nbn20180930_10q.htm
 

 

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-Q

 

Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

 

For the quarterly period ended September 30, 2018

 

Commission File Number: 1-14588

 

 

Northeast Bancorp


(Exact name of registrant as specified in its charter)

 

Maine

 

01-0425066

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

     

500 Canal Street, Lewiston, Maine

 

04240

(Address of Principal executive offices)

 

(Zip Code)

 

(207) 786-3245

Registrant's telephone number, including area code

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subjected to such filing requirements for the past 90 days. Yes ☑ No ___

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑  No ___

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or an emerging growth company. See definition of “accelerated filer,” and “large accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 Large accelerated filer ☐

 

Accelerated filer ☒

  

 

  

Non-accelerated filer ☐

 

Smaller reporting company ☐

 

 

  

Emerging growth company ☐

  

  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐ 

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes_ No ☑

  

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of November 2, 2018, the registrant had outstanding 8,235,943 shares of voting common stock, $1.00 par value per share and 811,946 shares of non-voting common stock, $1.00 par value per share. 

 

1

 

 

Part I.

Financial Information

 

 

Item 1.

Financial Statements (Unaudited)

3

 

 

Consolidated Balance Sheets September 30, 2018 and June 30, 2018

3

 

 

 

 

 

 

Consolidated Statements of Income Three Months Ended September 30, 2018 and 2017

4
       
   

Consolidated Statements of Comprehensive Income Three Months Ended September 30, 2018 and 2017

5
       

 

 

Consolidated Statements of Changes in Shareholders' Equity Three Months Ended September 30, 2018 and 2017

6

 

 

 

 

 

 

Consolidated Statements of Cash Flows Three Months Ended September 30, 2018 and 2017

7

 

 

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

8

 

 

 

 

 

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

27

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosure about Market Risk

40

 

 

 

 

 

Item 4.

Controls and Procedures

41
       

Part II.

Other Information

 

 

 

 

 

 

Item 1.

Legal Proceedings

42

 

 

 

 

 

Item 1A.

Risk Factors

42

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

 

 

 

 

 

Item 3.

Defaults Upon Senior Securities

42

 

 

 

 

 

Item 4.

Mine Safety Disclosures

42

 

 

 

 

 

Item 5.

Other Information

42

 

 

 

 

 

Item 6.

Exhibits

42
       
   

Signatures

43

 

2

 

PART 1- FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

 

 

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands, except share and per share data)

   

September 30, 2018

   

June 30, 2018

 

Assets

               

Cash and due from banks

  $ 2,668     $ 3,889  

Short-term investments

    203,049       153,513  

Total cash and cash equivalents

    205,717       157,402  
                 
                 

Available-for-sale debt securities, at fair value

    79,157       81,068  

Equity securities, at fair value

    6,620       6,619  

Total investment securities

    85,777       87,687  
                 

Residential real estate loans held for sale

    1,940       3,405  

SBA loans held for sale

    1,350       3,750  

Total loans held for sale

    3,290       7,155  
                 
                 

Loans

               

Commercial real estate

    599,624       579,450  

Commercial and industrial

    191,286       188,852  

Residential real estate

    93,308       100,256  

Consumer

    2,978       3,244  

Total loans

    887,196       871,802  

Less: Allowance for loan losses

    5,288       4,807  

Loans, net

    881,908       866,995  
                 
                 

Premises and equipment, net

    6,314       6,591  

Real estate owned and other repossessed collateral, net

    1,549       2,233  

Federal Home Loan Bank stock, at cost

    1,652       1,652  

Intangible assets, net

    758       867  

Servicing rights, net

    3,010       2,970  

Bank-owned life insurance

    16,729       16,620  

Other assets

    7,013       7,564  

Total assets

  $ 1,213,717     $ 1,157,736  
                 

Liabilities and Shareholders' Equity

               

Deposits

               

Demand

  $ 67,500     $ 72,272  

Savings and interest checking

    109,564       109,637  

Money market

    398,423       420,886  

Time

    440,020       352,145  

Total deposits

    1,015,507       954,940  
                 

Federal Home Loan Bank advances

    15,000       15,000  

Subordinated debt

    24,043       23,958  

Capital lease obligation

    536       605  

Other liabilities

    15,240       24,803  

Total liabilities

    1,070,326       1,019,306  
                 

Commitments and contingencies

    -       -  
                 
                 

Shareholders' equity

               

Preferred stock, $1.00 par value, 1,000,000 shares authorized; no shares issued and outstanding at September 30, 2018 and June 30, 2018

    -       -  

Voting common stock, $1.00 par value, 25,000,000 shares authorized; 8,226,648 and 8,056,527 shares issued and outstanding at September 30, 2018 and June 30, 2018, respectively

    8,226       8,057  

Non-voting common stock, $1.00 par value, 3,000,000 shares authorized; 820,742 and 882,314 shares issued and outstanding at September 30, 2018 and June 30, 2018, respectively

    821       882  

Additional paid-in capital

    77,075       77,016  

Retained earnings

    58,501       54,236  

Accumulated other comprehensive loss

    (1,232 )     (1,761 )

Total shareholders' equity

    143,391       138,430  

Total liabilities and shareholders' equity

  $ 1,213,717     $ 1,157,736  

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

3

 

 

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(Dollars in thousands, except share and per share data)

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 

Interest and dividend income:

               

Interest and fees on loans

  $ 17,525     $ 15,383  

Interest on investment securities

    362       266  

Other interest and dividend income

    880       529  

Total interest and dividend income

    18,767       16,178  
                 

Interest expense:

               

Deposits

    3,682       2,176  

Federal Home Loan Bank advances

    118       172  

Subordinated debt

    601       508  

Obligation under capital lease agreements

    7       11  

Total interest expense

    4,408       2,867  

Net interest and dividend income before provision for loan losses

    14,359       13,311  

Provision for loan losses

    532       354  

Net interest and dividend income after provision for loan losses

    13,827       12,957  
                 

Noninterest income:

               

Fees for other services to customers

    492       526  

Gain on sales of SBA loans

    851       1,019  

Gain on sales of residential loans held for sale

    174       291  

Net unrealized loss on equity securities

    (40 )     -  

Loss on real estate owned, other repossessed collateral and premises and equipment, net

    (40 )     -  

Bank-owned life insurance income

    110       112  

Other noninterest income

    7       10  

Total noninterest income

    1,554       1,958  
                 

Noninterest expense:

               

Salaries and employee benefits

    5,509       5,254  

Occupancy and equipment expense

    1,127       1,109  

Professional fees

    534       442  

Data processing fees

    601       604  

Marketing expense

    124       87  

Loan acquisition and collection expense

    439       365  

FDIC insurance premiums

    81       80  

Intangible asset amortization

    109       109  

Other noninterest expense

    831       664  

Total noninterest expense

    9,355       8,714  

Income before income tax expense

    6,026       6,201  

Income tax expense

    1,492       1,615  

Net income

  $ 4,534     $ 4,586  
                 

Weighted-average common shares outstanding:

               

Basic

    8,995,925       8,841,511  

Diluted

    9,183,729       9,089,936  
                 

Earnings per common share:

               
                 

Basic

  $ 0.50     $ 0.52  

Diluted

    0.49       0.50  
                 

Cash dividends declared per common share

  $ 0.01     $ 0.01  

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

4

 

 

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 
                 

Net income

  $ 4,534     $ 4,586  
                 

Other comprehensive income, before tax:

               

Available-for-sale debt securities:

               

Change in net unrealized loss on available-for-sale debt securities

    (74 )     122  

Derivatives and hedging activities:

               

Change in accumulated loss on effective cash flow hedges

    482       22  

Reclassification adjustments included in interest expense

    70       23  

Total derivatives and hedging activities

    552       45  

Total other comprehensive income, before tax

    478       167  

Income tax expense related to other comprehensive income

    129       63  

Other comprehensive income, net of tax

    349       104  

Comprehensive income

  $ 4,883     $ 4,690  

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

5

 

 

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(Dollars in thousands, except share and per share data)

 

                                                                   

Accumulated

         
                                                                   

Other

   

Total

 
   

Preferred Stock

   

Voting Common Stock

   

Non-voting Common Stock

   

Additional

   

Retained

   

Comprehensive

   

Shareholders'

 
   

Shares

   

Amount

   

Shares

   

Amount

   

Shares

   

Amount

   

Paid-in Capital

   

Earnings

   

Loss

   

Equity

 
                                                                                 

Balance at June 30, 2017

    -       -       7,840,460     $ 7,841       991,194     $ 991     $ 77,455     $ 38,142     $ (1,632 )   $ 122,797  

Net income

    -       -       -       -       -       -       -       4,586       -       4,586  

Other comprehensive income, net of tax

    -       -       -       -       -       -       -       -       104       104  

Conversions between voting common stock and non- voting common stock, net

    -       -       -       -       -       -       -       -       -       -  

Dividends on common stock at $0.01 per share

    -       -       -       -       -       -       -       (87 )     -       (87 )

Stock-based compensation

    -       -       -       -       -       -       220       -       -       220  

Issuance of restricted common stock

    -       -       10,000       10       -       -       (10 )     -       -       -  

Cancellation and forfeiture of restricted common stock

    -       -       (15,089 )     (15 )     -       -       (39 )     -       -       (54 )

Stock options exercised, net

    -       -       63,788       63       -       -       (917 )     -       -       (854 )

Balance at September 30, 2017

    -     $ -       7,899,159     $ 7,899       991,194     $ 991     $ 76,709     $ 42,641     $ (1,528 )   $ 126,712  
                                                                                 

Balance at June 30, 2018

    -       -       8,056,527     $ 8,057       882,314     $ 882     $ 77,016     $ 54,236     $ (1,761 )   $ 138,430  

Net income

    -       -       -       -       -       -       -       4,534       -       4,534  

Other comprehensive income, net of tax

    -       -       -       -       -       -       -       -       349       349  

Conversions between voting common stock and non- voting common stock, net

    -       -       61,572       61       (61,572 )     (61 )     -       -       -       -  

Dividends on common stock at $0.01 per share

    -       -       -       -       -       -       -       (89 )     -       (89 )

Stock-based compensation

    -       -       -       -       -       -       299       -       -       299  

Issuance of restricted common stock

    -       -       114,925       114       -       -       (114 )     -       -       -  

Cancellation and forfeiture of restricted common stock

    -       -       (6,376 )     (6 )     -       -       (126 )     -       -       (132 )

Stock options exercised, net

    -       -       -       -       -       -       -       -       -       -  

Adjustment for adoption of ASU 2016-01

    -       -       -       -       -       -       -       (180 )     180       -  

Balance at September 30, 2018

    -     $ -       8,226,648     $ 8,226       820,742     $ 821     $ 77,075     $ 58,501     $ (1,232 )   $ 143,391  

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

6

 

 

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 

Operating activities:

               

Net income

  $ 4,534     $ 4,586  

Adjustments to reconcile net income to net cash used in operating activities:

               

Provision for loan losses

    532       354  

Loss on sale and impairment of real estate owned and other repossessed collateral, net

    40       -  

Net unrealized loss on equity securities

    40       -  

Accretion of fair value adjustments on loans, net

    (1,592 )     (2,938 )

Accretion of fair value adjustments on borrowings, net

    57       50  

Amortization of subordinated debt issuance costs

    28       28  

Originations of loans held for sale

    (25,271 )     (30,545 )

Net proceeds from sales of loans held for sale

    26,523       29,450  

Gain on sales of residential loans held for sale

    (174 )     (291 )

Gain on sales of SBA and other loans held for sale

    (851 )     (1,019 )

Net increase in servicing rights

    (40 )     (109 )

Amortization of intangible assets

    109       109  

Bank-owned life insurance income, net

    (110 )     (112 )

Depreciation of premises and equipment

    333       292  

Stock-based compensation

    299       220  

Amortization of available-for-sale debt securities, net

    109       240  

Changes in other assets and liabilities:

               

Other assets

    496       (990 )

Other liabilities

    (9,085 )     (3,992 )

Net cash used in operating activities

    (4,023 )     (4,667 )

Investing activities:

               

Purchases of available-for-sale debt securities

    (15,992 )     -  

Proceeds from maturities and principal payments on investment securities, net

    17,680       2,067  

Loan purchases

    (34,803 )     (3,651 )

Loan originations, principal collections, and purchased loan paydowns, net

    24,538       22,599  

Purchases and disposals of premises and equipment, net

    (56 )     (629 )

Proceeds from sales of real estate owned and other repossessed collateral

    694       -  

Net cash (used in) provided by investing activities

    (7,939 )     20,386  

Financing activities:

               

Net increase (decrease) in deposits

    60,567       (27,127 )

Dividends paid on common stock

    (89 )     (87 )

Repayment of capital lease obligation

    (69 )     (65 )

Repurchases for tax withholdings on restricted common stock

    (132 )     (54 )

Stock options exercised, net

    -       (854 )

Net cash provided by (used in) financing activities

    60,277       (28,187 )

Net increase (decrease) in cash and cash equivalents

    48,315       (12,468 )

Cash and cash equivalents, beginning of period

    157,402       163,283  

Cash and cash equivalents, end of period

  $ 205,717     $ 150,815  

Supplemental schedule of noncash investing activities:

               

Transfers from loans to real estate owned and other repossessed collateral, net

  $ 50     $ 1,214  

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

7

 

NORTHEAST BANCORP AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

September 30, 2018

 

 

1. Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements include the accounts of Northeast Bancorp (“Northeast” or the “Company”) and its wholly-owned subsidiary, Northeast Bank (the “Bank”).

 

These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the accompanying consolidated financial statements contain all adjustments (consisting principally of normal recurring accruals) considered necessary for a fair presentation of the Company's financial position, results of operations, and cash flows for the interim periods presented. These accompanying unaudited financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2018 (“Fiscal 2018”) included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission.

 

 

2. Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2015-14, Revenue from Contracts with Customers (Topic 606) (“ASU 2015-14”) was issued in August 2015 which deferred adoption to annual reporting periods beginning after December 15, 2017, which was adopted during the three months ended September 30, 2018. The timing of the Company’s revenue recognition did not change. The Company’s largest portions of revenue, interest and fees on loans, interest and dividend income on securities and short-term investments, bank-owned life insurance income, and gain on sales of loans, are specifically excluded from the scope of the guidance. Additionally, fees for other services to customers includes loan servicing fee income which is accounted for under ASC Topic 860, Transfers and Servicing, (“Topic 860”), and is not subject to Topic 606. The other component of fees for other services to customers is deposit fees. The majority of the Company’s deposit fees are specifically related to a customer accessing its funds, in which case the revenue is currently recognized in a consistent manner with Topic 606. Revenue that is not specifically related to a customer accessing its funds (i.e. account maintenance fees), can be waived; however, the amount of waived fees is not considered material, and thus the revenue is consistently recognized with Topic 606.  All other revenue is also recognized in a manner consistent with Topic 606. Because of the above, management believes that revenue recognized under the new guidance approximates revenue recognized under current GAAP.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). This guidance changes how entities account for equity investments that do not result in consolidation and are not accounted for under the equity method of accounting. Entities will be required to measure these investments at fair value at the end of each reporting period and recognize changes in fair value in net income. A practicability exception will be available for equity investments that do not have readily determinable fair values; however, the exception requires the Company to adjust the carrying amount for impairment and observable price changes in orderly transactions for the identical or a similar investment of the same issuer. This guidance also changes certain disclosure requirements and other aspects of current GAAP. The Company adopted this guidance during the three months ended September 30, 2018. This adoption resulted in a reclassification of $180 thousand from accumulated other comprehensive loss to retained earnings in the consolidated financial statements, with no net effect on shareholders' equity. In addition, the disclosure of the fair value of “Loans, net” in “Notes to Unaudited Consolidated Financial Statements – Note 11: Fair Value Measurements” is now calculated based on an exit pricing strategy versus an entry pricing strategy.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). The new guidance establishes the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. Entities will be required to recognize the lease assets and lease liabilities that arise from leases in the statement of financial position and to disclose qualitative and quantitative information about lease transactions, such as information about variable lease payments and options to renew and terminate leases. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within the fiscal year. The Company is currently evaluating the impact of the adoption of ASU 2016-02 to determine the potential impact it will have on its consolidated financial statements. The Company’s assets and liabilities will increase based on the present value of the remaining lease payments for leases in place at the adoption date; however, this is not expected to be material to the Company’s results of operations.

