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, 2010 and 2009 and the financial condition at March 31, 2010 and June 30, 2009. 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, 2009, 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 refere nce 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 va riety of factors, including, but not limited to, those related to the current disruptions in the financial and credit markets, 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, 2009 and the additional risk factors in Part II of this 10-Q. 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.
Merger Announcement
On March 30, 2010, Northeast Bancorp (“Northeast") issued a press release announcing that it had entered into an Agreement and Plan of Merger (the "Merger Agreement") with FHB Formation, LLC of Boston, MA, a Delaware limited liability company ("FHB"). Pursuant to the terms and conditions set forth in the Merger Agreement, FHB will merge with and into Northeast (the "Merger"), with Northeast continuing as the surviving corporation (the "Surviving Corporation").
At the effective time of the Merger, each share of Northeast’s common stock, par value $1.00 per share, issued and outstanding immediately prior to the effective time of the Merger ("Northeast Common Stock") will be converted into the right to receive, at the election of the holder (i) one share of common stock of the Surviving Corporation (the "Stock Consideration") or (ii) $13.93 (the "Cash Consideration"), subject to allocation and proration procedures which provide that, in the aggregate, 1,393,399 shares of Northeast Common Stock will be converted into the Stock Consideration and the remaining shares of outstanding Northeast Common Stock will be converted into the Cash Consideration. Holders of Northeast Common Stock prior to the consummation of the Merger will own, in the aggregate, approximately 40% of the Surviving Company common stock outstanding immediately following the consummation of the Merger, on a fully diluted basis. In connection with the Merger, each outstanding option to purchase shares of Northeast common stock will be converted into an option to purchase an identical number of shares of the Surviving Corporation at the same exercise price as the Northeast option.
The surviving company’s business plan aims to reinforce and expand Northeast’s established franchise and brand with employment growth, stronger involvement in local communities and balance sheet growth. In addition, the surviving company intends to add a loan purchasing and servicing program through the creation of a Loan Acquisition and Servicing Group. Through this group, the surviving company expects to blend an appropriate amount of purchased performing commercial loans into the portfolio and to develop a servicing capability that is expected to generate additional fee income from managing commercial loans for the benefit of third party customers.
The Investment will bring significant new capital and resources to further build upon Northeast’s community banking and financial services franchise. Northeast will retain its headquarters in Lewiston, ME, and Northeast’s management and employees will continue in their positions. With this transaction, Northeast’s customer accounts and retail locations will not change, making this transaction seamless for customers across all of Northeast’s business lines, including its investment group, Northeast Financial Services and its wholly-owned subsidiary, Northeast Bank Insurance Group, Inc.
For additional information, see the current report on 8-K filed on March 31, 2010; the Agreement and Plan for Merger is filed as an exhibit to the current report.
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, 2009 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: increasing interest-bearing, non-maturing deposits, decreasing non-accrual loans, improving the net interest margin, executing our plan of increasing noninterest income and improving our efficiency ratio.
Interest-bearing, non-maturing deposits increased $24.6 million compared to June 30, 2009, primarily from a new savings account product, which is open solely to customers with maturing certificates of deposit. This new product pays a rate of 1.30% and accounted for $13.5 million of the increase in interest-bearing, non-maturing deposits.
Loans decreased $7.1 million compared to June 30, 2009, due principally to a $21.7 million decrease in indirect consumer loans. Excluding this decrease, there was a net increase of $14.6 million in the other loan portfolios, primarily residential and commercial real estate loans.
The net interest margin was 3.30% for the quarter ended March 31, 2010, an increase of 28 basis points compared to 3.02% for the quarter ended March 31, 2009. Compared to the quarter ended December 31, 2009, our net interest margin increased 1 basis point.
Since our balance sheet was liability sensitive at December 31, 2009, due to the cost of interest-bearing liabilities repricing more quickly than the yield of interest-bearing assets, net interest income would generally be expected to increase during a period of declining interest rates (and decrease during a period of rising interest rates).
Management believes that the allowance for loan losses as of March 31, 2010 was adequate, under present conditions, for the known credit risk in the loan portfolio. Due to increased loan delinquencies and non-accruals comparing March 31, 2010 to the levels at June 30, 2009, we increased our allowance for loan losses by $159,000, to $5,923,000, as compared to June 30, 2009.
Our efficiency ratio, calculated by dividing noninterest expense by the sum of net interest income and noninterest income, was 82% and 85% for the three months ended March 31, 2010 and 2009, respectively. The ratio has decreased due to the increase in net interest income and noninterest income as compared to the same period one year ago.
We sold our Rangeley, Maine insurance agency customer list and certain fixed assets on January 31, 2010. The sale resulted in a gain of $129,906 which was included in other noninterest income for the quarter and nine months ended March 31, 2010. The land and building occupied by our Rangeley office has been closed and listed for sale. We recognized impairment expense of $91,080 as a result of adjusting the book value of the building and land to its estimated fair value.
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 is also 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, 2010, we had ten banking offices, one financial center, a loan production office in Portsmouth, New Hampshire and twelve insurance offices located in western and south-central Maine and southeastern New Hampshire. At March 31, 2010, we had consolidated assets of $612.0 million and consolidated stockholders' equity of $50.1 million.
