FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 2010
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number (1-14588)
NORTHEAST BANCORP
(Exact name of registrant as specified in its charter)
Maine (State or other jurisdiction of incorporation or organization) | 01-0425066 (I.R.S. Employer Identification No.) |
500 Canal Street, Lewiston, Maine (Address of principal executive offices) | 04240 (Zip Code) |
Registrant's telephone number, including area code: | (207) 786-3245 |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: | Name of each exchange on which registered: |
Common Stock, $1.00 par value | NASDAQ |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes_ No X
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes_ No X
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes X No__
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "smaller reporting company," " large accelerated filer" and “accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer _ Accelerated filer _ Non-accelerated filer _ Smaller Reporting Company X
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes_ No X
The aggregate market value of the Registrant's common shares held by non-affiliates, as of December 31, 2009, was approximately $16,736,804 based on the last reported sales price of the Company's common shares on the NASDAQ exchange as of the close of business on such date. Although directors and executive officers of the registrant and its subsidiaries were assumed to be "affiliates" of the registrant for the purposes of this calculation, this classification is not to be interpreted as an admission of such status. There were 2,331,332 common shares of the registrant outstanding as of September 24, 2010.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents, in whole or in part, are specifically incorporated by reference in the indicated Part of this Annual Report on Form 10-K:
Document | Form 10-K Reference Location |
Proxy Statement for the 2010 Annual Meeting of Shareholders | III |
This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the Securities Act of 1934 and is subject to risks, uncertainties, and other factors which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. See "Item 1. Business -Forward Looking Statements and Risk Factors."
Table of Content
Part I. | | |
| | Business |
| | |
| | Risk Factors |
| | |
| | Properties |
| | |
| | Legal Proceedings |
| | |
| | (Removed and Reserved ) |
| | |
Part II | | |
| | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities |
| | |
| | Selected Financial Data |
| | |
| | Management's Discussion and Analysis of Financial Condition and Results of Operations |
| | |
| | Financial Statements and Supplementary Data |
| | |
| | Financial Statements Required by Regulation S-X |
| | |
| | Report of Independent Registered Public Accounting Firm |
| | |
| | Consolidated Balance Sheets June 30, 2010 and 2009 |
| | |
| | Consolidated Statements of Income Years Ended June 30, 2010, 2009 and 2008 |
| | |
| | Consolidated Statements of Changes in Stockholders' Equity Years Ended June 30, 2010, 2009 and 2008 |
| | |
| | Consolidated Statements of Cash Flows Years Ended June 30, 2010, 2009 and 2008 |
| | |
| | Notes to Consolidated Financial Statements |
| | |
| | Statistical Disclosures Required by Industry Guide 3 |
| | |
| | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
| | |
| | Controls and Procedures |
| | |
| | Other Information |
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Part III | | |
| | Directors, Executive Officers and Corporate Governance |
| | |
| | Executive Compensation |
| | |
| | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder matters |
| | |
| | Certain Relationships and Related Transactions and Director Independence |
| | |
| | Principal Accounting Fees and Services |
| | |
Part IV | | |
| | Exhibits, Financial Statement Schedules |
PART I
Overview and History
Northeast Bancorp ("us", "our", "we", or the "Company"), a Maine corporation chartered in April 1987, is a bank holding company registered under the Bank Holding Company Act of 1956 (the "BHCA"). Prior to 1996, the Company operated under the name Bethel Bancorp. The Company's primary subsidiary and principal asset is its wholly-owned banking subsidiary, Northeast Bank (the "Bank" or "Northeast Bank"), which has eleven banking branches. The Bank offers property and casualty insurance products through the Bank's wholly owned subsidiary, Northeast Bank Insurance Group, Inc. ("NBIG"). NBIG has fourteen insurance agency offices, four of which are located in our banking branches. In addition, we also offer investmen t brokerage services, including financial planning products and services, through our office in Falmouth, Maine.
Northeast Bank, which was originally organized in 1872 as a Maine-chartered mutual savings bank and was formerly known as Bethel Savings Bank F.S.B., is a Maine state-chartered bank and a member of the Federal Reserve System. From 1987 to August 2004, Northeast Bank was a federal savings bank and the Company was a unitary savings and loan holding company registered with the Office of Thrift Supervision ("OTS"). In August 2004, Northeast Bank's charter was converted into a Maine state-chartered universal bank, and the Company became a bank holding company under the BHCA. In connection with the conversion of its charter, Northeast Bank applied for and was granted membership in the Federal Reserve System. 160;Accordingly, the Company and Northeast Bank are currently subject to the regulatory oversight of the Federal Reserve Bank of Boston ("FRB") and the State of Maine Bureau of Financial Institutions.
As of June 30, 2010, the Company, on a consolidated basis, had total assets of approximately $622 million, total deposits of approximately $384 million, and stockholders' equity of approximately $51 million. Unless the context otherwise requires, references herein to the Company include the Company and its subsidiary on a consolidated basis.
Strategy
Northeast Bancorp through its subsidiary, Northeast Bank, the Bank's subsidiary, NBIG, and third party affiliations, provides a broad range of financial services to individuals and companies in western and south-central Maine and southeastern New Hampshire. Although historically the Bank had been primarily a residential mortgage lender, over the last decade the Bank has expanded its commercial loan business, increased its line of financial products and services, and expanded its market area. Management’s strategy 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 and southeastern New Hampshire, closely managing the yields on earning ass ets and rates on interest-bearing liabilities, introducing new financial products and services, increasing the number of bank services per household, increasing non-interest income from expanded investment and insurance brokerage and trust services, and controlling the growth of non-interest expenses. Management believes that this strategy will increase core earnings in the long term by providing stronger interest margins, additional non-interest income and increased loan volume. We believe that the local character of the Bank's business and its "community bank" management philosophy allows it to compete effectively in its market area.
Our community banking strategy emphasizes the development of long-term full banking relationships with customers at each branch location by increasing the number of products and services with each customer and providing consistent, high quality service from:
· | employees with local decision-making authority; |
· | employees who are familiar with the customers' needs, their business environment and competitive demands; and |
· | employees who are able to develop and customize personalized financial solutions that are tailored to the customer's needs. |
With the goal of providing a full range of banking, financial planning, investment brokerage, and property and casualty insurance services to our customers, and in an effort to develop strong, long-term primary banking relationships with businesses and individuals, we have expanded our commercial banking operations by selectively making commercial loans to small and medium sized companies. In this regard, our business development efforts have been directed towards full service credit packages and financial services, as well as competitively priced mortgage packages. In our effort to attract and maintain strong customer relationships, we also have continually expanded the financial products and services that we make avail able to our customers. In particular, we expanded our insurance division through acquisitions in order to provide a broader array of insurance products to our customers, and we have continued to maintain an investment banking services division to provide financial planning products and services to them as well.
The Bank is subject to examination and regulation by the Maine Bureau of Financial Institutions (the "Maine Bureau") and the FRB, and its deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC") to the extent permitted by law. The Bank also is a member of the Federal Home Loan Bank ("FHLB") of Boston.
The principal executive offices of Northeast Bancorp and the Bank are located at 500 Canal Street, Lewiston, Maine, 04240, and our telephone number is (207) 786-3245.
Market Area
The Bank is headquartered in Lewiston, Maine with full service branches in Auburn, Augusta, Bethel, Brunswick, Buckfield, Harrison, Lewiston, Poland, Portland, and South Paris, Maine. The Bank's investment brokerage division has an office in Falmouth, Maine from which investment, insurance and financial planning products and services are offered. The Bank’s mortgage loan originators are in most of our branches and in an office in Portsmouth, New Hampshire. NBIG has offices in Auburn, Anson, Augusta, Berwick, Bethel, Jackman, Livermore Falls, Scarborough, South Paris, Thomaston, and Turner, Maine where the Bank's insurance division offers personal and commercial casualty and property insurance products. T he Company's primary market area, which covers the western and south central regions of the State of Maine, is characterized by a diverse economy that has experienced an economic decline in recent years.
Market for Services
Management believes that the Bank's principal customer and product markets are: (i) the residential mortgage loan market within its primary market area; (ii) small-to-medium sized businesses within its primary market area; and (iii) a wide range of consumer-oriented financial services and products such as financial planning services, investments, life insurance, property and casualty insurance, trust services, college loans and other similar products.
Businesses are solicited through the personal efforts of the officers and directors of both Northeast Bancorp and the Bank. We believe that a locally-based, independent bank is often perceived by the local business community as possessing a clearer understanding of local commerce and its needs. We also believe that we are able to make prudent lending decisions more quickly than our competitors without compromising asset quality or profitability.
Competition
We encounter intense competition in our market area in making loans, attracting deposits, and selling other customer products and services. The deregulation of the banking industry, the ability to create financial services holding companies to engage in a wide range of financial services other than banking, and the widespread enactment of state laws which permit multi-bank holding companies, as well as the availability of nationwide interstate banking, has created a highly competitive environment for financial services providers. In one or more aspects of our business, we compete with other savings banks, commercial banks, credit unions, mutual funds, insurance companies, brokerage and investment banking compa nies, finance companies, and other financial intermediaries operating in Maine and elsewhere. Many of our primary competitors, some of which are affiliated with large bank holding companies or other larger financial-based institutions, have substantially greater resources, larger established customer bases, higher lending limits, extensive branch networks, numerous ATMs and greater advertising and marketing budgets. They may also offer services that we do not currently provide.
The principal factors in competing for deposits are convenient office locations, flexible hours, interest rates and services, and Internet banking, while those relating to loans are interest rates, the range of lending services offered and lending fees. Additionally, we believe that an emphasis on personalized financial planning and advice tailored to individual customer needs, together with the local character of the Bank's business and its "community bank" management philosophy enhances our ability to compete successfully in our market areas. Further, we also offer a wide range of financial services to our customers, including not only basic loan and deposit services, but also investment services, trust services, and insurance pr oducts. We believe that our ability to provide such services and advice, and to provide the financial services and products required by our customers, is an attractive alternative to consumers in our market area.
Lending Activities
General
The primary source of income generated by the Bank is from the interest earned from our loan portfolio. The principal lending activities of the Bank are the origination and purchase of conventional mortgages for the purpose of constructing, financing, or re-financing one-to-four family residential properties and commercial properties. The majority of the properties securing the mortgage loan portfolio are located in the State of Maine. Interest rates and origination fees charged on loans originated by the Bank are generally competitive with other financial institutions and other mortgage originators in its general market area.
Although residential and commercial real estate lending remains a strong component of the Bank's lending operations, consistent with our business strategy, we also actively seek an increased volume of commercial and consumer loans. Commercial loans are originated for commercial construction, acquisition, remodeling and general business purposes. In this regard, the Bank, among other loan products, also originates loans to small businesses in association with the Small Business Administration, Rural Development Administration and Finance Authority of Maine. Consumer loans include those for the purchase of automobiles, boats, home improvements and personal investments.
Residential Lending
The major component of the Bank's lending activities consists of the origination of single-family residential mortgage loans collateralized by owner-occupied property, most of which is located in its primary service areas. The Bank offers a variety of mortgage loan products. Its originations generally consist of adjustable rate mortgages ("ARMs") or fixed rate mortgage loans having terms of 15 years or 30 years amortized on a monthly basis, with principal and interest due each month. The Bank holds in portfolio all adjustable rate mortgage loans. Fixed rate loans are sold into the secondary market. Additionally, the Bank offers home equity loans and home equity lines of credit.
Fixed rate and adjustable rate mortgage loans collateralized by single family residential real estate generally have been originated in amounts of no more than 80% of appraised value. The Bank may, however, lend up to 95% of the value of the property collateralizing the loan; if loans are made in amounts in excess of 80% of the value of the property, the loan must be insured by private or federally guaranteed mortgage insurance. In the case of mortgage loans, the Bank requires mortgagee's title insurance to protect against defects in its lien on the property that collateralizes the loan. The Bank in most cases requires title, fire, and extended casualty insurance to be obtained by the borrower, and, where required by app licable regulations, flood insurance. The Bank maintains its own errors and omissions insurance policy to protect against loss in the event of failure of a mortgagor to pay premiums on fire and other hazard insurance policies.
The Bank offers adjustable rate mortgages with rate adjustments tied to the weekly average rate of one, three and five year U.S. Treasury securities with specified minimum and maximum interest rate adjustments. The interest rates on a majority of these mortgages are adjusted yearly with limitations on upward adjustments of 2% per adjustment period and 6% over the life of the loan. The Bank generally charges a higher interest rate if the property is not owner-occupied. It has been the Bank's experience that the proportions of fixed-rate and adjustable-rate loan originations depend in large part on the interest rate environment. As interest rates fall, there is generally a reduced demand for variable rate mortga ges and, as interest rates rise, there is generally an increased demand for variable rate mortgages.
Although the contractual loan payment period for single-family residential real estate loans is generally for a 15 to 30 year period, such loans often remain outstanding for significantly shorter periods than their contractual terms. The Bank generally does not charge a penalty for prepayment of mortgage loans. Mortgage loans originated by the Bank customarily include a "due on sale" clause giving the Bank the right to declare a loan immediately due and payable if, among other events, that the borrower sells or otherwise disposes of the real property subject to a mortgage. In general, the Bank enforces due on sale clauses. The Bank generally applies the same underwriting criteria to residential mort gage loans whether purchased or originated. In its loan purchases, the Bank generally reserves the right to reject particular loans from a loan package being purchased and rejects loans in a package that do not meet its underwriting criteria. In connection with loan purchases, the Bank receives various representations and warranties from the sellers of the loans regarding the quality and characteristics of the loans. In determining whether to purchase or originate a loan, the Bank assesses both the borrower's ability to repay the loan and the adequacy of the proposed collateral. On originations, the Bank obtains appraisals of the property securing the loan. On purchases, the Bank reviews the appraisal obtained by the loan seller or originator. On purchases and originations, the Bank reviews information concerning the income, financial condition, employment and credit history of the applicant.
We have adopted written, non-discriminatory underwriting standards for use in the underwriting and review of every loan considered for origination or purchase. These underwriting standards are reviewed and approved annually by our board of directors. Our underwriting standards for fixed rate residential mortgage loans generally conform to standards established by Fannie Mae ("FNMA") and the Federal Home Loan Mortgage Corporation (the "FHLMC"). A loan application is obtained or reviewed by the Bank's underwriters to determine the borrower's ability to repay, and confirmation of the more significant information is obtained through credit reports, financial statements, and employment and other verifications.
Commercial Real Estate Lending
The Bank originates both multi-family and commercial real estate loans. Multi-family and commercial property loans generally are made in amounts up to 80% of the lesser of the appraised value or the purchase price of the property. Although the largest multi-family or commercial loan in our portfolio at June 30, 2010 was $3,850,582, most of these loans have balances under $500,000.
The Bank's permanent commercial real estate loans are secured by improved property such as office buildings, medical facilities, retail centers, warehouses, apartment buildings, condominiums and other types of buildings, which are located in its primary market area. Multi-family and commercial real estate loans generally have fixed or variable interest rates indexed to FHLB and prime interest rates with notes having terms of 3 to 5 years. Mortgage loan maturities have terms up to 20 years.
Loans secured by multi-family and commercial real estate generally are larger and involve greater risks than one-to-four family residential mortgage loans. Because payments on loans secured by multi-family and commercial properties often are dependent on successful operation or management of the properties, repayment of such loans may be subject, to a greater extent, to adverse conditions in the real estate market or the economy. We seek to minimize these risks in a variety of ways, including limiting the size of our multi-family and commercial real estate loans and generally restricting such loans to our primary market area. In determining whether to originate multi-family or commercial real estate loans, we also consider such factors as the financial condition of the borrower and the debt service coverage of the property. The Company intends to continue to make multi-family and commercial real estate loans as market demand and economic conditions permit.
Commercial Lending
The Bank offers a variety of commercial loan services, including term loans, lines of credit and equipment and receivables financing. A broad range of short-to-medium term commercial loans, both collateralized and uncollateralized, are made available to businesses for working capital (including the support of inventory and receivables), business expansion (including acquisitions of real estate and improvements), and the purchase of equipment and machinery. Equipment loans are typically originated on both a one year line of credit basis and on a fixed-term basis ranging from one to five years. The purpose of a particular loan generally determines its structure.
The Bank's commercial loans primarily are underwritten in the Company's market areas on the basis of the borrower's ability to make repayment from the cash flow of its business and generally are collateralized by business assets, such as accounts receivable, equipment and inventory. As a general practice, the Bank takes as collateral a security interest in any available real estate, equipment or other business assets, although such loans may be made on an uncollateralized basis. Collateralized working capital loans are primarily secured by short-term assets whereas term loans are primarily secured by long-term assets.
The availability of funds for the repayment of commercial loans may be substantially dependent on the success of the business itself. Further, the collateral underlying the loans, which may depreciate over time, usually cannot be appraised with as much precision as residential real estate, and may fluctuate in value based on the success of the business.
Consumer Loans
Consumer loans made by the Bank include loans collateralized by automobiles, recreational vehicles, and boats, second mortgages, home improvement loans, mobile home loans, home equity lines of credit, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The Bank's consumer loan portfolio consists primarily of loans to individuals for various consumer purposes, but includes some business purpose loans, primarily loans collateralized by small trucks and automobiles, which are payable on an installment basis. Most of these loans are for terms of up to 60 months and, although generally collateralized by liens on various personal assets of the borrower, they may be originated without c ollateral. Consumer loans are made at fixed and variable interest rates and may be made based on up to a 7 year amortization schedule.
Consumer loans are attractive to us because they typically have a shorter term and carry higher interest rates than that charged on other types of loans. Consumer loans, however, do pose additional risks of collectability when compared to traditional types of loans granted by banks such as residential mortgage loans. In many instances, the Bank is required to rely on the borrower's ability to repay since the collateral may be of reduced value at the time of collection. Accordingly, the initial determination of the borrower's ability to repay is of primary importance in the underwriting of consumer loans.
The Bank discontinued its indirect lending activities in October, 2008 due to increasing delinquencies and increasing charge-offs which resulted in this line of business being unprofitable.
Construction Loans
The Bank originates residential construction loans to finance the construction of single-family dwellings. Most of the residential construction loans are made to individuals who intend to erect owner-occupied housing on a purchased parcel of real estate. The Bank's construction loans to individuals typically range in size from $100,000 to $400,000. Construction loans also are made to contractors to erect single-family dwellings for resale. Construction loans are generally offered on the same basis as other residential real estate loans, except that a larger percentage down payment is typically required.
The Bank also may make residential construction loans to real estate developers for the acquisition, development and construction of residential subdivisions. The Bank has limited reliance on this type of loan. Such loans may involve additional risk attributable to the fact that funds will be advanced to fund the project under construction, which is of uncertain value prior to completion, and because it is relatively difficult to evaluate accurately the total amount of funds required to complete a project.
The Bank finances the construction of individual, owner-occupied houses on the basis of written underwriting and construction loan management guidelines. Construction loans are structured either to be converted to permanent loans with the Bank at the end of the construction phase or to be paid off upon receiving financing from another financial institution. Construction loans on residential properties are generally made in amounts up to 80% of appraised value. Construction loans to developers generally have terms of up to 12 months. Loan proceeds on builders' projects are disbursed in increments as construction progresses and as inspections warrant. The maximum loan amount for constructio n loans is based on the lesser of the current appraisal value or the purchase price for the property.
Loans collateralized by multi-family residential real estate and subdivisions generally are larger than loans collateralized by single-family, owner-occupied housing and also generally involve a greater degree of risk. Payments on these loans depend to a large degree on the results of operations and management of the properties, and repayment of such loans may be more subject to adverse conditions in the real estate market or the economy.
Loan Origination and Processing
Loan originations are derived from a number of sources. Residential loan originations can be attributed to real estate broker referrals, mortgage loan brokers, direct solicitation by the Bank's loan officers, present depositors and borrowers, builders, attorneys, walk-in customers and, in some instances, other lenders. Loan applications, whether originated through the Bank or through mortgage brokers, are underwritten and closed based on the same standards, which generally meet FHLMC underwriting guidelines. Consumer and commercial real estate loan originations emanate from many of the same sources. The legal lending limit of the Bank, as of June 30, 2010, was approximately $9.1 million.
