Good day, everyone, welcome to the Northeast Bancorp fiscal year 2019 first 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 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. The question and answer session for this call will be conducted electronically following the presentation. Please note that 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 risk 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 Rick Wayne. Please go ahead, sir.
Good morning, thank you all for joining us today. I'm Rick Wayne, the Chief Executive Officer of Northeast Bancorp, and with me on the call is JP Lapointe, our Chief Financial Officer. After the close of the market yesterday, for the first quarter of fiscal 2019, we announced quarterly net income of $4.5 million, or $0.49 per diluted common share, 12.8% return on equity, 1.5% return on assets, and an efficiency ratio of 58.8%. As will be discussed in more detail, we had significant growth in our higher-yielding LASG portfolio, strong volume in our SBA portfolio, and a decline in non-performing assets with continued disciplined expense management. Turning to slide three. During the first quarter bank-wide, we generated $136.3 million of loans, including $105.9 million in our loan acquisition and servicing group, or LASG.
LASG loan production included $71.1 million of originated loans and $34.8 million of purchased loans. Of the $71.1 million of originated loans, 93% were variable rate and 85% were indexed to Prime with a weighted average yield of 7.48% as of September 30th. For the quarter, the LASG portfolio had net growth of $20 million or 2.9% compared to the linked quarter, or 11.6% on an annualized basis. Additionally, we generated $18.9 million of loans in our SBA division, all of which were loans secured by hotels, demonstrating the continued build-out of our SBA hotel vertical. We generated a net gain of $851,000 on the sale of $12.3 million of SBA loans. Net interest margin for the quarter was 4.9%, and our total return on purchase loans for the quarter was 9.5%, which included $1.5 million of transactional income. Turning to slide four.
As we have discussed in the past, under a regulatory commitment made in connection with the 2010 merger, purchase loans are limited to 40% of total loans. Loan purchasing capacity decreased to $92.7 million as of September 30th as a result of the growth in the LASG purchase 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. Now on slide five. Under another regulatory commitment, non-owner-occupied commercial real estate loans are limited to 300% of total capital. As of September 30th, capacity under this condition was $120.2 million. Moving on to slide six. Of the $105.9 million invested by LASG for the quarter, $34.8 million were purchased loans and $71.1 million were originated loans.
Purchased loans for the quarter have unpaid principal balances of $37.1 million, representing a purchase price of 93.9%. As frequently mentioned in these investor calls, loan purchasing is transactional and can vary, sometimes significantly, from quarter to quarter. Since the merger in 2010, LASG has invested an aggregate of $1.6 billion consisting of approximately $762 million of purchase loans and approximately $880 million of originated loans. During the past quarter, we reviewed loans with $179.3 million of unpaid principal balances and bid on loans with $54.4 million of UPB, and we purchased loans with UPB of $37.1 million at 93.9% or $34.8 million invested. The $34.8 million invested consisted of 58 loans acquired in five separate transactions. As I've 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 seven.
At the end of the quarter, the discount on purchase loans was $36.4 million as compared to $37.1 million at June 30th. The change is primarily due to $34.8 million of purchases with a related $2.3 million discount, offset by regularly scheduled accretion as well as purchase loan payoffs and paydowns in the quarter. Purchase loan payoffs generated $1.5 million of transactional income. Approximately 85% of the $36.4 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 detail on returns from the LASG portfolio.
For the quarter, the purchase portfolio generated a total return of 9.5%, reflecting transactional income of $1.5 million from unscheduled loan payoffs and sales, which was lower than the average of $2.4 million of transactional income and the weighted average return of 11.7% for the prior four quarters. As discussed in the past, transactional income realized on the purchase portfolio, as well as the amount of loans purchased, may not be consistent from quarter to quarter. The LASG originated portfolio generated a return of 7.4% in the quarter. Turning to slide nine, we provide statistics on the LASG portfolio as of September 30th. Of significance, as noted in the chart in the top right, the purchase loan portfolio has a net investment basis of 89%, consistent with the linked quarter.
On an invested basis, the average loan size is approximately $733,000, and 85% of the portfolio consisted of loans with an investment size less than $6 million. The loan portfolio has a diverse collateral type, primarily focused on retail and mixed use, industrial hospitality, multifamily, and office. By geography, the largest concentrations are in California and New York, with 17% and 15% of the portfolio respectively. Our collateral is geographically diverse, with collateral in 42 states. Turning to slide 10, one of the benefits of the SBA program is the ability to sell the guaranteed portion of the 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 $18.9 million of SBA loans, of which $18.6 million were funded.
