Northeast Bank - Q3 2024

Transcript

Operator (participant)

Welcome to the Northeast Bank Third Quarter Fiscal Year 2024 Earnings Call. My name is Gigi, and I'll be your operator for today's call. This call is being recorded. With us today from the bank is Rick Wayne, President and Chief Executive Officer, Richard Cohen, Chief Financial Officer, and Pat Dignan, Executive Vice President and Chief Operating Officer. Yesterday, 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. 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 star one one on your touch-tone phone. As a reminder, this conference is being recorded. 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 risks 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. I will now turn the call over to Rick Wayne. Mr. Wayne, you may begin.

Rick Wayne (CEO)

Thank you. Good morning, and thank you for joining our investor call. With me are Pat Dignan, our Chief Operating Officer, and Richard Cohen, our Chief Financial Officer. This morning, after I have my comments, Richard will discuss income and expense items as well as our at-the-market offering, and Pat will discuss in more detail our purchased and originated loan activity. After we have all presented, we would be happy to answer any questions. I'd like to first turn to page three in the investor deck and highlight a few items. First of all, big picture, we thought it was a very strong quarter. We had net income of $13.9 million or $1.83 of earnings per share. Our ROE was 16.45%.

Our ROA was 1.87%, and our NIM was 5.01%. Finally, the tangible book value was $44.11 at the end of the quarter. First, I want to talk about loans, and as I said, when I'm finished, Pat will fill in a lot more details, but I want to provide an overview. For the quarter, we originated $153 million of loans, and there were no purchase loans in the quarter. But with respect to the purchase loans, of course, there is a story behind this, which Pat will explain. It's not, it's not bad news, it's good news, but Pat will talk about that. The purchase volume, I would point out, is typically lower in the first quarter of each calendar year.

For FY 2023, it was $21.5 million. I'm comparing the same quarter, I should be clear on that, because we're at June 30 year-end. And for the same quarter, the first calendar quarter of 2022 was $23.9 million. So both of those are relatively small numbers. In part, there's not the same urgency for sellers in the first calendar quarter when there's been a lot of activity in the fourth calendar quarter, which was the case for us. I also want to talk about the originated loan book in a little bit more detail. Out of the $153 million of originations in the quarter, $143 million or 93% were in our Lender Finance program.

That is to leverage non-bank lenders in their lending, which we, we really like, that part of our originated portfolio. They're all floating, either tied to SOFR or Prime. Most of them have floors, and the weighted average of that new production, where rates are now, is 9.3%, which is quite strong. The lender finance portfolio, and now I'm gonna talk about our whole portfolio, at March 31 was $532 million, of our originated loans, representing a 63% advance rate against our borrower's loan balance, and a weighted average loan to value of 44% against the underlying collateral. Obviously, quite strong with low LTV and low advance rate.

We have the underlying borrower, our borrower, all in the collateral, all in the capital stack, providing protection to our loans. I also wanna point out something that we don't talk about that often, but it's worth noting, is that in our purchase loan business, because we're buying at a discount, generally because of interest rate adjustments and occasionally because of credit adjustments we have a lot of discount on our books. We have, at March 31, $174 million of accretable discount on our purchase loan book.

Just to remind you, accretable discount we bring into income over the life of the loan, and we have almost $18 million of allowance on the purchase loans, which to the extent we collect that, which typically we collect a fair amount of that, will come into income through the allowance. And so that's the combined about that is about $191 million. $2 million of accretable discount and allowance we have on our balance sheet, which bodes well for us. You know, the other point is, this is kind of good and bad. The very nature of our originated loan booking, loan book and our activity is primarily are bridge loans.

They have a weighted average life, at least historically, of 1.6 years, so it's short. The benefits of that kind of lending are we get very premium pricing for it, but there's not that much competition for banks doing the kind of bridge lending that we're doing. That's very good. Second benefit is because it pays off so early, we have a freshness to our existing loan book because it's turning. And I have some data on that. For fiscal year to date, so for nine months, we originated a total of $285 million of loans, and we had $297 million of pay downs.