The loan underwriting procedures followed by the Bank conform to regulatory specifications and are designed to assess the borrower's ability to make principal and interest payments and the value of any assets or property serving as collateral for the loan. Generally, as part of the process, a bank loan officer meets with each applicant to obtain the appropriate employment and financial information as well as any other required loan information. Upon receipt of the borrower's completed loan application, the Bank then obtains reports with respect to the borrower's credit record, and orders and reviews an appraisal of any collateral for the loan (prepared for the Bank through an independent appraiser). The loan information supplied by the borrower is independently verified. Loan officers or other loan production personnel in a position to directly benefit monetarily through loan solicitation fees from individual loan transactions do not have approval authority. Once a loan application has been completed and all information has been obtained and verified, the loan request is submitted to a final review process. As part of the loan approval process, all uncollateralized loans of more than $25,000 and all new collateralized loans of more than $750,000 require pre-approval by the Bank's loan committee. Loans to one borrower are subject to limits depending on our internal risk ratings.
Loan applicants are notified promptly of the decision of the Bank by telephone and a letter. If the loan is approved, the commitment letter specifies the terms and conditions of the proposed loan, including the amount of the loan, interest rate, amortization term, a brief description of the required collateral and required insurance coverage. Prior to closing any long-term loan, the borrower must provide proof of fire and casualty insurance on the property serving as collateral, which insurance must be maintained during the full term of the loan. Title insurance is required on loans collateralized by real property. Interest rates on committed loans are normally locked in at the time of application f or a 30 to 45 day period.
Other Subsidiaries
The Company acquired a wholly-owned subsidiary, ASI Data Services, Inc. (ASI), through two stock purchases during 1993-1994. ASI initially provided data processing services to the Company and its subsidiaries. The Company's board transferred the assets and operations of ASI to the Bank in 1996, and ASI now is an inactive corporate subsidiary.
NBIG, a Maine corporation and a wholly-owned subsidiary of the Bank, was originally formed in 1982 and was formerly known as Northeast Financial Services, Inc. ("NFS"). It transitioned from an entity for real estate development projects, which terminated in fiscal 2005, to acquiring insurance agencies. Subsequent to the 2004 acquisition of Solon-Anson Insurance Agency, Inc. ("Solon Anson") by NFS, Solon-Anson was merged into NFS in April, 2005. NFS's name was then changed to Northeast Bank Insurance Group, Inc. in May 2005. NBIG now supports the Bank's insurance agencies, which allows the Bank to deliver insurance products to its customers. At June 30, 2010, investment in this subsidiary constituted 1.61% of the Company' s total assets.
Employees
As of June 30, 2010, the Company, the Bank and NBIG together employed 229 full-time and 23 part-time employees. The Company's employees are not represented by any collective bargaining unit. The Company believes that its relations with its employees are good.
SUPERVISION AND REGULATION
The banking industry is extensively regulated under both federal and state law. This regulatory framework is intended primarily to protect depositors and the federal deposit insurance funds, and not to protect shareholders. The following discussion summarizes certain aspects of the regulatory framework applicable to the Company and Northeast Bank. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions.
Bank Holding Company Regulation
General. As a bank holding company registered under the Bank Holding Company Act of 1956 (the "BHCA"), the Company is subject to the regulation and supervision of, and inspection by, the Federal Reserve Board ("FRB"), its primary regulator. The Company also is registered as a Maine financial institution holding company under Maine law and is subject to regulation and examination by the Superintendent of Financial Institutions of the State of Maine ("Superintendent"). The Company is required to file reports with, and provide other information regarding its business operations and those of its subsidiaries to, the FRB and the Superintendent.
The BHCA prohibits a bank holding company, with certain limited exceptions, from (i) acquiring or retaining direct or indirect ownership or control of more than 5% of the outstanding voting stock of any company which is not a bank or bank holding company, or (ii) engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or performing services for its subsidiaries unless such non-banking business is determined by the FRB to be so closely related to banking or managing or controlling banks as to be properly incident thereto. Generally, permissible activities for bank holding companies include, among other things, factoring accounts receivable, acquiring and servicing loans, leasing personal p roperty, performing certain data processing services, acting as an agent or broker in selling credit life insurance and certain other types of insurance in connection with credit transactions, and conducting certain insurance underwriting activities. The BHCA does not place territorial limits on permissible non-bank activities of bank holding companies. In making determinations of what non-banking activities are permissible, the FRB is required to weigh the expected benefit to the public, such as greater convenience, increased competition or gains in efficiency, against the possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. Generally, bank holding companies, such as the Company, are required to obtain prior approval of the FRB to engage in any new activity not previously approved by the FRB. Further, despite prior approval, the FRB reserves the power to order any bank holding company or its subsidiaries to t erminate any activity when the FRB has reasonable grounds to believe that continuation of such activity constitutes a serious risk to the financial soundness, safety, or stability of the bank holding company or any of its bank subsidiaries.
Financial Modernization. The Gramm-Leach-Bliley Financial Modernization Act of 1999 (the "GLB Act"), which amended the BHCA, significantly relaxed previously existing restrictions on the activities of bank holding companies and their subsidiaries by:
· | allowing bank holding companies that qualify as "a financial holding company" to engage in a substantially broader range of activities that are financial in nature; |
· | allowing insurers and other financial service companies to acquire banks; |
· | removing various restrictions that apply to bank holding company ownership of securities firms and mutual fund advisory companies; and |
· | establishing the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations. |
Under the GLB Act, an eligible bank holding company may elect to be a "financial holding company" and thereafter engage in a range of activities that are financial in nature and that are not permissible for bank holding companies. These activities, may be conducted either directly or through a subsidiary, and include activities such as insurance underwriting, securities underwriting and dealing and making merchant banking investments in commercial and financial companies. A financial holding company also may engage in any activity that the FRB determines by rule or order to be financial in nature, incidental to such financial activity, or complementary to a financial activity and does not pose a substantial risk to the safety and soundne ss of an institution or the financial system generally. In addition to these activities, a financial holding company may engage in those activities permissible for a bank holding company.
In order for a bank holding company to be eligible for financial holding company status, all of the subsidiary insured depository institutions must be "well-capitalized" and "well-managed" and have at least a satisfactory rating on its most recent Community Reinvestment Act of 1977 ("CRA") review. A bank holding company seeking to become a financial holding company must file a declaration with the FRB that it elects to become a financial holding company. If, after becoming a financial holding company, any of the insured depository institution subsidiaries should fail to continue to meet these requirements, the financial holding company would be prohibited from engaging in activities not permissible for bank holding companies unless it was abl e to return to compliance within a specified period of time.
Although Northeast Bank, our sole banking subsidiary, meets the capital, management, and CRA requirements, the Company has not made a declaration to elect to become a financial holding company and, at this time, has no plans to do so.
Banking Acquisitions. The BHCA requires, among other things, the prior approval of the FRB in any case where a bank holding company proposes to (i) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless it already owns a majority of such voting shares), (ii) acquire all or substantially all of the assets of another bank or bank holding company, or (iii) merge or consolidate with any other bank holding company. The FRB will not approve any acquisition, merger, or consolidation that would result in a monopoly, or that would have a substantially anti-competitive effect, unless t he anti-competitive impact of the proposed transaction is clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The FRB also is required to consider the financial and managerial resources and future prospects of the holding companies and banks, the projected capital adequacy on a post-acquisition basis, and the acquiring institution's performance under the CRA.
In addition, Maine law requires the prior approval of the Superintendent for (i) the acquisition of more than 5% of the voting shares of a Maine financial institution or any financial institution holding company that controls a Maine financial institution, or (ii) the acquisition by a Maine financial institution holding company of more than 5% of a financial institution or a financial institution holding company domiciled outside the State of Maine.
Interstate Banking and Branching. The Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Banking and Branching Act") provides that bank holding companies which meet specified capital and management adequacy standards, and any state-imposed age requirements, are eligible to acquire banks in states other than their home states unless, as a result of such acquisition, the bank would control more than 10% of the total deposits of insured depository institutions in the United States or more than 30% of such deposits in that state (or other applicable state law limits).
Further, the Interstate Banking and Branching Act authorizes adequately capitalized and managed banks to cross state lines to merge with other banks, subject to certain restrictions, thereby creating interstate branches. A bank also may open new branches in a state in which it does not directly have banking operations if that state has enacted a law permitting de novo branching.
Maine law expressly authorizes interstate banking combinations that are approved by the Superintendent and do not result in deposit concentrations exceeding 30% of the total deposits of the State of Maine (unless such limitation is waived by the Superintendent). Further, interstate branch acquisitions and the establishment of de novo branches also are authorized under Maine law. However, if an out-of-state financial institution seeks to establish or acquire branches in Maine, the laws of the jurisdiction of such financial institution must expressly authorize, under conditions no more restrictive than the State of Maine, the Maine financial institution to engage in interstate branch acquisitions or establishment of de novo branches in that sta te.
Source of Strength; Safety and Soundness. Under FRB policy, the Company is expected to act as a source of financial strength to, and commit resources to support, Northeast Bank. In addition, any capital loans by a bank holding company to its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a Federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and e ntitled to a priority of payment.
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance funds in the event of a depository institution default. For example, under the Federal Deposit Insurance Company Improvement Act of 1991 ("FDICIA"), to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become "undercapitalized" with the terms of any capital restoration plan filed by such subsidiary with its appropriate Federal bank r egulatory agency up to the lesser of (i) an amount equal to 5% of the institution's total assets at the time the institution became undercapitalized or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan. See "-- Capital Adequacy Guidelines - Classification of Banking Institutions" and "- Enforcement, Policies and Actions".
In addition, the "cross-guarantee" provisions of FDICIA require insured depository institutions which are under common control to reimburse the FDIC for any loss incurred, or reasonably expected to be incurred, by the FDIC as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. Accordingly, the cross-guarantee provisions enable the FDIC to access a bank holding company's healthy members of the FDIC. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the insurance fund. The FDIC's claims are superior to claims of stockholders of the insured depository institution or its holding company but are subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.
Under FDICIA, as amended, Federal banking regulatory agencies have adopted guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines.
Bank Regulation
General. Northeast Bank is a Maine state-chartered banking corporation and a member of the Federal Reserve System and, as such, is subject to the supervision, examination, and regulation by the Maine Bureau of Financial Institutions and the FRB.
As a state-chartered commercial bank, Northeast Bank is subject to the applicable provisions of Maine law and the regulations adopted by the Maine Bureau of Financial Institutions. The FRB and the Maine Bureau of Financial Institutions regularly examine the operations of Northeast Bank and are given authority to approve or disapprove mergers, consolidations, the establishment of branches and similar corporate actions. Maine law and the Superintendant regulate (in conjunction with applicable federal laws and regulations), among other things, Northeast Bank's capital, permissible activities, reserves, investments, lending authority, the issuance of securities, payment of dividends, transactions with affiliated parties and borrowing. The federal and state banking regulators also have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law.
Transactions with Affiliates. There are various legal restrictions on the extent to which the Company and any non-bank subsidiaries affiliated with Northeast Bank can borrow or otherwise obtain credit from Northeast Bank. Northeast Bank also is subject to certain restrictions on the purchase of, or investments in, the securities of, and purchase of assets from, the Company and its non-bank subsidiaries, on loans or extensions of credit by a bank to third parties collateralized by the securities or obligations of the Company and any of its non-bank subsidiaries, and on the issuance of guaranties, ac ceptances and letters of credit on behalf of the Company or any of its non-bank subsidiaries. Northeast Bank is subject to further restrictions on most types of transactions with the Company and its non-bank subsidiaries which require the terms of such transactions to be substantially equivalent to the terms of similar transactions with non-affiliated entities.
Further, the Company and Northeast Bank are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property, or furnishing of services. For example, Northeast Bank may not generally require a customer to obtain other services from Northeast Bank or the Company, and may not require the customer to promise not to obtain other services from a competitor, as a condition to an extension of credit.
Loans to Insiders. Northeast Bank also is subject to certain restrictions imposed by federal and state banking regulatory agencies on extensions of credit to executive officers, directors, principal shareholders or any related interest of such persons. Sections 22(g) and 22(h) of the Federal Reserve Act, as amended, and Regulation O, promulgated by the FRB, provide that extensions of credit to such insiders (a) must be made on substantially the same terms, including interest rates and collateral as, and follow credit underwriting procedures that are not less stringent than those prevailing at the time for, comparable transactions with persons not covered abov e and who are not employees, (b) must not involve more than the normal risk of repayment or present other unfavorable features, and (c) may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Northeast Bank's capital. The regulators do allow small discounts on fees on residential mortgages for directors, officers, and employees. Northeast Bank also is subject to certain lending limits and restrictions on overdrafts to such persons and extensions of credit in excess of certain limits must be approved by the board of directors of Northeast Bank. A violation of these restrictions may result in the assessment of substantial civil monetary penalties on Northeast Bank or any officer, director, employee, agent or other person participating in the conduct of the affairs of Northeast Bank or the imposition of a cease and desist order.
Bank Subsidiaries' Activities. The powers of Maine-chartered banks include provisions designed to provide these banks with competitive equity to the powers of national banks. In addition, the GLB Act permits state banks to engage in activities that are permissible for subsidiaries of financial holding companies to the extent such activities are permitted under applicable state law. The GLB Act also expressly preserves the ability of state banks, such as Northeast Bank, to retain all existing subsidiaries. In order to form a financial subsidiary, a state bank must be "well capitalized." State banks with financial subsidiaries will be subject to certain capital deduction, risk management, and affiliate transaction rules. In this regard, FRB rules provide that state bank subsidiaries that engage only in activities that the bank could engage in directly will not be deemed to be a financial subsidiary.
Dividend Restrictions
The Company is a legal entity separate and distinct from Northeast Bank. The primary source of revenues and funds of the Company, including funds to pay dividends to our shareholders, have been and will likely continue to be from dividends, if any, paid to us by Northeast Bank. There are statutory and regulatory limitations on the payment of dividends by Northeast Bank to the Company as well as by the Company to its shareholders. As to the payment of dividends, Northeast Bank is subject to the laws and regulations of the State of Maine and to the regulations of the FRB.
If, in the opinion of the applicable federal bank regulatory authority, a depository institution or holding company under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the depository institution or holding company, could include the payment of dividends), such authority may require, after notice and hearing (except in the case of an emergency proceeding where there is no notice or hearing), that such institution or holding company cease and desist from such practice. The Federal bank regulatory agencies have indicated that paying dividends that deplete a depository institution's or holding company's capital base to an inadequate level would be such an unsa fe and unsound banking practice. Moreover, under FDICIA, an insured institution may not pay a dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. See "- Capital Adequacy Guidelines - Prompt Corrective Regulatory Action". Moreover, the FRB and the FDIC have issued policy statements which provide that bank holding companies and insured depository institutions generally should only pay dividends out of current operating earnings.
At June 30, 2010, under dividend restrictions imposed under federal and state laws, Northeast Bank could declare, without obtaining governmental approvals, aggregate dividends to the Company of approximately $3,778,000.
Capital Adequacy Guidelines
Minimum Capital Requirements. The Company and Northeast Bank are required to comply with capital adequacy standards established by the FRB. There are two basic measures of capital adequacy for bank holding companies that have been promulgated by the FRB: a risk-based measure and a leverage measure.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in credit and market risk profile among banks and bank holding companies, to account for off-balance sheet exposure and to lessen disincentives for holding liquid assets. Under these standards, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. In addition, the Federal bank regulatory agencies may from time to time require that a banking organization maintain capital above the minimum limits, whether because of its financial condition or actual or anticipa ted growth. FRB policy also provides that banking organizations generally, and in particular those that are experiencing substantial internal growth or actively making acquisitions, are expected to maintain capital positions that are substantially in excess of the minimum supervisory levels, without significant reliance on intangible assets.
These risk-based capital standards define a two-tier capital framework. Under these regulations, the minimum ratio of total capital ("Total Capital") to risk-weighted assets (including certain off-balance sheet activities, such as stand-by letters of credit) is 8%. At least one-half of the Total Capital must be "Tier 1 Capital," consisting of common equity, retained earnings or undivided profits, qualifying non-cumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock and minority interests in the equity account of consolidated subsidiaries, less certain goodwill items and other intangible assets (i.e., at least 4% of the risk weighted assets). The remainder ("Tier 2 Capital") may consist of (a) the allowance for credit losses of up to 1.25% of risk-weighted risk assets, (b) preferred stock that does not qualify as Tier 1 Capital, (c) qualifying hybrid capital instruments, (d) perpetual debt, (e) mandatory convertible securities, and (f) subordinated debt and intermediate term-preferred stock up to 50% of Tier 1 Capital. Assets and off-balance sheet items are assigned to one of four categories of risk weights, based primarily on relative credit risk. The minimum guideline for Tier 1 Capital is 4.0%. At June 30, 2010, the Company's consolidated Tier 1 Capital ratio was 8.40%, and its Total Capital ratio was 14.09%.
In addition, the FRB has established minimum leverage ratio guidelines for bank holding companies. The guidelines provide for a minimum Tier 1 Capital to average assets (less goodwill and certain other intangible assets) ("Leverage Ratio") of at least 3% plus an additional cushion of 100 to 200 basis points. The Company's Leverage Ratio at June 30, 2010, was 12.59%.
Federal bank regulatory agencies also have adopted regulations which require regulators to take into consideration concentrations of credit risk and risks from non-traditional activities, as well as an institution's ability to manage those risks, when determining the adequacy of an institution's capital. Other factors taken into consideration include: interest rate exposure; liquidity, funding and market risk; the quality and level of earnings; the quality of loans and investments; the effectiveness of loan and investment policies; and management's overall ability to monitor and control financial and operational risks, including concentrations of credit and non-traditional activities. This evaluation is made as part of the institution's regul ar safety and soundness examination. Further, each Federal banking agency prescribes standards for depository institution holding companies relating to internal controls, information systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, maximum rates of classified assets to capital, minimum earnings sufficient to absorb losses and other standards as they deem appropriate. In addition, pursuant to the requirements of FDICIA, Federal bank regulatory agencies all have adopted regulations requiring regulators to consider interest rate risk (when interest rate sensitivity of an institution's assets does not match its liabilities or its off-balance sheet position) in the evaluation of a bank's capital adequacy.
Northeast Bank is subject to substantially similar risk-based and leverage capital requirements as those applicable to the Company. As of June 30, 2010, Northeast Bank was in compliance with applicable minimum capital requirements.
Classification of Banking Institutions. Among other things, FDICIA provides Federal bank regulatory agencies with broad powers to take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements. The extent of those powers depends upon whether the institutions in question are "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," or "critically undercapitalized." A depository institution's classification will depend upon where its capital levels are in relation to various relevant capital measures, which include a risk-based capital measure and a leverage ratio c apital measure, and certain other factors.
The Federal bank regulatory agencies have adopted regulations establishing relevant capital measures and relevant capital levels. Under these regulations, a bank will be considered:
| Total Risk Based Capital Ratio | Tier 1 Risk-Based Capital Ratio | Leverage Ratio | Other |
Well Capitalized: | 10% or greater | 6% or greater | 5% or greater | Not subject to any order or written directive to meet and maintain a specific capital level for any capital measure |
Adequately Capitalized | 8% or greater | 4% or greater | 4% or greater (3% in the case of a bank with a composite CAMEL rating of 1) | |
Undercapitalized | less than 8% | less than 4% | less than 4% (3% in the case of a bank with a composite CAMEL rating of 1) | |
Significantly Undercapitalized | less than 6% | less than 3% | less than 3% | |
Critically Undercapitalized | | | | Ratio of tangible equity to total assets is less than or equal to 2% |
Under certain circumstances, a depository institution's primary Federal bank regulatory agency may use its authority to reclassify a "well classified" bank as "adequately capitalized" or subject an "adequately capitalized" or "undercapitalized" institution to supervisory actions applicable to the next lower capital category if it determines that the bank is in an unsafe or unsound condition or deems the bank to be engaged in an unsafe or unsound practice and not have corrected the deficiency. The banking agencies are permitted to establish individual minimum capital requirements exceeding the general requirements described above. Generally, failing to maintain the status of "well capitalized" or "adequately capitalized" subjects a depository institution to restrictions and limitations on its business that become progressively more severe as capital levels decrease. At June 30, 2010, Northeast Bank met the definition of a "well capitalized" institution.
Prompt Corrective Regulatory Action. Federal banking regulators are required to take "prompt corrective action" if an insured depository institution fails to satisfy certain minimum capital requirements and other measures deemed appropriate by the federal banking regulators. See "- Capital Adequacy Guidelines" and "- Enforcement Policies and Actions." Failure to meet the capital adequacy guidelines could subject a banking institution to capital raising requirements. A bank is prohibited from making any capital distribution (including the payment of a dividend) or paying a management fee to its hold ing company if the bank would thereafter be “undercapitalized". Limitations exist for "undercapitalized" depository institutions regarding, among other things, asset growth, acquisitions, branching, new lines of business, acceptance of brokered deposits and borrowings from the Federal Reserve System. These institutions also are required to submit a capital instruction plan that includes a guarantee from the institution's holding company. See "Bank Holding Company Regulation - Source of Strength; Safety and Soundness". A "significantly undercapitalized" depository institution may be subject to a number of requirements and restrictions, including orders to sell a sufficient quantity of voting stock to become "adequately capitalized," requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. The appointment of a receiver or conservator may be required for "critically undercapitalized" institutions.