The company sold $12.3 million of the guaranteed portion of loans in the secondary market, of which $7.4 million were originated in the current quarter and $4.9 million were originated in prior quarters. For the quarter ended September 30th, the net gain on sale, including the capitalized servicing asset, was $851,000. On slide 11, we show the detail of the SBA sale pipeline as it stands at September 30th. The bank holds $1.4 million in SBA loans held for sale, which represent the guaranteed portion of SBA loans which have closed and are fully funded at quarter end. There is also an additional $12.8 million in the guaranteed portion of SBA loans that have closed and will be fully funded in subsequent quarters. In total, this represents an additional $14.2 million in future SBA guaranteed loan sales before considering any loan production in future quarters.
Now I'd like to turn it over to JP, who will discuss in more detail our financial results. After which, we will be happy to answer your questions. J.P.
Thanks, Rick, good morning, everyone. I'm picking up on slide 12 to provide more information on our financial results. Net income for the quarter was $4.5 million, or $0.49 per diluted common share. Diluted earnings per share were up $0.01 from the quarter ended June 30th, 2018, which I shall refer to as the linked quarter. Down $0.01 from the quarter ended September 30th, 2017, which I shall refer to as the comparable prior year quarter. The increase of $0.01 from the linked quarter was due to higher interest income, which amounted to $18.8 million in the current quarter, compared to $18 million in the linked quarter, as a result of higher average balances in the LASG and SBA portfolios.
This was offset by higher interest expense of $4.4 million in the current quarter, compared to $3.6 million in the linked quarter, as a result of higher costs of deposits to fund loan originations. Net interest income was down $405,000 from the linked quarter due to no gain on sale of other loans as no other loans were sold during the current quarter, offset by higher loan servicing fees in the current quarter. Non- interest expense had a favorable variance of $123,000 compared to the linked quarter due to lower salary and employee benefit costs offset by higher loan expense. Additionally, we saw the benefit of the lower Federal corporate income tax rate in the current quarter, which drove income tax expense down to $1.5 million, or an effective tax rate of 24.8%, as compared to $2.3 million, or an effective tax rate of 34.5% in the linked quarter.
The decrease from the comparable prior year quarter of $0.01 was due to an increase in deposit funding costs, which increased $1.5 million, along with an increase in net interest expense of $641,000, primarily due to higher salary and employee benefit costs, and an increase in other non- interest expense from the quarterly valuation of servicing rights, as well as a decrease in non-interest income of $404,000, primarily due to lower gains on sales of SBA and residential loans. These were offset by higher interest income of $18.8 million, compared to $16.2 million from higher average balances in the LASG and SBA portfolios, as well as a lower effective tax rate.
The tax rate for both the current quarter and the comparable prior year quarter included income tax benefits recognized under ASU 2016-09, whereby the tax effects of vested stock awards or exercised stock options are treated as discrete items in the reporting period in which they occur. The tax benefits recognized in the current quarter decreased by $637,000 compared to the comparable prior year quarter. Turning to slide 13. Over the past year, we have seen net loan portfolio growth of $127.6 million. The majority of the growth over the last 12 months comes from our LASG portfolio, with $410.2 million of purchases and originations. As shown in the chart, in the trailing 12-month period, we have closed $56.2 million of SBA loans and sold $32.4 million of the guaranteed piece portion of these loans into the secondary market.
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 $306.2 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 $137 million, or 24%, since September 30th, 2017. In the current quarter, LASG originated $71.1 million of loans and purchased loans with a recorded investment amounting to $34.8 million. Turning to funding on slide 15. In order to fund loan growth, we have had net deposit growth of $153 million, or 18%, over the trailing 12-month period.
Over the past year, all of the deposit types, excluding demand deposits, have seen growth. However, the majority of the growth has been within our time deposit products. Despite the growth in the time deposit products, our non-maturity accounts, which include money market, savings, and demand deposit products, as a percent of total deposits, remains high at 57% as of September 30th, 2018, as compared to 65% of total deposits as of September 30th, 2017. Slide 16 shows trends in the main components of our income. Compared to the linked quarter, base net interest income increased $436,000 due to higher average balances in the LASG and SBA portfolios, along with higher rates earned on our loans as a majority of our LASG-originated and SBA portfolios are tied to the Prime interest rate.
