Good day everyone. Welcome to the Northeast Bancorp Fiscal Year 2019 third quarter earnings results conference call. This call is being recorded. With us today from the company is Richard Wayne, President and Chief Executive Officer, and Jean-Pierre Lapointe, Chief Financial Officer. Earlier this morning, an investor presentation was uploaded to the company's website, which we'll 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, the 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, this presentation contains forward-looking statements about Northeast Bancorp.
Forward-looking statements are based upon the current expectations of Northeast Bancorp's management and are subject to risks and uncertainties. Actual results may differ materially from those discussed in the forward-looking statements. Northeast Bancorp does not undertake any obligation to update any forward-looking statements. At this time, I would like to turn the call over to Richard Wayne. Please go ahead, sir.
Good morning. 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 J.P. Lapointe, our Chief Financial Officer. Before we discuss our financial results, I would like to provide an update on the proposed reorganization announced in January 2019. As previously discussed, under the proposed reorganization, Northeast Bancorp would merge into Northeast Bank, with the bank continuing as the surviving entity. Shares of Northeast Bank's common stock would be owned directly by Northeast Bancorp shareholders in the same proportion as their ownership of Northeast Bancorp stock immediately prior to the reorganization. The board and the executive officers of Northeast Bancorp will hold the same position in Northeast Bank following the reorganization. The FDIC approved the reorganization on March 11th, and shareholders will vote on the reorganization at our shareholder meeting on May 9th.
Once completed, the reorganization will improve our efficiency by eliminating redundant corporate infrastructure and activities, and by removing a second level of supervision and oversight that comes with our holding company. Accordingly, our commitments to the Federal Reserve will no longer be applicable and will be replaced with internal standards to ensure the bank continues to operate in a safe and sound manner. Commitments made to the Maine Bureau of Financial Institutions in 2010 as to Tier 1 leverage and total capital ratios are consistent with our internal standards and will remain in place. For the third quarter of fiscal 2019, after the close of the market yesterday, we announced quarterly net income of $4.8 million, or $0.52 per diluted common share. Earnings were positively affected by strong net loan growth in the LASG-originated portfolio of $42.2 million, or 10% over the linked quarter.
This quarterly activity helped us achieve a return on average equity of 13%, a return on average assets of 1.6%, and an efficiency ratio of 57.7%. Turning to slide three. During the third quarter, bank-wide, we generated $104.7 million of loans, including $89.1 million in our Loan Acquisition and Servicing Group, or LASG. $84.5 million of which were originated loans and $4.6 million were purchased loans. Of the $84.5 million of originated loans, 88% were variable rate with a weighted average yield of 7.54% as of March 31. As we discussed previously, purchased loan volume can be lumpy, and this quarter's purchases of $4.6 million were lower than usual. At the same time, however, loan purchases of $88.7 million for the first three quarters of fiscal 2019 compares favorably with purchases of $71.5 million for the first three quarters of fiscal 2018.
We generated $6.4 million of loans in our SBA division, of which $5 million were loans secured by hotels. We recognized a net gain of $568,000 on the sale of $6.7 million of SBA loans. Net interest margin for the quarter was 5.2%, and our total return on purchased loans for the quarter was 10.2%, which included $1.9 million of transactional income. Turning to slide four. As we have discussed in the past, under a regulatory commitment in connection with the 2010 merger, purchase loans are limited to 40% of total loans. Loan purchasing capacity increased to $108.1 million as of March 31, as a result of the growth in the LASG-originated portfolio during the quarter. Loan purchasing capacity increases or decreases depending upon the relative amount of purchased and originated loans on our balance sheet at any given point in time.
If the reorganization is completed as contemplated, purchased loans could constitute 60% of total loans, rather than the current limit of 40%. Additionally, on slide five, under another regulatory commitment, non-owner occupied commercial real estate loans are limited to 300% of total capital. As of March 31, capacity under this condition was $90.1 million. If the reorganization is completed as contemplated, the limit would be 500% of total capital rather than the current limit of 300%. Moving on to slide six. Of the $89.1 million invested by LASG for the quarter, $4.6 million were purchase loans and $84.5 million were originated loans. Purchase loans for the quarter have unpaid principal balances of $4.7 million, representing a purchase price of $98.5 million. As frequently mentioned in these investor calls, loan purchasing is transactional and can vary, sometimes significantly, from quarter to quarter.
