Northeast Bank

Good day, everyone, and welcome to the Northeast Bank Fiscal Year 2020 Second Quarter Earnings Results Conference Call. This call is being recorded. With us today from the bank is Rick Wayne, President and Chief Executive Officer, and J.P. LaPointe, Chief Financial Officer. Earlier this morning, 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. 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 Bank. Forward-looking statements are based upon the current expectations of Northeast Bank's management and are subject to risk 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. At this time, I would 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 J.P. LaPointe, our Chief Financial Officer. Before turning the call over to J.P. for a more detailed analysis of I would like to discuss highlights for the quarter ended December 31, which is the second quarter of our fiscal year. For the second quarter, after the close of the market yesterday, we announced quarterly net income of $4.9 million, or 53 cents per diluted common share, a return on average equity of 12.1%, A return on average assets of 1.7% and a net interest margin of 5.6%. Earnings were positively affected by strong loan growth in the LASG portfolio of $75.4 million, or 10% over the link quarter, and transactional income of $2.4 million, as well as lower non-interest expense. Turning to slide three. During the second quarter bank-wide we generated a record $175.4 million of loans, which brought the quarter-end loan portfolio to slightly in excess of $1 billion. The quarter-end loan balance represents a significant increase over the average loan balance of $946 million in the second quarter. Loans closed in the second quarter included 163.4 million in LASG, of which 98.6 million were originated and 64.8 million were purchased. The weighted average yield of the LASG loans originated in the second quarter was 7.4% as of December 31, of which 82% were variable, mostly tied to prime. The total return on purchase loans for the quarter was 10.2%, which included $2.4 million of transactional income. And as previously mentioned, net interest margin for the quarter was 5.6%. Moving on to slide four, of the $163.4 million invested by LASG for the quarter, $64.8 million were purchase loans, and 98.6 million were originated loans. Purchase loans for the quarter have unpaid principal balances of $66.8 million, representing a purchase price of 97.1%. Since the merger in 2010, LASG has invested an aggregate of $2.2 billion consisting of $957 million of purchase loans and $1.2 billion of originated loans. During the quarter, the market for purchase loans was quite robust. We reviewed loans with $526 million of unpaid principal balances and bid on $100 million. We purchased loans with unpaid principal balances of $66.8 million, as discussed above. The $64.8 million invested consisted of 138 loans acquired in 10 separate transactions. Moving on to slide five. At the end of the quarter, the discount on purchased loans was $33.8 million, unchanged from September 30th. During the quarter, there was acceleration, accretion, from purchase loan payoffs of $20.2 million, which generated $2 million of transactional interest income offset by the quarter's purchases with the related $2 million of discount. Approximately 86% of the $33.8 million of discount is expected to be realized over the remaining life of the purchase loans through scheduled accretion. The non-accredible portion of the discount represents contractual cash flows that in our estimation may not be collectible. Turning to slide six, we provide detail on returns from the LASG portfolio. For the quarter, the purchase portfolio generated a total return of 10.2%, reflecting transactional income of $2.4 million. As we've discussed in the past, Transactional income realized on the purchase loan portfolio, as well as the amount of loans purchased, may not be consistent from quarter to quarter. The LASG originated portfolio generated a strong return of 7.7% in the quarter. Turning to slide seven, we provide statistics on the LASG loan portfolio as of December 31, 2019. of significance. As noted in the chart in the top right corner, the purchase loan portfolio has a net investment basis of 92%, an increase from 91% in the linked quarter. On an invested basis, the average loan size for purchase loans was $414,000, and the average loan size for originated loans was $2.2 million. 77% of LASG loans at an investment size of less than $6 million. The loan portfolio has a diverse collateral type, primarily focused on multifamily retail, industrial hospitality, office, and mixed use. By geography, the largest concentrations are in New York and California, with 26% and 21% of the portfolio respectively. Our collateral is geographically diverse with collateral in 45 different states. 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. JP.

