Welcome to the Northeast Bank Fourth Quarter Fiscal Year 2022 Earnings Call. My name is Jenny. I’ll be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, the conference is being recorded.

I will now turn the call over to Rick Wayne. You may begin..

Good morning and thank you all for joining us today. As mentioned, I am Rick Wayne, the Chief Executive Officer of Northeast Bank. And with me on the call are; JP Lapointe, our Chief Financial Officer; and Pat Dignan, our Chief Credit Officer and Executive Vice President. After my comments, JP, Pat and I will be happy to answer your questions.

Let me first turn to Page 3 of the Investor Deck that was uploaded on our website last night, and I want to comment on a few items listed on Page 3. First, the – for the quarter, we reported $10.3 million of net income or $1.35 per diluted share. Our return on equity was 16.55% and our return on assets was 2.68%.

And a big driver of our income for the quarter were our National Lending loan volume and, in particular, the activity run, our originated loans.

For the quarter, we originated $172.9 million of loans and for the year, $587.8 million of loans, you know, that’s a record for us both quarter on the quarter and the – and for the year by a – for the year in particular, by a substantial amount.

And I also want to point out on those loans that 93% or 94% of our originated loan – loans are variable tied to prime. And, of course, in a rising interest rate environment that is helpful to have variable rate loans. I just want to comment on something about that, which was, I think requires some explanation.

Because our yield on our loan book for the quarter, originated loans was 7%, and was 6.9% for the prior quarter. And so it only went up 10 basis points and one might wonder why and with loans that are tied to prime why they only went up 10 basis points, and I will answer that question for you.

And that is that – and that we – our loans are structured so that if there’s a payoff before maturity, you know, each loan, we negotiate a minimum amount of interest that the borrower asked to pay. And we had more loans payoff early in the prior quarter than we did in this quarter.

And to put some numbers to that, that 6.9% in the prior quarter included 70 basis points of minimum interest that paid off – loans are paid off early. So, net of that, the yield was 6.2%. As compared to the fourth quarter, where we only had 50 basis points of minimum interest.

So, netting of that, the yield was 6.5%, which is a long way of making the point that ignoring minimum interest, the yield on our originated loan book went up 30 basis points from Q3 to Q4, reflecting changes in interest rates. To the extent you’re thinking of that, I hope that clarifies that.

One of these things that – that one of the big things we’ve been working on is understanding that our correspondent fee income was going to go down each quarter and eventually go away.

Just as a reminder, we have correspondent fee income resulting from discount when the loans were purchased and we also share in the servicing income on the portfolio that loan source has on the PPP loans that they purchased.

For reference point let’s take a look at Slide number 4 in the deck and I will remind you that starting in the fourth quarter of 2020 through the first quarter of 2022, loan source purchased $11.2 billion of PPP loans. And at the end of the June 3, 2022, there remain $1.4 billion.

So there was about $9.8 billion of loans that were either paid off or forgiven. The reason that’s meaningful is that, loan source earns 65 basis points on the PPP loans that they hold and as the portfolio gets paid down and why I should point away and we share half of that and as the portfolio pays down, our share of the income goes down.

And so – and to put some numbers to that it for a second we turn to Slide number 29, trying to get to, you can see that looking at the quarterly amount of corresponding fee income which is in blue on the – this is on the right-side of the Investor Deck on that page, that correspond to fee income, if we compare where it was in Q4 of FY ‘21, I’m sorry, if we compare with Q1 of our Fiscal ‘22 with Q4, corresponding fee income went down by $4.1 million, because the PPP loans were being either paid off or forgiven.

And what we, investors know and we’ve talked about, you know what we need to do was increase our loan book to offset that.

And now if we look at the base net interest income, which is in blue on the chart next to the one I just described, you can see that if we compare Q4, which just ended with Q1, that base net interest income increased by $4.3 million.

Punch line is, we’re growing our loan book for generating more net interest income and we have more than offset the amount of a reduction in correspondent fee income. For the year, if we look at it for the year, I have this number. That net interest income if we compare FY ‘22 with FY ‘21, net interest income increased by $16 million.