Enforcement Policies and Actions
The enforcement powers available to Federal banking regulators and the Superintendent over commercial banks and bank holding companies are extensive. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders, to initiate injunctive actions against banking organizations and affiliated parties, and, in extreme cases, to terminate deposit insurance. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the Federal bank regulatory agencies. Current law generally req uires public disclosure of final enforcement actions.
Community Reinvestment Act
Bank holding companies and their subsidiary banks are subject to the provisions of the CRA and the regulations promulgated thereunder by the appropriate Federal bank regulatory agency. Under the terms of the CRA, Northeast Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires each appropriate Federal bank regulator y agency, in connection with its examination of a subsidiary depository institution, to assess such institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by that institution. The CRA also requires all institutions to make public disclosure of their CRA ratings. Further, such assessment also is part of the FRB's consideration of applications to acquire, merge or consolidate with, or assume the liabilities of, another banking institution or its holding company, or to open or relocate a branch office. In the case of a bank holding company applying for approval to acquire a bank or a bank holding company, the FRB will assess the record of each subsidiary bank of the applicant bank holding company in considering the application. Pursuant to current CRA regulations, an institution's CRA rating is based on its actual performance in meeting community needs. In particular, the rating system focuses on three tests: (a) a lending test, which evaluates the institution's record of making loans in its service areas; (b) an investment test, which evaluates the institution's record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (c) a service test, which evaluates the institution's delivery of services through its branches, ATMs, and other offices. The current CRA regulations also clarify how an institution's CRA performance will be considered in the application process. Northeast Bank received a "satisfactory" CRA rating in its most recent examination.
FDIC Insurance Premiums
Northeast Bank is required to pay quarterly FDIC deposit insurance assessments. Under the FDIC's risk-based insurance system, insured institutions are currently assessed premiums based on the institution's capital position and other supervisory factors. Each financial institution is assigned to one of three capital groups - well capitalized, adequately capitalized or undercapitalized - and further assigned to one of three subgroups - within a capital group, on the basis of supervisory evaluations by the institution's primary federal and, if applicable, state supervisors and other information relevant to the institution's financial condition and the risk posed to the applicable FDIC deposit insurance fund. The actual assessment rate applica ble to a particular institution (and any applicable refund) will, therefore, depend in part upon the risk assessment classification so assigned to the institution by the FDIC.
Gramm-Leach-Bliley Act
The GLB Act, enacted in 1999, amended and repealed portions of the Glass-Steagall Act and other federal laws restricting the ability of bank holding companies, securities firms, and insurance companies to affiliate with each other and enter into new lines of business. The GLB Act established a comprehensive framework to permit financial companies to expand their activities, including through affiliations, and to modify the federal regulatory structure governing some financial services activities. The increased authority of financial firms to broaden the type of financial services that they may offer to customers and to affiliates with other types of financial service companies may lead to further consolidation in the financial services indust ry. However, it also may lead to additional competition in these markets in which we operate by allowing new entrants into various segments of those markets that were not the traditional competitors in the segments. Furthermore, the authority granted by the GLB Act may encourage the growth of larger competitors.
With respect to bank securities activities, the GLB Act repeals the exemption from the definition of "broker" previously afforded to banks and replaces it with a set of limited exemptions that permits certain activities which have been performed historically by banks to continue. Further, the GLB Act amends the securities laws to include banks with the general definition of dealer.
In addition, the GLB Act imposes regulations on financial institution with respect to customer privacy. The GLB generally prohibits disclosure of customer information to non-affiliated third parties unless the customer had been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to provide written disclosure of their privacy policies to customers at the time the banking relationship is formed and annually thereafter. Financial institutions, however, are required to comply with state law if it is more protective of customer privacy than the GLB Act. The privacy provisions became effective in July 2001.
The GLB Act contains a variety of other provisions including a prohibition against ATM surcharges unless the customer has first been provided notice of the imposition and amount of the fee. The GLB Act reduces the frequency of CRA examinations for smaller institutions and imposes certain reporting requirements on depository institutions that make payment to non-governmental entities in connection with the CRA.
Anti-Money Laundering and Anti-Terrorism Legislation
Congress enacted the Bank Secrecy Act of 1970 (the "BSA") to require financial institutions, including the Company and Northeast Bank, to maintain certain records and to report certain transactions to prevent such institutions from being used to hide money derived from criminal activity and tax evasion. The BSA establishes, among other things: (a) record keeping requirements to assist government enforcement agencies in tracing financial transactions and flow of funds; (b) reporting requirements for Suspicious Activity Reports and Currency Transaction Reports to assist government enforcement agencies in detecting patterns of criminal activity; (c) enforcement provisions authorizing criminal and civil penalties for illegal activities and vio lations of the BSA and its implementing regulations; and (d) safe harbor provisions that protect financial institutions from civil liability for the cooperative efforts.
The USA Patriot Act of 2001 (the "USA Patriot Act") is intended to strengthen the ability of U.S. law enforcement agencies and the intelligence communities to work cohesively to combat terrorism on a variety of fronts. The USA Patriot Act amended the BSA and incorporates anti-terrorist financing provisions into the requirements of the BSA and its implementing regulations. Under the USA Patriot Act, FDIC insured banks and commercial banks are required to increase their due diligence efforts for correspondent accounts and private banking customers. The USA Patriot Act requires banks to engage in additional record keeping or reporting, requiring identification of owners of accounts, or of the customers of foreign banks with accounts, and restric ting or prohibiting certain correspondent accounts. Among other things, the USA Patriot Act requires all financial institutions, including the Company and Northeast Bank to institute and maintain a risk-based anti-money laundering compliance program that includes a customer identification program, provides for information sharing with law enforcement and between certain financial institutions by means of an exemption from the privacy provision of the GLB Act, prohibits U.S. banks and broker-dealers from maintaining accounts with foreign "shell" banks, establishes due diligence and enhanced due diligence requirements for certain foreign correspondent banking and foreign private banking accounts and imposes additional record keeping requirements for certain correspondent banking arrangements. The USA Patriot Act also grants broad authority to the Secretary of the Treasury to take actions to combat money laundering, and federal bank regulators are required to evaluate the effectiveness of an applicant in combat ing money laundering in determining whether to approve any application submitted by a financial institution. The Company and Northeast Bank have adopted policies, procedures, and controls to comply with the BSA and the USA Patriot Act, and they engage in very few transactions of any kind with foreign financial institutions or foreign persons.
The Department of the Treasury's Office of Foreign Asset Control ("OFAC") administers and enforces economic and trade sanctions against targeted foreign countries, entities and individuals based on U.S. foreign policy and national security goals. As a result, financial institutions, including the Company and Northeast Bank, must scrutinize transactions to ensure that they do not represent obligations of, or ownership interests in, entities owned or controlled by sanctioned targets. In addition, the Company and Northeast Bank restrict transactions with certain targeted countries except as permitted by OFAC.
Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") implemented a broad range of corporate governance and accounting measures, executive compensation disclosure requirements, and enhanced and timely disclosure obligations for corporate information, all of which are designed to ensure that the stockholders of corporate America are treated fairly and have full and accurate information about the public companies in which they invest. All companies that file periodic reports with the SEC are affected by the Sarbanes-Oxley Act.
Specifically, the Sarbanes-Oxley Act and various regulations promulgated thereunder, established among other things:
· | the creation of an independent accounting oversight board to oversee the audit of public companies and auditors who perform such audits; |
· | auditor independence provisions which restrict non-audit services that independent accountants may provide to their audit clients; |
· | additional responsibilities for financial statements for the chief executive officer and chief financial officer of the reporting entity; |
· | a prohibition on personal loans to directors and officers, except certain loans made by financial institutions on non-preferential terms and in compliance with other bank regulatory requirements; |
· | additional corporate governance and responsibility measures which (a) require the chief executive officer and chief financial officer to certify financial statements and to forfeit salary and bonuses in certain situations, and (b) protect whistleblowers and informants; |
· | enhance independence and expertise requirements of members of audit committees; |
· | expansion of the audit committee's authority and responsibility by requiring that the audit committee (a) have direct control of the outside auditor, (b) be able to hire and fire the auditor, and (c) approve all non-audit services; |
· | mandatory disclosure by analysts of potential conflicts of interest; and |
· | enhanced penalties for fraud and other violations. |
On September 11, 2007, the Company changed its listing from the American Stock Exchange to the NASDAQ Stock Exchange. Both exchanges have adopted corporate governance rules that have been approved by the SEC.
The Company has taken steps to comply with the provisions of the Sarbanes-Oxley Act and the regulations adopted thereunder. Based on our total assets, we were first required to provide management’s assessment of the company’s internal control over financial reporting in our annual report on Form 10-K filed for our first fiscal year ending on or after December 15, 2007 (i.e., fiscal year 2008). Compliance with the foregoing provision is expected to increase our administrative costs. However, following the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, we are not required to obtain an annual attestation report by our auditors for the annual report on Form 10-K filed for our first fiscal year ending on or a fter December 15, 2009 (i.e., fiscal year 2010).
Monetary Policy and Economic Control
The commercial banking business is affected not only by legislation, regulatory policies, and general economic conditions, but also by the monetary policy of the FRB. Changes in the discount rate on member bank borrowing, availability of borrowing at the "discount window," open market operations, the imposition of changes in reserve requirements against member banks' deposit and assets of foreign branches and the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates are some of the instruments of monetary policy available to the FRB. These monetary policies are used in varying combinations to influence overall growth and distributions of bank loans, investments and deposits, and these polic ies may affect interest rates charged on loans or paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks and are expected to do so in the future. The monetary policies of these agencies are influenced by various factors, including inflation, unemployment, short-term and long-term changes in the international trade balance and in the fiscal policies of the United States Government. Future monetary policies and the effect of such policies on the future business and earnings of Northeast Bank cannot be predicted.
Industry Restructuring
For well over a decade, the banking industry has been undergoing a restructuring process which is anticipated to continue. The restructuring has been caused by product and technological innovations in the financial services industry, deregulation of interest rates and increased competition from foreign and nontraditional banking competitors, and has been characterized principally by the gradual erosion of geographic barriers to intrastate and interstate banking and the gradual expansion of investment and lending authorities for bank institutions.
Members of Congress and the administration may consider additional legislation designed to institute reforms to promote the viability of the industry. Such legislation could revise the federal regulatory structure for insured depository institutions; others could affect the nature of products, services, and activities that bank holding companies and their subsidiaries may offer or engage in, and the types of entities that may control depository institutions. There can be no assurance as to whether or in what form any such future legislation might be enacted, or what impact such legislation might have upon the Company or Northeast Bank.
STATISTICAL DISCLOSURE
The additional statistical information contained in Item 8(b) of this Form 10-K, "Financial Statements and Supplementary Data" as it relates to the disclosures required by Industry Guide 3 under the Securities Act of 1933, as amended, is incorporated herein by reference.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
This Annual Report on Form 10-K (including the Exhibits hereto) 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 reserve adequacy, simulation of changes in interest rates, capital spending and interest and non-interest 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 statement s. 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", "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 communication 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.
Potential risks, uncertainties, and other factors which could cause the Company's financial performance or results of operations to differ materially from current expectations or such forward-looking statements include, but are not limited to:
a) | general economic conditions, either nationally or in the markets where the Company or its subsidiaries offer their financial products or services, may be less favorable than expected, resulting in, among other things, a deterioration of credit quality or in a decreased demand for our products or services; |
b) | A significant increase in competitive pressures in the banking and financial services industry and, more particularly, a significant increase in competition in the Company's market areas as described under "Business -- Market for Services and Competition"; |
c) | changes in the interest rate environment which could reduce our margins and increase defaults in our loan portfolio, including those described under "Management's Discussion and Analysis of Results of Operations and Financial Condition --Risk Management", and also may have a negative impact on the Company's interest rate exchange agreement; |
d) | the adequacy of the allowance for loan losses and the Bank's asset quality, including those matters described in "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Results of Operations". |
e) | changes in political conditions or changes occurring in the legislative or regulatory environment that adversely affect the businesses in which we are engaged, including the impact of any changes in laws and regulations relating to banking, securities, taxes, and insurance; |
f) | rapid technology changes; |
g) | our ability to increase market share and to control expenses, and changes in consumer spending, borrowing, and saving habits; |
h) | changes in trade, tax, monetary, or fiscal policies, including the interest rate policies of the FRB; |
i) | money market and monetary fluctuations, and changes in inflation or in the securities markets; |
j) | future acquisitions and the integration of acquired businesses and assets; |
k) | changes in the Company's organizational structure and in its compensation and benefit plans, including those necessitated by pressures in the labor market for attracting and retaining qualified personnel; |
l) | the effect of changes in accounting policies and practices, as may be adopted by regulatory agencies as well as the Financial Accounting Standards Board; |
m) | unanticipated litigation, regulatory, or other judicial proceedings; |
n) | the success of the Company at managing the risks involved in the foregoing; |
o) | other one-time events, risks and uncertainties detailed from time to time in the filings of the Company with the Securities and Exchange Commission; |
p) | continue diversification of income streams; |
q) | changes in the sources of liquidity; |
r) | our inability to obtain approvals for the pending merger with FHB Formation, LLC on the proposed merger terms; and |
s) | the business strategy proposed in the merger of FHB Formation, LLC and the Company will not be successful, or such implementation may be more difficult, time-consuming or costly than expected. |
All written or oral forward-looking statements that are made or attributable to us are expressly qualified in their entirety by this cautionary notice. Such forward-looking statements speak only to the date that such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.
The Company's results are strongly influenced by general economic conditions in its market areas in the western, central, and mid-coastal regions of the State of Maine. Deterioration in these conditions could have a material adverse effect on the quality of the Bank's loan portfolio and the demand for its products and services. In particular, changes in the real estate or service industries, or a slow-down in population growth, may adversely impact the Company's performance. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
All forward-looking statements presume a continuation of the existing regulatory environment and monetary policy. The banking industry is subject to extensive state and federal regulation, and significant new laws or regulations, or changes in or repeals of existing laws or regulations, may cause results of the Company to differ materially. Further, federal monetary policy, particularly as implemented by the FRB, significantly affect credit conditions for the Bank and its customers. Such changes could adversely impact the Company's financial results. In addition, the Sarbanes-Oxley Act of 2002 and the numerous rulemaking initiatives adopted or proposed in connection therewith or in reaction thereto have significantly increased the regulatory burdens of publicly held companies. Accordingly, the cost of compliance with, and the personnel necessary to satisfy the obligations imposed by, these regulatory initiatives may divert resources from our core business operations and may adversely affect our profitability. See "Item 1. Business Supervision and Regulation."
A significant source of risks are related to the possibility that losses will be sustained because borrowers, guarantors, and related parties fail to perform in accordance with the terms of their loans. The Bank has adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that management believe are appropriate to minimize the risks in the Bank's loan portfolio. However, such policies may not prevent unexpected losses that could adversely affect the Company's results and the allowance for loan losses may not be adequate in all instances. See "Item 7. Management's Discussion and Analysis of Financial Condition and Re sults of Operations - Results of Operations,"" - Financial Condition," and" - Risk Management." Further, certain types of lending relationships carry greater risks of nonperformance and collectability, such as commercial and consumer loans. For a discussion of the risks associated with such lending relationships, see "Item 1. Business -- Lending Activities."
The following discussion addresses risks that management believes are specific to the pending merger of Northeast with FHB Formation, LLC, with Northeast surviving, and our business, and that could have a negative impact on the Company’s financial performance. When analyzing an investment in the Company, the risks and uncertainties described below, together with all of the other information included or incorporated by reference in this report, should be carefully considered. This list should not be viewed as comprehensive and may not include all risks that may affect the financial performance of the Company:
Risks Related to the Merger
You may not receive the form of merger consideration that you elect.
If the merger is completed, each outstanding share of Northeast common stock will be converted into the right to receive either $13.93 in cash or one share of the surviving corporation common stock, plus cash in lieu of any fractional share. You will have the opportunity to elect to receive all cash, all stock or a combination of cash and stock with respect to the shares of Northeast common stock that you hold. Your right as a Northeast shareholder to receive the consideration you elect for your shares is limited because of the allocation procedures set forth in the merger agreement, which are intended to ensure that 40% of the outstanding shares of Northeast common stock will be converted into the right to receive cash, and 60% of these shares of Northeast common stock will be converted into the right to receive surviving corporation common stock. If the total cash elections by Northeast shareholders are greater, or less, than the aggregate cash consideration to be paid in the merger, or the total stock elections by Northeast shareholders are greater, or less, than the aggregate stock consideration to be paid in the merger, you may not receive exactly the form of consideration that you elect and you may receive a pro rata amount of cash and surviving corporation common stock. A detailed discussion of the merger consideration provisions of the merger agreement is set forth under the sections titled “The Merger Agreement - Merger Consideration,” “Election Procedures,” and “Allocation Procedures,” beginning on page 78 of the S-4 filed with the SEC on June 15, 2010. We recommend that you carefully read that discussion and the merger agreement attached to the proxy statement/prospectus as Appendix A.
In order to make an election, you must submit your shares of Northeast common stock, and you will then not be able to sell those shares unless you revoke your election prior to the election deadline.
If you are a Northeast shareholder and want to make a cash or stock election, you will have to deliver your stock certificates (or follow the procedures for guaranteed delivery) and a properly completed and signed form of election to the exchange agent. The actual election deadline is October 15, 2010, unless extended. The election deadline must be at least five business days in advance of the completion of the merger, but it may be further in advance of the actual closing date. You will not be able to sell any shares of Northeast common stock that you have delivered as part of your election unless you revoke your election before the election deadline by providing written notice to the exchange agent. 60; If you do not revoke your election, you will not be able to liquidate your investment in Northeast common stock for any reason until you receive cash and/or surviving corporation common stock in the merger. In the time between delivery of your shares and the closing of the merger, the trading price of Northeast’s common stock may fluctuate, and you might otherwise want to sell your shares of Northeast common stock to gain access to cash, make other investments, or reduce the potential for a decrease in the value of your investment. The date that you will receive your merger consideration depends on the completion date of the merger, which is uncertain. The completion date of the merger might be later than expected due to unforeseen events, such as delays in obtaining regulatory approvals.
Northeast will be subject to business uncertainties and contractual restrictions while the merger is pending.
Uncertainty about the effect of the merger on employees and customers may have an adverse effect on Northeast. These uncertainties may impair Northeast’s ability to attract, retain and motivate strategic personnel until the merger is consummated, and could cause customers and others that deal with Northeast to seek to change existing business relationships with Northeast. Experienced employees in the financial services industry are in high demand, and competition for their talents can be intense. Employees of Northeast may experience uncertainty about their future role with the surviving corporation until, or even after, strategies with regard to the combined company are announced or executed. ; If strategic Northeast employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with the surviving corporation, Northeast’s business following the merger could be harmed. In addition, the merger agreement restricts Northeast from making certain acquisitions and taking other specified actions until the merger occurs without the consent of FHB. These restrictions may prevent Northeast from pursuing attractive business opportunities that may arise prior to the completion of the merger.
The tax consequences of the merger for Northeast shareholders will be dependent upon the merger consideration received.
The tax consequences of the merger to you will depend upon the merger consideration that you receive. A Northeast shareholder who receives surviving corporation common stock in connection with the merger will not recognize gain or loss. A Northeast shareholder who receives cash in exchange for all of that shareholder’s shares of Northeast common stock pursuant to the merger will either be treated as having redeemed those shares to Northeast or as having sold their shares to FHB or its members and generally will recognize capital gain or loss in an amount equal to the difference between the amount of cash received and the shareholder’s aggregate tax basis for such shares of Northeast common stock, which gain o r loss will be long-term capital gain or loss if such shares of Northeast common stock were held for more than one year. You should consult your own tax advisors as to the effect of the merger on your specific interests.
The required regulatory approvals may not be obtained, may delay the date of completion of the merger or may contain materially burdensome conditions.
Northeast and FHB are required to obtain the approvals of the Board of Governors of the Federal Reserve System and the Maine Bureau of Financial Institutions prior to completing the merger and have agreed to used their reasonable best efforts to obtain these approvals. Satisfying any requirements of these regulatory agencies may delay the date of completion of the merger or such approval may not be obtained at all. In addition, you should be aware that, as in any transaction, it is possible that, among other things, restrictions on Northeast after the merger may be sought by governmental agencies as a condition to obtaining the required regulatory approvals and these conditions could be materially burdensome to the survi ving corporation. We cannot assure you as to whether these regulatory approvals will be received, the timing of the approvals, or whether any conditions will be imposed.