The Company's principal asset is all the capital stock of Northeast Bank (the "Bank"), a Maine state-chartered universal bank. The Company's results of operations are primarily dependent on the results of the operations of the Bank. The Bank's ten offices are located in Auburn, Augusta, Bethel, Brunswick, Buckfield, Harrison, Lewiston, Poland, Portland, and South Paris, Maine. The Bank's financial center located in Falmouth, Maine houses our investment brokerage division which offers investment, insurance and financial planning products and services. We also operate a loan production office in Portsmouth, New Hampshire.
Our newest branch opened in Poland, Maine in February, 2010. At the same time, our branch in Mechanic Falls closed and the customer accounts from this branch were transferred to the new Poland branch. In January 2010, our branch located at 882 Lisbon Street in Lewiston was closed, and the customer accounts from the closed branch were transferred to our branch at 500 Canal Street, also in Lewiston.
The Bank's wholly owned subsidiary, Northeast Bank Insurance Group Inc, is our insurance agency. Its twelve offices are located in Anson, Auburn, Augusta, Berwick, Bethel, Jackman, Livermore Falls, Thomaston, Turner, Scarborough, and South Paris, Maine and Rochester, New Hampshire. We sold our customer lists of our agency offices in Mexico and Rangeley on December 31, 2009 and January 31, 2010, respectively. Each agency office was closed following the sale.
We acquired Goodrich Insurance Associates of Berwick, Maine on May 15, 2009, and merged them into our Spence & Matthew office in November, 2009. Seven agencies have been acquired previously: Hyler Agency of Thomaston, Maine was acquired on December 11, 2008; Spence & Matthews, Inc of Berwick, Maine and Rochester, New Hampshire was acquired on November 30, 2008; Hartford Insurance Agency of Lewiston, Maine was acquired on August 30, 2008; Russell Agency of Madison, Maine was acquired on June 28, 2008; Southern Maine Insurance Agency of Scarborough, Maine was acquired on March 30, 2008; Sturtevant and Ham, Inc. of Livermore, Maine was acquired on December 1, 2006; and Palmer Insurance of Turner, Maine was acquired on November 28, 2006. Following the acquisitions, the Russell Agency was moved to our existing agency of fice in Anson, Maine and the Hartford Insurance Agency was moved to our existing agency office in Auburn, Maine. All of our insurance agencies offer personal and commercial property and casualty insurance products. See Note 6 in our June 30, 2009 audited consolidated financial statements and Note 10 of the March 31, 2010 unaudited consolidated financial statements for more information regarding our insurance agency acquisitions.
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 loans. The Bank sells residential mortgage loans into the secondary market. The Bank also invests in mortgage-backed securities and bonds issued by United States government sponsored enterprises and corporate and municipal securities. The Bank's profitability depends primarily on net interest income, which 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). Th e 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 months ended March 31, 2010 and 2009
General
The Company reported consolidated net income of $530,632, or $0.20 per diluted share, for the three months ended March 31, 2010 compared to $387,370, or $0.14 per diluted share, for the three months ended March 31, 2009, an increase of $143,262, or 37%. Net interest and dividend income increased $364,261, or 9%, as a result of a higher net interest margin. The provision for loan losses increased $22,062, or 4%, compared to the quarter ended March 31, 2009. Noninterest income increased $360,251, or 13%, from increased fees for other services to customers, investment and insurance commissions. Noninterest expense increased $428,643, or 7%, primarily due to increased salaries and benefits and other noninterest expense.
Annualized return on average equity ("ROE") and return on average assets ("ROA") were 4.32% and 0.35%, respectively, for the quarter ended March 31, 2010 as compared to 3.27% and 0.26%, respectively, for the quarter ended March 31, 2009. 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 $1,675,614, or $0.64 per diluted share, for the nine months ended March 31, 2010 compared to $750,060, or $0.29 per diluted share, for the nine months ended March 31, 2009, an increase of $925,554, or 123%. Net interest and dividend income increased $808,328, or 6%, as a result of a higher net interest margin and increased earning assets. The provision for loan losses increased $80,321, or 5%, compared to the nine months ended March 31, 2009. Noninterest income increased $1,165,833, or 15%, from increased fees for other services to customers, gains on sales of loans, investment and insurance commissions. Noninterest expense increased $474,936, or 3%, primarily due to increased salaries and employee benefits and other noninterest expense.
Annualized return on average equity ("ROE") and return on average assets ("ROA") were 4.54% and 0.37%, respectively, for the nine months ended March 31, 2010 as compared to 2.30% and 0.16%, respectively, for the nine months ended March 31, 2009. The increases in the returns on average equity and average assets were primarily due to the increase in net income.
Net Interest and Dividend Income
Net interest and dividend income for the three months ended March 31, 2010 increased to $4,595,208 as compared to $4,230,947 for the same period in 2009. The increase in net interest and dividend income of $364,261, or 9%, was primarily due to a 28 basis point increase in net interest margin, on a tax equivalent basis, and more than offset the impact of a decrease in average earning assets of $4,171,190, or 1%, for the quarter ended March 31, 2010 as compared to the quarter ended March 31, 2009. The decrease in average earning assets was primarily due to a decrease in average loans of $16,253,149 which was partially offset by an increase in average available-for-sale securities of $6,588,898, or 4%, from the purchase of U.S. government-sponsored enterprise mortgage-backed securities, and an increase in average interest-bearing deposits an d regulatory stock of $5,493,061, or 63%. Average loans as a percentage of average earning assets was 68% and 71% for quarters ended March 31, 2010 and 2009, respectively. Our net interest margin, on a tax equivalent basis, was 3.30% and 3.02% for the quarters ended March 31, 2010 and 2009, respectively. Our net interest spread, on a tax equivalent basis, for the three months ended March 31, 2010 was 3.02%, an increase of 32 basis points from 2.70% for the same period a year ago. Comparing the three months ended March 31, 2010 and 2009, the yields on earning assets decreased 30 basis points, and the cost of interest-bearing liabilities decreased 62 basis points. The decrease in the cost of interest-bearing liabilities reflects the lower interest rates paid on a significant volume of maturing certificates of deposits, and decreases in interest rates paid on interest-bearing non-maturing deposits.
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, 2010 and 2009.
| | | Difference Due to | | | | |
| | | Volume | | | Rate | | | Total | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Total Interest-earnings Assets | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | |
Securities sold under Repurchase Agreements | | | | | | | | | | | | |
| | | | | | | | | | | | |
Total Interest-bearing Liabilities | | | | | | | | | | | | |
Net Interest and Dividend Income | | | | | | | | | | | | |
| | | | | | | | | | | | | |
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 $54,273 and $50,436 for the three months ended March 31, 2010 and 2009, respectively. | |
Net interest and dividend income for the nine months ended March 31, 2010 increased to $13,307,126 as compared to $12,498,798 for the same period in 2009. The increase in net interest and dividend income of $808,328, or 6%, was primarily due to an 18 basis point increase in net interest margin, on a tax equivalent basis, and by an increase in average earning assets of $2,543,460, or less than 1%, for the nine months ended March 31, 2010 as compared to the nine months ended March 31, 2009. The increase in average earning assets was primarily due to an increase in average available-for-sale securities of $13,179,674, or 9%, from the purchase of mortgage-backed securities and an increase in average interest-bearing deposits and regulatory stock of $4,204,770, or 44%, partially offset by a decrease in average loans of $14,840,984, or 4%. Aver age loans as a percentage of average earning assets was 69% and 72% for quarters ended March 31, 2010 and 2009, respectively. Our net interest margin, on a tax equivalent basis, was 3.15% and 2.97% for the nine months ended March 31, 2010 and 2009, respectively. Our net interest spread, on a tax equivalent basis, for the nine months ended March 31, 2010 was 2.94%, an increase of 20 basis points from 2.74% for the same period a year ago. Comparing the nine months ended March 31, 2010 and 2009, the yields on earning assets decreased 48 basis points, and the cost of interest-bearing liabilities decreased 68 basis points. The decrease in the cost of interest-bearing liabilities reflects the lower interest rates paid on a significant volume of maturing certificates of deposit, and decreases in interest rates paid on interest-bearing non-maturing deposits.
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, 2010 and 2009.
| | | Difference Due to | | | | |
| | | Volume | | | Rate | | | Total | |
| | | | | | | | | | | | |
| | | | ) | | | | | | | | |
| | | | | | | | | | | | |
Total Interest-earnings Assets | | | | ) | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | |
Securities sold under Repurchase Agreements | | | | | | | | | | | | |
| | | | ) | | | | | | | | |
Total Interest-bearing Liabilities | | | | ) | | | | | | | | |
Net Interest and Dividend Income | | | | | | | | | | | | |
| | | | | | | | | | | | | |
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 $158,930 and $152,434 for the nine months ended March 31, 2010 and 2009, 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 Bank's balance sheet is currently 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 an increase in its net interest margin during a period of decreasing interest rates, or a decrease in its net interest margin during a period of increasing interest rates.
As of March 31, 2010 and 2009, 53% and 47%, 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, 2010 was $640,598, an increase of $22,062, or 4%, from $618,536 for the three months ended March 31, 2009. For the nine months ended March 31, 2010 and 2009, the provisions for loan losses were $1,723,142 and $1,642,821, respectively, an increase of $80,321, or 5%. The provision for loan losses reflects the high level of net credit losses of $589,598 and $661,537 for the quarters ended March 31, 2010 and 2009, respectively, and $1,564,142 and $1,620,821 for the nine months ended March 31, 2010 and 2009, respectively. In conjunction with the overdraft privilege program implemented in July, 2009, a portion of the provision for loan losses was used to create a reserve for uncollectible overdraft fees that have been charged to customers overdrawing their checking accounts. The overdrawn checking accounts were reclassified to consumer loans. The provision for loan losses excluding the overdraft privilege program was $630,491 and $1,679,897 for the quarter and nine months ended March 31, 2010, respectively.