 

 

In June 2016, the FASB issued ASU 2016-13, Financial InstrumentsCredit Losses (Topic 326) (“ASU 2016-13”). This guidance is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this guidance replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU will be effective for fiscal years beginning after December 15, 2019. Early adoption is available as of the fiscal year beginning after December 15, 2018. The Company is evaluating the provisions of the guidance, and will closely monitor developments and additional guidance to determine the potential impact on the Company’s consolidated financial statements. Management is in the process of identifying the methodologies and the additional data requirements necessary to implement the guidance and has engaged an existing third-party service provider to assist in implementation.

  

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”) which amends the scope of modification accounting for share-based payment arrangements. This update provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. This update was adopted during the three months ended September 30, 2018 and did not have an impact on the Company’s consolidated financial statements.

 

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815) (“ASU 2017-12”). This guidance permits hedge accounting for risk components in hedging relationships involving nonfinancial risk and interest rate risk, and improves the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. The amendments in this guidance are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.

 

In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases (“ASU 2018-10”) and ASU 2018-11, Leases (Topic 842) (“ASU 2018-11”). The guidance provides clarification on the application of ASU 2016-02, specifically on certain narrow aspects of the guidance issued under ASU 2016-02, including comparative reporting requirements for initial adoption and, for lessors only, separating lease and non-lease components in a contract and allocating the consideration in the contract to the separate components. For entities that have not adopted ASU 2016-02 before the issuance of these updates, the amendments in this guidance are the same as the effective date and transition requirements in ASU 2016-02. The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurements (Topic 820) (“ASU 2018-13”). This update modifies disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. This includes removing requirements related to transfers between Level 1 and Level 2, the policy of timing of transfers between levels, and the valuation process for Level 3 fair value measurements, modifying disclosure requirements related to investments in certain entities that calculate net asset value, and adding disclosure requirements for changes in unrealized gains and losses for recurring Level 3 fair value measurements and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in this guidance are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.

 

 

 

3. Investment Securities

 

The following presents a summary of the amortized cost, gross unrealized holding gains and losses, and fair value of investment securities.

 

   

September 30, 2018

 
   

Amortized

   

Gross Unrealized

   

Gross Unrealized

   

Fair

 
   

Cost

   

Gains

    Losses    

Value

 
   

(Dollars in thousands)

 

U.S. Government agency securities

  $ 57,085     $ -     $ (264 )   $ 56,821  

Agency mortgage-backed securities

    23,483       -       (1,147 )     22,336  

Equity investments measured at net asset value

    6,907       -       (287 )     6,620  
Total investment securities   $ 87,475     $ -     $ (1,698 )   $ 85,777  

 

   

June 30, 2018

 
   

Amortized

   

Gross Unrealized

   

Gross Unrealized

   

Fair

 
    Cost    

Gains

   

Losses

   

Value

 
   

(Dollars in thousands)

 

U.S. Government agency securities

  $ 57,129     $ -     $ (242 )   $ 56,887  

Agency mortgage-backed securities

    25,276       -       (1,095 )     24,181  

Equity investments measured at net asset value

    6,866       -       (247 )     6,619  
Total investment securities   $ 89,271     $ -     $ (1,584 )   $ 87,687  

 

At September 30, 2018 and June 30, 2018, the Company held no securities of any single issuer (excluding the U. S. Government and government agencies) with a book value that exceeded 10% of shareholders’ equity.

 

When securities are sold, the adjusted cost of the specific security sold is used to compute the gain or loss on sale. There were no securities sold during the three months ended September 30, 2018 or 2017. At September 30, 2018, no investment securities were pledged as collateral to secure outstanding borrowings.

 

The following summarizes the Company’s gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

 

   

September 30, 2018

 
   

Less than 12 Months

   

More than 12 Months

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 
   

(Dollars in thousands)

 
                                                 

U.S. Government agency securities

  $ 41,873     $ (213 )   $ 14,948     $ (51 )   $ 56,821     $ (264 )

Agency mortgage-backed securities

    554       (15 )     21,782       (1,132 )     22,336       (1,147 )

Equity investments measured at net asset value

    -       -       5,067       (287 )     5,067       (287 )
Total investment securities   $ 42,427     $ (228 )   $ 41,797     $ (1,470 )   $ 84,224     $ (1,698 )

 

   

June 30, 2018

 
   

Less than 12 Months

   

More than 12 Months

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
    Value     Losses     Value     Losses     Value     Losses  
   

(Dollars in thousands)

 

U.S. Government agency securities

  $ 57,168     $ (233 )   $ -     $ -     $ 57,168     $ (233 )

Agency mortgage-backed securities

    19,571       (298 )     13,332       (322 )     32,903       (620 )

Equity investments measured at net asset value

    5,115       (95 )     -       -       5,115       (95 )
Total investment securities   $ 81,854     $ (626 )   $ 13,332     $ (322 )   $ 95,186     $ (948 )

 

 

There were no other-than-temporary impairment losses on securities during the three months ended September 30, 2018 or 2017.

 

At September 30, 2018, the Company had 41 securities in an unrealized loss position. At September 30, 2018, all of the Company’s available-for-sale securities were issued or guaranteed by either government agencies or government-sponsored enterprises. The decline in fair value of the Company’s investment securities at September 30, 2018 is attributable to changes in interest rates.

 

In addition to considering current trends and economic conditions that may affect the quality of individual securities within the Company’s investment portfolio, management of the Company also considers the Company’s ability and intent to hold such securities to maturity or recovery of cost. At September 30, 2018, the Company does not intend to sell and it is not more likely than not that the Company will be required to sell the investment securities before recovery of its amortized cost. As such, management does not believe any of the Company’s investment securities are other-than-temporarily impaired at September 30, 2018.

 

The investments measured at net asset value include a fund that seeks to invest in securities either issued or guaranteed by the U.S. government or its agencies, as well as a fund that primarily invests in the federally guaranteed portion of SBA 7(a) loans that adjust quarterly or monthly and are indexed to the Prime Rate. The underlying composition of these funds is primarily government agencies, other investment-grade investments, or the guaranteed portion of SBA 7(a) loans, as applicable. As of September 30, 2018, the effective duration of the fund that seeks to invest in securities either issued or guaranteed by the U.S. government or its agencies is 4.58 years.

 

 

ASU 2016-01, Recognition and Measurements of Financial Assets and Financial Liabilities, was adopted on July 1, 2018, and a cumulative effect adjustment of $180 thousand was recorded to reclassify the amount of accumulated unrealized losses, net, related to equity securities from accumulated other comprehensive loss to retained earnings. For the three months ended September 30, 2018, there were $40 thousand of net unrealized losses on equity securities recognized in the consolidated statement of income.

 

The amortized cost and fair values of available-for-sale debt securities by contractual maturity are shown below as of September 30, 2018. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

 

   

Amortized Cost

   

Fair Value

 
   

(Dollars in thousands)

 

Due within one year

  $ 16,992     $ 16,938  

Due after one year through five years

    40,093       39,883  

Due after five years through ten years

    -       -  

Due after ten years

    -       -  

Total U.S. Government agency securities

    57,085       56,821  

Agency mortgage-backed securities

    23,483       22,336  

Total available-for-sale debt securities

  $ 80,568     $ 79,157  

 

 

 

4. Loans, Allowance for Loan Losses and Credit Quality

 

Loans are carried at the principal amounts outstanding, or amortized acquired fair value in the case of acquired loans, adjusted by partial charge-offs and net of deferred loan costs or fees. Loan fees and certain direct origination costs are deferred and amortized into interest income over the expected term of the loan using the level-yield method. When a loan is paid off in full, the unamortized portion is recognized in interest income. Interest income is accrued based upon the daily principal amount outstanding, except for loans on nonaccrual status.

 

Loans purchased by the Company are accounted for under ASC 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"). At acquisition, the effective interest rate is determined based on the discount rate that equates the present value of the Company's estimate of cash flows with the purchase price of the loan. Prepayments are not assumed in determining a purchased loan's effective interest rate and income accretion. The application of ASC 310-30 limits the yield that may be accreted on the purchased loan, or the "accretable yield," to the excess of the Company's estimate, at acquisition, of the expected undiscounted principal, interest, and other cash flows over the Company's initial investment in the loan. The excess of contractually required payments receivable over the cash flows expected to be collected on the loan represents the purchased loan's "nonaccretable difference." Subsequent improvements in expected cash flows of loans with nonaccretable differences result in a prospective increase to the loan's effective yield through a reclassification of some, or all, of the nonaccretable difference to accretable yield. The effect of subsequent credit-related declines in expected cash flows of purchased loans are recorded through a specific allocation in the allowance for loan losses. 

 

Loans are generally placed on nonaccrual status when they are past due 90 days as to either principal or interest, or when in management's judgment the collectability of interest or principal of the loan has been impaired. Loans accounted for under ASC 310-30 are placed on nonaccrual when it is not possible to reach a reasonable expectation of the timing and amount of cash flows to be collected on the loan. When a loan has been placed on nonaccrual status, previously accrued and uncollected interest is reversed against interest on loans. Interest on nonaccrual loans is accounted for on a cash-basis or using the cost-recovery method when collectability is doubtful. A loan is returned to accrual status when collectability of principal and interest is reasonably assured and the loan has performed for a reasonable period of time.

 

In cases where a borrower experiences financial difficulties and the Company makes certain concessionary modifications to contractual terms, the loan is classified as a troubled debt restructuring ("TDR"), and therefore by definition is an impaired loan. Concessionary modifications may include adjustments to interest rates, extensions of maturity, and other actions intended to minimize economic loss and avoid foreclosure or repossession of collateral. For loans accounted for under ASC 310-30, the Company evaluates whether it has granted a concession by comparing the restructured debt terms to the expected cash flows at acquisition plus any additional cash flows expected to be collected arising from changes in estimate after acquisition. As a result, if an ASC 310-30 loan is modified to be consistent with, or better than, the Company's expectations at acquisition, the modified loan would not qualify as a TDR. Nonaccrual loans that are restructured generally remain on nonaccrual status for a minimum period of six months to demonstrate that the borrower can meet the restructured terms. If the restructured loan is on accrual status prior to being modified, it is reviewed to determine if the modified loan should remain on accrual status. If the borrower's ability to meet the revised payment schedule is not reasonably assured, the loan is classified as a nonaccrual loan. With limited exceptions, loans classified as TDRs remain classified as such until the loan is paid off.

 

 

The composition of the Company’s loan portfolio is as follows on the dates indicated.

 

 

    September 30, 2018     June 30, 2018  
    Originated    

Purchased

   

Total

   

Originated

   

Purchased

   

Total

 
   

(Dollars in thousands)

 

Residential real estate

  $ 69,776     $ 14,398     $ 84,174     $ 75,873     $ 13,926     $ 89,799  

Home equity

    9,134       -       9,134       10,457       -       10,457  

Commercial real estate

    314,394       285,230       599,624       303,399       276,051       579,450  

Commercial and industrial

    190,366       920       191,286       187,857       995       188,852  

Consumer

    2,978       -       2,978       3,244       -       3,244  

Total loans

  $ 586,648     $ 300,548     $ 887,196     $ 580,830     $ 290,972     $ 871,802  

 

 

Total loans include deferred loan origination costs, net, of $339 thousand and $223 thousand as of September 30, 2018 and June 30, 2018, respectively.

 

Past Due and Nonaccrual Loans

 

The following is a summary of past due and nonaccrual loans:

 

   

September 30, 2018

 
                   

Past Due

   

Past Due

                                 
    Past Due     Past Due     90 Days or     90 Days or                                  
    30-59     60-89     More-Still     More-    

Total Past

   

Total

   

Total

   

Nonaccrual

 
    Days     Days     Accruing     Nonaccrual    

Due

   

Current

   

Loans

   

Loans

 
   

(Dollars in thousands)

 

Originated portfolio:

                                                               

Residential real estate

  $ 351     $ 220     $ -     $ 1,536     $ 2,107     $ 67,669     $ 69,776     $ 2,633  

Home equity

    -       -       -       10       10       9,124       9,134       152  

Commercial real estate

    854       -       -       1,244       2,098       312,296       314,394       1,703  

Commercial and industrial

    100       -       -       807       907       189,459       190,366       1,453  

Consumer

    53       -       -       100       153       2,825       2,978       185  

Total originated portfolio

    1,358       220       -       3,697       5,275       581,373       586,648       6,126  

Purchased portfolio:

                                                               

Residential real estate

    421       -       -       202       623       13,775       14,398       202  

Commercial real estate

    1,074       16       -       2,395       3,485       281,745       285,230       4,815  

Commercial and industrial

    149       5       -       104       258       662       920       358  

Total purchased portfolio

    1,644       21       -       2,701       4,366       296,182       300,548       5,375  

Total loans

  $ 3,002     $ 241     $ -     $ 6,398     $ 9,641     $ 877,555     $ 887,196     $ 11,501  

 

   

June 30, 2018

 
                   

Past Due

   

Past Due

                                 
    Past Due     Past Due     90 Days or     90 Days or                                  
    30-59     60-89     More-Still     More-    

Total Past

   

Total

   

Total

   

Nonaccrual

 
    Days     Days     Accruing     Nonaccrual    

Due

   

Current

   

Loans

   

Loans

 
   

(Dollars in thousands)

 

Originated portfolio:

                                                               

Residential real estate

  $ 404     $ 181     $ -     $ 1,201     $ 1,786     $ 74,087     $ 75,873     $ 2,914  

Home equity

    89       -       -       154       243       10,214       10,457       298  

Commercial real estate

    27       210       -       169       406       302,993       303,399       1,499  

Commercial and industrial

    -       -       -       792       792       187,065       187,857       1,368  

Consumer

    77       82       -       19       178       3,066       3,244       134  

Total originated portfolio

    597       473       -       2,335       3,405       577,425       580,830       6,213  
                                                                 

Purchased portfolio:

                                                               

Residential real estate

    -       -       -       202       202       13,724       13,926       202  

Commercial real estate

    659       274       -       3,086       4,019       272,032       276,051       5,180  

Commercial and industrial

    17       -       -       91       108       887       995       363  

Total purchased portfolio

    676       274       -       3,379       4,329       286,643       290,972       5,745  

Total loans

  $ 1,273     $ 747     $ -     $ 5,714     $ 7,734     $ 864,068     $ 871,802     $ 11,958  

 

 

Allowance for Loan Losses and Impaired Loans

 

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. For residential and consumer loans, a charge-off is recorded no later than the point at which a loan is 180 days past due if the loan balance exceeds the fair value of the collateral, less estimated costs to sell. For commercial loans, a charge-off is recorded on a case-by-case basis when all or a portion of the loan is deemed to be uncollectible. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses consists of general, specific, and unallocated reserves and reflects management’s estimate of probable loan losses inherent in the loan portfolio at the balance sheet date. Management uses a consistent and systematic process and methodology to evaluate the appropriateness of the allowance for loan losses on a quarterly basis. The calculation of the allowance for loan losses is segregated by portfolio segments, which include: residential real estate, commercial real estate, commercial and industrial, consumer, purchased loans, and SBA loans. Risk characteristics relevant to each portfolio segment are as follows:

 

Residential real estate: All loans in this segment are collateralized by residential real estate and repayment is primarily dependent on the credit quality, loan-to-value ratio and income of the individual borrower. The overall health of the economy, particularly unemployment rates and housing prices, has a significant effect on the credit quality in this segment. For purposes of the Company’s allowance for loan loss calculation, home equity loans and lines of credit are included in residential real estate.