If the merger is not completed, Northeast will have incurred substantial expenses without its shareholders realizing the expected benefits.
Northeast has incurred substantial expenses in connection with the transactions described in this document. If the merger is not completed, Northeast expects that it will have incurred approximately $566,000in merger-related expenses. Northeast may also be required to pay FHB a termination fee of $1 million under certain circumstances. These expenses would likely have a material adverse impact on the financial condition of Northeast because it would not have realized the expected benefits of the merger. There can be no assurance that the merger will be completed.
The termination fee and the restrictions on solicitation contained in the merger agreement may discourage other companies from trying to acquire Northeast.
Until the completion of the merger, Northeast is prohibited from soliciting, initiating, encouraging or, with some exceptions, considering any inquiries or proposals that may lead to a proposal or offer for a merger or other business combination transaction with any person other than FHB. In addition, Northeast has agreed to pay a termination fee of $1 million to FHB in specified circumstances. These provisions could discourage other companies from trying to acquire Northeast even though those other companies might be willing to offer greater value to Northeast shareholders than FHB has offered in the merger. The payment of the termination fee also could have a material adverse effect on Northeast’s fina ncial condition.
The surviving corporation common shares to be received by Northeast shareholders as a result of the merger will have different rights from shares of Northeast common stock.
Upon completion of the merger, Northeast shareholders who receive shares of surviving corporation common stock in the merger will become surviving corporation shareholders, and their rights as shareholders will be governed by the amended and restated articles of incorporation and bylaws of the surviving corporation and Maine corporate law. The rights associated with Northeast common stock are different from the rights associated with the surviving corporation’s common stock.
Some of the directors and executive officers of Northeast may have interests and arrangements that may have influenced their decisions to support or recommend that you approve the merger.
The interests of some of the directors and executive officers of Northeast may be different from those of Northeast shareholders, and directors and officers of Northeast may be participants in arrangements that are different from, or in addition to, those of Northeast shareholders. These interests and arrangements include rights to indemnification and directors’ and officers’ liability insurance and the continued service on the surviving corporation’s board of directors by two members of the Northeast board of directors who were members of the Northeast board of directors as of the date of the merger agreement. In addition, the surviving corporation intends to retain certain Northeast executive officers in senior leadership roles with the surviving corporation following consummation of the merger and has entered into new employment arrangements with these executive officers contingent upon the consummation of the merger.
The fairness opinion obtained by Northeast from its financial advisor will not reflect changes in circumstances subsequent to the date of the merger agreement.
Northeast has not obtained an updated opinion as of the date of this document from Keefe, Bruyette & Woods, Inc., its financial advisor. Changes in the operations and prospects of Northeast, general market and economic conditions and other factors which may be beyond the control of FHB and Northeast, and on which the fairness opinion was based, may alter the value of Northeast or the price of shares of Northeast common stock or surviving corporation common stock by the time the merger is completed. The opinion does not speak to the time the merger will be completed or to any other date other than the date of such opinion. As a result, the March 30, 2010 opinion will not address the fairness of the merger c onsideration, from a financial point of view, at the time the merger is completed.
The merger may distract management from their other responsibilities.
The merger could cause the management of Northeast to focus time and energies on matters relating to the merger that otherwise would be directed to Northeast’s business and operations. Any such distraction on the part of Northeast’s management, if significant, could affect Northeast’s ability to service existing business and develop new business and could adversely affect the business and earnings of Northeast following the merger.
Unanticipated costs relating to the merger could reduce Northeast’s future earnings per share.
FHB believes that it has reasonably estimated the likely incremental costs of Northeast’s operations following the merger. However, it is possible that unexpected transaction costs such as taxes, fees or professional expenses or unexpected future operating expenses such as increased personnel costs or increased taxes, as well as other types of unanticipated adverse developments, could have a material adverse effect on the results of operations and financial condition of Northeast following the merger. Moreover, the final acquisition accounting adjustments could vary significantly from the preliminary acquisition accounting adjustments included in the S-4 filed with the SEC on June 15, 2010, in the section titl ed "Unaudited Pro Forma Financial Information", as a result of changes in market conditions, interest rates, or other factors such as Northeast's loan portfolio credit quality." If unexpected costs are incurred, the merger could have a significant dilutive effect on Northeast’s earnings per share. In other words, if the merger is completed, the earnings per share of Northeast’s common stock could be less than they would have been if the merger had not been completed.
If the merger is not consummated by December 31, 2010, either Northeast or FHB may choose not to proceed with the merger.
Either Northeast or FHB may terminate the merger agreement if the merger has not been completed by December 31, 2010, unless the failure of the merger to be completed has resulted from the failure of the party seeking to terminate the merger agreement to perform its obligations.
Risks Related to Northeast’s Business
The surviving corporation may not be successful in its implementation of its business strategy.
The surviving corporation’s business strategy following the merger includes building a Loan Acquisition and Servicing Group and growing deposits with an online affinity savings program. The surviving corporation’s ability to develop and offer new products and services following the merger will depend on whether the Federal Reserve Board approves the business plan, and whether the surviving corporation can hire and retain enough suitably experienced and talented employees, identify enough suitable customers and successfully build the systems and obtain the other resources necessary for creating the new product and service offerings. The surviving corporation may not be able to do so, or, identify suitable empl oyees and customers and building the systems and obtain the other resources necessary may be more expensive, or take longer, than the surviving corporation expects. There can be no assurance that the surviving corporation’s business strategy following the merger will be accretive to earnings within a reasonable period of time.
The current economic environment poses significant challenges for Northeast and could adversely affect Northeast’s financial condition and results of operations.
Northeast is operating in a challenging and uncertain economic environment that includes generally uncertain national and local conditions. Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets. Dramatic declines in the housing market over the past eighteen months, with decreasing home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions. Continued declines in real estate values and home sales volumes and financial stress on borrowers as a result of the uncertain economic environment could have an adverse effect on Northeast’s borrowers or its customers , which could materially adversely affect Northeast’s financial condition and results of operations. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on Northeast and others in the financial services industry. In particular, Northeast faces the following risks in connection with these events:
| Northeast’s borrowers may be unable to make timely repayments of their loans, or the value of real estate collateral securing the payment of such loans may decrease, which could result in increased delinquencies, foreclosures and customer bankruptcies, any of which would increase levels of non-performing loans, resulting in significant credit losses, would increase expenses and could have a material adverse effect on Northeast’s operating results. |
| Increased regulation of Northeast’s industry and compliance with such regulation may increase Northeast’s costs, limit its ability to pursue business opportunities and increase compliance challenges. |
| Increased competition among financial services companies based on the recent consolidation of competing financial institutions and the conversion of investment banks into bank holding companies may adversely affect Northeast’s ability to market its products and services. |
| Northeast may be required to pay significantly higher FDIC deposit premiums and assessments because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. |
| Consumer confidence in the financial industry has weakened and individual wealth has deteriorated, which could lead to declines in deposits and impact liquidity. |
| Continued asset valuation declines could adversely impact Northeast’s credit losses and result in goodwill and other asset impairments. |
Recent market volatility has impacted and may continue to impact Northeast’s business and the value of Northeast’s common stock.
The performance of Northeast’s business and the trading price of the shares of Northeast’s common stock have been and may continue to be affected by many factors including volatility in the credit, mortgage and housing markets, the markets for securities relating to mortgages or housing, and with respect to financial institutions generally. Government action, such as the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinforcement Act of 2009 (the “ARRA”), may also affect Northeast and the value of Northeast’s common stock. Given the unprecedented nature of this volatility, Northeast cannot predict what impact, if any, this volatility will have on Northeast’ s business or share price and, for these and other reasons, Northeast’s shares of common stock may trade at a price lower than that at which they were acquired pursuant to the merger.
Northeast operates in a highly regulated environment and may be adversely affected by changes in laws and regulations, or the manner in which they are applied.
Northeast is subject to extensive regulation, supervision and examination by the Federal Reserve Board, the Maine Superintendent and by the FDIC, as insurer of the Bank’s deposits. Such regulation and supervision govern the activities in which Northeast may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on operations, the classification of Northeast’s assets and the determination of the level of allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on operations.
Northeast’s participation in the Capital Purchase Program, which includes restrictions on the ability to pay dividends or repurchase outstanding common stock and restrictions on executive compensation, may act to depress the market value of Northeast’s common stock, potentially restrict its operational flexibility and hinder its ability to attract and retain well qualified executives.
Pursuant to its participation in the Capital Purchase Program, Northeast’s ability to declare or pay dividends on any of Northeast’s shares of common stock is limited to $0.09 per share per quarter. Northeast is unable to declare or pay dividends on shares of common stock if in arrears on the payment of dividends on its Series A preferred stock. In addition, Treasury’s approval generally is required for Northeast to make any stock repurchase (other than purchases of Series A preferred stock or shares of common stock in connection with the administration of any employee benefit plan in the ordinary course of business and consistent with past practice) unless all of the Series A preferred stock has been r edeemed or transferred by Treasury to unaffiliated third parties. In addition, outstanding shares of common stock may not be repurchased if Northeast is in arrears on the payment of Series A preferred stock dividends. The restriction on Northeast’s ability to pay dividends may depress the market price for its shares of common stock.
In addition, Northeast must comply with the executive compensation and corporate governance standards imposed by ARRA for as long as Treasury holds any securities acquired from Northeast pursuant to the Capital Purchase Program or upon exercise of the warrant held by Treasury. In addition, the restrictions on Northeast’s ability to compensate senior executives as compared to executive compensation at companies that did not participate in the Capital Purchase Program may limit Northeast’s ability to recruit and retain senior executives. Treasury’s ability to change the terms, rules or requirements of the Capital Purchase Program could adversely affect Northeast’s financial condition and result s of operations.
The outstanding Series A preferred stock could decrease net income and earnings per share, and the warrant issued to Treasury may be dilutive to holders of Northeast’s common stock.
The sale of the Series A preferred stock to Treasury increased the number of outstanding shares of common stock on a fully-diluted basis. In addition, the Series A preferred stock carry a preferred dividend. The dividends declared on the Series A preferred stock will reduce the net income available to holders of Northeast’s common stock and earnings per share. In addition, the ownership interest of the existing holders of Northeast’s common stock will be diluted to the extent that Treasury exercises the warrant it acquired in connection with Northeast’s participation in the Capital Purchase Program.
If Northeast is unable to redeem the outstanding Series A preferred stock, the annual dividend rate will increase substantially.
If Northeast is unable to redeem the outstanding Series A preferred stock prior to December 12, 2013, the annual dividend rate would increase from 5.0% to 9.0%. Depending on Northeast’s financial condition at the time, such an increase in the annual dividend rate on the Series A preferred stock could have a material negative effect on liquidity and results of operations.
Competition in the financial services industry is intense and could result in Northeast losing business or experiencing reduced margins.
Northeast currently primarily operates in western and south central Maine. Northeast’s future growth and success will depend on its ability to compete effectively in these Maine markets, in the markets in which the Loan Acquisition and Servicing Group invests and in the markets in which the online affinity savings program operates. Northeast faces aggressive competition from other domestic and foreign lending institutions and from numerous other providers of financial services. The ability of non-banking financial institutions to provide services previously limited to commercial banks has intensified competition. Because non-banking financial institutions are not subject to the same regulatory restrictions as banks and bank holding companies, they can often operate with greater flexibility and lower cost structures. Securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. This may significantly change the competitive environment in which Northeast conducts its business. Some of Northeast’s competitors have significantly greater financial resources and/or face fewer regulatory constraints. As a result of these various sources of competition, Northeast could lose business to competitors or could be forced to price products and services on less advantageous terms to retain or attract clients, either of which would adversely affect its profitability.
Adverse events in Maine, where Northeast’s business is currently concentrated, could adversely impact its results and future growth.
Northeast’s business, the location of its branches, the primary source of repayment for its small business loans and the real estate collateralizing its commercial real estate loans and its home equity loans are primarily concentrated in Maine. Unlike larger national or other regional banks that are more geographically diversified, Northeast’s business and earnings are closely tied to general business and economic conditions, particularly the economy of Maine. As a result, Northeast is exposed to geographic risks and adverse changes in laws and regulations in Maine would have a greater negative impact on Northeast’s revenues, financial condition and business than similar institutions in markets outside of Maine.
Northeast is dependent upon the services of its management team.
Northeast is dependent upon the ability and experience of a small number of its key management personnel who have substantial experience with Northeast’s operations, the financial services industry and the markets in which Northeast offers its services. Northeast’s future success depends on the continued contributions of its existing senior management personnel. The loss of the services of one or more senior executives or key managers could have a material adverse effect on Northeast. Northeast’s success also depends on its ability to continue to attract, manage and retain other qualified personnel. We cannot assure you that Northeast will continue to attract or retain such personn el.
Northeast is a holding company and depends on its subsidiary for dividends, distributions and other payments.
Northeast is a separate and distinct legal entity from its banking subsidiary and depends on dividends, distributions and other payments from the Bank to fund dividend payments on Northeast’s common stock and to fund all payments on its other obligations. Northeast and the Bank are subject to laws that authorize regulatory authorities to block or reduce the flow of funds from the Bank to Northeast. Regulatory action of that kind could impede access to the funds that Northeast needs in order to make payments on its obligations or dividend payments. In addition, if the Bank’s earnings are not sufficient to make dividend payments to Northeast while maintaining adequate capital levels, Northeast may no t be able to make dividend payments to its common and preferred shareholders. Further, Northeast’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the Bank’s creditors.
Northeast may not be able to pay dividends and, if Northeast pays dividends, Northeast cannot guarantee the amount and frequency of such dividends.
In addition to the restrictions on the ability to declare or pay dividends imposed by the terms of the Series A preferred stock, the continued payment of dividends on shares of the surviving company common stock will also depend upon Northeast’s debt and equity structure, earnings and financial condition, need for capital in connection with possible future acquisitions, and other factors, including economic conditions, regulatory restrictions, and tax considerations. Northeast cannot guarantee that it will pay dividends or, if it pays dividends, the amount and frequency of these dividends.
An increase in Northeast’s allowance for loan losses will result in reduced earnings.
As a lender, Northeast is exposed to the risk that its customers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans will not be sufficient to assure full repayment. Northeast evaluates the collectability of its loan portfolio and provides an allowance for loan losses that it believes is adequate based upon various factors. Many of these factors are difficult to predict or estimate accurately, particularly in a changing economic environment. The process of determining the estimated losses inherent in Northeast’s loan portfolio requires subjective and complex judgments and the level of uncertainty concerning economic conditions may adver sely affect Northeast’s ability to estimate the incurred losses in its loan portfolio. If Northeast’s evaluation is incorrect and borrower defaults cause losses exceeding the portion of the allowance for loan losses allocated to those loans, Northeast’s earnings could be significantly and adversely affected. Northeast may experience losses in its loan portfolios or perceive adverse trends that require it to significantly increase its allowance for loan losses in the future, which would reduce future earnings.
Prepayments of loans may negatively impact Northeast’s business.
In certain circumstances, Northeast’s customers may prepay the principal amount of their outstanding loans. The speed at which such prepayments occur, as well as the size of such prepayments, are within Northeast’s customers’ discretion. If customers prepay the principal amount of their loans, and Northeast is unable to lend those funds to other borrowers or invest the funds at the same or higher interest rates, Northeast’s interest income will be reduced. A significant reduction in interest income could have a negative impact on Northeast’s results of operations and financial condition.
Northeast’s loan portfolio subjects it to credit risk.
Northeast is exposed to the risk that its borrowers may default on their obligations. Credit risk arises through the extension of loans, certain securities, letters of credit and financial guarantees. Although credit personnel analyze the creditworthiness of individual borrowers and limits are established for the total credit exposure to any one borrower, such limits may not have the effect of adequately limiting Northeast’s credit exposure.
Changes in interest rates could adversely affect Northeast’s net interest income and profitability.
The majority of Northeast’s assets and liabilities are monetary in nature. As a result, the earnings and growth of Northeast are significantly affected by interest rates, which are subject to the influence of economic conditions generally, both domestic and foreign, to events in the capital markets and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve Board. The nature and timing of any changes in such policies or general economic conditions and their effect on Northeast cannot be controlled and are extremely difficult to predict. Changes in interest rates can impact Northeast’s net interest income as well as the valuation of its assets and liabilities.
Banking is an industry that depends, to a large extent, on its net interest income. Net interest income is the difference between (1) interest income on interest-earning assets, such as loans, and (2) interest expense on interest-bearing liabilities, such as deposits. Changes in interest rates can have differing effects on Northeast’s net interest income. In particular, changes in market interest rates, changes in the relationships between short-term and long-term market interest rates, or the yield curve, or changes in the relationships between different interest rate indices can affect the interest rates charged on interest-earning assets differently than the interest rates paid on interest-bearing lia bilities. This difference could result in an increase in interest expense relative to interest income and therefore reduce Northeast’s net interest income. While Northeast has attempted to structure its asset and liability management strategies to mitigate the impact on net interest income of changes in market interest rates, it cannot provide assurances that it will be successful in doing so.
Deposit premium insurance assessments may increase substantially, which will adversely affect expenses.
The FDIC imposes an assessment against financial institutions for deposit insurance. This assessment is based on the risk category of the institution and, prior to 2009, ranged from 5 to 43 basis points of the institution’s deposits. On February 27, 2009, the FDIC issued a final rule that increasing the current deposit insurance assessment rates to a range of 12 to 45 basis points, effective as of April 1, 2009. In addition, in May 2009, the FDIC imposed a special assessment on all insured institutions due to recent bank and savings association failures. The special assessment amounted to 5 basis points on each institution’s assets minus Tier 1 capital as of June 30, 2009, subject t o a maximum equal to 10 basis points times the institution’s assessment base. Northeast’s special assessment was $275,000. The FDIC may impose additional emergency special assessments of up to 5 basis points per quarter on each institution’s assets minus Tier 1 capital if necessary to maintain public confidence in federal deposit insurance or as a result of deterioration in the deposit insurance fund reserve ratio due to institution failures. The latest date possible for imposing any such additional special assessment was December 31, 2009, with collection on March 30, 2010. Any additional emergency special assessment imposed by the FDIC may negatively impact Northeast’s earnings.
Northeast may not be able to attract and retain investment services and insurance clients at current levels.
Due to intense competition, Northeast’s investment services division and its insurance offices may not be able to attract and retain clients at current levels. Competition is strong in Northeast’s geographic market areas because there are numerous well-established and successful investment services and insurance firms in these areas. Many of Northeast’s competitors have greater resources than Northeast. Northeast’s ability to successfully attract and retain investment services and insurance clients is dependent upon its ability to compete with competitors’ investment and insurance products, client services and marketing and distribution capabilities. If Northeast is not successful in attracting and ret aining investment services and insurance clients, its results of operations and financial condition may be negatively impacted.
Regulators may restrict distributions or require divestiture if Northeast’s subsidiaries are undercapitalized.
If an FDIC-insured depository institution, such as the Bank, fails to meet certain capital standards or requirements (such institution being referred to as an “undercapitalized institution”), the appropriate regulatory agency would be required by law to take one or more of certain specific actions with respect to such institution (for example, the regulatory agency may require the institution to issue new shares, merge with another depository institution, restrict the interest rates it pays on deposits, restrict its asset growth, terminate certain activities, have a new election for its board of directors, dismiss certain directors or officers, divest of certain subsidiaries and/or take any other action that will better resolve th e problems of the institution in a manner that will minimize the long-term loss to the FDIC) in the event the undercapitalized institution failed to submit an acceptable capital restoration plan or failed to implement such plan. If Northeast were to control an undercapitalized institution, then the Federal Reserve would be required by law to take one or more of such actions if (i) Northeast and any other company that controls the undercapitalized institution did not agree to guarantee the capital restoration plan for such undercapitalized institution or (ii) the institution was “significantly undercapitalized” as defined in regulations issued by the appropriate regulatory agency. In either case, the appropriate regulatory agency may (a) prohibit Northeast from making any capital distribution without the prior approval of such regulatory agency; (b) require Northeast to divest companies that are controlled by Northeast and that are in danger of becoming in solvent and pose a significant risk to the undercapitalized institution; and (c) require Northeast to divest the undercapitalized institution.
Negative public opinion could damage Northeast’s reputation and adversely impact business and revenues.