So that means a lot of that portfolio is paying off, and we're replacing it with loans that have just been underwritten more recently. I would point out that normally our originated loan book grows. In this case, since beginning of the year, it has decreased, as you can see from the $285 million of originations versus $297 million of pay downs. You know, that is not what we expect to happen longer term, and Pat will talk about the originated loan activity to amplify that point. Finally, before I turn it over to Richard, I wanna talk about asset quality. Our non-performing loans in the quarter decreased from 118 basis points to 105 basis points.

And the allowance to gross loans has decreased from 1.06% to 0.98%. The charge-offs in the quarter were a total of twenty basis points, excuse me. But 15 basis points of that was just CECL-related. When CECL was adopted, we, under the CECL rules, we needed to gross up some of our our purchased loans, and then have an allowance for the amount that we grossed it up. So for example if we bought a loan that was, say, a $50,000 loan, but we didn't pay anything for it in the pool bid, pre-CECL, we would have carried that at zero. Post-CECL, we show the loan at $50,000, with a $50,000 allowance.

So with respect to 15 basis points of the charge-offs, they are, in my example, attributable to the gross up of the loan and the allowance was set up. So the charge-offs, as you would normally think of it against our principal, was 5 basis points. And I think with that, Richard?

Richard Cohen (CFO)

Great. Thank you very much, Rick. We're gonna run through a few items, as Rick mentioned, the net interest income, the cost of funds, the non-interest expense, and a discussion about the ATM offering. From a net interest income perspective, the bank generated in the third quarter $36.5 million of NII. That $36.5 million included $1.2 million of transactional income. In other words, if you exclude that transactional income, the base NII was $35.3 million, and that is higher than we've seen in historic quarters. The key reason for the NII was the larger balances that generated that yield. The yield on the purchase book was 8.7%. On the originated book was 10.1%, giving us a weighted average yield on national lending of 9.22%.

If we then take a look at the cost of funds, which then generated the net interest margin that you heard Rick speak about, being 5.01%, the cost of funds was 4.23% on a weighted average basis. That is up 15 basis points compared to the second quarter, and you can refer to slide 15 if you want to get a sense of that. We had a change in the mix of deposits in the bank in the third quarter. We had an increase in our term funding and a corresponding decrease in FHLB borrowing. Let me break that down quickly. Our brokered certificates of deposit, the BCDs, were up $132 million, whereas the FHLB borrowing was down by $96 million. That was a deliberate effort by us to increase our off-balance sheet capacity.

Turning now to non-interest expense. The non-interest expense for the quarter was $16.4 million. There are two key components to that. The key change that was that you'll notice is there was a $1.05 million accrual for the incentive compensation. That was a true-up because of our expectation on the annual total, and we accrued three quarters of the total annual expense. Ordinarily, we take that true-up in the fourth quarter. If you strip out that $1.05 million, you're left with non-interest expense of $15.4 million, which is the comparable non-interest expense in comparison with prior years. Turning now to the ATM offering. You'll recall that that is the bank selling shares in order to raise capital in the market. For the quarter, the bank sold 180,000 shares.

That generated proceeds per share of $52.34, and the total dollar proceeds from the ATM in the third quarter was $9.4 million. The impact of that on our tangible book value was $0.31 per share. The reason for the ATM is that we believe there are significant opportunities to both originate and acquire loans, given the current level of activity in the market. Those sort of transactions are typically lumpy, as has been mentioned before, and we see the ATM as one of the tools we have available to us to enable us to achieve our business objectives. I'll now turn over to Pat Dignan.

Patrick Dignan (COO)

Thanks, Richard. Despite no loan purchases last quarter, there's really nothing unusual about the quarter. As Rick pointed out, the first calendar quarter is generally slow on the purchase side, as most sellers are really not focused on balance sheet repositioning that earlier in the year. Having said that, we did review several opportunities that are rolling into this quarter, and we have confidence that there'll be meaningful volume in the fourth quarter. And we're confident that if you look at the entire fiscal year, we'll have a very strong year for purchase loans overall. Moreover, if interest rates remain at these levels, we expect purchase loan opportunities will increase in the second half of this year.