Since 2010, LASG has invested an aggregate of $1.8 billion, consisting of approximately $816 million of purchase loans and $1 billion of originated loans. During the past quarter, we reviewed loans with approximately $141 million of unpaid principal balances and bid on loans with $27 million of unpaid principal balances. Subsequently, we purchased loans with unpaid principal balances of $4.7 million at 98.5%, or $4.6 million invested. The $4.6 million invested consisted of eight loans acquired in three separate transactions. Moving on to slide seven. At the end of the quarter, the discount on purchase loans was $34.4 million, as compared to $37.7 million on December 31.
The decrease is primarily due to regularly scheduled accretion, accelerated accretion from purchase loan payoffs in the quarter, and gains from purchase loan sales, all of which generated $1.9 million of transactional income, partially offset by $4.6 million of purchases with a related $71,000 discount. Approximately 88% of the $34.4 million discount is expected to be realized over the remaining life of the purchase 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 eight, we provide details on returns from the LASG portfolio. For the quarter, the purchase portfolio generated a total return of 10.2%, reflecting transactional interest income of $1.4 million from unscheduled loan payoffs, and a $582,000 gain on a purchase loan sale.
As we've discussed in the past, transactional income realized on the purchase portfolio, as well as the amounts of loans purchased, may not be consistent from quarter to quarter. The originated portfolio generated a strong return of 7.9% in the quarter. Turning to slide nine, we provide statistics on the LASG portfolio as of March 31. Of significance, as noted in the chart in the top right, the purchase loan portfolio has a net investment balance of 90%, which is consistent with the linked quarter. On an invested basis, the average loan size for purchase loans was $400,000, and the average loan size for originated loans was $2.1 million. 80% of LASG loans had an investment size of less than $6 million. The loan portfolio has a diverse collateral type, primarily focused on retail, industrial, hospitality, multifamily, office, and mixed use.
By geography, the largest concentrations are in California and New York, with 18% and 12% of the portfolio respectively. Our collateral is geographically diverse, with collateral in 41 different states. Turning to slide 10. 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 and funded $6.4 million of SBA loans. Additionally, the company sold $6.7 million of the guaranteed portion of SBA loans in the secondary market, of which $4.8 million were originated in the current quarter and $1.9 million were originated in prior quarters. On slide 11, we show the detail of the SBA pipeline as it stands on March 31.
There was $9.7 million of guaranteed portion of SBA loans that have closed and will be fully funded in subsequent quarters, representing potential future SBA guarantee loan sales before considering any loan production in future quarters. Now I'd like to turn it over to J.P., who will discuss in more detail our financial results. After which, we will be happy to answer your questions. J.P.?
Thanks, Rick, and good morning, everyone. I'm picking up on slide 12 to provide more information on our financial results. Net income for the quarter was $4.8 million, or $0.52 per diluted common share. Diluted earnings per share were down $0.04 from the quarter ended December 31st, 2018, which I shall refer to as the linked quarter, and up $0.09 from the quarter ended March 31st, 2018, which I shall refer to as the comparable prior year quarter. The decrease of $0.04 per diluted common share from the linked quarter was due to lower interest income, which amounted to $20.2 million in the current quarter, compared to $20.3 million in the linked quarter as a result of lower transactional interest income, which was partially offset by higher average balances in the LASG portfolio.
This was further impacted by higher interest expense of $5.1 million in the current quarter, compared to $4.7 million in the linked quarter as a result of higher funding costs. The provision for loan losses amounted to $414,000 in the current quarter compared to $101,000 in the linked quarter due to changes in the composition of the loan portfolio. Gains on sale of SBA loans amounted to $568,000 during the current quarter compared to $942,000 in the linked quarter due to fewer sales of SBA loans. Partially offsetting these decreases was an increase in the gain on sale of other loans, which amounted to $582,000 during the current quarter, compared to zero in the linked quarter. Additionally, non-interest expense amounted to $9.8 million during the current quarter compared to $9.9 million in the linked quarter, primarily due to decreases in professional fees and impairment charges on servicing assets.
The effective tax rate for the current quarter was 28.3%, compared to 28.7% in the linked quarter. The increase from the comparable prior year quarter of $0.09 per diluted common share was due to an increase in interest income of $3.7 million due to an increase in average balances on loans and higher rates earned, partially offset by a decrease in transactional income. This increase was offset by higher deposit funding costs, which increased by $1.8 million due to higher average balances and increased rates offered, and an increase in non-interest expense of $777,000, primarily due to increased salary and employee benefit costs and increased loan acquisition and collection expenses incurred. Turning to slide 13. Over the past year, we have seen net loan portfolio growth of $145.3 million, or 18%.