Thanks, Rick, and good morning, everyone. I'm picking up on slide 8 to provide more information on our financial results. As announced in our earnings release that was made public after the close of business yesterday, net income for the quarter was $4.9 million, or 53 cents per diluted common share. Diluted net income per common share was up one cent from the quarter ended September 30th, 2019, which I shall refer to as the linked quarter, and down three cents from the quarter ended December 31st, 2018, which I shall refer to as a comparable prior year quarter. The increase of one cent per diluted common share from the linked quarter was due to a decrease in non-interest expense of $565,000 and an increase in non-interest income of $161,000, partially offset by a decrease in net interest income of $192,000 and an increase in the provision for loan losses of $379,000. The decrease in non-interest expense was primarily related to a decrease in salary and employee benefits expense mostly related to decreased payroll taxes and a reduction in stock compensation expense. The increase in non-interest income was due to a gain on real estate owned on a property that was transferred in during the quarter and recorded at its fair value less expected cost to sell. Net interest income was down primarily due to a decrease in loan interest income of $214,000 due to lower average balances in the loan portfolio along with lower interest income earned in the SBA and community bank portfolios, partially offset by a decrease in interest expense. Additionally, the provision for loan losses amounted to $243,000 in the current quarter, which increased from a credit of $136,000 in the linked quarter, primarily as a result of the growth in the loan portfolio. The effective tax rate for the current quarter was 28.9% which increased slightly from 28.7% in the linked quarter. The decrease from the comparable prior year quarter of 3 cents per diluted common share was primarily due to a decrease in non-interest income of $208,000 due to a $638,000 decrease in gains from the sale of SBA loans as the bank has shifted its focus away from SBA originations. partially offset by an increase of $338,000 in gain on real estate owned due to a property transferred in during the quarter and $108,000 in gains on sales of residential loans due to higher volume and higher pricing of loans sold. Additionally, there was a decrease in net interest income primarily due to a decrease in other interest and dividend income as the bank now holds less cash with the Federal Reserve which resulted in a decrease of $644,000 in interest income due to lower average balances and lower rates earned. This decrease was partially offset by a $556,000 increase in loan interest income due to increased average balances in the LASG portfolio. Interest expense was flat from the comparable prior year period while the provision for loan losses increased $142,000 from the comparable prior year period due to the loan portfolio composition and management's evaluation of losses inherent in the portfolio. Additionally, there was a decrease in non-interest expense of $114,000 from the comparable prior year quarter due to a $211,000 decrease in professional fees, partially related to legal expenses associated with the corporate reorganization recorded in the comparable prior year quarter, along with a $108,000 decrease in occupancy and equipment expense from decreased repairs and maintenance costs and a $104,000 decrease in loan acquisition and collection expense due to expense reimbursements received during the current quarter. These decreases were partially offset by an increase in salary and employee benefits of $227,000 mostly due to salary and incentive compensation increases and a $172,000 increase in data processing fees due to increased IT outsourcing costs. The effective tax rate for the current quarter was 28.9% which increased slightly from 28.7% in the comparable prior year quarter. Turning to slide nine. Over the past year, we have seen net growth in the LASG portfolio of $98.5 million, or 13%. While payoffs, paydowns, and amortization were higher in the linked quarter, that activity has decreased to normalized levels in the current quarter, with current quarter LASG originations and purchases reaching record levels at $98.6 million and $64.8 million, respectively. These results are further detailed on slide 10, which shows the composition of the loan portfolio over the most recent five quarters. The net loan growth over this time is driven by the strength of the LASG portfolio, which had net loan growth of $98.5 million, or 13%, since December 31st, 2018. In the current quarter, LASG originated $98.6 million of loans and purchased loans with a recorded investment amounting to $64.8 million. 84% of the LASG originated loan portfolio have an interest rate floor, which was a weighted average floor of 7.2% as of December 31st, 2019. Additionally, 10% of the LASG originated loan portfolio is fixed at a weighted average rate of 8.2%. Turning to funding on slide 11, our deposits have decreased by $47 million, or 5%, over the trailing 12-month period. In connection with the corporate reorganization that was completed during the fourth quarter of fiscal 2019, we increased our loan to core deposit ratio from 100% to 125%, which allowed us to reduce our excess deposits. However, deposits increased compared to the linked quarter in order to fund the loan growth in the LASG portfolio. Over the past year, time deposits have grown while money market accounts have decreased. Our non-maturity accounts, which include money market, savings, and demand deposit products as a percent of total deposits has decreased from 53% as of December 31st, 2018 to 48% as of December 31st, 2019. Compared to the linked quarter, interest expense decreased $45,000, $135,000 of which was interest expense savings on deposits partially offset by a $93,000 increase in interest expense from FHLB advances due to the increase in average balance resulting from FHLB advances taken during the quarter. Our cost of deposits only decreased four basis points from the length quarter. However, we had $40 million of bulletin board time deposits that matured in December 2019, which were at a weighted average rate of 2.99%, and bulletin board time deposits retained or put on during December, whether rollovers or new deposits, were at a weighted average rate of 1.86%, which will allow us to see additional cost savings going forward. Operating results are further detailed on slide 12, which shows trends in total revenue and operating non-interest expense over the past five quarters. Compared to the linked quarter, total revenue has decreased by $31,000 