On the originated side, the past two quarters were slower than normal due to less transaction volume generally, mostly due to large disagreements on value and also because of high interest rates. There's also a more conservative posture on our part, especially around cap rates. Transaction volume appears to have picked up, as evidenced by increased volume in CMBS, most likely due to growing confidence in the market. There's a lot of new capital in the lender finance space, creating increased competition. The silver lining through this is that there's an increase in the need for bank leverage. Of our total originated volume this quarter, 90% was in the lender finance space, and the vast majority of this volume will continue to grow into the next quarter. Rick?

Rick Wayne (CEO)

Thank you, Pat. Thank you, Richard. Now we will turn it over to you for any questions that you might have.

Operator (participant)

Thank you. We will now begin the question and answer session. If you have a question, please press star one, one on your touchtone phone. If you wish to be removed from the queue, please press star one, one. If you are 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 star one one on your touchtone phone. Our first question comes from the line of Alex Twerdahl from Piper Sandler.

Hey, good morning, all.

Rick Wayne (CEO)

Good morning, Alex.

Alex Twerdahl (Managing Director and Senior Research Analyst)

First, Pat or Rick on that last point, Pat, that you were making on the need for bank leverage, and I think you said something about as it related to pickup and CMBSs. Can you just go into that and explain exactly what you mean by the additional need for bank leverage there?

Patrick Dignan (COO)

Well, there's just been a lot of capital being raised by non-bank lenders to get into the real estate space, coupled with just fewer transactions overall. Those non-bank lenders need to be very, very competitive on rate, and so leverage helps them do that. And so that's been good for us.

Alex Twerdahl (Managing Director and Senior Research Analyst)

All right, thank you for spelling that out for us. So on the originated activity this quarter, I guess, just starting on the originated activity this quarter, and I guess, as I look at the yields, the yields overall were over 10%. I think, Rick, you mentioned the weighted average production was 9.3. So is there something in there, some acceleration of interest that pushed those yields higher this quarter?

Rick Wayne (CEO)

Well, I gave the number, for the 9.3 was for what we booked in the quarter. The overall number, let me just get, of the 10% is that includes our whole portfolio. So we have some loans that are higher. And for this quarter's production we didn't have any transaction, any acceleration of any of that as we have. So if you look at on the slide in the book number 22, Alex, in the originated column, this is now our whole portfolio. So you can see that the regularly scheduled interest and accretion on the whole book is 9.66%. And so, this is really back-of-the-envelope math.

If we have this quarter, we did $153 million at 9.33% or 9.31%, rather. The other part of the legacy portfolio coming into the quarter was probably more like 9.70% or 9.80%, 'cause it was more of the portfolio, and the rate was higher. But what we didn't have for the number I quoted was any accelerated accretion because we just booked it. And you can see that for the whole portfolio, there was 43 basis points, which took the 9.66%-10.09%. For all the others that are listening, that's a lot of numbers I threw out. I think if you look at page 22 of our slide deck, that will, that'll be clear for you, hopefully.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Okay, appreciate that. And then when you talked, you alluded to some opportunities out there for loan purchases in the coming quarters. Could you just remind us sort of where your appetite is in terms of loan sizes, loan pool sizes both in terms of and maybe kind of overall purchase capacity, both in terms of the capital and capital constraints, and then also just in terms of just the, sort of the capacity with your current workforce to be able to manage through some of that stuff.

I know that's a several-part question, but I think there's been a lot more conversation about some big pools being potentially sold in the near term, and so we just wanna be able to make sure we're lining up what your appetite is with what other people are talking about as well.

Rick Wayne (CEO)

So my next comments will be, and the numbers will be rounded. I don't have those exactly in front of me, although we have them. But so we have about $550 million-$600 million of the loan capacity now, if we were to leverage our capital to a level that we were comfortable with. And that, of course, gets increased as we, if we were to sell stock under our at the market or the ATM offering that we have out there, and of course, also increased by earnings every quarter as well.

