This Management's Discussion and Analysis of Results of Operations and Financial Condition presents a review of the results of operations for the three and nine months ended March 31, 2008 and 2007 and the financial condition at March 31, 2008 and June 30, 2007. This discussion and analysis is intended to assist in understanding the results of operations and financial condition of Northeast Bancorp and its wholly-owned subsidiary, Northeast Bank. Accordingly, this section should be read in conjunction with the consolidated financial statements and the related notes and other statistical information contained herein. See our annual report on Form 10-K, for the fiscal year ended June 30, 2007, for discussion of the critical accounting policies of the Company. Certain amounts in the prior year have been reclassified to conform to the current-year presentation.
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 and Section 21E of the Securities Exchange Act of 1934, such as statements relating to our 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". In addition, the Company may from time to time make such oral or written "forward-looking statements" in future filings with the Securities and Exchange Commission (including exhibits thereto), in its reports to shareholders, and in other communications made by or with the approval of the Company.
Such forward-looking statements reflect our current views and expectations based largely on information currently available to our management, and on our current expectations, assumptions, plans, estimates, judgments, and projections about our business and our industry, and they involve inherent risks and uncertainties. Although we believe 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, we cannot give you any assurance that our expectations will, in fact, occur or that our estimates or assumptions will be correct. We caution you that actual results could differ materially from those expressed or implied by such forward-looking statements due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, changes in technology, changes in the securities markets, and the availability of and the costs associated with sources of liquidity. Accordingly, investors and others are cautioned not to place undue reliance on such forward-looking statements. For a more complete discussion of certain risks and uncertainties affecting the Company, please see "Item 1. Business - Forward-Looking Statements and Risk Factors" set forth in our Form 10-K for the fiscal year ended June 30, 2007. These forward-looking statements speak only as of the date of this report and we do 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.
Overview of Operations
This Overview is intended to provide a context for the following Management's Discussion and Analysis of the Results of Operations and Financial Condition, and should be read in conjunction with our unaudited consolidated financial statements, including the notes thereto, in this quarterly report on Form 10-Q, as well as our audited consolidated financial statements for the year ended June 30, 2007 as filed on Form 10-K with the SEC. We have attempted to identify the most important matters on which our management focuses in evaluating our financial condition and operating performance and the short-term and long-term opportunities, challenges, and risks (including material trends and uncertainties) which we face. We also discuss the action we are taking to address these opportunities, challenges, and risks. The Overview is not intended as a summary of, or a substitute for review of, Management's Discussion and Analysis of the Results of Operations and Financial Condition.
Northeast Bank is faced with the following challenges: growing our loan portfolio, improving net interest margins, executing our plan of increasing noninterest income and improving the efficiency ratio.
Loans have decreased compared to June 30, 2007, due principally to a decrease in residential real estate, commercial real estate and commercial loans. While competition for commercial real estate and small commercial loans is intense, we are not competing for relationships where we believe transactions do not reflect pricing or structure for risk.
To improve net interest income, we leveraged our balance sheet using investment securities during the nine months ended March 31, 2008. During the quarter ended March 31, 2008, we purchased $5 million of mortgage-backed securities funded with overnight advances from the Federal Home Loan Bank of Boston. For the six months ended December 31, 2007, $42 million of mortgage-backed securities were purchased and funded through a repurchase agreement and available funds. This leveraging of our balance sheet increased overall earning assets at March 31, 2008 compared to prior periods.
Net interest margins are expected to continue to improve slightly over the near term. This will be due to the volume of certificates of deposits that is expected to reprice in the next quarter to interest rates lower than one year ago. Since our balance sheet was liability sensitive at December 31, 2007, the cost of interest-bearing liabilities reprice more quickly than the yield of interest-bearing assets and would generally be expected to result in an increase in net interest income during a period of falling interest rates (and a decrease in net interest income during a period of rising interest rates). We believe that the prospect of additional decreases in prime rate in the immediate future is likely but will be smaller decreases as compared to the action by the Federal Reserve Bank lowering the federal funds rate which also caused prime rate to decline by 175 basis points in the quarter ended March 31, 2008, a total of 300 basis points since June 30, 2007. Any significant improvement in net interest income would also result from an increased volume of new loan originations as opposed to rate changes in market rates.
Management believes that the allowance for loan losses as of March 31, 2008 was adequate, under present conditions, for the known credit risk in the loan portfolio. While non-accrual loans and loan delinquencies increased compared to the levels at June 30, 2007, we maintained our allowance for loan losses at $5,756,000 as the loan portfolio decreased $17,646,702 during the nine months ended March 31, 2008.
We expect to improve non-interest income through the expansion of Northeast Bank Insurance Agency, Inc. into western and southern Maine, the wealth management division of our trust department, and the investment brokerage division and the continued increase in commercial and consumer property and casualty insurance policies through the cross-sale to bank customers and sale to new customers. Non-interest expense is expected to increase to support this expansion.
Our efficiency ratio, calculated by dividing noninterest expense by the sum of net interest income and noninterest income, was 83% and 85% for the three months ended March 31, 2008 and 2007, respectively. The ratio has improved due primarily to the increase in noninterest income as compared to the same periods during the prior fiscal year. For the nine months ended March 31, 2008 and 2007, the efficiency ratio was 86% and 84%, respectively.
Description of Operations
Northeast Bancorp (the "Company") is a Maine corporation and a bank holding company registered with the Federal Reserve Bank of Boston ("FRB") under the Bank Holding Company Act of 1956. The FRB is the primary regulator of the Company and it supervises and examines our activities. The Company also is a registered Maine financial institution holding company under Maine law and is subject to regulation and examination by the Superintendent of Maine Bureau of Financial Institutions. We conduct business from our headquarters in Lewiston, Maine and, as of March 31, 2008, we had twelve banking offices and fourteen insurance offices located in western and south-central Maine and southeastern New Hampshire. At March 31, 2008, we had consolidated assets of $586.4 million and consolidated stockholders' equity of $42.9 million.
The Company's principal asset is all 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 Bank's 12 offices are located in Auburn, Augusta, Bethel, Brunswick, Buckfield, Falmouth, Harrison, Lewiston (2), Mechanic Falls, Portland, and South Paris, Maine. The Bank's investment brokerage division offers investment, insurance and financial planning products and services from its office in Falmouth, Maine.
The Bank's wholly owned subsidiary, Northeast Bank Insurance Group Inc, is our insurance agency. Seven agencies have been acquired in the past seventeen months: Hyler Agency of Thomaston, Maine was acquired on December 11, 2007; Spence & Matthews, Inc of Berwick, Maine and Rochester, New Hampshire was acquired on November 30, 2007; Hartford Insurance Agency of Lewiston, Maine was acquired on August 30, 2007; Russell Agency of Madison, Maine was acquired on June 28, 2007; Southern Maine Insurance Agency of Scarborough, Maine was acquired on March 30, 2007; Sturtevant and Ham, Inc. of Livermore, Maine was acquired on December 1, 2006; and Palmer Insurance of Turner, Maine on November 28, 2006. The Russell Agency was moved to our existing agency office in Anson, Maine and the Hartford Insurance Agency was moved to our existing agency office in Auburn, Maine following the acquisitions. Our insurance agency offices are located in Anson, Auburn, Augusta, Berwick, Bethel, Jackman, Livermore Falls, Mexico, Rangeley (its headquarters), Thomaston, Turner, Scarborough, and South Paris, Maine and Rochester, New Hampshire. All of our insurance agencies offer personal and commercial property and casualty insurance products. See Note 6 in our June 30, 2007 audited consolidated financial statements and Note 10 of the March 31, 2008 unaudited consolidated financial statements for more information regarding our insurance agency acquisitions.