As a financial institution, Northeast’s earnings and capital are subject to risks associated with negative public opinion. Negative public opinion could result from Northeast’s actual or alleged conduct in any number of activities, including lending practices, the failure of any product or service sold by Northeast to meet its clients’ expectations or applicable regulatory requirements, corporate governance and acquisitions, or from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect Northeast’s ability to keep, attract and/or retain clients and can expose it to litigation and regulatory action. ;Actual or alleged conduct by one of Northeast’s businesses can result in negative public opinion about its other businesses. Negative public opinion could also affect Northeast’s credit ratings, which are important to its access to unsecured wholesale borrowings. Significant changes in these ratings could change the cost and availability of these sources of funding.
Clients could pursue alternatives to bank deposits, causing Northeast to lose a relatively inexpensive source of funding.
Checking and savings account balances and other forms of client deposits could decrease if clients perceive alternative investments, such as the stock market, as providing superior expected returns. If clients move money out of bank deposits in favor of alternative investments, Northeast could lose a relatively inexpensive source of funds, increasing its funding costs.
Consumers may decide not to use banks to complete their financial transactions, which could affect net income.
Technology and other changes now allow parties to complete financial transactions without banks. For example, consumers can pay bills and transfer funds directly without banks. This process could result in the loss of fee income, as well as the loss of client deposits and the income generated from those deposits.
Northeast’s future growth, if any, may require Northeast to raise additional capital in the future, but that capital may not be available when it is needed.
Northeast is required by regulatory authorities to maintain adequate levels of capital to support its operations. Northeast may need to raise additional capital to support its operations or its growth, if any. Northeast’s ability to raise additional capital will depend, in part, on conditions in the capital markets and Northeast’s financial performance at that time, both of which are outside Northeast’s control. Accordingly, Northeast may be unable to raise additional capital, if and when needed, on acceptable terms, or at all. If Northeast cannot raise additional capital when needed, its ability to further expand its operations through internal growth and acquisitions could be mat erially impaired. In addition, if Northeast decides to raise additional equity capital, Investors’ interest could be diluted.
Recently enacted financial reform legislation may have a significant impact on the Corporation and results of its operation.
On July 21, 2010, the President of the United States signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). The goals of the new legislation include restoring public confidence in the financial system following the 2007-2008 financial and credit crises, preventing another financial crisis and allowing regulators to identify failings in the system before another crisis can occur. Among other things, the Act creates the Financial Stability Oversight Council, with oversight authority for monitoring and regulating systemic risk, and the Bureau of Consumer Financial Protection, which will have broad regulatory and enforcement powers over consumer financial products and services. 60;The Act also changes the responsibilities of the current federal banking regulators, imposes additional corporate governance and disclosure requirements in areas such as executive compensation and proxy access, and limits or prohibits proprietary trading and hedge fund and private equity activities of banks. The scope of the Act impacts many aspects of the financial services industry, and it requires the development and adoption of many implementing regulations over the next several months and years; thus, the effects of the Act on the financial services industry will depend, in large part, upon the extent to which regulators exercise the authority granted to them under the Act and the approaches taken in implementing regulations. The Company and the entire financial services industry has begun to assess the potential impact of the Act on business and operations, but at this early stage, the likely impact cannot be ascertained with any degree of certainty. However, it would appear th at the Company is likely to be impacted by the Act in the areas of corporate governance, deposit insurance assessments, capital requirements and restrictions on fees charges that may be charged to consumers.
The principal executive and administrative offices of the Company and the Bank are located at 500 Canal Street, Lewiston, Maine ("Headquarters Building"). In 2005, the Bank entered into a 15 year lease with respect to the Headquarters Building, and we moved our principal executive and administrative offices to this four story building located in downtown Lewiston. We lease the entire building, a total of 27,000 square feet. For the first ten years of the lease, the annual rent expense is approximately $264,000. In addition to executive and administrative offices, this building also houses our operations, loan processing and underwriting, loan servicing, accounting, human resources and commercial len ding departments. We also opened a 500 square foot branch office in this building.
In addition to the branch office located in our Headquarters Building, we have nine banking branches located, and eleven insurance agency offices located in the State of Maine as set forth below.
Branch Locations | Ownership |
232 Center Street, Auburn | Lease (1) |
235 Western Avenue, Augusta | Fee Simple |
11 Main Street, Bethel | Fee Simple |
168 Maine Street, Brunswick | Fee Simple |
2 Depot Street, Buckfield | Fee Simple |
46 Main Street, Harrison | Fee Simple |
500 Canal Street, Lewiston | Lease (2) |
1399 Maine Street, Poland | Lease (3) |
77 Middle Street, Portland | Lease (4) |
235 Main Street, South Paris | Fee Simple |
|
Insurance Agency Locations | |
59 Main Street, Anson, Maine | Fee Simple |
232 Center Street, Auburn, Maine* | Lease (1) |
235 Western Avenue, Augusta, Maine* | Fee Simple |
4 Sullivan Square, Berwick, Maine | Fee Simple |
11 Main Street, Bethel, Maine* | Fee Simple |
346 Main Street, Jackman, Maine | Lease (5) |
28 Main Street, Livermore Falls, Maine | Lease (6) |
423 U. S. Route 1, Scarborough, Maine | Lease (7) |
235 Main Street, South Paris, Maine* | Fee Simple |
472 Main Street, Thomaston, Maine | Lease (8) |
10 Snell Hill Road, Turner, Maine | Fee Simple |
|
*Each of these insurance agency locations are situated in an existing bank branch location at the address indicated. |
|
(1) Lease term is ten years and expires May 1, 2016. |
(2) Lease term is 15 years and expires July 15, 2020. |
(3) Lease term is 15 years but with notice can be terminated in 10 years, and expires January 1, 2025. |
(4) Lease term is five years and expires September 30, 2012. |
(5) Lease term is one year and automatically renews in September each year. |
(6) Lease is a tenant at will. |
(7) Lease term is three years and expires July 31, 2010. The lease became a tenant at will after the expiration date. |
(8) Lease is a tenant at will. |
The Bank's investment division leases space at 202 US Route One, Falmouth, Maine, which has a term of five years and expires August 31, 2012. In addition, the Bank has purchased land in Windham, Maine and Northeast Bank Insurance Group, Inc. has purchased land in Jay, Maine. The land in Jay was under contract to sell on June 30, 2010. The sale was closed on July 9, 2010.
Northeast Bank Insurance Group, Inc. (“NBIG”) exercised its option to purchase the building occupied by the Spence & Matthews Insurance Agency located at 4 Sullivan Square, Berwick, Maine from the President of Northeast Bank Insurance Group, Inc. The transaction closed on June 24, 2009. The option price of $375,000 was determined at the time NBIG acquired the Spence & Mathews Agency in November 2007. The purchase transaction was subject to approval by the Board of Directors of Northeast Bank, the sole owner of NBIG.
On September 1, 2006, the Bank purchased its South Paris, Maine branch, previously leased from a member of our Board of Directors. The $400,000 purchase price was based upon an independent appraisal. The consideration paid was 5,000 shares of Company common stock and $297,000 in cash. The common stock issued was based on the market price on the day prior to the closing. This acquisition was not material to the balance sheet or the results of operations for the Company.
There are no material pending legal proceedings to which the Company is a party or to which any of its property is subject. There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business of banking, to which the Bank is a party or of which any of the Bank's property is the subject. There are no material pending legal proceedings to which any director, officer or affiliate of the Company, any owner of record beneficially of more than five percent of the common stock of the Company, or any associate of any such director, officer, affiliate of the Company or any security holder is a party adverse to the Company or has a material interest adverse to the Company or the Bank.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities
On September 11, 2007, the Company changed its listing from AMEX to NASDAQ. The common stock of Northeast Bancorp currently trades on the NASDAQ under the symbol "NBN". As of the close of business on September 1, 2010, there were approximately 2,331,332 shares of common stock outstanding held by approximately 411 stockholders of record.
The following table sets forth the high and low closing sale prices of the Company's Common Stock as reported on NASDAQ, and dividends paid during each quarter for periods indicated.
2009 – 2010 | High | Low | Div Pd |
Jul 1- Sep 30 | 10.00 | 7.66 | .090 |
Oct 1 - Dec 31 | 9.71 | 8.42 | .090 |
Jan 1 - Mar 31 | 15.28 | 8.50 | .090 |
Apr 1 - Jun 30 | 15.14 | 12.00 | .090 |
2008 – 2009 | High | Low | Div Pd |
Jul 1- Sep 30 | 11.97 | 9.44 | .090 |
Oct 1 - Dec 31 | 11.03 | 6.54 | .090 |
Jan 1 - Mar 31 | 8.80 | 6.61 | .090 |
Apr 1 - Jun 30 | 10.86 | 7.35 | .090 |
On September 18, 2010, the last reported sale price of the Company's Common stock as quoted on NASDAQ was $12.92. Holders of the Company's Common stock are entitled to receive dividends when and if declared by the Board of Directors out of funds legally available therefore. The amount and timing of future dividends payable on the Company's Common Stock will depend on, among other things, the financial condition of the Company, regulatory considerations, and other factors. The Company is a legal entity separate from the Bank, but its revenues are derived primarily from the Bank. Accordingly, the ability of the Company to pay cash dividends on its stock in the future generally will be dependent upon the earnings of the Bank and the B ank's ability to pay dividends to the Company. The payment of dividends by the Bank will depend on a number of factors, including capital requirements, regulatory limitations, the Bank's results of operations and financial condition, tax considerations, and general economic conditions. National banking laws regulate and restrict the ability of the Bank to pay dividends to the Company. See "Item 1.Business - Supervision and Regulation".
There were no stock repurchases under the 2006 Stock Repurchase Plan for the year ended June 30, 2010.
Unregistered Sales of Equity Securities and Use of Proceeds The following table provides the information on any purchase made by or on behalf of the Company of shares of Northeast Bancorp common stock during the indicated periods. |
Period (1) | Total Number Of Shares Purchased (2) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Program | Maximum Number of Shares that May Yet be Purchased Under The Program (3) |
Apr. 1 – Apr. 30 | - | - | - | 58,400 |
May 1 – May 31 | - | - | - | 58,400 |
Jun. 1 – Jun. 30 | - | - | - | 58,400 |
(1) | Based on trade date, not settlement date. |
(2) | Represents shares purchased in open-market transactions pursuant to the Company's 2006 Stock Repurchase Plan. |
(3) | On December 15, 2006, the Company announced that its Board of Directors of the Company approved the 2006 Stock Repurchase Plan pursuant to which the Company is authorized to repurchase in open-market transactions up to 200,000 shares of its common stock from time to time until the plan expires on December 31, 2010, unless extended. |
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Management's Discussion and Analysis of Financial Condition and Results of Operations, which follows, presents a review of the consolidated operating results of Northeast Bancorp, Inc. (the "Company") for the fiscal years ended June 30, 2010, 2009 and 2008. This discussion and analysis is intended to assist you in understanding the results of our operations and financial condition. You should read this discussion together with your review of the Company's Consolidated Financial Statements and related notes and other statistical information included in this report. Certain amounts in the years prior to 2010 have been reclassified to conform to the 2010 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 reserve adequacy, simulation of the impact of changes in interest rates, capital spending, 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. T hese 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", "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, the availability of and the costs associated with sources of liquidity and changes in the current economic climate. Accordingly, investors and others are cautioned not to place undue reliance on such forward-looking statements. For a more complete discussion of certa in risks and uncertainties affecting the Company, please see "Item 1. Business - Forward-Looking Statements and Risk Factors" set forth in this Form 10-K. 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.
CRITICAL ACCOUNTING POLICIES
Note 1 to the Consolidated Financial Statements contains a summary of Northeast Bancorp's significant accounting policies.
Allowance for Loan Losses
The allowance for loan losses represents management's estimate of probable losses inherent in the loan portfolio. The level of the allowance for loan losses is important to the presentation of the Company's results of operations and financial condition. The determination of what the loan loss allowance should be requires management to make subjective and difficult judgments, some of which may relate to matters that are inherently uncertain. Actual results may differ materially from these estimates and assumptions. This evaluation process is subject to numerous estimates and judgments. The frequency of default, risk ratings, and the loss recovery rates, among other things, a re 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 loss, the greater the negative impact on our net income. Larger balance, non-homogeneous 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, the regional economy and other factors. Management also considers overall portfolio indicators, including trends in internally risk-r ated loans, classified loans, nonaccrual 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. Each portfolio of smaller balance, homogeneous loans, including residential real estate and consumer loans, is collectively evaluated for impairment. The allowance for loan losses is established via 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 e conomic factors.
For a further description of our estimation process in determining the allowance for loan losses, see “Asset Quality” below.
GENERAL
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 Company also is a registered Maine financial institution holding company. The FRB is the primary regulator of the Company, and the Company is also subject to regulation and examination by the Superintendent of the Maine Bureau of Financial Institutions. We conduct business from our headquarters in Lewiston, Maine and, as of June 30, 2010, from 10 banking offices, one financial center and 11 insurance agency offices located in western and south-central Maine, and a mortgage loan pr oduction office in Portsmouth, New Hampshire. At June 30, 2010, we had consolidated assets of $622.2 million and consolidated stockholders' equity of $50.9 million.
Northeast Bancorp'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. In addition to the Bank’s ten branch offices, its investment brokerage division has an office in Falmouth, Maine from which investment, insurance and financial planning products and services are offered. The Bank's wholly-owned subsidiary, Northeast Bank Insurance Group, Inc. (“NBIG”), offers personal and commercial property and casualty insurance products. Four of NBIG’s eleven insurance age ncy offices operate in our Auburn, Augusta, Bethel, and South Paris, Maine branches.
Business 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 consumer loans. The Bank sells residential mortgage and commercial real estate 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 emphasizes the growth of noninterest sources of income from sale of residential mortgage loans, trust management, financial planning, investment brokerage and commissions from the sale of property and casualty insurance. The Bank's profitability depends primarily on net interest income, which is the difference between interest income earned from interest-earning assets (i.e. loans and investments) and interest expense incurred on interest-bearing liabilities (i.e. customer deposits and borrowed funds). Our net interest margin (net interest income as a percentage of average interest earning assets) is lower than our peers primarily due to our higher cost of funds. The Bank has focused on increasing the mix of demand deposit and non-maturing, interest-bearing deposit accounts which have a lower cost compared to certificates of deposit.
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 per household, increasing noninterest income from expanded trust, investment and insurance brokerage services and controlling the growth of noninterest expenses. It also is part of our business strategy to make targeted acquisitions in our current market areas from time to time when opportunities present themselves. We did not make any acquisitions duri ng the year ended June 30, 2010.
The Company's profitability is affected by the Bank's net interest income, which is affected by interest rate spread, or the difference between the average yield earned on its interest-earning assets and the average rate paid on its interest-bearing liabilities, and by interest margin, which is net interest income as a percentage of average interest-earning assets. Net income is also affected by the level of the provision for loan losses, noninterest income and noninterest expense of Northeast Bancorp and the Bank, and the effective tax rate. Noninterest income consists primarily of loan and deposit service fees, trust, investment brokerage and insurance commission revenue and gains on the sales of loans and investments. Noninterest expenses consist of compensation and benefits, occupancy related expenses, deposit insurance premiums paid to the FDIC, and other operating expenses, which include professional fees, advertising, computer services, supplies, telecommunication and postage expenses.
Economic Conditions
We believe that our market area has generally witnessed an economic decline and a decrease in residential and commercial real estate values starting in 2009 which continued from 2009 through 2010. The economy and real estate markets in our market areas will continue to be significant determinants of the quality of our assets in future periods and our results of operations, liquidity and financial condition. We believe future economic activity will significantly depend on consumer confidence, consumer spending, the value of real estate and business expenditures for new capital equipment, all of which are tied to strong employment.
EXECUTIVE SUMMARY
The following were significant factors comparing our results for fiscal 2010 to fiscal 2009:
· | During fiscal 2010, we accomplished the following strategic objectives: |
| o | Increased noninterest income by 13%; |
| o | Expanded our mortgage loan origination sales and processing division; |
| o | Increased customer demand deposits, NOW, money market and savings accounts; |
| o
| Opened a new branch in Poland, Maine, consolidating our Mechanic Falls branch into Poland and consolidating our branch at 882 Lisbon Street, Lewiston into the Gateway branch; |
| o | Sold the books of business from our insurance agency offices in Mexico and Rangeley, Maine; and |
| o | Entered into a merger agreement with FHB Formation, LLC which will add approximately $16.2 million in new capital. |
· | Net income increased to $1,718,672 for fiscal 2010 compared to $958,989 for fiscal 2009, an increase of $759,683, or 79%. Increased net interest income and noninterest income, combined with a decrease in the provision for loan losses, more than offset increases in noninterest expense from goodwill impairment, merger related professional fees, and computer services. |
· | Capital ratios for the Company and the Bank increased in fiscal 2010 compared to fiscal 2009, exceeding the regulatory definition for a “well capitalized” financial institution. |
· | The allowance for loan losses was $5,806,000 at June 30, 2010, an increase of $42,000 compared to June 30, 2009. The allowance increased as a percentage of total loans to 1.52% at June 30, 2010 compared to 1.46% at June 30, 2009. Total loans decreased $11.3 million during fiscal 2010 primarily from runoff of indirect consumer auto and RV loans. |
· | Net interest margin increased to 315 basis points in fiscal 2010 compared to 299 basis points in fiscal 2009, resulting in an increase in net interest income year over year. This increase in net interest margin was primarily due to lowering our overall cost of funds, in part from our maturing certificates of deposit resetting to lower interest rates and reducing the interest rates paid on interest-bearing, non-maturing deposits. |
RESULTS OF OPERATIONS
Comparison of Fiscal Years Ended June 30, 2010 and 2009
Overview
For the fiscal year ended June 30, 2010 ("fiscal 2010"), we reported net income of $1,718,672, or $0.63 per diluted share, as compared to $958,989, or $0.36 per diluted share, for the fiscal year ended June 30, 2009 ("fiscal 2009"), an increase of $759,683, or 79%. This increase was attributable to increases in net interest and noninterest income and a decrease in the provision for loan losses partially offset by an increase in noninterest expenses. The return on average assets was 0.28% in fiscal 2010 compared to 0.16% in fiscal 2009. The return on average equity was 3.47% in fiscal 2010 compared to 2.14% in fiscal 2009. The increase in our return on average assets and return on average equity was primarily due to the increase in net income. Average assets increased $2.2 million in fiscal 2010 compared to fiscal 2009. Similarly, average equity increased $4.7 million primarily from increased net income, other comprehensive income, and the full year impact of the preferred stock sold in fiscal 2009.
Net interest income increased by 6% in fiscal 2010 as compared to fiscal 2009. This increase was primarily due to an increase in our net interest margin of 16 basis points compared to fiscal 2009. Average interest earning assets increased approximately $2.0 million as compared to the average interest earning assets in fiscal 2009. Noninterest income increased 13% during fiscal 2010, primarily from increased fees and services charges on loans and deposits, gain on sale of residential real estate loans, investment brokerage commission and insurance commission revenue. These increases were partially offset by losses realized on the sale of personal property and real estate acquired, and lower net securities gains. The provision for loan losses decreased 11% primarily due to a decrease in net credit losses of $0.2 million in fiscal 2010 compared to fiscal 2009. Noninterest expense increased 4% during fiscal 2010, which was primarily due to goodwill impairment expense and professional fees for legal, accounting, and investment banking fees related to the pending merger with FHB Formation, LLC. Neither goodwill impairment nor merger-releated expenses are deductible for income tax purposes.
Net Interest Income
Net interest income increased by $963,281, or 6%, during fiscal 2010, primarily as a result of an increase in net interest margin. Average interest earning assets also increased $2.0 million, or less than 1%, during fiscal 2010 resulting from an increase in average available-for-sale securities of $11.5 million and an increase in average interest-bearing deposits and regulatory stock of $3.7million, partially offset by a decrease in average loans of $13.2 million. The increase in average investment securities was due to increases in mortgage-backed securities which were used as collateral for FHLB advances and letters of credit, and securities sold under agreements to repu rchase. The overall decrease in average loans was due to the decrease in average commercial, construction and consumer loans of $31.2 million which was partially offset by an $18.0 million increase in average loans held-for-sale, residential real estate and commercial real estate loans. Average interest-bearing deposits increased by $11.3 million, or 3%, during fiscal 2010 primarily due to an increase in average NOW, money market and savings accounts, which increased by $27.3 million, or 29%, partially offset by the decrease in brokered deposits of $7.4 million and certificate of deposit accounts of $8.6 million, or 7%. Average short-term borrowings increased during fiscal 2010 by $6.5 million, or 18%. Average borrowings decreased $19.7 million, or 13%, primarily from decreases in advances from the FHLB Boston and advances from Fed Discount Window borrower-in-custody program. The yield on average interest earning assets decreased 46 basis points, to 5.52%, in fisca l 2010. The cost of funds decreased 65 basis points, to 2.58%, due to a decrease in the cost of interest-bearing deposits. Table 1 provided in Item 8 of this Form 10-K shows the average balances, yields and rates of assets, liabilities, and stockholders’ equity of the Company for the past three years. The table below shows the changes from 2009 to 2010 in net interest income by category due to changes in rate and volume.