We increased the allowance for loan losses by $159,000 compared to its June 30, 2009 balance by recognizing a provision greater than 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, 2010; the decrease in net charge-offs of $56,679 for the nine months ended March 31, 2010 compared to the same period in 2009; the increase in net charge-offs of $150,904 for the quarter ended March 31, 2010 compared to the quarter ended June 30, 2009; an increase in loan delinquency to 3.89% at March 31, 2010 compared to 3.42% at June 30, 2009; a decrease of $50,000, or less than 1%, in non-performing loans (90 days or more past due) at March 31, 2010 compared to June 30, 2009; and a decrease in internally classified and criticized loan s at March 31, 2010 compared to June 30, 2009. 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 1.53% at March 31, 2010 and 1.46% at June 30, 2009 compared to 1.40% at March 31, 2009.
Noninterest Income
Total noninterest income was $3,065,114 for the quarter ended March 31, 2010, an increase of $360,251, or 13%, from $2,704,863 for the quarter ended March 31, 2009. This increase reflected the combined impact of a $113,408, or 48%, increase in fees for other services to customers which was primarily attributable to the overdraft privilege program implemented in July, 2009, a $220,186, or 89%, increase in investment commissions due to higher sales volume, a $217,139, or 14%, increase in insurance commissions due to an increase in contingent and growth bonuses, and a $44,011, or 17%, increase in other noninterest income primarily due to $129,905 gain from the sale of the customer list of the Rangeley insurance agency office, partially offset by a $174,057, or 55%, decrease in gain on the sale of loans primarily due to the volume of resident ial real estate loans sold into the secondary market for the quarter ended March 31, 2010 of $14.1 million compared to $32.0 million sold in the same period one year ago.
For the nine months ended March 31, 2010, total noninterest income was $9,073,849, an increase of $1,165,833, or 15%, from $7,908,016 for the nine months ended March 31, 2009. This increase was due to a $290,158, or 35%, increase in fees for other services to customers, primarily the overdraft privilege program, a $279,363, or 65%, increase in gains on the sales of loans on volume of $54.6 million in the nine months ended March 31, 2010 compared to $42.6 million for the nine months ended March 31, 2009, a $179,628, or 14%, increase investment commissions due to sales volume, a $232,698, or 5%, increase in insurance commissions due to the full year impact of the acquisition of Goodrich Insurance Associates combined with an increase in contingent and growth bonuses and a $114,322, or 18%, increase in other noninterest income due to the $245,677 gain realized on the sale of the Mexico and Rangeley insurance agency offices’ customer lists, partially offset by lower trust income and lower gains from options trading.
Noninterest Expense
Total noninterest expense for the three months ended March 31, 2010 was $6,271,749, an increase of $428,643, or 7%, from $5,843,106 for the three months ended March 31, 2009. The increase was primarily due to a $212,558, or 7%, increase in salaries and employee benefits due to increases in staff for the mortgage origination and investment brokerage divisions and a $210,747, or 14%, increase in other noninterest expense due to increased professional fees, including $157,154 in legal and investment banking fees related to the announced merger, and equity securities impairment expense compared to the quarter ended March 31, 2009. The increase in salaries and benefits expense of $212,558, or 7%, was due to increases in staffing in the mortgage origination, loan processing and investment brokerage areas in order to capitalize on market opportu nities. Occupancy expense increased $45,690, or 9%, primarily due to impairment expense of $91,080 recognized from the write-down of our Rangeley insurance agency building to its estimated fair value, which was partially offset by a decrease in rent expense, building repairs and maintenance, utilities and capital lease amortization compared to the quarter ended March 31, 2009. The capital lease for our Berwick insurance agency office converted to a land and building asset upon exercise of the purchase option in June, 2009. The decrease in equipment expense of $35,781, or 9%, was due to a decrease in equipment repairs and maintenance.
For the nine months ended March 31, 2010, total noninterest expense was $18,439,783, an increase of $474,936, or 3%, from $17,964,847 for the nine months ended March 31, 2009. This increase was primarily due to an increase of $201,559, or 2%, in salaries and employee benefits due to expanding staff in mortgage loan origination, loan processing and investment brokerage, or $46,618, or 3% increase of occupancy expense primarily due to impairment expense of $136,690 recognized from the write-down of the Mexico and Rangeley buildings to their estimated fair value with the increase partially offset by a decrease in capital lease amortization, building repairs and maintenance, ground maintenance and utilities, and a $345,027, or 8%, increase in other noninterest expense from an increase of $364,700 in professional fees (including consulting and merger related legal and investment banking fees), an increase of $179,590 in FDIC insurance assessments and an increase of $77,991 for computer services partially offset by decreases in collection expenses of $72,991, supplies of $19,506, telecommunications of $10,888, travel and entertainment of $31,941 and equity security impairment expense of $121,025 compared to the same period in 2009. Equipment expense decreased $102,662, or 8%, primarily due to decreases in depreciation expense for furniture, software, and vehicles and computer maintenance.
Income Taxes
For the quarter and nine months ended March 31, 2010, the increase in income tax expense was primarily due to the increase in income before income taxes as compared to the same periods in 2009.
Efficiency Ratio
Our efficiency ratio, which is total non interest expense as a percentage of the sum of net interest and dividend income and non-interest income, was 82% and 85% for the three months ended March 31, 2010 and 2009, respectively. The decrease in the efficiency ratio for the three months ended March 31, 2010 was due to an increase in net interest and noninterest income compared to the three months ended March 31, 2009. For the nine months ended March 31, 2010 and 2009, our efficiency ratio was 82% and 88%, respectively. The decrease in the efficiency ratio for the nine months ended March 31, 2010 was also due an increase in net interest and noninterest income compared to the same period of 2009.
Financial Condition
Our consolidated assets were $611,970,296 and $598,148,130 as of March 31, 2010 and June 30, 2009, respectively, an increase of $13,822,166, or 2%. This increase was primarily due to increases of $22,352,857, or 15%, in available-for-sale securities, $137,680, or 6%, in loans held-for-sale, and $3,418,318, or 10%, in combined premises and equipment, acquired assets, accrued interest receivable, regulatory stock, bank owned life insurance and other assets, partially offset by decreases of $3,969,431, or 30%, in cash and due from banks and interest-bearing deposits, $7,268,784, or 2%, in net loans primarily from a decrease in consumer loans, and a $848,474, or 10%, decrease in intangible assets resulting from amortization and sale of the customer list intangibles allocated to the Mexico and Rangeley insurance agencies of $299,459. For the three months ended March 31, 2010, average total assets were $613,193,300, a decrease of $2,697,599, or less than 1%, from $615,890,899 for the same period in 2009. This average asset decrease was primarily attributable to decreases in loans held-for-sale and net loans.
Total stockholders' equity was $50,096,057 and $47,316,880 at March 31, 2010 and June 30, 2009, respectively, an increase of $2,779,177, or 6%, due to net income for the nine months ended March 31, 2010 and an increase in accumulated other comprehensive income partially offset by dividends paid. Book value per outstanding share was $19.74 at March 31, 2010 and $18.57 at June 30, 2009. Tangible book value per outstanding share was $14.60 at March 31, 2010 and $13.05 at June 30, 2009. The increase in tangible book value was due primarily to a decrease in goodwill and other intangibles from the amortization of other intangibles and sale of the customer list intangible allocated to the Mexico and Rangeley insurance agency offices during the quarter ended March 31, 2010.
Investment Securities
The available-for-sale investment portfolio was $170,762,997 as of March 31, 2010, an increase of $22,352,857, or 15%, from $148,410,140 as of June 30, 2009. Excess cash balance and funds from the decrease in loans and increase in short-term borrowings were used to purchase U.S. government-sponsored enterprise mortgage-backed securities.
The investment portfolio as of March 31, 2010 consisted of mortgage-backed, collateralized mortgage obligation and debt securities issued by U.S. government-sponsored enterprises and corporations, municipal bonds, trust preferred 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 $166,706,630 for the three months ended March 3 1, 2010 as compared to $160,117,732 for the three months ended March 31, 2009, an increase of $6,588,898, or 4%. This increase was due primarily to the purchase of U.S. government-sponsored enterprise mortgage-backed securities noted above.
Our entire investment portfolio was classified as available-for-sale at March 31, 2010 and June 30, 2009, 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, 2010 were $165,524,623 and $170,762,997, respectively. The difference between the carrying value and the cost of the securities of $5,238,374 was primarily attributable to the increase in market value of mortgage-backed securities above their cost. The net unrealized losses on collateralized mortgage obligations, trust preferred and equity securities was $414,716, and the net unrealiz ed gains on U.S. government-sponsored enterprises bonds and mortgage-backed, corporate debt, and municipal securities were $5,653,090 at March 31, 2010. The U.S. government-sponsored enterprise bonds and corporate debt securities have increased in market value due to the decreases in long-term interest rates as compared to June 30, 2009. Substantially all of the U.S. government-sponsored enterprise bonds and mortgage-backed and municipal securities held in our portfolio are high investment grade securities. Five municipal bonds, six trust preferred securities and three preferred stocks in the bank’s portfolio had been downgraded by credit rating agencies below our investment grade. Each of these securities was subject to impairment testing at March 31, 2010. No additional impairment expense was recognized. 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 othe r 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 enterprise bonds and mortgage-backed, corporate debt, municipal securities, and trust preferred 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 $389,115,253 as of March 31, 2010 decreased $6,972,104, or 2%, from $396,087,357 as of June 30, 2009. Compared to June 30, 2009, residential real estate loans increased $12,087,094, or 9%, loans held-for-sale increased $137,680, or 6%, and commercial real estate loans increased $5,107,455, or 4%. The decreases in the other portfolios more than offset these increases including construction loans, which decreased $1,646,208, or 26%, commercial loans, which decreased $417,816, or 1%, and consumer and other loans, which decreased $21,673,109, or 22%. Deferred fees decreased $567,200. The total loan portfolio, including loans held-for-sale, averaged $390,502,357 for the three months ended March 31, 2010, a decrease of $16,253,149, or 4%, compared to $406,755,506 for the three months ended March 31 , 2009.
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, excluding loans held-for-sale, consisting of primarily owner-occupied residential loans, were 39% of total loans as of March 31, 2010, and 35% as of June 30, 2009 and March 31, 2009, respectively. The variable rate product as a percentage of total residential real estate loans was 39%, 37% and 36% 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 residential real estate loans into the secondary market to manage interest rate risk. Average residential real estate mortgages of $146,117,184 for the three months ended March 31, 2010 increased $6,208,641, or 4%, from $139,908,543, for the three m onths ended March 31, 2009. This increase was due to the origination of loans for portfolio. 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 2% of residential real estate loans at March 31, 2010. The Bank has not pursued a similar strategy recently.
Commercial real estate loans as a percentage of total loans were 33%, 31%, and 29% as of March 31, 2010, June 30, 2009 and March 31, 2009, 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 96% as of March 31, 2009, 95% as of June 30, 2009 and March 31, 2009, 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 $126,954,026 for the three months ended March 31, 2010 increased $11,137,963, or 10%, from $115,816,063 for the same period in 2009.
Construction loans as a percentage of total loans were 1% as of March 31, 2010 and June 30, 2009 and 3% as of March 31, 2009. 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 62% as of March 31, 2010, 51% as of June 30, 2009 and 66% as of March 31, 2009. Average construction loans were $4,390,522 and $9,380,160 for the three months ended March 31, 2010 and 2009, respectively, a decrease of $4,989,638, or 53%.
Commercial loans as a percentage of total loans were 7% as of March 31, 2010, 8% as of June 30, 2009 and 7% as of March 31, 2009. The variable rate products as a percentage of total commercial loans were 69% as of March 31, 2010, 70% as of June 30, 2009, and 69% as of March 31, 2009. 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 $28,744,162 for the three months ended March 31, 2010 decreased $509,105, or 2%, from $29,253,267 for the same period in 2008.
Effective October 31, 2008, we terminated all consumer indirect lending. Our decision to exit this line of business was based on its low profitability and our expectation that an acceptable level of returns was not likely to be attained in future periods.
Consumer and other loans as a percentage of total loans were 20% for the period ended March 31, 2010, 25% as of June 30, 2009 and 26% as of March 31, 2009. At March 31, 2010, indirect auto, indirect recreational vehicle, and indirect mobile home loans represented 22%, 52%, and 18% of total consumer loans, respectively. Since these loans are primarily fixed rate products, they have interest rate risk when market rates increase. The consumer loan department underwrote all the indirect automobile, recreational vehicle loans and mobile home loans to mitigate credit risk. The Bank typically paid a one-time origination fee to dealers of indirect loans. The fees were deferred and amortized over the life of the loans as a yield adjustment. Management attempted 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 $81,258,276 and $107,916,923 for the three months ended March 31, 2010 and 2009, respectively. The $26,658,647, or 25%, decrease was due to the runoff of indirect loans. The composition of consumer loans is detailed in the following table.
| | | Consumer Loans as of | |
| | | March 31, 2010 | | | June 30, 2009 | |
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Classification of Assets
Loans are classified as non-performing when reaching 90 days or more delinquent or, when less than 90 days past due, when we judge 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 $9,844,000 and $9,894,000 at March 31, 2010 and June 30, 2009, respectively, or 2.55% and 2.51% of total loans, respectively. The Bank's allowance for loan losses was equal to 60% and 58% of the total non-performing loans at March 31, 2010 and June 30, 2009, respectively. The following table represents the Bank's non-performing loans as of March 31, 2010 and June 30, 2009:
| Description | | March 31, 2010 | | | June 30, 2009 | |
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Non-performing loans decreased slightly in the nine months ended March 31, 2010 compared to June 30, 2009 primarily from real estate secured loans. Of total non-performing loans at March 31, 2010, $3,804,000 of these loans were current and paying as agreed compared to $3,352,000 at June 30, 2009, an increase of $452,000. The Bank continues to classify these loans as non-performing until the respective borrowers have demonstrated a sustainable period of performance. At March 31, 2010, the Bank had $109,000 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 $928,000 when compared to the level of $1,037,000 at June 30, 2009.
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:
| 3/31/10 | | 12/31/09 | | 9/30/09 | | 6/30/09 | | 3/31/09 |
| | | | | | | | |
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, was 3.89% as of March 31, 2010 and 4.59% as of March 31, 2009.
Allowance for Loan Losses
The Bank's allowance for loan losses was $5,923,000 as of March 31, 2010, an increase of $159,000, or 3%, from the level at June 30, 2009, representing 1.53% and 1.46% of total loans at March 31, 2010 and June 30, 2009, respectively. 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 allowa nce. 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 curren t 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, tr ends 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, 2010, 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, 2010 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, 2009. 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 A+ or better at March 31, 2010. 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 val ue. For this reason, management considers BOLI an illiquid asset. BOLI represented 24.5% of the Bank’s total risk-based capital as of March 31, 2010, which is below our 25% policy limit.
Goodwill of $4,490,500 as of March 31, 2010 was unchanged from the balance as of June 30, 2009. Goodwill resulted from consideration paid in excess of identified tangible and intangible assets from the nine insurance agency acquisitions.