So we have a lot of room to, without raising a lot more capital, outside of the ATM, for example, just kind of where we are to put a lot more purchase loans on our, on our balance sheet. In terms of what we'd like, we're not limited, particularly by pool size, subject to what I just described as our overall current limit, our overall loan capacity. When we look at loan pools, it's more we look at them loan by loan. We have both a legal lending limit in terms of the size of the loan under Maine law of 20% of total capital, but we never get that close.

With that, our house limit is more like 10% of that number. But our sweet spot on purchased loans are anywhere. It's a big sweet spot call it $1 million to call it $10 or $12 million. Occasionally, we have a larger one, and sometimes we have smaller ones, and we have a slide in the book on page 7 that makes the point. Now, this is for all of our lending. It shows that only 17% of our loan book are loans that are $15 million or more. And so, I mean, 83% of our loan book is less than $15 million, and only 8% is between $10 million and $15 million. So I'll say it another way.

75% of our loan book are loans that are less than $10 million, with a big chunk between $2 million and $6 million and under $2 million. In terms of the kind of loans that we look at we're looking for performing loans. We're looking for loans that are generating sufficient cash flow. We have a preference for loans that are in liquid markets, so that if we ever have to take back the collateral, which is rare, that there's a market for those. We generally stay away from construction and way away from construction loans or land loans, or development loans, or the things where there's historically been a lot of risk for that.

You know, our portfolio is, well, we're in 44 states, and we keep track of that, but don't ask which states we're not in, please, but we do keep track of it. You know, our biggest concentration is in New York, followed by California, followed by Florida and New Jersey, but then we're around in a lot of other states. And we also on purchase loans we get whatever the interest rate and the structure of the loan is when we acquire it. That's a lot of information on your question. I hope it was relevant information now that I've given you all that to what your question is.

You didn't ask exactly about this, but I want to just amplify a little bit Pat's comment about no volume in Q3, but there were transactions we were knee-deep into that have rolled into Q4. So we're expecting, of course, but the caveat is not done till it's done. We would expect meaningful volume in our fourth fiscal quarter or the one that we are currently in.

Patrick Dignan (COO)

The last part of your question was on staffing, and I just add Rick's comments-

Rick Wayne (CEO)

Thank you.

Patrick Dignan (COO)

That we're fully staffed on the lending side. We have capacity to absorb more volume if we can find it.

Rick Wayne (CEO)

A lot of operational leverage on that. Thank you, Pat, for pointing that out.

Alex Twerdahl (Managing Director and Senior Research Analyst)

If there was another billion+ purchase like we saw a couple of years ago if that would be absorbable in the current staff, and it sounds like the answer is probably.

Rick Wayne (CEO)

That's not probably. It's, yes. Subject to adding maybe one or two people, but I don't want to have any. First of all, I'm not suggesting at all, I'm just responding to your million-dollar question, billion-dollar question, that as Pat said, we have a lot, we have a lot, we have a lot, we have a lot of people here already and maybe some and more entry-level folks to help with part of it, but there's a lot of operating leverage. And you can—this is what I was gonna say, you can do the arithmetic. I don't want to say anything about that, Alex, but what that would mean to put $1 billion of loans on the books with moderate non-interest expense increases.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Yeah. Understood. Back to the comments on the ATM and the comment of significant opportunities. Is the ATM and the amount that you raised, was that kind of a specific amount in order to kind of be able to just sort of have that capital on hand? Or is that more testing the market to see how quickly you could bring it in, should you need it, or maybe just a little bit more on the thought process around utilizing that channel and the timing that you used it?

Richard Cohen (CFO)

Alex, I can speak to that. So, there was no specific target. What we were trying to do was to utilize the ATM at sensible volumes over a sensible period of time. So we didn't set out to deliver a very specific target or to achieve a very specific price. It's a long-term program. We utilize it when the opportunities seem appropriate to us.