And that’s a result of that our loan book grew on our loan - National Lending portfolio grew by $284 million or 30% FY – end of FY ‘22, compared to FY ‘21. And if we just look at the originated – part of that, it grew $236 million or 45% from the beginning of the fiscal year. And that is what we are focused on just growing our National Lending book.

Just a few other comments before we open it up for questions. On our non-interest expense line, it grew, if you compare the fourth quarter that is June 30th, with the third quarter, September 30th, non-interest expense grew by $1.5 million.

And that was, as is usually the case in the fourth quarter, where we take a look at – the comp committee takes a look at how The Bank is doing and if appropriate, adds to the incentive comp, and that $1.5 million was virtually all additional incentive comp in the fourth quarter.

And just for modeling purposes, you know as we’re growing going into this fiscal year, FY ‘23, adding more people and probably a good number for – per quarter non-interest expense is around $13 million, for those that are doing the modeling.

Also we bought back during the quarter – I have that number that we purchased, JP how much?.

285,000..

285,000 shares in the quarter. And for the year, we bought back 821,000 shares. Just took a look at this, this morning I thought someone might be interested since we started the repurchase program, we have repurchased 3.8 million shares at an average price of $16.93, which is about 34% of the shares outstanding before we started a repurchase program.

Finally, just a few words on our 7(a) program with NEWITY. This is – again, this is taking longer than we had expected. And this is – these are not the biggest numbers in the world. But in the quarter, we closed 26 loans for $600,000, I shouldn’t say, you know we closed, yes, 600 – 26 loans for $600,000.

And I don’t want to promise more than we can deliver, so we’ll see what happens in the next quarters. But the technology is working, we were able to close loans. The marketing is continuing. And I’m hopeful that we will have better numbers to report when we report at the end of our first fiscal quarter.

But no promises on that score, we will see when we will see asset qualities or things that are in the report.

So I’ll point out, I know you could read them, but you know delinquencies were at a very low number at around $7 million and non-accruals came down to about $13 million, which are numbers that are – levels that are much lower than we have been in some time and particularly impressive given the size of our loan book now which is about $1.3 billion.

And with that, I will turn it over to all of you to answer any questions that you might have. Thank you..

Thank you. [Operator Instructions] And our first question comes from Alexander Twerdahl. Please go ahead..

Hey, good morning, guys..

Good morning..

Good morning..

At first off, I was just wondering if you could give us a little bit of commentary on what you’re seeing in the loan purchase market, just given all the volatility and changes in interest rates, if that market has changed at all, and what your expectations are for later this year?.

I don’t – I don’t know if our operator read the forward-looking statements. So I will remind you that it’s in the material. When I answer the question, we have a – we’re seeing a lot of activity now in the pipeline.

We think that the higher interest rate environment and concerns about real – credit quality for some banks in the real estate area, I think – we think we’re expecting to see a fair amount of activity in this.

We’ve also seen some of the groups that previously would have bid against us, that out of the bidding and now becoming sellers of their portfolio. I would remind everybody that you know I had – I was very optimistic about the loan purchase possibilities when COVID started, and we were wrong.

But hopefully we won’t be wrong now, we think that there will be a lot of opportunities we see a lot in the pipeline. Now, of course, you know the results are always binary, you win or you don’t win. And so, it could turn out we don’t buy as much as we are hoping for.

Pat, do you want to add to that, add any color to that question?.

Just to add on to what you said about the rising rates of obviously resulted in increased funding costs for a lot of our non-bank competitors, which is good for us.

On the seller side, fixed rate assets are becoming you know there’s – it looks like there’s some activity out there with banks trying to shed some of that in anticipation of further increases.

And also on the on the credit side, there’s – there’s some debt service coverage pressure as a result of rising rates, all of those factors are causing the market there to be – be in some increase in activity and a lot of talk on the street have more to come. So we’re very hopeful that there’ll be some opportunity for us this year..

I would add to that, that there are not many banks that are in the business of buying loans nationally.