 

Commercial real estate: Loans in this segment are primarily income-producing properties. For owner-occupied properties, the cash flows are derived from an operating business, and the underlying cash flows may be adversely affected by deterioration in the financial condition of the operating business. The underlying cash flows generated by non-owner occupied properties may be adversely affected by increased vacancy rates. Management periodically obtains rent rolls and operating statements, with which it monitors the cash flows of these loans. Adverse developments in either of these areas will have an adverse effect on the credit quality of this segment. For purposes of the allowance for loan losses, this segment also includes construction loans.

 

Commercial and industrial: Loans in this segment are made to businesses and are generally secured by the assets of the business. Repayment is expected from the cash flows of the business. This segment also includes loans to non-bank lenders, which are generally secured by a collateral assignment of the notes and mortgages on loans originated by the non-bank lenders. Weakness in national or regional economic conditions, and a corresponding weakness in consumer or business spending, will have an adverse effect on the credit quality of this segment.

 

Consumer: Loans in this segment are generally secured, and repayment is dependent on the credit quality of the individual borrower. Repayment of consumer loans is generally based on the earnings of individual borrowers, which may be adversely impacted by regional labor market conditions.

 

Purchased: Loans in this segment are typically secured by commercial real estate, multi-family residential real estate, or business assets and have been acquired by the Bank’s Loan Acquisition and Servicing Group (“LASG”). Loans acquired by the LASG are, with limited exceptions, performing loans at the date of purchase. Repayment of loans in this segment is largely dependent on cash flow from the successful operation of the property, in the case of non-owner occupied property, or operating business, in the case of owner-occupied property. Loan performance may be adversely affected by factors affecting the general economy or conditions specific to the real estate market, such as geographic location or property type. Loans in this segment are evaluated for impairment under ASC 310-30. The Company reviews expected cash flows from purchased loans on a quarterly basis. The effect of a decline in expected cash flows subsequent to the acquisition of the loan is recognized through a specific allocation in the allowance for loan losses.

 

SBA: Loans in this segment are comprised of both commercial real estate and commercial and industrial loans to small businesses, underwritten and originated by the Bank’s national SBA group (“SBA Division”). Loans are underwritten and originated primarily in accordance with SBA 7(a) guidelines, and are partially guaranteed by the SBA. Loans are primarily secured by income-producing properties and/or assets of the businesses. Adverse developments in national or regional economic conditions, and a corresponding weakness in consumer or business spending, will have an adverse effect on the credit quality of this segment.

 

The general component of the allowance for loan losses for originated loans is based on historical loss experience adjusted for qualitative factors stratified by loan segment. The Company does not weight periods used in that analysis to determine the average loss rate in each portfolio segment. This historical loss factor is adjusted for the following qualitative factors:

 

 

Levels and trends in delinquencies;

 

 

Trends in the volume and nature of loans;

 

 

Trends in credit terms and policies, including underwriting standards, procedures and practices, and the experience and ability of lending management and staff;

 

 

 

Trends in portfolio concentration;

 

 

National and local economic trends and conditions;

 

 

Effects of changes or trends in internal risk ratings; and

 

 

Other effects resulting from trends in the valuation of underlying collateral.

 

The allocated component of the allowance for loan losses relates to loans that are classified as impaired. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than the carrying value of the loan.

 

For all portfolio segments, except loans accounted for under ASC 310-30, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. For the purchased loan segment, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to realize cash flows as expected at acquisition. For loans accounted for under ASC 310-30 for which cash flows can reasonably be estimated, loan impairment is measured based on the decrease in expected cash flows from those estimated at acquisition, excluding changes due to changes in interest rate indices and other non-credit related factors, discounted at the loan’s effective rate assumed at acquisition. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting the scheduled principal and interest payments when due.

 

The following table sets forth activity in the Company’s allowance for loan losses.

 

   

Three Months Ended September 30, 2018

 
   

Residential

   

Commercial

   

Commercial

                                 
   

Real Estate

   

Real Estate

   

and Industrial

   

Consumer

   

Purchased

   

SBA

   

Total

 
   

(Dollars in thousands)

 

Beginning balance

  $ 605     $ 1,527     $ 620     $ 39     $ 587     $ 1,429     $ 4,807  

Provision (credit)

    99       93       164       (12 )     10       178       532  

Recoveries

    2       7       7       18       -       -       34  

Charge-offs

    (81 )     -       (2 )     (2 )     -       -       (85 )

Ending balance

  $ 625     $ 1,627     $ 789     $ 43     $ 597     $ 1,607     $ 5,288  

 

   

Three Months Ended September 30, 2017

 
   

Residential

   

Commercial

   

Commercial

                                 
   

Real Estate

   

Real Estate

   

and Industrial

   

Consumer

   

Purchased

   

SBA

   

Total

 
   

(Dollars in thousands)

 

Beginning balance

  $ 472     $ 1,219     $ 394     $ 53     $ 303     $ 1,224     $ 3,665  

Provision (credit)

    41       29       184       (14 )     7       107       354  

Recoveries

    7       -       18       6       -       -       31  

Charge-offs

    (12 )     -       -       (4 )     -       -       (16 )

Ending balance

  $ 508     $ 1,248     $ 596     $ 41     $ 310     $ 1,331     $ 4,034  

 

 

The following table sets forth information regarding the allowance for loan losses by portfolio segment and impairment methodology.

 

   

September 30, 2018

 
   

Residential

   

Commercial

   

Commercial

                                 
   

Real Estate

   

Real Estate

   

and Industrial

   

Consumer

   

Purchased

   

SBA

   

Total

 
   

(Dollars in thousands)

 

Allowance for loan losses:

                                                       

Individually evaluated

  $ 337     $ 128     $ 3     $ 22     $ -     $ 342     $ 832  

Collectively evaluated

    288       1,499       786       21       -       1,265       3,859  

ASC 310-30

    -       -       -       -       597       -       597  

Total

  $ 625     $ 1,627     $ 789     $ 43     $ 597     $ 1,607     $ 5,288  
                                                         

Loans:

                                                       

Individually evaluated

  $ 5,137     $ 2,541     $ 47     $ 340     $ -     $ 3,585     $ 11,650  

Collectively evaluated

    73,773       250,588       184,372       2,638       -       63,627       574,998  

ASC 310-30

    -       -       -       -       300,548       -       300,548  

Total

  $ 78,910     $ 253,129     $ 184,419     $ 2,978     $ 300,548     $ 67,212     $ 887,196  

 

 

   

June 30, 2018

 
   

Residential

   

Commercial

   

Commercial

                                 
   

Real Estate

   

Real Estate

   

and Industrial

   

Consumer

   

Purchased

   

SBA

   

Total

 
   

(Dollars in thousands)

 

Allowance for loan losses:

                                                       

Individually evaluated

  $ 322     $ 139     $ 8     $ 6     $ -     $ 112     $ 587  

Collectively evaluated

    283       1,388       612       33       -       1,317       3,633  

ASC 310-30

    -       -       -       -       587       -       587  

Total

  $ 605     $ 1,527     $ 620     $ 39     $ 587     $ 1,429     $ 4,807  
                                                         

Loans:

                                                       

Individually evaluated

  $ 5,682     $ 2,687     $ 33     $ 292     $ -     $ 3,170     $ 11,864  

Collectively evaluated

    80,520       246,742       181,767       2,952       -       56,985       568,966  

ASC 310-30

    -       -       -       -       290,972       -       290,972  

Total

  $ 86,202     $ 249,429     $ 181,800     $ 3,244     $ 290,972     $ 60,155     $ 871,802  

 

The following table sets forth information regarding impaired loans. Loans accounted for under ASC 310-30 that have performed based on cash flow and accretable yield expectations determined at date of acquisition are not considered impaired assets and have been excluded from the tables below.

 

   

September 30, 2018

   

June 30, 2018

 
           

Unpaid

                   

Unpaid

         
   

Recorded

   

Principal

   

Related

   

Recorded

   

Principal

   

Related

 
   

Investment

   

Balance

   

Allowance

   

Investment

   

Balance

   

Allowance

 
   

(Dollars in thousands)

 

Impaired loans without a valuation allowance:

                                               

Originated:

                                               

Residential real estate

  $ 3,031     $ 3,024     $ -     $ 3,162     $ 3,154     $ -  

Commercial real estate

    1,458       1,453       -       1,641       1,634       -  

Commercial and industrial

    1,659       1,659       -       2,401       2,401       -  

Consumer

    279       302       -       271       296       -  

Purchased:

                                               

Residential real estate

    202       217       -       202       217       -  

Commercial real estate

    6,381       9,064       -       6,601       9,330       -  

Commercial and industrial

    95       173       -       108       186       -  

Total

    13,105       15,892       -       14,386       17,218       -  
                                                 

Impaired loans with a valuation allowance:

                                               

Originated:

                                               

Residential real estate

    2,106       2,086       337       2,520       2,497       322  

Commercial real estate

    1,621       1,612       191       1,241       1,233       139  

Commercial and industrial

    1,435       1,434       282       607       607       120  

Consumer

    61       62       22       21       22       6  

Purchased:

                                               

Residential real estate

    -       -       -       -       -       -  

Commercial real estate

    4,401       4,950       298       4,748       5,362       280  

Commercial and industrial

    357       415       299       349       407       307  

Total

    9,981       10,559       1,429       9,486       10,128       1,174  

Total impaired loans

  $ 23,086     $ 26,451     $ 1,429     $ 23,872     $ 27,346     $ 1,174  

 

 

The following tables set forth information regarding interest income recognized on impaired loans.

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 
   

Average

   

Interest

   

Average

   

Interest

 
   

Recorded

   

Income

   

Recorded

   

Income

 
   

Investment

   

Recognized

   

Investment

   

Recognized

 
   

(Dollars in thousands)

 

Impaired loans without a valuation allowance:

                               

Originated:

                               

Residential real estate

  $ 3,097     $ 19     $ 4,095     $ 36  

Commercial real estate

    1,550       10       1,393       93  

Commercial and industrial

    2,030       33       1,850       37  

Consumer

    275       2       272       6  

Purchased:

                               

Residential real estate

    202       -       1,067       -  

Commercial real estate

    6,491       59       8,868       80  

Commercial and industrial

    102       -       30       -  

Total

    13,747       123       17,575       252  
                                 

Impaired loans with a valuation allowance:

                               

Originated:

                               

Residential real estate

    2,313       23       1,614       21  

Commercial real estate

    1,431       27       1,396       22  

Commercial and industrial

    1,021       1       845       4  

Consumer

    41       -       35       1  

Purchased:

                               

Residential real estate

    -       -       -       -  

Commercial real estate

    4,575       31       3,534       27  

Commercial and industrial

    353       -       94       -  

Total

    9,734       82       7,518       75  

Total impaired loans

  $ 23,481     $ 205     $ 25,093     $ 327  

 

 

Credit Quality

 

The Company utilizes a ten-point internal loan rating system for commercial real estate, construction, commercial and industrial, and certain residential loans as follows:

 

Loans rated 1 – 6: Loans in these categories are considered “pass” rated loans. Loans in categories 1-5 are considered to have low to average risk. Loans rated 6 are considered marginally acceptable business credits and have more than average risk.

 

Loans rated 7: Loans in this category are considered “special mention.” These loans show signs of potential weakness and are being closely monitored by management.

 

Loans rated 8: Loans in this category are considered “substandard.” Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified have a well-defined weakness or weaknesses that jeopardize the orderly repayment of the debt.

 

Loans rated 9: Loans in this category are considered “doubtful.” Loans classified as doubtful have all the weaknesses inherent in one graded 8 with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 

Loans rated 10: Loans in this category are considered “loss” and of such little value that their continuance as loans is not warranted.

 

On an annual basis, or more often if needed, the Company formally reviews the ratings of all loans subject to risk ratings. Annually, the Company engages an independent third-party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its annual review process. Risk ratings on purchased loans, with and without evidence of credit deterioration at acquisition, are determined relative to the Company’s recorded investment in that loan, which may be significantly lower than the loan’s unpaid principal balance. 

 

 

The following tables present the Company’s loans by risk rating.

 

 

   

September 30, 2018

 
   

Originated Portfolio

                 
   

Commercial

   

Commercial

           

Purchased

         
   

Real Estate

   

and Industrial

   

Residential(1)

   

Portfolio

   

Total

 
   

(Dollars in thousands)

 

Loans rated 1- 6

  $ 307,933     $ 186,460     $ 14,543     $ 289,445     $ 798,381  

Loans rated 7

    4,620       2,212       96       5,505       12,433  

Loans rated 8

    1,841       1,694       815       5,598       9,948  

Loans rated 9

    -       -       -       -       -  

Loans rated 10

    -       -       -       -       -  
Total   $ 314,394     $ 190,366     $ 15,454     $ 300,548     $ 820,762  

 

   

June 30, 2018

 
   

Originated Portfolio

                 
   

Commercial

   

Commercial

           

Purchased

         
   

Real Estate

   

and Industrial

   

Residential(1)

   

Portfolio

   

Total

 
   

(Dollars in thousands)

 

Loans rated 1- 6

  $ 298,200     $ 184,024     $ 13,531     $ 279,111     $ 774,866  

Loans rated 7

    3,505       2,198       100       5,899       11,702  

Loans rated 8

    1,694       1,635       823       5,962       10,114  

Loans rated 9

    -       -       -       -       -  

Loans rated 10

    -       -       -       -       -  
Total   $ 303,399     $ 187,857     $ 14,454     $ 290,972     $ 796,682  

 

    (1) Certain of the Company’s loans made for commercial purposes, but secured by residential collateral, are rated under the Company’s risk-rating system.

 

 

Troubled Debt Restructurings

 

The following table shows the Company’s post-modification balance of TDRs by type of modification.

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 
   

Number of

   

Recorded

   

Number of

   

Recorded

 
   

Contracts

   

Investment

   

Contracts

   

Investment

 
   

(Dollars in thousands)

 

Extended maturity

    -     $ -       1     $ 18  

Adjusted interest rate

    -       -       -       -  

Rate and maturity

    3       170       -       -  

Principal deferment

    -       -       1       655  

Court ordered concession

    -       -       -       -  
Total     3     $ 170       2     $ 673  

 

 

The following table shows loans modified in a TDR and the change in the recorded investment subsequent to the modifications occurring.

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 
           

Recorded

   

Recorded

           

Recorded

   

Recorded

 
   

Number of

   

Investment

   

Investment

   

Number of

   

Investment

   

Investment

 
   

Contracts

   

Pre-Modification

   

Post-Modification

   

Contracts

   

Pre-Modification

   

Post-Modification

 
   

(Dollars in thousands)

 

Originated portfolio:

                                               

Residential real estate

    3     $ 170     $ 170       1     $ 18     $ 18  

Home equity

    -       -       -       -       -       -  

Commercial real estate

    -       -       -       -       -       -  

Commercial and industrial

    -       -       -       1       655       655  

Consumer

    -       -       -       -       -       -  

Total originated portfolio

    3       170       170       2       673       673  
                                                 

Purchased portfolio:

                                               

Residential real estate

    -       -       -       -       -       -  

Commercial real estate

    -       -       -       -       -       -  

Total purchased portfolio

    -       -       -       -       -       -  

Total

    3     $ 170     $ 170       2     $ 673     $ 673  

 

 

The Company considers TDRs past due 90 days or more to be in payment default. Two loans modified in a TDR in the last twelve months totaling $1.5 million defaulted during the three months ended September 30, 2018. As of September 30, 2018, there were no further commitments to lend to borrowers associated with loans modified in a TDR.