Rate/Volume Analysis for the Year Ended June 30, 2010 versus June 30, 2009 | |
| | | | | | |
| | Difference Due to | | | | |
| | Volume | | | Rate | | | Total | |
Investments | | $ | 576,823 | | | | (937,557 | ) | | | (360,734 | ) |
Loans, net | | | (826,702 | ) | | | (1,258,445 | ) | | | (2,085,147 | ) |
FHLB deposits & other | | | 26,486 | | | | (76,292 | ) | | | (49,806 | ) |
Total interest-earning assets | | | (223,393 | ) | | | (2,272,294 | ) | | | (2,495,687 | ) |
| | | | | | | | | | | | |
Deposits | | | 306,520 | | | | (2,559,922 | ) | | | (2,253,402 | ) |
Short-term borrowings | | | 115,832 | | | | (179,357 | ) | | | (63,525 | ) |
Borrowings | | | (844,350 | ) | | | (306,328 | ) | | | (1,150,678 | ) |
Total interest-bearing liabilities | | | (421,998 | ) | | | (3,045,607 | ) | | | (3,467,605 | ) |
Net interest income | | $ | 198,605 | | | | 773,313 | | | | 971,918 | |
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 above include FHLB advances, obligation under capital leases, structured repurchase agreements and junior subordinated debentures. The adjustments to interest income and yield required to make the presentation on a fully tax equivalent basis were $212,141 and $203,504 for the twelve months ended June 30, 2010 and 2009, respectively.
Provision for Loan Losses
The provision for loan losses in fiscal 2010 was $1,864,419, a decrease of $235,231, or 11%, compared to fiscal 2009. Net charge-offs were $1,822,419 in fiscal 2010 compared to $1,991,650 in fiscal 2009, a decrease of $169,231. The decrease in charge-offs was the primary reason for the decrease in the provision for loan losses for fiscal 2010. The impact of the decrease in loans on the provision for loan losses was offset by increases in loan delinquency, classified and criticized loans, net losses and nonperforming loans for fiscal 2010. Of the total net charge offs in fiscal 2010, indirect consumer loans accounted for $571,908, a 47% decrease in fiscal 2010 com pared to fiscal 2009. Net charge-offs to average loans outstanding was 0.47% in fiscal 2010 compared to 0.49% in fiscal 2009.
The allowance for loan losses at June 30, 2010 was $5,806,000 as compared to $5,764,000 at June 30, 2009, an increase of $42,000, or 1%. The ratio of the allowance to total loans was 1.52% at June 30, 2010 compared to 1.46% at June 30, 2009. The ratio of the allowance for loan losses to nonperforming loans was 66% at June 30, 2010 and 58% at June 30, 2009. The decrease in this ratio reflects a decrease of $1,053,000 in nonperforming loans, to $8,841,000 at June 30, 2010, primarily from nonperforming commercial loans and commercial real estate loans. Since our quarterly testing of the allowance for loans losses includes nonperforming loans, management believes the allowance for loan losses is sufficient to absorb the estimated credit losses associated with nonperforming loans. Of total non-performing loans at June 30, 2010 and 2009, $3,198,723 and $3,352,000, respectively, were current with principal and interest payments. Nonperforming loans were 2.31% of total loans at June 30, 2010 as compared to 2.51% at June 30, 2009. The decrease in the ratio of nonperforming loans to total loans was due to the decrease in nonperforming loans comparing fiscal 2010 to fiscal 2009. For additional information on the allowance for loan losses, see “Critical Accounting Policies” above, and see “Asset Quality” below for additional discussion on loans.
Noninterest Income
Noninterest income for the fiscal years ended June 30, 2010 and 2009 was $12,146,071 and $10,772,860, respectively, an increase of $1,373,211, or 13%, in fiscal 2010.
Fees for other services to customers of $1,503,689 increased $400,008, or 36%, during fiscal 2010. This increase was due to higher fees from a new overdraft protection program introduced in July 2009 as compared to fiscal 2009.
Net securities losses of $17,803 during fiscal 2010 changed by $286,176 from net securities gains of $268,373 in fiscal 2009. The losses in fiscal 2010 primarily resulted from sale of trust preferred securities.
Gains on the sales of loans of $1,263,600 increased $436,900, or 53%, during fiscal 2010. This increase was due to increased volume of residential real estate loans sold as the Bank expanded the mortgage loan origination division to a staff of 18 during fiscal 2010 compared to staff of 10 in fiscal 2009. The volume of loans sold in fiscal 2010 was $79 million compared to $68 million in fiscal 2009. Sold loan volume is subject to changing interest rates. Fixed rate residential real estate loans are sold to reduce our exposure to interest rate risk.
Investment commission revenue of $2,053,738 increased $465,082, or 29%, during fiscal 2010. This increase was due to expanding the sales staff to 13 in fiscal 2010 from 10 in fiscal 2009 and a general improvement in the equity markets during the same period.
Insurance commission revenue of $6,212,581 increased $347,838, or 6%, during the fiscal year 2009. The increase resulted from the impact of the increased contingent and bonus payments. The commission revenue was unchanged compared to fiscal 2009 during a continuing market of soft premiums for property and casualty insurance.
Bank owned life insurance (BOLI) income of $502,383 increased $11,074, or 2%, during fiscal 2010. The average interest yield, net of mortality cost, was 3.86% in fiscal 2010 compared to 3.98% in fiscal 2009. The additions to cash surrender value are based on this average interest yield. These interest rates are determined by the life insurance companies and are reset quarterly or annually. Each policy is subject to minimum interest rates.
Other noninterest income of $627,883 decreased $1,515, or less than 1%, during fiscal 2010. This decrease was primarily due to gains of $244,858 realized on the sales of the book of business of the Mexico and Rangeley insurance agencies net of the unamortized intangibles of $299,259 and certain fixed assets. Both were sales to in market competitors. We sold our Mechanic Falls branch following the transfer of customer accounts to our new Poland branch, resulting in a gain of $31,267. Rental revenue from the multifamily properties in Other Real Estate Owned added $90,373 to other noninterest income. These increases were partially offset by decreases in trust income of $98,417 due to exiting pension administration services, in the gains from purchase and sale of covered calls of $28,913, and an increase in losses from the disposition of acquired assets of $238,632.
Noninterest Expense
Noninterest expense for fiscal years ended June 30, 2010 and 2009 was $25,416,623 and $24,461,043, respectively, an increase of $955,580, or 4%. Our efficiency ratio, which is noninterest expense as a percentage of the total of net interest income and noninterest income, improved to 85.0% during fiscal 2010 from 88.8% in fiscal 2009. The increases in net interest income and noninterest income in fiscal 2010 compared to the prior year resulted in the change in the efficiency ratio.
Salaries and employee benefits expense of $13,919,899 increased $170,027, or 1%, during the fiscal year 2009. Total full-time equivalent employees were 242 compared to 247 at June 30, 2010 and 2009, respectively. The decrease in full-time equivalents was due to primarily to a decrease in our insurance agency staff as the result of closing offices and a decrease in our branch system staff due to consolidation. These decreases were partially offset by the expansion of a sales and processing staff for the mortgage loan origination division. The increased gains on sales of residential real estate and increased investment commissions resulted in increased compensation expense in fiscal 2010 compared to the prior year. This increase in compensation expense was partially offset by decreased compensation expense in our insurance agency and a decrease in medical plan benefits expense which returned to more normal levels as compared to fiscal 2009.
Occupancy expense of $1,864,642 increased $54,623, or 3%, during the fiscal 2010. This increase was primarily due to impairment expense of $136,691 related to the closure of insurance agency offices in Mexico and Rangeley. This increase was partially offset by a decrease in building repair and maintenance expense of $26,005, ground maintenance expense of $26,163 and utilities expense of $38,905.
Equipment expense of $1,473,620 decreased $129,899, or 8%, during the fiscal 2010. The decrease was due to lower depreciation and software maintenance expense.
Intangible asset amortization of $723,974 decreased $23,973, or 3%, in fiscal 2010 due to the sale of the customer lists of the Mexico and Rangeley offices of NBIG reducing the base of the customer list intangibles and related amortization expense from the date of sale to June 30, 2010. Through June 30, 2009, we had been acquiring insurance agencies, thereby increasing the customer list and non-compete intangibles and the related amortization.
Goodwill of $407,896 related to a bank acquisition in 1990 and carried on the balance sheet of Northeast Bancorp was impaired and expensed at June 30, 2010. The level one test required under ASC 350-20-35, “Intangibles-Goodwill and Other, Subsequent Measurement,” determined that the fair value of the Company was less than its carrying value. The fair value of the Company common stock of $13.93 per shared was based on a fairness opinion. Since the level one test was not met, the fair valuing of the Company’s consolidated balance sheet was performed. The implied goodwill resulting from subtracting the fair value of the net assets from the fa ir value of the Company was less than the carrying amount of $407,896. This result required the entire balance of goodwill on the balance sheet of the Company to be written off. The Company passed the level one test at June 30, 2009. The goodwill carried on the balance sheet of NBIG passed the level one test so no impairment was recognized.
Other noninterest expense of $7,026,592 increased $476,906, or 7%, during fiscal year 2010. This increase compared to fiscal 2009 was due to an increase in professional fees of $834,790, including $540,514 of legal, accounting, investment banking and other professional services related to the pending merger, and increases in consulting fees for IT projects, improving processes in our insurance agency, and implementing the overdraft protection program. Other noninterest expense also increased during fiscal 2010 compared to the prior year as the result of an increase in FDIC insurance expense of $26,076 due to the volume of non-deposit funding, causing our assessment rate to increase, co mputer services expenses $109,157 due to higher item processing expense, clearing charges on a higher volume of investment brokerage transactions, increased usage of Internet banking services, and dues and assessments of $44,327 primarily due to the Maine Bureau of Financial Institution safety and soundness examination fees. Partially offsetting these increases were decreases in loan expenses of $73,996 due to lower collection and problem loan workout expenses, deposit expenses of $59,282 due to an insurance payment on fraud losses in fiscal 2008, supplies expense of $24,626 and telephone expense of $31,568 due to re-negotiating vendor contracts, travel and entertainment expense of $29,425, other losses of $100,000, employee recruitment of $46,109, and a net decrease in other-than-temporary impairment expense on equity and non-marketable securities of $204,336 for fiscal 2010 compared to the prior year. The other-than-temporary impairment expenses resulted from the periodic analysis by management of imp aired securities pursuant to which management determined that recovery of cost was unlikely within a reasonable period of time for certain equity, bank–issued trust preferred securities, and non-marketable securities. The impairment expense includes no credit component impairment in fiscal 2010 compared to $98,730 of credit component impairment on debt securities in fiscal 2009.
The Company's effective tax rate was 34.2% and 3.9% for the fiscal years ended June 30, 2010 and 2008, respectively. The expenses recognized for goodwill impairment and the pending merger are not deductible for income tax purposes. See Note 12 in the Consolidated Financial Statements for additional information.
Comprehensive Income
The Company's total comprehensive income was $4,613,969 and $3,714,205 during 2010 and 2009, respectively. Comprehensive income differed from our net income in 2010 and 2009 due to the change in the fair value of available-for-sale securities, net of income tax and change in fair value of purchased interest rate caps and interest rate swaps, net of income tax. In fiscal 2010, there was a net increase in fair value of $3,306,826 attributable to an increase in net unrealized gains on available-for-sale securities, net of income tax and a decrease in fair value of $411,529 on the unrealized losses on purchased interest rate caps and interest rate swaps, net of income tax. There was a net increase in fair value in fiscal 2009 of $2,755,216 in the unrealized gains on available-for-sale securities, net of income tax. See the Consolidated Statements of Changes in Shareholders' Equity and Note 16 in the Consolidated Financial Statements for additional information.
Comparison of Fiscal Years Ended June 30, 2009 and 2008
Overview
For the fiscal year ended June 30, 2009 ("fiscal 2009"), we reported net income of $958,989, or $0.36 per diluted share, as compared to $1,931,289, or $0.82 per diluted share, for the fiscal year ended June 30, 2008 ("fiscal 2008"), an decrease of $972,300, or 50%. This decrease was attributable to an increase in the provision for loan losses and an increase in noninterest expense partially offset by an increases in net interest income and noninterest income. The return on average assets was 0.16% in fiscal 2009 compared to 0.33% in fiscal 2008. The return on average equity was 2.1% in fiscal 2009 compared to 4.63% in fiscal 2008. The decrease in our r eturn on average assets and return on average equity was primarily due to the decrease in net income. Average assets increased $31.7 million in fiscal 2009 compared to fiscal 2008, also contributing to the decrease in the return on average assets. Similarly, average equity increased $3.0 million primarily from the sale of preferred stock and contributed to the decrease in the return on average equity.
Net interest income increased by 17% in fiscal 2009 as compared to fiscal 2008. This increase was primarily due to an increase in our net interest margin of 29 basis points compared to fiscal 2008. Average interest earning assets increased approximately $28.7 million as compared to the average interest earning assets in fiscal 2008. Noninterest income increased 7% during fiscal 2009, primarily from increased insurance commission revenue, gain on sale of residential real estate loans, and higher fees and service charges on loans and deposits. These increases were partially offset by lower investment brokerage commission revenue and lower net securities gains. The provision f or loan losses increased 151% primarily due to an increase in net credit losses of $1.1 million in fiscal 2009 compared to fiscal 2008. Noninterest expense increased 15% during fiscal 2009, which was primarily due to the full year impact of three insurance agency acquisitions completed in fiscal 2008, including the amortization of intangibles, increases in benefits expense, FDIC insurance expense, loan collection expense and investment security impairment expenses.
Net Interest Income
Net interest income increased by $2,438,807, or 17%, during fiscal 2009, primarily as a result of an increase in net interest margin. Average interest earning assets also increased $28.7 million, or 5%, during fiscal 2009 resulting from an increase in average available-for-sale securities of $35.5 million and an increase in average interest-bearing deposits and regulatory stock of $2.4 million, partially offset by a decrease in average loans of $9.7 million. The increase in average investment securities was due to increases in mortgage-backed securities which were used as collateral for structured repurchase agreements, FHLB advances and letters of credit, and securities s old under agreements to repurchase. The overall decrease in average loans was due to the decrease in average residential real estate, commercial and consumer loans of $19.3 million which was partially offset by a $9.6 million increase in commercial real estate and construction loans. Average interest-bearing deposits increased by $6.0 million, or 2%, during fiscal 2009 primarily due to an increase in average money market accounts, which increased by $15.2 million, or 111%, partially offset by the decrease in brokered deposits of $4.1 million and NOW accounts of $5.3 million, or 10%. Average short-term borrowings increased during fiscal 2009 by $2.0 million, or 6%. Average borrowings increased $19.2 million, or 14%, primarily from structured repurchase agreements and advances from the Fed Discount Window borrower-in-custody program. The yield on average interest earning assets decreased 62 basis points, to 5.98%, in fiscal 2009. The cost of funds decrease d 99 basis points, to 3.23%, due to a decrease in the cost of interest-bearing deposits. Table 1 provided in Item 8 of this Form 10-K shows the average balances, yields and rates of assets, liabilities, and stockholders’ equity of the Company for the past three years. The table below shows the changes from 2008 to 2009 in net interest income by category due to changes in rate and volume.
Rate/Volume Analysis for the Year Ended June 30, 2009 versus June 30, 2008 | |
| | | | | | |
| | Difference Due to | | | | |
| | Volume | | | Rate | | | Total | |
Investments | | $ | 1,844,748 | | | $ | 170,156 | | | $ | 2,014,904 | |
Loans, net | | | (639,281 | ) | | | (2,744,528 | ) | | | (3,383,809 | ) |
FHLB deposits & other | | | 63,597 | | | | (323,424 | ) | | | (259,827 | ) |
Total interest-earning assets | | | 1,269,064 | | | | (2,897,796 | ) | | | (1,628,732 | ) |
| | | | | | | | | | | | |
Deposits | | | 233,359 | | | | (3,955,032 | ) | | | (3,721,673 | ) |
Short-term borrowings | | | 67,327 | | | | (593,674 | ) | | | (526,347 | ) |
Borrowings | | | 882,612 | | | | (705,158 | ) | | | 177,454 | |
Total interest-bearing liabilities | | | 1,183,298 | | | | (5,253,864 | ) | | | (4,070,566 | ) |
Net interest income | | $ | 85,766 | | | $ | 2,356,068 | | | $ | 2,441,834 | |
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 above include FHLB advances, obligation under capital leases, structured repurchase agreements and junior subordinated debentures. The adjustments to interest income and yield required to make the presentation on a fully tax equivalent basis were $203,504 and $200,477 for the twelve months ended June 30, 2009 and 2008, respectively.
Provision for Loan Losses
The provision for loan losses in fiscal 2009 was $2,099,650, an increase of $1,263,166, or 151%, compared to fiscal 2008. Net charge-offs were $1,991,650 in fiscal 2009 compared to $936,484 in fiscal 2008, an increase of $1,055,166. The increase in charge-offs was the primary reason for the increase in the provision for loan losses for fiscal 2009. The impact of the decrease in loans on the provision for loan losses was offset by increases in loan delinquency, classified and criticized loans, net losses and nonperforming loans for fiscal 2009. Of the total net charge offs in fiscal 2009, indirect consumer loans accounted for $1,009,566, a 172% increase in fiscal 2009 compared to fiscal 2008. Net charge-offs to average loans outstanding was 0.49% in fiscal 2009 compared to 0.23% in fiscal 2008.
The allowance for loan losses at June 30, 2009 was $5,764,000 as compared to $5,656,000 at June 30, 2008, an increase of $108,000, or 2%. The ratio of the allowance to total loans was 1.46% at June 30, 2009 compared to 1.38% at June 30, 2008. The ratio of the allowance for loan losses to nonperforming loans was 58% at June 30, 2009 and 73% at June 30, 2008. The decrease in this ratio reflects an increase of $2,191,000 in nonperforming loans, to $9,894,000, primarily from nonperforming residential real estate and commercial real estate loans. Of total non-performing loans at June 30, 2009, $3,352,000 was current with principal and interest payments. Non performing loans were 2.51% of total loans at June 30, 2009 as compared to 1.88% at June 30, 2008. The increase in the ratio of nonperforming loans to total loans was due to the increase in nonperforming loans and a decrease in total loans comparing fiscal 2009 to fiscal 2008. For additional information on the allowance for loan losses, see “Critical Accounting Policies” above, and see “Asset Quality” below for additional discussion on loans.
Noninterest Income
Noninterest income for the fiscal years ended June 30, 2009 and 2008 was $10,772,860 and $10,803,224, respectively, a decrease of $30,364, or less than 1%, in fiscal 2009. Most of this decrease was due to the decrease in investment commission income.
Fees for other services to customers of $1,103,681 increased $9,638, or 1%, during fiscal 2009. This increase was due to higher overdraft, ATM and debit card fee revenue as compared to fiscal 2008.
Net securities gains of $268,373 decreased $24,728, or 8%, during fiscal 2009. The gains in fiscal 2009 primarily resulted from restructuring the bond portfolio by selling mortgage-backed securities with significant extension risk in a rising rate environment. Extension risk is the increase in average lives of mortgage-backed securities based on the estimated reduction in loan principal prepayments as interest rates increase. Gains from the sale of equity and bond securities are subject to market and economic conditions, and there can be no assurance that gains reported in prior periods will be achieved in the future.
Gains on the sales of loans of $826,700 increased $212,106, or 35%, during fiscal 2009. This increase was due to increased volume of residential real estate loans sold as the Bank increased the number of mortgage loan originators during fiscal 2009. Sold loan volume is subject to changing interest rates. Fixed rate residential real estate loans are sold to reduce our exposure to interest rate risk.
Investment commission revenue of $1,588,656 decreased $634,279, or 29%, during fiscal 2009. This decrease was primarily due to the equity market conditions in 2009.
Insurance commissions of $5,864,743 increased $500,463, or 9%, during fiscal year 2009. The increase resulted from the full year impact of the acquisition of the Hartford, Spence & Mathews and Hyler insurance agencies acquired in fiscal 2008, accounting for $950,198, and the Goodrich Associates acquisition, accounting for $12,062, with these increases partially offset by a decrease in net bonus payments of $377,807 and a decrease in commission revenue of $83,990 from agency offices acquired prior to fiscal 2008.