The majority of the loan growth over the last 12 months comes from our LASG portfolio, with $427.3 million of purchases and originations. As shown in the chart, in the trailing 12-month period, we have closed $63 million of SBA loans and sold $47.5 million of loans, of which $42.7 million were the guaranteed portion of SBA loans. While bank-wide loan production has been strong over the trailing 12 months, increases have been significantly offset by paydowns and amortization in the purchase and originated portfolios, which amounted to $300.3 million over the trailing 12 months. These results are further detailed on slide 14, which shows the composition of the loan portfolio over the most recent five quarters. The net loan growth over this time is primarily driven by the strength of the LASG portfolio, which had net loan growth of $161 million, or 25% since March 31st, 2018.
In the current quarter, LASG originated $84.5 million of loans and purchased loans with a recorded investment amounting to $4.6 million. Turning to funding on slide 15. In order to fund loan growth, we have had net deposit growth of $41 million, or 4% over the trailing 12-month period. Over the past year, time deposits have seen significant growth 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 but remains high at 47% as of March 31st, 2019 as compared to 68% as of March 31st, 2018. Slide 16 shows trends in the main components of our income.
Compared to the linked quarter, base net interest income increased $135,000 due to higher average balances in the LASG portfolio, along with higher rates earned on our loans as the majority of our LASG originated portfolio is tied to Prime Rate. Base interest income increased $595,000 due to the increase in the average balance of the LASG portfolio and the increase in Prime Rate, which was then offset by decreased transactional income and increased funding costs, which increased $460,000 from the linked quarter. Transactional interest income from the purchased loan portfolio decreased by $745,000 compared to the linked quarter. The purchased portfolio had a total return of 10.2% in the current quarter, compared to 10.3% in the linked quarter.
The increase in net interest income from the comparable prior year quarter is largely attributable to an increase in base net interest income of $2.6 million due to higher average balances in the LASG and SBA portfolios, and higher rates earned on the loans in these portfolios, with a decrease of $738,000 in transactional interest income from the purchased portfolio. The 10.2% return on the purchased portfolio in the current quarter is down from 12.2% in the comparable prior year quarter due to lower transactional income offset by an increase in regularly scheduled interest and accretion. The lower purchased loan yield was more than offset by the higher average balances in the current quarter as compared to the comparable prior year quarter. Compared to the comparable prior year quarter, base interest income increased $4.4 million, while funding costs increased $1.8 million.
Non-interest income increased by $321,000 over the linked quarter, primarily due to the $582,000 increase in the gain on sale of other loans related to LASG purchased loans that were sold during the quarter. An increase in fees for other services to customers related to charges taken during the linked quarter in commercial loan servicing fees as a result of the write-off of servicing assets for SBA loans that paid off, offset by a $374,000 decrease in the gain on sale of SBA loans.
Non-interest income is down $16,000 from the comparable prior year quarter, primarily due to a $119,000 decrease in the gain on sale of residential loans due to lower volume sold in the current quarter and a $27,000 decrease in fees for other services to customers due to lower deposit fees and commercial loan servicing fees, partially offset by a $66,000 increase in the gain on sale of other loans and a $65,000 increase in unrealized gains on equity securities. 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, total revenue has decreased by $289,000 due to decrease in net interest income caused by lower transactional income and higher funding costs, partially offset by an increase in base interest income and non-interest income.
Non-interest expense decreased by $151,000 from the linked quarter, primarily due to decreased professional fees and an impairment charge on the servicing asset recognized in the linked quarter that was not incurred during the current quarter. Total revenue has helped us achieve an annualized return on average equity of 13%, a return on average assets of 1.6%, along with an efficiency ratio of 57.7% in the current quarter. Compared to the comparable prior year quarter, total revenue has increased by $1.9 million, while non-interest expense has increased by $777,000. The increase in revenue is primarily due to an increase in base net interest income due to higher average balances and rates earned in the LASG and SBA portfolios.
The increase in non-interest expense compared to the comparable prior year quarter is primarily due to a $453,000 increase in compensation expense due to increased base salaries and benefits, stock-based compensation expense, and employee incentive compensation, a $345,000 increase in loan acquisition and collection expenses incurred as a result of increased efforts related to collections on purchased loan payoffs and real estate owned. An increase in data processing of $208,000 related to the outsourcing of data processing services. These increases were partially offset by a decrease in occupancy and equipment expense of $202,000. Slide 18 provides additional information on trends in yields, average balances, and our net interest margin, which was 5.2% in the current quarter as compared to 5.33% in the linked quarter and 4.94% 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 less transactional interest income from the loan portfolio and higher funding costs. The average balance of loans from the current quarter was $934 million as compared to $910 million in the linked quarter and $783 million in the comparable prior year quarter. Primarily due to growth in the LASG originated and purchased portfolios. Slide 19 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 1.32%, and non-performing assets to total assets has increased to 1.2% from 1.16%. These metrics have also both decreased compared to June 30th, 2018 and 2017.
