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NBN > SEC Filings for NBN > Form 10-K on 27-Sep-2013All Recent SEC Filings

Show all filings for NORTHEAST BANCORP /ME/ | Request a Trial to NEW EDGAR Online Pro

Form 10-K for NORTHEAST BANCORP /ME/


27-Sep-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations

Northeast Bancorp (the "Company") is a Maine corporation and a bank holding company registered with the Federal Reserve under the Bank Holding Company Act of 1956. The Company also is a registered Maine financial institution holding company. The Federal Reserve is the primary regulator of the Company, and the Company is also subject to regulation and examination by the Superintendent of the Maine Bureau of Financial Institutions. The Company's principal asset is the capital stock of Northeast Bank (the "Bank"), a Maine state-chartered universal bank. Accordingly, the Company's results of operations are primarily dependent on the results of the operations of the Bank.

The Management's Discussion and Analysis of Financial Condition and Results of Operations, which follows, presents a review of the consolidated operating results of the Company for the fiscal year ended June 30, 2013 ("fiscal 2013") and the fiscal year ended June 30, 2012 ("fiscal 2012"). This discussion and analysis is intended to assist you in understanding the results of our operations and financial condition. You should read this discussion together with your review of the Company's Consolidated Financial Statements and related notes and other statistical information included in this report. Certain amounts in the periods prior to fiscal 2013 have been reclassified to conform to the fiscal 2013 presentation.

Overview

Financial Presentation

On December 29, 2010, the merger (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 our 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 (the "Successor Company"). In the application of ASC 805 to this transaction, the following was considered:

Identify the Accounting Acquirer: FHB was identified as the accounting acquirer. FHB, which was incorporated on March 9, 2009, acquired a controlling financial interest of approximately 60% of the Successor Company's total outstanding voting and non-voting common stock in exchange for contributed capital and cash consideration.

In the evaluation and identification of FHB as the accounting acquirer, it was concluded that FHB was a substantive entity involved in significant pre-merger activities, including the following: raising capital; incurring debt; incurring operating expenses; leasing office space; hiring staff to develop the surviving company's business plan; retaining professional services firms; and identifying acquisition targets and negotiating potential transactions, including the Merger.

Determine the Acquisition Date: December 29, 2010, the closing date of the Merger, was the date that FHB gained control of the combined entity.

Recognize assets acquired and liabilities assumed: Because neither Northeast Bancorp, the Predecessor Company (the acquired company), nor FHB (the accounting acquirer) exist as separate entities after the Merger, a new basis of accounting at fair value for the Successor Company's assets and liabilities was established in the consolidated financial statements. At the acquisition date, the Successor Company recognized the identifiable assets acquired and the liabilities assumed based on their then fair values in accordance with ASC Topic 820, Fair Value Measurement ("ASC 820"). The Successor Company recognized a bargain purchase gain as the difference between the total purchase price and the net assets acquired.

As a result of application of the acquisition method of accounting to Northeast Bancorp after the merger on December 29, 2010, the Company's financial statements from the periods prior to the transaction date are not directly comparable to the financial statements for periods subsequent to the transaction date. To make this distinction, the Company has labeled balances and results of operations prior to the transaction date as "Predecessor Company" and balances and results of operations for periods subsequent to the transaction date as "Successor Company." The lack of comparability arises from the assets and liabilities having new accounting bases as a result of recording them at their fair values as of the transaction date rather than at historical cost basis. To denote this lack of comparability, a heavy black line has been placed between the Successor Company and Predecessor Company columns in the discussion herein.


Table of Contents

In connection with the transaction, as part of the regulatory approval process the Company made certain commitments to the Board of Governors of the Federal Reserve System (the "Federal Reserve"), the most significant of which are,
(i) maintain a Tier 1 leverage ratio of at least 10%, (ii) maintain a total risk-based capital ratio of at least 15%, (iii) limit purchased loans to 40% of total loans, (iv) fund 100% of the Company's loans with core deposits (defined as non-maturity deposits and non-brokered insured time deposits), and (v) 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 of the commitment to hold commercial real estate loans to within 300% of total risk-based capital to exclude owner-occupied commercial real estate loans. 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 June 30, 2013 follow.

Condition                                                   Ratio at June 30, 2013
(i)  Tier 1 leverage ratio                                                   17.78 %
(ii)  Total risk-based capital ratio                                         27.54 %
(iii) Ratio of purchased loans to total loans                                37.57 %
(iv) Ratio of loans to core deposits                                         92.94 %
(v)  Ratio of commercial real estate loans to total
risk-based capital                                                          159.07 %

As a result of the sale of the Company's insurance agency business in the first quarter of fiscal 2012 and discontinuation of further significant business activities in the insurance agency segment, the Company has classified the results of its insurance agency division as discontinued operations in the Company's consolidated financial statements and discussion herein.

