2 0 1 6 A N N U A L R E P O R T
Richard Wayne
President and Chief Executive Officer
‘‘
I believe that we
have built significant
franchise value through
our diversified lending
and deposit gathering
platforms.
‘‘
Dear Shareholders,
It is with great pleasure that I report on the results of fiscal 2016.
Over the past year, we continued to execute on our business plan
and focus on our commitment to the Company’s shareholders.
This commitment is singularly focused on producing quality and
consistent returns from our balance sheet, funding our growth
cost-effectively with core deposits, and increasing shareholder
value through prudent capital management.
Year over year, Northeast grew earnings per share by 11%
to $0.80 and had a return on equity of 6.7%. This increase in
earnings was driven largely by net loan growth of 13.1%, a solid
net interest margin of 4.59%, transactional interest income
resulting from the resolution of loans purchased at a discount,
fee income from the sale of the guaranteed portion of Small
Business Administration (“SBA”) and United States Department
of Agriculture (“USDA”) loans into the secondary market, and
keeping our operating expenses in check.
To achieve our goals, we remain focused on building our
franchise through the implementation of the following business
strategies:
(cid:2) Continuing our community banking tradition. With a
history that dates to 1872, our Community Banking Division
maintains its focus on sales and service, with the goal of
attracting and retaining deposits, and serving the lending needs
of retail and commercial customers within our core markets.
(cid:2) Growing the Loan Acquisition and Servicing Group’s
(“LASG”) national origination and purchase loan business.
We purchase commercial real estate loans nationally, at prices
that on average have produced yields significantly higher
than those available on our originated loan portfolio. We also
originate loans nationally, taking advantage of our core expertise
in underwriting and servicing national credits.
(cid:2) Growing our national SBA and USDA origination business.
We originate loans on a national basis to small businesses
benefitting from partial guarantees from the SBA or USDA.
(cid:2) Generating deposits to fund our business. We offer a full
line of deposit products through our ten-branch network located
in the Community Banking Division’s market and ableBanking,
our online savings platform. We also offer state-of-the-art cash
management services.
Community Banking Division
In the Community Banking Division, we continued to further
our small business lending across Maine in order to foster job
creation and support local businesses. Working within a very
competitive market, our community bank lenders had success
in originating new loans, which aggregated $22 million for the
year, and maintaining strong relationships with our existing
customer base.
Our Residential Mortgage Division had another strong year,
generating $93.8 million in originations for fiscal 2016. We sold a
significant portion of these loans into the secondary market and
realized gains on sale totaling $1.7 million.
As part of our ongoing efforts to support our communities, we
continue to devote both monetary and volunteer resources
to worthwhile local non-profit organizations. Our Community
Involvement Volunteer Program continues to be a key driver of
employee engagement. With two days annually made available
for community service, this program allows our 175+ employees
to mobilize in response to community needs and the causes they
are passionate about.
LASG
Our LASG continued to build its national commercial loan
portfolio, generating $210.6 million in new purchases and
originations in fiscal 2016, and achieving net growth of 21%,
or $81.6 million. During the year, we purchased loans with
an aggregate unpaid principal balance of $108.7 million at an
aggregate purchase price of $100 million. At June 30, 2016, net
of pay-downs, payoffs and sales, the purchased loan portfolio
stood at $239.7 million, and produced a total return of 11.4% for
the year; a measure that includes both interest income and gains
on asset sales.
In addition, the LASG team has continued to grow the commercial
origination platform to supplement purchasing activities and to
further leverage the team’s expertise. Excluding secured loans
to broker-dealers, the originated portfolio grew by 48% to $175
million at June 30, 2016, and earned an average yield of 6.11%.
SBA Division
In fiscal 2016, we continued to capitalize on our national
credit platform by growing our SBA division. In the past year,
we originated $54.5 million of SBA and USDA loans and sold
$39 million of the guaranteed portion of these loans into the
secondary market at premiums ranging from 108.8% to 117.6%,
realizing net gains of $4.2 million for the year.
Deposits
We rely on three channels to generate the deposits necessary
to fund asset growth: our ten retail branches across Maine; our
direct savings platform, ableBanking; and time deposits through
deposit listing services. In the past year we had net deposit growth
of approximately $125 million or 19%. In fiscal 2016, 96% of the
net growth was due to an increase in our non-maturity accounts
which consist of our money market, savings and demand
deposit products. The growth in these core deposit products
has strengthened our overall deposit mix such that non-maturity
accounts represent approximately 56% of total deposits as of
June 30, 2016.
Capital Management
The Company remains dedicated to increasing shareholder
value through the sound execution of our business strategies
and prudent capital management. In the past year, because we
believed that our shares were undervalued, we repurchased
322,900 shares of Northeast stock at an average share price of
$10.40.
In addition, in fiscal 2016 the Company issued $15.05 million of
subordinated notes that qualify for Tier 2 capital treatment. The
subordinated notes will allow us to continue to implement our
growth strategy, and diversify our capital mix, with a source of
non-dilutive, low-cost capital.
With the share buyback and issuance of subordinated notes, our
capital position remains strong, with a Tier 1 leverage ratio of
13.27% and a Total capital ratio of 20.39%.
* * *
I am very proud of our achievements in fiscal 2016, and excited
about what the future holds for our Company and shareholders.
I believe that we have built significant franchise value through
our diversified lending and deposit gathering platforms. Each
day, our management team and Board are focused on achieving
the goals that we set for ourselves at the beginning of each
fiscal year. We believe our operational capacity, lending expertise
and capital resources leave us very well-positioned to achieve
those goals.
Thank you for your continued support.
Sincerely,
Richard Wayne
President and Chief Executive Officer
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
(cid:2)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2016
(cid:3)
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
OR
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:
Voting Common Stock, $1.00 par value
Name of each exchange on which registered:
The NASDAQ Stock Market LLC
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 (cid:3) No (cid:2)
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 (cid:3) No (cid:2)
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 (cid:2) No (cid:3)
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 (cid:2) No (cid:3)
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. (cid:3)
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 “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
Non-accelerated filer
(cid:3)
(cid:3)
Accelerated filer
Smaller Reporting Company
(cid:2)
(cid:2)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes (cid:3) No (cid:2)
The aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates, computed by reference to the last reported sales
price of the registrant’s voting common stock on the NASDAQ Global Market on December 31, 2015 was approximately $76,592,849.
As of September 2, 2016, the registrant had outstanding 7,487,552 shares of voting common stock, $1.00 par value per share, and 1,343,683 shares of non-
voting common stock, $1.00 par value per share.
Portions of the registrant’s proxy statement for the 2016 Annual Meeting of Shareholders to be held on November 22, 2016 are incorporated by reference
in Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K. The registrant intends to file such proxy statement with the Securities and
Exchange Commission no later than 120 days after the end of its fiscal year ended June 30, 2016.
DOCUMENTS INCORPORATED BY REFERENCE
The Company has determined that as of the end of its fiscal year ended June 30, 2016, it is an accelerated filer as defined in Rule 12b-2 promulgated under
the Securities Exchange Act of 1934, as amended. As permitted by Item 10(f) of Regulation S-K, the Company is providing scaled disclosure applicable to
smaller reporting companies in this Annual Report on Form 10-K.
EXPLANATORY NOTE
This page intentionally left blank
Part I.
Table of Contents
Item 1. Business ..................................................................................................................................................
1
Item 1A. Risk Factors ............................................................................................................................................
16
Item 1B. Unresolved Staff Comments ...................................................................................................................
24
Item 2. Properties ................................................................................................................................................
24
Item 3. Legal Proceedings ..................................................................................................................................
24
Item 4. Mine Safety Disclosures .........................................................................................................................
24
Part II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of
Equity Securities .....................................................................................................................................
25
Item 6. Selected Financial Data ..........................................................................................................................
27
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations .................
28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ................................................................
48
Item 8. Financial Statements and Supplementary Data ......................................................................................
49
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .................
93
Item 9A Controls and Procedures .........................................................................................................................
93
Item 9.B Other Information ...................................................................................................................................
96
Part III
Item 10. Directors, Executive Officers and Corporate Governance .....................................................................
96
Item 11. Executive Compensation ........................................................................................................................
96
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
96
Item 13. Certain Relationships and Related Transactions, and Director Independence .......................................
96
Item 14. Principal Accounting Fees and Services.................................................................................................
96
Part IV
Item 15. Exhibits, Financial Statement Schedules ...............................................................................................
97
i
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,
as amended and Section 21E of the Securities Exchange Act of 1934, as amended, such as statements relating to the financial
condition, prospective results of operations, future performance or expectations, plans, objectives, prospects, loan loss
allowance adequacy, simulation of changes in interest rates, capital spending, finance sources and revenue sources of
Northeast Bancorp ("we," "our," "us," "Northeast" or the "Company"). These statements relate to expectations concerning
matters that are not historical facts. Accordingly, statements that are based on management's projections, estimates,
assumptions, and judgments constitute forward-looking statements. These forward looking statements, which are based on
various assumptions (some of which are beyond the Company's control), may be identified by reference to a future period or
periods, or by the use of forward-looking terminology such as "believe", "expect", "estimate", "anticipate", "continue", "plan",
"approximately", "intend", "objective", "goal", "project", or other similar terms or variations on those terms, or the future or
conditional verbs such as "will", "may", "should", "could", and "would".
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 the Company believes 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, the Company
cannot give you any assurance that its expectations will in fact occur or that its estimates or assumptions will be correct. The
Company cautions you that actual results could differ materially from those expressed or implied by such forward-looking
statements as a result of, among other factors, the factors referenced in this report under Item 1A. "Risk Factors"; changes in
interest rates; competitive pressures from other financial institutions; the effects of a deterioration in general economic
conditions on a national basis or in the local markets in which the Company operates, including changes which adversely
affect borrowers' ability to service and repay our loans; changes in loan defaults and charge-off rates; changes in the value of
securities and other assets, adequacy of loan loss reserves, or deposit levels necessitating increased borrowing to fund loans
and investments; changes in government regulation; the risk that we may not be successful in the implementation of our
business strategy; the risk that intangibles recorded in the Company's financial statements will become impaired; and changes
in assumptions used in making such forward-looking statements. These forward-looking statements speak only as of the date
of this report and the Company does 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.
ii
Item 1.
Business
Overview
PART I
Northeast Bancorp, incorporated under Maine law in 1987, is a bank holding company, registered with the Board of
Governors of the Federal Reserve System (the "Federal Reserve") under the Bank Holding Company Act of 1956, as
amended. The Company's primary subsidiary and principal asset is its wholly-owned banking subsidiary, Northeast Bank
(the "Bank" or "Northeast Bank"), a Maine state-chartered bank originally organized in 1872.
On December 29, 2010, the merger of the Company and FHB Formation LLC, a Delaware limited liability company ("FHB"),
was consummated. In connection with the transaction, as part of the regulatory approval process, the Company and the Bank
made certain commitments to the Federal Reserve, the most significant of which are (i) to maintain a Tier 1 leverage ratio of
at least 10%, (ii) to maintain a total capital ratio of at least 15%, (iii) to limit purchased loans to 40% of total loans, (iv) to
fund 100% of the Company's loans with core deposits (defined as non-maturity deposits and non-brokered insured time
deposits), and (v) to hold commercial real estate loans (including owner-occupied commercial real estate) to within 300% of
total capital. On June 28, 2013, the Federal Reserve approved the amendment of the commitment to hold commercial real
estate loans to within 300% of total capital to exclude owner-occupied commercial real estate loans. All other commitments
made to the Federal Reserve in connection with the merger remain unchanged. The Company and the Bank are currently in
compliance with all commitments to the Federal Reserve.
As of June 30, 2016, the Company, on a consolidated basis, had total assets of $986.2 million, total deposits of $800.4 million,
and shareholders' equity of $116.6 million. We gather retail deposits through the Community Banking Division's ten full-
service branches in Maine and through its online deposit program, ableBanking; originate loans through the Community
Banking Division; purchase and originate commercial loans on a nationwide basis through the Bank’s Loan Acquisition and
Servicing Group ("LASG"); and originate Small Business Administration ("SBA") loans on a nationwide basis through the
Bank’s national SBA group ("SBA Division").
Unless the context otherwise requires, references herein to the Company include the Company and its subsidiary on a
consolidated basis.
Strategy
The Company's goal is to prudently grow its franchise, while maintaining sound operations and risk management, by
implementing the following strategies:
Continuing our community banking tradition. With a history that dates to 1872, our Community Banking Division maintains
its focus on sales and service, with the goal of attracting and retaining deposits, and serving the lending needs of retail and
commercial customers within our core markets.
Growing LASG’s national originated and purchased loan business. We purchase commercial real estate loans nationally, at
prices that on average have produced yields significantly higher than those available on our originated loan portfolio. We
also originate loans nationally, taking advantage of our core expertise in underwriting and servicing national credits.
Growing our national SBA origination business. We originate loans on a national basis to small businesses, primarily through
the SBA 7(a) program, which provides the partial guarantee of the SBA.
Generating deposits to fund our business. We offer a full line of deposit products through our ten-branch network located in
the Community Banking Division’s market. ableBanking is a direct savings platform providing an additional channel to raise
core deposits to fund our asset strategy.
Market Area and Competition
The Community Banking Division’s market area includes the six New England states, with the majority of its activities
centered in the western and central regions of the State of Maine. We encounter significant competition in the Community
Banking Division market area in originating loans, attracting deposits, and selling other customer products and services. Our
competitors include savings banks, commercial banks, credit unions, mutual funds, insurance companies, brokerage and
investment banking companies, finance companies, and other financial intermediaries. Many of our primary competitors
there have substantially greater resources, larger established customer bases, higher lending limits, extensive branch
1
networks, numerous ATMs and greater advertising and marketing budgets. They may also offer services that we do not
currently provide. ableBanking has nationwide scope in its deposit gathering activities and competes with banks and credit
unions, as well as other, larger, online direct banks having a national reach.
The LASG, the SBA Division and ableBanking activities are nationwide. The LASG competes primarily with community
banks, regional banks and private equity funds operating nationwide in its bid to acquire commercial loans. We believe that
we often have a competitive advantage in bidding against private equity funds on performing loans because those funds
generally have higher funding costs and, therefore, higher expectations for return on investment than we do. Furthermore,
private equity funds typically do not compete for small balance commercial loans and typically pursue larger, bulk
transactions. Due to improving credit quality over the past several years and the continued low interest rate environment, the
supply of loans available for purchase has declined, competition has increased, and spreads have tightened. Despite these
trends, we believe that the LASG continues to have a competitive advantage in bidding against other banks because we have
a specialized group with experience in purchasing commercial real estate loans. Additionally, most banks we compete against
are community banks looking to acquire loans in their market; these banks usually have specific criteria for their acquisition
activities and do not pursue pools with collateral or geographic diversity.
The SBA Division competes primarily with community banks, regional banks, national/global banks, and non-bank licensed
lenders on a nationwide basis. Capitalizing on our LASG origination loan infrastructure, the SBA Division is in a position to
review and act quickly on a variety of lending opportunities. Risk management, approvals, underwriting and other due
diligence for these loans is similar to that for the LASG loans. We believe that the SBA Division has an advantage in
originating commercial loans because of its ability to utilize in-house staff to quickly and accurately screen loan opportunities
and accelerate the underwriting process.
Lending Activities
General
We conduct our loan-related activities through three primary channels: the Community Banking Division, the LASG, and
the SBA Division. The Community Banking Division originates loans directly to consumers and businesses located in its
market area. The LASG purchases primarily performing commercial real estate loans, on a nationwide basis, typically at a
discount from their outstanding principal balances, producing yields higher than those normally achieved on the Company's
originated loan portfolio. The LASG also originates commercial real estate and commercial and industrial loans on a
nationwide basis. The SBA Division originates loans to small businesses, primarily through the SBA 7(a) program, which
provides the partial guarantee of the SBA. At June 30, 2016, our total loan portfolio (excluding loans held for sale) was
$692.4 million, of which $203.4 million, or 29.4%, was originated by the Community Banking Division, $462.6 million, or
66.8%, was purchased or originated by the LASG and $26.4 million, or 3.8%, was originated by the SBA Division.
2
The following table sets forth certain information concerning our portfolio loan purchases and originations for the periods
indicated (including loans held for sale):
Loans, including loans held for sale, beginning of year .................................. $
Additions:
LASG Purchases and Originations:
Originations ..............................................................................................
Purchases ..................................................................................................
Subtotal .................................................................................................
SBA Division Originations ..........................................................................
Community Bank Originations:
Residential mortgages held for sale .........................................................
Residential mortgage held to maturity .....................................................
Home equity .............................................................................................
Commercial real estate .............................................................................
Commercial and industrial .......................................................................
Consumer .................................................................................................
Subtotal .................................................................................................
Total originations and purchases .................................................................
Reductions:
Sales of residential loans held for sale .........................................................
Sales of portfolio loans ................................................................................
Charge-offs ..................................................................................................
Pay-downs and amortization, net .................................................................
Total reductions ...........................................................................................
Loans, including loans held for sale, end of year ............................................ $
Annual percentage increase in loans ...............................................................
Year Ended June 30,
2016
2015
(Dollars in thousands)
621,172
$
528,361
110,578
99,999
210,577
54,469
90,011
3,828
765
15,029
6,973
185
116,791
381,837
(89,901 )
(39,081 )
(1,265 )
(172,807 )
(303,054 )
$
699,955
12.68 %
130,502
82,654
213,156
34,544
97,438
7,857
1,024
13,580
6,317
211
126,427
374,127
(106,045)
(22,351)
(238)
(152,682)
(281,316)
621,172
17.57%
We individually underwrite all loans that we originate and purchase. Our loan underwriting policies are reviewed and
approved annually by our Board of Directors. Each loan, regardless of whether it is originated or purchased, must meet
underwriting criteria set forth in our lending policies and the requirements of applicable federal and state regulations. All
loans are subject to approval procedures and amount limitations, and the Board approves loan relationships exceeding certain
prescribed dollar limits. Our policies are reviewed and approved at least annually by our Board of Directors. We supplement
our own supervision of the loan underwriting and approval process with periodic loan audits by internal personnel and outside
professionals experienced in loan review. As of June 30, 2016, the Bank’s legal lending limit was $24.0 million.
We typically retain servicing rights for all loans that we originate or purchase, except for residential loans that we originate
and sell servicing released in the secondary market.
Community Banking Division Originations
Loan Portfolio. The Community Banking Division’s loan portfolio consists primarily of loans to businesses and consumers
in the Community Banking Division's market area.
(cid:2) Residential Mortgage Loans. We originate residential mortgage loans secured by one- to four-family properties
throughout Maine, southern New Hampshire, and Massachusetts. Such loans may be originated for sale in the secondary
market or to be held on the Bank's balance sheet. We also offer home equity loans and home equity lines of credit, which
are secured by first or second mortgages on one- to four-family owner-occupied properties and which are held on our
balance sheet. At June 30, 2016, portfolio residential loans totaled $111.3 million, or 16.1% of total loans. Of the
residential loans we held for investment at June 30, 2016, approximately 51.6% were adjustable rate. Included in
residential loans are home equity lines of credit and other second mortgage loans aggregating approximately
$18.0 million.
3
(cid:2) Commercial Real Estate Loans. We originate multi-family and other commercial real estate loans secured by property
located primarily in the Community Banking Division's market area. At June 30, 2016, commercial real estate loans
outstanding were $70.1 million, or 10.1% of total loans. Although the largest commercial real estate loan originated by
the Community Banking Division had a principal balance of $4.1 million at June 30, 2016, the majority of the
commercial real estate loans originated by the Community Banking Division had principal balances less than
$500 thousand.
(cid:2) Commercial and industrial Loans. We originate commercial and industrial loans, including term loans, lines of credit
and equipment and receivables financing to businesses located primarily in the Community Banking Division's market
area. At June 30, 2016, commercial and industrial loans outstanding were $16.1 million, or 2.3% of total loans. At
June 30, 2016, there were 112 commercial and industrial loans outstanding with an average principal balance of
$143 thousand. The largest of these commercial and industrial loans had a principal balance of $2.3 million at June 30,
2016.
(cid:2) Consumer Loans. We originate, on a direct basis, automobile, boat and recreational vehicle loans. At June 30, 2016,
consumer loans outstanding were $6.0 million, or 0.9% of total loans.
Underwriting of Loans. Most residential loans, including those held for investment, are originated in accordance with the
standards of the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, the Federal Housing
Authority, or other third party correspondent lenders. Our underwriting process for all other loans originated by the
Community Banking Division is as follows:
(cid:2) Most of our Community Bank originated loans are sourced through relationships between loan officers and third party
referral sources or current or previous customers.
(cid:2) After a loan officer has taken basic information from the borrower, the request is submitted to the Community Banking
Division's loan production department. The loan production department obtains comprehensive information from the
borrower and third parties, and conducts verification and analysis of the borrower information, which is assembled into
a single underwriting package that is submitted for final approval.
LASG Purchases and Originations
General. Of the loans originated or purchased by the LASG that were outstanding as of June 30, 2016, $336.4 million, or
72.7%, consisted of commercial real estate loans. The following table summarizes the LASG loan portfolio as of June 30,
2016:
Non-owner occupied commercial real estate ................... $
Owner occupied commercial real estate ...........................
Commercial and industrial ...............................................
1-4 family residential .......................................................
Total ................................................................................. $
142,286 $
94,666
198
2,559
239,709 $
52,744 $
46,727
123,447
-
222,918 $
195,030
141,393
123,645
2,559
462,627
Purchased
Originated
(Dollars in thousands)
Total
Since the inception of the LASG through June 30, 2016, we have purchased loans for an aggregate investment of $486
million, of which $100.0 million was purchased during fiscal 2016. We have also originated loans totaling $346 million, of
which $110.6 million was originated in fiscal 2016. As of June 30, 2016, the unpaid principal balance of loans purchased or
originated by the LASG ranged from $1 thousand to $12.0 million and, excluding secured loans to broker-dealers, have an
average balance of $756 thousand. Included in the balance are non-real estate secured loans to broker-dealers, which have
balances of $12.0 million each. The real estate loans were secured principally by retail, industrial, hospitality, multi-family
and office properties in 36 states.
4
The following table shows the LASG loan portfolio stratified by book value as of June 30, 2016, excluding deferred fees and
costs:
Range
Amount
Percent of Total
(Dollars in thousands)
$0 - $500 ........................................................................................ $
$500 - $1,000 .................................................................................
$1,000 - $2,000 ..............................................................................
$2,000 - $3,000 ..............................................................................
$3,000 - $4,000 ..............................................................................
Greater than $4,000 ........................................................................
$
58,644
74,481
105,202
54,915
37,313
131,487
462,042
12.69%
16.12%
22.77%
11.89%
8.08%
28.45%
100.00%
The following tables show the LASG loan portfolio by location and type of collateral as of June 30, 2016, excluding deferred
fees and costs:
Collateral Type
Multifamily .......... $
Office ...................
Hospitality ............
Retail ....................
Industrial ..............
Securities ..............
Other real estate ....
All other ...............
$
Percent of Total State
Amount
(Dollars in
thousands)
Percent of Total
Amount
(Dollars in
thousands)
42,881
37,809
67,450
70,266
67,970
54,346
37,084
84,236
462,042
9.28% CA ..................... $
8.18% NY .....................
14.60% NJ ......................
15.21% FL ......................
14.71% AZ .....................
11.76%
IL .......................
8.03% TX .....................
18.23% Non-real estate ..
100.00% All other ............
$
65,591
69,300
32,586
14,958
17,858
14,461
19,349
74,164
153,775
462,042
14.20%
15.00%
7.05%
3.24%
3.86%
3.13%
4.19%
16.05%
33.28%
100.00%
Loan Purchase Strategies. The LASG's loan purchasing strategy involves the acquisition of commercial loans, typically
secured by real estate or other business assets located throughout the United States.
We acquire commercial loans typically at a discount to their unpaid principal balances. While we acquire loans on a
nationwide basis, we seek to avoid significant concentration in any geographic region or in any one collateral type. We do
not seek acquisition opportunities for which the primary collateral is land, construction, or one- to four-family residential
property, although in a very limited number of cases, loans secured by such collateral may be included in a pool of otherwise
desirable loans. Purchased loans are sourced on a nationwide basis from banks, insurance companies, investment funds and
government agencies, either directly or indirectly through advisors.
We focus on servicing released, whole loan or lead participation transactions so that we can control the management of the
portfolio through our experienced asset management professionals. Purchased loans can be acquired as a single relationship
or combined with other borrowers in a larger pool. Loans are bid to a minimal acceptable yield to maturity based on the
overall risk of the loan, including expected repayment terms and the underlying collateral value. Updated loan-to-value ratios
and loan terms both influence the amount of discount the Bank requires in determining whether a loan meets the Bank's
guidelines. We often achieve actual results in excess of our minimal acceptable yield to maturity when a loan is prepaid.
At June 30, 2016, purchased loans had an unpaid principal balance of $271.3 million and a book value of $239.7 million,
representing discount across the portfolio of 11.6%.
5
The following table shows the purchased loan portfolio as of June 30, 2016 by original purchase price percentage:
Initial Investment as a % of
Unpaid Principal Balance
Amount
(Dollars in
thousands)
Percent of Total
0% - 60% ................................................................................................. $
60% - 70% ...............................................................................................
70% - 80% ...............................................................................................
80% - 90% ...............................................................................................
>90% .......................................................................................................
$
4,355
4,065
21,412
62,959
146,918
239,709
1.82%
1.70%
8.93%
26.26%
61.29%
100.00%
Secondary Market for Commercial Loans. Commercial whole loans are typically sold either directly by sellers or through
loan sale advisors. Because a central database for commercial whole loan transactions does not exist, we attempt to compile
our own statistics by both polling major loan sale advisors to obtain their aggregate trading volume and tracking the deal flow
that we see directly via a proprietary database. This data reflects only a portion of the total market, as commercial whole
loans that are sold in private direct sales or through other loan sale advisors are not included in our surveys. In recent years,
the ratio of performing loans to total loans in the market has increased, in part, because sellers have worked through their
most troubled, non-performing loans or are looking to minimize the discount they would receive in a secondary market
transaction. While the 2008-2010 economic crisis led to a high level of trading volume, we also expect the market to remain
active in times of economic prosperity, as sellers tend to have additional reserve capacity to sell their unwanted assets.
Furthermore, we believe that the continued consolidation of the banking industry will create secondary market activity as
acquirers often sell non-strategic borrowing relationships or assets that create excess loan concentrations.
Underwriting of Purchased Loans. We review many loan purchase opportunities and commence underwriting on a relatively
small percentage of them. During fiscal 2016, we reviewed approximately 105 transactions representing loans with
$799.8 million in unpaid principal balance. Of those transactions that we reviewed, we placed bids in 61 transactions
representing loans with $255.7 million in unpaid principal balance. Ultimately, we closed 35 transactions in which we
acquired $108.7 million in unpaid principal balance for an aggregate purchase price of $100.0 million, or 92.0% of the unpaid
principal balance.
Purchased loans are underwritten by a team of in-house, seasoned analysts before being considered for approval. Prior to
commencing underwriting, loans are analyzed for performance characteristics, loan terms, collateral quality, and price
expectations. We also consider whether the loans would make our total purchased loan portfolio more or less diverse with
respect to geography, loan type and collateral type. The opportunity is underwritten once it has been identified as fitting our
investment parameters. While the extent of underwriting may vary based on investment size, procedures generally include
the following:
(cid:2) A loan analyst reviews and analyzes the seller credit file and our own internal and third party research in order to
assess credit risk.
(cid:2) With the assistance of local counsel, where appropriate, an in-house attorney makes a determination regarding the
quality of loan documentation and enforceability of loan terms.
(cid:2) An in-house real estate specialist performs real estate collateral evaluations, which includes conducting original
market research for trends and sale and lease comparables, and develops a valuation based on current data reflecting
what we believe are recent trends.
(cid:2) An environmental assessment is performed on real estate collateral where appropriate.
(cid:2) A property inspection is generally performed on all real estate collateral securing a loan, focusing on several
characteristics, including, among other things, the physical quality of the property, current occupancy, general
quality and occupancy within the neighborhood, market position and nearby property listings.
(cid:2) An underwriting package containing the analysis and results is reviewed and submitted for approval by the LASG
Credit Committee.
6
Collateral Valuation. The estimated value of the real property collateralizing the loan is determined by the LASG's in-house
real estate group, which considers, among other factors, the type of property, its condition, location and its highest and best
use in its marketplace. An inspection is conducted for the real property securing all loans bid upon. For loans that exceed a
certain dollar threshold as prescribed in our credit policy, members of the LASG typically conduct an in-person site
inspection.
We generally view cash flow from operations as the primary source of repayment on purchased loans. The LASG analyzes
the current and likely future cash flows generated by the collateral to repay the loan. Also considered are minimum debt
service coverage ratios, consisting of the ratio of net operating income to total principal and interest payments. Consideration
of the debt service coverage ratio is critical to the pricing and rating of purchased and originated loans, and is analyzed
carefully. For purchased loans, care is taken to ensure that, unless significantly offset by other factors in the credit, the
purchase price results in an adjusted debt service coverage ratio that is within the Bank’s lending limits. Moreover, if the debt
service coverage ratio based on the contractual payments, regardless of the Bank’s exposure, is significantly below 1.0x, then
steps are taken to document alternative sources of repayment or develop a realistic plan to ensure continued performance of
the loan.
Loan Pricing. In determining the amount that we are willing to bid to acquire individual loans or loan pools, the LASG
considers the following:
(cid:2) Collateral securing the loan;
(cid:2) Geographic location;
(cid:2) Financial resources of the borrower or guarantors, if any;
(cid:2) Recourse nature of the loan;
(cid:2) Age and performance of the loan;
(cid:2) Length of time during which the loan has performed in accordance with its repayment term;
(cid:2) Yield expected to be earned; and
(cid:2) Servicing restrictions, if any.
In addition to the factors listed above and despite the fact that purchased loans are typically performing loans, the LASG also
estimates the amount that we may realize through collection efforts or foreclosure and sale of the collateral, net of expenses,
and the length of time and costs required to complete the collection or foreclosure process in the event a loan becomes non-
performing or is non-performing at the time of purchase.
Loan Originations. In addition to purchasing loans, the LASG also originates commercial loans on a nationwide basis.
Capitalizing on our purchased loan infrastructure, the LASG is in a position to review and act quickly on a variety of lending
opportunities. Risk management, approvals, underwriting and other due diligence for these loans is similar to that for
purchased loans, other than the appraisal and documentation process, which mirrors the Community Banking Division’s
practice of employing local attorneys and real estate appraisers to assist in the process. We believe that the LASG has an
advantage in originating commercial loans because of its ability to utilize in-house staff to quickly and accurately screen loan
opportunities and accelerate the underwriting process.
Loan Servicing. We conduct all loan servicing for purchased and originated loans with an in-house team of experienced asset
managers who actively manage the loan portfolio. Asset managers initiate and maintain regular borrower contact, and ensure
that the loan credit analysis is accurate. Collateral valuations, property inspections, and other collateral characteristics are
updated periodically as a result of our ongoing in-house real estate analysis. All asset management activity and analysis is
contained within a central database.
SBA Division
General. The SBA Division, launched in November 2014, originates loans to small businesses nationwide, most often through
the SBA's 7(a) program, which provides a partial government guarantee. Our loans are typically secured by liens on business
assets and mortgages on commercial properties, and also benefit from SBA guarantees. We seek to build a loan portfolio that
is diverse with respect to geography, loan type and collateral type.
7
The following table summarizes the SBA Division loan portfolio as of June 30, 2016:
SBA Division
(Dollars in
thousands)
Non-owner occupied commercial real estate ........................................................................................ $
Owner occupied commercial real estate ................................................................................................
Commercial and industrial ....................................................................................................................
1-4 family residential ............................................................................................................................
Total ...................................................................................................................................................... $
5,639
14,414
6,242
133
26,428
The Company's SBA loan portfolio includes owner and non-owner occupied loans as defined under regulatory call report
instructions. The regulatory call report instructions primarily consider the primary source of repayment on the loan for this
determination. However, these loans meet the SBA requirements to be considered owner occupied as the owner or controlling
entity are actively involved in the daily operations of the underlying core business.
In addition to the loans held in the SBA Division loan portfolio, as of June 30, 2016, $1.1 million in the loans held for sale
portfolio were attributable to the SBA Division, consisting of the guaranteed portion of the SBA Division loans that we expect
to sell in the secondary market.
Secondary Market for SBA Guarantees. We typically sell the SBA-guaranteed portion of our variable-rate originations
(generally 75% of the principal balance) at a premium in the secondary market. We generally retain a 25% unguaranteed
interest and the accompanying servicing rights to the entire loan. We hold most fixed-rate SBA loan originations in portfolio.
Underwriting of SBA Division Loans. Our loan policies and procedures establish guidelines governing our SBA lending
program. Generally, these guidelines address the types of loans that we seek, target markets, underwriting and collateral
requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines
are subject to approval procedures and amount limitations. Our policies are reviewed and approved at least annually by our
Board of Directors to ensure that we are following SBA underwriting guidelines.
Loan Servicing. We conduct all loan servicing for SBA Division loans with an in-house team of experienced asset managers
who actively manage the loan portfolio. Asset managers initiate and maintain regular borrower contact, and ensure that the
loan credit analysis is accurate. Collateral valuations, property inspections, and other collateral characteristics are updated
periodically as a result of our ongoing in-house real estate analysis. All asset management activity and analysis is contained
within a central database.
Investment Activities
Our securities portfolio and short-term investments provide and maintain liquidity, assist in managing the interest rate
sensitivity of our balance sheet, and serve as collateral for certain of our obligations. Individual investment decisions are
made based on the credit quality of the investment, liquidity requirements, potential returns, cash flow targets, and consistency
with our asset/liability management objectives.
Sources of Funds
Deposits have traditionally been the primary source of the Bank's funds for lending and other investment purposes. In addition
to deposits, the Bank obtains funds from the amortization and prepayment of loans and mortgage-backed securities, the sale,
call or maturity of investment securities, advances from the Federal Home Loan Bank of Boston (the "FHLBB"), other term
borrowings and cash flows generated by operations.
Deposits
We offer a full line of deposit products to customers in western and south-central Maine through our ten-branch network.
Our deposit products consist of demand deposit, NOW, money market, savings and certificate of deposit accounts. Our
customers access their funds through ATMs, MasterCard® Debit Cards, Automated Clearing House funds (electronic
transfers) and checks. We also offer telephone banking, online banking and bill payment, mobile banking and remote deposit
capture services. Interest rates on our deposits are based upon factors that include prevailing loan demand, deposit maturities,
8
alternative costs of funds, interest rates offered by competing financial institutions and other financial service firms, and
general economic conditions. At June 30, 2016, we had core deposits of $800.4 million, representing 100% of total deposits.
We define core deposits as non-maturity deposits and non-brokered insured time deposits.
Our online deposit program, ableBanking, provides an additional channel through which to obtain core deposits to support
our growth. ableBanking, which was launched in late fiscal 2012 as a division of Northeast Bank, had $142.6 million in
money market and time deposits as of June 30, 2016. We also use deposit listing services to gather deposits from time to
time, in support of our liquidity and asset/liability management objectives. At June 30, 2016, listing service deposits totaled
$196.6 million, bearing a weighted average remaining term of 0.81 years.
Borrowings
While we currently consider core deposits (defined as non-maturity deposits and non-brokered insured time deposits) as our
primary source of funding to support asset growth, advances from the FHLBB and other sources of wholesale funding remain
an important part of our liquidity contingency planning. Northeast Bank may borrow up to 50% of its total assets from the
FHLBB, and borrowings are typically collateralized by mortgage loans and securities pledged to the FHLBB. At June 30,
2016, we had $16.8 million of available borrowing capacity based on collateral. Northeast Bank can also borrow from the
Federal Reserve Bank of Boston, with any such borrowing collateralized by consumer loans pledged to the Federal Reserve.
For the foreseeable future, we expect to rely less on borrowings than other banks of similar size, because of our regulatory
commitment to fund 100% of our loans with core deposits, although the availability of FHLBB and Federal Reserve Bank of
Boston advances and other sources of wholesale funding remain an important part of our liquidity contingency planning.
Employees
As of June 30, 2016, the Company employed 183 full-time and 20 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.