Northeast Bank Insurance Group, Inc. purchased real estate from Sargent Appraisal Services, Inc which is wholly owned by Craig Sargent. Mr. Sargent is employed as the President of Northeast Bank Insurance Group. The first of two transactions was the purchase of real estate located at 59 and 63 Main Street in Anson, Maine and Route 4 in Jay, Maine on December 19, 2007 for a purchase price of $128,000. The second purchase was real estate located at 89 Main Street in Mexico, Maine and 2568 Main Street in Rangeley, Maine on January 8, 2008 for a purchase price of $433,000. The prices were based upon independent appraisals except for the land in Jay, Maine which was purchased for $45,000. Mr. Sargent was paid a total of $561,000 in cash. Northeast Bank Insurance Group, Inc. will continue to operate each location in Anson, Mexico, and Rangeley as insurance agency offices. Management of Northeast Bancorp and the Bank believe that the transaction reflected arm’s-length, negotiated terms.
Bank Strategy
The principal business of the Bank consists of attracting deposits from the general public and applying those funds to originate or acquire residential mortgage loans, commercial loans, commercial real estate loans and a variety of consumer, indirect auto and indirect recreational vehicle loans. The Bank sells, from time to time, fixed rate residential mortgage loans into the secondary market. The Bank also invests in mortgage-backed securities, securities issued by United States government sponsored enterprises, corporate and municipal securities. The Bank's profitability depends primarily on net interest income. It continues to be our largest source of revenue and is affected by the level of interest rates, changes in interest rates and by changes in the amount and composition of interest-earning assets(i.e. loans and investments) and interest-bearing liabilities(i.e. customer deposits and borrowed funds). The Bank also emphasizes the growth of non-interest sources of income from investment and insurance brokerage, trust management and financial planning to reduce its dependency on net interest income.
Our goal is to continue modest, but profitable, growth by increasing our loan and deposit market share in our existing markets in western and south-central Maine, closely managing the yields on interest-earning assets and rates on interest-bearing liabilities, introducing new financial products and services, increasing the number of bank services sold to each household, increasing non-interest income from expanded trust services, investment and insurance brokerage services and controlling the growth of non-interest expenses. Additional acquisitions of insurance agencies are not planned for the near term.
Results of Operations
Comparison of the three and nine months ended March 31, 2008 and 2007
General
The Company reported consolidated net income of $672,169, or $0.29 per diluted share, for the three months ended March 31, 2008 compared to $524,967, or $0.21 per diluted share, for the three months ended March 31, 2007, an increase of $147,202, or 28%. Net interest and dividend income decreased $391,608, or 10%, as a result of a lower net interest margin, partially offset by increased earning assets. The provision for loan losses increased $87,582, or 44%, compared to the quarter ended March 31, 2007. Noninterest income increased $1,253,294, or 52%, primarily from increased insurance commissions and net securities gains. Noninterest expense increased $581,118, or 11%, primarily due to increased salaries and employee benefits and other noninterest expenses related to insurance agency acquisitions.
Annualized return on average equity ("ROE") and return on average assets ("ROA") were 6.45% and 0.46%, respectively, for the quarter ended March 31, 2008 as compared to 5.13% and 0.38%, respectively, for the quarter ended March 31, 2007. The increases in the returns on average equity and average assets were primarily due to the increase in net income for the most recent quarter.
The Company reported consolidated net income of $1,505,162, or $0.63 per diluted share, for the nine months ended March 31, 2008 compared to $1,396,991, or $0.57 per diluted share, for the nine months ended March 31, 2007, an increase of $108,171, or 8%. Net interest and dividend income decreased $1,346,961, or 11%, as a result of a lower net interest margin. The provision for loan losses decreased $218,814, or 25%, with the allowance for loan losses remaining unchanged compared to June 30, 2007. Noninterest income increased $2,289,966, or 40%, primarily from increased insurance commission revenue. Noninterest expense increased $1,069,739, or 7%, primarily from insurance agency acquisitions.
The annualized ROE and ROA were 4.83% and 0.35%, respectively, for the nine months ended March 31, 2008 as compared to 4.55% and 0.33%, respectively, for the nine months ended March 31, 2007. The increases in the returns on average equity and average assets were primarily due to increased net income for the nine months ended March 31, 2008.
Net Interest and Dividend Income
Net interest and dividend income for the three months ended March 31, 2008 decreased to $3,402,670 as compared to $3,794,278 for the same period in 2007. The decrease in net interest and dividend income of $391,608, or 10%, was primarily due to a 43 basis point decrease in net interest margin, on a tax equivalent basis, partially offset by an increase in average earning assets of $22,165,574, or 4%, for the quarter ended March 31, 2008 as compared to the quarter ended March 31, 2007. The increase in average earning assets was primarily due to an increase in average available-for-sale securities of $46,502,428, or 57%, from the purchase of mortgage-backed securities reduced by a decrease in average loans of $22,212,515, or 5%, and a decrease in average interest-bearing deposits and regulatory stock of $2,124,339, or 23%. Average loans as a percentage of average earning assets was 75% and 83% for quarters ended March 31, 2008 and 2007, respectively. Our net interest margin, on a tax equivalent basis, was 2.55% and 2.98% for the quarters ended March 31, 2008 and 2007, respectively. Our net interest spread, on a tax equivalent basis, for the three months ended March 31, 2008 was 2.23%, a decrease of 25 basis points from 2.48% for the same period a year ago. Comparing the three months ended March 31, 2008 and 2007, the yields on earning assets decreased 29 basis points and the cost of interest-bearing liabilities decreased 4 basis points. The decrease in our yield on earning assets reflects the 175 basis point decrease in prime rate during the quarter ended March 31, 2008. The relatively smaller decrease in the cost of interest-bearing liabilities reflects the competitive pressure on interest rates to attract new customers and retain existing customer relationships. We were not able to increase our net interest spread due to the decrease in the prime rate during the quarter ended March 31, 2008, which primarily affected rates on loans, and a relatively small volume of interest-bearing liabilities (primarily certificates of deposit) that repriced to lower rates.
The changes in net interest and dividend income, on a tax equivalent basis, are presented in the schedule below, which compares the three months ended March 31, 2008 and 2007.
| | | Difference Due to | | | | |
| | | Volume | | | Rate | | | Total | |
| | $ | 578,576 | | | $ | 62,373 | | | $ | 640,949 | |
| | | (391,573 | ) | | | (242,306 | ) | | | ( 633,879 | ) |
| | | (19,571 | ) | | | (13,779 | ) | | | (33,350 | ) |
Total Interest-earnings Assets | | | 167,432 | | | | (193,712 | ) | | | (26,280 | ) |
| | | | | | | | | | | | | |
| | | (59,823 | ) | | | 50,058 | | | | (9,765 | ) |
Securities sold under Repurchase Agreements | | | (50,357 | ) | | | (83,199 | ) | | | ( 133,556 | ) |
| | | 587,847 | | | | (79,629 | ) | | | 508,218 | |
Total Interest-bearing Liabilities | | | 477,667 | | | | (112,770 | ) | | | 364,897 | |
Net Interest and Dividend Income | | $ | (310,235 | ) | | $ | (80,942 | ) | | $ | ( 391,177 | ) |
| | | | | | | | | | | | | |
Rate/volume amounts which are partly attributable to rate and volume are spread proportionately between volume and rate based on the direct change attributable to rate and volume. Borrowings in the table include junior subordinated notes, FHLB borrowings, structured repurchase agreements, capital lease obligation and other borrowings. The adjustment to interest income and yield on a fully tax equivalent basis was $50,766 and $50,335 for the three months ended March 31, 2008 and 2007, respectively. | |
Net interest and dividend income for the nine months ended March 31, 2008 decreased to $10,564,811, as compared to $11,911,772 for the same period in 2007. The decrease in net interest and dividend income of $1,346,961, or 11%, was primarily due to a 37 basis point decrease in net interest margin, on a tax equivalent basis, partially offset by an increase in average earning assets of $6,103,566, or 1%, for the nine months ended March 31, 2008 as compared to the nine months ended March 31, 2007. The increase in average earning assets was primarily due to an increase in average available-for-sale securities of $26,649,121, or 31%, from the purchase of FNMA and FHLMC mortgage-backed securities, partially offset by a decrease in average loans of $19,286,316, or 4%, and a decrease in average interest-bearing deposits and regulatory stock of $1,259,239, or 13%. Average loans as a percentage of average earning assets was 78% and 82% for quarters ended March 31, 2008 and 2007, respectively. Our net interest margin, on a tax equivalent basis, was 2.66% and 3.03% for the nine months ended March 31, 2008 and 2007, respectively. Our net interest spread, on a tax equivalent basis, for the nine months ended March 31, 2008 was 2.36%, a decrease of 27 basis points from 2.63% for the same period a year ago. Comparing the nine months ended March 31, 2008 and 2007, the yields on earning assets decreased 9 basis points compared to an 18 basis point increase in the cost of interest-bearing liabilities. The decreases in our yield on earning assets and the increase in cost of interest-bearing liabilities reflect the competitive pressure on interest rates to attract new customers and retain existing customer relationships and general rising interest rate environment. We were not able to increase our net interest spread due to the relatively low volume of interest-bearing liabilities (primarily certificates of deposit) that repriced to lower rates, and a decreasing prime rate, resulting in downward repricing of immediately adjustable rate loans, during the nine months ended March 31, 2008.
The changes in net interest and dividend income, on a tax equivalent basis, are presented in the schedule below, which compares the nine months ended March 31, 2008 and 2007.
| | | Difference Due to | | | | |
| | | Volume | | | Rate | | | Total | |
| | $ | 964,220 | | | $ | 240,113 | | | $ | 1,204,333 | |
| | | (1,040,013 | ) | | | (176,090 | ) | | | (1,216,103 | ) |
| | | (31,735 | ) | | | (8,729 | ) | | | (40,464 | ) |
Total Interest-earnings Assets | | | (107,528 | ) | | | 55,294 | | | | (52,234 | ) |
| | | | | | | | | | | | | |
| | | (498,734 | ) | | | 613,446 | | | | 114,712 | |
Securities sold under repurchase Agreements | | | (55,789 | ) | | | (47,769 | ) | | | (103,558 | ) |
| | | 1,412,099 | | | | (131,773 | ) | | | 1,280,326 | |
Total Interest-bearing Liabilities | | | 857,576 | | | | 433,904 | | | | 1,291,480 | |
Net Interest and Dividend Income | | $ | (965,104 | ) | | $ | (378,610 | ) | | $ | (1,343,714 | ) |
| | | | | | | | | | | | | |
Rate/volume amounts which are partly attributable to rate and volume are spread proportionately between volume and rate based on the direct change attributable to rate and volume. Borrowings in the table include junior subordinated notes, FHLB borrowings, structured repurchase agreements, capital lease obligation and other borrowings. The adjustment to interest income and yield on a fully tax equivalent basis was $151,812 and $148,565 for the nine months ended March 31, 2008 and 2007, respectively. | |
The Company's business primarily consists of the commercial banking activities of the Bank. The success of the Company is largely dependent on its ability to manage interest rate risk and, as a result, changes in interest rates, as well as fluctuations in the level of assets and liabilities, affecting net interest and dividend income. This risk arises from our core banking activities: lending and deposit gathering. In addition to directly impacting net interest and dividend income, changes in interest rates can also affect the amount of loans originated and sold by the Bank, the ability of borrowers to repay adjustable or variable rate loans, the average maturity of loans, the rate of amortization of premiums and discounts paid on securities, the amount of unrealized gains and losses on securities available-for-sale and the fair value of our saleable assets and the resultant ability to realize gains. The interest sensitivity of the Bank's balance sheet is currectly a liability sensitive position, where the costs of interest-bearing liabilities reprice more quickly than the yield of interest-bearing assets. As a result, the Bank is generally expected to experience a decrease in its net interest margins during a period of increasing interest rates, or an increase in its net interest margin during a period of decreasing interest rates.
As of March 31, 2008 and 2007, 43% and 45%, respectively, of the Bank's loan portfolio was composed of adjustable rate loans based on a prime rate index or short-term rate indices such as the one-year U.S. Treasury bill. Interest income on these existing loans would increase if short-term interest rates increase. An increase in short-term interest rates would also increase deposit and FHLB advance rates, increasing the Company's interest expense. The impact on future net interest and dividend income from changes in market interest rates will depend on, among other things, actual rates charged on the Bank's loan portfolio, deposit and advance rates paid by the Bank and loan volume.
Provision for Loan Losses
The provision for loan losses for the three months ended March 31, 2008 was $287,625, an increase of $87,582, or 44%, from $200,043 for the three months ended March 31, 2007. For the nine months ended March 31, 2008 and 2007, the provisions for loans losses were $657,561 and $876,375, respectively, a decrease of $218,814, or 25%. We maintained the allowance for loan losses flat to its June 30, 2007 balance by recognizing a provision equal to net charge-offs. For our internal analysis of adequacy of the allowance for loan losses, we considered: the decrease in net loans during the nine months ended March 31, 2008; the decrease in net charge-offs of $218,814 for the nine months ended March 31, 2008 compared to the same period in 2007; the increase in net charge-off of $87,582 for the quarter ended March 31, 2008 compared to the same period one year ago; an increase in loan delinquency to 3.90% at March 31, 2008 compared to 2.42% at June 30, 2007 and 2.08% at March 31, 2007 due to the amount of loan balances past due; an increase of $2,524,000 in non-performing loans (more than 90 days past due) at March 31, 2008 compared to June 30, 2007; and a decrease in internally classified and criticized loans at March 31, 2008 compared toJune 30, 2007. Management deemed the allowance for loan losses adequate for the risk in the loan portfolio. See Financial Condition for a discussion of the Allowance for Loan Losses and the factors impacting the provision for loan losses. The allowance as a percentage of outstanding loans increased to 1.41% at March 31, 2008 compared to 1.35% at June 30, 2007 and March 31, 2007, respectively.
Noninterest Income
Total noninterest income was $3,640,833 for the quarter ended March 31, 2008, an increase of $1,253,294, or 52%, from $2,387,539 for the quarter ended March 31, 2007. This increase reflected the combined impact of a $1,239,523, or 165% increase in insurance agency commissions due to insurance agency acquisitions, an increase in fees for other services to customers of $18,062, an increase in net securities gains of $258,704 from replacing U.S. government sponsored enterprise agency bullets and callable bonds with higher yielding mortgage-backed securities, an increase in investment commissions of $16,324 and an increase in BOLI income of $22,335 primarily from the purchases of additional BOLI policies compared to the same period one year ago. These increases were partially offset by a decrease in gains on the sales of loans of $296,746 due to a decrease in the volume of residential real estate and commercial real estate loans sold, and a decrease in other noninterest income of $4,908.
For the nine months ended March 31, 2008 and 2007, total noninterest income was $8,027,091 and $5,737,125, respectively, an increase of $2,289,966, or 40%. This increase was primarily due to insurance agency commissions which increased $2,350,974, or 147%. In addition, fees for other services to customers increased $33,199, net securities gains increased $228,704 from the restructuring of the bond portfolio above, and BOLI income increased $46,081 from the purchases of additional policies. These increases were partially offset by a decrease in gains on the sales of loans due to a decrease in the volume of residential and commercial real estate loans sold and a decrease in other noninterest income of $97,827 due to gains recognized from the sale of the former Lisbon Falls branch during the nine months ended March 31, 2007.
Noninterest Expense
Total noninterest expense for the three months ended March 31, 2008 was $5,846,368, an increase of $581,118, or 11%, from $5,265,250 for the three months ended March 31, 2007. This increase was primarily due to a $316,040, or 10%, increase in salaries and employee benefits from an increase of 36 full-time staff from our insurance agency acquisitions partially offset by lower deferred compensation expenses. The increase in occupancy expense of $82,100, or 18%, was due to the increase in rent and utilities for the additional leased insurance agency offices acquired and ground maintenance (snow removal) expenses. Equipment expense increased $35,853, or 10%, primarily due to increased software licensing expense. Intangible amortization increased $102,833, or 127%, from the customer list and non-compete intangibles added from the four insurance agency acquisitions since March 31, 2007. Other noninterest expense increased $44,292, or 4%, primarily from increased collections related expenses, increased deposit fraud losses, increased travel and entertainment expense, and increased other-than-temporary impairment expenses on marketable securities. These increases in noninterest expense were partially offset by a decrease in off-balance sheet credit reserve and out-sourced computer services expenses compared to the three months ended March 31, 2007.
For the nine months ended March 31, 2008 and 2007, total noninterest expense was $15,968,821 and $14,899,082, respectively, an increase of $1,069,739, or 7%. The increase in salaries and employee benefits of $588,498, or 7%, was due to adding 36 full-time staff through our insurance agency acquisitions. Occupancy expense increased $105,383, or 8%, from rent increase for leased insurance agency offices acquired, utilities and ground maintenance expenses. Intangible amortization expense increased $198,480, or 85%, was due to the customer list and non-compete intangibles created from the four insurance agency acquisitions since March 31, 2007. The increase in other noninterest expense of $139,638, or 4%, was due to increases in professional fees, advertising expense, collection expenses, deposit fraud losses and travel and entertainment expense partially offset by a decrease in postage and a decrease in other-than-temporary write-down expense on non-marketable securities.
For the three months ended March 31, 2008, the increase in income tax expense was primarily due to the increase in income before income taxes as compared to the same periods in 2007. For the nine months ended March 31, 2008, the decrease in income tax expense was due to the mix of increase of tax-exempt interest and BOLI income compared to the same period in 2007.
Our efficiency ratio, which is total non interest expense as a percentage of the sum of net interest income and noninterest income, was 83% and 85% for the three months ended March 31, 2008 and 2007, respectively, and 86% and 84% for the nine months ended March 31, 2008 and 2007, respectively. The decrease in the efficiency ratio for the three months ended March 31, 2008 was due to a net increase in the sum of net interest income and noninterest income compared to the three months ended March 31, 2007. The increase in the efficiency ratio for the nine months ended March 31, 2008 was due to the increase in noninterest expense, primarily from acquired insurance agencies, compared to the same period in fiscal 2007.
Financial Condition
Our consolidated assets were $586,426,179 and $556,800,980 as of March 31, 2008 and June 30, 2007, respectively, an increase of $29,625,199, or 5%. This increase was primarily due to an increase of $42,110,629, or 49%, in available-for-sale securities, and increases in goodwill and intangibles, net of amortization, of $6,124,526, and bank owned life insurance of $2,326,432, partially offset by a decrease of $17,646,702, or 4%, in net loans, primarily commercial real estate and commercial loans, a decrease in loans held-for-sale of $433,335, or 26%, a decrease in cash and due from banks of $1,553,738, and a decrease in other assets of $1,861,772. For the three months ended March 31, 2008, average total assets were $586,632,348, an increase of $32,749,244, or 6%, from $553,883,104 for the same period in 2007. This average asset increase was primarily attributable to an increase in available-for-sale securities, goodwill and intangibles and BOLI.
Total stockholders' equity was $42,926,221 and $40,849,878 at March 31, 2008 and June 30, 2007, respectively, an increase of $2,076,343, or 5%, due to net income for the nine months ended March 31, 2008 and a decrease in accumulated other comprehensive loss, partially offset by dividends paid and stock repurchased. Book value per outstanding share was $18.54 at March 31, 2008 and $16.68 at June 30, 2007. Tangible book value per outstanding share was $12.88 at March 31, 2008 and $13.83 at June 30, 2007. This decrease in tangible book value was attributable to the additional goodwill and other intangibles recognized since March 31, 2007.
Investment Activities
The available-for-sale investment portfolio was $128,458,699 as of March 31, 2008, an increase of $42,110,629, or 49%, from $86,348,070 as of June 30, 2007. This increase was primarily due to leveraging transactions carried out in August, 2007 and December, 2007 in which $44 million of mortgage-backed securities were acquired funded through available funds and structured repurchase agreements of $40 million with an average rate of 4.47% and a spread of approximately 1.35%. To reduce the balance sheet exposure to rising interest rates, $50 million of interest rate caps were imbedded in these transactions with a strike rate based on three month LIBOR. Interest rate floors of $20 million were sold with a strike rate of 4.88% based on three month LIBOR. See note 7 for additional information.
We restructured the available-for-sale investments by selling $14 million of U.S. government sponsored agency bullet and callable bonds replacing them with higher yielding mortgage-backed securities. An additional mortgage-backed security was also purchased and funded with overnight FHLB advances.
The investment portfolio as of March 31, 2008 consisted of debt securities issued by U.S. government-sponsored enterprises and corporations, mortgage-backed securities, municipal securities and equity securities. Generally, funds retained by the Bank as a result of increases in deposits or decreases in loans, which are not immediately used by the Bank, are invested in securities held in its investment portfolio. The investment portfolio is used as a source of liquidity for the Bank. The investment portfolio is structured so that it provides for an ongoing source of funds for meeting loan and deposit demands and for reinvestment opportunities to take advantage of changes in the interest rate environment. The investment portfolio averaged $127,922,276 for the three months ended March 31, 2008 as compared to $81,419,848 for the three months ended March 31, 2007, an increase of $46,502,428, or 57%. This increase was due primarily to the leveraging transaction and purchasing of mortgage-backed securities noted above.
Our entire investment portfolio was classified as available-for-sale at March 31, 2008 and June 30, 2007, and is carried at market value. Changes in market value, net of applicable income taxes, are reported as a separate component of stockholders' equity. Gains and losses on the sale of securities are recognized at the time of the sale using the specific identification method. The amortized cost and market value of available-for-sale securities at March 31, 2008 were $126,043,939 and $128,458,699, respectively. The difference between the carrying value and the cost of the securities of $2,414,760 was primarily attributable to the increase in market value of mortgage-backed securities above their cost. The net unrealized loss on equity securities was $352,932 and the net unrealized gains on U.S. government-sponsored enterprises, corporate debt, mortgage-backed and municipal securities were $2,767,692 at March 31, 2008. The U.S. government-sponsored enterprises, corporate debt and mortgage-backed securities have increased in market value due to the recent decreases in long-term interest rates as compared to June 30, 2007. Substantially all of the U.S. government-sponsored enterprises, mortgage-backed and municipal securities held in our portfolio are high investment grade securities. The single corporate bond in the bank’s portfolio has been downgraded by credit rating agencies below our investment grade. We did not consider it impaired at March 31, 2008 due to the short maturity of the bond. Management believes that the yields currently received on this portfolio are satisfactory. Management reviews the portfolio of investments on an ongoing basis to determine if there have been any other than temporary declines in value. Some of the considerations management takes into account in making this determination are market valuations of particular securities and an economic analysis of the securities' sustainable market values based on the underlying company's profitability. Management plans to hold the equity, U.S. government-sponsored enterprises, corporate debt, mortgage-backed and municipal securities which have market values below cost until a recovery of market value occurs or until maturity.