0.1, 0.2 as a bank with really low funding costs are rising a little bit and will rise more, but gives us a competitive advantage against non-banks and it seems that some of the non-banks are with a rising rate – interest rate you know are going to be less competitive.

Historically, their funding was through a securitization, where the rates were quite low for them and that’s not the case now. So we’re optimistic but as I said, you know results are binary, you win or don’t win.

I should also, we have the resources, human resources you know to – you know look at a lot of loans and we’ve been doing it as you know, Alex and others do, we’ve been doing this for a very long time. So hopefully our time has come..

With that last point with respect to the human resources, do you have the capacity to meaningfully increase the loan purchases as well as maintain the growth rates that we’ve been seeing on the originated portfolios?.

We do. You know as part of our – when I mentioned earlier about the projected you know costs going forward, you know we have in a fair number of slots to hire more people.

And, but you know, we’ll do what it takes to carefully and you know underwrite for both purchased and originated loans and not, you know, we won’t fund by any loan or originate any loan, unless we’re 100% comfortable in the underwriting that we have done. But I don’t think we’ll have a bandwidth problem on what we’re seeing now.

And we will hire more people as we need them going into the next year..

Great. For this past quarter, the volume that we saw, was it – was the supply just not there? Or were you losing bids to others? Or is just the pricing not appropriate? What kind of drove the lower volumes based on your commentary, I would have expected to see volumes a little bit higher..

I think we looked – we looked at a lot. I mean, we looked at what was available in the market in our – in our sweet spot and we – and we bid on a fair number and that’s why as Rick pointed out it’s a lumpy business. And you know I think what the market, they supplied the market last quarter was that started to pick up toward the end of the quarter.

So I don’t think it’s indicative of anything we – anything other than – other than that..

Okay.

On the originated loans, the yields on the new production just given the variable nature of those, are those – are those yields pretty similar to the book yield that you’d have to that kind of I think you said 6.5% quarter yield? Is that where new loans will be coming on as well?.

No, they’re coming on that – yeah, I – that well in that range you know anywhere between you know between Prime, 1.5 and 2.5, so that there’s a range for those. And they don’t, of course, reflect the expected 75 basis point increase in prime that will be announced. But that – that’s about right..

Okay..

It’s going to go up with rate increases in prime, is really the point I’m making..

Yeah. Can you give us some commentary on the cost of funds and I know it’s ticked up a little bit and you have this slide here that shows that it should probably tick up a little bit more and you’ve done a lot with respect to improving your deposit profile over the last couple of quarters.

But you know in terms of the pressures that you’re seeing on deposit costs, where those are coming from?.

Sure. You know I think you made the point that you know we’re starting in a better place than where we were you know two years ago.

So you know being at a 36 basis point cost of funds you know for this quarter, obviously lower than where we had been, there’s definitely some you know pressure upwards for customers who are you know asking us to re-price their deposits and everything, you know but we’re definitely not a 100% beta.

So you know while we do expect you know rates to go up, we expect our loans to move up significantly more than our deposits.

But you know I think it’s kind of a sign of the market and kind of based on what our competitors do also, you know as competitors move, we have to be a little more agile and flexible to make sure that we can continue to fund the growth that we you know hope to see in the balance sheet, by retaining our deposits to continue to grow more.

So we do have a projected uptick in the cost of deposits, but you know nothing overly significant based on where the projected rates are expected to go over the next you know at least six months..

Okay. And Rick, I think you said in your prepared remarks that we should be modeling expenses in the coming quarters around $13 million per quarter, which seems kind of an uptick from where you were last quarter and kind of the non-year end quarters. Can you maybe just talk a little bit about why that is mostly –.

It’s mostly – it’s mostly – you know it comes in – well, I think there’s three big buckets of that. You know, one our more headcount you know this year with inflation you know base salaries went up because of you know, we gave out kind of the standard increase in base is higher than they’ve been in the past because of inflation.

And we’re also moving from our current office to another office for those that know Boston and the Seaport, you know we needed more space and you know we signed this lease in 2012 and rents are higher. So we have – it’s kind of rate volume, we’re taking more space and it’s more expensive.

So, those are the three major items that are accounting for the increase in non-interest expense..