Intangible assets of $7,463,003 as of March 31, 2010 decreased $848,474, or 10%, from $8,311,477 as of June 30, 2009 due to amortization and the sale of the Mexico and Rangeley agency customer lists. This asset consists of customer lists and non-compete intangibles from the insurance agency acquisitions. See Note 1 of the audited consolidated financial statements as of June 30, 2009 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 $380,364,418 as of March 31, 2010 decreased $5,021,568, or 1%, from $385,385,986 as of June 30, 2009. The overall decrease in customer deposits was due to the decrease in: demand deposit accounts of $269,261, or 1%; brokered certificates of deposit of $6,026,253, or 55%; and certificates of deposit of $23,281,137, or 10%. Management did not promote certificates of deposits, causing customers to move to other interest bearing, non-maturing accounts or to competitors. Overall, this lowered our cost of funds. Partially offsetting the decreases in demand deposits and certificates of deposits, NOW account balances increased $4,436,269, or 10%, from the introduction of a new high yield checking account, money market accounts increased $6,643,085, or 17%, and savings accounts increased $13,475,729, or 71%, during the nine month s ended March 31, 2010. The new Companion Savings account was introduced during the quarter ended December 31, 2009, targeted to matured certificate of deposit balances, and accounted for the increased balance in savings accounts. Management's strategy was 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 $379,541,837 for the three months ended March 31, 2010 increased $11,136,285, or 3%, compared to the average for the three months ended March 31, 2009 of $368,405,552. This increase in total average deposits compared to March 31, 2009 was attributable to an increase in average demand deposit accounts of $2,070,040, or 7%, an increase in average NOW accounts of $4,106,935, or 9%, an increase in average money market accounts of $13,037,973, or 42%, and an increase in average savings accounts of $12,157,414, or 64%. These increases were partially offset by a decrease in average brokered certificates of deposit of $10,358,858, or 68%, and a decrease in average certificates of deposit of $9,877,219, or 4%. Excluding average brokered deposits, average customer deposits increased $21,495,143, or 6%, for the three months ended March 31, 2010 compared to the same period one year ago.
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. All interest-bearing non-maturing deposit accounts have market 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. By policy, we limit the use of brokered deposits to 25% of total assets. At March 31, 2010 and June 30, 2009, brokered time deposits as a percentage of total assets were 1.0% and 1.8%, respectively, and 1.9% at March 31, 2009. The weighted average maturity for the brokered deposits was approximately 1.8 years.
Advances from the Federal Home Loan Bank of Boston (FHLB) were $50,500,000 as of March 31, 2010, an increase of $9,685,000, or 24%, from $40,815,000 as of June 30, 2009. At March 31, 2010, we had pledged U.S. government-sponsored enterprise agency and mortgage-backed securities of $38,884,385 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. 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 not subject to liens , pledges and encumbrances are required to secure FHLB advances. Municipal securities cannot be pledged to the FHLB. Average advances from the FHLB were $50,615,333 for the three months ended March 31, 2010, a decrease of $10,508,700, or 17%, compared to $61,124,033 average for the same period last year.
Structured repurchase agreements were $65,000,000 at March 31, 2010, equal to the balance as of June 30, 2009. We pledged $74,837,808 of mortgage-backed securities and cash, which resulted from margin calls, as collateral. In addition to leveraging our balance sheet to improve net interest income, three of six structured repurchase agreements have imbedded purchased interest rate caps to reduce the risk to net interest income in periods of rising interest rates. Our balance sheet is liability sensitive, where interest-bearing liabilities reprice more quickly than our interest-earning assets. Average structured repurchase agreements were $65,000,000 as of March 31, 2010, an increase of $4,772,222, or 8%, compared to $60,277,778 as of March 31, 2009. See note 7 for additional information.
Short-term borrowings, consisting of securities sold under repurchase agreements and other sweep accounts, were $41,456,124 as of March 31, 2010, an increase of $7,020,815, or 20%, from $34,435,309 as of June 30, 2009. The increase is attributable to new cash management accounts generated in the nine months ended March 31, 2010. Market interest rates are offered on this product. At March 31, 2010, we had pledged U.S. government agency and mortgage-backed securities of $42,076,389 as collateral for repurchase agreements. Sweep accounts had letters of credit issued by the FHLB outstanding of $18,573,000. Average short-borrowings were $43,530,047 for the three months ended March 31, 2010, an increase of $6,904,843, or 19%, compared to the average for the three months ended March 31, 2009 of $36,625,204.
The Bank has a line of credit under the FRB 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 qualifying municipal bonds, and the line bears a variable interest rate equal to the then current federal funds rate plus 0.25%. At March 31, 2010 and June 30, 2009, there was no outstanding balance. Average FRB borrower-in-Custody for the three months ended March 31, 2010, was zero compared to $15,000,000 for the three months ended March 31, 2009, a decrease of 100%.
The following table is a summary of the liquidity the Bank has the ability to access as of March 31, 2010 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 and municipal bonds |
Total Unused Borrowing Capacity | | | |
Retail deposits, brokered time 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 the need to meet 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, 2010:
| Affiliated Trusts | | Outstanding Balance | | Rate | | First Call Date |
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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 $675,000 based on the current interest rates.
The Company paid $325,000 to purchase two interest rate caps to hedge the risk of rising interest rates over the next five years for junior subordinated notes related to NBN Capital Trusts II and III. The $6 million notional value of the purchase caps covers the portion of the outstanding balance not owned by the Company. Each junior subordinated note has an adjustable interest rate indexed to three month LIBOR. The purchased cap’s three month LIBOR strike rate was 2.505%. Since the inception date of September 30, 2009, no amortization expense of the purchased interest rate caps was recognized in the quarter ended March 31, 2010. The next reset date is June 30, 2010.