Loan Portfolio
Total loans, including loans held-for-sale, of $409,127,866 as of March 31, 2008 decreased $18,080,037, or 4%, from $427,207,903 as of June 30, 2007. Compared to June 30, 2007, each loan category decreased. Residential real estate loans, including commercial 1 to 4 family loans and loans held for sale, decreased $2,845,868, or 2%, construction loans decreased $367,095, or 7%, commercial real estate loans decreased $5,344,485, or 5%, commercial loans decreased $6,851,938, or 17%, and consumer loans decreased $2,573,214, or 2%. Net deferred loan origination costs decreased $97,437. The total loan portfolio averaged $410,443,610 for the three months ended March 31, 2008, a decrease of $22,212,515, or 5%, compared to $432,656,125 for the three months ended March 31, 2007.
The Bank primarily lends within its local market areas, which management believes helps it to better evaluate credit risk. The Bank's local market, as well as the secondary market, continues to be very competitive for loan volume.
Residential real estate loans consisting of primarily owner-occupied residential loans as a percentage of total loans were 35% as of March 31, 2008, and 34% as of June 30, 2007 and March 31, 2007, respectively. The variable rate product as a percentage of total residential real estate loans was 34%, 37% and 38% for the same periods, respectively. Generally, management has pursued a strategy of increasing the percentage of variable rate loans as a percentage of the total loan portfolio to help manage interest rate risk. We currently plan to continue to sell all newly originated fixed-rate residential real estate loans into the secondary market to manage interest rate risk. Average residential real estate mortgages of $144,907,630 for the three months ended March 31, 2008 decreased $1,351,480, or 1%, from the three months ended March 31, 2007. This decrease was due to the origination of more fixed rate loans for sale. Purchased loans included in our loan portfolio are pools of residential real estate loans acquired from and serviced by other financial institutions. These loan pools are an alternative to mortgage-backed securities, and represented 3% of residential real estate loans at March 31, 2008. The Bank has not pursued a similar strategy recently.
Commercial real estate and commercial loans both decreased at March 31, 2008 compared to the same period in the prior year. The decrease reflects the intense competition for new and renewing commercial real estate and commercial loans. The Bank tightened its credit underwriting standards as delinquencies and classified and criticized loans increased, and priced new commercial real estate and commercial loans to reflect risk.
Commercial real estate loans as a percentage of total loans were 26%, 26%, and 27% as of March 31, 2008, June 30, 2007 and March 31, 2007, respectively. Commercial real estate loans have minimal interest rate risk because the portfolio consists primarily of variable rate products. The variable rate products as a percentage of total commercial real estate loans were 95% as of March 31, 2008, 94% as of June 30, 2007 and 93% as of March 31, 2007, respectively. The Bank tries to mitigate credit risk by lending in its market area, as well as by maintaining a well-collateralized position in real estate. Average commercial real estate loans of $104,655,078 for the three months ended March 31, 2008 decreased $12,308,984, or 11%, from the same period in 2007.
Construction loans as a percentage of total loans were 1% as of March 31, 2008, June 30, 2007 and March 31, 2007, respectively. Limiting disbursements to the percentage of construction completed controls risk. An independent consultant or appraiser verifies the construction progress. Construction loans have maturity dates of less than one year. Variable rate products as a percentage of total construction loans were 50%, 60%, and 59% for the same periods, respectively. Average construction loans were $5,631,120 and $9,240,134 for the three months ended March 31, 2008 and 2007, respectively, a decrease of $3,609,014, or 39%.
Commercial loans as a percentage of total loans were 9% as of March 31, 2008 and 10% as of June 30, 2007 and March 31, 2007, respectively. The variable rate products as a percentage of total commercial loans were 63%, 58%, and 57% for the same periods, respectively. The repayment ability of commercial loan customers is highly dependent on the cash flow of the customer's business. The Bank mitigates losses by strictly adhering to the Company's underwriting and credit policies. Average commercial loans of $34,770,362 for the three months ended March 31, 2008 decreased $8,802,981, or 20%, from $43,573,343 for the same period in 2007.
Consumer and other loans as a percentage of total loans were 29%, 29%, and 28% for the periods ended March 31, 2008, June 30, 2007, and March 31, 2007, respectively. At March 31, 2008, indirect auto, indirect recreational vehicle, and indirect mobile home loans represented 30%, 47%, and 19% of total consumer loans, respectively, compared to 31%, 43%, and 21%, respectively, of total consumer loans at June 30, 2007. Since these loans are primarily fixed rate products, they have interest rate risk when market rates increase. The consumer loan department underwrites all the indirect automobile, recreational vehicle loans and mobile home loans to mitigate credit risk. The Bank typically pays a one-time origination fee to dealers of indirect loans. The fees are deferred and amortized over the life of the loans as a yield adjustment. Management attempts to mitigate credit and interest rate risk by keeping the products with average lives of no longer than five years, receiving a rate of return commensurate with the risk, and lending to individuals in the Bank's market areas. Average consumer and other loans were $117,795,962 and $114,007,139 for the three months ended March 31, 2008 and 2007, respectively. The $3,788,823, or 3%, increase was due to increased indirect recreational vehicle lending. The composition of consumer loans is detailed in the following table.
| | |
| | | Consumer Loans as of | | | | |
| | | March 31, 2008 | | | June 30, 2007 | |
| | $ | 34,290,293 | | | | 30 | % | | $ | 36,808,246 | | | | 31 | % |
| | | 54,391,753 | | | | 47 | % | | | 51,611,223 | | | | 43 | % |
| | | 22,402,765 | | | | 19 | % | | | 24,961,562 | | | | 21 | % |
| | | 111,084,811 | | | | 96 | % | | | 113,381,031 | | | | 95 | % |
| | | 5,222,698 | | | | 4 | % | | | 5,499,692 | | | | 5 | % |
| | $ | 116,307,509 | | | | 100 | % | | $ | 118,880,723 | | | | 100 | % |
Classification of Assets
Loans are classified as non-performing when reaching more than 90 days delinquent or when less than 90 days past due and based on our judgment that the loan is likely to present future principal and/or interest repayment problems. In both situations, we cease accruing interest. The Bank had non-performing loans totaling $7,614,000 and $5,090,000 at March 31, 2008 and June 30, 2007, respectively, or 1.87% and 1.20% of total loans, respectively. The Bank's allowance for loan losses was equal to 77% and 113% of the total non-performing loans at March 31, 2008 and June 30, 2007, respectively. The following table represents the Bank's non-performing loans as of March 31, 2008 and June 30, 2007:
Non-performing loans increased in the three months ended March 31, 2008 compared to June 30, 2007. Of total non-performing loans at March 31, 2008, $2,217,000 of these loans were current and paying as agreed compared to $2,038,000 at June 30, 2007, an increase of $179,000. Consumer and other non-performing loans were primarily indirect auto loans pending sale at auction. The difference between the carrying amount of the indirect auto loan and its estimated auction sale value had been charged off. The commercial real estate and commercial non-performing loans are subject to a loan-by-loan review determining the risk of loss based on the estimated distressed sale value of collateral. This risk of loss was incorporated in determining the adequacy of the allowance for loan losses.
At March 31, 2008, the Bank had $680,000 in loans classified special mention or substandard that management believes could potentially become non-performing due to delinquencies or marginal cash flows. These special mention and substandard loans decreased by $1,862,000 when compared to the level of $2,542,000 at June 30, 2007.
The following table reflects the quarterly trend of total delinquencies 30 days or more past due and non-performing loans for the Bank as a percentage of total loans:
| 3/31/08 | 12/31/07 | 9/30/07 | 6/30/07 | 3/31/07 |
| 4.41% | 4.49% | 3.11% | 2.90% | 2.47% |
Loans classified as non-performing remain on such status until the borrower has demonstrated a sustainable period of performance. Excluding loans classified as non-performing but whose contractual principal and interest payment are current, the Bank's total delinquencies 30 days or more past due, as a percentage of total loans, would be 3.90% as of March 31, 2008.
Allowance for Loan Losses
The Bank's allowance for loan losses was $5,756,000 as of March 31, 2008, unchanged from the level at June 30, 2007 representing 1.41% and 1.35%, respectively, of total loans for each of the periods. Management maintains this allowance at a level that it believes is reasonable for the overall probable losses inherent in the loan portfolio. The allowance for loan losses represents management's estimate of this risk in the loan portfolio. This evaluation process is subject to numerous estimates and judgments. The frequency of default, risk ratings, and the loss recovery rates, among other things, are considered in making this evaluation, as are the size and diversity of individual large credits. Changes in these estimates could have a direct impact on the provision and could result in a change in the allowance. The larger the provision for loan losses, the greater the negative impact on our net income. Larger balance, commercial and commercial real estate loans representing significant individual credit exposures are evaluated based upon the borrower's overall financial condition, resources, and payment record, the prospects for support from any financially responsible guarantors and, if appropriate, the realizable value of any collateral. The allowance for loan losses attributed to these loans is established through a process that includes estimates of historical and projected default rates and loss severities, internal risk ratings and geographic, industry and other environmental factors. Management also considers overall portfolio indicators, including trends in internally risk-rated loans, classified loans, non accrual loans and historical and forecasted write-offs and a review of industry, geographic and portfolio concentrations, including current developments. In addition, management considers the current business strategy and credit process, including credit limit setting and compliance, credit approvals, loan underwriting criteria and loan workout procedures. Within the allowance for loan losses, amounts are specified for larger-balance, commercial and commercial real estate loans that have been individually determined to be impaired. These specific reserves consider all available evidence including, as appropriate, the present value of the expected future cash flows discounted at the loan's contractual effective rate and the fair value of collateral. Each portfolio of smaller balance, residential real estate and consumer loans is collectively evaluated for impairment. The allowance for loan losses is established pursuant to a process that includes historical delinquency and credit loss experience, together with analyses that reflect current trends and conditions. Management also considers overall portfolio indicators including historical credit losses, delinquent, non-performing and classified loans, trends in volumes, terms of loans, an evaluation of overall credit quality and the credit process, including lending policies and procedures and economic factors. For the nine months ended March 31, 2008, we have not changed our approach in the determination of the allowance for loan losses. There have been no material changes in the assumptions or estimation techniques as compared to prior periods in determining the adequacy of the allowance for loan losses.
Management believes that the allowance for loan losses as of March 31, 2008 was adequate considering the level of risk in the loan portfolio. 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. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. These agencies may require the Bank to recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examination. The Bank's most recent joint examination by the Federal Reserve Bank of Boston and the Maine Bureau of Financial Institutions was completed in March, 2008. At the time of the examination, the regulators proposed no adjustments to the allowance for loan losses.
Other Assets
Bank owned life insurance (BOLI) is invested in the general account of three insurance companies and in separate accounts of a fourth insurance company. We rely on the creditworthiness of each insurance company for general account BOLI policies. For separate account BOLI policies, the insurance company holds the underlying bond and stock investments in a trust for the Bank. Standard and Poor's rated these companies AA- or better at March 31, 2008. Interest earnings, net of mortality costs, increase cash surrender value. These interest earnings are based on interest rates reset at least annually, and are subject to minimum interest rates. These increases were recognized in other income and are not subject to income taxes. Borrowing on or surrendering the policy may subject the Bank to income tax expense on the increase in cash surrender value. For this reason, management considers BOLI an illiquid asset. BOLI represented 27.1% of the Bank’s Tier 2 capital as of March 31, 2008, which exceeds our 25% policy limit and was due to the goodwill and intangibles from the insurance agency acquisitions which was deducted in calculating the Bank’s Tier 2 capital.
Goodwill of $4,628,103 as of March 31, 2008 increased $1,747,300, or 60%, as compared to $2,880,803 as of June 30, 2007. The increase resulted from consideration paid in excess of identified tangible and intangible assets from the three insurance agency acquisitions that occurred during the nine months ended March 31, 2008.
Intangible assets of $8,487,307 as of March 31, 2008 increased $4,377,226, or 107%, from $4,110,081 as of June 30, 2007. This asset consists of customer lists and non-compete intangibles from the insurance agency acquisitions. This increase in intangibles includes additions of $4,810,000 in customer list and non-compete intangibles from the three insurance agencies acquired in the nine months ended March 31, 2008, net of intangible amortization of $432,774 for the nine months ended March 31, 2008. See Note 1 of the audited consolidated financial statements as of June 30, 2007 for additional information on intangible assets.
Capital Resources and Liquidity
The Bank continues to attract new local core and certificates of deposit relationships. As alternative sources of funds, the Bank utilizes FHLB advances and brokered time deposits ("brokered deposits") when their respective interest rates are less than the interest rates on local market deposits. FHLB advances are used to fund short-term liquidity demands and supplement the growth in earning assets.
Total deposits of $361,266,127 as of March 31, 2008 decreased $3,287,650, or 1%, from $364,553,777 as of June 30, 2007. Excluding the decrease in brokered deposits, customer deposits increased $5,787,722, or 2%. Brokered deposits decreased $9,075,372, or 40%, from the repayment of maturing balances. As a result of promoting a tiered money market account offering a 3.00% interest rate on the highest tier, money market accounts increased $11,582,376, or 144%. Certificates of deposit increased $6,067,757, or 3%, reflecting the promotion of a 15 month term certificate of deposit. Since December 31, 2007, we have moved interest rates offered on certificates of deposit to the middle of the market. Partially offsetting the increase in these accounts, demand accounts decreased $5,177,394, or 14%, NOW accounts decreased $5,003,612, or 9%, and savings accounts decreased $1,681,405, or 8%, during the nine months ended March 31, 2008. Management's strategy is to offer non-maturing, interest-bearing deposits with interest rates near the top of the market to attract new relationships and cross sell additional deposit accounts and other bank services.
Total average deposits of $362,168,626 for the three months ended March 31, 2008 decreased $10,705,750, or 3%, compared to the average for the three months ended March 31, 2007 of $372,874,376. This decrease in total average deposits compared to March 31, 2007 was attributable to a decrease in average demand deposits of $2,966,464, or 9%, a decrease in average NOW accounts of $4,581,433, or 8%, a decrease in average savings of $1,767,903, or 8%, and a $13,935,727, or 42%, decrease in average brokered time deposits. These decreases were partially offset by a $6,941,666, or 74%, increase in money market accounts and $5,604,111, or 3%, increase in average certificate of deposits. These decreases in core account balances reflect customers moving funds to higher yielding certificates of deposit. Excluding average brokered deposits, average customer deposits increased $3,229,977, or 1%, for the three months ended March 31, 2008 compared to the same period one year ago.
Even though deposit interest rates have remained competitive, the rates of return are potentially higher than with other financial instruments such as mutual funds and annuities. All interest-bearing non-maturing deposit accounts have market interest rates. Like other companies in the banking industry, the Bank will be challenged to maintain or increase its core deposits, and improve its net interest margin as the mix of deposits shifts to deposit accounts with higher interest rates.
