Northeast Bancorp (NASDAQ:NBN) Q7 2017 Earnings Conference Call January 31, 2017 10:00 AM ET
Rick Wayne - President and CEO
Brian Shaughnessy - CFO
Jeff Kitsis - Sandler O’Neill
Good day, everyone. And welcome to the Northeast Bancorp Fiscal Year 2017 Second 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 Brian Shaughnessy, 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 the 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 information for the Northeast Bancorp. Such information constitutes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which involve significant risks and uncertainties. Actual results may differ materially from the results discussed on the 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. I am Rick Wayne, the Chief Executive Officer of Northeast Bancorp; and with me on the call is, Brian Shaughnessy, our Chief Financial Officer and Treasurer.
I'd like to start with an overview of the quarter. We are very pleased with our operating performance for this quarter, not only that we surpassed $1 billion in assets, but after the close of the market yesterday we announced record earnings with quarterly net income of $3.1 million, or $0.35 per diluted common share. Earnings for the quarter were positively affected by a strong loan growth and larger average balance sheet. Transactional income from LASG purchase loans and gain on sale of SBA loans originated by our SBA division.
Turning to Slide 3; bank-wide, for the quarter, we generated $139.9 million of loans, including $46 million of purchased loans and $45.7 million of originated loans in LASG; $22.9 million in our community banking division, and $25.3 million in our SBA division while generating a net gain of $1.7 million on the sale of $17.5 million of SBA loans. Our purchase loan yield for the quarter was 13.01%, which included $2.9 million of transactional interest income.
Year-to-date, the Company has generated $239.1 million of loans, which included 59.9 million of loans purchased, 88 million of LASG loans originated, $50.7 million of community bank originations and 40.5 million of SBA originations. Year-to-date, the Company has sold $24.8 million of SBA loans and the purchase loan portfolio has yielded 11.7%. Earnings, year-to-date are $4.9 million with earnings per share of $0.54.
Turning to Slide 4, as we've discussed in the past under regulatory commitment made in connection with the 2010 merger, purchased loans are limited to 40% of total loans. Loan purchasing capacity was 91.6 million at December 31st. Loan purchase capacity increases or decreases depending upon the relative amount of purchased and originated loans on our balance sheet at any 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. At December 31st, capacity under this condition was $146.2 million. It is important to note that owner-occupied commercial real estate is not subject to this regulatory condition; owner-occupied commercial real estate is, generally speaking, real estate collateral used in the business of the borrower.
SBA loans secured by commercial real estate are typically considered owner-occupied for purposes of this regulatory condition. We have been focused on loans to borrowers with owner-occupied real estate collateral, with a $222 million portfolio at December 31st, an increase of 57% over the prior 12 months.
Moving onto Slide 6; of the 91.7 million invested by LASG for the quarter, 46 million were purchased loans and 45.7 million were originated loans. Purchased loans for the quarter have unpaid principal balances of $51.1 million, representing a purchase price of 90.1%. Since the merger in 2010, LASG has invested an aggregate of $984 million consisting of $548 million of purchased loans and $436 million of originated loans.
I would like to briefly comment on what we saw in the small balance performing commercial loan purchase market during the past quarter. As I noted, we purchased loans at an invested amount of 46 million, and an unpaid principal balance of 51.1 million. During the past quarter, we reviewed loans with approximately $431 million of unpaid principal balances and bid on loans with approximately 88 million of unpaid principle balances.
Of interest in this quarter with purchases of UPB of 51.1 million, this represents a successful bidding percentage of 58%, which is in line with previous quarters. As I have said before, we remain disciplined in our selection, underwriting, and bidding on loan pools and singularly focused on building a quality portfolio.
Moving on to Slide 7; at the end of the quarter the discount on purchased loans was $33.5 million, as compared to $32.4 million at September 30. The change is primarily due to $46 million of purchases offset by approximately $29 million of purchased loan pay-offs and pay downs in the quarter.
Purchase loan pay-offs generated $2.9 million of transactional income. Approximately 83% of the $33.5 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 collectible.