Bank owned life insurance (BOLI) income of $491,309 increased $34,111, or 7%, during fiscal 2009. This increase was due to a full year impact of additional policies purchased in fiscal 2008. The average interest yield, net of mortality cost, was 3.98% in fiscal 2009 compared to 4.07% in fiscal 2008. The additions to cash surrender value are based on this average interest yield. These interest rates are determined by the life insurance companies and are reset quarterly or annually. Each policy is subject to minimum interest rates.
Other noninterest income of $651,926 decreased $69,663, or 10%, during fiscal 2009. This decrease was primarily due to decreases in trust income of $59,263 and gains from the trading of covered call options of $34,558, partially offset by the increase in loan servicing fees of $37,580.
Noninterest Expense
Noninterest expense for fiscal years ended June 30, 2009 and 2008 was $24,461,043 and $21,854,454, respectively, an increase of $2,606,589, or 12%. Our efficiency ratio, which is noninterest expense as a percentage of the total of net interest income and noninterest income, increased to 88.8% during fiscal 2009 from 86.9% in fiscal 2008. The increase in operating expenses, resulting from the full year impact of the insurance agencies acquired in fiscal 2008 and increases in group medical benefits claims expense, FDIC insurance expense and collection expense in 2009, compared to the prior year, offset the increases in net interest income and noninterest income resulting in the increase in the eff iciency ratio.
Salaries and employee benefits expense of $13,749,872 increased $730,474, or 6%, during the fiscal year 2009. This increase included the salary and employee benefits full year impact from insurance agency acquisitions in fiscal 2008 of $631,365, an increase in group medical benefits expense for our insurance agency and bank of $695,326 due to increased claims in our self-insured group medical plan and an increase in temporary help, deferred compensation and other benefits of $96,309. These increases were partially offset by a $375,205 increase in deferred costs related to the origination of loans for portfolio and held for sale. Total full-time equivalent employees were 248 compared t o 244 at June 30, 2009 and 2008, respectively.
Occupancy expense of $1,810,019 increased $17,192, or 1%, during the fiscal year 2009. This increase was primarily due to increased ground maintenance, utilities, janitorial, and depreciation expense related to the insurance agencies offices acquired in fiscal year 2008 and the new building added to the South Paris branch totaling $85,331. These increases were partially offset by a decrease in rent expense and building repair and maintenance expense of $68,139.
Equipment expense of $1,603,519 increased $16,222, or 1%, during the fiscal year 2009. The increase was due to depreciation and computer repairs and maintenance expense. These expenses were partially offset by decreases in software and vehicle depreciation expense and personal property tax expense compared to fiscal year 2008.
Intangible asset amortization of $747,947 increased $137,290, or 22%, in fiscal year 2009 from the full year impact of amortization of customer list and non-compete intangibles from insurance agency acquisitions in fiscal year 2008.
Other expense of $6,549,686 increased $1,705,411, or 35%, during fiscal year 2009. This increase compared to fiscal year 2008 was due to an increase in FDIC insurance expense of $519,716 associated with the increased cost of deposit insurance coverage to $250,000 combined with the special assessment at June 30, 2009 of $275,000 (based on total assets of the Bank less its Tier I capital), an increase in computer services expense of $190,220 resulting from higher item processing, Internet banking processing and conversions to our core software systems of recently acquired insurance agencies, collection and loan expense increasing $538,960 from the increase in the volume of loan workouts and collateral recovery, an increase in other losses of $100,000 resulting from the settlement of a lawsuit and an increase in other-than-temporary impairment expense on equity and non-marketable securities of $428,209 and $10,005, respectively, for fiscal year 2009 compared to $147,247 and $47,020, respectively, in fiscal year 2008, resulting in an aggregate increase of $243,947. These other-than-temporary impairment expenses resulted from the periodic analysis by management of impaired securities under which management determined that recovery of cost was unlikely within a reasonable period of time for certain equity, bank–issued trust preferred securities, and non-marketable securities. The impairment expense includes $98,730 of credit component impairment on debt securities in accordance with FSP FAS 115-2 and FAS 124-2. The $112,568 balance was attributable to professional fees, advertising, and postage expense increases, partially offset by decreases in other ins urance, supplies expense, deposit expense, and dues and subscriptions expense.
The Company's effective tax rate was 3.9% and 21.5% for the fiscal years ended June 30, 2009 and 2008, respectively. See Note 12 in the Consolidated Financial Statements for additional information.
Comprehensive Income
The Company's comprehensive income was $3,714,205 and $2,541,763 during fiscal year 2009 and 2008, respectively. Comprehensive income differed from our net income in 2009 and 2008 due to the change in the fair value of available-for-sale securities, net of income tax. In fiscal year 2009, there was a net increase in fair value of $2,755,216 attributable to an increase in net unrealized gains on available-for-sale securities, net of income tax. There was a net increase in fair value in fiscal year 2008 of $610,474. See the Consolidated Statements of Changes in Shareholders' Equity and Note 16 in the Consolidated Financial Statements for additional information.
FINANCIAL CONDITION/CAPITAL RESOURCES
The Company's total assets increased $24,046,070, or 4%, to $622,194,200 at June 30, 2010 compared to $598,148,130 at June 30, 2009. This increase was primarily due to a $9,749,651 increase in interest-bearing deposits, $15,777,562 increase in available-for-sale securities, $11,817,498 increase in loans held-for-sale partially offset by $11,384,245 decrease in net loans and a $2,336,735 decrease in cash and due from banks. Stockholders' equity totaled $50,906,059 and $47,316,880 at June 30, 2010 and 2009, respectively, an increase of $3,589,179. Stockholders' equity was increased by net income of $1,718,672, an increase in other comprehensive income of $2,895,297, stock opt ions exercised of $22,420, partially offset by the payment of cash dividends on common and preferred stock of $1,047,210.
Cash and Cash Equivalents
Average cash and cash equivalents (cash and due from bank and short-term investments) increased $3,334,748, or 29%, to $14,728,356 in fiscal 2010 as compared to $11,393,608 in fiscal 2009. This increase was due to an increase in interest-bearing deposits, primarily margin accounts, with the issuers of our structured repurchase agreements.
Investments Securities and Other Interest-earning Assets
The average balance of the available-for-sale securities portfolio was $163,601,174 and $152,050,639 for fiscal 2010 and fiscal 2009, respectively. This increase of $11,550,535, or 8%, was primarily due to the purchase of US Government-sponsored enterprise bonds and mortgage-backed securities. The mortgage-backed securities were pledged to wholesale repurchase agreements and substitute for cash held in margin accounts for structured repurchase agreements. The portfolio is comprised of U.S. Government-sponsored enterprise bonds and mortgage-backed securities, municipal securities, equity securities, preferred stock and bank-issued trust preferred securities, with 91% of our investment portfolio consisting of U.S. Government-sponsored enterprise mortgage-backed securities and short-term U.S. Government-sponsored enterprise bonds. See Item 8, Tables 2 and 3, for a detail of available-for-sale securities and investment maturities, respectively, and note 8 of the consolidated financial statements for details on the structured repurchase agreements
All of the Company's securities are classified as available-for-sale and were carried at fair value of $164,187,702 and $148,410,140 as of June 30, 2010 and 2009, respectively. These securities had net unrealized gains after taxes of $4,757,970 at June 30, 2010 and net unrealized losses after tax of $1,451,144 at June 30, 2009. See Note 2 to the Consolidated Financial Statements. These unrealized gains and losses do not impact net income or regulatory capital, but are recorded as an adjustment to stockholders' equity, net of related deferred income taxes, and are a component of comprehensive income contained in the Consolidated Statements of Changes in Stockholders' Equity.
Loans
The average balance for loans, including loans held-for-sale, was $392,398,366 in fiscal 2010, compared to $405,610,821 in fiscal 2009. This decrease of $13,212,455, or 3%, in our average balance for loans at June 30, 2010, was attributable to decreases in average construction, commercial, and consumer loans, partially offset by an increase in average loans held-for-sale, residential real estate, and commercial real estate loans. See Item 8, Tables 4 and 5, for additional information on the composition of the loan portfolio and loan maturities, respectively.
Residential real estate loans averaged $147,862,607 in fiscal 2010, as compared to $141,059,082 in fiscal 2009. This increase of $6,803,525, or 5%, was attributable to an increase in loans held-for-sale and residential real estate loans. We continued to sell most of the residential real estate loans originated by us into the secondary market. Residential real estate loans were 41% of the total loan portfolio at June 30, 2010, compared to 35% at 2009. Of residential real estate loans at June 30, 2010, approximately 39% were variable rate products, compared to 37% at June 30, 2009. This increase in the percentage of variable rate products resulted from an increase in home equity lines of credit.
Commercial real estate loans increased and commercial loans decreased during fiscal 2010. The increase in commercial real estate loans reflects increased market opportunity. The decrease in commercial loans reflects the Bank’s efforts to tighten its credit underwriting standards as delinquencies and classified and criticized loans increased, to price these loans to reflect risk. The competition for new and renewing commercial real estate and commercial loans has been intense.
Commercial real estate loans averaged $125,897,469 in fiscal 2010 and $114,686,143 in fiscal 2009. This increase of $11,211,326, or 10%, reflects the factors noted above. Our focus was to lend primarily to small businesses within our market areas. This portfolio consists of loans secured primarily by income-producing commercial real estate and multifamily residential real estate. Commercial real estate loans were 32% and 31% of the total loan portfolio at June 30, 2010 and 2009, respectively. Approximately 96% and 95% of the commercial real estate loans were variable rate product, with this portfolio reflecting our desire to minimize the interest rate risk, at June 30, 2010 and 2009, respectively.
Construction loans averaged $4,980,129 in fiscal 2010 and $7,329,835 in fiscal 2009. This decrease of $2,349,706, or 32%, consisted of both residential real estate and commercial construction loans. Construction loans were 2% of the total loan portfolio at June 30, 2010 and 2009, respectively. Most construction loans are subject to interest rates based on the prime rate, have contractual maturities less than 12 months, and disbursements are made on construction-as-completed basis and verified by inspection. Approximately 77% of the construction loans were variable rate product at June 30, 2010, compared to approximately 51% at June 30, 2009.
Commercial loans averaged $28,370,474 in fiscal 2010 and $29,880,572 in fiscal 2009. This decrease of $1,510,098, or 5%, reflects the above factors. Commercial loans were 8% of total loans at June 30, 2010 and 2009, respectively. Variable rate products comprised 69% and 70% of this loan portfolio at June 30, 2010 and 2009, respectively. The commercial loan credit risk exposure is highly dependent on the cash flow of the customer's business. The Company mitigates credit risk by strictly adhering to our underwriting and credit policies.
Consumer and other loans averaged $83,683,638 in fiscal 2010 and $110,286,010 in fiscal 2009. This decrease of $26,602,372, or 24%, was attributable to the Bank exiting the indirect vehicle loan business in October 2008. Consumer and other loans comprised 18% and 25% of the total loan portfolio at June 30, 2010 and 2009, respectively. Consumer and other loans, including indirect auto and recreational vehicle loans, are mostly fixed rate products. At June 30, 2010 and 2009, we held $14,168,491 and $25,862,715 of indirect auto loans, respectively. Indirect auto, indirect RV and indirect mobile home loans together comprised approximately 92% and 94% of to tal consumer and other loans, at June 30, 2010 and 2009, respectively. The detail of consumer loans at June 30, 2010 and 2009 appears in the following table. Management attempts to mitigate credit and interest rate risk by keeping the products offered short-term, earning a rate of return commensurate with the risk, and lending to individuals in the Company's known market areas. We experienced a decrease in consumer loan delinquency from 2.94% to 2.82% and a decrease in non-performing loans from $574,000 to $394,000 for the fiscal years ended June 30, 2009 and 2010, respectively. Net charge-off of consumer loans decreased from $1,308,000 to $733,000 for the fiscal years ended June 30, 2009 and 2010, respectively.
Indirect loan portfolios included in consumer and other loans are detailed in the following table.
| | Consumer Loans | | | | |
| | June 30, 2010 | | | % of Total | | | June 30, 2009 | | | % of Total | |
Indirect Auto | | $ | 14,168,491 | | | | 21 | % | | $ | 25,862,715 | | | | 27 | % |
Indirect RV | | | 35,594,893 | | | | 52 | % | | | 46,002,568 | | | | 48 | % |
Indirect Mobile Home | | | 12,996,776 | | | | 19 | % | | | 18,874,678 | | | | 19 | % |
Subtotal Indirect | | | 62,760,160 | | | | 92 | % | | | 90,739,961 | | | | 94 | % |
Other | | | 5,728,638 | | | | 8 | % | | | 5,725,006 | | | | 6 | % |
Total | | $ | 68,488,798 | | | | 100 | % | | $ | 96,464,967 | | | | 100 | % |
BOLI averaged $13,027,962 in fiscal 2010 and $12,531,526 in fiscal 2009. This increase was $496,436, or 4%. BOLI assets were invested in the general account of three insurance companies and separate accounts in a fourth insurance company. A general account policy’s cash surrender value is supported by the general assets of the insurance company. A separate account policy’s cash surrender value is supported by assets segregated from the general assets of the insurance company. Standard and Poor's rated these companies A+ or better at June 30, 2010. Interest earnings, net of mortality costs, increase the cash surrender value. ;These interest earnings are based on interest rates reset each year, subject to minimum interest rates. The increases in cash surrender value offset all or a portion of the increase in employee benefit costs. The increase in cash surrender value was recognized in other income and was 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 these reasons, management considers BOLI an illiquid asset. BOLI represented 24.46% of capital plus the allowance for loan losses at June 30, 2010.
Goodwill and intangible average assets were $4,489,383 and $7,808,337, respectively, for fiscal 2010, and $4,406,778 and $8,139,464, respectively, for fiscal 2009. The increase in average goodwill resulted from the full year impact from one insurance agency acquired late in fiscal 2009. In addition to the amortization recognized in fiscal 2010 of $560,891, customer list sales of the Mexico and Rangeley insurance agencies reduced the intangibles by $299,459. These intangibles are being amortized over lives from 10 to 24 years, with an average life of 13.67 years and a remaining average life of 11.72 years. Goodwill and intangibles are subject to impairment testing annually.& #160; Goodwill impairment expense of $407,896 was recognized in fiscal 2010. None was recognized in fiscal 2009.
Deposits
Average demand deposit accounts were $34,185,673 for the year ended June 30, 2010 as compared to $33,615,942 in fiscal 2009. The increase was $569,731, or 2%.
Average interest-bearing deposits increased by $11,289,607, or 3%, during fiscal 2010 to $346,010,418. This increase was primarily due to increased NOW, money market and savings balances, a total of $27,261,093. This increase was partially offset by decreases in average certificates of deposit balances of $8,619,440, or 4%, to $217,750,440, and in average brokered deposit balances of $7,352,046, or 53%, to $6,649,225. The increases in money market and savings accounts were due to marketing promotions, including a savings account targeted to retain maturing certificates of deposit. These increases allowed the Bank to decrease brokered time deposits as they matured . The average interest rate paid on NOW accounts decreased from 0.99% in fiscal 2009 to 0.79% in fiscal 2010. The average interest rate paid on money market accounts decreased from 1.87% in fiscal 2009 to 1.21% in fiscal 2010. The average interest rate paid on savings accounts increased from 0.36% in fiscal 2009 to 0.62% in fiscal 2010 with the average rate paid in 2010 reflecting the impact of a promotional savings account. The average interest rate paid on certificates of deposit decreased from 3.45% in fiscal 2009 to 2.68% in fiscal 2010. See Item 8, Table 10, for the scheduled maturities of certificates of deposit of $100,000 or more.
At June 30, 2010 and 2009, total deposits decreased $1,188,763, or less than 1%, to $384,197,223 from $385,385,986, respectively.
We use brokered time deposits as part of our overall funding strategy. At June 30, 2010, outstanding brokered time deposits of $4,883,250 as a percentage of total assets was 0.78%, compared to 1.82% at June 30, 2009. The average interest rate paid on brokered time deposits decreased from 4.30% in fiscal 2009 to 3.27% in fiscal 2010. Generally, interest rates paid on brokered time deposits exceed rates paid on FHLB advances with similar maturities, but the incremental interest expenses did not have a material impact on the results of operations for fiscal 2010 or fiscal 2009.
Other Funding Sources
Short-term borrowings, which consist of securities sold under repurchase agreements and other sweep accounts, Federal Home Loan Bank of Boston (FHLB) advances, Fed Discount Window Borrower-in-custody advances, structured repurchase agreements and junior subordinated debentures are the Company's sources of funding other than deposits.
Average FHLB advances for fiscal 2010 were $48,859,033, compared to $61,851,068 in fiscal 2009. This decrease was $12,992,035, or 21%. These advances had an average cost of 3.68% during fiscal 2010 compared to 3.94% during fiscal 2009. At June 30, 2010 and 2009, FHLB advances were $50,500,000 and $40,815,000, respectively, an increase of $9,685,000, or 24% reflecting our strategy to extend maturities and take advantage of low interest rates. The Company had unused advance capacity with the FHLB of $29,019,000 at June 30, 2010. Management intends to increase available FHLB advance capacity by continuing to add qualifying securities and commercial real estate loans . See Note 8 to the Consolidated Financial Statements.
Average structured repurchase agreements for fiscal 2010 were $65,000,000 compared to $58,794,521 in fiscal 2009, an increase of $6,205,479, or 11%. At June 30, 2010, structured repurchase agreements were $65,000,000 which was flat compared to June 30, 2009. The structured repurchase agreements were collateralized by acquiring and pledging U.S. Government-sponsored enterprise mortgage-backed securities as a leverage strategy to improve net interest income. The structured repurchase agreements were imbedded primarily with purchased interest rate caps to reduce the interest rate risk our liability sensitive balance sheet (interest-bearing liabilities repricing more quickly than interest - -bearing assets) has to rising interest rates. The imbedded purchased interest rate caps had a notional amount of $30 million in fiscal 2010 compared to $70 million in fiscal 2009. An imbedded purchased interest rate cap with a notional amount of $40 million and a sold interest rate floor with a notional amount of $20 million expired in fiscal 2010. All remaining purchased interest rate caps had strike rates based on three month LIBOR. The purchased interest rate caps were utilized to reduce the interest rate risk exposure to rising interest rates. See Note 8 to the Consolidated Financial Statements for additional information.
Average short-term borrowings during fiscal 2010 were $42,939,460 compared to $36,412,192 during fiscal 2009, an increase of $6,527,268, or 18% resulting from new municipal relationships. This liability was collateralized by U.S. government-sponsored enterprise bonds and mortgage-backed securities. Other sweep accounts were subject to Federal Home Loan Bank Letter of Credit coverage. See Note 8 to the Consolidated Financial Statements.
Average Fed Discount Window Borrower-in-custody advances during fiscal 2010 were zero compared to $11,584,088 during fiscal 2009. Under the terms of this credit line, the Bank has pledged its indirect auto loans and eligible municipal bonds, and the line bears an interest rate equal to the then current federal funds rate plus 0.50%. At June 30, 2010, the credit availability under the Borrower in Custody program was $19,095,000. There were no borrowings outstanding under this credit line at either June 30, 2010 or June 30, 2009, respectively.
The following is a summary of the unused borrowing capacity of the Bank at June 30, 2010 available to meet our short-term funding needs:
Brokered time deposits | | $ 149,999,000 | | Subject to policy limitation of 25% of total assets |
Federal Home Loan Bank of Boston | | 29,019,000 | | Unused advance capacity subject to eligible and qualified collateral |
Fed Discount Window Borrower-in-Custody | | 19,095,000 | | Unused credit line subject to the pledge of indirect auto loans and eligible municipal bonds |
Total Unused Borrowing Capacity | | $ 198,113,000 | | |
We had outstanding $16,496,000 at June 30, 2010 and 2009, respectively, of junior subordinated debentures issued by us to affiliated trusts. See “Capital” for more information on junior subordinated debentures and affiliated trusts.
ASSET QUALITY
Our lending and credit policies require the regular independent review of our loan portfolio to monitor our asset quality. We also maintain an internal rating system which provides a process to regularly assess the adequacy of our allowance for loan losses.
At June 30, 2010 and 2009, the allowance for loan losses was $5,806,000 and $5,764,000, respectively. The increase in the allowance for loan losses was attributable to the increase in loss factors used to determine the adequacy of the allowance for loan losses, such as increases in loan delinquencies, non-performing loans and classified and criticized loans in fiscal 2010 compared to fiscal 2009.