We use brokered deposits as part of our overall funding strategy and as an alternative to customer certificates of deposits, FHLB advances and junior subordinated debentures to fund the growth of our earning assets. Policy limits the use of brokered deposits to 25% of total assets. We use five national brokerage firms to source brokered deposits. Each brokerage company utilizes a system of agents who solicit customers throughout the United States. The terms of these deposits allow for withdrawal prior to maturity only in the case of the depositor's death, have maturities generally beyond one year, have maturities no greater than $5 million in any one month and bear interest rates equal to or slightly above comparable FHLB advance rates. Brokered deposits carry the same risk as local certificates of deposit, in that both are interest rate sensitive with respect to the Bank's ability to retain the funds. At March 31, 2008, brokered time deposits as a percentage of total assets was 2.3% compared to 4.0% at June 30, 2007 and 6.5% at March 31, 2007. The weighted average maturity for the brokered deposits was approximately 0.7 years.
Advances from the Federal Home Loan Bank of Boston (FHLB) were $86,880,000 as of March 31, 2008, a decrease of $6,136,698, or 7%, from $93,016,698 as of June 30, 2007. At March 31, 2008, we had pledged U.S. government agency and mortgage-backed securities of $37,362,407 as collateral for FHLB advances. We plan to continue to purchase additional mortgage-backed securities to pledge as collateral for advances. These purchases will be funded from the cash flow from mortgage-backed securities and residential real estate loan principal and interest payments, and promotion of certificate of deposit accounts and brokered deposits. Newly originated adjustable residential real estate loans will be held in portfolio and will qualify as collateral. In addition to U.S. government agency and mortgage-backed securities, pledges of residential real estate loans, certain commercial real estate loans and certain FHLB deposits free of liens, pledges and encumbrances are required to secure FHLB advances. Municipal securities cannot be pledged. Average advances from the FHLB were $83,224,517 for the three months ended March 31, 2008, a decrease of $5,460,419, or 7%, compared to $77,764,098 average for the same period last year.
Structured repurchase agreements were $40,000,000 at March 31, 2008. This source of funding was used for the two leveraging transactions, one each in the quarters ended September 30, 2007 and December 31, 2007. We pledged $44,025,168 of mortgage-backed securities as collateral. The structured repurchase agreement for the quarter ended September 30, 2007 bears an average interest rate of 4.45%, has a two year period where the issuer cannot call the funding due and matures in five years on August 28, 2012. Interest is paid quarterly. The structured repurchase agreement for the quarter ended March 31, 2008 bears an interest rate of 4.18%, has a three year period where the issuers cannot call the funding due and has a five year final maturity on December 13, 2012. See note 7 for additional information.
Short-term borrowings, consisting of securities sold under repurchase agreements and other sweep accounts, were $28,791,495 as of March 31, 2008, a decrease of $4,313,882, or 13%, from $33,105,377 as of June 30, 2007. Market interest rates are offered on this product. At March 31, 2008, we had pledged U.S. government agency and mortgage-backed securities of $31,528,402 as collateral for repurchase agreements. Average securities sold under repurchase agreements were $32,393,258 for the three months ended March 31, 2008, a decrease of $5,312,205, or 14%, compared to the average for the three months ended March 31, 2007 of $37,705,463.
The Bank has a line of credit under the Borrower-in-Custody program offered through the Federal Reserve Bank Discount Window. Under the terms of this credit line, the Bank has pledged its indirect auto loans, and the line bears a variable interest rate equal to the then current federal funds rate plus 0.50%. At March 31, 2008, there were no borrowings outstanding under this credit line.
The following table is a summary of the liquidity the Bank has the ability to access as of March 31, 2008 in addition to the traditional retail deposit products:
| | Subject to policy limitation of 25% of total assets |
Federal Home Loan Bank of Boston | | Unused advance capacity subject to eligible and qualified collateral |
Federal Reserve Bank Discount Window Borrower-in-Custody | | Unused credit line subject to the pledge of indirect auto loans |
Total Unused Borrowing Capacity | | |
Brokered time deposits, retail deposits and FHLB advances are used by the Bank to manage its overall liquidity position. 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 the level of brokered time deposits.
Management believes that there are adequate funding sources to meet its liquidity needs for the foreseeable future. Primary among these funding sources are the repayment of principal and interest on loans, the renewal of time deposits, the potential growth in the deposit base, and the credit availability from the Federal Home Loan Bank of Boston and the Fed Discount Window Borrower-in-Custody program. 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.
The following table summarizes the outstanding junior subordinated notes as of March 31, 2008:
| Affiliated Trusts | | Outstanding Balance | | | Rate | | First Call Date |
| | $ | 3,093,000 | | | | 5.50 | % | |
| | | 3,093,000 | | | | 6.50 | % | |
| | | 10,310,000 | | | | 5.88 | % | |
| | $ | 16,496,000 | | | | 5.93 | % | |
The excess funds raised from the issuance of trust preferred securities are available for capital contributions to the Bank. The annual interest expense is approximately $978,000 based on the current interest rates.
See Note 2 for more information on NBN Capital Trusts II, III and IV and the related junior subordinated debt.
Under the 2006 Stock Repurchase Plan, the Company may purchase up to 200,000 shares of its common stock from time to time in the open market at prevailing prices. Common stock repurchased pursuant to the plan will be classified as issued but not outstanding shares of common stock available for future issuance as determined by the Board of Directors, from time to time. For the three months ended March 31, 2008, the Company repurchased 10,000 shares of stock for $150,000, an average of $15.00 per share. Total stock repurchases under the 2006 Plan for the nine months ended March 31, 2008 were 137,800 shares of stock for $2,314,330, an average of $16.79 per share. Total stock repurchases under the 2006 Plan since inception were 141,600 shares for $2,382,274, an average of $16.82 per share, through March 31, 2008. The remaining repurchase capacity of the plan was 58,400 shares at quarter end. Management believes that these and future purchases have not and will not have a significant effect on the Company's liquidity. The repurchase program may be discontinued by Northeast Bancorp at any time.
Total stockholders' equity of the Company was $42,926,221 as of March 31, 2008, as compared to $40,849,878 at June 30, 2007. The increase of $2,076,343, or 5%, was due to net income for the nine months ended March 31, 2008 of $1,505,162, an increase in other comprehensive income of $3,493,428, stock options exercised of $45,125 and a stock grant of $1,537 that was partially offset by the repurchase of stock of $2,314,330 and the payment of dividends of $654,579. Book value per common share was $18.54 as of March 31, 2008, as compared to $16.68 at June 30, 2007. Tier 1 capital to total average assets of the Company was 7.39% as of March 31, 2008 and 9.07% at June 30, 2007. This decrease was due to the intangible assets recognized in the acquisition of the Hartford, Spence & Matthews and Hyler insurance agencies.
The Company's net cash provided by operating activities was $2,275,289 during the nine months ended March 31, 2008, which was a $4,361,316 increase compared to the same period in 2007, and was primarily attributable to a decrease in loans held for sale for the nine months ended March 31, 2008. Investing activities were a net use of cash primarily due to purchasing investment securities, insurance agency acquisitions and BOLI partially offset by the decrease in loans during the nine months ended March 31, 2008 as compared to the same period in 2007. Financing activities resulted in a net source of cash from structured repurchase agreements partially offset by net decreases in deposits and short-term borrowings, stock repurchases and a net decrease in FHLB advances compared to the same period in 2007. Overall, the Company's cash and cash equivalents decreased by $1,340,635 during the nine months ended March 31, 2008.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), contains various provisions intended to capitalize the Bank Insurance Fund ("BIF") and also affects a number of regulatory reforms that impact all insured depository institutions, regardless of the insurance fund in which they participate. Among other things, FDICIA grants the FRB broader regulatory authority to take prompt corrective action against insured institutions that do not meet capital requirements, including placing undercapitalized institutions into conservatorship or receivership. FDICIA also grants the FRB broader regulatory authority to take corrective action against insured institutions that are otherwise operating in an unsafe and unsound manner.
