the sale of SBA loans, offset by a decrease in gain on the sale of other loans of $114,000 and a decrease in income from a loss on real estate of $142,000.

Noninterest income is down $931,000 from the comparable prior year quarter, primarily due to an $833,000 decrease in gains on the sale of SBA loans due to fewer SBA loan sales in the current quarter and a $134,000 decrease in the gain on sale of residential loans..

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 $1.4 million, while noninterest expense has increased by $503,000.

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 and purchased portfolios 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 a $480,000 increase in compensation expense due to employee incentive compensation. Additionally, loan expense increased $92,000 from the linked quarter due to the increase in loan volume during the quarter.

Compared to the comparable prior year quarter, total revenue has decreased by $280,000, while noninterest expense has increased by $114,000.

The decrease in revenue is primarily due to a decrease in the gain on sales of SBA loans of $833,000 from the comparable prior year quarter, partially offset by an increase in net interest income before loan loss provision of $651,000.

The decrease in revenue in the current quarter was further impacted by the $114,000 of higher noninterest expense, primarily related to increased data processing costs from outsourcing our network and loan expenses due to increased activity in the quarter.

Total revenue has helped us achieve an annualized return on equity of 13%, a return on assets of 1.5%, along with an efficiency ratio of 57.9% in the quarter..

Slide 18 shows originations and the associated gains in the residential loan 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 yields, average balances and our net interest margin, which was 5.28% in the current quarter as compared to 4.94% in the linked quarter and 5.55% in the comparable prior year quarter.

As previously discussed, the net interest margin, which increased from the linked quarter, is largely driven by an increase in base net interest income, offset by slightly lower transactional interest income from the purchased portfolio.

Additionally, the average balance of loans for the current quarter was $825 million, as we originated and purchased a large amount of loans near the end of the quarter.

So looking forward, we are starting the first quarter of fiscal 2019 with a beginning balance of $872 million, which should result in a higher average balance for the first quarter of fiscal 2019..

Slide 20 provides a snapshot of our asset quality metrics. Compared to the linked quarter, nonperforming loans to total loans has decreased to 1.37% from 1.67% and nonperforming assets to total assets has decreased to 1.23% from 1.25%. These metrics have also both decreased compared to the June 30, 2017.

In the top right-hand corner, classified commercial loans were $9.1 million as of June 30, 2018, a decrease from $10.5 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 were 4 basis points in the current quarter, up from 3 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'd like to open up the call to Q&A. .

[Operator Instructions] And our first question comes from Alex Twerdahl with Sandler O'Neill. .

And first off, I'm just trying to get -- just trying to work through in my mind the -- in my model, the moving parts in the margin, which, excluding the accelerated transactional income this quarter saw a pretty nice pick up. And I appreciate that you gave the amount of loans that are -- LASG originated loans that are tied to prime.

But do you have the amount of variable loans in the SBA and the main franchise and the rest of the loan portfolio that are also variable?.

Our researchers are researching, as you're asking that question, Alex. I can tell you, in the SBA, what we hold is virtually all variable. We... .

That's also prime based?.

Yes. And as a general rule, everything we are originating or selling, once we fully fund it and pricing for adjustable rate loans tied to prime get significantly higher premiums than fixed rate. So that part is easy.

What was the second part of your question, Alex?.

I was just -- I think, you pretty much answered it. Just trying to get a sense for the rest of the portfolio outside of the SBA and the originated LASG loans that have some variability.

And then, I guess, the other piece of the margin question would be on the liability side, which, even though your cost of deposits and cost of funds are maybe a little bit higher than a typical bank, they actually kind of held in pretty well in the second quarter compared to -- or in the second calendar quarter versus the calendar first quarter.

How are you thinking about -- as you look at your deposit options, how should we be thinking about the deposit beta from here going forward and how to model the cost of liabilities?.

On the -- I think, as you pointed out in your report, the strength of our franchise is much more focused on the ability to put on high-yielding, high-quality assets. It's not on having the least expensive funding costs in the world. We are typically funding either through our money market account or product, I should say, which currently has a rate.

This is the ableBanking one, which currently has a rate of 1.85, or through -- we have a 1-year able CD rate, which is at 2.5, or on the bulletin boards, which are mostly other banks using -- buying CDs kind of as part of their treasury function, which [ a 1 year is about 2.80. I mean, those ] are incremental funding costs as we grow our bank.

That's where we are now. I would expect that, as we grow our banks, we are -- on the funding side, we will be on the higher side compared to other banks.

I would add in, though, even in the numbers I'm describing, where on the bulletin boards or on the online savings products, we're often not at the highest, there are banks that are paying more than we are as well.

Then, I would just add to that notwithstanding, that funding cost based on the excellent pricing we're getting on our originated loans and the returns that we achieve on our purchased loans, our NIM is quite high. .

I would agree. And another question, just about the dynamics in the originated LASG portfolio. And the origination volumes have been pretty strong for couple of quarters. I'm just trying to -- as I sort of model the forward balances of that out, also, I see that there's a fair amount of runoff in the portfolio. I know they're relatively short in terms.

Was this quarter the runoff we saw, call it, somewhere in the neighborhood of $50 million, is that kind of a typical quarter in terms of what you kind of have to pedal against in order to grow that portfolio?.

I don't think we have enough data points to tell you in any given quarter what's typical. I would suggest you kind of think about the numbers slightly differently that we originated and purchased for the -- for fiscal year '18 about $350 million. That's $125 million of purchases and $225 million of originations, so that's roughly $350 million.

And our LASG book grew net about $110 million. It's a little bit -- I think that, for frame of reference, is probably a reasonable way to think about. It could turn out the mix between purchased and originated changes, it could be that we do more than that. But I think that, that's probably reasonable.

One of the things we're trying to focus on is, in our originated book, not only doing the portfolio finance, which, for everyone, I know you know, Alex, for everyone else on the call is lending money to nonbank lenders to leverage their lending activities.

We're also trying to increase the amount of direct lending we do, where we can have term loans that go out 2 or 3 years, gets -- still get the kind of rates and have higher prepayment penalties or lockouts or yield maintenance where we can have a less runoff.

But it's the nature of our businesses that the runoffs tend to be higher than in more traditional real estate lending. .

Okay.. And then just a final question for me, as it relates to noninterest expenses. I appreciate that the end of the calendar -- I'm sorry, end of the fiscal year is generally more expensive quarter for salaries and comp true-ups, et cetera.

Should we expect the back half of the year, the expense run rate to look a lot more like the first quarter or the first calendar quarter of this year? Is that reasonable?.

Yes, I would say that, as JP pointed out, the figure that was almost $450,000 relating to incentive comp that we improved so much during the year, but then when we see how the year ends up, the comp committee determines what is an incentive pool. But absent that, the fourth quarter would have looked pretty much like the linked quarter.

I would expect that quarters 1 and 2 will go back to looking like the prior quarters. Except as we grow our balance sheet, we may have some relatively small amount of increases as we tend to do, as you would expect with a larger balance sheet.

But I would not take -- suggest you take the fourth quarter and multiply it by 4 and assume that's the run rate. .

[Operator Instructions] And I'm showing no further questions. Now I'd like to turn the call over to Rick Wayne for closing remarks. .

Thank you. Thank you for participating to all of you on the line and all of you that will subsequently listen when -- you can catch this on our website. And as I generally say, we welcome your input. If there's additional information we can provide you to provide more transparency into our company, let us know and if we're able to do that, we will.

And again, thank you for your support. .

Thank you all. Bye. .

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day..