Okay. And then just a couple more questions for me.

When you – you guys will adopt CECL on January 1,2023, is that correct?.

That’s correct..

And do you have any sort of early guidance or you know color that you could help us kind of figure out where that ACL might shake in and kind of how your loan portfolios given sort of the purchase nature, a big chunk of it and you know then another big chunk that’s had a zero loss history you know like how CECL might impact your various portfolios?.

Yeah, it will most likely reduce you know the majority of our portfolio or segments you know given the low LTVs and the minimal losses that we have in our originated portfolio you know where we see an increase is in the residential real estate side when you look at you know the life of those loans is much longer than you know the short-term nature of what we have in the – in the National Lending originating portfolio.

You know one of the other factors is that, we will have to begin reserving for purchase loans in the allowance for credit losses. So that’ll come in also as a factor. You know and some of that – that we have right now is in purchase discounts.

So some of that discount that’s sitting against the loan balance will actually migrate over to the allowance for loan losses when we adopt CECL. So there was just going to be a reclassification in the balance sheet, and have no capital or earnings impact at that time.

So we expect the overall allowance you know probably won’t change materially from where it is now. But kind of how we get there, there might be some – some components moving around on the balance sheet at that time..

Okay. And then that last piece, the purchase discount going into the reserve for purchased loans. Post the sort of January 1 adoption date, we look forward into some quarters for next year.

Does that mean that a larger quarter of purchases would result in a larger provision?.

That depends on where FASB ends up. They’re looking at still updating some of the CECL guidance that will allow you to take some of that discount that you purchase on loans and move it over to the allowance at the time of purchase.

But the way CECL is worded right now is that you would have to reserve for purchase loans through a provision in the income statement, but FASB is looking at making an adjustment for purchase loans in the future..

Okay. And then just the final question, Rick, on the NEWITY 7(a) program, I think you said you closed 26 loans. I think there’s $600,000 of that’s loan balances, correct, not income for you guys.

And can you just remind us how that might – should those volumes pick up? You know how that’s going to actually impact the income statement?.

Are you seeing, Alex, how the – if the volume were to pick up, how that would impact the earnings? Is that your question?.

Yeah, I know there’s a gain on sale component. And then there’s also if I remember correctly –.

Okay. Yeah I can say so –.

Reserve as well –.

So, if we were to – yeah so if we were to sell those loans, they’re now priced at prime 2.75 and currently if you – one were to sell loans, these are 10-year loans that prime 2.75. Assuming they get the same pricing as larger, traditional 7(a) loans.

Today, the premiums are 8 points, come down a little bit, it was one time 10 or 11, maybe a little bit more, but currently, it’s 8, I think it’ll change as rates change over time.

So if we were to sell those loans, there’s a 90% guarantee on the loan, so if it’s sold off let’s say it was to make the math easier you had $1 million of UPV and the loans you could sell off $900,000 and the premium would be 8% on that, so there would be a gain of $72,000. We would split that with NEWITY. And so we get $36,000, they get $36,000.

We would keep the 10% that we didn’t sell on our books and earn prime 2.75 on that. And I should have added that, if there were any losses in that portfolio, we’ll split that with NEWITY 50:50 and we will withhold starting off, if we look at the – we expect the losses in the portfolio over time will be 3%.

So we would withhold 1.5% of NEWITY’s share of the gain on it. I should point out for the audience if I’m only using that $1 million to make the arithmetic easy, you know if it is linear. And so if it was a much bigger number, obviously that would be much more interesting which is our – that’s what we’re trying to accomplish.

I was going to say hope, but that sounds too tentative. That’s what we think will happen with more volume..

Awesome. Thanks for taking all my questions..

Those are all excellent ones. Thank you, Alex..

[Operator Instructions] And we have no further questions at this time..

Well, thank you. Thank you, everybody for listening in and your continued support. We look forward to talking again at the end of the current quarter. We try and make our slide deck as helpful as possible and the information we provide if you have any suggestions as the standing offer, let us know and if we can accommodate it, we will do that.

And on that note, I will say thank you and goodbye..

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect..