Northeast Bank (NBN) 2022 Q4 法說會逐字稿

Welcome to the Northeast Bank Fourth Quarter Fiscal Year 2022 Earnings Call. My name is Jenny. I'll be your operator for today's call. (Operator Instructions) As a reminder, the conference is being recorded.

I will now turn the call over to Rick Wayne. You may begin.

Good morning, and thank you all for joining us today. As mentioned, I am Rick Wayne, the Chief Executive Officer of Northeast Bank. And with me on the call are JP Lapointe, our Chief Financial Officer; and Pat Dignan, our Chief Credit Officer and Executive Vice President. After my comments, JP, Pat and I will be happy to answer your questions.

Let me first turn to Page 3 of the investor deck that was uploaded on our website last night. I want to comment on a few items listed on Page 3. First, for the quarter, we reported $10.3 million of net income or $1.35 per diluted share. Our return on equity was 16.55%, and our return on assets was 2.68%. And a big driver of our income for the quarter were our National Lending loan volume, and in particular, the activity in our originated loans.

For the quarter, we originated $172.9 million of loans, and for the year, $587.8 million of loans. That's a record for us, both quarter-on-the-quarter and the -- and for the year by a -- for the year, in particular, by a substantial amount. And I also want to point out on those loans that 93% or 94% of our originated loans are variable tied to prime. And of course, in a rising interest rate environment, that is helpful to have variable rate loans.

I just want to comment on something about that, which was, I think, requires some explanation because our yield on our loan book for the quarter on originated loans was 7% and was 6.9% for the prior quarter. And so it only went up 10 basis points. And one might wonder why and with loans that are tied to prime why they only went up 10 basis points, and I will answer that question for you. And that is that in the -- we -- our loans are structured so that if there is a payoff for maturity, each loan, we negotiate a minimum amount of interest that the borrower has to pay. And we had more loans pay off early in the prior quarter than we did in this quarter. And to put some numbers to that, that 6.9% in the prior quarter included 70 basis points of minimum interest that paid off -- from loans that paid off early.

So net of that, the yield was 6.2% as compared to the fourth quarter where we only had 50 basis points of minimum interest. So netting of that, the yield was 6.5%, which is a long way of making the point that ignoring minimum interest, the yield on our originated loan book went up 30 basis points from Q3 to Q4, reflecting changes in interest rates. To the extent you're thinking of that, I hope that clarifies that.

One of these things -- one of the big things we've been working on is understanding that our correspondent fee income was going to go down each quarter and eventually go away. Just as a reminder, we have correspondent fee income resulting from discount when the loans were purchased and we also share in the servicing income on the portfolio that Loan Source has on the PPP loans that they purchased.

For reference point, let's take a look at Slide #4 in the deck. And I will remind you that starting in the fourth quarter of 2020 through the first quarter of 2022, Loan Source purchased $11.2 billion of PPP loans. And at the end of the June 30, 2022, they remained $1.4 billion. So there was about $9.8 billion of loans that were either paid off or forgiven.

The reason that's meaningful is that Loan Source earns 65 basis points on the PPP loans that they hold. And as the portfolio gets paid down -- and I should point out, and we share half of that. And as the portfolio pays down, our share of the income goes down.

And so -- and to put some numbers to that, if for a second, we turn to Slide #29, which I'm trying to get to, you can see that looking at the quarterly amount of correspondent fee income, which is in blue, on the -- this is on the right side of the investor deck on that page. That corresponding fee income, if we compare where it was in Q4 of FY '21 -- I'm sorry, if we compare with Q1 of our fiscal '22 with Q4, corresponding fee income went down by $4.1 million because the PPP loans were being either paid off or forgiven.

And what we -- investors know and we've talked about, what we need to do is increase our loan book to offset that. And now if we look at the base net interest income, which is in blue on the chart next to the one I just described, you can see that if we compare Q4, which just ended with Q1, that base net interest income increased by $4.3 million. Punchline is we're growing our loan book, we're generating more net interest income, and we have more than offset the amount of reduction in correspondent fee income.

For the year -- if we look at it for the year, I have this number, that net interest income, if we compare FY '22 with FY '21, net interest income increased by $16 million. And that's a result of -- that our loan book grew. Our National Lending portfolio grew by $284 million or 30% FY -- the end of FY '22 compared to FY '21. And if we just look at the originated part of that, it grew $236 million or 45% from the beginning of the fiscal year. And that is what we are focused on is growing our National Lending book.

Just a few other comments before we open it up for questions. On our noninterest expense line, it grew -- if you compare the fourth quarter, that is June 30, with the third quarter, September 30, noninterest expense grew by $1.5 million. And that was, as is usually the case in the fourth quarter, where we take a look at -- the Comp Committee takes a look at how the bank is doing and if appropriate, adds to the incentive comp, and that $1.5 million was virtually all additional incentive comp in the fourth quarter.

And just for modeling purposes, as we're going into this fiscal year, FY '23, adding more people and probably a good number for -- per quarter noninterest expense is around $13 million for those that are doing the modeling. Also, we bought back during the quarter, I have that number -- repurchased, JP, how much?

285,000.

285,000 shares in the quarter. And for the year, we bought back 821,000 shares. So I just took a look at this morning, I thought someone might be interested. Since we started the repurchase program, we have repurchased 3.8 million shares at an average price of $16.93, which is about 34% of the shares outstanding before we started a repurchase program.

Finally, just a few words on our 7(a) program with annuity. This is again -- this is taking longer than we had expected. And this is -- these are not the biggest numbers in the world. But in the quarter, we closed 26 loans for $600,000, I shouldn't say -- we closed, yes -- 26 loans for $600,000. And I don't want to promise more than we can deliver. So we'll see what happens in the next quarters. But the technology is where. We're able to close loans. The marketing is continuing, and I'm hopeful that we will have better numbers to report when we report at the end of our first fiscal quarter, but no promises on that score. We will when we will see.

Asset quality. These are things that are in the report. So I'll point out -- I know you can read them, but delinquencies were at a very low number at around $7 million and nonaccruals came down to about $13 million, which are numbers that are -- levels that are much lower than we have been in some time and particularly impressive given the size of our loan book now, which is about $1.3 billion.

And with that, I will turn it over to all of you to answer any questions that you might have. Thank you.

(Operator Instructions) And our first question comes from Alexander Twerdahl.

First off, I was just wondering if you could give us a little bit of commentary on what you're seeing in the loan purchase market just given all the volatility and changes in interest rates if that market has changed at all and what your expectations are for later this year?

Great. I don't know if our operator read the forward-looking statements. So I will remind you that it's in the material. When I answer the question, we have -- we're seeing a lot of activity now in the pipeline. We think that the higher interest rate environment and concerns about real -- credit quality for some banks in the real estate area, I think -- we think -- we're expecting to see a fair amount of activity in this. We've also seen some of the groups that previously would have bid against us out of the bidding and now becoming sellers of their portfolio.

I would remind everybody that I was very optimistic about the loan purchase possibilities when COVID started, and we were wrong. But hopefully, we won't be wrong now. We think that there will be a lot of opportunities. We see a lot in the pipeline now. Of course, the results are always binary. You win or you don't win. And so it could turn out we don't buy as much as we are hoping for.

Pat, do you want to add to that, add any color to that question?

Just to add on to what you said that the rising rates have obviously resulted in increased funding costs for a lot of our nonbanking competitors, which is good for us. On the seller side, fixed-rate assets are becoming -- there's -- it looks like there's some activity out there with banks trying to shed some of that in anticipation of further increases. And also on the credit side, there's debt service coverage pressure as a result of rising rates. All of those factors are causing the market there to be -- some increase in activity and a lot of talk on the street of more to come. So we're very hopeful that there will be some opportunity for us this year.