Other Subsidiaries
As of June 30, 2016, the Bank had five wholly-owned non-bank subsidiaries:
(cid:2) Northeast Bank Insurance Group, Inc. ("NBIG"). The insurance agency assets of NBIG were sold on September 1,
2011. The entity currently holds the real estate formerly used in its insurance agency business.
(cid:2) 200 Elm Realty, LLC, which was established to hold commercial real estate acquired as a result of loan workouts.
(cid:2) 500 Pine Realty, LLC, which was established to hold residential real estate acquired as a result of loan workouts.
(cid:2) 17 Dogwood Realty, LLC, which was established to hold commercial real estate acquired as a result of loan
workouts.
(cid:2) Portland, Inc., which was established to employ a business development officer to solicit SBA loans in New Jersey.
The Company's wholly-owned subsidiary, ASI Data Services, Inc. ("ASI"), is an inactive corporate subsidiary. 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.
Supervision and Regulation
General
As a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the "BHCA"), the
Company is subject to regulation and supervision by the Federal Reserve. As a Federal Deposit Insurance Corporation
("FDIC") insured Maine-chartered bank, the Bank is subject to regulation and supervision by the Maine Bureau of Financial
Institutions (the "Bureau") and the FDIC. This regulatory framework is intended to protect depositors, the federal deposit
insurance fund, consumers and the banking system as a whole, and not necessarily investors in the Company. The following
discussion is qualified in its entirety by reference to the full text of the statutes, regulations, policies and guidelines described
below.
9
Bank Holding Company Regulation
Unless a bank holding company becomes a financial holding company under the BHCA, as amended by the Gramm-Leach-
Bliley Act ("GLBA") as discussed below, the BHCA generally prohibits a bank holding company from engaging directly or
indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary
banks or other activities permitted under the BHCA and from acquiring a direct or indirect interest in or control of more than
5% of the voting shares of any company that is not a bank or a bank holding company. However, subject to complying with
applicable prior notice or approval requirements under the BHCA, a bank holding company may engage in, and may own
shares of companies engaged in certain activities, that the Federal Reserve had determined as of November 11, 1999 to be so
closely related to banking or managing and controlling banks so as to be incident thereto. The BHCA requires every bank
holding company to obtain the prior approval of the Federal Reserve before it may merge with another bank holding company,
acquire all or substantially all of the assets of any bank, or acquire ownership or control of any voting shares of a bank or
bank holding company, if, after such acquisition, it would own or control, directly or indirectly, more than 5% of any class
of voting securities of such bank or bank holding company.
GLBA amended the BHCA to permit bank holding companies that qualify, and have elected to be treated as financial holding
companies, to engage in financial activities and acquire interests in companies engaged in financial activities. “Financial
activities” is broadly defined to include not only banking, insurance and securities underwriting activities, but also merchant
banking and additional activities that the Federal Reserve, in consultation with the Secretary of the Treasury, determines to
be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to
the safety and soundness of depository institutions or the financial system generally. Under the Dodd-Frank Wall Street
Reform and Consumer Protection Act (the "Dodd-Frank Act"), however, a bank holding company and its affiliates are
prohibited from engaging in proprietary trading and from sponsoring and investing in hedge funds and private equity funds,
except as permitted under certain limited circumstances. In order to engage in financial activities under GLBA, a bank holding
company must qualify as and make an effective election to be a "financial holding company." To qualify as a financial holding
company, a bank holding company and each of its depository institution subsidiaries must be "well capitalized" and "well
managed." A financial holding company may not commence any additional financial activity not permissible for all bank
holding companies or acquire a company engaged in any financial activity that is not permissible for all bank holding
companies if any depository institution subsidiary of the company has received on its most recent examination under the
Community Reinvestment Act of 1977 ("CRA") a rating less than "satisfactory." A bank holding company that elects to be
treated as a financial holding company may face significant consequences if it or any of its insured depository institution
subsidiaries fail to maintain the required capital and management qualifications, including entering into an agreement with
the Federal Reserve which imposes limitations on its operations and may even require divestitures. Although the Company
believes that it meets the qualifications to become a financial holding company under GLBA, it has not elected "financial
holding company" status, but rather to retain its pre-GLBA bank holding company regulatory status for the present time.
The Company is required by the BHCA to file an annual report and additional reports required with the Federal Reserve. The
Federal Reserve also makes periodic inspections of the Company and its subsidiaries.
Dividend Restrictions
The Company is a legal entity separate and distinct from the Bank. The revenue of the Company (on a parent company only
basis) is derived primarily from interest and dividends from the Bank. The right of the Company, and consequently the right
of shareholders of the Company, to participate in any distribution of the assets or earnings of the Bank through the payment
of such dividends or otherwise is necessarily subject to the prior claims of creditors of the Bank (including depositors), except
to the extent that certain claims of the Company in a creditor capacity may be recognized.
It is the policy of the Federal Reserve that a bank holding company should eliminate, defer or significantly reduce dividends
if the organization’s net income available to shareholders for the past four quarters is not sufficient to fully fund the dividends,
the prospective rate of earnings retention is not consistent with the organization’s capital needs, asset quality and overall
financial condition, or the bank holding company will not meet or is in danger of not meeting its minimum regulatory capital
adequacy ratios. The Federal Reserve has the authority to prohibit a bank holding company, such as the Company, from
paying dividends if it deems such payment to be an unsafe or unsound practice.
The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the
payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends
by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis. Maine law
requires the approval of the Bureau for any dividend that would reduce a bank's capital below prescribed limits.
10
Source of Strength
Under the Dodd-Frank Act, the Company is required to serve as a source of financial strength for the Bank in the event of
the financial distress of the Bank. This provision codifies the longstanding policy of the Federal Reserve. In addition, any
capital loans by a bank holding company to any of its bank subsidiaries are subordinate to the payment of deposits and to
certain other indebtedness. 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 bank subsidiary will be assumed by the bankruptcy
trustee and entitled to a priority of payment.
Certain Transactions by Bank Holding Companies with their Affiliates
There are various statutory restrictions on the extent to which bank holding companies and their non-bank subsidiaries may
borrow, obtain credit from or otherwise engage in "covered transactions" with their insured depository institution subsidiaries.
In general, an “affiliate” of an insured depository institution includes the depository institution’s parent holding company and
any subsidiary of the parent holding company. However, an “affiliate” does not generally include an operating subsidiary of
an insured depository institution. The Dodd-Frank Act amended the definition of affiliate to include any investment fund for
which the depository institution or one of its affiliates is an investment adviser. An insured depository institution (and its
subsidiaries) may not lend money to, or engage in other covered transactions with, its non-depository institution affiliates if
the aggregate amount of covered transactions outstanding involving the bank, plus the proposed transaction, exceeds the
following limits: (a) in the case of any one such affiliate, the aggregate amount of covered transactions of the insured
depository institution and its subsidiaries cannot exceed 10% of the capital stock and surplus of the insured depository
institution; and (b) in the case of all affiliates, the aggregate amount of covered transactions of the insured depository
institution and its subsidiaries cannot exceed 20% of the capital stock and surplus of the insured depository institution. For
this purpose, "covered transactions" are defined by statute to include a loan or extension of credit to an affiliate, a purchase
of or investment in securities issued by an affiliate, a purchase of assets from an affiliate, the acceptance of securities issued
by an affiliate as collateral for a loan or extension of credit to any person or company, the issuance of a guarantee, acceptance
or letter of credit on behalf of an affiliate, securities borrowing or lending transactions with an affiliate that creates a credit
exposure to such affiliate, or a derivatives transaction with an affiliate that creates a credit exposure to such affiliate. Certain
covered transactions are also subject to collateral security requirements. Covered transactions as well as other types of
transactions between a bank and a bank holding company must be on market terms, which means that the transaction must
be conducted on terms and under circumstances that are substantially the same, or at least as favorable to the bank, as those
prevailing at the time for comparable transactions with or involving nonaffiliates or, in the absence of comparable
transactions, that in good faith would be offered to or would apply to nonaffiliates. Moreover, Section 106 of the Bank
Holding Company Act Amendments of 1970 provides that, to further competition, a bank holding company and its
subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or
sale of property of any kind, or furnishing of any service.
Regulation of the Bank
As a Maine-chartered bank, the Bank is subject to the supervision of and regulation by the Bureau and the FDIC, as the
Bank's insurer of deposits. This supervision and regulation is for the protection of depositors, the FDIC's Deposit Insurance
Fund ("DIF"), and consumers, and is not for the protection of the Company's shareholders. The prior approval of the Bureau
and the FDIC is required, among other things, for the Bank to establish or relocate a branch office, assume deposits, or engage
in any merger, consolidation, purchase or sale of all or substantially all of the assets of any bank. The Federal Reserve may
directly examine the subsidiaries of the Company, including the Bank. However, the BHCA requires that the Federal Reserve
provide notice to and consult with the federal bank supervisory agencies and other functional regulatory agencies before
commencing an examination of a depository institution or a functionally regulated subsidiary and, to the fullest extent
possible, avoid duplication of examination activities, reporting requirements and requests for information.
Capital Adequacy and Safety and Soundness
Regulatory Capital Requirements. The Federal Reserve has issued risk-based and leverage capital rules applicable to bank
holding companies such as the Company, and the FDIC has issued similar rules that apply to insured state nonmember banks,
such as the Bank. These guidelines are intended to reflect the relationship between the banking organization's capital and the
degree of risk associated with its operations based on transactions recorded on-balance sheet as well as off-balance sheet
items. The FRB and the FDIC may from time to time require that a banking organization maintain capital above the minimum
levels discussed below, due to the banking organization's financial condition or actual or anticipated growth.
11
The capital adequacy rules define qualifying capital instruments and specify minimum amounts of capital as a percentage of
assets that banking organizations are required to maintain. Common equity Tier 1 capital for banks and bank holding
companies consists of common shareholders’ equity and related surplus. Tier 1 capital for banks and bank holding companies
generally consists of the sum of common shareholders' equity, non-cumulative perpetual preferred stock, and related surplus
and, in certain cases and subject to limitations, minority interest in consolidated subsidiaries, less goodwill, other non-
qualifying intangible assets and certain other deductions. Tier 2 capital generally consists of hybrid capital instruments,
perpetual debt and mandatory convertible debt securities, cumulative perpetual preferred stock, term subordinated debt and
intermediate-term preferred stock, and, subject to limitations, allowances for loan losses. The sum of Tier 1 and Tier 2 capital
less certain required deductions represents qualifying total capital.
Prior to the effectiveness of certain provisions of the Dodd-Frank Act, bank holding companies were permitted to include
trust preferred securities and cumulative perpetual preferred stock in Tier 1 capital, subject to limitations. However, the FRB's
capital rule applicable to bank holding companies permanently grandfathers nonqualifying capital instruments, including
trust preferred securities, issued before May 19, 2010 by depository institution holding companies with less than $15 billion
in total assets as of December 31, 2009, subject to a limit of 25% of Tier 1 capital. In addition, under rules that became
effective January 1, 2016, accumulated other comprehensive income (positive or negative) must be reflected in Tier 1 capital;
however, the Company was permitted to make a one-time, permanent election to continue to exclude accumulated other
comprehensive income from capital. In March 2016, the Company made a one time, permanent election to continue to exclude
accumulated other comprehensive income from capital.
Under the capital rules, risk-based capital ratios are calculated by dividing Tier 1 and total capital, respectively, by risk-
weighted assets. Assets and off-balance sheet credit equivalents are assigned to one of several risk-weight categories, based
primarily on relative risk. The rules require banks and bank holding companies to maintain a minimum common equity Tier 1
capital ratio of 4.5%, a minimum Tier 1 capital ratio of 6%, a total capital ratio of 8% and a leverage ratio of 4%. Additionally,
subject to a transition schedule, the capital rules require a bank holding company to establish a capital conservation buffer of
Tier 1 capital in an amount above the minimum risk-based capital requirements for "adequately capitalized" institutions equal
to 2.5% of total risk weighted assets, or face restrictions on the ability to pay dividends, pay discretionary bonuses, and to
engage in share repurchases.
Under rules effective January 1, 2015, a bank holding company, such as the Company, is considered "well capitalized" if the
bank holding company (i) has a total capital ratio of at least 10%, (ii) has a Tier 1 risk-based capital ratio of at least 6%, and
(iii) is not subject to any written agreement order, capital directive or prompt corrective action directive to meet and maintain
a specific capital level for any capital measure. In addition, the FDIC has amended its prompt corrective action rules to reflect
the revisions made by the revised capital rules described above. Under the FDIC's revised rules, which became effective
January 1, 2015, an insured state nonmember bank is considered "well capitalized" if it (i) has a total capital ratio of 10.0%
or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a common Tier 1 equity ratio of 6.5% or greater, (iv) a
leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt
corrective action directive to meet and maintain a specific capital level for any capital measure.
The Company and the Bank are considered "well capitalized" under all regulatory definitions.
Generally, a bank, upon being notified that it is not adequately capitalized (i.e., that it is "undercapitalized"), becomes subject
to the prompt corrective action provisions of Section 38 of the Federal Deposit Insurance Act (the “FDIA”) that, for example,
(i) restrict payment of capital distributions and management fees, (ii) require that the Federal Reserve monitor the condition
of the institution and its efforts to restore its capital, (iii) require submission of a capital restoration plan, (iv) restrict the
growth of the institution's assets and (v) require prior regulatory approval of certain expansion proposals. A bank that is
required to submit a capital restoration plan must concurrently submit a performance guarantee by each company that controls
the bank. A bank that is "critically undercapitalized" (i.e., has a ratio of tangible equity to total assets that is equal to or less
than 2.0%) will be subject to further restrictions, and generally will be placed in conservatorship or receivership within
90 days.
Deposit Insurance. Deposits in the Bank are insured by the FDIC to the maximum extent permitted by law. Pursuant to the
Dodd-Frank Act, FDIC deposit insurance has been permanently increased from $100,000 to $250,000 per depositor for
deposits maintained by the depositor in the same right and capacity. The FDIC utilizes a risk-based assessment system that
imposes insurance premiums based upon a risk matrix that takes into account a bank's capital level and supervisory rating
("CAMELS rating"). CAMELS ratings reflect the applicable bank regulatory agency to applicable limits by the DIF and are
subject to deposit, management, earnings, liquidity and sensitivity to risk. Assessment rates may also vary for certain
institutions based on long term debt issuer ratings, secured or brokered deposits. Pursuant to the Dodd-Frank Act, deposit
premiums are based on assets rather than insurable deposits. To determine its actual insurance premiums, the Bank computes
12
the base amount on its average consolidated assets less its average tangible equity (defined as the amount of Tier 1 capital)
and its applicable assessment rate. After adjustments, assessment rates range from 2.5 to 9 basis points on the broader
assessment base for banks in the lowest risk category up to 30 to 45 basis points for banks in the highest risk category.
The Dodd-Frank Act required the FDIC to take action to increase the minimum DIF reserve ratio, the ratio of the fund balance
to estimated insured deposits, from 1.15% to 1.35% by September 30, 2020. Further, the Dodd-Frank Act required that, in
setting assessments, the FDIC offset the effect of the increase in the minimum reserve ratio from 1.15% to 1.35% on banks
with less than $10 billion in assets.
To satisfy these requirements, on March 15, 2016, the FDIC’s Board of Directors approved a final rule to increase the DIF’s
reserve ratio to the statutorily required minimum ratio of 1.35% of estimated insured deposits. The final rule imposes on large
banks a surcharge of 4.5 basis points of their assessment base, after making certain adjustments. Large banks will pay
quarterly surcharges in addition to their regular risk-based assessments. Overall regular risk-based assessment rates will
decline once the reserve ratio reaches 1.15%.
If the reserve ratio reaches 1.15% before July 1, 2016, surcharges will begin July 1. If the reserve ratio has not reached 1.15%
by July 1, 2016, surcharges will begin the first quarter after the reserve ratio reaches 1.15%. The surcharges will continue
through the quarter in which the reserve ratio first meets or exceeds 1.35%, but not past the fourth quarter of 2018. If the
reserve ratio has not reached 1.35% by the end of 2018, a shortfall assessment will be imposed on large banks to close the
gap.
Small banks will receive credits to offset the portion of their assessments that help to raise the reserve ratio from 1.15% to
1.35%. After the reserve ratio reaches 1.38%, the FDIC will automatically apply a small bank’s credits to reduce its regular
assessment up to the entire amount of the assessment.
In addition, on April 26, 2016, the FDIC’s Board of Directors adopted a final rule that amends the way insurance assessment
rates are calculated for established small banks, generally those banks with less than $10 billion of assets that have been
insured for at least five years. The rule updates the data and methodology that the FDIC uses to determine risk-based
assessment rates for these institutions with the intent of better reflecting risks and ensuring that banks that take on greater
risks pay more for deposit insurance than their less risky counterparts. The rule revises the financial ratios method used to
determine assessment rates for these banks so that it is based on a statistical model that estimates the probability of failure
over three years. The rule eliminates risk categories for established small banks and uses the financial ratios method for all
such banks (subject to minimum or maximum assessment rates based on a bank’s CAMELS composite rating). Under the
small bank pricing rule, beginning the first assessment period after June 30, 2016, where the DIF’s reserve ratio has reached
1.15%, assessments for established small banks with a CAMELS rating of 1 or 2 will range from 1.5 to 16 basis points, after
adjustments, while assessment rates for established small institutions with a CAMELS composite rating of 4 or 5 may range
from 11 to 30 basis points, after adjustments. Under the FDIA, the FDIC may terminate deposit insurance upon a finding that
the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or
has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Safety and Soundness Standard. The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations
or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit
underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and
benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by the
federal bank regulatory agencies 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, these guidelines require, among other things, appropriate systems and practices to identify and manage
the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound
practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services
performed by an executive officer, employee, director or principal shareholder. In addition, the federal banking agencies
adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an
agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so
notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an
acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order
directing other actions of the types to which an undercapitalized institution is subject under the "prompt corrective action"
provisions of FDIA. See "Regulatory Capital Requirements" above. If an institution fails to comply with such an order, the
agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.
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Depositor Preference. The FDIA provides that, in the event of the "liquidation or other resolution" of an insured depository
institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and
certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims
against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will
have priority in payment ahead of unsecured, non-deposit creditors, including depositors whose deposits are payable only
outside of the United States and the parent bank holding company, with respect to any extensions of credit they have made
to such insured depository institution.
Activities and Investments of Insured State Banks
The powers of a Maine-chartered bank, such as the Bank, include provisions designed to provide Maine banks with
competitive equity to the powers of national banks. In general, the FDIA prohibits a state insured bank from directly or
indirectly engaging as a principal in any activity that is not permissible for a national bank and from making any equity
investment of a type that is not permissible for a national bank. However, GLBA amended the FDIA to authorize state banks
to establish financial subsidiaries that engage in "activities as principal that would only be permissible" for a national bank
to conduct in a financial subsidiary. This provision permits state banks, to the extent permitted under state law, to engage in
certain financial activities which are permissible for subsidiaries of a financial holding company. Because Maine law
explicitly permits banks chartered by the state to engage in all activities permissible for federally-chartered banks, the Bank
is permitted to form subsidiaries to engage in the activities authorized by GLBA for financial subsidiaries of state banks. In
order to form a financial subsidiary, a state bank must be well managed, the state bank and all of its insured depository
institution affiliates must be well-capitalized, and the state bank must comply with certain capital deduction, risk management
and affiliate transaction rules. A state bank may not commence new activities that may only be conducted through a financial
subsidiary or directly or indirectly acquire a company engaged in such activities if the bank or any of its affiliates received a
CRA rating of less than “satisfactory” in its most recent CRA examination.
Consumer Protection Regulation
The Company and the Bank are subject to a number of federal and state laws designed to protect consumers and prohibit
unfair or deceptive business practices. These laws include the Equal Credit Opportunity Act, the Fair Housing Act, Home
Ownership Protection Act, the Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act of
2003 ("FACT Act"), GLBA, the Truth in Lending Act, CRA, the Home Mortgage Disclosure Act, the Real Estate Settlement
Procedures Act, the National Flood Insurance Act, Electronic Funds Transfer Act, Truth in Savings Act, Secure and Fair
Enforcement Act, Expedited Funds Availability Act, and various state law counterparts. These laws and regulations mandate
certain disclosure requirements and regulate the manner in which financial institutions must interact with customers when
taking deposits, making loans, collecting loans and providing other services. Further, the Dodd-Frank Act established the
CFPB, which has the responsibility for making rules and regulations under the federal consumer protection laws relating to
financial products and services. The CFPB also has a broad mandate to prohibit unfair or deceptive acts and practices and is
specifically empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with
consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties.
The FDIC examines the Bank for compliance with CFPB rules and enforces CFPB rules with respect to the Bank.
Mortgage Reform
The Dodd-Frank Act prescribes certain standards that mortgage lenders must consider before making a residential mortgage
loan, including verifying a borrower's ability to repay such mortgage loan. The Dodd-Frank Act also allows borrowers to
assert violations of certain provisions of the Truth-in-Lending Act as a defense to foreclosure proceedings. Under the Dodd-
Frank Act, prepayment penalties are prohibited for certain mortgage transactions and creditors are prohibited from financing
insurance policies in connection with a residential mortgage loan or home equity line of credit. The Dodd-Frank Act requires
mortgage lenders to make additional disclosures prior to the extension of credit, in each billing statement and for negative
amortization loans and hybrid adjustable rate mortgages. Additionally, the Dodd-Frank Act prohibits mortgage originators
from receiving compensation based on the terms of residential mortgage loans and generally limits the ability of a mortgage
originator to be compensated by others if compensation is received from a consumer.
Privacy and Customer Information Security
GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal
information about consumers to nonaffiliated third parties. In general, the Bank must provide its customers with an annual
disclosure that explains its policies and procedures regarding the disclosure of such nonpublic personal information and,
except as otherwise required or permitted by law, the Bank is prohibited from disclosing such information except as provided
in such policies and procedures. However, as a result of amendments made by the Fixing America’s Surface Transportation
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Act, a financial institution is not required to send an annual privacy notice if the institution only discloses nonpublic personal
information in accordance with certain exceptions from the GLBA that do not require an opt-out to be provided and if the
institution has not changed its policies and practices since the most recent privacy disclosure provided to consumers. GLBA
also requires that the Bank develop, implement and maintain a comprehensive written information security program designed
to ensure the security and confidentiality of customer information (as defined under GLBA), to protect against anticipated
threats or hazards to the security or integrity of such information; and to protect against unauthorized access to or use of such
information that could result in substantial harm or inconvenience to any customer. The Bank is also required to send a notice
to customers whose "sensitive information" has been compromised if unauthorized use of this information has occurred or is
"reasonably possible." Most states, including Maine, have enacted legislation concerning breaches of data security and the
duties of the Bank in response to a data breach. Congress continues to consider federal legislation that would require consumer
notice of data security breaches. Pursuant to the FACT Act, the Bank must also develop and implement a written identity
theft prevention program to detect, prevent, and mitigate identity theft in connection with the opening of certain accounts or
certain existing accounts. Additionally, the FACT Act amends the Fair Credit Reporting Act to generally prohibit a person
from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the
consumer is given notice and a reasonable opportunity and a reasonable and simple method to opt out of the making of such
solicitations.
Regulatory Enforcement Authority
The enforcement powers available to the federal banking agencies include, among other things, the ability to assess civil
money penalties, to issue cease and desist or removal orders and to initiate injunctive actions against banking organizations
and institution-affiliated parties, as defined. In general, these enforcement actions may be initiated for violations of law 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 regulatory authorities. Under certain circumstances, federal and state law
requires public disclosure and reports of certain criminal offenses and also final enforcement actions by the federal banking
agencies.
Community Reinvestment Act
Pursuant to the CRA, regulatory authorities review the performance of the Bank in meeting the credit needs of the
communities it serves. The applicable regulatory authorities consider compliance with this law in connection with the
applications for, among other things, approval for de novo branches, branch relocations and acquisitions of banks and bank
holding companies. The Bank received a "satisfactory" rating at its CRA examination dated September 1, 2016, its most
recent exam.
Failure of an institution to receive at least a "satisfactory" rating could inhibit such institution or its holding company from
undertaking certain activities, including engaging in activities permitted for a financial holding company under GLBA, and
acquisitions of other financial institutions. The FDIC must take into account the record of performance of banks in meeting
the credit needs of the entire community served, including low- and moderate-income neighborhoods. Current CRA
regulations for large banks primarily rely on objective criteria of the performance of institutions under three key assessment
tests: a lending test, a service test and an investment test. For smaller banks, current CRA regulations primarily evaluate the
performance of institutions under two key assessment tests: a lending test and, in addition, for intermediate small banks, a
community development test. The Company is committed to meeting the existing or anticipated credit needs of its entire
community, including low- and moderate-income neighborhoods, consistent with safe and sound banking operations.
Branching and Acquisitions
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as amended ("Riegle-Neal") and the Dodd-Frank
Act permit well capitalized and well managed bank holding companies, as determined by the Federal Reserve, to acquire
banks in any state subject to certain concentration limits and other conditions. Riegle-Neal also generally authorizes the
interstate merger of banks. In addition, among other things, Riegle-Neal and the Dodd-Frank Act permit banks to establish
new branches on an interstate basis to the same extent a bank chartered by the host state may establish branches. Bank holding
companies are required to obtain prior Federal Reserve approval to directly or indirectly acquire more than 5% of a class of
voting securities, or substantially all of the assets, of a bank holding company, bank or savings association.
Anti-Money Laundering and the Bank Secrecy Act
Under the Bank Secrecy Act ("BSA"), a financial institution is required to have systems in place to detect certain transactions,
based on the size and nature of the transaction. Financial institutions are generally required to report to the United States
Treasury any cash transactions involving more than $10,000. In addition, financial institutions are required to file suspicious
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activity reports for transactions that involve more than $5,000 and which the financial institution knows, suspects or has
reason to suspect involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The
Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of
2001 (the "USA PATRIOT Act"), which amended the BSA, is designed to deny terrorists and others the ability to obtain
anonymous access to the U.S. financial system. The USA PATRIOT Act has significant implications for financial institutions
and businesses of other types involved in the transfer of money. The USA PATRIOT Act, together with the implementing
regulations of various federal regulatory agencies, has caused financial institutions, such as the Bank, to adopt and implement
additional policies or amend existing policies and procedures with respect to, among other things, anti-money laundering
compliance, suspicious activity, currency transaction reporting, customer identity verification and customer risk analysis. In
evaluating an application under Section 3 of the BHCA to acquire a bank or an application under the Bank Merger Act to
merge banks or affect a purchase of assets and assumption of deposits and other liabilities, the applicable federal banking
regulator must consider the anti-money laundering compliance record of both the applicant and the target.
The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and
others. These sanctions, which are administered by the U.S. Treasury Department’s Office of Foreign Assets Control
("OFAC"), take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions
on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports
to a sanctioned country and prohibitions on "U.S. persons" engaging in financial transactions relating to making investments
in, or providing investment-related advice or assistance to, a sanctioned country; (ii) a blocking of assets in which the
government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property
subject to U.S. jurisdiction (including property in the possession or control of U.S. persons); and (iii) restrictions on
transactions with or involving certain persons or entities. Blocked assets (for example, property and bank deposits) cannot be
paid out, withdrawn, set off or transferred in any manner without a license from OFAC.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank of Boston (the "FHLBB"), which is one of the regional Federal Home
Loan Banks comprising the Federal Home Loan Bank System. Each Federal Home Loan Bank provides a central credit
facility primarily for member institutions. Member institutions are required to acquire and hold shares of capital stock in the
FHLBB in an amount at least equal to the sum of 0.35% of the aggregate principal amount of its unpaid residential mortgage
loans and similar obligations based on year-end call report data and up to 4.5% of its advances (borrowings) from the FHLBB.
The Bank was in compliance with this requirement with an investment in FHLBB stock as of June 30, 2016 of $2.4 million.
The Bank receives dividends on its FHLBB stock. The FHLBB has recently declared dividends equal to an annual yield of
approximately the daily average three-month LIBOR yield for the quarter for which the dividend has been declared. Dividend
income on FHLBB stock of $113 thousand was recorded during the most recent fiscal year.
Any advances from the FHLBB must be secured by specified types of collateral, and long-term advances may be used for
the purpose of providing funds for residential housing finance, commercial lending and to purchase investments. Long term
advances may also be used to help manage interest rate risk for asset and liability management purposes. As of June 30, 2016,
the Bank had $30.1 million in outstanding FHLBB advances.
Item 1A.
Risk Factors
Investing in our common stock involves a high degree of risk. You should carefully consider the following risks and
uncertainties, together with all other information in this prospectus, including our consolidated financial statements and
related notes, before investing in our common stock. Any of the risk factors we describe below could adversely affect our
business, financial condition or results of operations. The trading price of our voting common stock could decline if one or
more of these risks or uncertainties actually occur, causing you to lose all or part of your investment. Certain statements
below are forward-looking statements. See "A Note About Forward-Looking Statements."
Risks Associated With Our Business
We are subject to regulatory conditions that could constrain our ability to grow our business.
In conjunction with the regulatory approvals received for the merger with FHB Formation LLC, we committed to maintain a
Tier 1 leverage ratio of at least 10%, maintain a total capital ratio of at least 15%, fund 100% of our loans with core deposits,
limit purchased loans to 40% of total loans and hold non-owner occupied commercial real estate loans to within 300% of
total capital. Core deposits, for purposes of this commitment, are defined as non-brokered non-maturity deposits and non-
brokered insured time deposits. At June 30, 2016, the ratio of our purchased loans to total loans was 34.3%. Our continued
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ability to purchase loans will be dependent on our ability to maintain the growth of our originated loan portfolio. To the extent
that our ability to originate loans is constrained by market forces or for any other reason, our ability to execute our loan
acquisition strategy would be similarly constrained.
A significant portion of loans held in our loan portfolio were originated by third parties, and such loans may not have
been subject to the same level of due diligence that Northeast Bank would have conducted had it originated the loans.
At June 30, 2016, 34.3% of the loans held in our loan portfolio were originated by third parties, and therefore may not have
been subject to the same level of due diligence that Northeast Bank would have conducted had it originated the loans.
Although the LASG conducts a comprehensive review of all loans that it purchases, loans originated by third parties may
lack current financial information and may have incomplete legal documentation and outdated appraisals. As a result, the
LASG may not have information with respect to an acquired loan which, if known at the time of acquisition, would have
caused it to reduce its bid price or not bid for the loan at all. This may adversely affect our yield on loans or cause us to
increase our provision for loan losses.
Our experience with loans held in our loan portfolio that were originated by third parties is limited.
At June 30, 2016, the 34.3% of the loans held in our loan portfolio that were originated by third parties had been held by us
for approximately 1.8 years, calculated on a weighted average basis. Consequently, we have had only a relatively short period
of time to evaluate the performance of those loans and the price at which we purchased them. Further experience with these
loans may provide us with information that could cause us to increase our provision for loan losses.
Our loan portfolio includes commercial real estate and commercial and industrial loans, which are generally riskier than
other types of loans.
At June 30, 2016, our commercial real estate mortgage and commercial and industrial loan portfolios comprised 82.7% of
total loans. Commercial loans generally carry larger loan balances and involve a higher risk of nonpayment or late payment
than residential mortgage loans. These loans, and purchased loans in particular, may lack standardized terms and may include
a balloon payment feature. The ability of a borrower to make or refinance a balloon payment may be affected by a number
of factors, including the financial condition of the borrower, prevailing economic conditions and prevailing interest rates.
Repayment of these loans is generally more dependent on the economy and the successful operation of a business. Because
of the risks associated with commercial loans, we may experience higher rates of default than if the portfolio were more
heavily weighted toward residential mortgage loans. Higher rates of default could have an adverse effect on our financial
condition and results of operations.
If our allowance for loan losses is not sufficient to absorb actual losses or if we are required to increase our allowance,
our financial condition and results of operations could be adversely affected.
We are exposed to the risk that our borrowers may default on their obligations. A borrower's default on its obligations under
one or more loans of the Bank may result in lost principal and interest income and increased operating expenses as a result
of the allocation of management time and resources to the collection and work-out of the loan. In certain situations, where
collection efforts are unsuccessful or acceptable work-out arrangements cannot be reached, the Bank may have to write off
the loan in whole or in part. In such situations, the Bank may acquire real estate or other assets, if any, that secure the loan
through foreclosure or other similar available remedies, and often the amount owed under the defaulted loan exceeds the
value of the assets acquired.
We periodically make a determination of an allowance for loan losses based on available information, including, but not
limited to, our historical loss experience, the quality of the loan portfolio, certain economic conditions, the value of the
underlying collateral, expected cash flows from purchased loans, and the level of non-accruing and criticized loans. We rely
on our loan quality reviews, our experience and our evaluation of economic conditions, among other factors, in determining
the amount of provision required for the allowance for loan losses. Provisions to this allowance result in an expense for the
period. If, as a result of general economic conditions, previously incorrect assumptions, or an increase in defaulted loans, we
determine that additional increases in the allowance for loan losses are necessary, we will incur additional expenses.
Determining the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant
estimates of current credit risks and future trends, all of which may undergo material changes. At any time, there are likely
to be loans in our portfolio that will result in losses but that have not been identified as nonperforming or potential problem
credits. We cannot be sure that we will be able to identify deteriorating credits before they become nonperforming assets or
that we will be able to limit losses on those loans that are identified. We have in the past been, and in the future may be,
required to increase our allowance for loan losses for any of several reasons. State and federal regulators, in reviewing our
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loan portfolio as part of a regulatory examination, may request that we increase our allowance for loan losses. Changes in
economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem
loans and other factors, both within and outside of our control, may require an increase in our allowance for loan losses. In
addition, if charge-offs in future periods exceed those estimated in our determination of our allowance for loan losses, we
will need additional increases in our allowance for loan losses. Any increases in our allowance for loan losses will result in
a decrease in our net income and, possibly, our capital, and could have an adverse effect on our financial condition and results
of operations.
Environmental liability associated with our lending activities could result in losses.
In the course of business, we may acquire, through foreclosure, properties securing loans we have originated or purchased
that are in default. Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered
on these properties. In this event, we might be required to remove these substances from the affected properties at our sole
cost and expense or we may be held liable to a government entity or to third parties for property damage, personal injury,
investigation and cleanup costs incurred by these parties in connection with environmental contamination or may be required
to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with
investigation or remediation activities could substantially exceed the value of affected properties. We may not have adequate
remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected
properties. If we become subject to significant environmental liabilities, our business, financial condition and results of
operations could be adversely affected.
We may not be able to attract and retain qualified key employees, which could adversely affect our business prospects,
including our competitive position and results of operations.
Our success is dependent upon our ability to attract and retain highly skilled individuals. There is significant competition for
those individuals with the experience and skills required to conduct many of our business activities. We may not be able to
hire or retain the key personnel that we depend upon for success. The unexpected loss of services of one or more of these or
other key personnel could have a material adverse impact on our business because of their skills, knowledge of the markets
in which we operate, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
We are subject to liquidity risk.
Liquidity is the ability to meet cash flow needs on a timely basis by converting assets into cash or cash equivalents and by
increasing liabilities at a reasonable cost. Liquidity sources include the amount of unencumbered or “free” investment
portfolio securities that the Bank owns, borrowings, cash flow from loan and investment principal payments and pre-
payments and residential mortgage loan sales. Our liquidity is used principally to originate or purchase loans, to repay deposit
liabilities and other liabilities when they come due, and to fund operating costs. The Company also requires funds for
dividends to shareholders, repurchases of shares, and for general corporate purposes. Customer demand for non-maturity
deposits can be difficult to predict. Changes in market interest rates, increased competition within our markets, and other
factors may make deposit gathering more difficult. Disruptions in the capital markets or interest rate changes may make the
terms of wholesale funding sources—which include Federal Home Loan Bank advances, the Federal Reserve's Borrower-in-
Custody program, securities sold under repurchase agreements, federal funds purchased and brokered certificates of deposit—
less favorable and may make it difficult to sell securities when needed to provide additional liquidity. As a result, there is a
risk that the cost of funding will increase or that we will not have sufficient funds to meet our obligations when they come
due.
We are subject to security and operational risks relating to our use of technology.