Turning to Slide 8, we provide details on returns from the LASG portfolio. For the quarter, the purchase portfolio generated a total return of 13%, reflecting transactional income of $2.9 million from unscheduled loan pay-offs, which was above the average of $1.6 million of transactional income for the prior four 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 returns of 5.89% in the quarter. In addition, you will note a yield of 0.99% on secured loans to broker-dealers, as interest on these loans increased during the current quarter.
Turning to Slide 9, we provide some statistics on the LASG loan portfolio as of December 31. Of significance, as noted in the chart in 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 $694,000 with the largest individual loan of $12 million. 77% of the portfolio consists of loans with an investment size of less than $4 million.
The loan portfolio has a diverse collateral type, primarily focused on industrial, retail, hospitality, multifamily, and office. By geography, the largest concentrations are in California at 17% of the portfolio and New York at 18% of the portfolio. Our collateral was geographically diverse with collateral in 37 different states.
Turning to Slide 10; for the SBA division activity, originations for the quarter were $25.3 million. 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 one quarter are sometimes sold in a subsequent quarter.
In the current quarter, we closed 25.3 million of SBA loans of which 24.7 million were fully funded in this quarter. The Company sold 17.5 million of the guaranteed portion of loans in the secondary market of which 9.3 million were originated in the current quarter and 8.2 million were originated or purchased in prior quarters. So, the quarter ended December 31st, the net gain on sale including a capitalized servicing asset was $1.7 million.
On Slide 11, we show detail of the SBA sale pipeline as it stands at December 31st. I would like to point out that these figures are a function of the timing of our SBA originations; their funding and subsequent sale. 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 at the quarter end.
Next, you will note an additional 7.1 million in the guaranteed portion of SBA loans that have closed as of December 31st but were not fully funded. The 7.1 million consists of 11 loans with an average guarantee balance of $643,000. These 11 loans have approximately 900,000 that is yet to be dispersed. In total, this represents an additional of $10.9 million in future SBA loan sales before considering any loan production in the second quarter.
And now, I would like to turn it over to Brian who will discuss in more detail our financial results, after which we will be happy to answer your questions.
Thanks, Rick, and good morning, everyone. I am picking it up on Slide 12 to provide a little more color on our financial results. As Rick noted, it was a record quarter for earnings with net income of approximately $3.1 million, or $0.35 per share. Earnings per share were up $0.16 from the linked quarter and up $0.17 from the comparable fiscal year 2016 quarter. The increase was largely driven by purchase loan transactional interest income of $2.9 million, the gain on the sales of SBA loans into the secondary market of 1.7 million, the benefit of a larger average balance sheet partially offset by an increase in non-interest expense.
Turning to Slide 13, over the past year we have seen net loan portfolio growth of $88 million, or 13%. The majority of the growth comes from our LASG portfolio with approximately 248 million of purchases and originations. As shown in this chart, in the trailing 12 month period since December 31, 2015, we have closed approximately 68.3 million of SBA loans and we have sold approximately $51 million of the guaranteed portion of these loans into the secondary market. These loan sales have contributed approximately $5.3 million to revenue in the same 12 month period.
While bank-wide loan production has been strong, increases have been partially offset by the following: a high level of pay downs in the amortization and the LASG purchased and originated portfolios, which averaged approximately $35 million per quarter over the past year, and a pay down of one secured loan to a broker-dealer of $12 million in FY 2016. Excluding this broker deal loan pay-off, the loan portfolio had net growth of approximately $100 million or 15% over the trailing 12 month period.
These results are further detailed on Slide 14, which shows the composition of net loan growth over the past five quarters. The net loan growth is primarily driven by the strength of purchases and originations by LASG which had net growth of approximately $104 million or 27% since December 31, 2015. In the current quarter loans generated by LASG totaled $91.7 million, which consisted of 46 million of purchased loans at an average price of 90.1% of the unpaid principal balance and 45.7 million of originated loans. In addition, the SBA loan portfolio has increased by $9 million as compared to the linked quarter. The increase is primarily due to funded originations of 24.7 million in the current quarter offset by 17.5 million of SBA into the secondary market.