 

 

ASC 310-30 Loans

 

The following tables present a summary of loans accounted for under ASC 310-30 that were acquired by the Company during the period indicated.

 

   

Three Months Ended

September 30, 2018

   

Three Months Ended

September 30, 2017

 
   

(Dollars in thousands)

 

Contractually required payments receivable

  $ 61,540     $ 5,912  

Nonaccretable difference

    (174 )     (157 )

Cash flows expected to be collected

    61,366       5,755  

Accretable yield

    (26,563 )     (2,104 )

Fair value of loans acquired

  $ 34,803     $ 3,651  

 

 

Certain loans accounted for under ASC 310-30 that were acquired by the Company are not accounted for using the income recognition model because the Company cannot reasonably estimate cash flows expected to be collected. These loans when acquired are placed on nonaccrual. The carrying amounts of such loans are as follows.

 

   

As of and for the Three Months

Ended September 30, 2018

   

As of and for the Three Months

Ended September 30, 2017

 
   

(Dollars in thousands)

 

Loans acquired during the period

  $ -     $ -  

Loans at end of period

    4,915       6,032  

 

The following tables summarize the activity in the accretable yield for loans accounted for under ASC 310-30.

 

   

Three Months Ended

September 30, 2018

   

Three Months Ended

September 30, 2017

 
   

(Dollars in thousands)

 

Beginning balance

  $ 138,178     $ 131,197  

Acquisitions

    26,563       2,104  

Accretion

    (5,533 )     (4,425 )

Reclassifications from non-accretable difference to accretable yield

    578       3,428  

Disposals and other changes

    (6,992 )     (9,381 )

Ending balance

  $ 152,794     $ 122,923  

 

 

The following table provides information related to the unpaid principal balance and carrying amounts of ASC 310-30 loans.

 

   

September 30, 2018

   

June 30, 2018

 
   

(Dollars in thousands)

 

Unpaid principal balance

  $ 329,242     $ 318,876  

Carrying amount

    294,106       284,317  

 

 

 

5. Transfers and Servicing of Financial Assets

 

The Company sells loans in the secondary market and for certain loans, retains the servicing responsibility. Consideration for the sale includes the cash received as well as the related servicing rights asset. The Company receives fees for the services provided.

 

Capitalized servicing rights as of September 30, 2018 and June 30, 2018 totaled $3.0 million, and are classified as servicing rights, net, on the consolidated balance sheets.

 

Mortgage loans sold during the quarter ended September 30, 2018 totaled $13.2 million, compared to $19.2 million during the quarter ended September 30, 2017. Mortgage loans serviced for others totaled $8.1 million at September 30, 2018 and $8.7 million at June 30, 2018. Additionally, the Company was servicing commercial loans participated out to various other institutions amounting to $25.8 million and $32.2 million at September 30, 2018 and June 30, 2018, respectively.

 

SBA loans sold during the quarter ended September 30, 2018 totaled $12.3 million, compared to $9.1 million during the quarter ended September 30, 2017. SBA loans serviced for others totaled $171.1 million at September 30, 2018 and $162.0 million at June 30, 2018.

 

Mortgage and SBA loans serviced for others are accounted for as sales and therefore are not included on the accompanying consolidated balance sheets. The risks inherent in mortgage servicing assets and SBA servicing assets relate primarily to changes in prepayments that result from shifts in interest rates.

 

Contractually specified servicing fees were $247 thousand and $262 thousand for the quarters ended September 30, 2018 and 2017, respectively, and were included as a component of loan-related fees within noninterest income.

 

The significant assumptions used in the valuation of the servicing rights included a range of discount rates from 9.0% to 23.3% and a weighted average prepayment speed assumption of 11.5%.

 

 

 

6. Earnings Per Share (EPS)

 

EPS is computed by dividing net income allocated to common shareholders by the weighted average common shares outstanding (including participating securities). The Company’s only participating securities are unvested restricted stock awards that contain non-forfeitable rights to dividends. The following table shows the weighted average number of shares outstanding for the periods indicated. Shares issuable relative to stock options granted have been reflected as an increase in the shares outstanding used to calculate diluted EPS, after applying the treasury stock method. The number of shares outstanding for basic and diluted EPS is presented as follows:

 

   

Three months Ended September 30,

 
   

2018

   

2017

 
   

(Dollars in thousands, except share

and per share data)

 
                 

Net income

  $ 4,534     $ 4,586  
                 
                 

Weighted average shares used in calculation of basic EPS

    8,995,925       8,841,511  

Incremental shares from assumed exercise of dilutive securities

    187,804       248,425  

Weighted average shares used in calculation of diluted EPS

    9,183,729       9,089,936  
                 
                 

Basic earnings per common share

  $ 0.50     $ 0.52  

Diluted earnings per common share

    0.49       0.50  

 

 

For the three months ended September 30, 2018 and 2017, the following stock options were excluded from the calculation of diluted EPS due to the exercise price of these options exceeding the average market price of the Company’s common stock for the period. These options, which were not dilutive at that date, may potentially dilute EPS in the future.

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 

Stock options

    -       81,004  

 

 

7. Derivatives and Hedging Activities

 

The Company has stand-alone derivative financial instruments in the form of interest rate caps that derive their value from a fee paid and are adjusted to fair value based on index and strike rate, and swap agreements that derive their value from the underlying interest rate. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments and the value of the derivative are based. Notional amounts do not represent direct credit exposures. Direct credit exposure arises in the event of nonperformance by the counterparties to these agreements, and is limited to the net difference between the calculated amounts to be received and paid, if any. Such differences, which represent the fair value of the derivative instruments, are reflected on the Company's balance sheet as derivative assets and derivative liabilities. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and does not expect any counterparties to fail to meet their obligations.

 

 

The Company currently holds derivative instruments that contain credit-risk related features that are in a net liability position, which may require that collateral be assigned to dealer banks. At September 30, 2018, the Company had posted cash collateral totaling $800 thousand with dealer banks related to derivative instruments in a net liability position.

 

The Company does not offset fair value amounts recognized for derivative instruments. The Company does not net the amount recognized for the right to reclaim cash collateral against the obligation to return cash collateral arising from derivative instruments executed with the same counterparty under a master netting arrangement.

 

Risk Management Policies—Derivative Instruments

 

The Company evaluates the effectiveness of entering into any derivative instrument agreement by measuring the cost of such an agreement in relation to the reduction in net income volatility within an assumed range of interest rates.

 

Interest Rate Risk Management—Cash Flow Hedging Instruments

 

The Company uses variable rate debt as a source of funds for use in the Company's lending and investment activities and other general business purposes. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore, generally hedges a portion of its variable-rate interest payments.

 

Information pertaining to outstanding interest rate caps and swap agreements used to hedge variable rate debt is as follows.

 

September 30, 2018

 

Notional

Amount

   

Inception Date

   

Termination

Date

   

Index

   

Receive

Rate

   

Pay

Rate

   

Strike

Rate

   

Unrealized

Loss

   

Fair Value

   

Balance Sheet

Location

 

(Dollars in thousands)

 

Interest rate swaps:

                                                                 
$ 5,000    

July 2013

   

July 2033

   

3 Mo. LIBOR

      2.29 %     3.38 %     n/a     $ (181 )   $ (181 )  

Other Liabilities

 
  5,000    

July 2013

   

July 2028

   

3 Mo. LIBOR

      2.29 %     3.23 %     n/a       (76 )     (76 )  

Other Liabilities

 
  5,000    

July 2013

   

July 2023

   

3 Mo. LIBOR

      2.29 %     2.77 %     n/a       54       54    

Other Assets

 

Forward-starting interest rate swaps:

                                                                 
  6,000    

February 2018

   

September 2029

   

3 Mo. LIBOR

      5.20 %     5.88 %     n/a       13       13    

Other Assets

 
  10,000    

February 2018

   

February 2030

   

3 Mo. LIBOR

      4.29 %     4.98 %     n/a       15       15    

Other Assets

 

Interest rate caps:

                                                                 
  6,000    

October 2014

   

September 2019

   

3 Mo. LIBOR

      n/a       n/a       2.50 %     (40 )     16    

Other Assets

 
  10,000    

March 2015

   

February 2020

   

3 Mo. LIBOR

      n/a       n/a       2.50 %     (60 )     52    

Other Assets

 
$ 47,000                                                     $ (275 )   $ (107 )        

 

June 30, 2018

 

Notional

Amount

   

Inception Date

   

Termination

Date

   

Index

   

Receive

Rate

   

Pay

Rate

   

Strike

Rate

   

Unrealized

Loss

   

Fair Value

   

Balance Sheet

Location

 

(Dollars in thousands)

 

Interest rate swaps:

                                                                 
$ 5,000    

July 2013

   

July 2033

   

3 Mo. LIBOR

      2.05 %     3.38 %     n/a     $ (293 )   $ (293 )  

Other Liabilities

 
  5,000    

July 2013

   

July 2028

   

3 Mo. LIBOR

      2.05 %     3.23 %     n/a       (154 )     (154 )  

Other Liabilities

 
  5,000    

July 2013

   

July 2023

   

3 Mo. LIBOR

      2.05 %     2.77 %     n/a       15       15    

Other Assets

 

Forward-starting interest rate swaps:

                                                                 

6,000

    February 2018    

September 2029

   

3 Mo. LIBOR

      5.14 %     5.88 %     n/a       (81 )     (81 )  

Other Liabilities

 

10,000

    February 2018    

February 2030

   

3 Mo. LIBOR

      4.23 %     4.98 %     n/a       (140 )     (140 )  

Other Liabilities

 

Interest rate caps:

                                                                 
  6,000    

October 2014

   

September 2019

   

3 Mo. LIBOR

      n/a       n/a       2.50 %     (91 )     15    

Other Assets

 
  10,000    

March 2015

   

February 2020

   

3 Mo. LIBOR

      n/a       n/a       2.50 %     (83 )     49    

Other Assets

 
$ 47,000                                                     $ (827 )   $ (589 )        

 

During the three months ended September 30, 2018 and 2017, no interest rate cap or swap agreements were terminated prior to maturity. Changes in the fair value of interest rate caps and swaps designated as hedging instruments of the variability of cash flows associated with variable rate debt are reported in other comprehensive income. These amounts subsequently are reclassified into interest expense as a yield adjustment in the same period in which the related interest on the debt affects earnings. Risk management results for the three months ended September 30, 2018 and 2017 related to the balance sheet hedging of variable rate debt indicates that the hedges were effective.

 

 

 

8. Other Comprehensive Income

 

The components of other comprehensive income are as follows:

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 
   

Pre-tax

   

Tax Expense

   

After-tax

   

Pre-tax

   

Tax Expense

   

After-tax

 
   

Amount

   

(Benefit)

   

Amount

   

Amount

   

(Benefit)

   

Amount

 
   

(Dollars in thousands)

 

Change in net unrealized loss on available-for-sale debt securities

  $ (74 )   $ (20 )   $ (54 )   $ 122     $ 45     $ 77  
                                                 

Change in accumulated loss on effective cash flow hedges

    482       130       352       22       9       13  

Reclassification adjustment for losses included in net income

    70       19       51       23       9       14  

Total derivatives and hedging activities

    552       149       403       45       18       27  

Total other comprehensive (loss) income

  $ 478     $ 129     $ 349     $ 167     $ 63     $ 104  

 


Accumulated other comprehensive loss is comprised of the following:

 

   

September 30, 2018

   

June 30, 2018

 
   

(Dollars in thousands)

 

Unrealized loss on investment securities

  $ (1,411 )   $ (1,584 )

Tax effect

    381       428  

After tax amount

    (1,030 )     (1,156 )

Unrealized loss on cash flow hedges

    (275 )     (827 )

Tax effect

    73       222  

After tax amount

    (202 )     (605 )

Accumulated other comprehensive loss

  $ (1,232 )   $ (1,761 )

 

 

 

9. Commitments and Contingencies

 

Commitments

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, and commitments to fund investments. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

 

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

 

Financial instruments with contract amounts which represent credit risk are as follows:

 

   

September 30, 2018

   

June 30, 2018

 
   

(Dollars in thousands)

 

Commitments to grant loans

  $ 22,957     $ 20,431  

Unfunded commitments under lines of credit

    32,862       29,478  

Standby letters of credit

    3,183       3,183  

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counter party. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.  The Company has recorded an allowance for possible losses on commitments and unfunded loans totaling $62 thousand and $52 thousand recorded in other liabilities at September 30, 2018 and June 30, 2018, respectively.

 

 

Contingencies

 

The Company and its subsidiary are parties to litigation and claims arising in the normal course of business. Management believes that the liabilities, if any, arising from such litigation and claims will not be material to the Company’s consolidated financial position or results of operations.

 

 

10.

Stock-Based Compensation

 

A summary of restricted share activity for the quarter ended September 30, 2018 follows:

 

   

 

 

Shares

   

 

Weighted Average Grant

Date Fair Value

 

Unvested at beginning of period

    318,334     $ 11.71  

Granted

    114,925       22.40  

Vested

    (53,453 )     10.30  

Forfeited

    (6,377 )     10.20  

Unvested at end of period

    373,429       15.23  

 

 

A summary of the vesting schedule for the shares granted in the quarter ended September 30, 2018 follows:

 

89,925 restricted shares vest in three equal installments, commencing on August 14, 2021; and,

 

25,000 restricted shares are subject to performance-based vesting over a three year period (the “performance shares”). The performance shares include an absolute metric and a sliding metric within the performance period. The absolute metric requires that the Company be in compliance with the regulatory commitments made to the Federal Reserve Bank and Maine Bureau of Financial Institutions.  The sliding metric is based on reaching certain thresholds in regards to the company’s return on equity (“ROE”).  The performance shares shall vest in certain defined increments for such periods if the ROE is at least 70% of such targeted returns.  This performance will be measured on both a year-by-year basis for three years, and an average basis over the three year performance period.

 

 

11. Fair Value Measurements

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. The Company uses prices and inputs that are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from one level to another. When market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. If there has been a significant decrease in the volume and level of activity for the asset or liability, regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same.

 

ASC 820 defines fair value and establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820 are described below:

 

Level 1 — Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

Level 2 — Valuations based on significant observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3 — Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

 

To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

 

Valuation techniques - There have been no changes in the valuation techniques used during the current period.

 

 

Transfers - There were no transfers of assets and liabilities measured at fair value on a recurring or nonrecurring basis during the current period.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis:

 

Investment securities - Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Examples of such instruments include publicly-traded common and preferred stocks. If quoted prices are not available, then fair values are estimated by using pricing models ( i.e., matrix pricing) and market interest rates and credit assumptions or quoted prices of securities with similar characteristics and are classified within Level 2 of the valuation hierarchy. Examples of such instruments include government agency and government sponsored enterprise mortgage-backed securities, as well as certain preferred and trust preferred stocks. Level 3 securities are securities for which significant unobservable inputs are utilized.

 

Certain investments are measured at fair value using the net asset value per share as a practical expedient. These investments include a fund that seeks to invest in securities either issued or guaranteed by the U.S. government or its agencies, as well as a fund that primarily invests in the federally guaranteed portion of SBA 7(a) loans. The Company’s investment in securities either issued or guaranteed by the U.S. government or its agencies can be redeemed daily at the closing net asset value per share. The Company’s investment in SBA 7(a) loans can be redeemed quarterly with sixty days’ notice. In accordance with ASU 2015-07, these investments have not been included in the fair value hierarchy.