Communication and information systems are critical to the conduct of our business because we use these systems to manage
our customer relationships and process accounting and financial reporting information. Although we have established policies
and procedures to prevent or limit the impact of system failures, interruptions and security breaches of these systems,
including cyber security breaches, there can be no assurance that such events will not occur or that they will be adequately
addressed if they do. In addition, any compromise of our security systems could prevent customers from using our website
and our online banking services, both of which involve the transmission of confidential information. Although we rely on
security and processing systems to provide the security and authentication necessary to securely transmit data, these
precautions may not protect our systems from compromises or breaches of security. Information security risks have increased
significantly due to the use of online, telephone and mobile banking channels by clients and the increased sophistication and
activities of organized crime, hackers, terrorists and other external parties. The occurrence of any failures, interruptions or
security breaches of our information systems could damage our reputation, result in the loss of business, subject us to
18
increased regulatory scrutiny or expose us to civil litigation and possible financial liability, including the costs of customer
notification and remediation efforts. Any of these occurrences could have an adverse effect on our financial condition and
results of operations.
We rely on other companies to provide key components of our business infrastructure.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and
core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any
problems caused by these third parties, including as a result of their not providing us their services for any reason or their
performing their services poorly, could adversely affect our ability to deliver products and services to our customers or
otherwise conduct our business efficiently and effectively. Replacing these third party vendors could also entail significant
delay and expense.
Damage to our reputation could significantly harm our business, including our competitive position and business
prospects.
We are dependent on our reputation within our market area, as a trusted and responsible financial company, for all aspects of
our relationships with customers, employees, vendors, third-party service providers, and others, with whom we conduct
business or potential future business. Our ability to attract and retain customers and employees could be adversely affected
if our reputation is damaged. Our actual or perceived failure to address various issues, including our ability to (a) identify
and address potential conflicts of interest, ethical issues, money-laundering, or privacy issues; (b) meet legal and regulatory
requirements applicable to the Bank and to the Company; (c) maintain the privacy of customer and accompanying personal
information; (d) maintain adequate record keeping; (e) engage in proper sales and trading practices; and (f) identify the legal,
reputational, credit, liquidity and market risks inherent in our products, could give rise to reputational risk that could cause
harm to us and our business prospects. These issues also include, but are not limited to, legal and regulatory requirements;
properly maintaining customer and employee personal information; record keeping; money-laundering; sales and trading
practices; ethical issues; appropriately addressing potential conflicts of interest; and the proper identification of the legal,
reputational, credit, liquidity and market risks inherent in our products. Failure to appropriately address any of these issues
could also give rise to additional regulatory restrictions and legal risks, which could, among other consequences, increase the
size and number of litigation claims and damages asserted or subject us to enforcement actions, fines and penalties and cause
us to incur related costs and expenses.
Internal controls may fail or be circumvented.
Effective controls over financial reporting are necessary to help ensure reliable financial reporting and prevent fraud.
Management is responsible for maintaining an effective system of internal control and assessing system effectiveness Any
system of controls, however well designed and operated, is based in part on certain assumptions and can provide only
reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the system of
internal control could have an adverse effect on our business, profitability, and financial condition, and could further result
in regulatory actions and loss of investor confidence.
Difficult economic conditions, both in the Community Banking Division's market area and more generally, could
adversely affect our financial condition and results of operations.
Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of
outstanding loans and the value of collateral securing those loans, is highly dependent upon the business environment in the
markets where we operate and in the United States as a whole. Our Community Banking Division primarily serves individuals
and businesses located in western and south-central Maine. As a result, a significant portion of our earnings are closely tied
to the economy of Maine. In addition, our loan portfolio includes commercial loans acquired or originated by the LASG and
the SBA Division that are secured by assets located nationwide. Deterioration in the economic conditions of the Community
Banking Division's market area in Maine, and deterioration of the economy nationally could result in the following
consequences:
(cid:2) Loan delinquencies may increase;
(cid:2) Problem assets and foreclosures may increase;
(cid:2) Demand for our products and services may decline;
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(cid:2) Collateral for our loans may decline in value, in turn reducing a customer's borrowing power and reducing the value
of collateral securing a loan; and
(cid:2) The net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us.
Our future growth, if any, may require us to raise additional capital, but that capital may not be available when we need
it.
As a bank, we are required by regulatory authorities to maintain adequate levels of capital to support our operations. In
addition, in conjunction with the regulatory approvals received for the merger with FHB Formation LLC, we committed to
maintain a Tier 1 leverage ratio of at least 10% and a total capital ratio of at least 15%. We may need to raise additional
capital to support our operations or our growth, if any. Our ability to raise additional capital will depend, in part, on conditions
in the capital markets and our financial performance at that time. Accordingly, we may be unable to raise additional capital,
if and when needed, on acceptable terms, or at all. If we cannot raise additional capital when needed, our ability to further
expand our operations through internal growth and acquisitions could be materially impaired. In addition, if we decide to
raise additional equity capital, investors' interests could be diluted. Our failure to meet any applicable regulatory guideline
related to our lending activities or any capital requirement otherwise imposed upon us or to satisfy any other regulatory
requirement could subject us to certain activity restrictions or to a variety of enforcement remedies available to the regulatory
authorities, including limitations on our ability to pay dividends or pursue acquisitions, the issuance by regulatory authorities
of a capital directive to increase capital and the termination of deposit insurance by the FDIC.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness
of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty and
other relationships. We have exposure to many different counterparties, and we routinely execute transactions with
counterparties in the financial industry, including brokers and dealers, other commercial banks, investment banks, mutual
and hedge funds, and other financial institutions. As a result, defaults by, or even rumors or questions about, one or more
financial services institutions, or the financial services industry generally, could lead to market-wide liquidity problems and
losses or defaults by us or by other institutions and organizations. Many of these transactions expose us to credit risk in the
event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us
cannot be liquidated or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure
due to us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
Risks Associated With the Industry
Competition in the financial services industry is intense and could result in us losing business or experiencing reduced
margins.
Our future growth and success will depend on our ability to continue to compete effectively in the Community Banking
Division's market area, and in the markets in which the LASG, the SBA Division, and ableBanking operate. We face
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 we conduct our business. Some of our competitors have
significantly greater financial resources, lending limits, and/or face fewer regulatory constraints and offer certain services
that we do not or cannot provide. As a result of these various sources of competition, we 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.
Changes in interest rates could adversely affect our net interest income and profitability.
The majority of our assets and liabilities are monetary in nature. As a result, our earnings and growth 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. The nature and timing of any changes in such policies or general economic conditions and their effect on us cannot
be controlled and are extremely difficult to predict. Changes in interest rates can affect our net interest income as well as the
value of our assets and liabilities. Net interest income is the difference between (i) interest income on interest-earning assets,
20
such as loans and securities, and (ii) interest expense on interest-bearing liabilities, such as deposits and borrowings. 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 liabilities. This difference could result in an increase
in interest expense relative to interest income, and therefore reduce our net interest income. Further, declines in market
interest rates may trigger loan prepayments, which in many cases are within our customers' discretion, and which in turn may
serve to reduce our net interest income if we are unable to lend those funds to other borrowers or invest the funds at the same
or higher interest rates.
We operate in a highly regulated industry, and laws and regulations, or changes in them, could limit or restrict our
activities and could have an adverse impact in our operations.
We are subject to regulation and supervision by the Federal Reserve, and our banking subsidiary, Northeast Bank, is subject
to regulation and supervision by the FDIC and the Maine Bureau of Financial Institutions. Federal and state laws and
regulations govern numerous matters, including changes in the ownership or control of banks and bank holding companies,
maintenance of adequate capital and the financial condition of a financial institution, permissible types, amounts and terms
of extensions of credit and investments, permissible non-banking activities, the level of reserves against deposits and
restrictions on dividend payments. The Federal Reserve, the FDIC and the Maine Bureau of Financial Institutions have the
power to issue cease and desist orders to prevent or remedy unsafe or unsound practices or violations of law by banks subject
to their regulation, and the Federal Reserve possesses similar powers with respect to bank holding companies. These and
other restrictions limit the manner in which we and Northeast Bank may conduct business and obtain financing.
Because our business is highly regulated, the laws, rules, regulations, and supervisory guidance and policies applicable to us
are subject to regular modification and change. Such changes may, among other things, increase the cost of doing business,
limit permissible activities, or affect the competitive balance between banks and other financial institutions. The Dodd-Frank
Act instituted major changes to the banking and financial institutions regulatory regimes in light of government intervention
in the financial services sector following the 2008 financial crisis. Other changes to statutes, regulations, or regulatory
policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in
substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services
and products we may offer, and/or increase the ability of non-banks to offer competing financial services and products, among
other things. Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money
penalties, and/or reputation damage, which could have a material adverse effect on our business, financial condition, and
results of operations. See "Supervision and Regulation" in Item 1, "Business."
The FDIC's assessment rates could adversely affect our financial condition and results of operations.
The FDIC insures deposits at FDIC-insured depository institutions, such as Northeast Bank, up to applicable limits. As a
result of recent economic conditions and the enactment of the Dodd-Frank Act, the FDIC has increased deposit insurance
assessment rates. If these increases are insufficient for the deposit insurance fund of the FDIC to meet its funding
requirements, there may need to be further special assessments or increases in deposit insurance premiums. We are generally
unable to control the amount of premiums that we are required to pay for FDIC insurance. If there is additional bank or
financial institution failures, we may be required to pay even higher FDIC premiums than the recently increased levels. Any
future additional assessments, increases or required prepayments in FDIC insurance premiums may materially adversely
affect results of operations, including by reducing our profitability or limiting our ability to pursue certain business
opportunities.
Changes in accounting standards can materially impact our financial statements.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of
operations. From time to time, the Financial Accounting Standards Board or regulatory authorities change the financial
accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to
predict and can materially impact how we record and report our financial condition and results of operations. In some cases,
we could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial
statements.
21
We may incur fines, penalties and other negative consequences from regulatory violations, possibly even inadvertent or
unintentional violations.
We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations. However,
some legal/regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the
noncompliance was inadvertent or unintentional and even though there was in place at the time systems and procedures
designed to ensure compliance. For example, we are subject to regulations issued by the Office of Foreign Assets Control, or
"OFAC," that prohibit financial institutions from participating in the transfer of property belonging to the governments of
certain foreign countries and designated nationals of those countries and certain other persons or entities whose interest in
property is blocked by OFAC-administered sanctions. OFAC may impose penalties for inadvertent or unintentional violations
even if reasonable processes are in place to prevent the violations. There may be other negative consequences resulting from
a finding of noncompliance, including restrictions on certain activities. Such a finding may also damage our reputation as
described below and could restrict the ability of institutional investment managers to invest in our securities.
Risks Associated With Our Common Stock
Market volatility has affected and may continue to affect the value of our common stock.
The performance of our common stock has been and may continue to be affected by many factors, including volatility in the
credit, mortgage and housing markets, and the markets with respect to financial institutions generally. Government action
and changes in government regulations may affect the value of our common stock. More general market fluctuations, industry
factors and general economic and political conditions and events, such as economic slowdowns or interest rate changes could
also cause the value of our common stock to decrease regardless of our operating results.
Our common stock trading volume may not provide adequate liquidity for investors.
Our voting common stock is listed on the NASDAQ Global Market. The average daily trading volume for Northeast voting
common stock is less than the corresponding trading volume for larger financial institutions. Due to this relatively low trading
volume, significant sales of Northeast voting common stock, or the expectation of these sales, may place significant
downward pressure on the market price of Northeast voting common stock. No assurance can be given that a more active
trading market in our common stock will develop in the foreseeable future or can be maintained. There can also be no
assurance that the offering will result in a material increase in the "float" for our common stock, which we define as the
aggregate market value of our voting common stock held by shareholders who are not affiliates of Northeast, because our
affiliates may purchase shares of voting common stock in the offering.
There is a limited market for and restrictions on the transferability of our non-voting common stock.
Our non-voting common stock is not and will not be listed on any exchange. Additionally, the non-voting common stock can
only be transferred in certain limited circumstances set forth in our articles of incorporation. Accordingly, holders of our non-
voting common stock may be required to bear the economic consequences of holding such non-voting common stock for an
indefinite period of time.
If we defer payments of interest on our outstanding junior subordinated debt securities or if certain defaults relating to
those debt securities or our outstanding subordinated notes occur, we will be prohibited from declaring or paying dividends
or distributions on, and from making liquidation payments with respect to, our common stock.
As of June 30, 2016, we had outstanding $16.5 million in aggregate principal amount of junior subordinated debt securities
issued in connection with the sale of trust preferred securities by affiliates of ours that are statutory business trusts. We have
also guaranteed those trust preferred securities. The indenture under which the junior subordinated debt securities were issued,
together with the guarantee, prohibits us, subject to limited exceptions, from declaring or paying any dividends or
distributions on, or redeeming, repurchasing, acquiring or making any liquidation payments with respect to, any of our capital
stock at any time when (i) there shall have occurred and be continuing an event of default under the indenture; (ii) we are in
default with respect to payment of any obligations under the guarantee; or (iii) we have elected to defer payment of interest
on the junior subordinated debt securities. In that regard, we are entitled, at our option but subject to certain conditions, to
defer payments of interest on the junior subordinated debt securities from time to time for up to five years.
Events of default under the indenture generally consist of our failure to pay interest on the junior subordinated debt securities
under certain circumstances, our failure to pay any principal of or premium on such junior subordinated debt securities when
due, our failure to comply with certain covenants under the indenture, and certain events of bankruptcy, insolvency or
liquidation relating to us.
22
As a result of these provisions, if we were to elect to defer payments of interest on the junior subordinated debt securities, or
if any of the other events described in clause (i) or (ii) of the first paragraph of this risk factor were to occur, we would be
prohibited from declaring or paying any dividends on our capital stock, from redeeming, repurchasing or otherwise acquiring
any of our capital stock, and from making any payments to holders of our capital stock in the event of our liquidation, which
would likely have a material adverse effect on the market value of our common stock.
As of June 30, 2016, we had outstanding $15.05 million in aggregate principal amount of 6.75% fixed-to-floating
subordinated notes due 2026. If we were to be in default with respect to payment of any obligation under the notes, we would
be prohibited from declaring or paying any dividends. We would also be prohibited from paying any distributions on,
redeeming, purchasing, acquiring, or making a liquidation payment with respect to any of the Company’s capital stock, which
would likely have a material adverse effect on the market value of our common stock.
We are dependent upon our subsidiaries for dividends, distributions and other payments.
We are a separate and distinct legal entity from Northeast Bank, and depend on dividends, distributions and other payments
from Northeast Bank to fund dividend payments on our common stock and to fund all payments on our other obligations.
We and Northeast Bank are subject to laws that authorize regulatory authorities to block or reduce the flow of funds from
Northeast Bank to us. 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 Northeast Bank does not maintain sufficient capital levels
or its earnings are not sufficient to make dividend payments to us, we may not be able to make dividend payments to our
common and preferred shareholders. Further, our right to participate in a distribution of assets upon a subsidiary's liquidation
or reorganization is subject to the prior claims of Northeast Bank's creditors.
We may not be able to pay dividends and, if we pay dividends, we cannot guarantee the amount and frequency of such
dividends.
The continued payment of dividends on shares of our common stock will depend upon our debt and equity structure, earnings
and financial condition, need for capital in connection with possible future acquisitions, growth and other factors, including
economic conditions, regulatory restrictions, and tax considerations. We cannot guarantee that we will pay dividends or, if
we pay dividends, the amount and frequency of these dividends.
We may issue additional shares of common or preferred stock in the future, which could dilute a shareholder's ownership
of common stock.
Our articles of incorporation authorize our Board of Directors, generally without shareholder approval, to, among other
things, issue additional shares of common or preferred stock. The issuance of any additional shares of common or preferred
stock could be dilutive to a shareholder's ownership of our common stock. To the extent that we issue options or warrants to
purchase common stock in the future and the options or warrants are exercised, our shareholders may experience further
dilution. Holders of shares of our common stock have no preemptive rights that entitle holders to purchase their pro rata share
of any offering of shares of any class or series and, therefore, shareholders may not be permitted to invest in future issuances
of Northeast common or preferred stock. We are required by federal and state regulatory authorities to maintain adequate
levels of capital to support our operations. Accordingly, regulatory requirements and/or deterioration in our asset quality may
require us to sell common stock to raise capital under circumstances and at prices that result in substantial dilution.
We may issue debt and equity securities that are senior to our common stock as to distributions and in liquidation, which
could negatively affect the value of our common stock.
In the future, we may increase our capital resources by entering into debt or debt-like financing or issuing debt or equity
securities, which could include issuances of senior notes, subordinated notes, preferred stock or common stock. In the event
of our liquidation, our lenders and holders of its debt or preferred securities would receive a distribution of our available
assets before distributions to the holders of Northeast common stock. Our decision to incur debt and issue securities in future
offerings will depend on market conditions and other factors beyond our control. We cannot predict or estimate the amount,
timing or nature of our future offerings and debt financings. Future offerings could reduce the value of shares of our common
stock and dilute a shareholder's interest in Northeast.
Our common stock is not insured by any governmental entity.
Our common stock is not a deposit account or other obligation of any bank and is not insured by the FDIC or any other
governmental entity.
23
Anti-takeover provisions could negatively impact our shareholders.
Federal law imposes restrictions, including regulatory approval requirements, on persons seeking to acquire control over
Northeast. Provisions of Maine law and provisions of our articles of incorporation and by-laws could make it more difficult
for a third party to acquire control of us or have the effect of discouraging a third party from attempting to acquire control of
us. We have a classified Board of Directors, meaning that approximately one-third of our directors are elected annually.
Additionally, our articles of organization authorize our Board of Directors to issue preferred stock without shareholder
approval and such preferred stock could be issued as a defensive measure in response to a takeover proposal. Other provisions
that could make it more difficult for a third party to acquire us even if an acquisition might be in the best interest of our
shareholders include supermajority voting requirements to remove a director from office without cause; restrictions on
shareholders calling a special meeting; a requirement that only directors may fill a Board vacancy; and provisions regarding
the timing and content of shareholder proposals and nominations.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Properties
At June 30, 2016, the Company conducted its business from its headquarters in Lewiston, Maine, an office in Boston,
Massachusetts, and an office in Portland, Maine. The Company also conducts business from its ten full-service bank branches
and six loan production offices located in western and south-central Maine and southern New Hampshire. The Company
believes that all of its facilities are well maintained and suitable for the purpose for which they are used.
In addition to its Lewiston, Maine, Boston, Massachusetts and Portland, Maine offices, the Company leases eleven of its
other locations. For information regarding the Company's lease commitments, please refer to "Lease Obligations" under
Note 15 of the Notes to the Consolidated Financial Statements in Item 8 of this Annual Report.
Item 3.
Legal Proceedings
From time to time, the Company and its subsidiaries are subject to certain legal proceedings and claims in the ordinary course
of business. Management presently believes that the ultimate outcome of these proceedings, individually and in the aggregate,
will not be material to the Company or its consolidated financial position. The Company establishes reserves for specific
legal matters when it determines that the likelihood of an unfavorable outcome is probable and the loss is reasonably
estimable. Legal proceedings are subject to inherent uncertainties, and unfavorable rulings could occur that could cause the
Company to establish litigation reserves or could have, individually or in the aggregate, a material adverse effect on its
business, financial condition, or operating results.
Item 4.
Mine Safety Disclosures
Not applicable.
24
PART II
Item 5.
Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of
Equity Securities
(a) The Company's voting common stock currently trades on the NASDAQ under the symbol "NBN." There is no established
public trading market for the Company's non-voting common stock. As of the close of business on September 2, 2016, there
were approximately 419 registered shareholders of record.
The following table sets forth the high and low closing sale prices of the Company's voting common stock, as reported on
NASDAQ, and quarterly dividends paid on the Company's voting and non-voting common stock during the periods indicated:
Fiscal year ended June 30, 2016
Jul 1 – Sep 30 ......................................................................... $
Oct 1 – Dec 31........................................................................
Jan 1 – Mar 31 ........................................................................
Apr 1 – Jun 30 ........................................................................
Fiscal year ended June 30, 2015
Jul 1 – Sep 30 ......................................................................... $
Oct 1 – Dec 31........................................................................
Jan 1 – Mar 31 ........................................................................
Apr 1 – Jun 30 ........................................................................
High
Low
11.02 $
11.02
11.00
11.72
High
Low
9.60 $
9.68
9.73
10.25
Dividend Paid
0.01
0.01
0.01
0.01
9.82 $
9.91
9.56
10.31
Dividend Paid
0.01
0.01
0.01
0.01
9.19 $
8.79
8.92
9.14
On September 2, 2016, the last reported sale price of the Company's voting common stock, as reported on NASDAQ was
$11.42. Holders of the Company's voting and non-voting common stock are entitled to receive dividends when and if declared
by the Board of Directors out of funds legally available. The amount and timing of future dividends payable on the Company's
voting and non-voting 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 Bank'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."
Information regarding securities authorized for issuance under our equity compensation plans will be included in the Proxy
Statement relating to our 2016 Annual Meeting of Shareholders and is incorporated herein by reference.
(b) Not applicable.
(c) On April 30, 2015, the Board of Directors voted to amend the Company’s existing stock repurchase program to authorize
the Company to purchase an additional 500,000 shares of its common stock, representing 5.1% of the Company’s outstanding
common shares or approximately $4.7 million based on the Company’s closing stock price on April 29, 2015. The amended
stock repurchase program will expire on April 30, 2017.
On February 25, 2016, the Board of Directors voted to further amend the Company’s existing stock repurchase program
subject to regulatory approval, which was received on March 2, 2016. The approved amendment, which was effective
March 2, 2016, increased the existing stock repurchase program by an additional 600,000 shares of the Company’s common
stock, representing 6.3% of the Company’s outstanding common shares or approximately $6.3 million based on the
Company’s closing stock price on March 2, 2016. The amended stock repurchase program will expire on March 2, 2018.
25
The following table sets forth information with respect to purchases made by us of our common stock during the fourth
quarter of fiscal year ended June 30, 2016:
Period
Apr. 1 –Apr. 30 .............................
May 1 –May 31 .............................
Jun. 1 –Jun. 30 ...............................
Total Number of
Shares Purchased
(1)
Total Number of
Shares Purchased
as Part of Publicly
Announced
Programs
Maximum
Number of Shares
that May Yet Be
Purchased Under
the Program
Weighted Average
Price Per share
11,800 $
1,600
-
10.78
11.14
-
1,323,162
1,324,762
1,324,762
646,838
645,238
645,238 (2)
(1) Based on trade date, not settlement date
(2) On August 22, 2016, the Company purchased 645,238 shares at a price of $10.75 per share.
26
Item 6.
Selected Financial Data
The following table sets forth our selected financial and operating data on a historical basis. The data set forth below does
not purport to be complete. It should be read in conjunction with, and is qualified in its entirety by, the more detailed
information, including the Company’s Consolidated Financial Statements and related notes, appearing elsewhere herein.
Twelve Months
Ended
June 30, 2016
Twelve Months
Ended
June 30, 2015
Twelve Months
Ended
June 30, 2014
(Dollars in thousands, except per share data)
Twelve Months
Ended
June 30, 2013
Twelve Months
Ended
June 30, 2012
Selected operations data:
Interest and dividend income .... $
Interest expense .........................
Net interest income ...................
Provision for loan losses ...........
Noninterest income ...................
Net securities gains ...................
Noninterest expense ..................
Income before income taxes ......
Income tax expense ...................
Net income from continuing
operations .......................................
Net (loss) income from discontinued
operations .......................................
Net income ......................................... $
Consolidated per share data:
Earnings:
Basic:
Continuing operations .................... $
Discontinued operations .............
Net income ............................. $
Diluted:
Continuing operations .................... $
Discontinued operations .............
Net income ............................. $
Cash dividends ...................... $
Book value .............................
Selected balance sheet data:
47,235 $
7,855
39,380
1,618
7,773
-
33,812
11,723
4,104
44,588 $
7,220
37,368
717
7,089
-
32,604
11,136
3,995
38,371 $
6,653
31,718
531
4,869
-
31,777
4,279
1,579
36,543 $
6,596
29,947
1,122
8,514
792
31,955
6,176
1,881
7,619
7,141
2,700
4,295
-
7,619 $
-
7,141 $
(8)
2,692 $
125
4,420 $
0.80 $
0.00
0.80 $
0.80 $
0.00
0.80 $
0.04 $
12.51
0.72 $
0.00
0.72 $
0.72 $
0.00
0.72 $
0.04 $
11.77
0.26 $
0.00
0.26 $
0.26 $
0.00
0.26 $
0.28 $
11.05
0.38 $
0.01
0.39 $
0.38 $
0.01
0.39 $
0.36 $
10.89
27,014
6,317
20,697
946
5,782
1,111
25,680
964
102
862
1,301
2,163
0.11
0.30
0.41
0.11
0.30
0.41
0.36
11.07
Total assets ........................................ $
Loans ................................................
Deposits ............................................
Borrowings and capital lease
obligations ......................................
Total shareholders’ equity .................
986,153 $
692,436
800,432
54,534
116,591
850,718 $
612,137
674,759
52,568
112,727
761,931 $
516,416
574,329
66,005
112,066
670,639 $
435,376
484,623
64,069
113,802
669,196
356,254
422,188
120,859
119,139
Other ratios:
Return on average assets ...............
Return on average equity ..............
Efficiency ratio...............................
Average equity to average total
assets ..........................................
Common dividend payout ratio .....
Tier 1 leverage capital ratio ............
Total capital ratio ...........................
0.85%
6.66%
71.71%
12.71%
5.00%
13.27%
20.39%
0.89%
6.35%
73.34%
14.00%
5.56%
14.49%
20.14%
0.37%
2.39%
86.85%
15.38%
107.6%
15.90%
23.69%
0.64%
3.79%
81.41%
16.93%
92.25%
17.78%
27.54%
0.36%
3.03%
93.08%
11.90%
71.26%
19.91%
33.34%
27
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Northeast Bancorp is a Maine corporation and a bank holding company registered with the Federal Reserve under the Bank
Holding Company Act of 1956. The Company also is a registered Maine financial institution holding company, and is subject
to regulation by both the Maine Bureau of Financial Institutions and the Federal Reserve. The Company's principal asset is
the capital stock of Northeast Bank, a Maine state-chartered universal bank, which is regulated by the FDIC and the Bureau.
The Company's results of operations are primarily dependent on the results of the operations of the Bank.
The Management's Discussion and Analysis of Financial Condition and Results of Operations, which follows, presents a
review of the consolidated operating results of the Company for the fiscal year ended June 30, 2016 ("fiscal 2016") and the
fiscal year ended June 30, 2015 ("fiscal 2015"). This discussion and analysis is intended to assist you in understanding the
results of our operations and financial condition. You should read this discussion together with your review of the Company's
Consolidated Financial Statements and related notes and other statistical information included in this report. Certain amounts
in the periods prior to fiscal 2016 have been reclassified to conform to the fiscal 2016 presentation.
Overview
On December 29, 2010, the merger (the "Merger") of the Company and FHB Formation LLC, a Delaware limited liability
company ("FHB"), was consummated. In connection with the transaction, as part of the regulatory approval process the
Company made certain commitments to the Board of Governors of the Federal Reserve System (the "Federal Reserve"), the
most significant of which are, (i) maintain a Tier 1 leverage ratio of at least 10%, (ii) maintain a total capital ratio of at least
15%, (iii) limit purchased loans to 40% of total loans, (iv) fund 100% of the Company's loans with core deposits (defined as
non-maturity deposits and non-brokered insured time deposits), and (v) hold commercial real estate loans (including owner-
occupied commercial real estate) to within 300% of total capital.
On June 28, 2013, the Federal Reserve approved the amendment of the commitment to hold commercial real estate loans to
within 300% of total capital to exclude owner-occupied commercial real estate loans. All other commitments made to the
Federal Reserve in connection with the merger remain unchanged. The Company and the Bank are currently in compliance
with all commitments to the Federal Reserve.
The Company's compliance ratios at June 30, 2016 are as follows:
Condition
(i) Tier 1 leverage ratio .............................................................................................................................
(ii) Total capital ratio ...............................................................................................................................
(iii) Ratio of purchased loans to total loans ...............................................................................................
(iv) Ratio of loans to core deposits (1) ......................................................................................................
(v) Ratio of non-owner occupied commercial real estate loans to total capital (2) ...................................
Ratio
13.27%
20.39%
34.25%
87.15%
174.12%
(1) Core deposits include all non-maturity deposits and non-brokered insured time deposits
(2) For purposes of calculating this ratio, commercial real estate includes all non-owner occupied commercial real estate
loans defined as such by regulatory guidance, including all land development and construction loans
Fiscal 2016 Financial Highlights
The Company's financial and strategic highlights for fiscal 2016 include the following:
(cid:2) Earned net income of $7.6 million, or $0.80 per diluted share, as compared to $7.1 million, or $0.72 per diluted
share, in fiscal 2015.
(cid:2) Generated loans of $382 million, growing the portfolio on a net basis by $80.3 million or 13.1%.
(cid:2) LASG purchased loans totaling $100.0 million and originated loans totaling $110.6 million, earning average
portfolio yields of 11.4% and 6.1%, respectively. The purchased loan yield of 11.4% includes regularly scheduled
interest and accretion, and accelerated accretion and fees recognized on loan payoffs. The Company also monitors
the "total return" on its purchased loan portfolio, a measure that includes gains on sales of purchased loans, as well
as interest, scheduled accretion and accelerated accretion and fees. On this basis, the purchased loan portfolio earned
a total return of 11.4% for fiscal 2016.
28
An overview of the LASG portfolio follows:
2016
2015
Year Ended June 30,
Purchased Originated
Secured
Loans to
Broker-
Dealers
Total
LASG
(Dollars in thousands)
Purchased Originated
Secured
Loans to
Broker-
Dealers
Total
LASG
Loans purchased or
originated during the
period:
Unpaid principal
balance ..................... $ 108,716 $ 110,578 $
99,999 110,578
Net investment basis .
- $ 219,294 $
- 210,577
93,694 $
82,654
82,502 $ 48,000 $ 224,196
82,502 48,000 213,156
Loan returns during the
period:
Yield (1) .......................
Total Return (1) (2) ......
Total loans as of period
end:
Unpaid principal
11.37%
11.38%
6.11%
6.10%
0.50%
0.50%
8.03%
8.04%
13.00%
13.33%
6.44%
6.75%
0.47%
0.47%
9.73%
10.02%
balance ..................... $ 271,268 $ 174,918 $ 48,000 $ 494,186 $ 239,933 $ 118,416 $ 60,000 $ 418,349
118,416 60,000 381,008
Net investment basis ... 239,709 174,918
48,000 462,627 202,592
(1) The yield and total return on LASG originated loans includes $385 thousand of fees related to one loan in the quarter
ended June 30, 2016.
(2) The total return on purchased loans represents scheduled accretion, accelerated accretion, gains on asset sales, and other
noninterest income recorded during the period divided by the average invested balance, on an annualized basis. The total
return does not include the effect of purchased loan charge-offs or recoveries in the quarter.
(cid:2)
Increased the Company's deposit base by $125.7 million, mainly the result of the increase in money market accounts
attracted through the Bank's Community Banking division.
(cid:2) Originated $54.5 million in SBA guaranteed loans through June 30, 2016, and sold $39.1 million of loans, for a gain
on sale of $4.2 million.
(cid:2) Raised $15.05 million of subordinated notes at a cost of 6.75% which qualify for Tier 2 Capital treatment.
(cid:2) Repurchased 322,900 shares at an average repurchase price of $10.40.
Results of Operations
General
Net income for the year ended June 30, 2016 was $7.6 million, a $478 thousand increase from $7.1 million for the year ended
June 30, 2015.
Items of significance affecting the Company's earnings included:
(cid:2) An increase in net interest and dividend income before provision for loan losses, which grew to $39.4 million as
compared to $37.4 million for the year ended June 30, 2015, principally due to higher average balances in the total
loan portfolio.
29
The following table summarizes interest income and related yields recognized on the Company's loans:
Average
Balance (1)
2016
Interest
Income (2)
Interest Income and Yield on Loans
Year Ended June 30,
Average
Yield
(Dollars in thousands)
Balance (1)
2015
Interest
Income
Yield
Community
Banking .............. $
SBA ......................
LASG:
Originated .........
Purchased ..........
Secured Loans to
Broker-Dealers
Total LASG ...
Total ........... $
218,649 $
23,786
147,193
216,763
58,511
422,467
664,902 $
10,483
1,448
8,987
24,638
293
33,918
45,849
4.79% $
6.09%
233,506 $
2,622
6.11%
11.37%
76,448
203,822
0.50%
8.03%
6.90% $
44,942
325,212
561,340 $
11,599
148
4,924
26,500
212
31,636
43,383
4.97%
5.64%
6.44%
13.00%
0.47%
9.73%
7.73%
(1) Includes loans held for sale.
(2) SBA interest income includes SBA fees of $33 thousand for the year ended June 30, 2016.
The yield on purchased loans is affected by unscheduled loan payoffs, which resulted in immediate recognition of the prepaid
loans’ discount in interest income. The following table details the “total return” on purchased loans, which includes total
transactional income of $7.3 million for the year ended June 30, 2016, a decrease of $2.6 million from the year ended
June 30, 2015. The following table summarizes the total return recognized on the purchased loan portfolio:
Regularly scheduled interest and accretion .......... $
Transactional income:
Gain on loan sales .............................................
Gain on sale of real estate owned .....................
Other noninterest income (loss) ........................
Accelerated accretion and loan fees .................
Total transactional income ............................
Total ......................................................... $
Year Ended June 30,
2016
2015
Income
Return (1)
Income
Return (1)
(Dollars in thousands)
17,382
8.02% $
17,327
8.48%
-
23
12
7,256
7,291
24,673
0.00%
0.01%
0.00%
3.35%
3.36%
11.38% $
190
607
(69)
9,173
9,901
27,228
0.09%
0.30%
-0.03%
4.49%
4.85%
13.33%
(1) The total return on purchased loans represents scheduled accretion, accelerated accretion, gains on asset sales, gains
on real estate owned and other noninterest income recorded during the period divided by the average invested
balance, on an annualized basis. The total return does not include the effect of purchased loan charge-offs or
recoveries in the quarter.
(cid:2) An increase of $901 thousand in the provision for loan losses principally due to two loans which were provided for
in the second quarter and increased volume of newly originated loans.
(cid:2) An increase of $684 thousand in noninterest income, principally resulting from an increase of $1.4 million in gains
realized on sale of portfolio loans. The year ended June 30, 2016 includes gains realized on sale of SBA loans of
$4.2 million. The increase is offset by a decrease of $193 thousand in gains realized on sale of residential loans held
for sale due to lower volume, as well as a decrease of $683 thousand in gain recognized on real estate owned and
other repossessed collateral, net.
(cid:2) An increase of $1.2 million in noninterest expense, principally due to an increase of $731 thousand in salaries and
employee benefits from increased employee head count and higher employee benefits costs. Additionally, there was
an increase of $428 thousand in other expense, attributable to the valuation of SBA servicing rights.
30
Net Interest Income
The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods
indicated:
2016
Interest Average
Average Income/ Yield/
Balance Expense Rate
Year Ended June 30,
2015
2014
Interest Average
Interest Average
Average Income/ Yield/
Balance Expense Rate
(Dollars in thousands)
Average Income/ Yield/
Balance Expense Rate
Assets:
Interest-earning assets:
Investment securities .............................. $ 100,503 $
930
Loans (1) (2) (3) ...................................... 664,902 45,921
Regulatory stock .....................................
2,960
113
Short-term investments (4) ..................... 91,563
343
Total interest-earning assets ........................ 859,928 47,307
Cash and due from banks ............................
3,596
Other non-interest earning assets ................ 35,607
Total assets .................................................. $ 899,131
Liabilities & Shareholders' Equity:
Interest-bearing liabilities:
NOW accounts ........................................ $ 68,304 $
182
Money market accounts .......................... 212,102 1,845
Savings accounts ..................................... 36,062
48
Time deposits .......................................... 349,978 3,952
Total interest-bearing deposits .................... 666,446 6,027
Short-term borrowings ...........................
20
Borrowed funds ....................................... 32,432 1,094
Subordinated debt ...................................
651
Capital lease obligations .........................
63
Total interest-bearing liabilities .................. 710,516 7,855
8,762
1,242
1,634
0.93% $108,204 $
913
6.91% 561,340 43,456
67
3.82%
4,102
0.37% 92,354
225
5.50% 766,000 44,661
2,704
33,741
$802,445
0.84% $ 115,849 $ 1,048
7.74% 495,113 37,009
1.63%
5,620
123
0.24% 78,838
191
5.83% 695,420 38,371
2,876
33,958
$ 732,254
0.27% $ 63,181 $
0.87% 133,266
0.13% 34,495
1.13% 340,046
0.90% 570,988
1.22%
2,578
3.37% 45,661
8,531
7.43%
5.07%
1,457
1.11% 629,215
162
1,002
46
3,800
5,010
29
1,389
718
74
7,220
0.26% $ 61,146 $
162
0.75% 85,333
447
0.13% 34,391
44
1.12% 314,848 3,470
0.88% 495,718 4,123
1.12%
2,230
24
3.04% 58,468 1,658
8,352
8.42%
765
5.08%
1,643
83
1.15% 566,411 6,653
0.90%
7.47%
2.19%
0.24%
5.52%
0.26%
0.52%
0.13%
1.10%
0.83%
1.08%
2.98%
9.16%
5.05%
1.18%
Non-interest bearing liabilities:
Demand deposits and escrow accounts ....... 67,041
Other liabilities ............................................
7,252
Total liabilities ............................................. 784,809
Shareholders' equity .................................... 114,322
Total liabilities and shareholders' equity ..... $ 899,131
54,940
5,913
690,068
112,377
$802,445
50,890
2,319
619,620
112,634
$ 732,254
Net interest income ......................................
$ 39,452
$ 37,441
$ 31,718
Interest rate spread .......................................
Net interest margin (5) ................................
4.39%
4.59%
4.68%
4.89%
4.34%
4.56%
(1) Interest income and yield are stated on a fully tax-equivalent basis using a 34% tax rate.
(2) Includes loans held for sale.
(3) Nonaccrual loans are included in the computation of average, but unpaid interest has not been included for purposes of determining interest income.
(4) Short term investments include FHLBB overnight deposits and other interest-bearing deposits.
(5) Net interest margin is calculated as net income divided by total interest-earning assets.
31
The following table presents the extent to which changes in volume and interest rates of interest earning assets and interest
bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information
is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by
prior period rate), (ii) changes attributable to changes in rates (changes in rates multiplied by prior period volume) and (iii)
changes attributable to a combination of changes in rate and volume (change in rates multiplied by the changes in volume).
Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to
volume and the changes due to rate.
Year Ended June 30, 2016
Compared to the Year Ended June 30, 2015
Change Due to
Rate
(Dollars in thousands)
Change Due to
Volume
Total Change
Interest earning assets:
Investment securities ................................................... $
Loans ...........................................................................
Regulatory stock ...........................................................
Short-term investments ................................................
Total increase (decrease) in interest income .................
Interest-bearing liabilities:
Interest-bearing deposits ...............................................
Short-term borrowings .................................................
Borrowed funds ............................................................
Subordinated debt .........................................................
Capital lease obligations ...............................................
Total increase in interest expense .................................
Total increase (decrease) in net interest and
(68) $
7,471
(23)
(2)
7,378
793
(12)
(434)
19
(11)
355
85 $
(5,006)
69
120
(4,732)
224
3
139
(86)
-
280
dividend income .................................................... $
7,023 $
(5,012) $
17
2,465
46
118
2,646
1,017
(9)
(295)
(67)
(11)
635
2,011
Year Ended June 30, 2015
Compared to the Year Ended June 30, 2014
Change Due to
Rate
(Dollars in thousands)
Change Due to
Volume
Total Change
Interest earning assets:
Investment securities .................................................... $
Loans ............................................................................
Regulatory stock ...........................................................
Short-term investments .................................................
Total increase in interest income ..................................
Interest bearing liabilities:
Interest bearing deposits ...............................................
Short-term borrowings ..................................................
Borrowed funds ............................................................
Subordinated debt .........................................................
Capital lease obligations ...............................................
Total increase in interest expense .................................
Total increase in net interest and dividend income ... $
(67) $
5,090
(29)
33
5,027
612
4
(314)
16
(9)
309
4,718 $
(68) $
1,357
(27)
1
1,263
275
1
45
(63)
-
258
1,005 $
(135)
6,447
(56)
34
6,290
887
5
(269)
(47)
(9)
567
5,723
For the year ended June 30, 2016, the $7.0 million volume-related change in net interest income was mainly the result of the
significant increase in loans, which grew by $103.6 million on average compared to fiscal 2015. The rate-related change in
fiscal 2016 compared to fiscal 2015 was principally due to the purchased loan yield differential, and a decline in yields on
the originated loan portfolios. For fiscal 2016, the net interest margin earned of 4.59% was 30 basis points lower than that
earned for the year ended June 30, 2015, principally due to the decrease in transactional income on purchased loans.
The Company’s total cost of funds improved to 1.01% in fiscal 2016, down from 1.06% in fiscal 2015, principally due to the
payoff of interest-bearing liabilities in fiscal 2016.
32
Provision for Loan Losses
Quarterly, the Company determines the amount of its allowance for loan losses adequate to provide for losses inherent in the
Company's loan portfolios, with the provision for loan losses determined by the net periodic change in the allowance for loan
losses. For acquired loans accounted for under ASC 310-30, Receivables—Loans and Debt Securities Acquired with
Deteriorated Credit Quality ("ASC 310-30"), a provision for loan loss is recorded when estimates of future cash flows
decrease due to credit deterioration.
The provision for loan losses for periods subsequent to the Merger reflects the impact of adjusting loans to their then fair
values, as well as the elimination of the allowance for loan losses in accordance with the acquisition method of accounting.
Subsequent to the Merger, the provision for loan losses has been recorded based on estimates of inherent losses in newly
originated loans and for incremental reserves required for pre-merger loans based on estimates of deteriorated credit quality
post-merger.
The provision for loan losses for the fiscal year ended June 30, 2016 was $1.6 million. This compares to a provision for loan
losses of $717 thousand for the year ended June 30, 2015. At June 30, 2016 and 2015, the allowance for loan losses was $2.4
million and $1.9 million, respectively, and the ratio of allowance for loan losses to total loans was 0.34% and 0.31%,
respectively.
Net charge-offs for the fiscal year ended June 30, 2016 totaled $1.2 million, representing approximately 0.18% of the
Company's average portfolio loan balance during the fiscal year. This compares to $158 thousand, or 0.03%, in fiscal 2015,
representing an increase of $1.0 million in fiscal 2016. The increase was principally due to two loans which were provided
for in the second quarter, and subsequently charged off.
For additional information on the allowance for loan losses, see "Asset Quality."
Noninterest Income
Noninterest income for the fiscal year ended June 30, 2016 totaled $7.8 million, an increase of $684 thousand, or 9.6%, from
fiscal 2015. When compared to fiscal 2015, the increase was principally due to the following:
(cid:2) An increase of $1.4 million in gains realized on sale of portfolio loans. The year ended June 30, 2016 includes gains
realized on sale of SBA loans of $4.2 million, compared to a $2.8 million gain on sale of SBA loans and LASG
purchased loans in the year ended June 30, 2015; and
(cid:2) A $683 thousand decrease in net gain recognized on real estate owned and other repossessed collateral, net.
Noninterest Expense
Noninterest expense for the fiscal year ended June 30, 2016 totaled $33.8 million, an increase of $1.2 million, or 3.7%, from
fiscal 2015. When compared to fiscal 2015, the increase was principally due to the following:
(cid:2) An increase of $731 thousand in salaries and employee benefit costs, principally due to increased employee head
count, as well as higher employee benefits; and
(cid:2) An increase of $428 thousand in other expense, which is primarily attributed to the valuation of SBA servicing rights.
Income Taxes
Income tax expense for the fiscal year ended June 30, 2016 totaled $4.1 million, representing 35.0% of pretax income, as
compared to $4.0 million, or 35.9% of pretax income, in fiscal 2015. The decrease in the Company's effective tax rate was
principally due to the adoption of ASU 2014-01, Investments—Equity Method and Joint Ventures (Topic 323): Accounting
for Investments in Qualified Affordable Housing Projects ("ASU 2014-01") in fiscal 2016 and changes in state apportionment.
See Note 1 of the Notes to the Company's Consolidated Financial Statements in this Annual Report for impact related to the
adoption of ASU 2014-01.
33
Financial Condition
Overview
The Company's total assets grew to $986.2 million at June 30, 2016, representing an increase of $135.5 million, or 15.9%,
compared to $850.7 million at June 30, 2015. Significant changes in the Company's balance sheet components include:
(cid:2) The loan portfolio – excluding loans held for sale – has grown by $80.3 million, or 13.1%, compared to June 30,
2015, principally on the strength of $81.6 million of net growth in commercial loans purchased or originated by the
LASG, net growth of $15.5 million in originations by the SBA Division and net growth of $3.9 million in commercial
originations by the Community Banking Division. The total net growth was offset by a pay down of one secured
loan to a broker-dealer for $12.0 million in the LASG portfolio and a $20.9 million decrease in the Community
Banking Division residential and consumer loan portfolio;
(cid:2) Deposits increased $125.7 million, or 18.6%, primarily due to growth in non-maturity accounts of $120.3 million,
or 36.6%, and growth in time deposits of $5.4 million, or 1.6%; and
(cid:2) Shareholders’ equity increased by $3.9 million from June 30, 2015, due principally to earnings of $7.6 million, offset
by $3.4 million in share repurchases (representing 322,900 shares). Additionally, there was an increase in stock-
based compensation of $613 thousand, offset by a decrease in accumulated other comprehensive loss of $618
thousand and $380 thousand in dividends paid on common stock.
Cash and Cash Equivalents
Cash and cash equivalents increased $61.3 million, or 68.2%, to $151.2 million at June 30, 2016 as compared to $89.9 million
at June 30, 2015. This increase was principally the result of net deposit growth of $125.7 million and the issuance of $15.05
million of subordinated notes in fiscal 2016, partially offset by net loan growth of $80.3 million.
Investments Securities
The available-for-sale securities portfolio totaled $100.6 million and $101.9 million at June 30, 2016 and 2015, respectively.
The Company's investment portfolio was comprised primarily of U.S. Government-sponsored enterprise bonds and
mortgage-backed securities guaranteed by government agencies. Generally, funds retained by the Company as a result of
increases in deposits or decreases in loans, to the extent not immediately deployed by the Bank, are invested in securities
held in its investment portfolio, which serves as a source of liquidity for the Company. The composition of the Company's
securities portfolio at the dates indicated follows.
June 30, 2016
Amortized
Cost
Fair
Value
June 30, 2015
Amortized
Cost
Fair
Value
(Dollars in thousands)
June 30, 2014
Amortized
Cost
Fair
Value
U.S. Government agency securities . $
Agency mortgage-backed securities .
Other investment measured at net
51,948 $
43,330
52,046 $
43,368
48,191 $
54,553
48,230 $
53,678
48,415 $
66,744
48,418
65,463
asset value ....................................
5,097
$ 100,375 $
5,158
100,572 $
-
102,744 $
-
-
101,908 $ 115,159 $
-
113,881
34
The table below sets forth certain information regarding the contractual maturities and weighted average yields of the
Company’s securities portfolio at June 30, 2016. Actual maturities of mortgage-backed securities will differ from contractual
maturities due both to scheduled amortization and prepayments.
Within One Year
Fair
Value Yield
After One Year
Through Five
Years
After Five Years
Through Ten
Years
After Ten Years
Total
Fair
Value Yield
Fair
Value Yield
(Dollars in thousands)
Fair
Value Yield
Fair
Value Yield
U.S. Government agency
securities ....................... $ 12,014 0.54% $ 40,032
0.83% $
-
0.00% $
- 0.00% $ 52,046
0.76%
Agency mortgage-backed
securities .......................
- 0.00%
-
$ 12,014 0.54% $ 40,032
0.00% 19,797
0.83% $ 19,797
0.85% 23,571 1.30% 43,368
0.85% $ 23,571 1.30% $ 95,414
1.09%
0.91%
The other investment measured at net asset value has no scheduled maturity date. However, the Company’s investment can
be redeemed daily at the closing net asset value.
Management reviews the portfolio of investments on an ongoing basis to determine if there have been any other-than-
temporary declines in value. No other-than-temporary impairment expense was recognized during fiscal 2016 or fiscal 2015.
Loans
Loans, including loans held-for-sale, totaled $700.0 million at June 30, 2016, compared to $621.2 million at June 30, 2015.
The increase of $78.8 million, or 12.7%, at June 30, 2016, was principally due to net increases of $77.9 million in commercial
real estate and $22.8 million in commercial and industrial, offset by a net decrease of $18.7 million in residential loans, $1.7
million in consumer loans and $1.5 million in loans held for sale. During fiscal 2016, the LASG purchased $100.0 million in
loans, consisting principally of commercial real estate loans. Additionally, during fiscal 2016, the LASG originated $110.6
million in loans.
The composition of the Company’s loan portfolio (excluding loans held-for-sale) at the dates indicated is as follows:
June 30, 2016
June 30, 2015
June 30, 2014
June 30, 2013
June 30, 2012
Percent
Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
(Dollars in thousands)
Percent
Percent
Percent
Residential real estate ... $ 113,962 16.46% $ 132,669 21.67% $ 148,634 28.79% $ 127,829 29.36% $ 137,571 38.61%
Commercial real estate .. 426,568 61.60% 348,676 56.96% 316,098 61.21% 264,490 60.75% 181,922 51.07%
Commercial and
5.51%
industrial ...................... 145,956 21.08% 123,133 20.12%
Consumer and other ......
4.81%
1.25%
Total loans ..................... 692,436 100.00% 612,137 100.00% 516,416 100.00% 435,376 100.00% 356,254 100.00%
Less: Allowance for loan
6.83% 19,612
3.06% 17,149
29,720
13,337
41,800
9,884
8.09%
1.91%
0.86%
5,950
7,659
losses ...........................
2,350
Loans, net ....................... $ 690,086
1,926
$ 610,211
1,367
$ 515,049
1,143
$ 434,233
824
$ 355,430
35
The Company’s loan portfolio (excluding loans held-for-sale) by lending division follows:
June 30, 2016
Community
Banking
Division
LASG
SBA Division
(Dollars in thousands)
Total
Percent of
Total
Originated loans:
Residential real estate .................... $
Home equity ..................................
Commercial real estate: non-
93,258 $
18,012
- $
-
133 $
-
93,391
18,012
13.49%
2.60%
owner occupied ..........................
49,514
52,744
5,639
107,897
15.58%
Commercial real estate: owner
occupied ....................................
Commercial and industrial .............
Consumer ......................................
Subtotal ......................................
Purchased loans:
Residential real estate ....................
Commercial real estate: non-
owner occupied ..........................
Commercial real estate: owner
occupied ....................................
Commercial and industrial .............
Subtotal ......................................
Total ........................................... $
20,578
16,069
5,950
203,381
-
-
-
-
-
203,381 $
46,727
123,447
-
222,918
2,559
142,286
94,666
198
239,709
462,627 $
14,414
6,242
-
26,428
81,719
145,758
5,950
452,727
11.80%
21.05%
0.86%
65.38%
-
-
2,559
0.37%
142,286
20.55%
-
-
-
26,428 $
94,666
198
239,709
692,436
13.67%
0.03%
34.62%
100.00%
June 30, 2015
Community
Banking
Division
LASG
SBA Division
(Dollars in thousands)
Total
Percent of
Total
Originated loans:
Residential real estate .................... $
Home equity ..................................
Commercial real estate: non-
106,138 $
24,326
137 $
-
- $
-
106,275
24,326
17.37%
3.97%
owner occupied ..........................
48,933
53,051
3,865
105,849
17.29%
Commercial real estate: owner
occupied ....................................
Commercial and industrial .............
Consumer ......................................
Subtotal ......................................
Purchased loans:
Residential real estate ....................
Commercial real estate: non-
owner occupied ..........................
Commercial real estate: owner
occupied ....................................
Commercial and industrial .............
Subtotal ......................................
Total ........................................... $
21,657
11,597
7,659
220,310
-
-
-
-
-
220,310 $
16,507
108,577
-
178,272
2,068
128,182
72,069
273
202,592
380,864 $
4,461
2,637
-
10,963
42,625
122,811
7,659
409,545
6.96%
20.06%
1.25%
66.90%
-
-
2,068
0.34%
128,182
20.94%
-
-
-
10,963 $
72,069
273
202,592
612,137
11.77%
0.05%
33.10%
100.00%
36
The following table summarizes the scheduled maturity of the Company’s loan portfolio at June 30, 2016. Demand loans,
loans having no stated repayment schedule, and overdraft loans are reported as being due in less than one year.
Within One
Year
Mortgages:
Residential:
After One Year
Through Five
Years
Scheduled Loan Maturities
After Five
Years
Through Ten
Years
(Dollars in thousands)
After Ten
Years
Originated ...................... $
Purchased .......................
856 $
7
Commercial:
Originated ......................
Purchased .......................
21,609
36,510
4,374 $
250
52,417
81,865
8,808 $
1,125
57,496
22,937
85,815 $
1,177
58,095
95,641
Non-mortgage loans:
Commercial:
Originated ......................
Purchased .......................
Consumer and other .............
Total loans ............................... $
75,776
-
1,118
135,876 $
55,040
198
8,463
202,607 $
11,934
-
4,995
107,295 $
3,008
-
2,922
246,658 $
Total
99,853
2,559
189,617
236,953
145,758
198
17,498
692,436
Predetermined rate
Loans Due After One Year, by Interest Rate Type
Floating or
Adjustable
(Dollars in thousands)
Total
Mortgages:
Residential:
Originated .......................................................... $
Purchased ...........................................................
Commercial:
Originated ..........................................................
Purchased ...........................................................
Non-mortgage loans:
Commercial:
Originated ..........................................................
Purchased ...........................................................
Consumer and other ................................................
Total ........................................................................... $
53,730 $
1,125
15,654
78,329
20,016
-
5,717
174,571 $
45,267 $
1,427
152,354
122,113
49,966
198
10,664
381,989 $
98,997
2,552
168,008
200,442
69,982
198
16,381
556,560
Approximately 62.7% of total portfolio loans at June 30, 2016, were variable rate products, compared to 54.4% at June 30,
2015.
Certain purchased loans have been identified as having evidence of credit deterioration since their origination, and it is
probable that the Company will not collect all contractually required principal and interest payments. Purchased loans are
accounted for using the measurement provisions set forth in ASC 310-30. The nonaccretable difference represents a loan's
contractually required payments receivable in excess of the amount of cash flows expected to be collected. Improvements in
expected cash flows result in prospective yield adjustments. The effect of a decrease in expected cash flows due to further
credit deterioration are recorded through the allowance for loan losses.
Other Assets
The cash surrender value of the Company's BOLI assets increased $449 thousand, or 2.9%, to $15.7 million at June 30, 2016,
compared to $15.3 million at June 30, 2015. BOLI assets are invested in the general account of three insurance companies
and in separate accounts of 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, 2016.
Interest earnings, net of mortality costs, increase the cash surrender value. These interest earnings are based on interest rates
37
that reset each year, and are subject to minimum guaranteed rates. These increases in cash surrender value are recognized in
other income and are not subject to income taxes. Management considers BOLI an illiquid asset. BOLI represented 11.0%
of the Company's total capital at June 30, 2016.
Intangible assets totaled $1.7 million and $2.2 million at June 30, 2016 and June 30, 2015, respectively. The $477 thousand
decrease was the result of core deposit intangible amortization during fiscal 2016.
Deposits
The Company's principal source of funding is its core deposit accounts. At June 30, 2016, core deposits, which the Company
defines as non-maturity deposits and non-brokered insured time deposits, represented 100% of total deposits.
Total deposits increased $125.7 million to $800.4 million as of June 30, 2016 from $674.8 million as of June 30, 2015. The
increase mainly resulted from the increase in money market accounts attracted through the Community Banking Division.
The following tables set forth certain information relative to the composition of the Company's average deposit accounts and
the weighted average interest rate on each category of deposits for the periods indicated:
Average
Balance
Year Ended June 30, 2016
Weighted
Average Rate
(Dollars in thousands)
Percent of Total
Average Deposits
Non-interest bearing demand deposits and escrow
accounts ................................................................. $
Regular savings ..........................................................
NOW accounts ...........................................................
Money market accounts .............................................
Time deposits ............................................................
Total average deposits ............................................... $
67,041
36,062
68,304
212,102
349,978
733,487
0.00%
0.13%
0.27%
0.87%
1.13%
0.82%
9.14%
4.92%
9.31%
28.92%
47.71%
100.00%
Year Ended June 30, 2015
Year Ended June 30, 2014
Average
Balance
Weighted
Average
Rate
Percent of
Total
Average
Deposits
Average
Balance
(Dollars in thousands)
Weighted
Average
Rate
Percent of
Total
Average
Deposits
Non-interest bearing
demand deposits and
escrow accounts ............ $
Regular savings .................
NOW accounts ..................
Money market accounts ....
Time deposits ...................
Total average deposits ...... $
54,940
34,495
63,181
133,266
340,046
625,928
0.00%
0.13%
0.26%
0.75%
1.12%
0.79%
8.78% $
5.51%
10.09%
21.29%
54.33%
100.00% $
50,890
34,391
61,146
85,333
314,848
546,608
0.00%
0.14%
0.26%
0.52%
1.10%
0.75%
9.31%
6.29%
11.19%
15.61%
57.60%
100.00%
There were no time deposits greater than $250 thousand as of June 30, 2016, and there were $569 thousand of time deposits
greater than $250 thousand as of June 30, 2015. The scheduled maturity of deposits greater than or equal to $100 thousand
is set forth below:
3 months or less ................................................................................................................................ $
Over 3 through 6 months ..................................................................................................................
Over 6 through 12 months ................................................................................................................
Over 12 months ................................................................................................................................
Total time certificates greater than or equal to $100 thousand ........................................................ $
June 30, 2016
(Dollars in thousands)
45,744
52,597
86,933
93,627
278,901
38
Borrowings
FHLBB advances, subordinated debt, and junior subordinated debentures have been the Company's sources of funding other
than deposits. In fiscal 2016, total borrowings increased by $2.2 million, or 4.3%, to $53.4 million.
Advances from the FHLBB were $30.1 million and $30.2 million at June 30, 2016 and June 30, 2015, respectively. Pledges
of residential real estate loans, certain commercial real estate loans and certain FHLBB deposits free of liens or pledges are
required to secure outstanding advances and available additional borrowing capacity from the FHLBB. There were no
wholesale repurchase agreements at June 30, 2016 and $10.0 million at June 30, 2015. At June 30, 2016, the Company had
no pledged investment securities.
There were no short-term borrowings at June 30, 2016, compared to $2.3 million at June 30, 2015. At June 30, 2016, the
Company had $23.4 million of letters of credit issued by the FHLBB for certain customer relationships.
On June 29, 2016, the Company entered into a Subordinated Note Purchase Agreement with certain institutional accredited
investors pursuant to which the Company sold and issued $15.05 million in aggregate principal amount of 6.75% fixed-to-
floating subordinated notes due 2026.
There were no balances outstanding at June 30, 2016 and 2015, respectively, for advances under the Federal Reserve Discount
Window Borrower-in-custody program. The available credit under the program was $1.9 million and $2.2 million at June 30,
2016 and June 30, 2015, respectively, with the decrease in fiscal 2016 attributable to payoffs of consumer loans pledged as
collateral.
The Company had junior subordinated debentures issued to affiliated trusts totaling $8.8 million and $8.6 million at June 30,
2016 and 2015, respectively. See “Capital” below for more information on our junior subordinated debentures and affiliated
trusts.
Asset Quality
Allowance for Loan Losses
The allowance for loan losses is maintained at a level that management considers adequate to provide for probable loan losses
based upon evaluation of known and inherent risks in the loan portfolio. The allowance is increased by providing for loan
losses through a charge to expense and by recoveries of loans previously charged-off and is reduced by loans being charged-
off.
39
At June 30, 2016, the allowance for loan losses totaled $2.4 million, or 0.34% of total loans, as compared to $1.9 million, or
0.31% of total loans, at June 30, 2015. The year over year increase in the Company’s allowance for losses was principally
the result of loan growth. The following table sets forth activity in Company’s allowance for loan losses for the periods
indicated.
Year Ended
June 30, 2016
Year Ended
June 30, 2015
Year Ended
June 30, 2014
(Dollars in thousands)
Year Ended
June 30, 2013
Year Ended
June 30, 2012
Allowance at beginning of period ............................... $
1,926
$
1,367
$
1,143
$
824
$
Loans charged-off during the period:
Residential real estate .........................................
Commercial real estate .......................................
Commercial and industrial .................................
Consumer and other ...........................................
Total loans charged-off ......................................
Recoveries on loans previously charged-off:
Residential real estate .........................................
Commercial real estate .......................................
Commercial and industrial .................................
Consumer and other ...........................................
Total recoveries ..................................................
Net loans charged off during the period ......................
Provision for loan losses .............................................
Allowance at end of period ......................................... $
Total loans at end of period (1) ...................................... $
Average loans outstanding during the period (1) ..........
Allowance as a percentage of total loans ....................
Ratio of net charge-offs to average loans outstanding
Allowance as a percentage of non-performing loans ...
134
988
77
66
1,265
35
5
14
17
71
1,194
1,618
2,350
692,436
659,995
$
$
207
-
3
28
238
24
1
34
21
80
158
717
1,926
612,137
555,073
$
$
267
26
43
69
405
63
2
8
25
98
307
531
1,367
516,416
488,172
$
$
369
135
203
148
855
6
10
7
29
52
803
1,122
1,143
435,376
376,660
$
$
0.34%
0.18%
30.02%
0.31%
0.03%
18.41%
0.26%
0.06%
18.66%
0.26%
0.21%
23.54%
437
248
26
17
352
643
3
-
44
37
84
559
946
824
356,254
333,053
0.23%
0.17%
13.48%
(1) Amounts and resulting ratios exclude loans held for sale
The following table allocates the allowance for loan losses by loan category and the percent of loans in each category to total
loans at the dates indicated below.
June 30, 2016
June 30, 2015
June 30, 2014
June 30, 2013
June 30, 2012
Percent of
Loans
to Total
Loans
Amount
Percent of
Loans
to Total
Loans
Amount
Amount
Percent of
Loans
to Total
Loans
(Dollars in thousands)
Amount
Percent of
Loans
to Total
Loans
Percent of
Loans
to Total
Loans
Amount
Residential real
estate ............... $
Commercial real
estate ...............
Commercial and
industrial ........
Consumer ............
Unallocated ..........
Total ..................... $
663
16.46% $
741
21.67% $
580
28.79% $
594
29.36% $
214
38.61%
1,328
61.60%
976
56.96%
625
61.21%
249
60.75%
93
51.07%
297
62
-
21.08%
0.86%
0.00%
2,350 100.00% $
118
35
56
1,926
20.12%
1.25%
0.00%
100.00% $
48
79
35
1,367
8.09%
1.91%
0.00%
100.00% $
70
189
41
1,143
6.83%
3.06%
0.00%
100.00% $
292
225
-
824
5.51%
4.81%
0.00%
100.00%
40
The following table reflects the annual trend of total loans 30 days or more past due, as a percentage of total loans at June 30:
Past due loans to total loans ...
1.00%
1.08%
1.14%
1.68%
1.95%
2016
2015
2014
2013
2012
Non-performing Assets
The table below sets forth the amounts and categories of the Company’s non-performing assets at the dates indicated:
June 30,
2016
June 30,
2015
June 30,
June 30,
2013
2014
(Dollars in thousands)
June 30,
2012
Nonperforming loans:
Originated portfolio:
Residential real estate .................................... $
Commercial real estate ..................................
Home equity ..................................................
Commercial and industrial ...........................
Consumer .....................................................
Total originated portfolio .....................................
Purchased portfolio:
Residential real estate ....................................
Commercial real estate ..................................
Total purchased portfolio .....................................
Total nonperforming loans ...................................
Real estate owned and other repossessed
collateral ...........................................................
Total nonperforming assets .................................. $
Nonperforming loans that are current .................. $
2,613 $
474
48
17
163
3,315
1,125
3,387
4,512
7,827
3,021 $
994
11
2
190
4,218
-
6,532
6,532
10,750
1,652
9,479 $
2,271 $
1,651
12,401 $
484 $
1,743 $
1,162
160
5
139
3,209
-
4,116
4,116
7,325
1,991
9,316 $
651 $
2,346 $
473
334
110
136
3,399
-
1,457
1,457
4,856
2,134
6,990 $
887 $
3,090
417
220
1,008
324
5,059
-
1,055
1,055
6,114
834
6,948
377
Non-performing loans to total loans .....................
Non-performing assets to total assets ...................
1.13%
0.96%
1.76%
1.46%
1.42%
1.22%
1.12%
1.04%
1.72%
1.04%
At June 30, 2016, the Company had $9.5 million of nonperforming assets, or 0.96% of total assets, compared to $12.4 million
of nonperforming assets, or 1.5% of total assets, as of June 30, 2015. The decrease in nonperforming assets in fiscal 2016
was principally associated with a decrease in purchased commercial real estate loans on nonaccrual.
Troubled Debt Restructurings (“TDRs”) represent loans for which concessions (such as extension of repayment terms or
reductions of interest rates to below market rates) are granted due to a borrower's financial condition. Such concessions may
include reductions of interest rates to below-market terms and/or extension of repayment terms. The balances and payment
status of TDRs follow:
Nonaccrual ....................................................................... $
Accrual .............................................................................
Total TDRs ....................................................................... $
1,152 $
7,036
8,188 $
2,131 $
6,365
8,496 $
2,117
4,057
6,174
June 30, 2016
June 30, 2015
(Dollars in thousands)
June 30, 2014
At June 30, 2016, the Company had real estate owned and other repossessed collateral of $1.7 million, with no net change
from June 30, 2015. The real estate and personal property collateral for commercial and consumer loans are written down to
fair 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 losses on disposition are recognized in noninterest income.
We continue to focus on asset quality and allocate significant resources to credit policy, loan review, asset management,
collection, and workout functions. Despite this ongoing effort, 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.
41
Potential Problem Loans
Commercial real estate and commercial loans are periodically evaluated under a ten-point rating system. These ratings are
guidelines in assessing the risk of a particular loan. The Company had $6.2 million and $8.9 million of loans rated substandard
or worse at June 30, 2016 and June 30, 2015, respectively, a decrease primarily attributable to upgraded purchased loans.
The following tables present the Company's loans by risk rating.
June 30, 2016
Commercial
Real Estate
Originated Portfolio
Commercial
and Industrial
Pass (1- 6) .......................................... $
Special mention (7) ...........................
Substandard (8) .................................
Doubtful (9) .......................................
Loss (10) ...........................................
$
186,165 $
2,493
958
-
-
189,616 $
Commercial
Real Estate
Originated Portfolio
Commercial
and Industrial
Pass (1- 6) .......................................... $
Special mention (7) ...........................
Substandard (8) .................................
Doubtful (9) .......................................
Loss (10) ...........................................
$
142,321 $
4,417
1,687
-
-
148,425 $
Residential
Real Estate(1)
(Dollars in thousands)
7,659 $
431
537
23
-
8,650 $
142,451 $
3,290
17
-
-
145,758 $
June 30, 2015
Residential
Real Estate(1)
(Dollars in thousands)
8,049 $
634
429
23
-
9,135 $
122,829 $
31
-
-
-
122,860 $
Purchased
Portfolio
Total
227,895 $
7,147
4,667
-
-
239,709 $
564,170
13,361
6,179
23
-
583,733
Purchased
Portfolio
Total
190,193 $
5,628
6,771
-
-
202,592 $
463,392
10,710
8,887
23
-
483,012
(1) Certain loans made for commercial purposes, but secured by residential collateral, are rated under the Company’s
risk-rating system.
Risk Management
Management and the Board of Directors of the Company recognize that taking and managing risk is fundamental to the
business of banking. Through the development, implementation and monitoring of its policies with respect to risk
management, the Company strives to measure, evaluate and control the risks it faces. The Board and management understand
that an effective risk management system is critical to the Company's safety and soundness. Chief among the risks faced by
us are credit risk, market risk (including interest rate risk), liquidity risk, and operational (transaction) risk.
Credit Risk
The Company considers credit risk to be the most significant risk that it faces, in that it has the greatest potential to affect the
financial condition and operating results of the Company. Credit risk is managed through a combination of policies and limits
established by the Board, the monitoring of compliance with these policies and limits, and the periodic evaluation of loans in
the portfolio, including those with problem characteristics. The Company also utilizes the services of independent third-
parties to provide loan review services, which consist of a variety of monitoring techniques after a loan is purchased or
originated.
In general, Northeast's policies establish limits on the maximum amount of credit that may be granted to a single borrower
(including affiliates), the aggregate amount of loans outstanding by type in relation to total assets and capital, and
concentrations of loans by size, property type, and geography. Underwriting criteria, such as collateral and debt service
coverage ratios and approval limits are also specified in loan policies. The Company's policies also address the performance
of periodic credit reviews, the risk rating of loans, when loans should be placed on non-performing status and factors that
should be considered in establishing the Bank's allowance for loan losses. For additional information, refer to "Asset Quality"
above and Item 1, "Business—Lending Activities."
42
Market Risk
Market risk is the risk of loss due to adverse changes in market prices and rates, and typically encompasses exposures such
as sensitivity to changes in market interest rates, foreign currency exchange rates, and commodity prices. The Company has
no exposure to foreign currency exchange or commodity price movements. Because net interest income is our primary source
of revenue, interest rate risk is a significant market risk to which the Company is exposed.
Interest rate risk can be defined as the exposure of future net interest income to adverse movements in interest rates. Net
interest income is affected by changes in interest rates as well as by fluctuations in the level, mix and duration of the
Company's assets and liabilities. Over and above the influence that interest rates have on net interest income, changes in rates
also affect the volume of lending activity, the ability of borrowers to repay loans, the volume of loan prepayments, the flow
and mix of deposits, and the market value of the Company's assets and liabilities.
The Company's management has established an Asset Liability Management Committee ("ALCO"), which is responsible for
managing the Company's interest rate risk in accordance with policies and limits approved by the Board of Directors. With
regard to management of market risk, the ALCO is charged with managing the Company's mix of assets and funding sources
to produce results that are consistent with the Company's liquidity, capital adequacy, growth, and profitability goals.
Exposure to interest rate risk is managed by Northeast through periodic evaluations of the current interest rate risk inherent
in its rate-sensitive assets and liabilities, coupled with determinations of the level of risk considered appropriate given the
Company's capital and liquidity requirements, business strategy, and performance objectives. Through such management,
Northeast seeks to mitigate the potential volatility in its net interest income due to changes in interest rates in a manner
consistent with the risk appetite established by the Board of Directors.
The ALCO's primary tool for measuring, evaluating, and managing interest rate risk is income simulation analysis. Income
simulation analysis measures the interest rate risk inherent in the Company's balance sheet at a given point in time by showing
the effect of interest rate shifts on net interest income over defined time horizons. These simulations take into account the
specific repricing, maturity, prepayment and call options of financial instruments that vary under different interest rate
scenarios. The ALCO reviews simulation results to determine whether the exposure to a decline in net interest income remains
within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure.
The Company considers a variety of specified rate scenarios, including instantaneous rate shocks, against static (or flat) rates
when measuring interest rate risk, and evaluates results over two consecutive twelve-month periods. All changes are measured
in comparison to the projected net interest income that would result from an "unchanged" scenario, where interest rates remain
stable over the measured time horizon(s). As of June 30, 2016, the income simulation analysis (as noted in the table below)
for the first twelve-month period indicated that exposure to changing interest rates fell within the Company's policy levels of
tolerance.
While the ALCO reviews simulation assumptions to ensure they are reasonable, and back-tests simulation results on a
periodic basis as a monitoring tool, income simulation analysis may not always prove to be an accurate indicator of the
Company's interest rate risk or future earnings. There are inherent shortcomings in income simulation, given the number and
variety of assumptions that must be made to perform it. For example, the projected level of future market interest rates and
the shape of future interest rate yield curves have a major impact on income simulation results. Many assumptions concerning
the repricing of financial instruments, the degree to which non-maturity deposits react to changes in market rates, and the
expected prepayment rates on loans, mortgage-backed securities, and callable debt securities are also inherently uncertain. In
addition, as income simulation analysis assumes that the Company's balance sheet will remain static over the simulation
horizon, the results do not reflect the Company's expectations for future balance sheet growth, nor changes in business
strategy that the Company could implement in response to rate shifts to mitigate its loss exposures. As such, although the
analysis described above provides an indication of the Company's sensitivity to interest rate changes at a point in time, these
estimates are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on the
Company's net interest income and will differ from actual results.