Rick Wayne (CEO)

Alex, just going back to the kind of the hypothetical you had suggested. If there were a $1 billion portfolio and our capacity is currently $600 million before we we earn money each quarter and we wanted to do that, that would require us to go out absent the AT, building up our capital slowly with the ATM, to go out and raise capital for that transaction, which we would prefer not to do with any urgency around it, as opposed to gradually building up our capital. Our view is that, we will utilize that capital. I'm not saying we're gonna utilize it this quarter or next quarter, but we think it's when where our stock price is today seems like a reasonable idea to do it in moderate amounts. We were approved for $50 million and last quarter, we purchased how much, Richard?

Richard Cohen (CFO)

$9.4 million.

Rick Wayne (CEO)

We used $9.4 million of it, and I wanna say we had about $9 million before that, so we have about $32 million left, so we're doing it moderately. I should point out, I'm not saying we're going to spend it sell stock this quarter. It really depends on a host of factors, but that was our thinking for the last quarter.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Yeah, understood. Then going on to expenses, and Richard, you mentioned about $1.05, I think you said, true up in accrual that normally would happen in the fourth fiscal quarter. So should we expect going forward, to see a more, I guess maybe like a steadier level of expenses? Normally, we see that fourth fiscal quarter of like a pretty decent increase in salaries, and then it kind of take back down in the first fiscal quarter. Is that not gonna happen this year?

Rick Wayne (CEO)

Well, I think that we will have in the fourth quarter, there will be still money that we accrue. We accrue money for our incentive comp all year round. It's just as we get later into the quarters, we take a look at how well the bank is doing and whether we think when we look at those that are gonna get incentive comp, which incidentally we pay bonuses to everyone in the bank. You know, some more and maybe much more than others. But as we get closer to the end of the year, so we were looking at what we thought we needed in March, so that's nine months into the quarter. So we added to it for this quarter.

I would expect that, no guarantees on this, but we're not gonna have the true up in the fourth quarter, nearly as large as we've had in prior quarters. So let me just try and put some numbers to make sense of all that for you. So normally, if you take out the $1 million, the non-interest expense is $15.4 million, right? That's the number that we had, I think, in the preceding two quarters, more or less, same number. That's kind of our run rate currently before we put in more money for incentive comp, but we don't know really how much we need until we move further along the year. I was wrong.

I'm looking at the chart now. It's 15.7 in the last quarter and 15.4 this quarter, and it was 15.4 in our first fiscal quarter. So I would think about that as a number, and then we'll see what the fourth quarter looks like, but we just thought it made sense to true up a meaningful portion of it in the third quarter.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Yeah. Okay, that makes sense. And then just final question for me, the SBA business, it seems like it's got the engine starting to rev up again, seeing a nice growth rate in originations and sales volume there. Can you just talk a little bit more about expectations and outlook and thoughts around that segment?

Rick Wayne (CEO)

Well, you're right that it's revved up. We did about $30 million of originations in the March 31 quarter. Of course, this has been a very slow build. You know, we started this about two and a half years ago. And at the time, I said, which I will repeat, I don't want to set expectations high on this. But it is, it's building, and we would expect it will continue to build, I'm sorry to do this to you, Alex. I know you'd like a better number than this. It's probably reasonable to assume that the path that we're on now will continue, and how much more it will be we'll see. Sorry about that unclear answer.

Patrick Dignan (COO)

Imprecise answer.

Alex Twerdahl (Managing Director and Senior Research Analyst)

It's been a line that's been all over the place over the last five or 10 years, so, I'm not gonna hold you to anything, but we will include it in our model. That's, that's all my questions for now. Appreciate the time, and, I'll get back in the queue.

Rick Wayne (CEO)

Thank you, Alex.

Operator (participant)

Thank you. If you have a question, please press star one one on your touch tone phone. If you wish to be removed from the queue, please press star one one. We have no further questions at this time. Now, I will turn the call over to Rick Wayne for closing remarks.

Rick Wayne (CEO)

Thank you. Thank all of you on the call and thank all of you who will listen to the call after this, which you can find this on our website. We will talk again in July. Thank you all.

Operator (participant)

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