Fiscal 2013 Financial Highlights

The Company's financial and strategic highlights for fiscal 2013 include the following:

Earned net income of $4.4 million, or $0.39 per diluted share, from continuing operations as compared to $1.0 million, or $0.15 per diluted share, from continuing operations in fiscal 2012.

Purchased commercial loans totaling $121.3 million, and earned an average yield on the purchased portfolio of 16.0%, a result that includes regularly scheduled interest and accretion, and accelerated accretion and fees recognized on loan payoffs. The Company also monitors the "total return" on its purchased loan portfolio, a measure that includes gains on sales of purchased loans, as well as interest, scheduled accretion and accelerated accretion and fees. On this basis, the purchased loan portfolio earned a total return of 18.3% for fiscal 2013. An overview of the LASG portfolio for fiscal 2013 follows:

                                           Purchased     Originated     Total LASG
                                                    (Dollars in thousands)
Purchased or originated during the year:
Unpaid principal balance                   $  155,216   $     37,181   $    192,397
Net investment basis                          121,336         37,208        158,544

Totals as of year end:
Unpaid principal balance                   $  204,276   $     38,846   $    243,122
Net investment basis                          166,786         38,879        205,665

Returns during the year:
Yield                                           16.04 %         9.34 %        15.28 %
Total Return (1)                                18.33 %         9.34 %        17.32 %



(1) The total return on purchased loans represents scheduled accretion, accelerated accretion, gains on asset sales, and other noninterest income recorded during the period divided by the average invested balance, on an annualized basis.

Increased the Company's deposit base by $62.4 million, principally through $69.0 million of net deposits raised through ableBanking, the Bank's online affinity deposit platform.

Redeemed TARP preferred stock and warrants totaling $4.3 million.


Table of Contents

Results of Operations - Continuing Operations

General

Net income from continuing operations for the year ended June 30, 2013 was $4.4 million, a $3.4 million increase over 2012. Items of significance affecting the Company's earnings included:

An increase in the net interest margin, which grew to 4.62%, compared to 3.69% for the year ended June 30, 2012, principally due to growth in the Company's purchased loan portfolio. The following table summarizes interest income and related yields recognized on the Company's loans.

                                                  Year Ended June 30,
                                         2013                            2012
                              Average    Interest             Average    Interest
                              Balance     Income     Yield    Balance     Income     Yield
                                                (Dollars in thousands)
Community Banking Division   $ 252,199   $  14,824    5.88 % $ 297,348   $  18,047    6.07 %
LASG:
Originated                      14,906       1,392    9.34 %     3,278         308    9.40 %
Purchased                      117,205      18,801   16.04 %    39,022       6,379   16.35 %
Total LASG                     132,111      20,193   15.28 %    42,300       6,687   15.81 %
Total                        $ 384,310   $  35,017    9.11 % $ 339,648   $  24,734    7.28 %

The yield on purchased loans was increased by unscheduled loan payoffs, which resulted in immediate recognition of the prepaid loans' discount in interest income. The following table details the "total return" on purchased loans, which includes transactional income of $10.6 million for the year ended June 30, 2013.

                                                   Year Ended June 30,
                                             2013                        2012
                                     Income      Return (1)      Income      Return (1)
                                                  (Dollars in thousands)
Regularly scheduled interest
and accretion                      $   11,038          9.35 %  $    3,762          9.64 %
Transactional income:
Gains on loan sales                     2,115          1.79 %         868          2.22 %
Gain on sale of real estate
owned                                     684          0.58 %           -          0.00 %
Other noninterest income                   36          0.03 %           -          0.00 %
Accelerated accretion and loan
fees                                    7,763          6.58 %       2,617          6.71 %
Total transactional income             10,598          8.98 %       3,485          8.93 %
Total                              $   21,636         18.33 %  $    7,247         18.57 %



(1) The total return on purchased loans represents scheduled accretion, accelerated accretion, gains on asset sales, and other noninterest income recorded during the period divided by the average invested balance, on an annualized basis.

Net gains on residential mortgage loan sales of $3.0 million, compared to $2.8 million in fiscal 2012.

Net gains on portfolio loan sales of $2.3 million, compared to $1.1 million in fiscal 2012.