I would add to that, that there are not many banks that are in the business of buying loans nationally. 0.1, 0.2, as a bank, with really low funding costs, they're rising a little bit and will rise more but it gives us a competitive advantage against nonbanks. And it seems that some of the nonbanks are with a rising rate -- interest rate are going to be less competitive. Historically, their funding was through a securitization where the rates were quite low for them, and that's not the case now. So we're optimistic. But as I said, results are binary. You win or don't win.

I should also -- we have the resources, human resources, to look at a lot of loans. And we've been doing it. As you know, Alex, and others do. We've been doing this for a very long time. So hopefully, our time has come.

With that last point with respect to the human resources, do you have the capacity to meaningfully increase the loan purchases as well as maintain the growth rates that we've been seeing on the originated portfolios?

We do. As part of our -- when I mentioned earlier about the projected cost going forward, we have then a fair number of slots to hire more people. And -- but we'll do what it takes to carefully and underwrite both purchased and originated loans and not -- we won't fund -- buy any loan or originate any loan unless we're 100% comfortable in the underwriting that we have done. But I don't think we'll have a bandwidth problem on what we're seeing now, and we will hire more people as we need them going into the next year.

Great. For this past quarter, the volume that we saw, was it -- was the supply just not there? Or are you losing bids to others? Or is this the pricing not appropriate? What kind of drove the lower volumes? Based on your commentary, I would have expected to see volumes a little bit higher.

I think we looked a lot. I mean we looked at what was available in the market in our sweet spot, and we bid on a fair number and that's why as Rick pointed out, it's a lumpy business. And I think the market -- the supply, the market last quarter was -- it started to pick up toward the end of the quarter. So I don't think it's indicative of anything other than that.

Okay. On the originated loans, the yields on the new production just given the variable nature of those, are those yields pretty similar to the book yield that you'd have to that kind of, I think, you said 6.5% core yield. Is that where new loans would be coming on as well?

No, they're coming on at -- yes, well, in that range, anywhere between prime 1.5% and 2.5%, so there's a range for those. And they don't, of course, reflect the expected 75 basis point increase in prime that will be announced, but that's about right. It's going to go up with [tip] rate increases in prime is really the point I'm making.

Yes. Can you give us some commentary on the cost of funds? And I know it's ticked up a little bit and you have the slide here that shows that it should probably tick up a little bit more. And you've done a lot with respect to improving your deposit profile over the last couple of quarters. But in terms of the pressures that you're seeing on deposit costs, where those are coming from?

Sure. I think you made the point that we're starting in a better place than where we were 2 years ago. So being at a 36 basis point cost of funds for this quarter, obviously lower than where we had been. There's definitely some pressure upwards for customers who are asking us to reprice their deposits and everything. But we're definitely not 100% beta. So while we do expect rates to go up, we expect our loans to move up significantly more than our deposits. But I think it's kind of side of the market.

And kind of based on what our competitors do also, as competitors move, we have to be a little more agile and flexible to make sure that we can continue to fund the growth that we hope to see in the balance sheet by retaining our deposits to continue to grow more. So we do have a projected uptick in the cost of deposits. But nothing overly significant based on where the projected rates are expected to go over the next at least 6 months.

Okay. And, Rick, I think you said in your prepared remarks that we should be modeling expenses in the coming quarters around $13 million per quarter, which seems kind of an uptick from where you were last quarter and kind of the non-year-end quarters. Can you maybe just talk a little bit about why that -- is that...

It's mostly -- it comes in -- well, I think there's 3 big buckets of that. One, are more head count. This year with inflation base salaries went up because of -- we gave out kind of the standard increase in base is higher than they've been in the past because of inflation. And we're also moving from our current office to another office, for those that know Boston and the Seaport, we needed more space, and we signed this lease in 2012 and rents are higher. So we have -- it's kind of rate volume. We're taking more space and it's more expensive. So those are the 3 major items that are accounting for the increase in noninterest expense.