Base interest income increased $1.3 million due to the increase in the average balance of the LASG and SBA portfolios and the increase in the Prime interest rate, which was offset by increased funding costs, which increased $844,000 from the linked quarter. Transactional interest income from the purchased loan portfolio decreased by $485,000 compared to the linked quarter. The purchase portfolio had a return of 9.5% in the current quarter, compared to 11.5% in the linked quarter. The increase in net interest income before loan loss provision from the comparable prior year quarter is largely attributable to an increase in base net interest income of $2.4 million due to higher average balances in the LASG portfolio and higher rates earned on the loans in this portfolio, offset by lower transactional interest income from the purchase portfolio.
The 9.5% return in the purchase portfolio in the current quarter is down from 12.3% in the comparable prior year quarter due to higher transactional interest income amounts in the comparable prior year quarter. The lower purchase yield was more than offset by 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 $3.9 million, while funding costs increased $1.5 million. Non-interest income decreased by $405,000 over the linked quarter, primarily due to the decrease of $402,000 in gain on sale of other loans and a $182,000 decrease in gain on the sale of SBA loans, partially offset by a smaller loss recognized on the sale of real estate owned and higher loan servicing fees compared to the linked quarter.
Non-interest income is down $404,000 from the comparable prior year quarter, primarily due to a decrease in the gains on sale of SBA loans, $168,000 due to lower pricing in the SBA guarantee market in the current quarter, and a decrease in the gain on sale of residential loans, $117,000 due to lower volume sold in the current quarter. 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 $454,000, primarily due to the decrease in gain on sale of other loans of $402,000. Non-interest expense decreased by $123,000 from the linked quarter, primarily due to lower compensation expense due to lower incentive compensation cost as compared to the linked quarter, which was offset by higher loan expense in the current quarter.
Total revenue has helped us achieve an annualized return on equity of 12.8%, a return on assets of 1.5%, along with an efficiency ratio of 58.8% in the current quarter. Compared to the comparable prior year quarter, total revenue has increased by $644,000, while non-interest expense has increased by $641,000. The increase in revenue is primarily due to an increase in base net interest income due to higher average balances in the LASG originated and purchase portfolios, offset by a decrease in gains from the sale of SBA loans. The increase in non-interest expense compared to the comparable prior year quarter is primarily due to a $255,000 increase in compensation expense due to increased employee compensation and a $167,000 increase in other non-interest expense, primarily due to the quarterly evaluation of servicing rights.
Slide 18 provides additional information on trends in yields, average balances, and our net interest margin, which was 4.93% in the current quarter as compared to 5.28% in the linked quarter and 5.13% in the comparable prior year quarter. As previously discussed, the net interest margin, which decreased from the linked quarter, is largely driven by an increase in base net interest income, offset by higher cost of deposits and average deposit balances, as well as lower transactional interest income from the purchase loan portfolio. Additionally, the average balance of loans for the current quarter was $894 million, as compared to $825 million in the linked quarter and $773 million in the comparable prior year quarter, primarily due to growth in the LASG originated and purchase portfolios. Slide 19 provides a snapshot of our asset quality metrics.
Compared to the linked quarter, non-performing loans to total loans has decreased to 1.30% from 1.37%, and non-performing assets to total assets has decreased to 1.08% from 1.23%. These metrics have also both decreased compared to June 30th, 2017. In the top right-hand corner, classified commercial loans were $8.9 million as of September 30th, 2018, a slight decrease from $9.1 million in the linked quarter. Finally, as noted in the chart on the bottom right-hand corner of 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. Overall, our allowance coverage has continued to increase and appears appropriate to address the risk in our loan portfolio. That concludes our prepared remarks. At this time, we would like to open up the call to Q&A.
Ladies and gentlemen, if you would like to ask a question, please do so by pressing the star key followed by the digit one on your touchtone 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 then one on your touchtone telephone to ask a question. Our first question or comment comes from the line of Alex Twerdahl from Sandler O'Neill. Your line is open.
Good morning, guys.
Good morning, Alex.
Morning, Alex.
I'm first off wondering if you could, Rick, give us a little bit more commentary or color on what you're seeing in the SBA line. I appreciate you kind of giving us sort of the color on what the pipeline looks like for potential gains going into the fourth quarter, but maybe the pipeline as well for originations. As well as kind of whether or not you think there's maybe a little seasonality that impacted the third quarter. Also maybe a little bit more about how you're thinking about that gain on sale, which seems like it took kind of a step back in the calendar third quarter relative to where we've seen it over the last couple of years, really.
Just so I get it, Alex Twerdahl, is your first question is, what do we see in the market on originations? Then there's a second one, what might we expect for pricing in the quarter that we're in now or the following quarter?