 

Derivative financial instruments - The valuation of the Company’s interest rate swaps and caps are determined using widely accepted valuation techniques including discounted cash flow analyses on the expected cash flows of derivatives. These analyses reflect the contractual terms of the derivatives, including the period to maturity, and use observable market-based inputs, including forward interest rate curves and implied volatilities. Unobservable inputs, such as credit valuation adjustments are insignificant to the overall valuation of the Company’s derivative financial instruments. Accordingly, the Company has determined that its interest rate derivatives fall within Level 2 of the fair value hierarchy.

 

The fair value of derivative loan commitments and forward loan sale agreements are estimated using the anticipated market price based on pricing indications provided from syndicate banks. These commitments and agreements are categorized as Level 2. The fair value of such instruments was nominal at each date presented.

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:

 

Collateral dependent impaired loans - Valuations of impaired loans measured at fair value are determined by a review of collateral values. Certain inputs used in appraisals are not always observable, and therefore impaired loans are generally categorized as Level 3 within the fair value hierarchy.

 

Real estate owned and other repossessed collateral - The fair values of real estate owned and other repossessed collateral are estimated based upon appraised values less estimated costs to sell. Certain inputs used in appraisals are not always observable, and therefore may be categorized as Level 3 within the fair value hierarchy. When inputs used in appraisals are primarily observable, they are classified as Level 2.

 

Servicing rights, net - The fair value of the servicing rights is based on a valuation model that calculates the present value of estimated future net servicing income. Adjustments are only recorded when the discounted cash flows derived from the valuation model are less than the carrying value of the asset. Certain inputs are not observable, and therefore servicing rights, net are generally categorized as Level 3 within the fair value hierarchy.

 

Fair Value of other Financial Instruments:

 

Cash and cash equivalents - The fair value of cash, due from banks, interest bearing deposits and Federal Home Loan Bank of Boston (“FHLBB”) overnight deposits approximates their relative book values, as these financial instruments have short maturities.

 

FHLBB stock - The carrying value of FHLBB stock approximates fair value based on redemption provisions of the FHLBB.

 

Loans - Fair values are estimated for portfolios of loans with similar financial characteristics. The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimates of maturity are based on the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic conditions, lending conditions and the effects of estimated prepayments.

 

Loans held for sale - The fair value of loans held-for-sale is estimated based on bid quotations received from loan dealers.

 

 

Interest receivable - The fair value of this financial instrument approximates the book value as this financial instrument has a short maturity. It is the Company’s policy to stop accruing interest on loans past due by more than 90 days. Therefore, this financial instrument has been adjusted for estimated credit losses.

 

Deposits - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW accounts and money market accounts, is equal to the amount payable on demand. The fair values of time deposits are based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. If that value were considered, the fair value of the Company’s net assets could increase.

 

FHLBB advances, capital lease obligations and subordinated debentures - The fair value of the Company’s borrowings with the FHLBB is estimated by discounting the cash flows through maturity or the next re-pricing date based on current rates available to the Company for borrowings with similar maturities. The fair value of the Company’s capital lease obligations and subordinated debentures are estimated by discounting the cash flows through maturity based on current rates available to the Company for borrowings with similar maturities.

 

Off-Balance Sheet Credit-Related Instruments - Fair values for off-balance-sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of such instruments was nominal at each date presented.

 

 

Assets and liabilities measured at fair value on a recurring basis are summarized below. 

 

   

September 30, 2018

 
   

Total

   

Level 1

   

Level 2

   

Level 3

 

Assets

 

(Dollars in thousands)

 

Available-for-sale debt securities:

                               

U.S. Government agency securities

  $ 56,821     $ -     $ 56,821     $ -  

Agency mortgage-backed securities

    22,336       -       22,336       -  

Equity investments measured at net asset value(1)

    6,620       -       -       -  

Other assets – interest rate caps

    68       -       68       -  

Other assets – interest rate swaps

    82               82          

Liabilities

                               

Other liabilities – interest rate swaps

  $ 257     $ -     $ 257     $ -  

 

   

June 30, 2018

 
   

Total

   

Level 1

   

Level 2

   

Level 3

 

Assets

 

(Dollars in thousands)

 

Available-for-sale debt securities:

                               

U.S. Government agency securities

  $ 56,887     $ -     $ 56,887     $ -  

Agency mortgage-backed securities

    24,181       -       24,181       -  

Equity investments measured at net asset value(1)

    6,619       -       -       -  

Other assets – interest rate caps

    64       -       64       -  

Other assets – interest rate swaps

    15               15          

Liabilities

                               

Other liabilities – interest rate swap

  $ 668     $ -     $ 668     $ -  

 

 

(1)

In accordance with ASU 820-10, certain investments that are measured at fair value using the net asset value per share (or its equivalent) as a practical expedient have not been classified in the fair value hierarchy. The fair value amount presented in the table are intended to permit reconciliation of the fair value amount to the consolidated financial statements.

 

 

Assets measured at fair value on a nonrecurring basis are summarized below.

 

   

September 30, 2018

 
   

Total

   

Level 1

   

Level 2

   

Level 3

 
   

(Dollars in thousands)

 

Collateral dependent impaired loans

  $ 2,677     $ -     $ -     $ 2,677  

Real estate owned and other repossessed collateral

    1,549       -       -       1,549  

Servicing rights, net

    3,010       -       -       3,010  

 

   

June 30, 2018

 
   

Total

   

Level 1

   

Level 2

   

Level 3

 
   

(Dollars in thousands)

 

Collateral dependent impaired loans

  $ 1,917     $ -     $ -     $ 1,917  

Real estate owned and other repossessed collateral

    2,233       -       -       2,233  

Servicing rights, net

    2,970       -       -       2,970  

 

 

The table below presents quantitative information about significant unobservable inputs (Level 3) for assets measured at fair value on a nonrecurring basis at the dates indicated.

 

   

Fair Value

   
   

September 30,

2018

   

June 30,
2018

 

Valuation Technique

   

(Dollars in thousands)

   

Collateral dependent impaired loans

  $ 2,677     $ 1,917  

Appraisal of collateral(1)

Real estate owned and other repossessed collateral

    1,549       2,223  

Appraisal of collateral(1)

Servicing rights, net

    3,010       2,970  

Discounted cash flow(2)

 

(1) Fair value is generally determined through independent appraisals of the underlying collateral. The Company may also use another available source of collateral assessment to determine a reasonable estimate of the fair value of the collateral. Appraisals may be adjusted by management for qualitative factors such as economic factors and estimated liquidation expenses. The range of these possible adjustments was 10% to 100%.

(2) Fair value is determined using a discounted cash flow model. The unobservable inputs include anticipated rate of loan prepayments and discount rates. The range of prepayment assumptions used was 10.6% to 11.5%. For discount rates, the range was 9.0% to 23.3%.

 

 

The table below summarizes the total gains (losses) on assets measured at fair value on a non-recurring basis for the three months ended September 30, 2018 and 2017.

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 
   

(In thousands)

 
                 

Collateral dependent impaired loans

  $ (324 )   $ 16  
                 

Real estate owned and other repossessed collateral

    -       -  

Servicing rights, net

    (107 )     -  

Total

  $ (431 )   $ 16  

 

 

The following table presents the estimated fair value of the Company's financial instruments.

 

   

Carrying

   

Fair Value Measurements at September 30, 2018

 
   

Amount

   

Total

   

Level 1

   

Level 2

   

Level 3

 
   

(Dollars in thousands)

 

Financial assets:

                                       

Cash and cash equivalents

  $ 205,717     $ 205,717     $ 205,717     $ -     $ -  

Available-for-sale debt securities

    79,157       79,157       -       79,157       -  

Equity investments measured at net asset value(1)

    6,620       6,620       -       -       -  

Federal Home Loan Bank stock

    1,652       1,652       -       1,652       -  

Loans held for sale

    3,290       3,290       -       3,290       -  

Loans, net

    881,908       879,760       -       -       879,760  

Accrued interest receivable

    2,870       2,870       -       2,870       -  

Interest rate caps

    68       68       -       68       -  

Interest rate swaps

    82       82       -       82       -  
                                         

Financial liabilities:

                                       

Deposits

    1,015,507       1,014,302       -       1,014,302       -  

Federal Home Loan Bank advances

    15,000       15,000       -       15,000       -  

Capital lease obligation

    536       546       -       546       -  

Subordinated debt

    24,043       26,001       -       -       26,001  

Interest rate swaps

    257       257       -       257       -  

 

   

Carrying

   

Fair Value Measurements at June 30, 2018

 
   

Amount

   

Total

   

Level 1

   

Level 2

   

Level 3

 
   

(Dollars in thousands)

 

Financial assets:

                                       

Cash and cash equivalents

  $ 157,402     $ 157,402     $ 157,402     $ -     $ -  

Available-for-sale debt securities

    81,068       81,068       -       81,068       -  

Equity investments measured at net asset value(1)

    6,619       6,619       -       -       -  

Federal Home Loan Bank stock

    1,652       1,652       -       1,652       -  

Loans held for sale

    7,155       7,155       -       7,155       -  

Loans, net

    866,995       868,730       -       -       868,730  

Accrued interest receivable

    2,528       2,528       -       2,528       -  

Interest rate caps

    64       64       -       64       -  

Interest rate swaps

    15       15               15          
                                         

Financial liabilities:

                                       

Deposits

    954,940       953,216       -       953,216       -  

Federal Home Loan Bank advances

    15,000       15,000       -       15,000       -  

Capital lease obligation

    605       619       -       619       -  

Subordinated debt

    23,958       25,961       -       -       25,961  

Interest rate swaps

    668       668       -       668       -  

 

 

(1)

In accordance with ASU 820-10, certain investments that are measured at fair value using the net asset value per share (or its equivalent) as a practical expedient have not been classified in the fair value hierarchy. The fair value amount presented in the table are intended to permit reconciliation of the fair value amount to the consolidated financial statements.

 

 
26

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with the consolidated financial statements, notes and tables included in Northeast Bancorp’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018, filed with the Securities and Exchange Commission.

 

A Note about Forward Looking Statements

 

This report contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended, such as statements relating to Northeast Bancorp’s financial condition, prospective results of operations, future performance or expectations, plans, objectives, prospects, loan loss allowance adequacy, simulation of changes in interest rates, capital spending and finance sources and revenue sources. These statements relate to expectations concerning matters that are not historical facts. Accordingly, statements that are based on management’s projections, estimates, assumptions, and judgments constitute forward-looking statements. These forward-looking statements, which are based on various assumptions (some of which are beyond the Company’s control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology such as “believe”, “expect”, “estimate”, “anticipate”, “continue”, “plan”, “approximately”, “intend”, “objective”, “goal”, “project”, or other similar terms or variations on those terms, or the future or conditional verbs such as “will”, “may”, “should”, “could”, and “would”. Although the Company believes that these forward-looking statements are based on reasonable estimates and assumptions, they are not guarantees of future performance and are subject to known and unknown risks, uncertainties, contingencies, and other factors. Accordingly, the Company cannot give you any assurance that its expectations will, in fact, occur or that its estimates or assumptions will be correct. The Company cautions you that actual results could differ materially from those expressed or implied by such forward-looking statements as a result of, among other factors, changes in interest rates and real estate values; competitive pressures from other financial institutions; weakness in general economic conditions on a national basis or in the local markets in which the Company operates, including changes which adversely affect borrowers’ ability to service and repay the Company’s loans; changes in loan defaults and charge-off rates; changes in the value of securities and other assets, adequacy of loan loss reserves, or deposit levels necessitating increased borrowing to fund loans and investments; changes in government regulation; operational risks including, but not limited to, cybersecurity breaches, fraud and natural disasters; the risk that the Company may not be successful in the execution of its business strategy; the risk that intangibles recorded in the Company’s financial statements will become impaired; changes in assumptions used in making such forward-looking statements; and the other risks and uncertainties detailed in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018 as updated in the Company’s Quarterly Reports on Form 10-Q and other filings submitted to the Securities and Exchange Commission. These forward-looking statements speak only as of the date of this report and the Company does not undertake any obligation to update or revise any of these forward-looking statements to reflect events or circumstances occurring after the date of this report or to reflect the occurrence of unanticipated events.

 

Description of Business and Strategy

 

Business Overview

Northeast Bancorp (“we,” “our,” “us,” “Northeast” or the “Company”), incorporated under Maine law in 1987, is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the “BHCA”), the Company is subject to regulation and supervision by the Federal Reserve. The Company’s primary subsidiary and principal asset is its wholly-owned banking subsidiary, Northeast Bank (the “Bank” or “Northeast Bank”), a Maine state-chartered bank originally organized in 1872. As a Federal Deposit Insurance Corporation (“FDIC”) insured Maine-chartered bank, the Bank is subject to regulation and supervision by the Maine Bureau of Financial Institutions (the “Bureau”) and the FDIC.

 

On December 29, 2010, the merger of the Company and FHB Formation LLC, a Delaware limited liability company (“FHB”), was consummated. As a result of the merger, the surviving company received a capital contribution of $16.2 million (in addition to the approximately $13.1 million in cash consideration paid to former shareholders), and the former members of FHB collectively acquired approximately 60% of the Company’s outstanding common stock. The Company applied the acquisition method of accounting, as described in Accounting Standards Codification (“ASC”) 805, Business Combinations (“ASC 805”) to the merger, which represents an acquisition by FHB of Northeast, with Northeast as the surviving company. 

 

In connection with the transaction, as part of the regulatory approval process, the Company and the Bank made certain commitments to the Federal Reserve, the most significant of which are (i) to maintain a Tier 1 leverage ratio of at least 10%, (ii) to maintain a total risk-based capital ratio of at least 15%, (iii) to limit purchased loans to 40% of total loans, (iv) to fund 100% of the Company’s loans with core deposits (defined as non-maturity deposits and non-brokered insured time deposits), and (v) to hold commercial real estate loans (including owner-occupied commercial real estate) to within 300% of total risk-based capital. On June 28, 2013, the Federal Reserve approved the amendment to exclude owner-occupied commercial real estate loans from the commitment to hold commercial real estate loans to within 300% of total risk-based capital. All other commitments made to the Federal Reserve in connection with the merger remain unchanged. The Company and the Bank are currently in compliance with all commitments to the Federal Reserve. The Company’s compliance ratios at September 30, 2018 follow:

 

Condition

 

Ratios as of September 30, 2018

 

(i) Tier 1 leverage capital ratio

    12.83 %

(ii) Total capital ratio

    19.81 %

(iii) Ratio of purchased loans to total loans, including loans held for sale

    33.75 %

(iv) Ratio of loans to core deposits (1)

    87.17 %

(v) Ratio of non-owner occupied commercial real estate loans to total capital (2)

    230.48 %

 

(1) Core deposits include all non-maturity deposits and non-brokered insured time deposits.

(2) For purposes of calculating this ratio, commercial real estate includes all non-owner occupied commercial real estate loans defined as such by regulatory guidance, including all land development and construction loans.

 

27

 

As of September 30, 2018, the Company, on a consolidated basis, had total assets of $1.2 billion, total deposits of $1.0 billion, and shareholders’ equity of $143.4 million. The Company gathers retail deposits through its banking offices in Maine and the Bank's online affinity deposit program, ableBanking; originates loans through the Bank’s Community Banking Division; originates Small Business Administration (“SBA”) and United States Department of Agriculture loans through the Bank’s national SBA group (“SBA Division”); and purchases and originates commercial loans through the Bank’s LASG. The Community Banking Division, with ten full-service branches, operates from the Bank’s headquarters in Lewiston, Maine. LASG, ableBanking, and the SBA Division operate from the Company's offices in Boston, Massachusetts.

 

Unless the context otherwise requires, references herein to the Company include the Company and its subsidiary on a consolidated basis.

 

Strategy

 

The Company's goal is to prudently grow its franchise, while maintaining sound operations and risk management, by means of the following strategies:

 

Continuing to grow the LASG’s national originated and purchased loan business. We purchase commercial real estate loans nationally, at prices that on average have produced yields significantly higher than those available on our originated loan portfolio. We also originate loans nationally, taking advantage of our core expertise in underwriting and servicing national credits.