Assuming a 200 basis point increase and 100 basis point decrease in interest rates starting on June 30, 2016, we estimate that
our net interest income in the following 12 months would increase by 0.4% if rates increased by 200 basis points and decrease
by 1.6% if rates declined by 100 basis points. These results indicate a modest level of asset sensitivity in our balance sheet.
An asset-sensitive position indicates that there are more rate-sensitive assets than rate-sensitive liabilities repricing or
maturing within specific time horizons, which would generally imply a favorable impact on net interest income in periods of
rising interest rates and a negative impact in periods of falling rates. A liability-sensitive position would generally imply a
negative impact on net interest income in periods of rising rates and a positive impact in periods of falling rates.
43
June 30, 2016 ..............................................................................................
June 30, 2015 ..............................................................................................
June 30, 2014 ..............................................................................................
0.4%
1.3%
0.4%
-1.6%
-0.2%
-1.1%
Up 200 Basis
Points
Down 100 Basis
Points
Liquidity Risk
Liquidity risk is defined as the risk associated with an organization's ability to meet current and future financial obligations
of a short-term nature. The Company uses its liquidity on a regular basis to fund existing and future loan commitments, to
pay interest on deposits and on borrowings, to fund maturing certificates of deposit and borrowings, to fund other deposit
withdrawals, to invest in other interest-earning assets, to make dividend payments to shareholders, and to meet operating
expenses. The Company's primary sources of liquidity consist of deposit inflows, borrowed funds, and the amortization,
prepayment and maturities of loans and securities. While scheduled payments from the amortization and maturities of loans
and investment securities are relatively predictable sources of funds, deposit flows and loan and investment prepayments can
be greatly influenced by general interest rates, economic conditions and competition. In addition to these regular sources of
funds, the Company may choose to sell portfolio loans and investment securities to meet liquidity demands.
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. Using these methods, the
Company actively manages its liquidity position under the direction of the ALCO.
The following is a summary of the unused borrowing capacity of the Company at June 30, 2016 available to meet our short-
term funding needs (dollars in thousands):
Brokered time deposits ................................... $
Federal Home Loan Bank of Boston ..............
Federal Discount Window Borrower-in-
Custody ......................................................
Other available lines ........................................
Total unused borrowing capacity ................. $
246,538 Subject to policy limitation of 25% of total assets
16,752
Unused advance capacity subject to eligible and qualified
collateral
1,936 Unused credit line subject to the pledge of loans
17,500
282,726
Retail deposits and other core deposit sources including deposit listing services are used by the Bank to manage its overall
liquidity position. While we currently do not seek wholesale funding such as FHLBB advances and brokered deposits, the
ability to raise them remains an important part of our liquidity contingency planning. While we closely monitor and forecast
our liquidity position, it is affected by asset growth, deposit withdrawals and meeting other contractual obligations and
commitments. The accuracy of our forecast assumptions may increase or decrease our overall available liquidity. To utilize
the FHLBB advance capacity, the purchase of additional capital stock in the Federal Home Loan Bank of Boston in the
amount of $1.8 million is required. At June 30, 2016, the Bank had $365.8 million of immediately accessible liquidity,
defined as cash that the Bank reasonably believes could be raised within 7 days through collateralized borrowings, brokered
deposits or security sales. This position represented 37.1% of total assets. Further, at June 30, 2016, the Company had
$151.2 million of cash and cash equivalents. This level of balance sheet liquidity is intended, in part, for future purchases of
commercial real estate loans.
On a parent company only basis, commitments and debt service requirements at June 30, 2016 consisted of junior
subordinated debentures issued to NBN Capital Trust II, NBN Capital Trust III and NBN Capital Trust IV with a principal
balance of $16.5 million as well as subordinated debt issued in June 2016 with a principal balance of $15.05 million. See
Note 9 of the Notes to the Consolidated Financial Statements for carrying values, maturity dates and the use of purchased
interest rate caps and swaps to hedge the interest expense in periods of rising interest rates. Based on the interest rates at
June 30, 2016, the annual aggregate payments to meet the debt service of the junior subordinated debentures is approximately
$412 thousand. In addition, the expected annual interest expense on subordinated notes issued in June 2016 is $1.1 million.
The principal sources of funds for the Company to meet parent-only obligations are dividends from the Bank, which are
subject to regulatory limitations, and borrowings from public and private sources. For information on the restrictions on the
payment of dividends by Northeast Bank, see Note 10 of the Notes to the Company's Consolidated Financial Statements in
this Annual Report.
44
Operational Risk
Operational risk, which we define as the risk of loss from failed internal processes, people and systems, and external events,
is inherent in all of our business activities. The principal ways in which we manage operational risk include the establishment
of departmental and business-specific policies and procedures, internal controls and monitoring requirements. Some specific
examples include our information security program, business continuity planning and testing, our vendor management
program, reconciliation processes, our enterprise risk assessment process, and new product and/or system introduction
processes. Periodic internal audits provide an important independent check on adherence to policies, procedures and controls
designed to mitigate risk exposure.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the
financing needs of its customers. These financial instruments include commitments to extend credit, unused lines of credit
and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess
of the amounts recognized in the condensed consolidated balance sheet. The contract or notional amounts of these instruments
reflect the extent of the Company's involvement in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for
commitments to extend credit, unused lines of credit and standby letters of credit is represented by the contractual amount of
those instruments. 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. 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.
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 contractual obligations and other commitments with off-balance sheet risk as
of June 30, 2016 follows:
Total
Less Than
1 Year
Payments Due - By Period
1-3
Years
(Dollars in thousands)
4-5
Years
After 5
Years
Contractual obligations:
Federal Home Loan Bank advances ................ $
Junior subordinated debentures .......................
Subordinated debt .............................................
Capital lease obligation ....................................
Total debt obligations .......................................
Operating lease obligations ..............................
Total contractual obligations ........................... $
30,000 $
16,496
15,050
1,249
62,795
9,269
72,064 $
25,000 $
-
-
306
25,306
1,249
26,555 $
5,000 $
-
-
612
5,612
2,421
8,033 $
- $
-
-
331
331
2,435
2,766 $
-
16,496
15,050
-
31,546
3,164
34,710
Total
Amount of Commitment Expiring - By Period
1-3
Less Than
Years
1 Year
(Dollars in thousands)
4-5
Years
After 5
Years
Commitments with off-balance sheet risk:
Commitments to extend credit ......................... $
Unused lines of credit .......................................
Standby letters of credit ...................................
Commitment to fund investment ......................
Total commitments ........................................... $
44,684 $
58,412
3,822
2,500
109,418 $
44,684 $
12,841
3,822
2,500
63,847 $
- $
30,070
-
-
30,070 $
- $
6,765
-
-
6,765 $
-
8,736
-
-
8,736
45
Capital
Shareholders’ equity was $116.6 million at June 30, 2016, an increase of $3.9 million from June 30, 2015. The increase was
due principally to earnings of $7.6 million, and an increase in stock-based compensation of $613 thousand, offset by
$3.4 million in share repurchases (representing 322,900 shares), a decrease in accumulated other comprehensive income of
$618 thousand and $380 thousand in dividends paid on common stock.
See Note 10 of the Notes to the Consolidated Financial Statements for information on the Company's capital ratios.
Regulatory capital ratios for the Company and the Bank currently exceed all applicable requirements, including the
commitments made to the Federal Reserve and the Bureau in connection with the merger with FHB Formation LLC to
maintain minimum Tier 1 leverage and total capital ratios of 10% and 15%, respectively.
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, nearly 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 Notes to the Consolidated Financial Statement includes the Financial Accounting Standards Board (“FASB”)
and the SEC issued statements and interpretations affecting the Company.
Critical Accounting Policies
Critical accounting policies are those that involve significant judgments and assessments by management, and that could
potentially result in materially different results under different assumptions and conditions. The Company considers the
following to be its critical accounting policies:
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses
charged to earnings. For residential and consumer loans, a charge-off is recorded no later than 180 days past due if the loan
balance exceeds the fair value of the collateral, less costs to sell. For commercial loans, a charge-off is recorded on a case-
by-case basis when all or a portion of the loan is deemed to be uncollectible. Subsequent recoveries, if any, are credited to
the allowance.
The allowance for loan losses consists of general, specific, and unallocated reserves and reflects management's estimate of
probable loan losses inherent in the loan portfolio at the balance sheet date. Management uses a consistent and systematic
process and methodology to evaluate the adequacy of the allowance for loan losses on a quarterly basis. The calculation of
the allowance for loan losses is segregated by portfolio segments, which include: commercial real estate, commercial and
industrial, consumer, residential real estate, and purchased loans. Risk characteristics relevant to each portfolio segment are
as follows:
Residential real estate: All loans in this segment are collateralized by residential real estate and repayment is
primarily dependent on the credit quality of the individual borrower. The overall health of the economy, particularly
unemployment rates and housing prices, has a significant effect on the credit quality in this segment. For purposes
of the Company's allowance for loan loss calculation, home equity loans and lines of credit are included in residential
real estate.
Commercial real estate: Loans in this segment are primarily income-producing properties. For owner-occupied
properties, the cash flows are derived from an operating business, and the underlying cash flows may be adversely
affected by deterioration in the financial condition of the operating business. The underlying cash flows generated
by non-owner occupied properties may be adversely affected by increased vacancy rates. Management periodically
obtains rent rolls, with which it monitors the cash flows of these loans. Adverse developments in either of these
areas will have an adverse effect on the credit quality of this segment. For purposes of the allowance for loan losses,
this segment also includes construction loans.
46
Commercial and industrial: Loans in this segment are made to businesses and are generally secured by the assets of
the business. Repayment is expected from the cash flows of the business. Continued weakness in national or regional
economic conditions, and a corresponding weakness in consumer or business spending, will have an adverse effect
on the credit quality of this segment.
Consumer: Loans in this segment are generally secured, and repayment is dependent on the credit quality of the
individual borrower. Repayment of consumer loans is generally based on the earnings of individual borrowers,
which may be adversely impacted by regional labor market conditions.
Purchased: Loans in this segment are typically secured by commercial real estate, multi-family residential real estate,
or business assets and have been acquired by the LASG. Loans acquired by the LASG are, with limited exceptions,
performing loans at the date of purchase. Loans in this segment acquired with specific material credit deterioration
since origination are identified as purchased credit-impaired. Repayment of loans in this segment is largely
dependent on cash flow from the successful operation of the property, in the case of non-owner occupied property,
or operating business, in the case of owner-occupied property. Loan performance may be adversely affected by
factors affecting the general economy or conditions specific to the real estate market, such as geographic location
or property type.
The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors
stratified by loan segment. The Company does not weight periods used in that analysis to determine the average loss rate in
each portfolio segment. This historical loss factor is adjusted for the following qualitative factors:
• Levels and trends in delinquencies;
• Trends in the volume and nature of loans;
• Trends in credit terms and policies, including underwriting standards, procedures and practices, and the experience
and ability of lending management and staff;
• Trends in portfolio concentration;
• National and local economic trends and conditions;
• Effects of changes or trends in internal risk ratings; and
• Other effects resulting from trends in the valuation of underlying collateral.
The allocated component of the allowance for loan losses relates to loans that are classified as impaired. Impairment is
measured on a loan-by-loan basis for commercial and industrial and commercial real estate loans by either the present value
of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is
collateral dependent. An allowance is established when the discounted cash flows or collateral value of the impaired loan is
lower than the carrying value of that loan.
For all portfolio segments, except loans accounted for under ASC 310-30, a loan is considered impaired when, based on
current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal
or interest when due according to the contractual terms of the loan agreement. Loans that experience insignificant payment
delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment
delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan
and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the
amount of the shortfall in relation to the principal and interest owed. For the purchased loan segment, a loan is considered
impaired when, based on current information and events, it is probable that the Company will be unable to realize cash flows
as estimated at acquisition. For loans accounted for under ASC 310-30 for which cash flows can reasonably be estimated,
loan impairment is measured based on the decrease in expected cash flows from those estimated at acquisition, excluding
changes due to changes in interest rate indices and other non-credit related factors, discounted at the loan's effective rate
assumed at acquisition. Factors considered by management in determining impairment include payment status, collateral
value, and the probability of the collecting scheduled principal and interest payments when due.
47
Purchased Loans
Loans that the Company purchases are initially recorded at fair value with no carryover of the related allowance for loan and
lease losses. Determining the fair value of the purchased loans involves estimating the amount and timing of principal and
interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market
rate of interest. The Company continues to evaluate the reasonableness of expectations for the timing and the amount of cash
to be collected. Subsequent decreases in expected cash flows may result in changes in the amortization or accretion of fair
market value adjustments, and in some cases may result in a loan being considered impaired.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Management”
and accompanying table set forth therein for quantitative and qualitative disclosures about market risk.
48
Item 8.
Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Northeast Bancorp
We have audited the accompanying consolidated balance sheet of Northeast Bancorp and subsidiary (the Company) as of
June 30, 2016, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity,
and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial
position of the Company as of June 30, 2016, and the results of its operations and its cash flows for the year then ended in
conformity with U.S. generally accepted accounting principles.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States),
the Company’s internal control over financial reporting as of June 30, 2016, based on criteria established in Internal Control
— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and
our report dated September 13, 2016 expressed an unqualified opinion on the effectiveness of the Company’s internal control
over financial reporting.
/s/ RSM US LLP
Boston, Massachusetts
September 13, 2016
49
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Northeast Bancorp
We have audited the accompanying consolidated balance sheet of Northeast Bancorp and subsidiary as of June 30, 2015, and
the related consolidated statements of income, comprehensive income, changes in shareholders' equity and cash flows for the
year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control
over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing
audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial
position of Northeast Bancorp and subsidiary at June 30, 2015, and the consolidated results of their operations and their cash
flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
Boston, Massachusetts
September 28, 2015
50
NORTHEAST BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share data)
Assets
Cash and due from banks ............................................................................................................... $
Short-term investments ..................................................................................................................
Total cash and cash equivalents .................................................................................................
Available-for-sale securities, at fair value ......................................................................................
Residential real estate loans held for sale .......................................................................................
SBA loans held for sale ..................................................................................................................
Total loans held for sale .............................................................................................................
Loans
Commercial real estate ...............................................................................................................
Residential real estate .................................................................................................................
Commercial and industrial .........................................................................................................
Consumer ...................................................................................................................................
Total loans ..............................................................................................................................
Less: Allowance for loan losses .................................................................................................
Loans, net ...............................................................................................................................
Premises and equipment, net ..........................................................................................................
Real estate owned and other repossessed collateral, net .................................................................
Federal Home Loan Bank stock, at cost .........................................................................................
Intangible assets, net ......................................................................................................................
Bank owned life insurance .............................................................................................................
Other assets ....................................................................................................................................
Total assets ................................................................................................................................. $
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Demand ...................................................................................................................................... $
Savings and interest checking ....................................................................................................
Money market ............................................................................................................................
Time ..........................................................................................................................................
Total deposits .........................................................................................................................
Federal Home Loan Bank advances ...............................................................................................
Wholesale repurchase agreements .................................................................................................
Short-term borrowings ...................................................................................................................
Subordinated debt ..........................................................................................................................
Capital lease obligation ..................................................................................................................
Other liabilities ..............................................................................................................................
Total liabilities ...........................................................................................................................
Commitments and contingencies (Note 15)
June 30, 2016
June 30, 2015
2,459 $
148,698
151,157
100,572
6,449
1,070
7,519
426,568
113,962
145,956
5,950
692,436
2,350
690,086
7,801
1,652
2,408
1,732
15,725
7,501
986,153 $
66,686 $
107,218
275,437
351,091
800,432
30,075
-
-
23,331
1,128
14,596
869,562
2,789
87,061
89,850
101,908
7,093
1,942
9,035
348,676
132,669
123,133
7,659
612,137
1,926
610,211
8,253
1,651
4,102
2,209
15,276
8,223
850,718
60,383
100,134
168,527
345,715
674,759
30,188
10,037
2,349
8,626
1,368
10,664
737,991
Shareholders' equity
Preferred stock, $1.00 par value, 1,000,000 shares authorized; no shares issued and
outstanding at June 30, 2016 and June 30, 2015 ....................................................................
-
-
Voting common stock, $1.00 par value, 25,000,000 shares authorized; 8,089,790 and
8,575,144 shares issued and outstanding at June 30, 2016 and June 30, 2015, respectively ..
8,089
8,575
Non-voting common stock, $1.00 par value, 3,000,000 shares authorized; 1,227,683 and
1,012,739 shares issued and outstanding at June 30, 2016 and June 30, 2015, respectively ..
Additional paid-in capital ..........................................................................................................
Retained earnings .......................................................................................................................
Accumulated other comprehensive loss .....................................................................................
Total shareholders' equity ..........................................................................................................
Total liabilities and shareholders' equity .................................................................................... $
1,228
83,020
26,160
(1,906)
116,591
986,153 $
1,013
85,506
18,921
(1,288)
112,727
850,718
The accompanying notes are an integral part of these consolidated financial statements.
51
NORTHEAST BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except share and per share data)
Interest and dividend income:
Interest and fees on loans .............................................................................................. $
Interest on available-for-sale securities ........................................................................
Other interest and dividend income .............................................................................
Total interest and dividend income ...........................................................................
Interest expense:
Deposits ........................................................................................................................
Federal Home Loan Bank advances .............................................................................
Wholesale repurchase agreements ................................................................................
Short-term borrowings ..................................................................................................
Subordinated debt .........................................................................................................
Obligation under capital lease agreements ...................................................................
Total interest expense ................................................................................................
Net interest and dividend income before provision for loan losses ..................................
Provision for loan losses ..................................................................................................
Net interest and dividend income after provision for loan losses .....................................
Noninterest income:
Fees for other services to customers .............................................................................
Gain on sales of residential loans held for sale .............................................................
Gain on sales of portfolio loans ....................................................................................
(Loss) gain recognized on real estate owned and other repossessed collateral, net ......
Bank-owned life insurance income ...............................................................................
Other noninterest income ..............................................................................................
Total noninterest income ...........................................................................................
Noninterest expense:
Salaries and employee benefits .....................................................................................
Occupancy and equipment expense ..............................................................................
Professional fees ...........................................................................................................
Data processing fees .....................................................................................................
Marketing expense ........................................................................................................
Loan acquisition and collection expense ......................................................................
FDIC insurance premiums ............................................................................................
Intangible asset amortization ........................................................................................
Other noninterest expense.............................................................................................
Total noninterest expense ..........................................................................................
Income before income tax expense ..................................................................................
Income tax expense ..........................................................................................................
Net income ...................................................................................................................... $
Year Ended June 30,
2016
2015
45,849 $
930
456
47,235
6,027
1,027
67
20
651
63
7,855
39,380
1,618
37,762
1,657
1,684
4,178
(255 )
449
60
7,773
19,548
5,227
1,463
1,487
285
1,368
489
477
3,468
33,812
11,723
4,104
7,619 $
43,383
913
292
44,588
5,010
1,101
288
29
718
74
7,220
37,368
717
36,651
1,494
1,877
2,821
428
440
29
7,089
18,817
4,939
1,658
1,355
244
1,458
504
589
3,040
32,604
11,136
3,995
7,141
Weighted-average shares outstanding:
Basic .............................................................................................................................
Diluted ..........................................................................................................................
9,474,999
9,484,635
9,980,733
9,980,733
Earnings per common share:
Basic ............................................................................................................................. $
Diluted ..........................................................................................................................
0.80 $
0.80
Cash dividends declared per common share .................................................................... $
0.04 $
0.72
0.72
0.04
The accompanying notes are an integral part of these consolidated financial statements.
52
NORTHEAST BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Net income ....................................................................................................................... $
Other comprehensive loss, before tax:
Available-for-sale securities:
Year Ended June 30,
2016
2015
7,619 $
7,141
Change in net unrealized gain on available-for-sale securities .................................
1,033
Derivatives and hedging activities:
Change in accumulated loss on effective cash flow hedges ......................................
Reclassification adjustments included in net income ................................................
Total derivatives and hedging activities .......................................................................
Total other comprehensive loss, before tax ..................................................................
Income tax benefit related to other comprehensive loss ...............................................
Other comprehensive loss, net of tax ............................................................................
Comprehensive income ............................................................................................... $
(2,032 )
(3 )
(2,035 )
(1,002 )
(384 )
(618 )
7,001 $
442
(529)
(49)
(578)
(136)
(131)
(5)
7,136
The accompanying notes are an integral part of these consolidated financial statements.
53
Balance at June 30,
2014 ......................
Net income .........
Other
comprehensive
income, net of
tax .....................
Common stock
repurchased ......
Conversion of
voting common
stock to non-
voting common
stock .................
Dividends on
common stock
at $0.04 per
share .................
Stock-based
compensation ...
Issuance of
restricted
common stock ..
Forfeiture of
restricted
common stock ..
Balance at June 30,
2015 ......................
Net income .........
Other
comprehensive
income, net of
tax .....................
Common stock
repurchased ......
Conversion of
voting common
stock to non-
voting common
stock .................
Dividends on
common stock
at $0.04 per
share .................
Stock-based
compensation ...
Issuance of
restricted
common stock ..
Cancellations and
forfeiture of
restricted
common stock ..
Balance at June 30,
NORTHEAST BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Dollars in thousands, except share and per share data)
Preferred
Stock
Voting Common
Stock
Shares Amount Shares
Amount
Shares
Non-voting Common
Stock
Additional
Paid-in
Amount Capital
Accumulated
Other
Comprehensive
Loss
Total
Shareholders’
Equity
Retained
Earnings
- $
-
- 9,260,331 $ 9,260
-
-
-
880,963 $
-
881 $
-
90,914 $ 12,182 $
7,141
-
(1,283) $
-
111,954
7,141
-
-
-
-
-
-
(710,662)
(711)
-
-
-
-
-
(5,955)
-
-
(5)
-
(5)
(6,666)
-
-
(131,776)
(132)
131,776
132
-
-
-
-
-
-
-
-
-
-
-
-
-
(402)
705
-
-
-
-
-
174,000
174
(174)
-
- $
-
-
-
-
(16,749)
(16)
-
-
16
-
-
- 8,575,144 $ 8,575 1,012,739 $
-
-
-
-
1,013 $
-
85,506 $ 18,921 $
7,619
-
(1,288) $
-
112,727
7,619
-
-
-
-
(322,900)
(323)
-
-
-
-
-
(3,036)
-
-
(618)
(618)
-
(3,359)
-
(402)
705
-
-
-
-
(214,944)
(215)
214,944
215
-
-
-
-
-
-
-
-
-
-
-
-
-
-
100,000
100
-
-
-
-
-
-
(380)
613
-
-
(100)
-
-
-
-
(380)
613
-
-
-
(47,510)
(48)
-
-
37
-
-
(11)
2016 ......................
- $
- 8,089,790
8,089 1,227,683 $
1,228 $
83,020 $ 26,160 $
(1,906) $
116,591
The accompanying notes are an integral part of these consolidated financial statements.
54
NORTHEAST BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Operating activities:
Net income ................................................................................................................................. $
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses ............................................................................................................
Loss (gain) recognized on real estate owned and other repossessed collateral, net ....................
Loss on premises and equipment ...............................................................................................
Accretion of fair value adjustments on loans, net ......................................................................
Accretion of fair value adjustments on deposits, net ..................................................................
Accretion of fair value adjustments on borrowings, net .............................................................
Originations of loans held for sale .............................................................................................
Net proceeds from sales of loans held for sale ...........................................................................
Gain on sales of residential loans held for sale, net ....................................................................
Gain on sales of portfolio loans, net ...........................................................................................
Amortization of intangible assets ...............................................................................................
Bank-owned life insurance income, net .....................................................................................
Depreciation of premises and equipment ...................................................................................
Deferred income tax expense (benefit) ......................................................................................
Stock-based compensation .........................................................................................................
Amortization of available-for-sale securities, net .......................................................................
Changes in other assets and liabilities:
Other assets ............................................................................................................................
Other liabilities .......................................................................................................................
Net cash provided by operating activities ..................................................................................
Investing activities:
Purchases of available-for-sale securities ...................................................................................
Proceeds from maturities and principal payments on available-for-sale securities ....................
Loan purchases...........................................................................................................................
Loan originations, principal collections, and purchased loan paydowns, net .............................
Purchases and disposals of premises and equipment, net ...........................................................
Proceeds from sales of premises and equipment ........................................................................
Proceeds from sales of real estate owned and other repossessed collateral ................................
Redemption of Federal Home Loan Bank stock ........................................................................
Net cash used in investing activities ..........................................................................................
Financing activities:
Issuance of subordinated debt, net of debt issuance costs ..........................................................
Net increase in deposits ..............................................................................................................
Net decrease in short-term borrowings ......................................................................................
Dividends paid on common stock ..............................................................................................
Repurchase of common stock ....................................................................................................
Repayment of FHLBB borrowings and wholesale repurchase agreements ................................
Repayment of capital lease obligation ........................................................................................
Taxes paid through cancellation of common stock ....................................................................
Net cash provided by financing activities ..................................................................................
Net increase in cash and cash equivalents ..................................................................................
Cash and cash equivalents, beginning of year ............................................................................
Cash and cash equivalents, end of year ..................................................................................... $
Year Ended June 30,
2016
2015
7,619 $
7,141
1,618
243
11
(9,384)
(6)
43
(130,010)
134,522
(1,684)
(4,178)
477
(449)
1,631
2,122
613
1,025
(1,001)
1,882
5,094
(45,160)
46,504
(99,999)
28,975
(1,190)
-
1,537
1,694
(67,639)
14,512
125,679
(2,349)
(380)
(3,359)
(10,000)
(240)
(11)
123,852
61,307
89,850
151,157 $
717
(428)
91
(11,899)
(171)
(112)
(98,383)
126,430
(1,877)
(2,821)
589
(440)
1,666
(1,185)
705
1,001
(60)
556
21,520
-
11,414
(82,654)
(24,585)
(1,244)
369
2,563
-
(94,137)
-
100,601
(635)
(402)
(6,666)
(12,500)
(190)
-
80,208
7,591
82,259
89,850
Supplemental schedule of cash flow information:
Interest paid ................................................................................................................................ $
Income taxes paid, net ................................................................................................................
7,773 $
2,166
7,487
5,664
Supplemental schedule of noncash investing and financing activities:
Transfers from loans to real estate owned and other repossessed collateral, net ........................ $
1,781 $
1,764
The accompanying notes are an integral part of these consolidated financial statements.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
The accounting and reporting policies of Northeast Bancorp and Subsidiary (the “Company" or "Northeast") conform to
accounting principles generally accepted in the United States of America ("US GAAP") and conform to practices within the
financial services industry.
Business
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. As a bank holding company, the Company is subject to the regulation
and supervision of the FRB. The Company provides a full range of banking services to individual and corporate customers
throughout south-central and western Maine and conducts loan purchasing and origination activities nationwide through its
wholly-owned subsidiary, Northeast Bank (the "Bank"), a Maine state-chartered universal bank. The Bank is subject to
supervision and regulation by applicable state and federal banking agencies, including the State of Maine Bureau of Financial
Institutions, the Federal Deposit Insurance Corporation ("FDIC"), and the FRB. The Bank faces competition from banks and
other financial institutions.
Business Combination Accounting
On December 29, 2010, the Company merged with FHB Formation LLC (the "Merger"). The Company applied the
acquisition method of accounting to this business combination, which represented an acquisition by FHB Formation LLC
("FHB") of Northeast, with Northeast as the surviving company. Under the acquisition method, the acquiring entity in a
business combination recognizes the assets acquired and liabilities assumed at their acquisition date fair values. Management
utilizes valuation techniques appropriate for the asset or liability being measured in determining these fair values. Any excess
of the purchase price over amounts allocated to assets acquired, including identifiable intangible assets, and liabilities
assumed is recorded as goodwill. In the Merger, amounts allocated to assets acquired and liabilities assumed were greater
than the purchase price, which resulted in the recognition of a bargain purchase gain. Acquisition-related costs were expensed
as incurred.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Northeast Bancorp, and its wholly-owned
subsidiary, Northeast Bank (including the Bank's wholly-owned subsidiaries). All significant intercompany transactions and
balances have been eliminated in consolidation.
NBN Capital Trust II, NBN Capital Trust III and NBN Capital Trust IV are considered affiliates and are deconsolidated
pursuant to criteria established by FASB Accounting Standards Codification ("ASC") 810, Consolidation ("ASC 810"). The
investments in these affiliates were $496 thousand in aggregate and are included in other assets.
Reclassifications
Certain previously reported amounts have been reclassified to conform to the current year's presentation.
Use of Estimates
The financial statements have been prepared in conformity with US GAAP. In preparing the financial statements,
management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities as of the date of the statement of financial condition and income and expenses
for the period. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan
losses and the determination of fair values in conjunction with the application of loan acquisition accounting.
56
Concentrations of Credit Risk
Most of the Community Banking Division's business activity is with customers located within the State of Maine. However,
the business activities of the Bank’s Loan Acquisition and Servicing Group ("LASG") and the SBA Division are diversified
across the country. In all regions, the Company’s focus is to originate and purchase commercial real estate loans. Repayment
of loans is expected from cash flows of the borrower. Losses on secured loans are limited by the value of the collateral upon
default of the borrowers. The Company does not have any significant concentrations to any one industry or customer.
Cash and Cash Equivalents
For purposes of presentation in the consolidated statements of cash flows, cash and cash equivalents consist of cash and due
from banks and short-term investments. The Company is required to maintain a certain reserve balance in the form of cash
or deposits with other financial institutions. At June 30, 2016 and 2015, such reserve balances totaled $4.0 million and
$4.4 million, respectively.
Available-for-Sale Securities
Securities for which the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and
carried at amortized cost. Those securities held for indefinite periods of time but not necessarily to maturity are classified as
available-for-sale. Securities held for indefinite periods of time include securities that management intends to use as part of
its asset/liability, liquidity, or capital management strategies and may be sold in response to changes in interest rates,
maturities, asset/liability mix, liquidity needs, regulatory capital needs or other business factors. Securities available-for-sale
are carried at estimated fair value with unrealized gains and losses reported on an after-tax basis in shareholders' equity as
accumulated other comprehensive income or loss.
Interest and dividends on securities are recorded on the accrual method. Premiums and discounts on securities are amortized
or accreted into interest income by the level-yield method over the remaining period to contractual maturity, adjusted for the
effect of actual prepayments in the case of mortgage-backed securities. These estimates of prepayment assumptions are made
based upon the actual performance of the underlying security, current interest rates, the general market consensus regarding
changes in mortgage interest rates, the contractual repayment terms of the underlying loans, the priority rights of the investors
to the cash flows from the mortgage securities and other economic conditions. When differences arise between anticipated
prepayments and actual prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated
future payments. Unamortized premium or discount is adjusted to the amount that would have existed had the new effective
yield been applied since purchase, with a corresponding charge or credit to interest income.
Security transactions are recorded on the trade date. Realized gains and losses are determined using the specific identification
method and are recorded in non-interest income.
Management evaluates securities for other-than-temporary impairment on a periodic basis. Factors considered in determining
whether an impairment is other-than-temporary include: (1) the length of time and the extent to which the fair value has been
less than cost, (2) the financial condition and near-term prospects of the issuer and (3) the intent and ability of the Company
to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value. If the Company
intends to sell an impaired security, the Company records an other-than-temporary loss in an amount equal to the entire
difference between the fair value and amortized cost. If a security is determined to be other-than-temporarily impaired but
the Company does not intend to sell the security, only the credit portion of the estimated loss is recognized in earnings, with
the other portion of the loss recognized in other comprehensive income.
Federal Home Loan Bank Stock
During the periods presented, the Company has owned investments in the stock of the Federal Home Loan Bank of Boston
("FHLBB"). No ready market exists for these stocks, and they have no quoted market values. The Bank, as a member of the
FHLBB, is required to maintain investments in the capital stock of the FHLBB equal to their membership base investments
plus an activity-based investment determined according to the Bank's level of outstanding FHLBB advances. The Company
reviews its investments in FHLBB stock periodically to determine if other-than-temporary impairment exists. The Company
reviews recent public filings, rating agency analysis and other factors, when making the determination. As of June 30, 2016
and 2015, no impairment has been recognized.
57
Loans Held for Sale and Loan Servicing
Residential real estate mortgage loans are designated as held for sale or held to maturity based on intent, which is determined
when loans are underwritten. Loans originated and held for sale in the secondary market are carried at the lower of cost or
fair value. The SBA Division loans are designated as held for sale based on intent to sell, which is determined on a quarterly
basis. The guaranteed portions of the loans are transferred to held for sale and are carried at the lower of cost or fair value.
Realized gains and losses on sales of residential loans are determined using the specific identification method, and realized
gains and losses on sales of SBA loans are determined using the allocation of participating interests sold and retained. Direct
loan origination costs and fees related to loans held for sale are deferred upon origination and are recognized as an adjustment
to the gain or loss on the date of sale.
In its mortgage banking activities, the Company sells loans both on a servicing released and servicing retained basis. The
Company recognizes as separate assets the rights to service mortgage loans for others, which is included in other assets on
the consolidated balance sheet. The Company capitalizes mortgage servicing rights at their allocated cost (based on the
relative fair values of the rights and the related loans) upon the sale of the related loans. The Company uses the amortization
method to subsequently measure servicing assets. Mortgage servicing rights are amortized over the estimated weighted
average life of the loans. The Company's assumptions with respect to prepayments, which affect the estimated average life
of the loans, are adjusted quarterly and as necessary to reflect current circumstances. The Company evaluates the estimated
life and fair value of its servicing portfolio based on data that is disaggregated to reflect note rate, type, and term on the
underlying loans. The Company performs an assessment of capitalized mortgage servicing rights for impairment based on
the current fair value of those rights. Fair value of the mortgage servicing rights is based on a valuation model that calculates
the present value of estimated future net servicing income. The valuation model incorporates assumptions that market
participants would use in estimating future net servicing income, such as the cost to service, the discount rate, prepayment
speeds and default rates and losses. Impairment is recognized through a valuation allowance to the extent that fair value is
less than the capitalized amount. If the Company later determines that all or a portion of the impairment no longer exists, a
reduction of the allowance may be recorded as an increase to income.
In connection with the mortgage loans to be held for sale, the Company often offers interest rate lock commitments to
prospective borrowers. The Company manages this interest rate risk by entering into offsetting forward sale agreements with
third party investors for certain funded loans and loan commitments. The Company uses "best efforts" forward loan sale
commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the
derivative loan commitments. The gross effect of the derivative loan commitments and forward sale agreements is nominal
at each date presented.
In its SBA Division activities, the Company recognizes the SBA servicing rights as separate assets, which is included in other
assets on the consolidated balance sheet. The Company capitalizes SBA servicing rights at the net present value of the fee
income and fee cost spread upon the sale of the related loans. The Company uses the amortization method to subsequently
measure servicing assets. The SBA servicing rights are amortized over the estimated weighted average life of the loans. The
Company's assumptions with respect to prepayments, which affect the estimated average life of the loans, are adjusted
quarterly and as necessary to reflect current circumstances. The Company evaluates the estimated life and fair value of its
servicing portfolio based on data that is disaggregated to reflect note rate, type, and term on the underlying loans. The
Company performs an assessment of capitalized SBA servicing rights for impairment based on the current fair value of those
rights. Fair value of the servicing rights is based on a valuation model that calculates the present value of estimated future
net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future
net servicing income, such as the cost to service, the discount rate, prepayment speeds and default rates and losses. Impairment
is recognized through a valuation allowance to the extent that fair value is less than the capitalized amount. If the Company
later determines that all or a portion of the impairment no longer exists, a reduction of the allowance may be recorded as an
increase to income.
Loans
Loans are carried at the principal amounts outstanding, or amortized acquired fair value in the case of acquired loans, adjusted
by partial charge-offs and net of deferred loan costs or fees. Loan fees and certain direct origination costs are deferred and
amortized into interest income over the expected term of the loan using the level-yield method. When a loan is paid off, the
unamortized portion is recognized in interest income. Interest income is accrued based upon the daily principal amount
outstanding except for loans on nonaccrual status.