An increase of $6.5 million in noninterest expense, principally resulting from increased staffing and infrastructure costs necessary to execute the Company's loan purchasing strategy. Further, during fiscal 2013, the Company incurred $1.4 million of nonrecurring expenses related to severance and the settlement of a previously disclosed lawsuit.


Table of Contents

Net Interest Income



The following table sets forth average balance sheets, average yields and costs,
and certain other information for the periods indicated:



                                                Successor Company (1)
                            Year Ended June 30, 2013            Year Ended June 30, 2012
                                     Interest    Average                 Interest    Average
                         Average      Income/     Yield/     Average      Income/     Yield/
                         Balance      Expense      Rate      Balance      Expense      Rate
                                               (Dollars in thousands)
Assets:
Interest-earning
assets:
Investment securities
(3)                     $  131,199   $   1,138       0.87 % $  138,708   $   2,019       1.46 %
Loans (4) (5)              384,310      35,017       9.11 %    339,648      24,734       7.28 %
Regulatory stock             5,398          75       1.39 %      5,673          72       1.27 %
Short-term
investments (6)            127,781         313       0.24 %     76,217         189       0.25 %
Total
interest-earning
assets                     648,688      36,543       5.63 %    560,246      27,014       4.82 %
Cash and due from
banks                        3,065                               2,910
Other non-interest
earning assets              37,206                              36,803
Total assets            $  688,959                          $  599,959

Liabilities &
Stockholders' Equity:
Interest-bearing
liabilities:
NOW accounts            $   55,763   $     153       0.27 % $   55,218   $     213       0.39 %
Money market accounts       63,931         337       0.53 %     44,692         175       0.39 %
Savings accounts            31,939          44       0.14 %     32,799          67       0.20 %
Time deposits              280,059       3,564       1.27 %    223,782       2,971       1.33 %
Total
interest-bearing
deposits                   431,692       4,098       0.95 %    356,491       3,426       0.96 %
Short-term borrowings
(7)                          1,472          19       1.29 %      1,075          21       1.95 %
Borrowed funds              75,633       1,710       2.26 %    112,812       2,119       1.87 %
Junior subordinated
debentures                   8,185         769       9.40 %      8,028         751       9.35 %
Total
interest-bearing
liabilities                516,982       6,596       1.28 %    478,406       6,317       1.32 %

Interest-bearing
liabilities of
discontinued
operations (8)                   -                                 271

Non-interest bearing
liabilities:
Demand deposits and
escrow accounts             49,343                              45,933
Other liabilities            5,982                               3,932
Total liabilities          572,307                             528,542
Stockholders' equity       116,652                              71,417
Total liabilities and
stockholders' equity    $  688,959                          $  599,959

Net interest income                  $  29,947                           $  20,697

Interest rate spread                                 4.36 %                              3.50 %
Net interest margin
(9)                                                  4.62 %                              3.69 %



(1) "Successor Company" means Northeast Bancorp and its subsidiary after the closing of the merger with FHB Formation LLC on December 29, 2010.

(2) "Predecessor Company" means Northeast Bancorp and its subsidiary prior to the closing of the merger with FHB Formation LLC on December 29, 2010.

(3) Interest income and yield are stated on a fully tax-equivalent basis using a 34% tax rate.

(4) Includes loans held for sale.

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

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

(7) Short term borrowings include securities sold under repurchase agreements and sweep accounts.

(8) The average balance of borrowings associated with discontinued operations has been excluded from interest expense, interest rate spread, and net interest margin.

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


Table of Contents

                               Successor Company (1)                     Predecessor Company (2)
                           184 Days Ended June 30, 2011             181 Days Ended December 28, 2010
                                        Interest    Average                        Interest     Average
                         Average        Income/      Yield/         Average        Income/       Yield/
                         Balance        Expense       Rate          Balance        Expense        Rate
                                                    (Dollars in thousands)
Assets:
Interest-earning
assets:
Investment
securities (3)         $    143,894    $    1,642       2.32 %   $     161,894    $    3,111        3.96 %
Loans (4) (5)               337,630        11,544       6.78 %         385,286        11,210        5.87 %
Regulatory stock              5,550            28       1.00 %           5,486            18        0.66 %
Short-term
investments (6)              75,080            90       0.24 %          39,212            39        0.20 %
Total
interest-earning
assets                      562,154        13,304       4.71 %         591,878        14,378        4.92 %
Cash and due from
banks                         3,432                                      3,340
Other non-interest
earning assets               43,668                                     34,724
Total assets           $    609,254                              $     629,942