 

Growing our national SBA origination business. We originate loans on a national basis to small businesses, primarily through the SBA 7(a) program, which provides the partial guarantee of the SBA.

 

Continuing our community banking tradition. With a history that dates to 1872, our Community Banking Division maintains its focus on sales and service, with the goal of attracting and retaining deposits, and serving the lending needs of retail and commercial customers within our core markets.

 

Generating deposits to fund our business. We offer a full line of deposit products through our ten-branch network located in the Community Banking Division’s market. ableBanking is a direct savings platform providing an additional channel to raise core deposits to fund our asset strategy.

 

Critical Accounting Policies

 

Critical accounting policies are those that involve significant judgments and assessments by management, and which could potentially result in materially different results under different assumptions and conditions. The reader is encouraged to review each of the policies included in Form 10-K for the year ended June 30, 2018 to gain a better understanding of how Northeast’s financial performance is measured and reported. There has been no material change in critical accounting policies during the three months ended September 30, 2018.

 

Overview

 

Net income totaled $4.5 million for the quarter ended September 30, 2018, a decrease of $52 thousand, or 1.1%, from net income of $4.6 million for the quarter ended September 30, 2017.

 

Net interest and dividend income before provision for loan losses increased by $1.0 million for the quarter ended September 30, 2018, compared to the quarter ended September 30, 2017. The increase is primarily due to higher average balances in the total loan portfolio. This increase was partially offset by lower transactional income, higher funding costs and higher average deposit balances.

 

Noninterest income decreased by $404 thousand for the quarter ended September 30, 2018, compared to the quarter ended September 30, 2017, principally due to the following:

 

A decrease in gain on sale of SBA loans of $168 thousand, due to lower pricing in the SBA guaranty market in the quarter; and

 

A decrease in gain on sale of residential loans of $117 thousand, due to lower volume of residential loans sold in the quarter.

 

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Noninterest expense increased by $641 thousand for the quarter ended September 30, 2018, compared to the quarter ended September 30, 2017, primarily due to the following:

 

An increase in salaries and employee benefits expense of $255 thousand, primarily due to increases in incentive compensation, stock-based compensation expense, and health insurance costs;

 

An increase in other noninterest expense of $167 thousand, primarily due to the quarterly valuation of SBA servicing rights;

 

An increase in professional fees of $92 thousand, primarily due to increased legal and other consulting costs; and

 

An increase in loan expense of $74 thousand, largely driven by direct expenses related to a repossessed asset.

 

Income tax expense decreased by $123 thousand for the quarter ended September 30, 2018, compared to the quarter ended September 30, 2017, primarily due to the following:

 

A decrease in income before income tax expense of $175 thousand, which resulted in a $49 thousand decrease in income tax expense; and

 

A decrease in the federal corporate income tax rate as a result of the Tax Cuts and Jobs Act signed into law on December 22, 2017, which resulted in a $691 thousand decrease in federal income tax expense; partially offset by

 

A decrease in the income tax benefit recognized of $637 thousand arising from the treatment of vested restricted stock awards under ASU 2016-09, Compensation–Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, whereby the tax effects of vested awards or exercised stock options are treated as a discrete item in the reporting period in which they occur.

 

Financial Condition

 

Overview

 

As of September 30, 2018, total assets were $1.2 billion, an increase of $56.0 million, or 4.8%, from total assets of $1.2 billion as of June 30, 2018. The principal components of the changes in the balance sheet follow:

 

The following table highlights the changes in the loan portfolio for the three months ended September 30, 2018:

 

   

Three Months Ended September 30, 2018

 
   

September 30, 2018

Balance

   

June 30, 2018

Balance

   

 

Change ($)

   

 

Change (%)

 
   

(Dollars in thousands)

 

LASG Purchased

  $ 300,548     $ 290,972     $ 9,576       3.29 %

LASG Originated

    407,822       397,363       10,459       2.63 %

SBA

    67,212       60,156       7,056       11.73 %

Community Banking

    111,614       123,311       (11,697 )     (9.49% )

Total

  $ 887,196     $ 871,802     $ 15,394       1.77 %

 

Loans generated by the Bank's LASG for the quarter ended September 30, 2018 totaled $105.9 million, which consisted of $34.8 million of purchased loans, at an average price of 93.9% of unpaid principal balance, and $71.1 million of originated loans. The Bank's SBA Division closed $18.9 million and funded $18.6 million of new loans during the quarter ended September 30, 2018. In addition, the Company sold $12.3 million of the guaranteed portion of SBA 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. Residential loan production sold in the secondary market totaled $13.2 million for the quarter.

 

As noted above in the “Business Overview” section, the Company made certain commitments to the Federal Reserve in connection with the merger of FHB with and into the Company in December 2010. The Company’s loan purchase and commercial real estate loan availability under these conditions follow.

 

 

 

Basis for Regulatory Condition

 

Condition

 

Availability at September 30, 2018

 
       

(Dollars in millions)

 

Total Loans

 

Purchased loans may not exceed 40% of total loans

  $ 92.7  

Regulatory Capital

 

Non-owner occupied commercial real estate loans may not exceed 300% of total capital

    120.2  

 

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An overview of the Bank’s LASG portfolio follows:

 

   

LASG Portfolio

 
   

Three Months Ended September 30,

 
   

2018

   

2017

 
   

Purchased

   

Originated

   

Total LASG

   

Purchased

   

Originated

   

Total LASG

 
   

(Dollars in thousands)

 

Loans purchased or originated during the period:

                                               

Unpaid principal balance

  $ 37,077     $ 71,136     $ 108,213     $ 4,318     $ 40,779     $ 45,097  

Net investment basis

    34,803       71,136       105,939       3,651       40,779       44,430  
                                                 

Loan returns during the period:

                                               

Yield

    9.46 %     7.43 %     8.31 %     12.28 %     6.35 %     8.85 %

Total Return (1)

    9.46 %     7.43 %     8.31 %     12.28 %     6.35 %     8.85 %
                                                 

Total loans as of period end:

                                               

Unpaid principal balance

  $ 336,908     $ 407,822     $ 744,730     $ 262,144     $ 340,756     $ 602,900  

Net investment basis

    300,548       407,822       708,370       231,232       340,756       571,988  

 

(1) The total return on purchased loans represents scheduled accretion, accelerated accretion, gains on asset sales, gains on real estate owned and other noninterest income recorded during the period divided by the average invested balance, which includes purchased loans held for sale, on an annualized basis. The total return on purchased loans does not include the effect of purchased loan charge-offs or recoveries during the period. Total return on purchased loans is considered a non-GAAP financial measure.

 

Assets

 

Cash and Due from Banks, Short-Term Investments and Investment Securities

 

Cash and cash equivalents were $205.7 million as of September 30, 2018, an increase of $48.3 million, or 30.7%, from $157.4 million at June 30, 2018. The increase is primarily due to the increase in deposits, offset by the increase in loans in the period.

 

Investment securities totaled $85.8 million as of September 30, 2018, compared to $87.7 million as of June 30, 2018, representing a decrease of $1.9 million, or 2.2%, primarily due to principal payments on mortgage-backed securities. Included in investment securities are securities issued by government agencies and government-sponsored enterprises, as well as an investment of $5.1 million in a CRA qualified fund that seeks to invest in securities either issued or guaranteed by the U.S. government or its agencies and an investment of $1.5 million in a CRA qualified fund that primarily invests in the federally guaranteed portion of SBA 7(a) loans. At September 30, 2018, no securities were pledged for outstanding borrowings.

 

30

 

Loans

 

The Company’s loan portfolio (excluding loans held-for-sale) by lending division follows:

 

    September 30, 2018  
    Community Banking Division     LASG     SBA Division     Total     Percent of Total  
    (Dollars in thousands)  

Originated loans:

                                       

Residential real estate

  $ 61,041     $ 8,735     $ -     $ 69,776       7.86 %

Home equity

    9,134       -       -       9,134       1.03 %

Commercial real estate: non-owner occupied

    17,685       151,739       38,142       207,566       23.40 %

Commercial real estate: owner occupied

    10,563       73,142       23,123       106,828       12.04 %

Commercial and industrial

    10,213       174,206       5,947       190,366       21.46 %

Consumer

    2,978       -       -       2,978       0.34 %
Total originated loans     111,614       407,822       67,212       586,648       66.13 %

Purchased loans:

                                       

Residential real estate

    -       14,398       -       14,398       1.62 %

Commercial real estate: non-owner occupied

    -       165,088       -       165,088       18.61 %

Commercial real estate: owner occupied

    -       120,142       -       120,142       13.54 %

Commercial and industrial

    -       920       -       920       0.10 %
Total purchased loans     -       300,548       -       300,548       33.87 %

Total loans

  $ 111,614     $ 708,370     $ 67,212     $ 887,196       100.00 %

 

 

    June 30, 2018  
   

Community Banking Division

   

LASG

   

SBA Division

   

Total

   

Percent of Total

 
    (Dollars in thousands)  

Originated loans:

                                       

Residential real estate

  $ 68,634     $ 7,111     $ 128     $ 75,873       8.70 %

Home equity

    10,457       -       -       10,457       1.20 %

Commercial real estate: non-owner occupied

    18,698       137,463       29,488       185,649       21.29 %

Commercial real estate: owner occupied

    11,351       81,916       24,483       117,750       13.51 %

Commercial and industrial

    10,927       170,873       6,057       187,857       21.55 %

Consumer

    3,244       -       -       3,244       0.37 %
Total originated loans     123,311       397,363       60,156       580,830       66.62 %

Purchased loans:

                                       

Residential real estate

    -       13,926       -       13,926       1.60 %

Commercial real estate: non-owner occupied

    -       150,805       -       150,805       17.30 %

Commercial real estate: owner occupied

    -       125,246       -       125,246       14.37 %

Commercial and industrial

    -       995       -       995       0.11 %
Total purchased loans     -       290,972       -       290,972       33.38 %

Total loans

  $ 123,311     $ 688,335     $ 60,156     $ 871,802       100.00 %

 

 

Classification of Assets

 

Loans are classified as nonperforming when 90 or more days past due, unless a loan is well-secured and in the process of collection. Loans less than 90 days past due, for which collection of principal or interest is considered doubtful, also may be designated as nonperforming. In both situations, accrual of interest ceases. The Company typically maintains such loans as nonperforming until the respective borrowers have demonstrated a sustained period of payment performance.

 

In cases where a borrower experiences financial difficulties and the Company makes certain concessionary modifications, the loan is classified as a TDR. Concessionary modifications may include adjustments to interest rates, extensions of maturity, or other actions intended to minimize economic loss and avoid foreclosure or repossession of collateral. Nonaccrual loans that are restructured generally remain on nonaccrual status for a minimum period of six months to demonstrate that the borrower can meet the restructured terms. If the restructured loan is on accrual status prior to being modified, it is reviewed to determine if the modified loan should remain on accrual status. If the borrower’s ability to meet the revised payment schedule is not reasonably assured, the loan is classified as a nonaccrual loan. With limited exceptions, loans classified as TDRs remain classified as such until the loan is paid off.

 

Other nonperforming assets include other real estate owned (“OREO”) and other personal property securing loans repossessed by the Bank. The real estate and personal property collateral for commercial and consumer loans is recorded at fair value less estimated costs to sell upon repossession. Revenues and expenses are recognized in the period when received or incurred on OREO and in-substance foreclosures. Gains and losses on disposition are recognized in noninterest income.

 

31

 

The following table details the Company's nonperforming assets and other credit quality indicators as of September 30, 2018 and June 30, 2018. Management believes that, based on their carrying amounts, nonperforming assets are well secured based on the estimated fair value of underlying collateral.

 

   

Nonperforming Assets at September 30, 2018

 
   

Originated

   

Purchased

   

Total

 
   

(Dollars in thousands)

 

Loans:

                       

Residential real estate

  $ 2,633     $ 202     $ 2,835  

Home equity

    151       -       151  

Commercial real estate

    1,703       4,816       6,519  

Commercial and industrial

    1,454       357       1,811  

Consumer

    185       -       185  
Total nonperforming loans     6,126       5,375       11,501  

Real estate owned and other repossessed collateral

    118       1,431       1,549  
Total nonperforming assets   $ 6,244     $ 6,806     $ 13,050  
                         

Ratio of nonperforming loans to total loans

                    1.30 %

Ratio of nonperforming assets to total assets

                    1.08 %

Ratio of loans past due to total loans

                    1.09 %

Nonperforming loans that are current

                  $ 2,470  

Commercial loans risk rated substandard or worse

                  $ 8,931  

Troubled debt restructurings:

                       

On accrual status

                  $ 11,583  

On nonaccrual status

                  $ 3,183  

 

   

Nonperforming Assets at June 30, 2018

 
   

Originated

   

Purchased

   

Total

 
   

(Dollars in thousands)

 

Loans:

                       

Residential real estate

  $ 2,914     $ 202     $ 3,116  

Home equity

    298       -       298  

Commercial real estate

    1,499       5,180       6,679  

Commercial and industrial

    1,368       363       1,731  

Consumer

    134       -       134  
Total nonperforming loans     6,213       5,745       11,958  

Real estate owned and other repossessed collateral

    115       2,118       2,233  
Total nonperforming assets   $ 6,328     $ 7,863     $ 14,191  
                         

Ratio of nonperforming loans to total loans

                    1.37 %

Ratio of nonperforming assets to total assets

                    1.23 %

Ratio of loans past due to total loans

                    0.89 %

Nonperforming loans that are current

                  $ 4,897  

Commercial loans risk rated substandard or worse

                  $ 9,090  

Troubled debt restructurings:

                       

On accrual status

                  $ 11,915  

Nonaccrual status

                  $ 3,543  

 

As of September 30, 2018, nonperforming assets totaled $13.1 million, or 1.08% of total assets, as compared to $14.2 million, or 1.23% of total assets, as of June 30, 2018.

 

OREO decreased by $684 thousand, or 30.6%, to $1.5 million at September 30, 2018, compared to $2.2 million at June 30, 2018. The decrease was primarily the result of the sale of one property in the quarter ended September 30, 2018.

 

Allowance for Loan Losses

 

In connection with the application of the acquisition method of accounting for the merger on December 29, 2010, the allowance for loan losses was reduced to zero when the loan portfolio was marked to its then current fair value. Since that date, the Company has provided for an allowance for loan losses as new loans are originated or in the event that credit exposure in the pre-merger loan portfolio or other acquired loans exceeds the exposure estimated when initial fair values were determined.

 

The Company’s allowance for loan losses was $5.3 million as of September 30, 2018, compared to $4.8 million as of June 30, 2018. The increase in the period is primarily the result of changes in the composition of the loan portfolio from an increase in loans originated by the SBA division, as well as an increase in specific reserve on two loan relationships.

 

The following table details ratios related to the allowance for loan losses for the periods indicated.

 

   

September 30, 2018

   

June 30, 2018

   

September 30, 2017

 

Allowance for loan losses to nonperforming loans

    45.98%       40.20%       24.23%  

Allowance for loan losses to total loans

    0.60%       0.55%       0.53%  

Last twelve months of net-charge offs to average loans

    0.04%       0.04%       0.03%  

 

While management believes that it uses the best information available to make its determinations with respect to the allowance, there can be no assurance that the Company will not have to increase its provision for loan losses in the future as a result of changing economic conditions, adverse markets for real estate or other factors.

 

32

 

Other Assets

 

Premises and equipment, net, decreased by $277 thousand, or 4.2%, to $6.3 million at September 30, 2018, compared to $6.6 million at June 30, 2018. The decrease was primarily due to depreciation and amortization.

 

Intangible assets totaled $758 thousand and $867 thousand at September 30, 2018 and June 30, 2018, respectively. The $109 thousand decrease was the result of intangible asset amortization during the period.