Loans purchased by the Company are accounted for under ASC 310-30, Receivables—Loans and Debt Securities Acquired
with Deteriorated Credit Quality ("ASC 310-30"). At acquisition, the effective interest rate is determined based on the
discount rate that equates the present value of the Company's estimate of cash flows with the purchase price of the loan.
58
Prepayments are not assumed in determining a purchased loan's effective interest rate and income accretion. The application
of ASC 310-30 limits the yield that may be accreted on the purchased loan, or the "accretable yield," to the excess of the
Company's estimate, at acquisition, of the expected undiscounted principal, interest, and other cash flows over the Company's
initial investment in the loan. The excess of contractually required payments receivable over the cash flows expected to be
collected on the loan represents the purchased loan's "nonaccretable difference." Subsequent improvements in expected cash
flows of loans with nonaccretable differences result in a prospective increase to the loan's effective yield through a
reclassification of some, or all, of the nonaccretable difference to accretable yield. The effect of subsequent credit-related
declines in expected cash flows of purchased loans are recorded through a specific allocation in the allowance for loan losses.
Loans are generally placed on nonaccrual status when they are past due 90 days as to either principal or interest, or when in
management's judgment the collectability of interest or principal of the loan has been significantly impaired. Loans accounted
for under ASC 310-30 are placed on nonaccrual when it is not possible to reach a reasonable expectation of the timing and
amount of cash flows to be collected on the loan. When a loan has been placed on nonaccrual status, previously accrued and
uncollected interest is reversed against interest on loans. Interest on nonaccrual loans is accounted for on a cash-basis or using
the cost-recovery method when collectability is doubtful. A loan is returned to accrual status when collectability of principal
is reasonably assured and the loan has performed for a reasonable period of time.
In cases where a borrower experiences financial difficulties and the Company makes certain concessionary modifications to
contractual terms, the loan is classified as a troubled debt restructuring ("TDR"), and therefore by definition is an impaired
loan. Concessionary modifications may include adjustments to interest rates, extensions of maturity, and other actions
intended to minimize economic loss and avoid foreclosure or repossession of collateral. For loans accounted for under ASC
310-30, the Company evaluates whether it has granted a concession by comparing the restructured debt terms to the expected
cash flows at acquisition plus any additional cash flows expected to be collected arising from changes in estimate after
acquisition. As a result, if an ASC 310-30 loan is modified to be consistent with, or better than, the Company's expectations
at acquisition, the modified loan would not qualify as a TDR. Nonaccrual loans that are restructured generally remain on
nonaccrual status for a minimum period of six months to demonstrate that the borrower can meet the restructured terms. If
the restructured loan is on accrual status prior to being modified, it is reviewed to determine if the modified loan should
remain on accrual status. If the borrower's ability to meet the revised payment schedule is not reasonably assured, the loan is
classified as a nonaccrual loan. With limited exceptions, loans classified as TDRs remain classified as such until the loan is
paid off.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses
charged to earnings. For residential and consumer loans, a charge-off is recorded no later than the point at which a loan is
180 days past due if the loan balance exceeds the fair value of the collateral, less costs to sell. For commercial loans, a charge-
off is recorded on a case-by-case basis when all or a portion of the loan is deemed to be uncollectible. Subsequent recoveries,
if any, are credited to the allowance.
The allowance for loan losses consists of general, specific, and unallocated reserves and reflects management’s estimate of
probable loan losses inherent in the loan portfolio at the balance sheet date. Management uses a consistent and systematic
process and methodology to evaluate the appropriateness of the allowance for loan losses on a quarterly basis. The calculation
of the allowance for loan losses is segregated by portfolio segments, which include: commercial real estate, commercial and
industrial, consumer, residential real estate, and purchased loans. Risk characteristics relevant to each portfolio segment are
as follows:
Residential real estate: All loans in this segment are collateralized by residential real estate and repayment is primarily
dependent on the credit quality, loan-to-value ratio and income of the individual borrower. The overall health of the
economy, particularly unemployment rates and housing prices, has a significant effect on the credit quality in this
segment. For purposes of the Company’s allowance for loan loss calculation, home equity loans and lines of credit are
included in residential real estate.
Commercial real estate: Loans in this segment are primarily income-producing properties. For owner-occupied
properties, the cash flows are derived from an operating business, and the underlying cash flows may be adversely
affected by deterioration in the financial condition of the operating business. The underlying cash flows generated by
non-owner occupied properties may be adversely affected by increased vacancy rates. Management periodically obtains
rent rolls, with which it monitors the cash flows of these loans. Adverse developments in either of these areas will have
an adverse effect on the credit quality of this segment. For purposes of the allowance for loan losses, this segment also
includes construction loans.
59
Commercial and industrial: Loans in this segment are made to businesses and are generally secured by the assets of the
business. Repayment is expected from the cash flows of the business. Weakness in national or regional economic
conditions, and a corresponding weakness in consumer or business spending, will have an adverse effect on the credit
quality of this segment.
Consumer: Loans in this segment are generally secured, and repayment is dependent on the credit quality of the
individual borrower. Repayment of consumer loans is generally based on the earnings of individual borrowers, which
may be adversely impacted by regional labor market conditions.
Purchased: Loans in this segment are typically secured by commercial real estate, multi-family residential real estate, or
business assets and have been acquired by the LASG. Loans acquired by the LASG are, with limited exceptions,
performing loans at the date of purchase. Repayment of loans in this segment is largely dependent on cash flow from the
successful operation of the property, in the case of non-owner occupied property, or operating business, in the case of
owner-occupied property. Loan performance may be adversely affected by factors affecting the general economy or
conditions specific to the real estate market, such as geographic location or property type. Loans in this segment are
evaluated for impairment under ASC 310-30. The Company reviews expected cash flows from purchased loans on a
quarterly basis. The effect of a decline in expected cash flows subsequent to the acquisition of the loan is recognized
through a specific allocation in the allowance for loan losses
The general component of the allowance for loan losses for originated loans is based on historical loss experience adjusted
for qualitative factors stratified by loan segment. The Company does not weight periods used in that analysis to determine
the average loss rate in each portfolio segment. This historical loss factor is adjusted for the following qualitative factors:
(cid:2) Levels and trends in delinquencies;
(cid:2) Trends in the volume and nature of loans;
(cid:2) Trends in credit terms and policies, including underwriting standards, procedures and practices, and the experience
and ability of lending management and staff;
(cid:2) Trends in portfolio concentration;
(cid:2) National and local economic trends and conditions;
(cid:2) Effects of changes or trends in internal risk ratings; and
(cid:2) Other effects resulting from trends in the valuation of underlying collateral.
The allocated component of the allowance for loan losses relates to loans that are classified as impaired. Impairment is
measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective
interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance is established when the
discounted cash flows or collateral value of the impaired loan is lower than the carrying value of that loan.
For all portfolio segments, except loans accounted for under ASC 310-30, a loan is considered impaired when, based on
current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal
or interest when due according to the contractual terms of the loan agreement. Loans that experience insignificant payment
delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment
delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan
and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the
amount of the shortfall in relation to the principal and interest owed. For the purchased loan segment, a loan is considered
impaired when, based on current information and events, it is probable that the Company will be unable to realize cash flows
as expected at acquisition. For loans accounted for under ASC 310-30 for which cash flows can reasonably be estimated,
loan impairment is measured based on the decrease in expected cash flows from those estimated at acquisition, excluding
changes due to changes in interest rate indices and other non-credit related factors, discounted at the loan’s effective rate
assumed at acquisition. Factors considered by management in determining impairment include payment status, collateral
value, and the probability of collecting the scheduled principal and interest payments when due.
60
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line
method over the estimated useful lives of the assets. Premises and equipment under capital leases are amortized over the
estimated useful lives of the assets or the respective lease terms, whichever is shorter. Maintenance and repairs are charged
to expense as incurred and the cost of major renewals and betterments are capitalized.
Intangible Assets
Identifiable intangible assets subject to amortization are amortized over the estimated lives of the intangibles using a method
that approximates the amount of economic benefits that are realized by the Company. Identifiable intangible assets are
reviewed for impairment annually and whenever events or changes in circumstances indicate that the carrying amount of the
assets may not be recoverable.
Real Estate Owned and Other Repossessed Collateral
Assets in control of the Company or acquired through foreclosure or repossession are held for sale and are initially recorded
at fair value less cost to sell at the date control is established, resulting in a new cost basis. The amount by which the recorded
investment in the loan exceeds the fair value (net of estimated cost to sell) of the foreclosed asset is charged to the allowance
for loan losses. Subsequent declines in the fair value of the foreclosed asset below the new cost basis are recorded through
the use of a valuation allowance or through a direct write-off. Subsequent increases in the fair value may only be recorded to
the extent of any previously recognized valuation allowance. Rental revenue received and gains and losses recognized on
foreclosed assets is included in other noninterest income, whereas operating expenses and changes in the valuation allowance
relating to foreclosed assets are included in other noninterest expense.
Impairment of Long-Lived Assets
The Company reviews long-lived assets, including premises and equipment, for impairment whenever events or changes in
business circumstances indicate that the remaining useful life may warrant revision or that the carrying amount of the long-
lived asset may not be fully recoverable. The Company performs undiscounted cash flow analyses to determine if impairment
exists. If impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses
on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.
Bank Owned Life Insurance
Increases in the cash surrender value of life insurance policies, as well as death benefits received net of any cash surrender
value, are recorded in other noninterest income, and are not subject to income taxes. The cash surrender value of the policies
not previously endorsed to participants are recorded as assets of the Company. Any amounts owed to participants relating to
these policies are recorded as liabilities of the Company. The Company reviews the financial strength of the insurance carriers
prior to the purchase of life insurance policies and no less than annually thereafter.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is
recognized in the period that includes the enactment date. The Company's policy is to recognize interest and penalties assessed
on uncertain tax positions in income tax expense.
Stock-Based Compensation
The Company's stock-based compensation plans provide for awards of stock options, restricted stock and other stock-based
compensation to directors, officers and employees. The cost of employee services received in exchange for awards of equity
instruments is based on the grant-date fair value of those awards. Compensation cost is recognized over the requisite service
period as a component of compensation expense. For awards with graded-vesting, compensation cost is recognized on a
straight-line basis over the requisite service period for the entire award. The Company uses the Black-Scholes model to
estimate the fair value of stock options, while the market price of the Company's common stock at the date of grant is used
for restricted stock awards.
61
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes
unrealized gains and losses on securities available for sale, unrealized losses related to factors other than credit on debt
securities, unrealized gains and losses on cash flow hedges and deferred gains on hedge accounting transactions.
Earnings Per Share
Basic earnings per share is calculated using the two-class method. The two-class method is an earnings allocation formula
under which earnings per share is calculated from common stock and participating securities according to dividends declared
and participation rights in undistributed earnings. Under this method, all earnings distributed and undistributed, are allocated
to participating securities and common shares based on their respective rights to receive dividends. Unvested share-based
payment awards that contain non-forfeitable rights to dividends are considered participating securities (i.e. unvested restricted
stock), not subject to performance based measures. Basic earnings per share is calculated by dividing net income available
to common shareholders by the weighted average number of common shares outstanding (inclusive of participating
securities). Diluted earnings per share have been calculated in a manner similar to that of basic earnings per share except that
the weighted average number of common shares outstanding is increased to include the number of additional common shares
that would have been outstanding if all potentially dilutive common shares (such as those resulting from the exercise of stock
options or the attainment of performance measures) were issued during the period, computed using the treasury stock method.
Derivatives
Derivative instruments are carried at fair value in the Company's financial statements. The accounting for changes in the fair
value of a derivative instrument is determined by whether it has been designated and qualifies as part of a hedging
relationship, and further, by the type of hedging relationship. For those derivative instruments that are designated and qualify
as hedging instruments, the Company designates the hedging instrument, based upon the exposure being hedged, as either a
fair value hedge or a cash flow hedge. For derivative instruments that are designated and qualify as a cash flow hedge
(i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective
portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income, net of
related tax, and reclassified into earnings in the same period or periods during which the hedged transactions affect earnings.
The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash
flows of the hedged item (i.e., the ineffective portion), if any, is recognized in current earnings during the period. For
derivative instruments designated and qualifying as a fair value hedge (i.e., hedging the exposure to changes in the fair value
of an asset or liability or an identified portion thereof that is attributable to the hedged risk), the gain or loss on the derivative
instrument, as well as the offsetting gain or loss on the hedged item attributable to the hedged risk, are recognized in current
earnings during the period of the change in fair values. At the inception of a hedge, the Company documents certain items,
including but not limited to the following: the relationship between hedging instruments and hedged items, Company risk
management objectives, hedging strategies, and the evaluation of hedge transaction effectiveness. Documentation includes
linking all derivatives designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to
specific forecasted transactions.
Hedge accounting is discontinued prospectively when (1) a derivative is no longer highly effective in offsetting changes in
the fair value or cash flow of a hedged item, (2) a derivative expires or is sold, (3) a derivative is de-designated as a hedge,
because it is unlikely that a forecasted transaction will occur, or (4) it is determined that designation of a derivative as a hedge
is no longer appropriate. For derivative instruments not designated as hedging instruments, the gain or loss on the derivative
is recognized in current earnings during the period of change.
Transfer of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee
obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred
assets, and (3) the Company does not maintain effective control over the transferred assets. There are no agreements to
repurchase before their maturity.
Transfers of a portion of a loan must meet the criteria of a participating interest. If it does not meet the criteria of a participating
interest, the transfer must be accounted for as a secured borrowing. In order to meet the criteria for a participating interest,
all cash flows from the loan must be divided proportionately, the rights of each loan holder must have the same priority, and
the loan holders must have no recourse to the transferor other than standard representations and warranties and no loan holder
has the right to pledge or exchange the entire loan.
62
The Company sells financial assets in the normal course of business, the majority of which are related to the SBA-guaranteed
portion of loans, as well as residential mortgage loan sales through established programs, commercial loan sales through
participation agreements, and other individual or portfolio loan and securities sales. In accordance with accounting guidance
for asset transfers, the Company considers any ongoing involvement with transferred assets in determining whether the assets
can be derecognized from the balance sheet. With the exception of servicing and certain performance-based guarantees, the
Company's continuing involvement with financial assets sold is minimal and generally limited to market customary
representation and warranty clauses.
When the Company sells financial assets, it may retain servicing rights and/or other interests in the financial assets. The gain
or loss on sale depends on the previous carrying amount of the transferred financial assets, the servicing right recognized,
and the consideration received and any liabilities incurred in exchange for the transferred assets. Upon transfer, any servicing
assets and other interests held by the Company are carried at the lower of cost or fair value.
Segment Reporting
All of the Company's operations are considered by management to be one operating segment.
Recent Accounting Pronouncements
In January 2014, the FASB issued ASU No. 2014-01, Investments—Equity Method and Joint Ventures (Topic 323):
Accounting for Investments in Qualified Affordable Housing Projects ("ASU 2014-01"). The amendments in ASU 2014-01
provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or
invest in affordable housing projects that qualify for the low-income housing tax credit. The amendments permit reporting
entities to make an accounting policy election to account for their investments in qualified affordable housing projects using
the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity
amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the
net investment performance in the income statement as a component of income tax expense (benefit). The amendments are
effective for fiscal years, and interim periods within those years, beginning after December 15, 2014 and should be applied
retrospectively to all periods presented. Early adoption is permitted. The Company’s adoption of this guidance did not have
a material impact on its consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU
2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of
ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in
an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer,
(ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price
to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance
obligation. ASU 2015-14, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”) was issued in August 2015
which defers adoption to annual reporting periods beginning after December 15, 2017. The Company is currently evaluating
the impact of the adoption of ASU 2014-09 on its consolidated financial statements.
In August 2014, the FASB issued ASU 2014-14, Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-
40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure (“ASU 2014-14”). ASU 2014-14
affects creditors that hold government-guaranteed mortgage loans, including those guaranteed by the Federal Housing
Administration (FHA) of the U.S. Department of Housing and Urban Development (HUD), and the U.S. Department of
Veterans Affairs (VA). The update requires that, upon foreclosure, a guaranteed mortgage loan be derecognized and a
separate other receivable be recognized when specific criteria are met. ASU 2014-14 is effective for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2014. The adoption of this guidance did not have a significant
impact on the Company’s financial statements.
In May 2015, the FASB issued ASU 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value
per Share (or Its Equivalent) (“ASU 2015-07”). The amendment affects reporting entities that elect to measure the fair value
of an investment using the net asset value per share as a practical expedient. The Company adopted the standard in the current
period. See Part I. Item I. “Notes to Consolidated Financial Statements – Note 18: Fair Value Measurements” for further
discussion and related effect.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and
Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). This guidance changes how entities account
for equity investments that do not result in consolidation and are not accounted for under the equity method of accounting.
63
Entities will be required to measure these investments at fair value at the end of each reporting period and recognize changes
in fair value in net income. A practicability exception will be available for equity investments that do not have readily
determinable fair values, however; the exception requires the Company to adjust the carrying amount for impairment and
observable price changes in orderly transactions for the identical or a similar investment of the same issuer. This guidance
also changes certain disclosure requirements and other aspects of current US GAAP. This guidance is effective for fiscal
years beginning after December 15, 2017, including interim periods within the fiscal year. Early adoption is permitted for
only one of the six amendments. The Company is currently evaluating the impact of the adoption of ASU 2016-01 on its
consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). The new guidance establishes the
principles to report transparent and economically neutral information about the assets and liabilities that arise from leases.
Entities will be required to recognize the lease assets and lease liabilities that arise from leases in the statement of financial
position and to disclose qualitative and quantitative information about lease transactions, such as information about variable
lease payments and options to renew and terminate leases. This guidance is effective for fiscal years beginning after
December 15, 2018, including interim periods within the fiscal year. The Company is currently evaluating the impact of the
adoption of ASU 2016-02 on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract
Novations on Existing Hedge Accounting Relationships (“ASU 2016-05”). The new guidance clarifies that a change in the
counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and
of itself, require de-designation of that hedging relationship provided that all other hedge accounting criteria continue to be
met. This guidance is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal
years. The adoption of this guidance is not expected to have a significant impact on the Company’s financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee
Share-Based Payment Accounting (“ASU 2016-09”). The new guidance simplifies several aspects of the accounting for
share-based payment transactions, including the income tax consequences, classification of awards as either equity or
liabilities, and classification on the statement of cash flows. Entities will be required to recognize the income tax effects of
awards in the income statement when the awards vest or are settled. This guidance is effective for fiscal years beginning after
December 15, 2016, and interim periods within those annual periods. The adoption of this guidance is not expected to have
a significant impact on the Company’s financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments (Topic 326) (“ASU 2016-13”). This update is intended
to provide financial statement users with more decision-useful information about the expected credit losses on financial
instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this
objective, the amendments in this update replace the incurred loss impairment methodology in current US GAAP with a
methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable
information to inform credit loss estimates. This ASU will be effective for fiscal years beginning after December 15, 2019.
Early adoption is available as of the fiscal year beginning after December 15, 2018. The Company is currently evaluating the
impact of this ASU on its consolidated financial statements.
2. Securities Available-for-Sale
The following presents a summary of the amortized cost, gross unrealized holding gains and losses, and fair value of securities
available for sale.
Amortized
Cost
U.S. Government agency securities ..................................... $
Agency mortgage-backed securities .....................................
Other investment measured at net asset value ......................
$
51,948 $
43,330
5,097
100,375 $
June 30, 2016
Gross
Gross
Unrealized
Unrealized
Gains
Losses
(Dollars in thousands)
98 $
90
61
249 $
- $
(52)
-
(52) $
Fair
Value
52,046
43,368
5,158
100,572
64
Amortized
Cost
U.S. Government agency securities ..................................... $
Agency mortgage-backed securities .....................................
Other investment measured at net asset value ......................
$
48,191 $
54,553
-
102,744 $
June 30, 2015
Gross
Gross
Unrealized
Unrealized
Gains
Losses
(Dollars in thousands)
40 $
2
-
42 $
(1) $
(877)
-
(878) $
Fair
Value
48,230
53,678
-
101,908
At June 30, 2016, the Company held no securities of any single issuer (excluding the U. S. Government and federal agencies)
with a book value that exceeded 10% of shareholders’ equity.
When securities are sold, the adjusted cost of the specific security sold is used to compute the gain or loss on sale. There were
no securities sold during fiscal 2016 or fiscal 2015. At June 30, 2016, no investment securities were pledged as collateral to
secure outstanding wholesale repurchase agreements and FHLBB advances.
The following summarizes the Company’s gross unrealized losses and fair values aggregated by investment category and
length of time that individual securities have been in a continuous unrealized loss position.
Less than 12 Months
Fair
Value
Unrealized
Losses
June 30, 2016
More than 12 Months
Total
Unrealized
Fair
Losses
Value
(Dollars in thousands)
Fair
Value
Unrealized
Losses
U.S. Government agency
securities ..................................... $
Agency mortgage-backed
securities .....................................
Other investment measured at net
asset value ...................................
$
- $
-
-
- $
- $
- $
- $
- $
-
25,350
(52)
25,350
-
- $
-
25,350 $
-
(52) $
-
25,350 $
-
(52)
-
(52)
Less than 12 Months
Fair
Value
Unrealized
Losses
June 30, 2015
More than 12 Months
Total
Fair
Unrealized
Losses
Value
(Dollars in thousands)
Fair
Value
Unrealized
Losses
U.S. Government agency
securities ..................................... $
2,999 $
(1) $
- $
- $
2,999 $
(1)
Agency mortgage-backed
securities .....................................
10,295
(106)
41,349
(771)
51,644
Other investment measured at net
asset value ...................................
$
-
13,294 $
-
(107) $
-
41,349 $
-
(771) $
-
54,643 $
(877)
-
(878)
There were no other-than-temporary impairment losses on securities during the years ended June 30, 2016 and 2015.
At June 30, 2016, the Company had eleven securities in a continuous loss position for greater than twelve months. At
June 30, 2016, all of the Company’s available-for-sale securities were issued or guaranteed by either government agencies
or government-sponsored enterprises. The decline in fair value of the Company’s available-for-sale securities at June 30,
2016 is attributable to changes in interest rates.
65
In addition to considering current trends and economic conditions that may affect the quality of individual securities within
the Company’s investment portfolio, management of the Company also considers the Company’s ability and intent to hold
such securities to maturity or recovery of cost. At June 30, 2016, the Company does not intend to sell and it is not more likely
than not that the Company will be required to sell the investment securities before recovery of its amortized cost. As such,
management does not believe any of the Company’s available-for-sale securities are other-than-temporarily impaired at
June 30, 2016.
The investment measured at net asset value is a fund that seeks to invest in securities either issued or guaranteed by the U.S.
government or its agencies. The underlying composition of the fund is primarily government agencies or other investment-
grade investments. The effective duration of the investments is 4.52 years.
The amortized cost and fair values of available-for-sale debt securities by contractual maturity are shown below as of
June 30, 2016. Actual maturities may differ from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
Amortized
Cost
Fair
Value
(Dollars in thousands)
Due within one year ......................................................................................... $
Due after one year through five years ..............................................................
Due after five years through ten years ..............................................................
Due after ten years ...........................................................................................
Total ................................................................................................................. $
12,011 $
39,937
19,708
23,622
95,278 $
12,014
40,032
19,797
23,571
95,414
3. Loans, Allowance for Loan Losses and Credit Quality
The composition of the Company’s loan portfolio is as follows on the dates indicated.
June 30, 2016
Originated Purchased
June 30, 2015
Originated Purchased
Total
(Dollars in thousands)
Total
Residential real estate .................... $
Home equity ..................................
Commercial real estate ..................
Commercial and industrial ............
Consumer .....................................
93,391 $
18,012
189,616
145,758
5,950
Total loans ................................. $ 452,727 $
2,559 $
-
236,952
198
-
239,709 $
95,950 $
18,012
426,568
145,956
5,950
692,436 $
106,275 $
24,326
148,425
122,860
7,659
2,068 $
-
200,251
273
-
409,545 $ 202,592 $
108,343
24,326
348,676
123,133
7,659
612,137
Total loans include deferred loan origination fees, net, of $58 thousand and $236 thousand as of June 30, 2016 and June 30,
2015, respectively.
Loans pledged as collateral with the FHLBB for outstanding borrowings and additional borrowing capacity totaled
$106.2 million and $131.3 million at June 30, 2016 and 2015, respectively.
66
Past Due and Nonaccrual Loans
The following is a summary of past due and non-accrual loans:
30-59
Days
60-89
Days
June 30, 2016
Past Due Past Due
90 Days or 90 Days or
More-Still More-
Accruing Nonaccrual
Total
Past
Due
(Dollars in thousands)
Total
Total
Current Loans
Accrual
Loans
Non-
Originated portfolio:
Residential real estate .... $
Home equity ..................
Commercial real estate ..
Commercial and
industrial ...................
Consumer ......................
Total originated portfolio ..
Purchased portfolio:
Residential real estate ...
Commercial and
industrial ...................
Commercial real estate ..
Total purchased portfolio ..
Total loans..................... $
302 $
146
132
-
73
653
910 $
-
-
-
56
966
-
-
-
-
-
653 $
-
19
19
985 $
- $
-
-
-
-
-
-
-
-
-
- $
1,555 $
48
188
2,767 $
90,624 $ 93,391 $
18,012
17,818
194
320 189,296 189,616
15
74
1,880
15 145,743 145,758
5,950
5,747
3,499 449,228 452,727
203
2,613
48
474
17
163
3,315
-
-
2,559
2,559
1,125
-
3,387
3,387
5,267 $
-
198
198
3,406 233,546 236,952
3,406 236,303 239,709
6,905 $ 685,531 $ 692,436 $
-
3,387
4,512
7,827
30-59
Days
60-89
Days
June 30, 2015
Past Due Past Due
90 Days or 90 Days or
More-Still More-
Accruing Nonaccrual
Total
Past
Due
(Dollars in thousands)
Total
Total
Current Loans
Accrual
Loans
Non-
Originated portfolio:
Residential real estate .... $
Home equity ..................
Commercial real estate ..
Commercial and
industrial ...................
Consumer ......................
Total originated portfolio ..
Purchased portfolio:
Residential real estate ...
Commercial and
industrial ...................
Commercial real estate ..
Total purchased portfolio ..
Total loans..................... $
239 $
9
300
-
105
653
973 $
-
-
-
29
1,002
-
-
-
86
86
739 $
-
299
299
1,301 $
Allowance for Loan Losses and Impaired Loans
- $
-
-
-
-
-
-
-
-
-
- $
1,393 $
11
704
2,605 $ 103,670 $ 106,275 $
24,326
24,306
1,004 147,421 148,425
20
2
56
2,166
2 122,858 122,860
7,659
7,469
3,821 405,724 409,545
190
3,021
11
994
2
190
4,218
-
-
2,068
2,068
-
-
2,410
2,410
4,576 $
-
273
273
2,795 197,456 200,251
2,795 199,797 202,592
6,616 $ 605,521 $ 612,137 $
-
6,532
6,532
10,750
The following table sets forth activity in the Company’s allowance for loan losses:
Residential Commercial
Real Estate Real Estate
Commercial
and
Industrial
Consumer Purchased Unallocated
Total
Year Ended June 30, 2016
Beginning balance ..... $
Provision ..................
Recoveries .................
Charge-offs ...............
Ending balance .......... $
741 $
21
35
(134)
663 $
694 $
547
5
(51)
1,195 $
(Dollars in thousands)
35 $
76
17
(66)
62 $
117 $
243
14
(77)
297 $
283 $
787
-
(937)
133 $
56 $
(56)
-
-
- $
1,926
1,618
71
(1,265)
2,350
67
Residential Commercial
Real Estate Real Estate
Year Ended June 30, 2015
Commercial
and
Beginning balance . $
Provision ..............
Recoveries .............
Charge-offs ............
Ending balance ...... $
580 $
344
24
(207)
741 $
358 $
335
1
-
694 $
Industrial Consumer Purchased Unallocated
Total
(Dollars in thousands)
48 $
38
34
(3)
117 $
79 $
(37)
21
(28)
35 $
268 $
15
-
-
283 $
34 $
22
-
-
56 $
1,367
717
80
(238)
1,926
The following table sets forth information regarding the allowance for loan losses by portfolio segment and impairment
methodology.
Residential
Real Estate
Commercial
Real Estate
June 30, 2016
Commercial
and
Industrial Consumer Purchased Unallocated
Total
(Dollars in thousands)
Allowance for loan
losses:
Individually
evaluated ........... $
386 $
59 $
2 $
Collectively
evaluated ............
ASC 310-30 ..........
Total ..................... $
Loans:
Individually
277
-
663 $
1,136
-
1,195 $
295
-
297 $
23 $
39
-
62 $
- $
-
133
133 $
- $
-
-
- $
470
1,747
133
2,350
evaluated ............ $
5,039 $
1,686 $
17 $
362 $
- $
- $
7,104
Collectively
187,930
evaluated ............
ASC 310-30 ..........
-
Total .................... $ 111,403 $ 189,616 $
106,364
-
145,741
-
145,758 $
5,588
-
5,950 $
-
239,709
239,709 $
-
-
- $
445,623
239,709
692,436
Residential
Real Estate
Commercial
Real Estate
June 30, 2015
Commercial
and
Industrial Consumer Purchased Unallocated
Total
(Dollars in thousands)
Allowance for loan
losses:
Individually
evaluated ........... $
435 $
21 $
- $
Collectively
evaluated ............
ASC 310-30 ..........
Total ..................... $
Loans:
Individually
306
-
741 $
673
-
694 $
117
-
117 $
- $
35
-
35 $
- $
- $
456
-
283
283 $
56
-
56 $
1,187
283
1,926
evaluated ............ $
4,095 $
2,381 $
2 $
253 $
- $
- $
6,731
Collectively
146,044
evaluated ............
ASC 310-30 ..........
-
Total .................... $ 130,601 $ 148,425 $
126,506
-
122,858
-
122,860 $
7,406
-
7,659 $
-
202,592
202,592 $
-
-
- $
402,814
202,592
612,137
68
The following table sets forth information regarding impaired loans. Loans accounted for under ASC 310-30 that have
performed based on cash flow and accretable yield expectations determined at date of acquisition are not considered impaired
assets and have been excluded from the tables below.
Recorded
Investment
June 30, 2016
Unpaid
Principal
Balance
June 30, 2015
Related
Allowance
Recorded
Unpaid
Principal
Investment Balance
Related
Allowance
Impaired loans without a valuation
allowance:
Originated:
Residential real estate .................. $
Consumer ....................................
Commercial real estate ................
Commercial and industrial ..........
Purchased:
Residential real estate ..................
Commercial real estate ................
Total ...............................................
Impaired loans with a valuation
allowance:
Originated:
(Dollars in thousands)
3,192 $
257
451
15
1,125
4,574
9,614
3,299 $
282
453
15
1,125
4,886
10,060
- $
-
-
-
-
-
-
1,975 $
253
1,505
2
2,076 $
262
1,510
2
-
7,673
11,408
-
9,606
13,456
Residential real estate ..................
Consumer ....................................
Commercial real estate ................
Commercial and industrial ..........
1,847
105
1,235
2
1,802
112
1,223
2
Purchased:
Commercial real estate ................
Total ................................................
Total impaired loans........................ $
1,484
4,673
14,287 $
1,812
4,951
15,011 $
386
23
59
2
66
536
536 $
2,120
-
876
-
2,060
-
870
-
1,208
4,204
15,612 $
1,644
4,574
18,030 $
The following tables set forth information regarding interest income recognized on impaired loans.
-
-
-
-
-
-
-
435
-
21
-
260
716
716
Year Ended June 30,
2016
2015
Average
Recorded
Investment
Interest
Income
Recognized
Average
Recorded
Investment
Interest
Income
Recognized
(Dollars in thousands)
Impaired loans without a valuation allowance:
Originated:
Residential real estate ............................................................. $
Consumer ...............................................................................
Commercial real estate ...........................................................
Commercial and industrial .....................................................
Purchased:
Residential real estate .............................................................
Commercial real estate ...........................................................
Total ..........................................................................................
Impaired loans with a valuation allowance:
Originated:
Residential real estate .............................................................
Consumer ...............................................................................
Commercial real estate ...........................................................
Commercial and industrial .....................................................
Purchased:
Commercial real estate ...........................................................
Total ...........................................................................................
Total impaired loans................................................................... $
2,584 $
255
978
9
563
6,123
10,512
1,984
53
1,056
1
1,346
4,440
14,952 $
151 $
27
31
-
51
140
400
96
3
63
-
83
245
645 $
1,490 $
226
1,436
1
-
5,265
8,418
1,715
20
1,029
-
1,549
4,313
12,731 $
92
80
71
1
-
249
493
87
17
59
-
41
204
697
69
Credit Quality
The Company utilizes a ten-point internal loan rating system for commercial real estate, construction, commercial and
industrial, and certain residential loans as follows:
Loans rated 1 — 6: Loans in these categories are considered “pass” rated loans. Loans in categories 1-5 are considered to
have low to average risk. Loans rated 6 are considered marginally acceptable business credits and have more than average
risk.
Loans rated 7: Loans in this category are considered “special mention.” These loans show signs of potential weakness and
are being closely monitored by management.
Loans rated 8: Loans in this category are considered “substandard.” Loans classified as substandard are inadequately
protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified
have a well-defined weakness or weaknesses that jeopardize the orderly repayment of the debt.
Loans rated 9: Loans in this category are considered “doubtful.” Loans classified as doubtful have all the weaknesses inherent
in one graded 8 with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of
currently existing facts, conditions and values, highly questionable and improbable.
Loans rated 10: Loans in this category are considered “loss” and of such little value that their continuance as loans is not
warranted.
On an annual basis, or more often if needed, the Company formally reviews the ratings of all loans subject to risk ratings.
Semi-annually, the Company engages an independent third-party to review a significant portion of loans within these
segments. Management uses the results of these reviews as part of its annual review process. Risk ratings on purchased loans,
with and without evidence of credit deterioration at acquisition, are determined relative to the Company’s recorded
investment in that loan, which may be significantly lower than the loan’s unpaid principal balance.
The following tables present the Company’s loans by risk rating.
Originated Portfolio
Commercial Commercial Residential
Real Estate and Industrial Real Estate (1)
Purchased
Portfolio
June 30, 2016
Loans rated 1- 6 ................................. $
Loans rated 7 .....................................
Loans rated 8 .....................................
Loans rated 9 .....................................
Loans rated 10 ...................................
$
186,165 $
2,493
958
-
-
189,616 $
(Dollars in thousands)
7,659 $
431
537
23
-
8,650 $
142,451 $
3,290
17
-
-
145,758 $
227,895 $
7,147
4,667
-
-
239,709 $
Originated Portfolio
Commercial Commercial Residential
Real Estate and Industrial Real Estate (1)
Purchased
Portfolio
June 30, 2015
Loans rated 1- 6 ................................. $
Loans rated 7 .....................................
Loans rated 8 .....................................
Loans rated 9 .....................................
Loans rated 10 ...................................
$
142,321 $
4,417
1,687
-
-
148,425 $
(Dollars in thousands)
8,049 $
634
429
23
-
9,135 $
122,829 $
31
-
-
-
122,860 $
190,193 $
5,628
6,771
-
-
202,592 $
Total
564,170
13,361
6,179
23
-
583,733
Total
463,392
10,710
8,887
23
-
483,012
(1) Certain of the Company’s loans made for commercial purposes, but secured by residential collateral, are rated under
the Company’s risk-rating system.
70
Troubled Debt Restructurings
The following table shows the Company’s post-modification balance of TDRs by type of modification.
Extended maturity ................................................
Adjusted interest rate ...........................................
Rate and maturity ................................................
Principal deferment ..............................................
Court ordered concession .....................................
Year Ended June 30,
2016
2015
Number of
Contracts
Recorded
Investment
Number of
Contracts
Recorded
Investment
- $
4
9
-
-
13 $
(Dollars in thousands)
-
129
1,297
-
-
1,426
7 $
9
6
1
4
27 $
1,934
430
211
443
84
3,102
The following table shows loans modified in a TDR and the change in the recorded investment subsequent to the
modifications.
Year Ended June 30,
2016
Recorded
Investment
Pre-
Recorded
Investment
Post-
Modification
Modification
Number of
Contracts
2015
Recorded
Investment
Pre-
Modification
Recorded
Investment
Post-
Modification
(Dollars in thousands)
Number of
Contracts
Originated portfolio:
Residential real estate
Home equity ..............