due to the decrease in net interest income, primarily caused by lower interest income in the SBA and community banking divisions, partially offset by an increase in interest income from the LASG portfolio and an increase in non-interest income from a gain on real estate owned. Additionally, non-interest expense decreased by $565,000 from the linked quarter, primarily due to decreases in salary and employee benefits expense and loan acquisition and collection expense. Total revenue has helped us achieve an annualized return on average equity of 12.1% A return on average assets of 1.7% and an efficiency ratio of 58% in the current quarter. Compared to the comparable prior year quarter, total revenue has decreased by $306,000 while non-interest expense decreased by $114,000. The decrease in revenue is primarily due to the $208,000 decrease in non-interest income due to a $638,000 decrease in gain on sale of SBA loans which was partially offset by a $338,000 increase in gain on real estate owned and a $108,000 increase in gain on sale of residential loans. Additionally, there was a decrease in net interest income due to decreased average balance and rates earned on short-term investments as the bank has held less cash with the Federal Reserve which was partially offset by an increase in interest income on LASG loans due to higher average balances. The decrease in non-interest expense compared to the comparable prior year quarter is primarily due to a $211,000 decrease in professional fees partially related to legal expenses associated with the corporate reorganization recorded in the comparable prior year quarter along with a $108,000 decrease in occupancy and equipment expense from decreased repairs and maintenance costs and a $104,000 decrease in loan acquisition and collection expense due to expense reimbursements received during the current quarter. These decreases were partially offset by an increase in salary and employee benefits of $227,000, mostly due to salary and incentive compensation increases and a $172,000 increase in data processing fees due to increased IT outsourcing costs. Slide 13 shows trends in the key components of our income. Compared to the linked quarter, base net interest income decreased $161,000 due to a $466,000 decrease and interest income from the SBA division loan portfolio, which was due to fee recognition from payoffs in the linked quarter. This was partially offset by a $357,000 increase in base net interest income in the LASG portfolio compared to the linked quarter due to higher average balances and rates earned in this portfolio. Transactional interest income from the purchase loan portfolio decreased by $31,000 compared to the linked quarter. The purchase loan portfolio had a yield of 9.8% in the current quarter compared to 9.7% in the linked quarter. Interest expense also decreased by $45,000 from the linked quarter. The decrease in net interest income from the comparable prior year quarter is largely attributable to a decrease in interest income from short-term investments given the lower average balance and rates earned on these investments, which was mostly offset by an increase in interest income from the LASG portfolio. as a result of increased average balances which was then partially offset by a decrease in rates earned from the comparable prior year period. The 9.8% yield on the purchase portfolio in the current quarter is down from 10.3% in the comparable prior year quarter. Due to less transactional interest income along with loans purchased at lower rates and thinner discounts over the past year paired with a higher average balance which requires higher interest and transactional amounts to be recognized to maintain higher returns. Non-interest income increased by $161,000 over the linked quarter, while non-interest income decreased by $208,000 from the comparable prior year quarter. The increase from the linked quarter is primarily a result of an increase of $316,000 in gain on real estate owned, partially offset by a $133,000 decrease in bank-owned life insurance income, resulting from a death benefit gain recognized in the linked quarter. The decrease from the comparable prior year quarter is due to a $638,000 decrease in gain on sale of SBA loans, partially offset by a $338,000 increase in gain on real estate owned and a $108,000 increase in gain on residential loans. Slide 14 provides additional information on trends in yields, average balances, and our net interest margin, which is 5.6% in the current quarter as compared to 5.7% in the linked quarter. and 5.3% in the comparable prior year quarter. As previously discussed, the net interest margin, which decreased from the linked quarter, is largely driven by a decrease in net interest income from lower SBA interest income resulting from the recognition of fee income related to payoffs during the linked quarter. The average balance of loans for the current quarter was $946 million as compared to $951 million in the linked quarter due to lower average balances in the SBA Community Banking and LASG originated divisions partially offset by growth in the LASG purchase portfolio and compared to $910 million in the comparable prior year quarter due to growth in the LASG portfolio partially offset by decreases in the SBA and Community Banking divisions from the comparable prior year quarter. Slide 15 provides a snapshot of our asset quality metrics. Compared to the linked quarter, non-performing loans to total loans has increased to 1.88% from 1.51%, and non-performing assets to total assets has increased to 1.76% from 1.43%. The increase in non-performing loans is primarily due to one LASG originated loan totaling $2.7 million and three LASG purchase loans totaling $2.1 million that were placed on non-accrual during the quarter. These loans are well secured and in the process of collection. In the top right-hand corner, classified commercial loans were $12.4 million as of December 31, 2019, an increase from $11.1 million in the linked quarter. As noted in the chart on the bottom right-hand corner of this slide, annualized net charge-offs to average loan balances have remained at very low levels over the past several years and were seven basis points in the current quarter compared to the linked quarter. Our allowance coverage appears to be appropriate to address the risk inherent in our loan portfolio with slight decreases in both adjusted allowance coverage and the coverage ratio, which is primarily due to the change in the composition of the loan portfolio and management's analysis of qualitative loss factors inherent in the loan portfolio. That concludes our prepared remarks. At this time, we would like to open up the call to Q&A.