Turning to funding on Slide 15, we have had net deposit growth of approximately $113 million, or 16%, over the trailing 12 month period. Over the past year, the majority of the growth is due to an increase in our non-maturity accounts, which consists of money market, savings, and demand deposit products. The growth in these products has strengthen our overall deposit mix where non maturity accounts represents approximately 60% of total deposits as of December 31, 2016. As compared to the linked quarter deposit growth was between time deposits and non-maturity accounts to help support our loan growth.
Slide 16, shows trends in the main components of our income. Compared to the linked quarter, the increase in net interest income before loan-loss provision is largely attributable to an increase in transactional interest income from our purchased portfolio. The purchased portfolio had a yield of 13% in the current quarter compared to 10.4% in the linked quarter. In addition, net interest income benefited from the larger average loan portfolio, which was approximately $40 million higher than the linked quarter. This increase was partially offset by an increase in our cost of deposits, which was incurred to health fund the loan growth in the current fiscal year.
These results are further detailed on Slide 17, which shows trends in total revenue and non-interest expense over the past five quarters. Compared to the linked quarter ending September 30, total revenue has increased by approximately $2.9 million, while non-interest expense has increased by approximately $400,000. As noted previously, the main components of this change are primarily due to the following. An increase in transitional interest income from our purchased portfolio of $1.6 million and increase in base net interest income of approximately $440,000, due to the benefit of larger average balance sheet and finally an increase in the gain or sale of loans from a SBA division of approximately 1 million.
The increase in non-interest expense has compared to the linked quarters primarily attributable to the following. An increase in loan expense, which is largely driven by loan purchasing volume and loan collection in the period, an increase of $220,000 related to the quarterly valuation of SBA serving rights, offset by a decrease in the required FDSE deposit insurance premiums for small financial institutions.
In regard to the quarterly valuation of SBA serving rights, we have continued to refine our assumptions in our SBA servicing portfolio, as the portfolio is grown and seasoned over the past two years. In the current quarter, we reside our portfolio with the cost of servicing of 40 basis points, which we believe it's consistent with other institutions that service SBA loans. This activity has helped the Company achieve an efficiency ratio of 61.7% in the current quarter.
Slide 18 shows originations in the associated gains in the residential portfolio over the past five quarters. The current quarter is seasonally slower as compared to the linked quarter ending September 30th; however, the gains continue to be a positive contribution to non-interest 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 4.94% as compared to 4.07% in the linked quarter and 4.87% in the comparable prior-year quarter. As noted earlier, the increase in net interest margin as compared to the linked quarter is largely attributable to an increase in transactional interest income and due to a larger average loan portfolio.
Slide 20 provides a snapshot of our asset quality metrics. Compared to the linked quarter, non-performing loans to total loans has increased to 1.33% from 1.24% and non-performing assets to total assets has increased to 1.32% from 1.29%. The increase compared to the linked quarter is primarily due to one loan being placed on non-accrual in the current quarter partially offset by a decrease in other real-estate owned. In addition, as of December 31, 2016 pass two loans totaled 21.9 million or 2.85% of total loans compared to 9.8 million in the linked quarter. The increase in the current quarter is primarily due to two following items.
The Company purchased 26 million of loans in the current quarter and 6 million of these loans were delinquent as of December 31st. Of that amount, 4.5 million of these loans have been paid current in January. In addition, 6 million of loans to 30-days past due, as of December 31st, and 4.1 million of these loans have been paid current in January. In the top right-hand corner of the slide, it notes that classified commercial loans were $4.2 million as of December 31st, which have decreased over the past several years.
Finally, as noted in the chart on the bottom right-hand corner of the slide, net charge-offs to average loan balances have remained at low levels over the past several years and were 6 basis points in the trailing 12-months.
That concludes our prepared remarks. We would like at this time to open up the call to Q&A.
[Operator Instructions] And our first question comes from Alex Twerdahl of Sandler O’Neill. Your line is now open.
This is Jeff Kitsis filling in for Alex this morning. You guys had a big quarter for buybacks last quarter and then no reports referenced to this quarter. Was wondering if you could please update us on how you are thinking about buybacks going forward and whether you think they are still a good use of capital above tangible book value?