In the top right-hand corner, classified commercial loans were $10.7 million as of March 31st, 2019, an increase from $9.9 million in the linked quarter. Finally, as noted in the chart on the bottom right-hand corner on the slide, annualized net charge-offs to average loan balances have remained at very low levels over the past several years and were four basis points in the current quarter, consistent with the linked quarter. Our allowance coverage appears appropriate to address the risk inherent in our loan portfolio with a slight increase in the allowance coverage, which is primarily due to the change in the composition of the loan portfolio, along with management's analysis of qualitative loss factors inherent in the portfolio. That concludes our prepared remarks. At this time, we would like to open up the call to Q&A.
Thank you. If you would like to ask a question, please do so by pressing the star key, followed by the digit one on your touch-tone telephone. If you are using a speakerphone to ask a question, please make sure your mute function is turned off to allow your signal to reach our equipment. We will proceed in the order that you signal us, and we'll take as many questions as time permits. Once again, please press star one on your touch-tone telephone to ask a question. Our first question comes from Alex Twerdahl with Sandler O'Neill. Please proceed.
Good morning.
Good morning.
This is Jeffrey Kitsis on for Alex today. After another very strong quarter for LASG originations, can you update us on how that pipeline looks heading into the second calendar quarter?
On the origination pipeline, Jeff?
Yeah.
Great question. Continues to be strong.
All right. Sounds good. Thanks. Second, looking at the overall rate sensitivity of the portfolio. NIIs benefited as the LASG originated portfolio has grown. Can you talk about how the balance sheet's positioned in case the next rate move brings rates lower?
Well, we're generally slightly asset sensitive, so if rates were adjusted lower, there would be some slight decrease in Net interest income. Most of our originated loans, most of our loans are tied to Prime Rate. I would point out that most of our loans are structured with floors as well at the time that we originate them. If we, for example, originate a loan today at Prime Rate Plus 2, that rate would be 7.5, and if Prime Rate went down by a quarter of a point, the rate on that loan would stay the same. I would say it would be fairly negligible.
Got you. Okay. Last question. Light quarter for SBA originations. Was that driven by demand or the government shutdown? Should we expect a rebound of income in this line of business?
We're mostly focused on the hotel vertical space. I would like to blame it on the government shutdown, but that was not really the reason why the volume was lower. I would say there's more competition in that space. We are unyielding in credit quality when it comes making a loan. We were presented with a lot of opportunities, most of which we turned down for a variety of reasons. Asking for too much debt, buying the property for too much money, inexperienced operator, insufficient resources by the owner borrower, post-financing. I would say the markets, this may be an overgeneralization, but you could kind of bifurcate it between the really high quality loans that are getting done at Prime Rate Plus a half or Prime Rate, in which case, the premium on sale is very low.
Those that get done at higher prices where the credit quality is poor. We're not willing to sacrifice on the credit quality, therefore the volume hasn't been great. We're seeing a lot of them. I remain hopeful that the number will get better. What we closed, the $6.4 million, of which $5 million was on a hotel space, that's what we were able to accomplish last quarter. I'd point out also that, as you know, and others know on the call, going back a couple of years ago, we had a lot more human resources allocated to this business line, which we have since repositioned and more in our origination business.
It's not as if we have a lot of costs in this business, but we choose not to close loans where the pricing is Prime Plus a half or Prime and the sale premium is small, and the piece that we hold
Is of lower quality and lower rate, significantly lower than we can get on our originated book. That is how I would describe the situation with that. It would be unrealistic to expect that volume was going to go from $5 million or $6.4 million this quarter to $25 million next quarter. I'm hopeful that it'll be higher than it was this quarter, but not by a factor of four.
Okay. That's all for me. Thank you very much for taking my questions.
Thank you. Our next question comes from Bruce Baughman with Franklin. Please proceed.
Good morning, Rick.
Good morning, Bruce.
I was puzzled by a paragraph in the release that talks about past due loans. Part of it says, "The increase in past due loans from June 30, 2018 is largely attributed to the 31-day month in March as past due loans totaled $18.3 million or 1.95% of total loans as of December 31, 2018." I can't quite understand what that's saying.