Liabilities &
Stockholders'
Equity:
Interest-bearing
liabilities:
NOW accounts           $     56,386    $      160       0.56 %   $      53,780    $      183        0.69 %
Money market
accounts                     52,238           135       0.51 %          55,955           213        0.77 %
Savings accounts             34,799            67       0.38 %          38,303            99        0.52 %
Time deposits               207,251         1,303       1.25 %         196,318         2,301        2.36 %
Total
interest-bearing
deposits                    350,674         1,665       0.94 %         344,356         2,796        1.64 %
Short-term
borrowings (7)               19,764            76       0.76 %          53,873           376        1.41 %
Borrowed funds              115,798         1,101       1.89 %         117,688         2,365        4.05 %
Junior subordinated
debentures                    7,921           365       9.14 %          16,496           340        4.16 %
Total
interest-bearing
liabilities                 494,157         3,207       1.29 %         532,413         5,877        2.23 %

Interest-bearing
liabilities of
discontinued
operations (8)                2,134                                      2,462

Non-interest bearing
liabilities:
Demand deposits and
escrow accounts              43,761                                     37,941
Other liabilities             4,075                                      5,576
Total liabilities           544,127                                    578,392
Stockholders' equity         65,127                                     51,550
Total liabilities
and stockholders'
equity                 $    609,254                              $     629,942

Net interest income                    $   10,097                                 $    8,501

Interest rate spread                                    3.42 %                                      2.69 %
Net interest margin
(9)                                                     3.58 %                                      2.92 %



(1) "Successor Company" means Northeast Bancorp and its subsidiary after the closing of the merger with FHB Formation LLC on December 29, 2010.

(2) "Predecessor Company" means Northeast Bancorp and its subsidiary prior to the closing of the merger with FHB Formation LLC on December 29, 2010.

(3) Interest income and yield are stated on a fully tax-equivalent basis using a 34% tax rate.

(4) Includes loans held for sale.

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

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

(7) Short term borrowings include securities sold under repurchase agreements and sweep accounts.

(8) The average balance of borrowings associated with discontinued operations has been excluded from interest expense, interest rate spread, and net interest margin.

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


Table of Contents

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) changes 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.

                                                       Year Ended June 30, 2013
                                               Compared to the Year Ended June 30, 2012
                                     Change Due to Volume     Change Due to Rate     Total Change
                                                        (Dollars in thousands)
Interest earning assets:
Investment securities               $                 (104 )  $              (777 )  $        (881 )
Loans                                                3,529                  6,754           10,283
Regulatory stock                                        (3 )                    6                3
Short-term investments                                 128                     (4 )            124
Total increase in interest
income                                               3,550                  5,979            9,529
Interest bearing liabilities:
Interest bearing deposits                              823                   (151 )            672
Short-term borrowings                                    6                     (8 )             (2 )
Borrowed funds                                        (790 )                  381             (409 )
Junior subordinated debentures                          14                      4               18
Total increase in interest
expense                                                 53                    226              279
Total increase in net interest
and dividend income                 $                3,497    $             5,753    $       9,250

A rate/volume comparison of fiscal 2012 and 2011 has not been presented because the successor and predecessor periods in fiscal 2011 are not comparable to fiscal 2012 due to the significant effect of acquisition accounting adjustments.

For the period, the 4.62% net interest margin earned was 93 basis points higher than that earned for the year ended June 30, 2012. The net interest margin improved during fiscal 2013 principally due to increased purchased loan volume, offset in part by a decline in the effect of accretion of Merger-related fair value adjustments and a reduction in the yield earned on investment securities.

The following table summarizes interest income and related yields recognized on the Company's loans.

                                                  Year Ended June 30,
                                         2013                            2012
                              Average    Interest             Average    Interest
                              Balance     Income     Yield    Balance     Income     Yield
                                                (Dollars in thousands)
Community Banking Division   $ 252,199   $  14,824    5.88 % $ 297,348   $  18,047    6.07 %
LASG:
Originated                      14,906       1,392    9.34 %     3,278         308    9.40 %
Purchased                      117,205      18,801   16.04 %    39,022       6,379   16.35 %
Total LASG                     132,111      20,193   15.28 %    42,300       6,687   15.81 %
Total                        $ 384,310   $  35,017    9.11 % $ 339,648   $  24,734    7.28 %

The yield on purchased loans was increased by unscheduled loan payoffs, which resulted in immediate recognition of the prepaid loans' discount in interest income. The following table details the "total return" on purchased loans, which includes transactional income of $10.6 million for the year ended June 30, 2013.

                                                   Year Ended June 30,
                                             2013                        2012
                                     Income      Return (1)      Income      Return (1)
                                                  (Dollars in thousands)
. . .
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