Well, when the Board considers buybacks of course they were looking at a few factors. One is the price of which we can buy back shares. The average price of our buybacks to date has been 10.05 even better that end where we've had opportunities to buy that really good price particularly less than tangible book we have. Our stock -- our tangible book is somewhere around 12.60. And the stock has been trading above that in the 13.75 to 14 range and even higher today. I mean that's one consideration, and I'm opining on whether the bank would buy back stock or not above tangible book, just understood, I'm not refining on that; the other part of the analysis of course is our use of capital in our business.
And we've had tremendous opportunity in the last quarter to book loans as evidenced by about $95 million of purchases and originations in LASG 25 million of SBA loans in particular and so given all of those factors, we didn't buy any availability of stock hit prices that we like, we didn't buyback any in the last quarter. So, the long winded way of saying we're doing what you would want the Board to do is analyze all of those factors and make a decision and I'm really not planning it all off what might happen in the future. We've a plan with 500,000 shares that are authorized for repurchase.
And you touched on SBA originations there. Do you think that there's any seasonality that helped create such a strong quarter this quarter, or is that more reflective of the team just hitting their stride?
We've been at this now, we started in November '14 and we've been building up both our infrastructure and the sourcing of business including a focus on generating business, not only through our business development officers, but through inside business that is customers coming and brokers coming directly to the bank. I thought 25 million was a very good number. I'm not projecting that, it'll be a linear number that it'll go from 15 as it did in the first quarter of our fiscal year to 25 to some number that's higher; with somewhat transactional you could have a loan that closes on December 28th, and of course it's counted in the December 31st quarter or it could roll over into the next quarter in which case it would count in the March 31st quarter. I'll say that we're focused on growing that business, and I do hope over a reasonable timeframe we're able to increase those numbers, all subject to the gigantic forward looking statement that was read earlier.
So it sounds like there are some timing issues that affect when the loans are booked, but less in terms of seasonality?
I'm not sure relative to the size that we're trying to book relative to volume that is out there. These 7(a) loans are many-many billions of dollars of business, and we're just a small part of it. So I'm not sure I would say that it -- the last quarter for September 30th, which started on July 1st was lower volume. But we had a fair amount of pipeline. So, I think we'll have to keep track of that as it relates to outsourcing of business to see whether or not we can comment on that.
Got it. Thank you, thank you. And another question, how much of the expense increase in the quarter do you expect to not carry over into calendar 1Q 2017?
I would say as a starting point, obviously, I'm not going to say that. None of these items are that the non-recurring; however, the big one that I pointed out related to the valuation of our SBA servicing rights in the current quarter. And as Rick mentioned, we've been at this for a couple of years now, and as that portfolio has grown and continued to seasoned on a quarterly basis where we find and reanalyze the assumptions that we used to value those servicing rights.
And in the current quarter, we continually take a look at what our own cost of servicing is and then compared to what we believe other market participants would service these loans at. And we valued our portfolio using a cost of serving of 40 basis points, which we believe is more in line with what other institution to service SBA loans will use as a cost of servicing. So, that item occurred in this quarter, one would hope that it wouldn’t happen again in the next quarter. But as I mentioned, we reevaluate and value these servicing rights on a quarterly basis. So, time will tell as we do that next quarter, but that was a charge that we took now.
I would say that I think we've indicated in prior calls that this is a little bit of a range, but our balance is growing reasonably rapidly. They are looking at expenses of $35 million to $36 million in the year, is probably a reasonable number. This quarter at nine was on the higher end of that. And as Brian mentioned, if we didn’t have the serving rights that would have saved just a couple of 100,000 bucks, which you would annualize that 800,000 which we kind get us in that range.
Over that five quarters are non-interest expense of average $8.7 million.
Thank you. [Operator Instructions] And that does conclude our question-and-answer session. Now, I will turn the call back over to Rick Wayne for any closing remarks.
Thank you all who are on the phone for your interest and participation. Hope you have found this illuminating and helpful, and look forward to talking to you at the end of the March 31, quarter. Thank you.
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.
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