 

Servicing rights, net totaled $3.0 million at both September 30, 2018 and June 30, 2018. The $40 thousand increase was the result of SBA loans sold during the three months ended September 30, 2018, offset by amortization and the revaluation of the servicing rights performed on a quarterly basis and amortization.

 

The cash surrender value of the Company’s bank-owned life insurance (“BOLI”) assets increased $109 thousand, or 0.7% to $16.7 million at September 30, 2018, compared to $16.6 million at June 30, 2018. Increases in cash surrender value are recognized in noninterest income and are not subject to income taxes. Borrowing on, or surrendering a policy, may subject the Company to income tax expense on the increase in cash surrender value. For these reasons, management considers BOLI an illiquid asset. BOLI represented 9.7% of the Company’s regulatory total capital at September 30, 2018.

 

Deposits, FHLBB Advances, Subordinated Debt, Liquidity, and Capital

 

Deposits

 

The Company’s principal source of funding is its core deposit accounts. At September 30, 2018, non-maturity accounts and non-brokered insured time deposits represented 100% of total deposits.

 

Total deposits increased $60.6 million, or 6.3%, to $1.0 billion as of September, 2018 from $954.9 million as of June 30, 2018. The increase was attributable primarily to an increase in time deposits of $87.9 million, or 25.0% due to promotions during the quarter, offset by a decrease in money market accounts of $22.5 million, or 5.3%.

 

The composition of total deposits at September 30, 2018 and June 30, 2018 is as follows:

 

   

September 30, 2018

   

June 30, 2018

 
   

Amount

   

Percent of Total

   

Amount

   

Percent of Total

 
   

(Dollars in thousands)

 

Demand deposits

  $ 67,500       6.65 %   $ 72,272       7.57 %

NOW accounts

    73,867       7.27 %     73,347       7.68 %

Regular and other savings

    35,697       3.52 %     36,290       3.80 %

Money market deposits

    398,423       39.23 %     420,886       44.07 %

Total non-certificate accounts

    575,487       56.67 %     602,795       63.12 %

Term certificates of $250 thousand or less

    440,020       43.33 %     352,145       36.88 %

Term certificates greater than $250 thousand

    -       0.00 %     -       0.00 %

Total certificate accounts

    440,020       43.33 %     352,145       36.88 %

Total deposits

  $ 1,015,507       100.00 %   $ 954,940       100.00 %

 

 

FHLBB Advances

 

Advances from the FHLBB were $15.0 million at both September 30, 2018 and June 30, 2018. As of September 30, 2018, the Company had pledged certain residential real estate loans and commercial real estate loans to secure outstanding advances and provide additional borrowing capacity. As of September 30, 2018, no securities were pledged for outstanding borrowings.

 

Subordinated Debt

 

On June 29, 2016, the Company entered into a Subordinated Note Purchase Agreement with certain institutional accredited investors pursuant to which the Company issued subordinated notes equal to $15.05 million in aggregate principal amount with an interest rate of 6.75% fixed-to-floating maturing in 2026 (“subordinated notes”). The subordinated notes, net of issuance costs, totaled $14.7 million at both September 30, 2018 and June 30, 2018.

 

The Company had junior subordinated debentures issued to affiliated trusts totaling $9.3 million and $9.2 million at September 30, 2018 and June 30, 2018, respectively. The unpaid principal balance of the junior subordinated debentures totaled $16.5 million at both September 30, 2018 and June 30, 2018.

 

33

 

Liquidity

 

The following table is a summary of unused borrowing capacity of the Company at September 30, 2018, in addition to traditional retail deposit products:

 

   

As of September 30, 2018

   
   

(Dollars in thousands)

   

Brokered time deposits

  $ 303,429  

Subject to policy limitation of 25% of total assets

Federal Home Loan Bank of Boston

    45,478  

Unused advance capacity subject to eligible and qualified collateral

Federal Discount Window Borrower-in-Custody

    1,056  

Unused credit line subject to the pledge of loans

Other available lines

    17,500    

Total unused borrowing capacity

  $ 367,463    

 

Retail deposits and other core deposit sources including deposit listing services are used by the Bank to manage its overall liquidity position. While we currently do not seek wholesale funding such as FHLBB advances and brokered deposits, the ability to raise them remains an important part of our liquidity contingency planning. While we closely monitor and forecast our liquidity position, it is affected by asset growth, deposit withdrawals and meeting other contractual obligations and commitments. The accuracy of our forecast assumptions may increase or decrease our overall available liquidity. To utilize the FHLBB advance capacity, the purchase of additional capital stock of the FHLBB may be required.

 

At September 30, 2018, the Company had $434.2 million of immediately accessible liquidity, defined as cash that the Bank reasonably believes could be raised within seven days through collateralized borrowings, brokered deposits or security sales. This position represented 35.8% of total assets. The Company also had $205.7 million of cash and cash equivalents at September 30, 2018.

 

Management believes that there are adequate funding sources to meet its liquidity needs for the foreseeable future. Primary funding sources are the repayment of principal and interest on loans, the renewal of time deposits, the potential for growth in the deposit base, and the credit availability from the FHLBB. Management does not believe that the terms and conditions that will be present at the renewal of these funding sources will significantly impact the Company’s operations, due to its management of the maturities of its assets and liabilities.

 

Capital

 

The unpaid principal balance and carrying amount of junior subordinated debentures totaled $16.5 million and $9.3 million, respectively, as of September 30, 2018. The unpaid principal balance and carrying amount of subordinated debt totaled $15.1 million and $14.7 million, respectively, as of September 30, 2018. The junior subordinated debt represents qualifying Tier 1 capital for the Company, up to a maximum of 25% of total Tier 1 capital, and subordinated debt represents qualifying Tier 2 capital for the Company. At September 30, 2018, the carrying amounts of the junior subordinated debt, net of the Company’s $496 thousand investment in the affiliated trusts, qualified as Tier 1 capital, and the subordinated debt qualified as Tier 2 capital.

 

At September 30, 2018, shareholders’ equity was $143.4 million, an increase of $5.0 million, or 3.6% from June 30, 2018. Book value per outstanding common share was $15.85 at September 30, 2018 and $15.49 at June 30, 2018. Tier 1 capital to total average assets of the Company was 12.8% as of September 30, 2018 and 13.1% at June 30, 2018.

 

Under the capital rules, risk-based capital ratios are calculated by dividing Tier 1 and total capital, respectively, by risk-weighted assets. Assets and off-balance sheet credit equivalents are assigned to one of several risk-weight categories, based primarily on relative risk. The rules require banks and bank holding companies to maintain a minimum common equity Tier 1 capital ratio of 4.5%, a minimum Tier 1 capital ratio of 6%, a total capital ratio of 8% and a leverage ratio of 4%. Additionally, subject to a transition schedule, the capital rules require a bank holding company to establish a capital conservation buffer of Tier 1 capital in an amount above the minimum risk-based capital requirements for "adequately capitalized" institutions equal to 2.5% of total risk weighted assets, or face restrictions on the ability to pay dividends, pay discretionary bonuses, and to engage in share repurchases.

 

A bank holding company, such as the Company, is considered "well capitalized" if the bank holding company (i) has a total capital ratio of at least 10%, (ii) has a Tier 1 risk-based capital ratio of at least 6%, and (iii) is not subject to any written agreement order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. In addition, the FDIC has amended its prompt corrective action rules to reflect the revisions made by the revised capital rules described above. Under the FDIC's revised rules, which became effective January 1, 2015, an insured state nonmember bank is considered "well capitalized" if it (i) has a total capital ratio of 10.0% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a common Tier 1 equity ratio of 6.5% or greater, (iv) a leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.

 

34

 

The Company and the Bank are considered "well capitalized" under all regulatory definitions. The Company's and the Bank's regulatory capital ratios are set forth below.

 

   

 

 

 

 

Actual

   

 

 

 

Minimum Capital

Requirements

 

 

Minimum To Be Well

Capitalized Under

Prompt Corrective

Action Provisions

   

Minimum

Capital Ratio

with Capital

Conservation

Buffer

 
   

Amount

   

Ratio

   

Amount

 

Ratio

 

Amount

   

Ratio

   

Ratio

 
                                                   

September 30, 2018:

 

(Dollars in thousands)

 

Common equity tier 1 capital to risk weighted assets:

                                                 

Company

  $ 143,960       16.50 %   $ 39,267  

>4.5%

    N/A       N/A       7.0 %

Bank

    162,154       18.59 %     39,261  

>4.5%

  $ 56,710    

>6.5%

      7.0 %
                                                   

Total capital to risk weighted assets:

                                                 

Company

    172,856       19.81 %     69,808  

>8.0%

    N/A       N/A       10.5 %

Bank

    167,503       19.20 %     69,797  

>8.0%

    87,247    

>10.0%

      10.5 %
                                                   

Tier 1 capital to risk weighted assets:

                                                 

Company

    152,761       17.51 %     52,356  

>6.0%

    N/A       N/A       8.5 %

Bank

    162,154       18.59 %     52,348  

>6.0%

    69,797    

>8.0%

      8.5 %
                                                   

Tier 1 capital to average assets:

                                                 

Company

    152,761       12.83 %     47,611  

>4.0%

    N/A       N/A       4.0 %

Bank

    162,154       13.63 %     47,595  

>4.0%

    59,494    

>5.0%

      4.0 %
                                                   

June 30, 2018:

                                                 

Common equity tier 1 capital to risk weighted assets:

                                                 

Company

  $ 139,247       16.02 %   $ 39,113  

>4.5%

    N/A       N/A       7.0 %

Bank

    156,856       18.04 %     39,120  

>4.5%

  $ 56,506    

>6.5%

      7.0 %
                                                   

Total capital to risk weighted assets:

                                                 

Company

    167,567       19.28 %     69,535  

>8.0%

    N/A       N/A       10.5 %

Bank

    161,714       18.60 %     69,546  

>8.0%

    86,933    

>10.0%

      10.5 %
                                                   

Tier 1 capital to risk weighted assets:

                                                 

Company

    147,990       17.03 %     52,151  

>6.0%

    N/A       N/A       8.5 %

Bank

    156,856       18.04 %     52,160  

>6.0%

    69,546    

>8.0%

      8.5 %
                                                   

Tier 1 capital to average assets:

                                                 

Company

    147,990       13.12 %     45,102  

>4.0%

    N/A       N/A       4.0 %

Bank

    156,856       13.92 %     45,075  

>4.0%

    56,344    

>5.0%

      4.0 %

 

In addition to the minimum regulatory capital required for capital adequacy purposes included in the table above, the Company is required to maintain a capital conservation buffer, in the form of common equity, in order to avoid restrictions on capital distributions and discretionary bonuses. The required amount of the capital conservation buffer was 1.875% on January 1, 2018 and will increase by 0.625% until it reaches 2.5% on January 1, 2019.

 

The Bank may not declare or pay a cash dividend on, or repurchase, any of its capital stock from the Company if the effect thereof would cause the capital of the Bank to be reduced below the capital requirements imposed by the regulatory authorities or if such amount exceeds the otherwise allowable amount under FRB rules.

 

In connection with the merger, as part of the regulatory approval process, the Company and the Bank made certain commitments to the Federal Reserve, the most significant of which are (i) to maintain a Tier 1 leverage ratio of at least 10%, (ii) to maintain a total capital ratio of at least 15%, (iii) to limit purchased loans to 40% of total loans, (iv) to fund 100% of the Company's loans with core deposits (defined as non-maturity deposits and non-brokered insured time deposits), and (v) to hold non-owner occupied commercial real estate loans to within 300% of total capital. The Company and the Bank are currently in compliance with all commitments to the Federal Reserve.

 

On October 21, 2016, the Board of Directors voted to amend the existing stock repurchase program to authorize the Company to purchase an additional 500,000 shares of its common stock, representing 5.7% of the Company’s outstanding common shares. The amended stock repurchase program expired on October 21, 2018, and there are no outstanding repurchase programs.

 

Off-Balance Sheet Financial Instruments

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, unused lines of credit, standby letters of credit, and commitments to fund investments. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized in the condensed consolidated balance sheet. The contract or notional amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments. 

 

35

 

See Part I. Item I. “Notes to Unaudited Consolidated Financial Statements – Note 9: Commitments and Contingencies” for further discussion.

  

Results of Operations

 

General

 

Net income totaled $4.5 million for the quarter ended September 30, 2018, a decrease of $52 thousand from $4.6 million for the quarter ended September 30, 2017.

 

 

Net Interest Income

 

Three Months Ended September 30, 2018 and 2017

 

Net interest and dividend income before provision for loan losses increased by $1.0 million for the quarter ended September 30, 2018, compared to the quarter ended September 30, 2017. The increase was primarily due to higher average balances in the loan portfolio. These increases were partially offset by lower transactional income, higher funding costs and higher average deposit balances.

 

The following table summarizes interest income and related yields recognized on the loan portfolios:

 

   

Interest Income and Yield on Loans

 
   

Three Months Ended September 30,

 
   

2018

   

2017

 
   

Average

   

Interest

           

Average

   

Interest

         
   

Balance (1)

   

Income

   

Yield

   

Balance (1)

   

Income

   

Yield

 
   

(Dollars in thousands)

 

Community Banking

  $ 120,340     $ 1,522       5.02 %   $ 150,178     $ 1,746       4.61 %

SBA

    71,165       1,285       7.16 %     53,527       941       6.97 %

LASG:

                                               

Originated

    398,333       7,464       7.43 %     328,775       5,265       6.35 %

Purchased

    304,107       7,254       9.46 %     240,136       7,431       12.28 %

Total LASG

    702,440       14,718       8.31 %     568,911       12,696       8.85 %

Total

  $ 893,945     $ 17,525       7.78 %   $ 772,616     $ 15,383       7.90 %

 

(1)   Includes loans held for sale.

 

 

The following table details the “Total Return” on purchased loans. When compared to the three months ended September 30, 2017, transactional income for the three months ended September 30, 2018 decreased by $1.3 million. The total return on purchased loans for the three months ended September 30, 2018 was 9.46%. The decrease over the prior comparable period was primarily due to higher accelerated accretion and loan fees in the three months ended September 30, 2017. The following table details the total return on purchased loans:

 

   

Total Return on Purchased Loans

 
   

Three Months Ended September 30,

 
   

2018

   

2017

 
   

Income

   

Return (1)

   

Income

   

Return (1)

 
   

(Dollars in thousands)

 

Regularly scheduled interest and accretion

  $ 5,761       7.51 %   $ 4,613       7.62 %

Transactional income:

                               

Gain on loan sales

    -       0.00 %     -       0.00 %

Gain on sale of real estate owned

    -       0.00 %     -       0.00 %

Other noninterest income (expense)

    -       0.00 %     -       0.00 %

Accelerated accretion and loan fees

    1,493       1.95 %     2,818       4.66 %

Total transactional income

    1,493       1.95 %     2,818       4.66 %

Total

  $ 7,254       9.46 %   $ 7,431       12.28 %

 

 

(1)

The total return on purchased loans represents scheduled accretion, accelerated accretion, gains on asset sales, gains on real estate owned and other noninterest income recorded during the period divided by the average invested balance, which includes purchased loans held for sale, on an annualized basis. The total return does not include the effect of purchased loan charge-offs or recoveries in the quarter. Total return is considered a non-GAAP financial measure.

 

The Company’s interest rate spread decreased by 28 basis points and net interest margin decreased by 20 basis points for the quarter ended September 30, 2018 compared to the quarter ended September 30, 2017. The decrease was principally due to higher deposit rates and average deposit balances, as well as lower transactional income recognized in the quarter.

 

36

 

The following sets forth the average balance sheets, interest income and interest expense, and average yields and costs for the three months ended September 30, 2018 and 2017.