The allowance for loan losses as a percentage of total loans was 1.52% and 1.46% at June 30, 2010 and 2009, respectively. This increase of 6 basis points was attributable primarily to a decline in loans in fiscal 2010 compared to fiscal 2009.
Classified loans, exclusive of non-performing loans, that could potentially become non-performing due to delinquencies or marginal cash flows were $210,000 and $1,037,000 at June 30, 2010 and 2009, respectively. Significant credit losses are not expected on these loans.
The following table reflects the annual trend of total delinquencies 30 days or more past due, including loans on non-accrual status, which are not delinquent, as a percentage of total loans at June 30:
2010 | | 2009 | | 2008 | | 2007 |
3.67% | | 4.27% | | 3.64% | | 2.90% |
Non-performing Assets
Total non-performing loans were $8,841,000 and $9,894,000 at June 30, 2010 and 2009, respectively. This decrease of $1,053,000, or 11%, was attributable primarily to a decrease in commercial real estate and commercial loans. Many of these substandard loans were subject to a specific review in order to estimate the risk of loss based on the liquidation of the collateral. This risk of loss is incorporated in determining the adequacy of the allowance for loan losses and represented approximately 15% of the allowance at June 30, 2010. The following table represents non-performing loans by category as of June 30, 2010 and 2009.
Description | | June 30, 2010 | | | June 30, 2009 | |
Residential real estate | | $ | 3,002,000 | | | $ | 1,620,000 | |
Commercial real estate | | | 3,701,000 | | | | 4,373,000 | |
Commercial loans | | | 1,744,000 | | | | 3,327,000 | |
Consumer and other | | | 394,000 | | | | 574,000 | |
Total non-performing | | $ | 8,841,000 | | | $ | 9,894,000 | |
Non-performing loans as a percentage of total loans were 2.31% and 2.51% at June 30, 2010 and 2009, respectively. The allowance for loan losses was equal to 66% and 58% of total non-performing loans at June 30, 2010 and 2009, respectively. At June 30, 2010, non-performing loans included $3,199,000 of loans that are current and paying as agreed, but which the Bank classifies as non-performing until the respective borrowers have demonstrated a sustainable period of performance. Of current non-performing loans, commercial real estate and commercial loans accounted for $2,391,000 and $575,000, respectively. Excluding current non-performing loans, the total delinquencies 3 0 days and more past due as a percentage of total loans would be 2.84% and 3.42% for June 30, 2010 and 2009, respectively.
See Item 8 Table 8 for a summary of non-performing assets for the last five years.
We continue to focus on asset quality issues and allocate significant resources to credit policy and loan review. Our collection, workout and asset management functions focus on the reduction of non-performing assets. Despite this ongoing effort on asset quality, there can be no assurance that adverse changes in the real estate markets and economic conditions will not result in higher non-performing assets levels in the future and negatively impact our results of operations through higher provision for loan losses, net loan charge-offs, decreased accrual of income and increased noninterest expenses.
Residential real estate, commercial real estate, commercial, and consumer and other loans are generally placed on nonaccrual when they reach 90 days past due. Secured consumer loans are written down to realizable value and unsecured consumer loans are charged-off when they become 90 days past due. Based on our judgment, we may place on nonaccrual status and classify as non-performing loans which are currently less than 90 days past due or loans that are performing in accordance with their terms but are likely to present future principal and/or interest repayment problems.
Net charge-offs were $1,822,419 during 2010, compared to $1,991,650 in 2009. The decrease of $169,231 was primarily due to lower gross charge-offs in indirect consumer loans, partially offset by higher gross charge-offs in commercial loans and commercial real estate loans. Net charge-offs as a percentage of average loans outstanding were 0.47% and 0.49% in 2010 and 2009, respectively. See Item 8 Table 6 for more information concerning charge-offs and recoveries for the last five years.
Potential Problem Loans
Commercial real estate and commercial loans are periodically evaluated under an eight-point risk rating system. These ratings are guidelines in assessing the risk of a particular loan. We had classified commercial real estate and commercial loans totaling $17,221,000 and $17,307,000 at June 30, 2010 and 2009, respectively, as substandard or lower under our risk rating system. This increase was primarily due to commercial customer relationships experiencing weaknesses in the underlying businesses. These loans were subject to our internal specific review for the risk of loss based on the liquidation of collateral. This risk of loss was included in determ ining the adequacy of the allowance for loan loss. At June 30, 2010, $5,445,000 of this amount was non-performing commercial real estate and commercial loans. The remaining $11,776,000 of commercial real estate and commercial loans classified as substandard at June 30, 2010 evidence one or more weaknesses or potential weaknesses and may become non-performing loans in future periods.
Management actively monitors the Bank's asset quality to evaluate the adequacy of the allowance for loan losses, charges off loans against the allowance for loan losses when appropriate, establishes specific loss allowances and changes the level of the loan loss allowance. The process of evaluating the allowance involves a high degree of management judgment. The methods employed to evaluate the allowance for loan losses are quantitative in nature and consider such factors as the loan mix, the level of non-performing loans, delinquency trends, past charge-off history, loan reviews and classifications, collateral and the current economic climate. The liquidation value of coll ateral for each classified commercial real estate or commercial loan is also considered in the evaluation of the allowance for loan loss.
Management believes that the allowance for loan losses is 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 allowance for loan losses in the future as a result of changing economic conditions, adverse markets for real estate or other factors. 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. No such adjustments were proposed by the Federal Reserve Bank of Boston or the Maine Bureau of Financial Institutions based on their 2010 examination.
At June 30, 2010, the Company had acquired assets of $1,292,161, compared to $672,669 at June 30, 2009, an increase of $619,492, or 92%. Acquired assets was comprised of other real estate owned of $860,558, in substance foreclosure loans of $339,397 and other assets acquired, primarily personal property securing consumer loans repossessed by the bank, of $92,206. The real estate and personal property collateral for commercial and consumer loans is written down to its estimated realizable value upon transfer to acquired assets. Revenues and expenses are recognized in the period when received or incurred on other real estate and in substance foreclosures. Gains and loss es on disposition are recognized in noninterest income. See Note 5 of the Consolidated Financial Statements for additional information. Management periodically receives independent appraisals on acquired assets. As a result of this review and the review of the acquired assets portfolio, the Company believes the allowance for losses on acquired assets is adequate to state acquired assets at lower of cost or fair value less estimated selling costs.
A reserve for off-balance sheet credit risk is part of other liabilities. At June 30, 2009, this account balance was $19,334, compared to $22,540 at June 30, 2010. The adequacy of this balance is subject to an analysis similar to the analysis applied to the allowance for loan losses by taking into consideration outstanding letters of credit and unadvanced construction loans.
RISK MANAGEMENT
Asset-Liability Management
The Company's operating results are largely dependent upon its ability to manage interest rate risk. Interest rate risk can be defined as the exposure of the Company's net interest income to adverse movements in interest rates. Although the Company regularly manages other risks, such as credit and liquidity risk, in the normal course of its business, management considers interest rate risk to be its most significant market risk, and it could potentially have the most material effect on the Company's financial condition and results of operations.
Asset-liability management is governed by policies reviewed and approved annually by the Board. The Board delegates responsibility for asset-liability management to the Asset Liability Management Committee (ALCO) which is comprised of members of senior management who set the strategic directives that guide the day-to-day asset-liability management activities. ALCO reviews and approves all major risk, liquidity and capital management programs, except for pricing, which is approved by a subcommittee comprised of ALCO members.
The Company continues to attempt to minimize the volatility of its net interest margin by managing the relationship of interest-rate sensitive assets to interest-rate sensitive liabilities. To accomplish this, management undertakes steps to increase the percentage of variable rate assets as a percentage of its total earning assets. The focus has been to originate variable rate commercial and commercial real estate loans, which reprice or mature more quickly than similar fixed-rate loans. Variable rate residential real estate loans are originated for the loan portfolio. Fixed rate residential real estate loans are originated for sale to the secondary market. Consumer loans, including i ndirect auto and recreational vehicle loans, are primarily originated with fixed rates. The Company's adjustable-rate loans are primarily tied to published indices, such as the Wall Street Journal prime rate and one-year U.S. Treasury Bills. Management considers the Bank's assets and liabilities well matched. The balance sheet is slightly asset sensitive.
The overall objective of interest rate risk management is to deliver consistent net interest income growth over a range of possible interest rate environments. We focus on interest rates, careful review of the cash flows of investment securities, loans and deposits and other modeling assumptions and asset liability strategies to help attain our goals and objectives.
Another objective of interest rate risk management is to control our estimated exposure to interest rate risk within limits established by the asset/liability committee and approved by our Board. These limits reflect our tolerance for interest rate risk over a wide range of both short-term and long-term measurements. We also evaluate risk through liquidation or run-off measures of assets and liabilities on our balance sheet and stress test measures. Stress testing demonstrates the impact of very extreme but lower probability events. The combination of these measures gives management a comprehensive view of the possible risk to future earnings. We attem pt to control interest rate risk by identifying and quantifying these risks.
Net interest income is our largest source of revenue. Net interest income sensitivity is our primary short-term measurement used to assess the interest rate risk of our on-going business. We believe that net interest income sensitivity gives us the best perspective on how day-to-day decisions affect our interest rate risk profile. We subject estimated net interest income over a 12 month period to various rate movements using a simulation model for various specified interest rate scenarios. Simulations are run quarterly and include scenarios where market rates are shocked up and down. Our base simulation assumes that rates do not change for the next 12 months. The sensitivity measurement is calculated as a percentage variance of the net interest income simulations to the base simulation results. The results are compared to policy guidelines and are disclosed in the following table.
Assuming a 200 basis point increase and 100 basis point decrease in interest rates starting on June 30, 2010, we estimate that our net interest income in the following 12 months would increase by 2.23% if rates went up 200 basis points and increase by 1.23% if rates went down 100 basis points. These results demonstrate the asset sensitivity nature of our balance sheet under which a simulated increase in interest income would be greater than the increase in interest expense in a rising rate environment because our interest-bearing assets reprice more quickly than our interest-bearing liabilities. In a falling rate environment, the interest-bearing liabilities reprice downwar d more quickly than our interest-bearing assets. The decrease in federal funds interest rates during fiscal 2009 to 0.25% caused the interest rate simulation for decreasing rates to change to 100 basis points.
| | Up 200 Basis Points | | Down 100 Basis Points |
June 30, 2010 | | 2.23% | | 1.23% |
| | | | |
| | Up 200 Basis Points | | Down 100 Basis Points |
June 30, 2009 | | -0.34% | | 1.52% |
LIQUIDITY
On a parent Company only basis, our commitments and debt service requirements at June 30, 2010 consisted of junior subordinated notes issued to NBN Capital Trust II and NBN Capital Trust III totaling $6,186,000 due March 30, 2034 and junior subordinated debentures issued to NBN Capital Trust IV totaling $10,310,000 due February 23, 2035. NBN Capital Trust II and NBN Capital Trust III each issued $3,093,000 of junior subordinated notes with a variable interest rate based on three month LIBOR plus 2.80%, which reprice quarterly. The interest rate was 3.33% at June 30, 2010. NBN Capital Trust IV issued $10,310,000 of junior subordinated debentures with a fixed interest rate of 5.88% until February 23, 2010, when the interest rate became variable based on three month LIBOR plus 1.89%. The interest rate for NBN Capital Trust IV was 2.37% at June 30, 2010. NBN Capital Trust II and III had a call option on March 30, 2009, which was not exercised, and NBN Capital Trust IV had a call option on February 23, 2010, which also was not exercised. See Note 18 to the Consolidated Financial Statements. Based on the interest rates at June 30, 2010, the annual aggregate payments to meet the debt service of the junior subordinated debentures is approximately $451,000. Including the impact of the interest rate swap fixing the interest expense on NBN Capital Trust IV, the annual interest expense is approximately $690,000.
Affiliated Trusts | | Trust Preferred Securities | | | Common Securities | | | Junior Subordinated Debentures | | | Interest Rate | | Maturity Date |
NBN Capital Trust II | | $ | 3,000,000 | | | $ | 93,000 | | | $ | 3,093,000 | | | | 3.33 | % | March 30, 2034 |
NBN Capital Trust III | | | 3,000,000 | | | | 93,000 | | | | 3,093,000 | | | | 3.33 | % | March 30, 2034 |
NBN Capital Trust IV | | | 10,000,000 | | | | 310,000 | | | | 10,310,000 | | | | 2.37 | % | February 23, 2035 |
Total | | $ | 16,000,000 | | | $ | 496,000 | | | $ | 16,496,000 | | | | 2.73 | % | |
During the twelve months ended June 30, 2010, the Company purchased two interest rate caps and an interest rate swap to hedge the interest rate risk on the notional amounts of $6 million and $10 million, respectively, of the Company’s junior subordinated debentures. Each was a cash flow hedge to manage the risk to net interest income in a period of rising interest rates.
The interest rate caps hedge the junior subordinated debentures resulting from the issuance of trust preferred securities by our affiliates NBN Capital Trust II and III. The notional amount of $3 million for each interest rate cap represents the outstanding junior subordinated debentures from each trust. The strike rate is 2.505%. The Company will recognize higher interest expense for the first 200 basis points increase in the three-month LIBOR. Once the three-month LIBOR rate exceeds 2.505% on a quarterly reset date, there will be a payment to the Company on the following quarter end. The effective date of the purchased interest rate caps was Septembe r 30, 2009 and matures in five years.
The interest rate swap hedges the junior subordinated debt resulting from the issuance of trust preferred securities by our affiliate NBN Capital Trust IV. The notional amount of $10 million represents the outstanding junior subordinated debentures from this trust. Under the terms of the interest rate swap the Company pays fixed rate of 4.69% quarterly for a five year period from the effective date of February 23, 2010. We receive quarterly interest payments of three-month LIBOR plus 1.89% over the same term.
The principal sources of funds for us to meet parent-only obligations are dividends from our banking subsidiary, which are subject to regulatory limitations, and borrowings from public and private sources. For information on the restrictions on the payment of dividends by our banking subsidiary, see Note 9 to the Consolidated Financial Statements. Under the terms and conditions of receiving funds from the US Treasury’s Capital Purchase Program, the Company’s dividends paid to common shareholders are limited to the per share dividends paid in the quarter ended September 30, 2008 ($0.09 per share).
For our banking subsidiary, liquidity represents the ability to fund asset growth, accommodate deposit withdrawals and meet other contractual obligations and commitments. Liquidity risk is the risk that a bank cannot meet anticipated or unexpected funding requirements or can meet them only at excessive cost. Liquidity is measured by the ability to raise cash when needed at a reasonable cost. Many factors affect a bank's ability to meet liquidity needs, including variation in the markets served, its asset-liability mix, its reputation and credit standing in the market and general economic conditions.
In addition to traditional deposits, the Bank has other liquidity sources, including the proceeds from maturing securities and loans, the sale of securities, asset securitizations and borrowed funds such as FHLB and FRB Borrower-in-custody advances and brokered time deposits. We monitor and forecast our liquidity position. There are several interdependent methods used by us for this purpose, including daily review of federal funds positions, monthly review of balance sheet changes, monthly review of liquidity ratios, quarterly review of liquidity forecasts and periodic review of contingent funding plans.
At June 30, 2010, our banking subsidiary had $198 million of immediately accessible liquidity, defined as cash that could be raised within 7 days through collateralized borrowings, brokered deposits or security sales. This position represented 32% of total assets, compared to a policy minimum of 10%.
OFF-BALANCE SHEET ARRANGEMENTS & 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 Com pany 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. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counter party.
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 June 30, 2010, follows:
| | | | | Payments Due by Period | |
Contractual Obligations | | Total | | | Less Than 1 Year | | | 1-3 Years | | | 4-5 Years | | | After 5 Years | |
FHLB advances | | $ | 50,500,000 | | | | 3,000,000 | | | | 20,000,000 | | | | 12,500,000 | | | | 15,000,000 | |
Structured Repurchase Agreements | | | 65,000,000 | | | | - | | | | 40,000,000 | | | | 15,000,000 | | | | 10,000,000 | |
Junior subordinated debentures | | | 16,496,000 | | | | 16,496,000 | | | | - | | | | - | | | | - | |
Capital lease obligation | | | 2,230,630 | | | | 155,811 | | | | 335,754 | | | | 371,428 | | | | 1,367,637 | |
Other borrowings | | | 2,629,660 | | | | 496,028 | | | | 1,090,878 | | | | 1,042,754 | | | | - | |
Total long-term debt | | | 136,856,290 | | | | 20,147,839 | | | | 61,426,632 | | | | 28,914,182 | | | | 26,367,637 | |
| | | | | | | | | | | | | | | | | | | | |
Operating lease obligations | | | 1,659,449 | | | | 449,356 | | | | 627,616 | | | | 284,231 | | | | 298,246 | |
Total contractual obligations | | $ | 138,515,739 | | | | 20,597,195 | | | | 62,054,248 | | | | 29,198,413 | | | | 26,665,883 | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | Amount of Commitment Expiration - Per Period | |
Commitments with off-balance sheet risk | | Total | | | Less Than 1 Year | | | 1-3 Years | | | 4-5 Years | | | After 5 Years | |
Commitments to extend credit (1)(3) | | $ | 15,212,000 | | | | 15,212,000 | | | | - | | | | - | | | | - | |
Commitments related to loans held for sale(2) | | | 5,869,000 | | | | 5,869,000 | | | | - | | | | - | | | | - | |
Unused lines of credit (3)(4) | | | 49,225,000 | | | | 24,572,000 | | | | 2,826,000 | | | | 4,160,000 | | | | 17,667,000 | |
Standby letters of credit (5) | | | 906,000 | | | | 906,000 | | | | - | | | | - | | | | - | |
| | $ | 71,212,000 | | | | 46,559,000 | | | | 2,826,000 | | | | 4,160,000 | | | | 17,667,000 | |
(1) | Represents commitments outstanding for residential real estate, commercial real estate, and commercial loans. |
(2) | Commitments of residential real estate loans that will be held for sale. |
(3) | Loan commitments and unused lines of credit for commercial and construction loans that expire or are subject to renewal in twelve months or less. |
(4) | Represents unused lines of credit from commercial, construction, and home equity loans. |
(5) | Standby letters of credit generally expiring in twelve months. |
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 June 30, 2010 was a gain of $27,811.
CAPITAL
At June 30, 2010 and 2009, stockholders' equity totaled $50,906,059 and $47,316,880, respectively, or 8.18% and 7.91% of total assets, respectively. In addition, we had on both June 30, 2010 and 2009, $16,496,000 of junior subordinated debentures which mature in 2034 and 2035 and qualify as Tier 1 Capital. See Note 18 to the Consolidated Financial Statements. The changes in stockholders' equity include net income for the year ended June 30, 2010 of $1,718,672, stock issued for $22,420 from the exercise of stock options, and a net increase of $2,895,297 in the net unrealized gains on available-for-sale securities and the unrealized loss on interest rate caps and swap offset by common dividend payments of $835,860, and preferred stock payments of $211,350. See Note 9 to the Consolidated Financial Statements for additional information on capital ratios.
Under the terms of the US Treasury’s Capital Purchase Program, the Company must have the consent of the US 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. The Board of Directors extended the 2006 Stock Repurchase Plan to permit stock repurchases in connection with benefit plans. Although the Board of Directors may discontinue the repurchase program at any time, it is scheduled to terminate on December 31, 2010. Under the 2006 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 is classified as authorized but unissued shares of common stock available for future issuance as determined by the Board of Directors. There were no stock repurchases under the 2006 plan in fiscal years 2010 and 2009. The remaining repurchase capacity of the 2006 plan is 58,400 shares. Since inception, total stock repurchases under the 2006 plan were 141,600 shares, for $2,382,274, through June 30, 2010. Management believes that these and future purchases have not and will not have a significant impact on the Company's liquidity.
Regulatory capital guidelines require the Bank to maintain certain capital ratios. The Bank's Tier 1 Capital was $49,267,000, or 8.24% of total average assets, at June 30, 2010 compared to $45,931,000, or 7.72% of total average assets, at June 30, 2009. The increase in the Bank’s Tier 1 Capital ratio was primarily due the increase to retained earnings from the net income for the twelve months ended June 30, 2010. We are also required to maintain risk-based capital ratios based on the level of certain assets, as adjusted to reflect their perceived level of risk. Our regulatory capital ratios currently exceed all applicable requirements. See Note 9 to the Con solidated Financial Statements.
IMPACT OF INFLATION
The consolidated financial statements and related notes 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.
IMPACT OF NEW ACCOUNTING STANDARDS
Note 1 of the Consolidated Financial Statement includes the Financial Accounting Standards Board (FASB) and the SEC issued statements and interpretations affecting the Company.