Yes.
Well, I thought, first of all, that our almost $19 million of originations was actually quite good. There is some seasonality in the summer months. While close to $19 million, we thought it was a strong number for that. I can tell you, though, that to kind of think about the future, it's a very competitive marketplace for SBA loans. We have seen in our own case in the hotel vertical that for loans of the quality that we want to book, the pricing is not Well, I'll tell you what the pricing is. The pricing is more between Prime one and a half and 175, and a couple points to the brokers. If you go back a while ago, say, a year or a year and a half, the pricing on those loans was more like Prime plus two and a quarter.
The reason that is occurring, of course, is there are a lot of lenders chasing that business. There are 3,000 or 4,000 banks that do SBA loans. There's maybe, I don't know this number exactly, but directionally, most of those are doing them in their local marketplaces, maybe 100 that do as we do, that do them nationally. There's a lot of competition which is driving down the pricing and also, frankly, driving down the availability. The business is getting tougher. Secondly, on the question of pricing, we're also seeing, and I'm sure you're seeing this with banks that you follow, the premiums that buyers are willing to pay are going down. By way of example, I have this somewhere.
In the current quarter, when you look at our gain, which includes both the gain and the servicing asset created, it was 7% of loans sold, and it was 9.5% in the linked quarter. I don't want to be totally gloomy about that because we're pleased with the inroads we're making, too, in the hotel vertical. As you know well, we moved from a BDO model to focusing more on a vertical model. When you compare that number with what we had done in the BDO and the quality of it's gotten better, much better, I would say. That's how I would fairly describe the state of affairs in the SBA world.
Okay. That's some helpful color. Maybe give us a little bit more color on the funding pressures that you are seeing this quarter. Obviously, the whole industry is seeing higher rates translate to higher deposit costs. This quarter specifically, were there some longer duration CDs or something that you put on that kind of impacted that more than what you have seen? Maybe talk about kind of how you are planning to address and think about the funding side of the balance sheet over the next couple of quarters.
This quarter, as we grew, and as J.P. mentioned, most of our funding came from term deposits, CDs that we are running in our ableBanking channel, and most of that has come from one-year CDs that are currently priced at 270. That's obviously on the expensive side, kind of the focus first on the good news and then talk about the cost of it. We have a condition that we need to fund our loans with core deposits, so we do not have the liberty of going to borrow money, although I suspect borrowings would be roughly the same. The good news is because we make so much money on the asset side, we are able to pay those rates, and we are able to attract money at those rates. We are able to fund ourselves, but we need to pay up for it.
One of the other things that is unique about our bank is that because we have to fund our loans with core deposits, we need to inventory money. We have a lot more cash on hand than probably other banks that you look at. That money that we are paying 270 for until we can deploy it in loans where it's sitting at the Fed at 220. We have 50 basis points of negative spread on the extra cash that we carry. Given that we are in the business of buying loans and that is somewhat transactional, we need to even inventory, if you will, more cash than others. I think we see, tell me, confirm, J.P., that this is right. I want to say that our funding costs on deposits went up 25 basis points last quarter compared to the linked quarter.
I would also point out on that, or I would amplify it, because I have said it before, that when you look at our portfolio, our originated portfolio, where we funded $71 million, most of which, 91% or 92% of which is variable, mostly tied to Prime. That had a rate of September 30th after adjusted of 7.5%. One of the reasons, Alex, that as you noted in your, as usual, well-written report, that there's some compression on net interest income. Some chunk of that really has to do with the fact that our balance sheets, not artificially higher, but needs to be higher because of the deposit requirements, and we are losing 50 basis points on that.
When you look at the spread on our loan book, on our originated book, having loans at the end of the quarter that are variable, that are yielding 7.50%, we think is terrific. The very main reason that from an earnings perspective this quarter was not as good, frankly, as we'd like to see, is because our transactional income was $1.5 million compared to an average of $2.4 million over the preceding four quarters. That on an after-tax basis is almost $0.09. I know you know this, but I'll just say it so the other listeners on the call will hear it. The difference is, if we have a loan that's paid off on September 30th and there's discount, it goes into that quarter, and if it pays off on October one, it goes into the following quarter.
We've invested $700 million or so in purchase loans with yields between 11% and 12%, and this quarter was 9.5%. We still have a lot of discount on the books, and a lot of it's timing. I know we get judged quarter by quarter. I'm not attempting to rationalize it. I'm only trying to make the point that as we say, but it's got the charm of being the truth. That purchase business, both in the amount of loans you buy and the transactional income can vary quarter by quarter. I didn't say lumpy because we say that all the time, but it really can vary quarter by quarter.