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 
           

Interest

   

Average

           

Interest

   

Average

 
   

Average

   

Income/

   

Yield/

   

Average

   

Income/

   

Yield/

 
   

Balance

   

Expense

   

Rate

   

Balance

   

Expense

   

Rate

 

Assets:

                                               

Interest-earning assets:

                                               

Investment securities

  $ 87,873     $ 362       1.63 %   $ 95,827     $ 266       1.10 %

Loans (1) (2) (3)

    893,945       17,525       7.78 %     772,616       15,393       7.90 %

Federal Home Loan Bank stock

    1,652       24       5.76 %     1,938       20       4.09 %

Short-term investments (4)

    172,641       856       1.97 %     160,354       509       1.26 %

Total interest-earning assets

    1,156,111       18,767       6.44 %     1,030,735       16,188       6.23 %

Cash and due from banks

    2,571                       3,134                  

Other non-interest earning assets

    31,234                       30,887                  

Total assets

  $ 1,189,916                     $ 1,064,756                  
                                                 

Liabilities & Shareholders' Equity:

                                               

Interest-bearing liabilities:

                                               

NOW accounts

  $ 69,705     $ 55       0.31 %   $ 69,577     $ 51       0.29 %

Money market accounts

    406,104       1,548       1.51 %     387,632       1,097       1.12 %

Savings accounts

    36,176       14       0.15 %     37,033       13       0.14 %

Time deposits

    406,151       2,065       2.02 %     312,485       1,015       1.29 %

Total interest-bearing deposits

    918,136       3,682       1.59 %     806,727       2,176       1.07 %

Federal Home Loan Bank advances

    15,000       118       3.12 %     20,007       172       3.41 %

Subordinated debt

    23,998       601       9.94 %     23,661       508       8.52 %

Capital lease obligations

    560       7       4.96 %     830       11       5.26 %

Total interest-bearing liabilities

    957,694       4,408       1.83 %     851,225       2,867       1.34 %
                                                 

Non-interest bearing liabilities:

                                               

Demand deposits and escrow accounts

    82,005                       80,565                  

Other liabilities

    9,740                       8,464                  

Total liabilities

    1,049,439                       940,254                  

Shareholders' equity

    140,477                       124,502                  

Total liabilities and shareholders' equity

  $ 1,189,916                     $ 1,064,756                  
                                                 

Net interest income (5)

          $ 14,359                     $ 13,321          
                                                 

Interest rate spread

                    4.61 %                     4.89 %

Net interest margin (6)

                    4.93 %                     5.13 %

 

(1)  Interest income and yield are stated on a fully tax-equivalent basis using the statutory tax rate.

(2)  Includes loans held for sale.

(3)  Nonaccrual loans are included in the computation of average, but unpaid interest has not been included for purposes of determining interest income.

(4) Short-term investments include FHLB overnight deposits and other interest-bearing deposits.

(5) Includes tax-exempt interest income of $0 and $10 thousand for the three months ended September 30, 2018 and 2017, respectively.

(6)  Net interest margin is calculated as net interest income divided by total interest-earning assets.

 

37

 

The following table presents the extent to which changes in volume and interest rates of interest earning assets and interest bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior period rate), (ii) changes attributable to changes in rates (changes in rates multiplied by prior period volume) and (iii) change attributable to a combination of changes in rate and volume (change in rates multiplied by the changes in volume). Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

 

   

Three Months Ended September 30, 2018 Compared to 2017

 
   

Change Due to Volume

   

Change Due to Rate

   

Total Change

 
   

(Dollars in thousands)

 

Interest earning assets:

                       

Investment securities

  $ (24 )   $ 120     $ 96  

Loans

    2,383       (251 )     2,132  

Federal Home Loan Bank stock

    (3 )     7       4  

Short-term investments

    42       305       347  

Total interest-earning assets

    2,398       181       2,579  
                         

Interest-bearing liabilities:

                       

Interest-bearing deposits

    407       1,099       1,506  

Federal Home Loan Bank advances

    (40 )     (14 )     (54 )

Subordinated debt

    7       86       93  

Capital lease obligations

    (3 )     (1 )     (4 )

Total interest-bearing liabilities

    371       1,170       1,541  

Total change in net interest income

  $ 2,027     $ (989 )   $ 1,038  

 

38

 

Provision for Loan Losses

 

Quarterly, the Company determines the amount of the allowance for loan losses that is appropriate to provide for losses inherent in the Company’s loan portfolios, with the provision for loan losses determined by the net change in the allowance for loan losses. For loans accounted for under ASC 310-30, a provision for loan loss is recorded when estimates of future cash flows are lower than had been previously expected. See Part I. Item I. “Notes to Unaudited Consolidated Financial Statements — Note 4: Loans, Allowance for Loan Losses and Credit Quality” for further discussion.

 

The provision for loan losses for periods subsequent to the merger with FHB reflects the impact of adjusting loans to their then fair values, as well as the elimination of the allowance for loan losses in accordance with the acquisition method of accounting. Subsequent to the merger, the provision for loan losses has been recorded based on estimates of inherent losses in newly originated loans and for incremental reserves required for pre-merger loans based on estimates of deteriorated credit quality post-merger.

 

Three Months Ended September 30, 2018 and 2017

 

The provision for loan losses for the quarters ended September 30, 2018 and 2017 was $532 thousand and $354 thousand, respectively. The increase in the Company’s provision for loan losses was primarily due to changes in the composition of the loan portfolio from an increase in loans originated by the SBA division, as well as an increase in specific reserves on two loan relationships.

 

Noninterest Income

 

Three Months Ended September 30, 2018 and 2017

 

Noninterest income decreased by $404 thousand for the quarter ended September 30, 2018, compared to the quarter ended September 30, 2017, principally due to the following:

 

A decrease in gain on sale of SBA loans of $168 thousand, due to lower pricing in the SBA guaranty market in the quarter; and

 

A decrease in gain on sale of residential loans of $117 thousand, due to lower volume of residential loans sold in the quarter.

 

Noninterest Expense

 

Three Months Ended September 30, 2018 and 2017

 

Noninterest expense increased by $641 thousand for the quarter ended September 30, 2018, compared to the quarter ended September 30, 2017, primarily due to the following:

 

An increase in salaries and employee benefits expense of $255 thousand, primarily due to increases in incentive compensation, stock-based compensation expense, and health insurance costs;

 

An increase in other noninterest expense of $167 thousand, primarily due to the quarterly valuation of SBA servicing rights;

 

An increase in professional fees of $92 thousand, primarily due to increased legal and other consulting costs; and

 

An increase in loan expense of $74 thousand, largely driven by direct expenses related to a repossessed asset.

 

Income Taxes

 

Three Months Ended September 30, 2018 and 2017

 

Income tax expense decreased by $123 thousand for the quarter ended September 30, 2018, compared to the quarter ended September 30, 2017, primarily due to the following:

 

A decrease in income before income tax expense of $175 thousand, which resulted in a $49 thousand decrease in income tax expense; and

 

A decrease in the federal corporate income tax rate as a result of the Tax Cuts and Jobs Act signed into law on December 22, 2017, which resulted in a $691 thousand decrease in federal income tax expense; partially offset by

 

A decrease in the income tax benefit recognized of $637 thousand arising from the treatment of vested restricted stock awards under ASU 2016-09, Compensation–Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, whereby the tax effects of vested awards or exercised stock options are treated as a discrete item in the reporting period in which they occur.

 

39

 

Item 3. Quantitative and Qualitative Disclosure about Market Risk

 

Market Risk

 

Market risk is the risk of loss due to adverse changes in market prices and rates, and typically encompasses exposures such as sensitivity to changes in market interest rates, foreign currency exchange rates, and commodity prices. The Company has no exposure to foreign currency exchange or commodity price movements. Because net interest income is our primary source of revenue, interest rate risk is a significant market risk to which the Company is exposed.

 

Interest Rate Risk

 

Interest rate risk can be defined as the exposure of future net interest income to adverse movements in interest rates. Net interest income is affected by changes in interest rates as well as by fluctuations in the level, mix and duration of the Company's assets and liabilities. Over and above the influence that interest rates have on net interest income, changes in rates also affect the volume of lending activity, the ability of borrowers to repay loans, the volume of loan prepayments, the flow and mix of deposits, and the market value of the Company's assets and liabilities.

 

Asset/Liability Management

 

The Company's management has established an Asset Liability Management Committee ("ALCO"), which is responsible for managing the Company's interest rate risk in accordance with policies and limits approved by the Board of Directors. With regard to management of market risk, the ALCO is charged with managing the Company's mix of assets and funding sources to produce results that are consistent with the Company's liquidity, capital adequacy, growth, and profitability goals.

 

Exposure to interest rate risk is managed by Northeast through periodic evaluations of the current interest rate risk inherent in its rate-sensitive assets and liabilities, coupled with determinations of the level of risk considered appropriate given the Company's capital and liquidity requirements, business strategy, and performance objectives. Through such management, Northeast seeks to mitigate the potential volatility in its net interest income due to changes in interest rates in a manner consistent with the risk appetite established by the Board of Directors.

 

The ALCO's primary tool for measuring, evaluating, and managing interest rate risk is income simulation analysis. Income simulation analysis measures the interest rate risk inherent in the Company's balance sheet at a given point in time by showing the effect of interest rate shifts on net interest income over defined time horizons. These simulations take into account the specific repricing, maturity, prepayment and call options of financial instruments that vary under different interest rate scenarios. The ALCO reviews simulation results to determine whether the exposure to a decline in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. The Company considers a variety of specified rate scenarios, including instantaneous rate shocks, against static (or flat) rates when measuring interest rate risk, and evaluates results over two consecutive twelve-month periods. All changes are measured in comparison to the projected net interest income that would result from an "unchanged" scenario, where interest rates remain stable over the measured time horizon(s).

 

While the ALCO reviews simulation assumptions to ensure they are reasonable, and back-tests simulation results on a periodic basis as a monitoring tool, income simulation analysis may not always prove to be an accurate indicator of the Company's interest rate risk or future earnings. There are inherent shortcomings in income simulation, given the number and variety of assumptions that must be made to perform it. For example, the projected level of future market interest rates and the shape of future interest rate yield curves have a major impact on income simulation results. Many assumptions concerning the repricing of financial instruments, the degree to which non-maturity deposits react to changes in market rates, and the expected prepayment rates on loans, mortgage-backed securities, and callable debt securities are also inherently uncertain. In addition, as income simulation analysis assumes that the Company's balance sheet will remain static over the simulation horizon, the results do not reflect the Company's expectations for future balance sheet growth, nor changes in business strategy that the Company could implement in response to rate shifts to mitigate its loss exposures. As such, although the analysis described above provides an indication of the Company's sensitivity to interest rate changes at a point in time, these estimates are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on the Company's net interest income and will differ from actual results.

 

Measuring Interest Rate Risk

 

The Company can be subject to margin compression depending on the economic environment and the shape of the yield curve.  Under the Company's current balance sheet position, the Company's margin generally performs slightly better over time in a rising rate environment, while it generally decreases in a declining rate environment and when the yield curve is flattening or inverted.

 

Under a flattening yield curve scenario, margin compression occurs as the spread between the cost of funding and the yield on interest earning assets narrows.  Under this scenario the degree of margin compression is highly dependent on the Company's ability to fund asset growth through lower cost deposits.  However, if the curve is flattening, while short-term rates are rising, the adverse impact on margin may be somewhat delayed, as increases in the Prime Rate will initially result in the Company's asset yields re-pricing more quickly than funding costs.

 

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Under an inverted yield curve situation, shorter-term rates exceed longer-term rates, and the impact on margin is similar but more adverse than the flat curve scenario.  Again, however, the extent of the impact on margin is highly dependent on the Company's balance sheet mix.

 

In a declining rate environment, margin compression will eventually occur as the yield on interest earning assets decreases more rapidly than decreases in funding costs.  The primary causes would be the impact of interest rate decreases (including decreases in the Prime Rate) on adjustable rate loans and the fact that decreases in deposit rates may be limited or lag decreases in the Prime Rate.

 

There have been no material changes in the results of the Company's net interest income sensitivity analysis as reported in the Company's 2018 Annual Report on Form 10-K.  At September 30, 2018, management continues to consider the Company's primary interest rate risk exposure to be margin compression that may result from changes in interest rates and/or changes in the mix of the Company's balance sheet components.  This would include the mix of fixed versus variable rate loans and investments on the asset side, and higher cost versus lower cost deposits and overnight borrowings versus term borrowings and certificates of deposit on the liability side.

 

Item 4. Controls and Procedures

 

The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports the Company files or submits under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer (the Company’s principal executive officer and principal financial officer, respectively), as appropriate to allow for timely decisions regarding timely disclosure. In designing and evaluating disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost/benefit relationship of possible controls and procedures.

 

The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q.

 

Based on this evaluation of the Company’s disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective as of September 30, 2018.

 

There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the quarter ended September 30, 2018 that have materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

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PART II – OTHER INFORMATION

 

Item 1.

Legal Proceedings

 

None.

 

 

Item 1A.

Risk Factors

 

There have been no material changes to the risk factors disclosed in Item 1A of the Company’s 2018 Annual Report on Form 10-K.

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

(c) There were no purchases made by the Company of its common stock during the three months ended September 30, 2018. The Company’s amended stock repurchase program expired on October 21, 2018.

   

Item 3.

 

 

 

Item 4.

 

 

 

Item 5.

 

 

 

Item 6.

Defaults Upon Senior Securities

 

None.

 

Mine Safety Disclosures

 

Not applicable.

 

Other Information

 

None.

 

Exhibits

 

 

 

Exhibits No.

Description

 

31.1

Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(a)). *

 

31.2

Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(a)). *

 

32.1

Certificate of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(b)). **

 

32.2

Certificate of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(b)). **

 

101

The following materials from Northeast Bancorp’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2018 formatted in XBRL: (i) Consolidated Balance Sheets as of September 30, 2018 and June 30, 2018; (ii) Consolidated Statements of Income for the three months ended September 30, 2018 and 2017; (iii) Consolidated Statements of Comprehensive Income for the three months ended September 30, 2018 and 2017; (iv) Consolidated Statements of Changes in Shareholders’ Equity for the three months ended September 30, 2018 and 2017; (v) Consolidated Statements of Cash Flows for the three months ended September 30, 2018 and 2017; and (v) Notes to Unaudited Consolidated Financial Statements. *

 

* Filed herewith

** Furnished herewith

 

42

 

SIGNATURES

 

Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: November 9, 2018

 

NORTHEAST BANCORP

     

 

By:

/s/ Richard Wayne

 

 

  Richard Wayne

 

 

  President and Chief Executive Officer

 

 

 

 

By:

/s/ Jean-Pierre Lapointe

 

 

  Jean-Pierre Lapointe

 

 

  Chief Financial Officer and Treasurer

 

43

 

NORTHEAST BANCORP

Index to Exhibits

 

Exhibits

No.

Description

 

31.1

Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(a)). *

 

31.2

Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(a)). *

 

32.1

Certificate of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(b)). **

 

32.2

Certificate of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Rule 13a-14(b)). **

 

101

The following materials from Northeast Bancorp’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2018 formatted in XBRL: (i) Consolidated Balance Sheets as of September 30, 2018 and June 30, 2018; (ii) Consolidated Statements of Income for the three months ended September 30, 2018 and 2017; (iii) Consolidated Statements of Comprehensive Income for the three months ended September 30, 2018 and 2017; (iv) Consolidated Statements of Changes in Shareholders’ Equity for the three months ended September 30, 2018 and 2017; (v) Consolidated Statements of Cash Flows for the three months ended September 30, 2018 and 2017; and (v) Notes to Unaudited Consolidated Financial Statements. *

 

* Filed herewith

** Furnished herewith

 

44