Commercial real
estate .......................
Commercial and
industrial .................
Consumer ..................
Total originated
9 $
-
1
1
1
502 $
-
154
2
19
533
-
154
2
19
17 $
-
1
-
6
1,223 $
-
200
-
51
1,223
-
200
-
51
portfolio ......................
12
677
708
24
1,474
1,474
Purchased portfolio:
Commercial real
estate .......................
1
718
718
3
1,628
Total purchased
portfolio ......................
Total .........................
1
13 $
718
1,395 $
718
1,426
3
27 $
1,628
3,102 $
1,628
1,628
3,102
As of June 30, 2016, there were no further commitments to lend to borrowers associated with loans modified in a TDR.
The Company considers TDRs past due 90 days or more to be in payment default. One loan modified in a TDR in the last
twelve months defaulted during the year ended June 30, 2016, with a balance of $8 thousand, compared to three loans during
the twelve months ended June 30, 2015, with an aggregate balance of $100 thousand.
71
ASC 310-30 Loans
The following tables present a summary of loans accounted for under ASC 310-30 that were acquired by the Company during
the period indicated.
Year Ended
June 30, 2016
Year Ended
June 30, 2015
(Dollars in thousands)
Contractually required payments receivable ....................................................... $
Nonaccretable difference .....................................................................................
Cash flows expected to be collected ....................................................................
Accretable yield ..................................................................................................
Fair value of loans acquired ................................................................................ $
148,394 $
(2,050 )
146,344
(46,345 )
99,999 $
128,452
(2,042)
126,410
(43,756)
82,654
Certain of the loans accounted for under ASC 310-30 that were acquired by the Company are not accounted for using the
income recognition model because the Company cannot reasonably estimate cash flows expected to be collected. When
acquired these loans are placed on non-accrual. The carrying amounts of such loans are as follows.
As of and for the
Year Ended
June 30, 2016
As of and for the
Year Ended
June 30, 2015
(Dollars in thousands)
Loans acquired during the period ......................................................................... $
Loans at end of period ..........................................................................................
424 $
4,512
357
6,127
The following tables summarize the activity in the accretable yield for loans accounted for under ASC 310-30.
Year Ended
June 30, 2016
Year Ended
June 30, 2015
(Dollars in thousands)
Beginning balance ............................................................................................... $
Acquisitions ........................................................................................................
Accretion .............................................................................................................
Reclassifications from non-accretable difference to accretable yield .................
Disposals and other changes ...............................................................................
Ending balance .................................................................................................... $
111,449 $
46,345
(16,900 )
7,079
(23,822 )
124,151 $
109,040
43,756
(16,886)
157
(24,618)
111,449
The following table provides information related to the unpaid principal balance and carrying amounts of ASC 310-30 loans.
Unpaid principal balance ................................................................................. $
Carrying amount ..............................................................................................
267,985 $
237,054
235,716
199,113
June 30, 2016
June 30, 2015
(Dollars in thousands)
4. Transfers and Servicing of Financial Assets
The Company sells loans in the secondary market and, for certain loans, retains the servicing responsibility. Consideration
for the sale includes the cash received as well as the related servicing rights asset. The Company receives fees for the services
provided.
Capitalized servicing rights as of June 30, 2016 totaled $1.8 million, compared to $1.1 million as of June 30, 2015, and are
included in other assets on the consolidated balance sheets.
Mortgage loans sold in the year ended June 30, 2016 totaled $89.1 million, compared to $101.3 million in the year ended
June 30, 2015. Mortgage loans serviced for others totaled $12.9 million at June 30, 2016 and $16.1 million at June 30, 2015.
Additionally, the Company was servicing commercial loans participated out to various other institutions amounting to $35.9
million and $38.8 million at June 30, 2016 and June 30, 2015, respectively.
72
SBA loans sold during the year ended June 30, 2016 totaled $39.1 million, compared to $22.2 million in the year ended
June 30, 2015. SBA loans serviced for others totaled $80.8 million at June 30, 2016 and $53.5 million at June 30, 2015.
Mortgage and SBA loans serviced for others are accounted for as sales and therefore are not included in the accompanying
consolidated balance sheets. The risks inherent in mortgage servicing assets and SBA servicing assets relate primarily to
changes in prepayments that result from shifts in interest rates.
Contractually specified servicing fees were $649 thousand and $471 thousand for the years ended June 30, 2016 and 2015,
respectively, and were included as a component of fees for other services to customers within non-interest income.
The significant assumptions used in the valuation for mortgage servicing rights as of June 30, 2016 included a weighted
average discount rate of 6.3% and a weighted average prepayment speed assumption of 19.4%. For the SBA servicing rights,
the significant assumptions used in the valuation included a discount rate, ranging from 7.8% to 13.0% and a weighted
average prepayment speed assumption of 7.5%.
Residential mortgage servicing rights activity was as follows:
Balance, June 30, 2014 .......................................................................................................................................... $
Amortization .....................................................................................................................................................
Allowance Adjustment .......................................................................................................................................
Balance, June 30, 2015 ..........................................................................................................................................
Amortization .....................................................................................................................................................
Allowance Adjustment .......................................................................................................................................
Balance, June 30, 2016 .......................................................................................................................................... $
June 30, 2016
(Dollars in thousands)
64
(28)
1
37
(19)
(1)
17
SBA servicing rights activity was as follows:
Balance, June 30, 2014 .......................................................................................................................................... $
Additions ............................................................................................................................................................
Amortization .....................................................................................................................................................
Allowance Adjustment .......................................................................................................................................
Balance, June 30, 2015 ..........................................................................................................................................
Additions ............................................................................................................................................................
Disposals ............................................................................................................................................................
Amortization .....................................................................................................................................................
Allowance Adjustment .......................................................................................................................................
Balance, June 30, 2016 .......................................................................................................................................... $
June 30, 2016
(Dollars in thousands)
236
940
(80)
(19)
1,077
1,230
(38)
(52)
(463)
1,754
5. Premises and Equipment
Premises and equipment consists of the following:
June 30, 2016
June 30, 2015
(Dollars in thousands)
Land ............................................................ $
Buildings .....................................................
Assets recorded under capital lease .............
Leasehold and building improvements ........
Furniture, fixtures and equipment ...............
Less accumulated depreciation ...................
Net premises and equipment ....................... $
804 $
1,760
1,850
3,452
7,962
15,828
8,027
7,801 $
804
1,760
1,850
3,051
7,745
15,210
6,957
8,253
Estimated Useful Life
(In years)
n/a
39
Term of lease
5-39 (or term of lease, if shorter)
3-7
Depreciation and amortization of premises and equipment included in occupancy and equipment expense was $1.6 million
for the year ended June 30, 2016 and $1.7 million for the year ended June 30, 2015.
73
6. Intangible Assets
At June 30, 2016 and 2015, intangible assets consisted of a core deposit intangible. The Company’s core deposit intangible
is being amortized on an accelerated basis over 9.5 years, with an estimated remaining life of 4 years.
The changes in the carrying amount of the core deposit intangible follow:
June 30, 2016
(Dollars in
thousands)
Balance, June 30, 2014 .......................................................................................................................... $
Amortization .....................................................................................................................................
Balance, June 30, 2015 ..........................................................................................................................
Amortization .....................................................................................................................................
Balance, June 30, 2016 .......................................................................................................................... $
2,798
(589)
2,209
(477)
1,732
The components of core deposit intangible follow:
Core Deposit Intangible:
Gross carrying amount .......................................................................................... $
Accumulated amortization ....................................................................................
Net carrying amount ............................................................................................ $
6,348 $
(4,616 )
1,732 $
6,348
(4,139)
2,209
Expected annual amortization expense associated with the core deposit intangible over the period of estimated economic
benefit is as follows:
June 30, 2016
June 30, 2015
(Dollars in thousands)
Fiscal Year
Expected Amortization
Expense
(Dollars in thousands)
2017 ....................................................................................................................................... $
2018 .......................................................................................................................................
2019 .......................................................................................................................................
2020 .......................................................................................................................................
Total ...................................................................................................................................... $
432
433
433
434
1,732
7. Deposits
The composition of deposits is as follows:
Demand ............................................................................................................... $
NOW ...................................................................................................................
Money market .....................................................................................................
Regular savings ...................................................................................................
Time certificates of less than $100 thousand .......................................................
Time certificates of greater than $100 thousand ..................................................
Total ..................................................................................................................... $
June 30, 2016
June 30, 2015
(Dollars in thousands)
66,686 $
71,148
275,437
36,070
72,190
278,901
800,432 $
60,383
64,289
168,527
35,845
82,973
262,742
674,759
There were no time deposits greater than $250 thousand as of June 30, 2016, and there were $569 thousand of time deposits
greater than $250 thousand as of June 30, 2015.
74
The scheduled maturities of time certificates by fiscal year are as follows:
Fiscal Year
June 30, 2016
(Dollars in
thousands)
2017 .......................................................................................................................................................
2018 .......................................................................................................................................................
2019 .......................................................................................................................................................
2020 .......................................................................................................................................................
Thereafter ..............................................................................................................................................
Total ...................................................................................................................................................... $
226,515
72,264
33,030
14,326
4,956
351,091
8. Borrowings
Federal Home Loan Bank Advances
A summary of advances from the Federal Home Loan Bank of Boston follows:
Maturity
By Fiscal
Year
2016
2017
2018
Unpaid Principal Balance
2016
Carrying Amount(1)
2015
2016
2015
(Dollars in thousands)
Weighted Average Interest Rate
2016
2015
-
25,000
5,000
30,000 $
15,000
10,000
5,000
30,000 $
-
25,037
5,038
30,075 $
15,000
10,123
5,065
30,188
$
-
2.10 %
4.29 %
2.46 %
0.38%
2.84%
1.43%
2.34%
(1) The difference between the carrying amount and the unpaid principal balance is the result of purchase accounting.
The premium or discount is being amortized or accreted as interest expense over the instrument’s contractual life.
At June 30, 2016, FHLBB advances with unpaid principal of $10.0 million were subject to call provisions and may be called
prior to the stated maturity.
Certain mortgage loans, free of liens, pledges and encumbrances and certain investment securities maintained at the FHLBB
not otherwise pledged have been pledged under a blanket agreement to secure these advances. The Company is required to
own stock in the Federal Home Loan Bank of Boston in order to borrow from the FHLBB.
At June 30, 2016, the Company had approximately $16.8 million of additional capacity to borrow from the FHLBB.
Wholesale Repurchase Agreements
As of June 30, 2016, the Company did not have any outstanding wholesale repurchase agreements. During the year ended
June 30, 2016, the Company paid off the wholesale repurchase agreements at maturity. At June 30, 2015, the Company had
wholesale repurchase agreements with an unpaid principal balance and carrying amount of $10.0 million, with a weighted
average interest rate of 4.44%.
Capital Lease Obligation
In fiscal 2006, the Company recognized a capital lease obligation for its Lewiston, Maine, headquarters. The present value
of the lease payments over fifteen years exceeded 90% of the fair value of the property.
75
The outstanding capital lease obligations are as follows for years ending June 30:
2017 ............................................................................................................................................... $
2018 ...............................................................................................................................................
2019 ...............................................................................................................................................
2020 ...............................................................................................................................................
2021 ...............................................................................................................................................
Total ..............................................................................................................................................
Imputed interest ............................................................................................................................
Capital lease obligation ................................................................................................................ $
306
306
306
306
25
1,249
(121)
1,128
Capital Lease Obligation
(Dollars in thousands)
Short-Term Borrowings
Short-term borrowings are sweep accounts, which are a demand account product that moves balances in excess of an agreed
upon target amount from a demand deposit account into an interest-bearing account overnight. The weighted average interest
rate on short-term borrowings was 1.91% at June 30, 2015. The Company held no short-term borrowings as of June 30, 2016.
9. Subordinated Debt
Trust Preferred Securities and Junior Subordinated Debentures
NBN Capital Trust II and NBN Capital Trust III were created in December 2003. NBN Capital Trust IV was created in
December 2004. Each such trust is a Delaware statutory trust (together, the "Private Trusts"). The exclusive purpose of the
Private Trusts was (i) issuing and selling common securities and preferred securities in a private placement offering (the
"Private Trust Securities"), (ii) using the proceeds of the sale of the Private Trust Securities to acquire Junior Subordinated
Deferrable Interest Notes ("Junior Subordinated Debentures"); and (iii) engaging only in those other activities necessary,
convenient or incidental thereto. Accordingly, the Junior Subordinated Debentures are the sole assets of each of the Private
Trusts.
The following table summarizes the Junior Subordinated Debentures issued by the Company to each affiliated trust and the
Private Trust Securities issued by each affiliated trust as of June 30, 2016. Amounts include the junior subordinated
debentures acquired by the affiliated trusts from the Company with the capital contributed by the Company in exchange for
the common securities of such trust, which were $93 thousand each for NBN Capital Trust II and III and $310 thousand for
NBN Capital Trust IV. The trust preferred securities (the "Preferred Securities") were sold in two separate private placement
offerings. The Company has the right to redeem the Junior Subordinated Debentures, in whole or in part, on or after March 30,
2009, for NBN Capital Trust II and III, and on or after February 23, 2010, for NBN Capital Trust IV, at the redemption price
specified in the associated Indenture, plus accrued but unpaid interest to the redemption date.
Maturity Date
Unpaid Principal Balance
2016
Carrying Amount(1)
2015
2016
2015
(Dollars in thousands)
NBN Capital Trust II ...........................
NBN Capital Trust III .........................
NBN Capital Trust IV .........................
March 30, 2034
March 30, 2034
February 23, 2035
$
$
3,093 $
3,093
10,310
16,496 $
3,093 $
3,093
10,310
16,496 $
1,868 $
1,868
5,083
8,819 $
1,835
1,835
4,956
8,626
(1) The difference between the carrying amount and the unpaid principal balance is the result of purchase
accounting. The premium or discount is being amortized or accreted as interest expense over the instrument’s
contractual life.
NBN Capital Trust II and III pay a variable rate based on three month LIBOR plus 2.80%, and NBN Capital Trust IV pays a
variable rate based on three month LIBOR plus 1.89%. Accordingly, the Preferred Securities of the Private Trusts currently
pay quarterly distributions at an annual rate of 3.45% for the stated liquidation amount of $1,000 per Preferred Security for
NBN Capital Trust II and III and an annual rate of 2.54% for the stated liquidation amount of $1,000 per Preferred Security
for NBN Capital Trust IV. The Company has fully and unconditionally guaranteed all of the obligations of each trust. The
guaranty covers the quarterly distributions and payments on liquidation or redemption of the Private Trust Securities, but
only to the extent of funds held by the trusts.
76
The Junior Subordinated Debentures each have variable rates indexed to three-month LIBOR. During the fiscal year ended
June 30, 2015, the Company purchased two interest rate caps to hedge the interest rate risk on notional amounts of $6 million
and $10 million, respectively, of the Company's Junior Subordinated Debentures. Each is a cash flow hedge used to manage
the risk to net interest income in a period of rising rates.
The interest rate caps hedge the junior subordinated debt resulting from the issuance of trust preferred securities by our
affiliates NBN Capital Trust II, NBN Capital Trust III and NBN Capital Trust IV. The notional amount of $6 million and
$10 million for each interest rate cap represents the outstanding junior subordinated debt from each trust. The strike rate is
2.50%. The Company will recognize higher interest expense on the junior subordinated debt for the first 200 basis points
increase in three-month LIBOR. Once the three-month LIBOR rate exceeds 2.50% on a quarterly reset date, there will be a
payment by the counterparty to the Company at the following quarter end. The effective date of the purchased interest rate
caps were October 2014 and March 2015, respectively, and mature five years after.
Subordinated Notes
On June 29, 2016, the Company entered into a Subordinated Note Purchase Agreement with certain institutional accredited
investors (the “Purchasers”) whereby the Company sold and issued $15.05 million in aggregate principal amount of 6.75%
fixed-to-floating subordinated notes due 2026 (the “Notes”). The Notes were issued by the Company to the Purchasers at a
price equal to 100% of their face amount. Issuance costs were $538 thousand and have been netted against Subordinated Debt
on the consolidated balance sheet. These costs are being amortized over the life of the Notes.
The Notes mature on July 1, 2026, with a fixed interest rate of 6.75% payable semiannually in arrears for five years until
July 1, 2021. Subsequently, the Company will be obligated to pay 3-month LIBOR plus 557 basis points quarterly in arrears
until either the early redemption date or the maturity date. The Notes are not convertible into or exchangeable for any other
securities or assets of the Company or any of its subsidiaries. The Notes are redeemable by the Company, in whole or in part,
on or after July 1, 2021 and at any time upon the occurrence of certain events. Any redemption by the Company would be at
a redemption price equal to 100% of the outstanding principal amount of the Notes being redeemed, including any accrued
and unpaid interest.
10. Capital and Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must
meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. The Company's and the Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk weightings and other factors.
The prompt corrective action regulations define specific capital categories based on an institution's capital ratios. The capital
categories, in declining order, are "well capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized."
As of June 30, 2016 and 2015, the most recent notification from the Company's and the Bank's regulator categorized the
Company and the Bank as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized
as "well capitalized," the Company and the Bank must maintain minimum Common equity tier 1 capital, total capital, Tier 1
capital and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that
management believes have changed the institution's regulatory designation as "well-capitalized" under the regulatory
framework for prompt corrective action.
77
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain
minimum amounts and ratios as set forth in the table below. At June 30, 2016 and 2015, the Company's and the Bank's ratios
exceeded the regulatory requirements. Management believes that the Company and the Bank met all capital adequacy
requirements to which they were subject as of June 30, 2016 and 2015. The Company's and the Bank's regulatory capital
ratios are set forth below.
Actual
Minimum
Capital
Requirements
Amount Ratio
Amount Ratio
(Dollars in thousands)
Minimum To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
Amount Ratio
June 30, 2016:
Common equity tier 1 capital to risk
weighted assets:
Company .................................................. $ 126,046
Bank ......................................................... 117,212
17.97% $
16.69%
31,559
31,611
>4.5% $
>4.5%
N/A
45,660
N/A
>6.5%
Total capital to risk weighted assets:
Company .................................................. 142,988
Bank ......................................................... 119,971
Tier 1 capital to risk weighted assets:
Company .................................................. 126,046
Bank ......................................................... 117,212
Tier 1 capital to average assets:
Company .................................................. 126,046
Bank ......................................................... 117,212
June 30, 2015:
Common equity tier 1 capital to risk
weighted assets:
20.39%
17.08%
56,105
56,197
>8.0%
>8.0%
N/A
70,246
N/A
>10.0%
17.97%
16.69%
42,079
42,148
>6.0%
>6.0%
N/A
56,197
N/A
>8.0%
13.27%
12.33%
38,006
38,022
>4.0%
>4.0%
N/A
47,528
N/A
>5.0%
Company .................................................. $ 121,224
Bank ......................................................... 107,477
19.82% $
17.55%
27,523
27,558
>4.5% $
>4.5%
N/A
39,806
N/A
>6.5%
Total capital to risk weighted assets:
Company .................................................. 123,187
Bank ......................................................... 111,228
Tier 1 capital to risk weighted assets:
Company .................................................. 121,224
Bank ......................................................... 107,477
Tier 1 capital to average assets:
Company .................................................. 121,224
Bank ......................................................... 107,477
20.14%
18.16%
48,932
48,999
>8.0%
>8.0%
N/A
61,249
N/A
>10.0%
19.82%
17.55%
24,465
24,496
>4.0%
>4.0%
N/A
36,744
N/A
>6.0%
14.49%
12.86%
33,464
33,421
>4.0%
>4.0%
N/A
41,776
N/A
>5.0%
The Bank may not declare or pay a cash dividend on, or repurchase, any of its capital stock from the Parent if the effect
thereof would cause the capital of the Bank to be reduced below the capital requirements imposed by the regulatory authorities
or if such amount exceeds the otherwise allowable amount under FRB rules.
In connection with the Merger, as part of the regulatory approval process, the Company and the Bank made certain
commitments to the Federal Reserve, the most significant of which are (i) to maintain a Tier 1 leverage ratio of at least 10%,
(ii) to maintain a total capital ratio of at least 15%, (iii) to limit purchased loans to 40% of total loans, (iv) to fund 100% of
the Company's loans with core deposits (defined as non-maturity deposits and non-brokered insured time deposits), and (v) to
hold non-owner occupied commercial real estate loans to within 300% of total capital. The Company and the Bank are
currently in compliance with all commitments to the Federal Reserve.
78
11. Earnings Per Common Share
EPS is computed by dividing net income allocated to common shareholders by the weighted average common shares
outstanding. The following table shows the weighted average number of shares outstanding for the periods indicated. Shares
issuable relative to stock options granted have been reflected as an increase in the shares outstanding used to calculate diluted
EPS, after applying the treasury stock method. The number of shares outstanding for basic and diluted EPS is presented as
follows:
Year ended June 30,
2016
2015
Net income .............................................................................................................. $
(Dollars in thousands, except share and
per share data)
7,619 $
7,141
Weighted average shares used in calculation of basic earnings per share ................
Incremental shares from assumed exercise of dilutive securities .........................
Weighted average shares used in calculation of diluted earnings per share .........
9,474,999
9,636
9,484,635
9,980,733
-
9,980,733
Earnings per common share: .................................................................................... $
Diluted earnings per common share: ........................................................................ $
0.80 $
0.80 $
0.72
0.72
For the years ended June 30, 2016 and 2015, the following stock options were excluded from the calculation of diluted EPS
due to the exercise price of these options exceeding the average market price of the Company's common stock for the period.
These options, which were not dilutive at that date, may potentially dilute EPS in the future.
Stock options ....................................................................................................
714,545
1,059,721
Year ended June 30,
2016
2015
12. Income Taxes
The current and deferred components of income tax expense follows:
Current provision
Federal ............................................................................................................. $
State .................................................................................................................
Total current provision ................................................................................
Deferred expense (benefit)
Federal .............................................................................................................
State .................................................................................................................
Total deferred expense (benefit) ..................................................................
Total tax provision ...................................................................................... $
Year Ended June 30,
2016
2015
(Dollars in thousands)
1,544 $
438
1,982
1,761
361
2,122
4,104 $
4,282
898
5,180
(901)
(284)
(1,185)
3,995
79
The reconciliation between the statutory federal income tax rate of 34% and the effective tax rate on income follows:
Expected income tax expense at federal tax rate ..................................................... $
State tax, net of federal tax benefit ...........................................................................
Non-taxable BOLI income ......................................................................................
Low-income housing tax credit, net of adoption of ASU 2014-01 ..........................
Tax exempt interest income .....................................................................................
Other ........................................................................................................................
Total tax provision ............................................................................................... $
Year Ended June 30,
2016
2015
(Dollars in thousands)
3,986 $
527
(153 )
(42 )
(76 )
(138 )
4,104 $
3,786
379
(150)
(42)
(76)
98
3,995
The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax
liabilities at June 30 follows:
Deferred tax assets
Allowance for loan losses ..................................................................................... $
Loan basis differential ..........................................................................................
Time deposit basis differential ..............................................................................
Capital lease ..........................................................................................................
Compensation and benefits ...................................................................................
Stock-based compensation ....................................................................................
Unrealized loss on derivatives ..............................................................................
Unrealized loss on available for sale securities ....................................................
Interest on nonperforming loans ...........................................................................
Other .....................................................................................................................
Gross deferred tax asset ....................................................................................
Less: valuation allowance ........................................................................................
Total deferred tax assets .......................................................................................
Deferred tax liabilities
Unrealized gain on available for sale securities ....................................................
Intangible assets ....................................................................................................
Prepaid expenses...................................................................................................
Premises and equipment .......................................................................................
Borrowings basis differential ................................................................................
Other .....................................................................................................................
Total deferred tax liability .................................................................................
Net deferred tax asset ........................................................................................... $
June 30,
2016
2015
(Dollars in thousands)
899 $
1,322
2
431
937
1,314
1,243
-
313
701
7,162
-
7,162
75
662
300
1,239
2,863
677
5,816
1,346 $
722
3,781
4
521
809
1,167
472
318
289
788
8,871
49
8,822
-
842
368
1,231
2,869
424
5,734
3,088
The net deferred tax asset was included in other assets in the accompanying balance sheet as of June 30, 2016 and June 30,
2015.
In accordance with ASC 740, Income Taxes, deferred tax assets are to be reduced by a valuation allowance if, based on the
weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The realization of the tax benefit depends upon the existence of sufficient taxable income within the carry-back and future
periods. The Company believes that it is more likely than not that the net deferred tax asset as of June 30, 2016 will be
realized, based upon the ability to generate future taxable income as well as the availability of current and historical taxable
income.
For federal tax purposes, the Company has a $2.0 million reserve for loan losses which remains subject to recapture. If any
portion of the reserve is used for purposes other than to absorb the losses for which it was established, approximately 150%
of the amount actually used (limited to the amount of the reserve) would be subject to taxation in the year in which used. As
the Company intends to use the reserve only to absorb loan losses, no provision has been made for potential liability that
would result if 100% of the reserve were recaptured.
80
From time to time, the Internal Revenue Service (the "IRS") and state tax authorities may review or challenge specific tax
positions taken by the Company in its ordinary course of business. The Company accounts for uncertainties in income taxes
by reserving for tax positions that may not be upheld under examination. Increases to the Company's unrealized tax positions
occur as a result of accruing for the unrecognized tax benefit as well the accrual of interest and penalties related to prior year
positions. Decreases in the Company's unrealized tax positions occur as a result of the statute of limitation lapsing on prior
year positions or settlements relating to outstanding positions. The Company reserves for uncertain tax positions, as well as
related interest and penalties, as a component of income tax expense therefore affecting the effective tax rate. The following
is a reconciliation of the beginning and ending amounts of the Company's uncertain tax positions:
Tax Position
Interest and
Penalties
(Dollars in thousands)
Total
Balance, June 30, 2014 ................................................................. $
Reduction of tax positions for prior years ....................................
Increase for prior year tax position ...............................................
Increase for current year tax position ...........................................
Balance, June 30, 2015 ................................................................. $
Reduction of tax positions for prior years ....................................
Increase for prior year tax position ...............................................
Increase for current year tax position ...........................................
Balance, June 30, 2016 ................................................................. $
101 $
-
8
-
109 $
(42)
-
-
67 $
12 $
-
6
-
18 $
(4)
-
-
14 $
113
-
14
-
127
(46)
-
-
81
The Company is currently open to audit under the statute of limitations by the IRS and state taxing authorities for the fiscal
2013 tax return and forward.
13. Employee Benefit Plans
401(k) Plan
The Company offers a contributory 401(k) plan that is available to all full-time salaried and hourly-paid employees who have
attained age 18, and completed 90 days of employment. Employees may contribute up to 100% of their base compensation,
subject to IRS limitations. The Company will match 50% of each employee's contribution up to the first 6% contributed. For
the years ended June 30, 2016 and 2015, the Company contributed $331 thousand and $315 thousand, respectively.
Deferred Compensation
The Company has individual deferred compensation agreements with five former senior officers. The Company recognized
deferred compensation expense of $31 thousand and $30 thousand for the years ended June 30, 2016 and 2015, respectively.
At June 30, 2016 and 2015, the Company's deferred compensation liability was $541 thousand and $512 thousand,
respectively.
14. Stock-Based Compensation
At the 2012 annual meeting of shareholders, the Company's shareholders approved the Northeast Bancorp Amended and
Restated 2010 Stock Option and Incentive Plan (the "Restated Plan"). The Restated Plan amends and restates the Northeast
Bancorp 2010 Option and Incentive Plan (the "2010 Plan"). The key material differences between the 2010 Plan and the
Restated Plan are:
(cid:2) The maximum number of shares of common stock to be issued under the Restated Plan is increased by 600,000
shares, from 810,054 shares to 1,410,054 shares;
(cid:2) The method by which shares subject to previously granted awards are added back to the Restated Plan has been
revised so that the only shares added back to the Restated Plan are those subject to awards that are forfeited, canceled
or otherwise terminated. The following shares shall not be added back to the Restated Plan: (i) shares tendered or
held back upon exercise of an option or settlement of an award to cover the exercise price or tax withholding, and
(ii) shares subject to a stock appreciation right that are not issued in connection with the stock settlement of the stock
appreciation right upon exercise thereof.
(cid:2) Minimum vesting periods are required for grants of restricted stock, restricted stock units and performance share
awards; and
81
(cid:2) The term of the Restated Plan will now expire on November 28, 2022, while grants of incentive options under the
Restated Plan may be made until September 21, 2022.
A summary of stock option activity for the year ended June 30, 2016 follows:
Outstanding at beginning of year ........................................................................
Granted .............................................................................................................
Exercised ..........................................................................................................
Forfeited ...........................................................................................................
Outstanding at end of year ...................................................................................
Exercisable ...........................................................................................................
1,059,721 $
-
-
(96,118)
963,603
466,385
12.58
-
-
10.06
12.83
13.05
Shares
Weighted Average
Exercise Price
Weighted Average
Grant Date Fair
Value
Shares
Exercisable, beginning of year .............................................................................
Vested ..............................................................................................................
Exercised .........................................................................................................
Forfeited or expired .........................................................................................
Exercisable, end of year ......................................................................................
305,595 $
167,456
-
(6,666)
466,385
3.55
2.96
-
4.43
3.48
There were no options granted in the year ended June 30, 2016. The fair values of options granted have been estimated on
the date of grant using the Black-Scholes option-pricing model using the following weighted-average assumptions for the
year ended June 30, 2015.
Assumptions:
Dividend yield .........................................................................................................................
Expected life (in years) ............................................................................................................
Expected volatility ...................................................................................................................
Risk-free interest rate ...............................................................................................................
Weighted average fair value per option ...................................................................................
0.43%
7.0
30.30%
2.03%
$3.11
Year Ended June 30, 2015
The expected volatility is based on historical volatility. The risk-free interest rate is for periods within the expected life of the
awards, and is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life is based on expected
exercise experience.
During the year ended June 30, 2013, certain provisions of outstanding stock options with market-based conditions were
modified. The options, consisting of 237,616 shares, were granted to three executives of the Company in December of 2010
and were to vest in three equal tranches upon the Company's common stock reaching applicable hurdle prices over specified
time periods. The applicable hurdle price varies depending on the number of years that have elapsed since the date of grant.
With respect to the first tranche, the applicable hurdle price was $27.86 for the period from December 29, 2010 through
December 29, 2015; $31.34 for the period from December 29, 2015 through December 29, 2016; and $34.83 for the period
from December 29, 2016 through December 29, 2017. With respect to the second tranche, the hurdle price was $31.34 for
the period from December 29, 2010 through December 29, 2016; and $34.83 for the period from December 29, 2016 through
December 29, 2017. With respect to the third tranche, the hurdle price was $34.83 for the period from December 29, 2010
through December 29, 2017.
The Company's Compensation Committee approved amending the hurdle prices as follows:
With respect to the first tranche, the applicable hurdle price is $16.43 for the period from December 29, 2010 through
December 28, 2015; $18.58 for the period from December 29, 2015 through December 28, 2016; and $20.77 for the period
from December 29, 2016 through December 28, 2017. With respect to the second tranche, the hurdle price is $18.58 for the
period from December 29, 2010 through December 28, 2016; and $20.77 for the period from December 29, 2016 through
December 28, 2017. With respect to the third tranche, the hurdle price is $20.77 for the period from December 29, 2010
through December 28, 2017.
82
Except as modified by this amendment, all other terms and conditions of each of the outstanding performance-based stock
options, including the option exercise price of $13.93 per share, remain in full force and effect.
The incremental expense resulting from the modification was calculated as the difference between the stock option’s fair
value immediately before and after the modification using the Hull-White option pricing model and the following weighted-
average assumptions:
Assumptions:
Dividend yield .............................................................................................................................
Expected life (in years) ................................................................................................................
Expected volatility ....................................................................................................................... 28.45% -
Risk-free interest rate ................................................................................................................... 0.07% -
3.72%
7.8
32.84%
1.54%
Incremental weighted average fair value per option .......................................................................
$0.52
The following table summarizes information about stock options outstanding at June 30, 2016:
Options Outstanding
Options Exercisable
(Dollars in thousands, except per share data)
Weighted
Average
Exercise
Price
9.30
9.38
9.38
12.63
13.93
14.52
12.83
Weighted
Average
Remaining
Life
Number
20,000
195,999
33,059
12,500
540,035
162,010
963,603
(in years)
7.64
6.59
2.50
5.58
4.50
3.73
4.81
Aggregate
Intrinsic
Value
39
366
62
-
-
-
467
Weighted
Average
Exercise
Price
9.30
9.38
9.38
12.63
13.93
14.52
13.05
Weighted
Average
Remaining
Life
Number
-
65,333
33,059
8,334
278,655
81,004
466,385
(in years)
7.64
6.59
2.50
5.58
4.50
3.73
4.81
Aggregate
Intrinsic
Value
-
122
62
-
-
-
184
A summary of restricted stock activity for the year ended June 30, 2016 follows:
Weighted Average
Grant
Date Fair Value
Shares
Unvested at beginning of period ..............................................................
Granted .................................................................................................
Vested ...................................................................................................
Forfeited ...............................................................................................
Unvested at end of period .........................................................................
212,010 $
100,000
(13,597)
(46,554)
251,859
9.34
10.82
9.33
9.53
9.93
At June 30, 2016 and 2015, the Company has accrued a liability of $48 thousand representing the maximum cash payment
for performance-based stock appreciation rights (“SARs”) granted in the fiscal year ended June 30, 2011. The SARs expire
in December of 2020.
Stock-based compensation totaled $613 thousand for the year ended June 30, 2016 and $705 thousand for the year ended
June 30, 2015. The tax benefit related to stock-based compensation expensed totaled $215 thousand for the year ended
June 30, 2016 and $253 thousand for the year ended June 30, 2015. The estimated amount and timing of future pre-tax stock-
based compensation expense to be recognized are as follows.
2017
2018
Stock options ......... $
Restricted stock ....
$
116 $
518
634 $
49 $
494
543 $
Year Ended June 30,
2019
2020
(Dollars in thousands)
5 $
460
465 $
- $
279
279 $
2021
Total
- $
51
51 $
170
1,802
1,972
83
15. Commitments, Contingent Liabilities and Other Off-Balance Sheet Risks
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 and to reduce its own exposure to fluctuations in interest rates. These financial instruments
include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts
of those instruments reflect the extent of involvement the Company has 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 and standby letters of credit is represented by the contractual amount of those instruments. The
Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet
instruments.
Financial instruments with contract amounts which represent credit risk are as follows:
June 30,
2016
2015
(Dollars in thousands)
Commitments to originate loans........................................................................... $
Unused lines of credit ..........................................................................................
Standby letters of credit .......................................................................................
Commitment to fund investment ..........................................................................
44,684 $
58,412
3,822
2,500
24,966
39,414
60
-
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 commitment
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 deemed necessary by the Company upon extension of credit, is
based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable,
inventory, property, plant and equipment, and income-producing commercial properties. The Company has recorded an
allowance for possible losses on commitments and unfunded loans totaling $81 thousand and $37 thousand recorded in other
liabilities at June 30, 2016 and 2015, respectively.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to
a third party. Those guarantees are issued to support private borrowing arrangements. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan facilities to customers. As of June 30, 2016 and
2015, the maximum potential amount of the Company's obligation was $3.8 million and $60 thousand, respectively, for
financial and standby letters of credit. The Company's outstanding letters of credit generally have a term of less than one
year. If a letter of credit is drawn upon, the Company may seek recourse through the customer's underlying line of credit. If
the customer's line of credit is also in default, the Company may take possession of the collateral, if any, securing the line of
credit.
Lease Obligations
The Company leases certain properties used in operations under terms of operating leases that include renewal options. The
leases contain renewal options and escalation clauses which provide for increased rental expense as these leases expire. Rental
expense under leases totaled $1.2 million for the year ended June 30, 2016 and $1.2 million for the year ended June 30, 2015.
84
Approximate future minimum lease payments over the remaining terms of the Company's leases at June 30, 2016 are as
follows:
Minimum lease
payments
(Dollars in
thousands)
2017 ....................................................................................................................................................... $
2018 .......................................................................................................................................................
2019 .......................................................................................................................................................