For that, I apologize for a very long-winded answer to your very precise question, but I wanted to touch on some of the things that I know are of interest to you.
No, I think that, yeah, you certainly have some lines that can be somewhat lumpy. In some quarters, they all fire at the same time, and some quarters, they all kind of don't fire at the same time. Just to the point on the LASG-originated loans, which I know most of those are Prime based and have been repricing higher, but just relative to the June quarter, the yields were kind of flat. Was there something that kind of inflated the June quarter's yield on the LASG-originated loans to make that kind of not seem as asset sensitive as it is?
Well, I'm going to need some help from somebody here to answer that. Can you JP. What was 753?
It's 743 this quarter. Last quarter was 745.
Anyone know? There must have been some fee income in there because I'd have to look at it more closely. I don't have the answer to that as we sit here with that. I will take a look at our public information where there will be an answer to that. We'll have something more to say on it.
We would expect
I don't want to mumble through it here. It's certainly within the realm of possibility that on our loans, there's a little bit of price compression. We may have done some more loans that were Prime plus two and a half, and now maybe some are at Prime plus two in the mix. We have public information on that that I will be able to figure out.
Got it. We would expect that portfolio based on the September hike to be yielding higher in the final calendar quarter of the year relative to what we saw this quarter, correct?
Yes. I would say this, that virtually all of the originated portfolio are variable, generally tied to Prime. There's two things that could affect the question that you're asking. One is, was there some amount of an exit fee or some kind of something that went into that interest income in the prior quarter. Secondly, sometimes we do loans at Prime plus two, sometimes Prime plus 2.5. There could be some of that in the mix. They're still very good numbers, and it's knowable. Let me just use that as a launching point, Pat, to make one more point, which I intended to earlier. When you touch on this in your report, one of the things I think that is important to point out, and I think very significant as we're building our earnings and the quality of the earnings.
For those of you that have the slide deck, if you look on page 16 of the deck, we have a slide that shows the components of our net interest income quarter by quarter. We break it up into base net interest income, which is the blue bar, and transactional interest income, which comes generally from prepays. You can see that in the quarter that ended September 30th, our base net interest income was call it $12.9 million with a little bit of rounding. If you go back just a year ago to the first fiscal quarter of fiscal year 2018, it was $10.5 million. It went up to $2.4 million, the base net interest income in that time period. Well, why does that happen? It happens because we're building our portfolio.
By way of example, our average loan balance for the quarter, if you go to slide 18, for the quarter that ended on September 30th, the average loan book was $895 million. The average loan book in the quarter that ended June 30th was $825 million. That's a $75 million increase in our average loan size. If you look quarter to quarter end, you wouldn't see that as clearly, but a lot of the loans were booked at the very end in the month of June. Between June and September, we've grown our loan book significantly. Therefore, transactional income is important. Yield on our purchase loan book is important. One of our goals is to build a high-yielding, high-quality loan book so we can have more consistent and predictable earnings.
Even with this quarter, with transactional income $900,000 lower than last quarter and SBA gains $200,000 lower, we still had, in my opinion, a very strong quarter. Not to our potential, but earning almost 13% ROE and 1.5% ROA and efficiency ratio of 58% or 59%, compared to most banks, pretty strong with lots of loan growth capacity.
My final question is just, JP, you gave some color on the tax rate this quarter. How should we be modeling that for the remainder of the year, excluding the impact of what happened this quarter?
Sure, Alex. I think for the year, excluding discrete items, should be somewhere around 27% for a tax rate going forward. Somewhere around there should be appropriate.
Great. Thank you for taking my questions.
Thank you, Alex.
Thank you. Ladies and gentlemen, if you have a question or comment at this time, please press star then one on your telephone keypad. I'm showing no additional audio questions in the queue at this time. I would like to turn the conference back over to Mr. Richard Wayne for any closing remarks.
Thank you. Thank you all for listening and participating, reviewing our material. Every quarter, we try and provide more visibility into our company so you can understand it more. I hope that the Q&A with Alex and some of my expanded answers were helpful and not tedious for you. I tried to provide some color to what's going on, and look forward to talking to you in our next call. As always, if you have suggestions on items you'd like us to provide some more visibility into, and we can, we would be happy to do it. With that, I wish all of you a very nice day and week. Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.