The Company entered into an interest rate swap to hedge the risk of rising interest rates over the next five years for junior subordinated notes related to NBN Capital Trust IV. The $10 million notional value for the interest rate swap covers the portion of the outstanding balance not owned by the Company. We pay a fixed rate of 4.69% until maturity (February 23, 2015) to the counterparty and receive a floating rate from the counterparty which resets quarterly to three month LIBOR plus 1.89% over the five year term.
See Note 2 for more information on NBN Capital Trusts II, III and IV and the related junior subordinated debt.
The Company sold $4.2 million of Series A Preferred Shares on December 12, 2008 to the U.S. Treasury under their Capital Purchase Program. Under the terms and conditions of the Capital Purchase Program, the Company’s ability to declare and pay dividends on any of our common shares and repurchase our common shares has been restricted. The Company also has to comply with executive compensation and corporate governance standards. The preferred dividends of 5% will increase in five years (after December, 2013) to 9% unless the preferred stock is redeemed. The Company contributed the net proceeds to the Bank as additional paid-in-capital.
Under the terms of the US Treasury Capital Purchase Program, the Company must have the consent of the U.S. Treasury to redeem, purchase, or acquire any shares of our common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement. For the nine months ended March 31, 2010, the Company repurchased no shares of stock.
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. There were no common stock repurchases during the nine months ended March 31, 2010. Total stock repurchases under the 2006 Plan since inception were 141,600 shares for $2,232,274, an average of $15.76 per share, through March 31, 2010. The remaining repurchase capacity of the plan was 58,400 shares at quarter end. Management believes that these purchases have not and will not have a significant effect on the Company's liquidity. Our Board of Directors extended the 2006 Stock Repurchase Plan until December 31, 2010. The repurchase program may be discontinued by Northeast Bancorp at any time.
Total stockholders' equity of the Company was $50,096,057 as of March 31, 2010, as compared to $47,316,880 at June 30, 2009. The increase of $2,779,177, or 6%, was due to net income for the nine months ended March 31, 2010 of $1,675,614, a net increase in net other comprehensive income of $1,880,925 and the exercise of stock options of $8,000 partially offset by the payment of common and preferred dividends of $785,362. Book value per common share was $19.74 as of March 31, 2010, as compared to $18.57 at June 30, 2009. Tier 1 capital to total average assets of the Company was 8.39% as of March 31, 2010 and 8.12% at June 30, 2009.
The Company's net cash provided by operating activities was $3,299,794 during the nine months ended March 31, 2010, which was a $772,795 decrease compared to the same period in 2009, and was attributable to an increase in other assets primarily from the prepaid FDIC assessment for the nine months ended March 31, 2010. Investing activities were a net use of cash primarily due to purchasing available-for-sale securities during the nine months ended March 31, 2010 though less than the same period in 2009. Financing activities resulted in a net source of cash from increases in short-term borrowings and advances from the FHLB partially offset by net decreases in deposits. Overall, the Company's cash and cash equivalents decreased by $3,969,431 during the nine months ended March 31, 2010.
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 these 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, 2010, 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, 2010, 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, 2010: | | | | | | | | | | | | | | | | | | |
Total capital to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 capital to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 capital to total average assets | | | | | | | | | | | | | | | | | | | | | | | | |
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, 2010: | | | | | | | | | | | | | | | | | | |
Total capital to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 capital to risk weighted assets | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 capital to total average assets | | | | | | | | | | | | | | | | | | | | | | | | |
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, 2010, follows:
| | | | | | Payments Due by Period | |
| | | | | | Less Than | | | | | | | | | After 5 | |
| Contractual Obligations | | Total | | | 1 Year | | | 1-3 Years | | | 4-5 Years | | | Years | |
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Structured repurchase agreements | | | | | | | | | | | | | | | | | | | | |
Junior subordinated notes | | | | | | | | | | | | | | | | | | | | |
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Operating lease obligations (1) | | | | | | | | | | | | | | | | | | | | |
Total contractual obligations | | | | | | | | | | | | | | | | | | | | |
| | | | | | Amount of Commitment Expiration - Per Period | |
| | | | | | Less Than | | | | | | | | | After 5 | |
| Commitments with off-balance sheet risk | | Total | | | 1 Year | | | 1-3 Years | | | 4-5 Years | | | Years | |
Commitments to extend credit (2)(4) | | | | | | | | | | | | | | | | | | | | |
Commitments related to loans held for sale(3) | | | | | | | | | | | | | | | | | | | | |
Unused lines of credit (4)(5) | | | | | | | | | �� | | | | | | | | | | | |
Standby letters of credit (6) | | | | | | | | | | | | | | | | | | | | |
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| (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, 2010 was a loss of $36,136.
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.
There have been no material changes in the Company's market risk from June 30, 2009. 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, 2009.
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, 2010.
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 2010 fiscal year that has materially affected, or in other factors that could affect, the Company's internal controls over financial reporting.