FDICIA defines specific capital categories based on an institution's capital ratios. Regulations require a minimum Tier 1 capital equal to 4.0% of adjusted total average assets, Tier 1 risk-based capital of 4.0% and a total risk-based capital standard of 8.0%. The prompt corrective action regulations define specific capital categories based on an institution's capital ratios. The capital categories, in declining order are "well capitalized", "adequately capitalized", "under capitalized", "significantly undercapitalized", and "critically undercapitalized". As of March 31, 2008, the most recent notification from the FRB categorized the Bank as well capitalized. There are no conditions or events since that notification that management believes has changed the institution's category.
At March 31, 2008, the Company's and Bank's regulatory capital was in compliance with regulatory capital requirements as follows:
Northeast Bancorp | | Actual | | | Required For Capital Adequacy Purposes | | | Required To Be "Well Capitalized" Under Prompt Corrective Action Provisions | |
| (Dollars in Thousands) | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| As of March 31, 2008: | | | | | | | | | | | | | | | | | | |
Total capital to risk weighted assets | | $ | 49,676 | | | | 12.00 | % | | $ | 33,109 | | | | 8.00 | % | | $ | 41,387 | | | | 10.00 | % |
Tier 1 capital to risk weighted assets | | $ | 42,334 | | | | 10.23 | % | | $ | 16,555 | | | | 4.00 | % | | $ | 24,832 | | | | 6.00 | % |
Tier 1 capital to total average assets | | $ | 42,334 | | | | 7.39 | % | | $ | 22,912 | | | | 4.00 | % | | $ | 28,640 | | | | 5.00 | % |
Northeast Bank | | Actual | | | Required For Capital Adequacy Purposes | | | Required To Be "Well Capitalized" Under Prompt Corrective Action Provisions | |
| (Dollars in Thousands) | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| As of March 31, 2008: | | | | | | | | | | | | | | | | | | |
Total capital to risk weighted assets | | $ | 44,952 | | | | 10.92 | % | | $ | 32,936 | | | | 8.00 | % | | $ | 41,170 | | | | 10.00 | % |
Tier 1 capital to risk weighted assets | | $ | 39,797 | | | | 9.67 | % | | $ | 16,468 | | | | 4.00 | % | | $ | 24,702 | | | | 6.00 | % |
Tier 1 capital to total average assets | | $ | 39,797 | | | | 6.98 | % | | $ | 22,808 | | | | 4.00 | % | | $ | 28,510 | | | | 5.00 | % |
Off-balance Sheet Arrangements and Aggregate Contractual Obligations
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 and standby letters of credit. 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.
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, unused lines of credit and standby letters of credit is represented by the contractual amount of those instruments. To control the credit risk associated with entering into commitments and issuing letters of credit, the Company uses the same credit quality, collateral policies and monitoring controls in making commitments and letters of credit as it does with its lending activities. The Company evaluates each customer's creditworthiness 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.
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 committed amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
Unused lines of credit and commitments to extend credit typically result in loans with a market interest rate.
A summary of the amounts of the Company's (a) contractual obligations, and (b) other commitments with off-balance sheet risk, both at March 31, 2008, follows:
| | | | | | Payments Due by Period | |
| | | | | | Less Than | | | | | | | | | After 5 | |
| Contractual Obligations | | Total | | | 1 Year | | | 1-3 Years | | | 4-5 Years | | | Years | |
| FHLB advances | | $ | 86,880,000 | | | $ | 51,880,000 | | | $ | 7,000,000 | | | $ | 13,000,000 | | | $ | 15,000,000 | |
| Structured repurchase agreements | | | 40,000,000 | | | | - | | | | 40,000,000 | | | | - | | | | - | |
| Junior subordinated notes | | | 16,496,000 | | | | 6,186,000 | | | | 10,310,000 | | | | - | | | | - | |
| Capital lease obligation | | | 2,554,027 | | | | 139,581 | | | | 300,275 | | | | 331,918 | | | | 1,782,253 | |
| Other borrowings | | | 4,532,602 | | | | 861,605 | | | | 1,537,365 | | | | 1,090,878 | | | | 1,042,754 | |
| Total long-term debt | | | 150,462,629 | | | | 59,067,186 | | | | 59,147,640 | | | | 14,422,796 | | | | 17,825,007 | |
| | | | | | | | | | | | | | | | | | | | | |
| Operating lease obligations (1) | | | 3,030,134 | | | | 503,265 | | | | 887,647 | | | | 684,274 | | | | 954,948 | |
| Total contractual obligations | | $ | 153,492,763 | | | $ | 59,570,451 | | | $ | 60,035,287 | | | $ | 15,107,070 | | | $ | 18,779,955 | |
| | | | | | | Amount of Commitment Expiration - Per Period |
| | | | | | | | Less Than | | | | | | | | | | | | After 5 | |
| Contractual Obligations | | | Total | | | | 1 Year | | | | 1-3 Years | | | | | | | | Years | |
| Commitments to extend credit (2)(4) | | $ | 19,275,220 | | | $ | 19,275,220 | | | $ | - | | | $ | - | | | $ | - | |
Commitments related to loans held for sale(3) | | | 1,880,400 | | | | 1,880,400 | | | | - | | | | - | | | | - | |
| Unused lines of credit (4)(5) | | | 42,079,964 | | | | 19,496,922 | | | | 1,329,813 | | | | 3,898,310 | | | | 17,354,919 | |
Standby letters of credit (6) | | | 3,066,514 | | | | 3,066,514 | | | | - | | | | - | | | | - | |
| | | $ | 66,302,098 | | | $ | 43,719,056 | | | $ | 1,329,813 | | | $ | 3,898,310 | | | $ | 17,354,919 | |
| (1) | Represents an off-balance sheet obligation. |
| (2) | Represents commitments outstanding for residential real estate, commercial real estate, and commercial loans. |
| (3) | Commitments of residential real estate loans that will be held for sale. |
| (4) | Loan commitments and unused lines of credit for commercial and construction loans expire or are subject to renewal in twelve months or less. |
| (5) | Represents unused lines of credit from commercial, construction, and home equity loans. |
| (6) | Standby letters of credit generally expire in twelve months. |
Management believes that the Company has adequate resources to fund all of its commitments.
The Bank has written options limited to those residential real estate loans designated for sale in the secondary market and subject to a rate lock. These rate-locked loan commitments are used for trading activities, not as a hedge. The fair value of the outstanding written options at March 31, 2008 was a gain of $ 8,506.
Impact of Inflation
The consolidated financial statements and related notes herein have been presented in terms of historic dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike industrial companies, substantially all of the assets and virtually all of the liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company's performance than the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as inflation.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
There have been no material changes in the Company's market risk from June 30, 2007. For information regarding the Company's market risk, refer to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2007.
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 our 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.
Our management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our 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 Form 10-Q.
Based on this evaluation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective as of March 31, 2008.
There were no significant changes in our internal controls over financial reporting (as defined in Rule 13a - 15(f) of the Exchange Act) that occurred during the first nine months of our 2008 fiscal year that has materially affected, or in other factors that could affect, the Company's internal controls over financial reporting.