What it means is this, if you have a loan that's due on the first day of the month. Let's compare a loan that's due on March 1 with a loan that is due on June 30th. Same loan. For a 31-day month, if that loan payment's not made on March 1, for the quarter ending March 31, it's 30 days past due and therefore counted as delinquent. In the month that's 30 days on June 30th, it's 29 days past due and therefore not delinquent or not 30 days past due as of the end of the month. We have two quarters that have 30-day months and two quarters that have 31-day months. A big part of our loans are due on the first day of the month, so it tends to have a weird effect.
One of the things that we're doing to provide more consistency around that is when we originate loans now and when we have a chance, when there's an opportunity to modify them, we move the payment date off the first day of the month so that we can have better comparisons quarter to quarter.
Okay. Thank you.
It's weird, I admit, but it's the way the days work.
Thank you.
Thank you, Bruce.
Once again, ladies and gentlemen, if you do have a question at this time, please press star then one. Our next question comes from David Minkoff with DCM Asset Management. Please proceed.
Good morning, J.P. and Rick. Congratulations on a pretty good quarter on most metrics that I can see here.
Thank you, David.
One question that kind of stuck out at me, it's on the lesser important area of the loan portfolio. On the loan balances in community banking, I noticed you were down roughly 5% in the three months and 19.18% in the nine months. Is that due to the fact that rates have been up for the nine months vis-à-vis prior years or the economy is slowing down that much? Are we charging a non-competitive rate vis-à-vis the other banks in your area? Why did we drop 19%, let's say, in the nine months for community banking?
It's actually for none of those reasons. In the community banking in Maine, which we refer to as our Community Banking Division.
Right
It is a very important part of our entire bank where they provide operational services, raise deposits in our branches. Our focus on lending in the Community Banking Division is really in two areas, residential lending and small business lending, both to support our CRA requirements. It's in our material, perhaps you and others haven't focused on this, that to get a satisfactory grade in CRA, you need to do half of your lending in your footprint. Now, obviously for us as a national real estate lender, that would be impossible for us. We have a CRA strategic plan where we have agreed with the FDIC in how we can get a satisfactory CRA grade. We focus a lot on community service, community development investments, lending in our residential area to low and moderate borrowers in low and moderate census tracts.
All of which we sell those loans, so that part of our balance sheet doesn't grow. To a much lesser extent, small business lending. I say that to provide some context for the following point, which is when we have a choice of lending money nationally at Prime Rate plus two or an alternative financing in market in Maine at 5% fixed for five or 10 years. We think it's a better allocation of our capital to be doing the national lending. It's not really an area where we're trying to grow our balance sheet, but we are trying to focus on those areas that are helpful in our CRA strategic plan.
Point well taken then. This was really done by design, you might say. Is that right?
Absolutely.
Okay, what were the average rates on those numbers? $99 million roughly versus $123 million, 12/31/2018. What was the average rate, just so I can put it in perspective, what was the average rate that you charge on those community banking loans?
JP, do you have that?
Sure. The yield on the community bank loans for the nine months ended March 31st, David, was 5.2%.
Okay. That competes favorably or in the right market with your competing banks up there, is that right? In other words, the drop certainly wasn't due to the fact that you're charging 5.2% and the other banks are charging 4.9%, let's say.
I'm sure it's competitive. First of all, the 5.2%, these are loans that we originated quite a while ago. We're not actively trying to grow our main commercial loan portfolio.
Okay.
As I said, we're focused more on the residential, which we sell, and to a much less extent, small business loans that count for CRA purposes.
Basically, we're not really too concerned that it's down 19%, basically as you explained, right? I mean, that's okay. We're okay with that, right?
We are.
Okay. I noticed is your symbol going to change after the May 9th vote, assuming it goes through? I know you're going to trade on NASDAQ. You trade on NASDAQ now, right, with NBN?
It'll be the same symbol. As I mentioned in my comments, you'll own the same number of shares in Northeast Bank as you own in Bancorp. All of the directors will stay the same, all of the employees will stay the same with the same titles, and the management team will stay the same.
The symbol is going to stay the same. Is that right?
Correct.
Great. Okay. That's all I have. Nice quarter. Keep up the good work.
Thank you, David, very much.
Okay.
Thank you. Once again, ladies and gentlemen, if you do have a question, please press star then one. One moment. With that concludes our Q&A session for today. I'd like to turn the call over to Richard Wayne for closing remarks.
Thank you. Thank you everyone for listening, support, your good questions, and look forward to talking again in July after we complete our June 30 quarter, and the end of our fiscal year. It's my assumption by then we will be talking as the public company, Northeast Bank, as opposed to Northeast Bancorp. Thank you all.
Thank you. With that, this concludes our presentation for today. Ladies and gentlemen, you may disconnect. Everyone have a great day.