Okay. And then just a couple more questions for me. When you -- you guys will adopt CECL on January 1, 2023, is that correct?

That's correct.

And do you have any sort of early guidance or color that you could help us kind of figure out where that ACL might shake in and kind of how your loan portfolio is given sort of the purchase nature of a big chunk of it and then another big chunk that's had a 0 loss history, like how CECL might impact your various portfolios?

Yes. It will most likely reduce the majority of our portfolio, our segments. Given the low LTVs and the minimal losses that we have in our originated portfolio, where we see an increase is in the residential real estate side, when you look at the life of those loan is much longer than the short-term nature of what we have in the National Lending originated portfolio.

One of the other factors is that we will have to begin reserving for purchase loans in the allowance for credit losses. So that will come in also was a factor. And some of that, that we have right now is in purchase discounts. So some of that discount that's sitting against the loan balance will actually migrate over to the allowance for loan losses when we adopt CECL. So it is just going to be a reclassification in the balance sheet and have no capital or earnings impact at that time. So we expect the overall allowance probably won't change materially from where it is now, but kind of how we get there, there might be some components moving around on the balance sheet at that time.

Okay. And then that last piece, the purchase discount going into the reserve for purchased loans. Post the sort of January 1 adoption date, if we look forward into some quarters for next year, does that mean that a larger quarter of purchases would result in a larger provision?

That depends on where FASB ends up. They're looking at still updating some of the CECL guidance that will allow you to take some of that discount that you purchase on loans and move it over to the allowance at the time of purchase. But the way CECL is worded right now is that you would have to reserve for purchase loans through a provision in the income statement, but FASB is looking at making an adjustment for purchase loans in the future.

Okay. And then just a final question, Rick, on the annuity 7(a) program, I think you said you closed 26 loans. I think it was $600,000 of that loan balance is correct, not income for you guys. And can you just remind us how that might -- should those volumes pick up, how that's going to actually impact the income statement?

Are you saying, Alex, how -- if the volume were to pick up, how that would impact the earnings, is that your question?

Yes. I know there's a gain on sale component and then there's also, if I remember correctly (inaudible) reserve as well...

Okay. So if we were to -- yes, if we were to sell those loans, they're now priced at prime 2.75%. And currently, if one were to sell loans -- these are 10-year loans at prime 2.75%, assuming they get the same pricing as larger traditional 7(a) loans, today, the premiums, 8 points come down a little bit. It was at one time 10 or 11, maybe a little bit more of it, but currently, it's 8. I think it will change as rates change over time. So if we were to sell those loans, there's a 90% guarantee on the loan.

So if you sold off -- let's say, it was to make the math easier, you had $1 million of UPB and the loans you could sell off $900,000 and the premium would be 8% on that. So there would be a gain of $72,000. We would split that with annuity. And so we get $36,000, they get $36,000. We would keep the 10% that we didn't sell on our books and earn prime 2.75% on that. And I should have added that if there were any losses in that portfolio, we'll split that with annuity 50-50, and we will withhold starting off, if we look at the -- we expect the losses in the portfolio over time will be 3%. So we would withhold 1.5% of annuity share of the gain on it.

I should point out for the audience, if I'm only using that $1 million to make the arithmetic easy, you [think] it's linear. And so if it was a much bigger number, obviously, that would be much more interesting, which is our -- that's what we're trying to accomplish. I was going to say hope, but that sounds too tentative. That's what we think will happen with more volume.

(Operator Instructions) And we have no further questions at this time.

Well, thank you. Thank you, everybody, for listening in and your continued support. We look forward to talking again at the end of the current quarter. We try and make our slide deck as helpful as possible and the information we provide, if you have any suggestions to standing offer, let us know. And if we can accommodate it, we will do that. And on that note, I will say thank you, and goodbye.

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