Northeast Bank: The Correspondent Fees Provide A Nice Earnings Boost

Summary

• NBN is posting very strong quarterly results as its structure to sell PPP loans and earn a service fee was a solid move.
• This will keep the earnings at an elevated level for 1-2 more years.
• The loan book is very well-run with an average LTV ratio of just 51%, which is very low.
• This is a very intriguing regional bank, and I'm adding it to my watch list.
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Introduction

Northeast Bank (NASDAQ:NBN) is a Maine-based bank with a history dating back to 1872. Sticking around for that long usually means a bank knows quite well what its limitations and core strengths are, and Northeast Bank’s balance sheet definitely appears to be more conservative than its peers as the LTV ratio is relatively low. On top of that, its earnings are temporarily boosted by a correspondent fee agreement which will allow Northeast Bank to report additional non-interest income in the next few years.

Data by YCharts

A very strong performance in H1 FY2021 – thanks to a non-recurring item

In the first six months of its FY 2021 (which ends in June), Northeast Bank reported an interest and dividend income of $36.8M, almost 10% lower than the $40.75M generated in H1 FY 2020. That’s not a reason to be concerned as the total interest expenses decreased by about 30% to $6.5M and this allowed the bank to keep the decrease of its net interest income relatively low: it decreased by just $0.9M.

Source: SEC filings

Additionally, the bank reported a total non-interest expense of just around $7.5M which is substantially lower than the $17.6M non-interest expense generated in H1 2020. What happened?

As you can see in the income statement, the net earnings were boosted by the so-called correspondent fee. Northeast Bank has been selling the PPP loans it issued to its customers. By selling the loans, Northeast Bank is generating a capital gain (but is obviously giving up on the recurring stream of interest income from these loans). Additionally, the parties that are buying the PPP loans aren’t just buying those loans from Northeast Bank. They have been purchasing loans from other sources as well, but Northeast Bank will act as the correspondent which means it’s eligible to earn a fixed fee (which will be spread out over several quarters) while the bank also receives 50% of the net servicing income on those PPP loans.

Source: company presentation

That’s an excellent arrangement and agreement as this allows Northeast Bank to immediately book profits on generating and selling the PPP loans, while its correspondent status also helps to earn a steady stream of income. That being said, although we can expect the correspondent fees to hit the income statement for the next 12-24 months, we shouldn’t consider these extra revenues to be recurring. It will provide a great boost to the earnings in FY 2021 and FY 2022, but investors are warned that the correspondent fee income will likely continue to decrease over time.

Taking these elements into consideration, Northeast Bank generated a pre-tax and pre-loan loss provision income of approximately $21.5M and a net income of just under $16M which includes a total loan loss provision of just $742,000. The EPS in the first half of the current financial year came in at $1.94 which is an excellent result, but again, the strong EPS was fueled by elements we can hardly consider to be long-term recurring contributions.

The loan book appears to be quite safe due to the very low LTV ratios on the real estate assets

I was very surprised to see Northeast Bank, which has a balance sheet size of in excess of $1.2B, only had to record less than a million dollars in loan loss provisions. Although the worst of the COVID pandemic seems to be behind us, let’s not forget the company’s H1 results comprise the period of July 1^st until December 31^st, so one could reasonably have expected to still see some elevated provisions.

Source: SEC filings

Looking at the asset side of the balance sheet (above), we see that about 15% of the assets are invested in very liquid assets: cash, short-term investments and available-for-sale securities. So my main focus was on the $992M loan book which seems to contain an awful lot of commercial real estate and other commercial and industrial loans.

That being said, the vast majority of the loans remains current. Of the $1B in loans (pre-loan loss allowances), only $23.1M is past due.

Source: SEC filings

That’s still quite interesting as the bank is adding just $0.74M in loan loss provisions although the total amount of loans past due has increased by almost $7M in the first half of FY 2021.

The explanation is pretty simple: the market value of the collateral of the $23M in loans is close to $50M so even if the loans default and the bank has to seize the assets, it expects to keep the losses very limited, as the average Loan-To-Value ratio of the main portfolio is very low.

Source: company presentation

The average LTV ratio is indeed just 51%, and this means the loans are quite qualitative. Even if the borrower defaults, odds are the bank will be able to recoup its entire outstanding amount.

Investment thesis

2021 and 2022 will be excellent years for the Northeast Bank as its strategic partnership with the purchasers of PPP loans will boost the earnings in 2021 and 2022. While this stream of additional income will eventually run dry, Northeast Bank will be able to use the tens of millions of dollars it will earn during this period to further expand its own balance sheet.

I am charmed by the bank’s conservative approach and the low LTV ratio makes it one of the safer banks out there. While the correspondent fees will decrease, going forward, I am also charmed by the relatively conservative balance sheet and LTV ratios. I currently don’t have a position in Northeast Bank, but I am adding the bank to my watchlist.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.