2020 .......................................................................................................................................................
2021 .......................................................................................................................................................
Thereafter .............................................................................................................................................
Total ...................................................................................................................................................... $
1,249
1,214
1,207
1,205
1,230
3,164
9,269
Legal Proceedings
The Company and its subsidiary are parties to litigation and claims arising in the normal course of business. Management
believes that the liabilities, if any, arising from such litigation and claims will not be material to the Company's consolidated
financial position or results of operations.
16. Other Comprehensive Loss
The components of other comprehensive loss follow:
Year Ended June 30,
Pre-tax
Amount
2016
Tax
Expense
(Benefit) Amount
After-tax
Pre-tax
Amount
(Dollars in thousands)
2015
Tax
Expense
(Benefit) Amount
After-tax
Change in net unrealized gain on
available-for-sale securities ....... $
1,033 $
393 $
640 $
442 $
116 $
326
Change in accumulated loss
on effective cash flow hedges ....
(2,032)
(776)
(1,256)
(529)
(228)
(301)
Reclassification adjustment
included in net income ...............
(3)
(1)
(2)
(49)
(19)
(30)
Total derivatives and hedging
activities ....................................
Total other comprehensive loss .... $
(2,035)
(1,002) $
(777)
(384) $
(1,258)
(618) $
(578)
(136) $
(247)
(131) $
(331)
(5)
Accumulated other comprehensive loss is comprised of the following components:
Unrealized gain (loss) on available-for-sale securities ..................................... $
Tax effect ......................................................................................................
Net-of-tax amount .....................................................................................
Unrealized loss on cash flow hedges ................................................................
Tax effect ......................................................................................................
Net-of-tax amount .....................................................................................
Accumulated other comprehensive loss .......................................................... $
June 30, 2016
June 30, 2015
(Dollars in thousands)
197 $
(75)
122
(3,276)
1,248
(2,028)
(1,906) $
(836)
318
(518)
(1,242)
472
(770)
(1,288)
85
17. Derivatives
The Company has stand-alone derivative financial instruments in the form of interest rate caps that derive their value from a
fee paid and are adjusted to fair value based on index and strike rate, and swap agreements that derive their value from the
underlying interest rate. These transactions involve both credit and market risk. The notional amounts are amounts on which
calculations, payments and the value of the derivative are based. Notional amounts do not represent direct credit exposures.
Direct credit exposure arises in the event of nonperformance by the counterparties to these agreements, and is limited to the
net difference between the calculated amounts to be received and paid, if any. Such differences, which represent the fair value
of the derivative instruments, are reflected on the Company's balance sheet as derivative assets and derivative liabilities. The
Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and
does not expect any counterparties to fail to meet their obligations.
The Company currently holds derivative instruments that contain credit-risk related features that are in a net liability position,
which may require that collateral be assigned to dealer banks. At June 30, 2016, the Company had posted cash collateral
totaling $3.1 million with dealer banks related to derivative instruments in a net liability position.
The Company does not offset fair value amounts recognized for derivative instruments. The Company does not net the amount
recognized for the right to reclaim cash collateral against the obligation to return cash collateral arising from derivative
instruments executed with the same counterparty under a master netting arrangement.
Risk Management Policies—Derivative Instruments
The Company evaluates the effectiveness of entering into any derivative instrument agreement by measuring the cost of such
an agreement in relation to the reduction in net income volatility within an assumed range of interest rates.
Interest Rate Risk Management—Cash Flow Hedging Instruments
The Company uses variable rate debt as a source of funds for use in the Company's lending and investment activities and
other general business purposes. These debt obligations expose the Company to variability in interest payments due to
changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest
expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and,
therefore, generally hedges a portion of its variable-rate interest payments.
Information pertaining to outstanding interest rate caps and swap agreements used to hedge junior subordinated debt and
FHLBB advances is as follows:
Notional
Amount
Inception
Date
Termination
Date
Index
Interest rate swaps:
$ 5,000
July 2013
July 2033
5,000
July 2013
July 2028
5,000
July 2013
July 2023
Interest rate caps:
6,000
10,000
October
2014
March
2015
September
2019
February
2020
$ 31,000
3 Mo.
LIBOR
3 Mo.
LIBOR
3 Mo.
LIBOR
3 Mo.
LIBOR
3 Mo.
LIBOR
June 30, 2016
Receive
Rate
(Dollars in thousands)
Pay
Rate
Strike
Rate
Unrealized
Gain
(Loss)
Fair
Value
Balance Sheet
Location
0.65%
3.38%
n/a $
(1,352) (1,352)
0.65%
3.23%
n/a
(1,005) (1,005)
0.65%
2.77%
n/a
(560)
(560)
Other
Liabilities
Other
Liabilities
Other
Liabilities
n/a
n/a
2.50%
(167)
10
Other Assets
n/a
n/a
2.50%
(192)
25
Other Assets
$
(3,276) $ (2,882)
86
Notional
Amount
Inception
Date
Termination
Date
Index
Interest rate swaps:
$ 5,000
July 2013
July 2033
5,000
July 2013
July 2028
5,000
July 2013
July 2023
Interest rate caps:
6,000
10,000
October
2014
March
2015
September
2019
February
2020
$ 31,000
3 Mo.
LIBOR
3 Mo.
LIBOR
3 Mo.
LIBOR
3 Mo.
LIBOR
3 Mo.
LIBOR
June 30, 2015
Pay
Rate
Receive
Rate
(Dollars in thousands)
Strike
Rate
Unrealized
Loss
Fair
Value
Balance Sheet
Location
0.28%
3.38%
n/a $
(472) $ (472)
0.28%
3.23%
n/a
(368) (368)
0.28%
2.77%
n/a
(208) (208)
Other
Liabilities
Other
Liabilities
Other
Liabilities
n/a
n/a
2.50%
(114)
63
Other Assets
n/a
n/a
2.50%
(80)
136
Other Assets
$ (1,242) $ (849)
During the years ended June 30, 2016 and 2015, no interest rate cap or swap agreements were terminated prior to maturity.
Changes in the fair value of interest rate caps and swaps designated as hedging instruments of the variability of cash flows
associated with variable rate debt are reported in other comprehensive income. These amounts subsequently are reclassified
into interest expense as a yield adjustment in the same period in which the related interest on the debt affects earnings. Risk
management results for the years ended June 30, 2016 and 2015 related to the balance sheet hedging of variable rate debt
indicates that the hedges were effective.
During the periods presented, amounts recognized in income related to hedge ineffectiveness resulted from amortization of
the non-zero fair value associated with the Company's single interest rate swap held at the time of the merger with FHB
Formation LLC in December 2010. During the periods presented, amounts recognized in income related to amounts excluded
from effectiveness testing resulted from amortization of the acquisition price of interest rate caps. The table below presents
amounts recognized in income related to both hedge ineffectiveness and amounts excluded from effectiveness testing.
Year Ended June 30,
2016
2015
(Dollars in thousands)
Interest income (expense):
Interest rate caps ............................................................................................... $
Interest rate swap ..............................................................................................
Total ................................................................................................................. $
3 $
-
3 $
(15)
64
49
The Company does not expect to record interest income or interest expense related to interest rate swap or interest rate cap
ineffectiveness in the next twelve months.
18. Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is,
not a forced liquidation or distressed sale) between market participants at the measurement date under current market
conditions. The Company uses prices and inputs that are current as of the measurement date, including during periods of
market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many
instruments. This condition could cause an instrument to be reclassified from one level to another. When market assumptions
are not readily available, the Company's own assumptions are set to reflect those that market participants would use in pricing
the asset or liability at the measurement date. If there has been a significant decrease in the volume and level of activity for
the asset or liability, regardless of the valuation technique(s) used, the objective of a fair value measurement remains the
same.
87
ASC 820 defines fair value and establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to
measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets
or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels
of the fair value hierarchy under ASC 820 are described below:
Level 1- Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity
has the ability to access at the measurement date.
Level 2- Valuations based on significant other observable inputs other than Level 1 prices such as quoted prices for
similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be
corroborated by observable market data.
Level 3- Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.
To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the
determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in
determining fair value is greatest for instruments categorized in Level 3. A financial instrument's level within the fair value
hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
Valuation techniques- There have been no changes in the valuation techniques used during the current period.
Transfers- There were no transfers of assets and liabilities measured at fair value on a recurring or nonrecurring basis
during the current period.
Assets and Liabilities Measured at Fair Value on a Recurring Basis:
Available-for-sale securities- Where quoted prices are available in an active market, securities are classified within
Level 1 of the valuation hierarchy. Examples of such instruments include publicly-traded common and preferred stocks.
If quoted prices are not available, then fair values are estimated by using pricing models (i.e., matrix pricing) and market
interest rates and credit assumptions or quoted prices of securities with similar characteristics and are classified within
Level 2 of the valuation hierarchy. Examples of such instruments include government agency and government sponsored
agency mortgage-backed securities, as well as certain preferred and trust preferred stocks. Level 3 securities are securities
for which significant unobservable inputs are utilized.
The other investment is measured at fair value using the net asset value per share as a practical expedient. The fund seeks
to invest in securities either issued or guaranteed by the U.S. government or its agencies. The Company’s investment
can be redeemed daily at the closing net asset value per share. In accordance with ASC 820-10, the investment has not
been included in the fair value hierarchy.
Derivative financial instruments- The valuation of the Company's interest rate swaps and caps are determined using
widely accepted valuation techniques including discounted cash flow analyses on the expected cash flows of derivatives.
These analyses reflect the contractual terms of the derivatives, including the period to maturity, and use observable
market-based inputs, including interest rate curves and implied volatilities. Unobservable inputs, such as credit valuation
adjustments are insignificant to the overall valuation of the Company's derivative financial instruments. Accordingly,
the Company has determined that its interest rate derivatives fall within Level 2 of the fair value hierarchy.
The fair value of derivative loan commitments and forward loan sale agreements are estimated using the anticipated
market price based on pricing indications provided from syndicate banks. These commitments and agreements are
categorized as Level 2. The fair value of such instruments was nominal at each date presented.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis:
Collateral dependent impaired loans- Valuations of impaired loans measured at fair value are determined by a review
of collateral values. Certain inputs used in appraisals are not always observable, and therefore impaired loans are
generally categorized as Level 3 within the fair value hierarchy.
Real estate owned and other repossessed collateral - The fair values of real estate owned and other repossessed collateral
are estimated based upon appraised values less estimated costs to sell. Certain inputs used in appraisals are not always
observable, and therefore may be categorized as Level 3 within the fair value hierarchy. When inputs used in appraisals
are primarily observable, they are classified as Level 2.
88
Loan servicing rights - The fair value of the SBA and mortgage servicing rights is based on a valuation model that
calculates the present value of estimated future net servicing income. Adjustments are only recorded when the discounted
cash flows derived from the valuation model are less than the carrying value of the asset. Certain inputs are not
observable, and therefore loan servicing rights are generally categorized as Level 3 within the fair value hierarchy.
Fair Value of other Financial Instruments:
Cash and cash equivalents- The fair value of cash, due from banks, interest bearing deposits and FHLBB overnight
deposits approximates their relative book values, as these financial instruments have short maturities.
FHLBB stock- The carrying value of FHLBB stock approximates fair value based on redemption provisions of the
FHLBB.
Loans- Fair values are estimated for portfolios of loans with similar financial characteristics. The fair value of performing
loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount
rates that reflect the credit and interest rate risk inherent in the loan. The estimates of maturity are based on the Company's
historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of
current economic conditions, lending conditions and the effects of estimated prepayments.
Loans held for sale- The fair value of loans held-for-sale is estimated based on bid quotations received from loan dealers.
Accrued interest receivable- The fair value of this financial instrument approximates the book value. It is the Company's
policy to stop accruing interest on loans past due by more than 90 days. Therefore, this financial instrument has been
adjusted for estimated credit loss.
Deposits- The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW
accounts and money market accounts, is equal to the amount payable on demand. The fair values of time deposits are
based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered
for deposits of similar remaining maturities. The fair value estimates do not include the benefit that results from the low-
cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. If that value were
considered, the fair value of the Company's net assets could increase.
Borrowings- The fair value of the Company's borrowings with the FHLBB is estimated by discounting the cash flows
through maturity or the next re-pricing date based on current rates available to the Company for borrowings with similar
maturities. The fair value of the Company's short-term borrowings, capital lease obligations, wholesale repurchase
agreements and other borrowings is estimated by discounting the cash flows through maturity based on current rates
available to the Company for borrowings with similar maturities.
Off-balance sheet credit-related instruments- Fair values for off-balance-sheet, credit-related financial instruments are
based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the
agreements and the counterparties' credit standing. The fair value of such instruments was nominal at each date presented.
89
Assets and liabilities measured at fair value on a recurring basis are summarized below.
Assets
Securities available-for-sale:
Total
June 30, 2016
Level 1
Level 2
(Dollars in thousands)
Level 3
U.S. Government agency securities .................................. $
Agency mortgage-backed securities .................................
Other investment measured at net asset value(1) ...............
Other assets – interest rate caps ............................................
Liabilities
Other liabilities – interest rate swaps ................................... $
52,046 $
43,368
5,158
35
- $
-
-
-
52,046 $
43,368
-
35
2,917 $
- $
2,917 $
Assets
Securities available-for-sale:
Total
June 30, 2015
Level 1
Level 2
(Dollars in thousands)
Level 3
U.S. Government agency securities .................................. $
Agency mortgage-backed securities .................................
Other investment measured at net asset value(1) ...............
Other assets – interest rate caps ............................................
Liabilities
Other liabilities – interest rate swap ..................................... $
48,230 $
53,678
-
199
- $
-
-
-
48,230 $
53,678
-
199
1,048 $
- $
1,048 $
-
-
-
-
-
-
-
-
-
-
(1)
In accordance with ASU 820-10, certain investments that are measured at fair value using the net asset value per
share (or its equivalent) as a practical expedient have not been classified in the fair value hierarchy. The fair value
amount presented in the table is intended to permit reconciliation of the fair value amount to the consolidated
financial statements.
Assets measured at fair value on a nonrecurring basis are summarized below.
Collateral dependent impaired loans ............................ $
Real estate owned and other repossessed collateral .....
Loan servicing rights ....................................................
922 $
1,652
1,771
(Dollars in thousands)
- $
-
-
- $
-
-
922
1,652
1,771
Total
Level 1
Level 2
Level 3
June 30, 2016
Total
Level 1
Level 2
Level 3
June 30, 2015
Collateral dependent impaired loans ............................ $
Real estate owned and other repossessed collateral .....
Loan servicing rights ....................................................
932 $
1,651
1,123
(Dollars in thousands)
- $
-
-
- $
-
-
932
1,651
1,123
The table below presents quantitative information about significant unobservable inputs (Level 3) for assets measured at fair
value on a nonrecurring basis at the dates indicated.
Fair Value
June 30,
June 30,
2016
2015
(Dollars in thousands)
Valuation Technique
Collateral dependent impaired loans ....................... $
Real estate owned and other repossessed collateral
Loan servicing rights ...............................................
922 $
1,652
1,771
932
1,651
1,123
Appraisal of collateral(1)
Appraisal of collateral(1)
Discounted cash flow(2)
90
(1) Fair value is generally determined through independent appraisals of the underlying collateral. The Company may also use
another available source of collateral assessment to determine a reasonable estimate of the fair value of the collateral.
Appraisals may be adjusted by management for qualitative factors such as economic factors and estimated liquidation
expenses. The range of these possible adjustments was 10% to 75%.
(2) Fair value is determined using a discounted cash flow model. The unobservable inputs include anticipated rate of loan
prepayments and discount rates. The range of prepayment assumptions used was 4.0% to 19.4%. For discount rates, the range
was 6.3% to 13.0%.
The following table presents the estimated fair value of the Company's financial instruments.
Carrying
Amount
Fair Value Measurements at June 30, 2016
Total
Level 1
(Dollars in thousands)
Level 2
Level 3
Financial assets:
Cash and cash equivalents .............................. $
Available-for-sale securities ...........................
Other investment measured at net asset
value(1) ........................................................
Federal Home Loan Bank stock .....................
Loans held for sale .........................................
Loans, net .......................................................
Accrued interest receivable ............................
Interest rate caps .............................................
Financial liabilities:
Deposits ..........................................................
Federal Home Loan Bank advances ...............
Short-term borrowings ...................................
Capital lease obligation ..................................
Subordinated debt ...........................................
Interest rate swaps ..........................................
151,157 $
95,414
151,157 $
95,414
151,157 $
-
- $
95,414
-
-
5,158
2,408
7,519
690,086
1,579
35
800,432
30,075
-
1,128
23,331
2,917
5,158
2,408
7,519
695,830
1,579
35
801,045
30,396
-
1,219
25,664
2,917
-
-
-
-
-
-
-
-
-
-
-
-
-
2,408
7,519
-
1,579
35
801,045
30,396
-
1,219
-
2,917
-
-
-
695,830
-
-
-
-
-
-
25,664
-
Carrying
Amount
Fair Value Measurements at June 30, 2015
Total
Level 1
(Dollars in thousands)
Level 2
Level 3
Financial assets:
Cash and cash equivalents .............................. $
Available-for-sale securities ...........................
Other investment measured at net asset
value(1) ........................................................
Federal Home Loan Bank stock .....................
Loans held for sale .........................................
Loans, net .......................................................
Accrued interest receivable ............................
Interest rate caps .............................................
Financial liabilities:
Deposits ..........................................................
Federal Home Loan Bank advances ...............
Wholesale repurchase agreements ..................
Short-term borrowings ...................................
Capital lease obligation ..................................
Subordinated debt ...........................................
Interest rate swaps ..........................................
89,850 $
101,908
89,850 $
101,908
89,850 $
-
- $
101,908
-
-
-
4,102
9,035
610,211
1,335
199
674,759
30,188
10,037
2,349
1,368
8,626
1,048
-
4,102
9,035
613,896
1,335
199
675,285
30,867
10,098
2,349
1,448
8,471
1,048
-
-
-
-
-
-
-
-
-
-
-
-
-
-
4,102
9,035
-
1,335
199
-
-
-
613,896
-
-
675,285
30,867
10,098
2,349
1,448
-
1,048
-
-
-
-
-
8,471
-
(1)
In accordance with ASU 820-10, certain investments that are measured at fair value using the net asset value per
share (or its equivalent) as a practical expedient have not been classified in the fair value hierarchy. The fair value
amount presented in the table is intended to permit reconciliation of the fair value amount to the consolidated
financial statements.
91
19. Condensed Parent Information
Condensed financial information for Northeast Bancorp follows:
Balance Sheets
Assets:
Cash ......................................................................................................................... $
Investment in subsidiary ..........................................................................................
Investment in common securities of affiliated trusts ...............................................
Other assets .............................................................................................................
Total assets .......................................................................................................... $
Liabilities and Shareholders’ Equity:
Subordinated debt .................................................................................................... $
Other liabilities ........................................................................................................
Total liabilities .....................................................................................................
Shareholders’ equity ............................................................................................
Total liabilities and shareholders’ equity ............................................................. $
Statements of Income
Income:
Other income ........................................................................................................... $
Total income ........................................................................................................
Expenses:
Interest expense .......................................................................................................
General and administrative expenses ......................................................................
Total expenses .....................................................................................................
Loss before income tax benefit and equity in undistributed net income of
subsidiary ......................................................................................................
Income tax benefit ...................................................................................................
Loss before equity in undistributed net income of subsidiary ..........................
Equity in undistributed net income of subsidiary ....................................................
Net income ....................................................................................................... $
June 30, 2016
June 30, 2015
(Dollars in thousands)
24,528 $
117,228
496
226
142,478 $
23,331 $
2,556
25,887
116,591
142,478 $
13,251
109,275
496
434
123,456
8,626
1,991
10,617
112,839
123,456
Year Ended June 30,
2016
2015
(Dollars in thousands)
62 $
62
651
954
1,605
(1,543 )
(579 )
(964 )
8,583
7,619 $
14
14
718
1,128
1,846
(1,832)
(684)
(1,148)
8,289
7,141
92
Statements of Cash Flows
Operating activities:
Net income .............................................................................................................. $
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of fair value adjustment for borrowings ............................................
Stock-based compensation .......................................................................................
Undistributed earnings of subsidiary .......................................................................
Increase in other assets and liabilities ......................................................................
Net cash provided by operating activities ...............................................................
Investing activities:
Increase in investment of bank subsidiary ...............................................................
Net cash used in investing activities ........................................................................
Financing activities:
Issuance of subordinated debt, net of debt issuance costs .......................................
Taxes paid through cancellation of common stock ..................................................
Repurchase of common stock ..................................................................................
Dividends paid to shareholders ...............................................................................
Net cash provided by (used in) financing activities ................................................
Net increase (decrease) in cash ...............................................................................
Cash, beginning of year ...........................................................................................
Cash, end of year ...................................................................................................... $
Year Ended June 30,
2016
2015
(Dollars in thousands)
7,619 $
193
613
(8,583)
673
515
-
-
14,512
(11)
(3,359)
(380)
10,762
11,277
13,251
24,528 $
7,141
186
705
(8,289)
1,029
772
-
-
-
-
(6,666)
(402)
(7,068)
(6,296)
19,547
13,251
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company carried out an evaluation, under the supervision and with the participation of the Company’s management,
including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls
and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Company’s Chief
Executive Officer and Chief Financial Officer concluded that as of June 30, 2016, the Company’s disclosure controls and
procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that
information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules
and forms. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the
Securities Exchange Act of 1934) occurred during the fourth quarter of our fiscal year ended June 30, 2016 that has materially
affected, or is reasonably likely to materially affect, our internal control over financial reporting.
An evaluation was performed under the supervision and with the participation of the Company’s management, including its
Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our internal controls
and procedures over financial reporting (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered
by this annual report.
Management Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal controls over financial reporting. The standard
measures adopted by management in making its evaluation are the measures in Interest Control—Integrated Framework
(2013) published by the Committee of Sponsoring Organizations of the Treadway Commission. We do not expect that our
disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that the control system’s objective will be met. Further, the
93
design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues, errors, and instances of fraud, if any, within the Company have been or
will be detected. The inherent limitations include, among other things, the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake. Controls and procedures also can be circumvented
by the individual acts of some persons, by collusion of two or more people, or by management or employee override of the
controls and procedures. The design of any system of controls and procedures is based in part upon certain assumptions about
the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under
all potential future conditions. Over time, controls and procedures may become inadequate because of changes in conditions
or deterioration in the degree of compliance with its policies or procedures. Because of the inherent limitation in a cost-
effective control system, misstatements due to error or fraud may occur and not be detected.
Based on their evaluation of disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer
concluded, subject to the limitations described above, that our internal controls and procedures over financial reporting as of
the end of the period covered by this report were effective and that there were no material weaknesses.
94
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Northeast Bancorp
We have audited Northeast Bancorp’s and subsidiary (the Company) internal control over financial reporting as of June 30,
2016, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission in 2013. The Company’s management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting
included in the accompanying “Management Report on Internal Control over Financial Reporting”. Our responsibility is to
express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material respects. Our audit included obtaining an
understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included
performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the
company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of
June 30, 2016, based on criteria established in Internal Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission in 2013.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States),
the consolidated balance sheet of Northeast Bancorp and subsidiary as of June 30, 2016, and the related consolidated
statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the year then ended, and
our report dated September 13, 2016 expressed an unqualified opinion.
/s/ RSM US LLP
Boston, Massachusetts
September 13, 2016
95
Changes in Internal Control over Financial Reporting
There have been no significant changes in our internal controls, or in other factors that could significantly affect our internal
controls, subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation, including
any corrective actions with regard to significant deficiencies or material weaknesses.
Item 9B.
Other Information.
None.
Item 10.
Directors, Executive Officers, and Corporate Governance.
PART III
The information required by Item 10 is included in the Proxy Statement relating to our 2016 Annual Meeting of Shareholders
and is incorporated herein by reference.
Item 11.
Executive Compensation
The information required by Item 11 is included in the Proxy Statement relating to our 2016 Annual Meeting of Shareholders
and is incorporated herein by reference.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Shareholders
The information required by Item 12 is included in the Proxy Statement relating to our 2016 Annual Meeting of Shareholders
and is incorporated herein by reference.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is included in the Proxy Statement relating to our 2016 Annual Meeting of Shareholders
and is incorporated herein by reference.
Item 14.
Principal Accounting Fees and Services
The information required by Item 14 is included in the Proxy Statement relating to our 2016 Annual Meeting of Shareholders
and is incorporated herein by reference.
96
PART IV
Item 15.
Exhibits, Financial Statement Schedules
(a) Financial Statements and Financial Statement Schedules
Consolidated Balance Sheets as of June 30, 2016 and 2015
Consolidated Statements of Income for the years ended June 30, 2016 and 2015
Consolidated Statements of Comprehensive Income for the years ended June 30, 2016 and 2015
Consolidated Statements of Changes in Shareholders’ Equity for the years ended June 30, 2016 and 2015
Consolidated Statements of Cash Flows for the years ended June 30, 2016 and 2015
Notes to Consolidated Financial Statements
(b) Exhibits
2.1 Agreement and Plan of Merger, dated as of March 30, 2010, by and between Northeast Bancorp and FHB
Formation LLC (incorporated by reference to Exhibit 2.1 of Northeast Bancorp’s Form 8-K filed with Securities
and Exchange Commission on March 31, 2010).
3.1 Amended and Restated Articles of Incorporation of Northeast Bancorp (incorporated by reference to Exhibit 3.1
of Northeast Bancorp’s Current Report on Form 8-K filed on January 5, 2011).
3.2 Articles of Amendment to the Amended and Restated Articles of Incorporation of Northeast Bancorp (incorporated
by reference to Exhibit 3.1 of Northeast Bancorp’s Current Report on Form 8-K filed on March 22, 2011).
3.3 Articles of Amendment to the Amended and Restated Articles of Incorporation of Northeast Bancorp (incorporated
by reference to Exhibit 3.1 of Northeast Bancorp’s Current Report on Form 8-K filed on November 29, 2012).
3.4 Amended and Restated Bylaws of Northeast Bancorp (incorporated by reference to Exhibit 3.2 of Northeast
Bancorp’s Current Report on Form 8-K filed on January 5, 2011).
4.1 Registration Rights Schedule to the Agreement and Plan of Merger, dated as of March 30, 2010, by and between
Northeast Bancorp and FHB Formation LLC (incorporated by reference to Amendment No. 1 on Form 10-K/A of
Northeast Bancorp filed on March 19, 2012).
10.1+ Form of Indemnification Agreement, dated as of December 29, 2010, by and between Northeast Bancorp and each
of the members of the Board (incorporated by reference to Exhibit 10.1 of Northeast Bancorp’s Current Report on
Form 8-K filed on January 5, 2011).
10.2+ Employment Agreement, dated December 30, 2010, by and between Northeast Bancorp and Richard Wayne
(incorporated by reference to Exhibit 10.2 of Northeast Bancorp’s Current Report on Form 8-K filed on
January 5, 2011).
10.3+ Employment Agreement, dated December 30, 2010, by and between Northeast Bancorp and Claire Bean
(incorporated by reference to Exhibit 10.3 of Northeast Bancorp’s Current Report on Form 8-K filed on
January 5, 2011).
10.4+ Employment Agreement, dated December 30, 2010, by and between Northeast Bancorp and Heather Campion
(incorporated by reference to Exhibit 10.4 of Northeast Bancorp’s Current Report on Form 8-K filed on January 5,
2011).
10.5+ Separation Agreement & General Release, dated August 15, 2013, by and between Northeast Bancorp and Heather
Campion (incorporated by reference to Exhibit 10.1 of Northeast Bancorp’s Current Report on Form 8-K filed on
August 15, 2013).
10.6+ Non-Qualified Time-Based Stock Option Agreement, dated December 29, 2010, by and between Northeast
Bancorp and Richard Wayne (incorporated by reference to Exhibit 10.5 of Northeast Bancorp’s Current Report on
Form 8-K filed on January 5, 2011).
10.7+ Non-Qualified Performance-Based Stock Option Agreement, dated March 22, 2013, by and between Northeast
Bancorp and Richard Wayne (incorporated by reference to Exhibit 10.1 of Northeast Bancorp’s Current Report
on Form 8-K filed on March 26, 2013).
10.8+ Non-Qualified Time-Based Stock Option Agreement, dated December 29, 2010, by and between Northeast
Bancorp and Claire Bean (incorporated by reference to Exhibit 10.7 of Northeast Bancorp’s Current Report on
Form 8-K filed on January 5, 2011).
97
10.9+ Non-Qualified Performance-Based Stock Option Agreement, dated March 22, 2013, by and between Northeast
Bancorp and Claire Bean (incorporated by reference to Exhibit 10.2 of Northeast Bancorp’s Current Report on
Form 8-K filed on March 26, 2013).
10.10+ Non-Qualified Time-Based Stock Option Agreement, dated December 29, 2010, by and between Northeast
Bancorp and Heather Campion (incorporated by reference to Exhibit 10.8 of Northeast Bancorp’s Current Report
on Form 8-K filed on January 5, 2011).
10.11+ Non-Qualified Performance-Based Stock Option Agreement, dated March 22, 2013, by and between Northeast
Bancorp and Heather Campion (incorporated by reference to Exhibit 10.3 of Northeast Bancorp’s Current Report
on Form 8-K filed on March 26, 2013).
10.12+ Non-Qualified Stock Option Agreement, dated December 30, 2010, by and between Northeast Bancorp and Robert
Glauber (incorporated by reference to Exhibit 10.11 of Northeast Bancorp’s Current Report on Form 8-K filed on
January 5, 2011).
10.13+ Amended and Restated Performance-Based Stock Appreciation Rights Agreement, dated March 24, 2011, by and
between Northeast Bancorp and Matthew Botein (incorporated by reference to Exhibit 10.1 of Northeast
Bancorp’s Current Report on Form 8-K filed on March 30, 2011).
10.14+ Non-Qualified Time-Based Stock Option Agreement, dated March 24, 2011, by and between Northeast Bancorp
and Matthew Botein (incorporated by reference to Exhibit 10.2 of Northeast Bancorp’s Current Report on Form
8-K filed on March 30, 2011).
10.15+ Non-Qualified Performance-Based Stock Option Agreement, dated March 24, 2011, by and between Northeast
Bancorp and Matthew Botein (incorporated by reference to Exhibit 10.3 of Northeast Bancorp’s Current Report
on Form 8-K filed on March 30, 2011).
10.16 Subordinated Note Purchase Agreement, dated June 29, 2016, by and among Northeast Bancorp and the
Purchasers identified therein (incorporated by reference to Exhibit 10.1 of Northeast Bancorp’s Current Report on
Form 8-K filed on June 29, 2016).
10.17 Form of 6.75% Fixed-to-Floating Subordinated Note due 2026 (incorporated by reference to Exhibit 4.1 of
Northeast Bancorp’s Current Report on Form 8-K filed on June 29, 2016).
21* Subsidiaries of Northeast Bancorp
23.1* Consent of RSM US LLP
23.2* Consent of Ernst & Young LLP
31.1* Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002.
31.2* Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002.
32.1** Rule 13a-14(b) Certifications of the Chief Executive Officer and Chief Financial Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
101.INS XBRL Instance Document*
101.SCH XBRL Taxonomy Extension Schema Document*
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB XBRL Taxonomy Extension Label Linkbase Document*
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document*
* Filed herewith.
** Furnished herewith
+ Management contract or compensatory plan or agreement
98
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NORTHEAST BANCORP
Date: September 13, 2016
By:
/s/ RICHARD WAYNE
Richard Wayne
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ RICHARD WAYNE
Richard Wayne
Chief Executive Officer and Director
(Principal Executive Officer)
September 13, 2016
/s/ BRIAN SHAUGHNESSY
Brian Shaughnessy
Chief Financial Officer (Principal Financial September 13, 2016
Officer and Principal Accounting Officer)
/s/ ROBERT GLAUBER
Robert Glauber
/s/ MATTHEW BOTEIN
Matthew Botein
/s/ CHERYL DORSEY
Cheryl Dorsey
/s/ PETER MCCLEAN
Peter McClean
/s/ JOHN C. ORESTIS
John C. Orestis
/s/ DAVID TANNER
David Tanner
/s/ JUDITH E. WALLINGFORD
Judith E. Wallingford
Chairman of the Board
September 13, 2016
September 13, 2016
September 13, 2016
September 13, 2016
September 13, 2016
September 13, 2016
September 13, 2016
Director
Director
Director
Director
Director
Director
99
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Board of Directors
for Northeast Bancorp
and Northeast Bank
Robert R. Glauber, Chairman
Lecturer
Harvard Kennedy School of
Government
Matthew B. Botein
Global Chief Investment
Officer and Co-Head
BlackRock Alternative Investors
BlackRock
Cheryl Lynn Dorsey
President
Echoing Green
John C. Orestis
President and
Chief Executive Officer
North Country Associates
David A. Tanner
Managing Director
Arlon Group LLC
Judith E. Wallingford
President
The Maine Water Company
Richard Wayne
President and
Chief Executive Officer
Northeast Bancorp
Senior Management
Richard Wayne
President and
Chief Executive Officer
Patrick Dignan
Executive Vice President
Brian Fenwick
SVP, Director of Loan Underwriting
Christopher Hickey
Director of Asset Management
and Managing Director
Jeanne A. Hulit
President, Community Banking
Division
Heidi Jacques
SVP, Director of Human Resources
Julie Jenkins
SVP, Director of Operations
James Krumsiek, Esq.
Managing Director and
Legal Counsel
Theresa Morrison
SVP, Director of Real Estate
Valuation
Brian Pinheiro
Chief Risk Officer
Brian Shaughnessy
Chief Financial Officer and
Treasurer
Jonathan Smith
SVP, Director of SBA Lending
Jeff Wright
SVP, Retail Sales &
Operations Manager,
Community Banking Division
Shareholder Information
Corporate Offices
Branch Offices
Annual Meeting
10:00 am EST, Tuesday, November 22, 2016 at
the offices of Goodwin Procter LLP, 100 Northern
Avenue, Boston, MA 02210.
Transfer Agent
Computershare, Inc.
250 Royall Street
Canton, MA 02021
800.942.5909
Annual Report on Form 10-K and
Other Financial Information
A copy of Northeast Bancorp’s Annual Report on
Form 10-K filed with the Securities and Exchange
Commission may be obtained from the Company
by sending a written request to:
Shareholder Relations
Northeast Bancorp
500 Canal Street
Lewiston, ME 04240
The common stock of Northeast Bancorp trades
on NASDAQ under the symbol NBN.
Forward-Looking Statements
Certain statements in this report that are not historical
facts may be considered forward-looking statements.
For more information regarding factors that could
cause actual results to differ materially from those
projected in the forward-looking statements, see
“A Note About Forward-Looking Statements” in the
Company’s 2016 Annual Report on Form 10-K.
Northeast Bancorp and its subsidiaries are
an Equal Opportunity Employer.
Northeast Bancorp
500 Canal Street
Lewiston, ME 04240
207.786.3245
Northeast Bancorp
200 Berkeley Street
Boston, MA 02116
617.585.3200
Northeast Bancorp
27 Pearl Street
Portland, ME 04101
207.774.1426
Connecting All Locations
800.284.5989
www.northeastbank.com
Loan Production
Offices
Maine
BANGOR
21 Main Street , Suite 203
Bangor, ME 04401
207.217.6750
New Hampshire
HAMPTON
881 Lafayette Road, Unit D
Hampton, NH 03842
603.570.4879
AUBURN
232 Center Street*
Auburn, ME 04210
207.783.5632
AUGUSTA
235 Western Avenue*
Augusta, ME 04330
207.623.0603
BETHEL
11 Main Street**
Bethel, ME 04217
207.824.2117
BRUNSWICK
186 Maine Street*
Brunswick, ME 04011
207.729.8711
BUCKFIELD
2 Depot Street**
Buckfield, ME 04220
207.336.2371
HARRISON
46 Main Street
Harrison, ME 04040
207.583.2954
LEWISTON
500 Canal Street**
Lewiston, ME 04240
207.786.3245
POLAND
1399 Maine Street*
Poland, ME 04274
207.998.3475
PORTLAND
27 Pearl Street**
Portland, ME 04101
207.774.1426
SOUTH PARIS
235 Main Street*
South Paris, ME 04281
207.743.8168
* Drive-up ATM
** Walk-up ATM