Northeast Bank

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. During the question and answer session, if you have a question, please press 01 on your touchtone phone. 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 three of the investor deck that was uploaded on our website last night. I want to comment on a few items listed on page three. First, 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 or an originated loans for the quarter. We originated a 172.9 million dollars of loans and for the year 587.8 million dollars of loans. You know that's a that's a record for us both quarter on the quarter and the end for the year. by a for the year in particular by a substantial amount. You 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 I think requires some explanation, because our yield on our loan book for the quarter on 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, 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 our loans are structured so that if there is a payoff for maturity, each loan we negotiate a minimum amount of interest that the borrower has to pay. And we had more loans. pay off 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 from loans that 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 originated long book one of 30 basis points from Q 3 to Q 4 reflecting changes in interest rates. It takes and you're thinking of that I hope that clarifies 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 Triple P loans that they purchased. For reference point, let's take a look at slide number four in the deck. And I will remind you that starting in The 4th quarter of 2020. Through the first quarter of 2022. Loan source purchased 11 point. 2 billion dollars. Triple P loans. And at the end of the. June 30, 2022. There remain 1 point. 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 a loan source earns 65 basis points on the PPP loans that they hold. And as the portfolio gets paid down, and I should point out, and we share half of that, and as the portfolio pays down, share of the income goes down and so it and the put some numbers to that it for a second we turn to us slide number 29. Trying to get to you can see that looking at the quarterly amount of correspondent fee income which is in blue on the this is on the right side of the investor deck on that page that correspond to the income we compare where it was in Q 4 of FY 21. I'm sorry we compare with Q 1 of our fiscal 22 with Q 4 Correspondent fee income went down by $4.1 million because the triple P loans were being either paid off or forgiven. And what we investors know, and we've talked about, what we need to do is 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. Punchline is we're growing our loan book, we're generating more net interest income, and we have more than offset the amount of 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 FY22 with FY21, net interest income increased by $16 million. And that's a result of that our loan book grew on our, The national lending portfolio grew by $284 million, or 30%, at the end of FY22 compared to FY21. 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... Our focus on is 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 going into this fiscal year, FY23, adding more people, probably a good number for per quarter not interest expense is around 13 million dollars for those that are doing the modeling. Also we bought back. During the quarter. I have that number for JP how much to 85 285,000 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. Just a few words on our 7 a program with no it. 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 close 26 loans for $600,000 I should say. You know we close yet 626 long 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're 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 quality, these are things that are in the report, so I'll point out I know you can read them, but 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. If you have a question, please press 01 on your touchtone phone. If you wish to be removed from the queue, please press 02. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press 01 on your touchtone phone. And our first question comes from Alexander Turtle. Please go ahead.

Hey, good morning, guys. Good morning. Hey, 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 change in interest rates. if that market has changed at all and what your expectations are for later this year.

I don't know if our operator read the forward-looking statement, so I will remind you that it's in the material. When I answer the question, 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 um a fair amount of activity in this we've also seen some of the groups that previously would have bid against us um 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 um 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 have 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 furthering increases. And also on the credit side, there's debt service coverage pressure as a result of rising rates. All of those factors are causing the market there to be some increase in activity and a lot of talk on the street of 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. Point one, point two, as a bank with really low funding costs, they're rising a little bit and will rise more. But it 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 program. 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, what 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, you know, But, you know, we'll do what it takes to carefully and, you know, underwrite both purchased and originated loans and not, you know, we won't fund, buy 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 the supply just not there? Or were you losing bids to others? Or is 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 a lot. I mean, we looked at what was available in the market in our sweet spot, 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 the market, the supply in the market last quarter was, it started to pick up toward the end of the quarter. So I don't know. I don't think it's indicative of anything other than that.

Okay. On the originated loans, the yields on the new production, just given the variable nature of those, are those yields pretty similar to the book yield that you'd have to that kind of, I think you said, six and a half core yield? Is that where new loans would be coming on as well?

No, they're coming on at... Yeah, well, in that range, you know, anywhere between, you know, between prime one and a half and two and a half. So 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's about right. Okay. It's going to go up with the rate of increases in prime. It's 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 the 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 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 reprice your deposits and everything. You know, but we're definitely not 100% beta. So, you know, while we do expect, you know, rates to go up, we expect our loans to move up, you know, 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 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 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

It's mostly, it's mostly, you know, it comes in. Well, I think there's three big buckets of that, you know, one or 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 it had 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. We needed more space and 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. 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 can help us kind of figure out where that ACL might shake in and kind of how your loan portfolio is given sort of the purchase nature of 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, our segments, you know, given the low LTDs and the minimal losses that we have in our originated portfolio. You know, where we see it increases 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 national lending originated 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 it'll just kind of be a reclassification in the balance sheet and have no capital or earnings impact at that time. So we expect the overall allowance probably won't change materially from where it is now, but kind of how we get there, there might be 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 purchase loans, post the sort of January 1 adoption date, if 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 CISO 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 annuity 7a program, I think you said you closed 26 loans. I think it was $600,000 of that's loan balance is 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 saying Alex, 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, I can say so. a reserve as well, or a provision as well.

Yes, if we were to sell those loans, they're now priced at prime 275. And currently, if one were to sell loans, these are 10-year loans at prime 275, assuming they get the same pricing as larger traditional 7A loans, today the premium's eight points. come down a little bit. It was at one time 10 or 11, maybe a little bit more, but currently it's eight. 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 you sold off, let's say it was to make the math easier, you had a million dollars of UPV on 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 annuity. And so we get 36, they get 36. We would keep the 10% that we didn't sell on our books and earn prime 275 on that. And I should have added that If there are any losses in that portfolio, we'll split that with annuity 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 percent, so we would withhold a percent and a half of annuity's share of the gain on it. I should point out for the audience, if I'm only using that million dollars to make the arithmetic easy, You know, you could, it's 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.

As a reminder, if you have a question, please press 01 on your touch-tone phone. 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 to 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.