Northeast Bancorp
NORTHEAST BANCORP /ME/ (Form: 10-Q, Received: 05/16/2011 09:37:01)
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

Quarterly Report pursuant to Section 13 or 15 (d) of

the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2011

Commission File Number: 1-14588

 

 

Northeast Bancorp

(Exact name of registrant as specified in its charter)

 

 

 

Maine   01-0425066

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

500 Canal Street, Lewiston, Maine   04240
(Address of Principal executive offices)   (Zip Code)

(207) 786-3245

Registrant’s telephone number, including area code

 

 

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 subjected to such filing requirements for the past 90 days.    Yes   x      No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, 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   ¨     No   ¨

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 definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller Reporting Company   x

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

As of May 11, 2011, the registrant had outstanding 3,311,173 shares of voting common stock, $1.00 par value per share, and 195,351 shares of non-voting common stock, $1.00 par value per share.

 

 

 


Table of Contents

Part I. Financial Information

     3   

        Item 1.

  

Financial Statements (Unaudited)

     3   
  

Consolidated Balance Sheets

March 31, 2011 (Unaudited) and June 30, 2010

     3   
  

Consolidated Statements of Income (Unaudited)

Three Months Ended March 31, 2011

93 Days Ended March 31, 2011

181 Days Ended December 28, 2010

Three Months Ended March 31, 2010

Nine Months Ended March 31, 2010

     5   
  

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

93 Days Ended March 31, 2011

181 Days Ended December 28, 2010

Nine Months Ended March 31, 2010

     7   
  

Consolidated Statements of Cash Flows (Unaudited)

93 Days Ended March 31, 2011

181 Days Ended December 28, 2010

Nine Months Ended March 31, 2010

     9   
  

Notes to Unaudited Consolidated Financial Statements (Unaudited)

     11   

        Item 2.

  

Management's Discussion and Analysis of Financial Condition and Results of Operations

     32   

        Item 3.

  

Quantitative and Qualitative Disclosure about Market Risk

     51   

        Item 4.

  

Controls and Procedures

     51   

Part II. Other Information

     51   

        Item 1.

  

Legal Proceedings

     51   

        Item 1A.

  

Risk Factors

     51   

        Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     52   

        Item 3.

  

Defaults Upon Senior Securities

     52   

        Item 4.

  

[Removed and Reserved]

     52   

        Item 5.

  

Other Information

     52   

        Item 6.

  

Exhibits

     52   

 

2


Table of Contents

PART 1- FINANCIAL INFORMATION

 

Item 1. Financial Statements (Unaudited)

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 

     Successor
Company (1)
           Predecessor
Company (2)
 
     March 31, 2011
(Unaudited)
           June 30, 2010
(Audited)
 
Assets          

Cash and due from banks

   $ 3,283           $ 7,019   

Short-term investments

     106,472             13,416   
                     

Total cash and cash equivalents

     109,755             20,435   

Available-for-sale securities, at fair value

     127,227             164,188   

Loans held-for-sale

     8,378             14,254   
 

Loans receivable

         

Residential real estate

     143,172             155,613   

Commercial real estate

     117,562             121,175   

Construction

     2,941             5,525   

Commercial business

     25,490             30,214   

Consumer

     23,891             69,782   
                     

Total loans, gross

     313,056             382,309   

Less allowance for loan losses

     14             5,806   
                     

Loans, net

     313,042             376,503   

Premises and equipment, net

     8,079             7,997   

Acquired assets, net

     753             1,292   

Accrued interest receivable

     1,375             2,081   

Federal Home Loan Bank stock, at cost

     4,889             4,889   

Federal Reserve Bank stock, at cost

     597             597   

Intangible assets

     13,344             11,371   

Bank owned life insurance

     13,667             13,286   

Other assets

     6,268             5,714   
                     

Total assets

   $ 607,374           $ 622,607   
                     

 

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Table of Contents

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Continued)

 

     Successor
Company (1)
           Predecessor
Company (2)
 
     March 31, 2011
(Unaudited)
           June 30, 2010
(Audited)
 
Liabilities and Stockholders’ Equity          

Liabilities:

         

Deposits

         

Demand

   $ 45,254           $ 35,266   

Savings and interest checking

     90,379             89,024   

Money market

     52,226             55,556   

Brokered time deposits

     4,934             4,883   

Certificates of deposit

     208,571             199,468   
                     

Total deposits

     401,364             384,197   

Federal Home Loan Bank advances

     43,974             50,500   

Structured repurchase agreements

     68,434             65,000   

Short-term borrowings

     13,226             46,168   

Junior subordinated debentures issued to affiliated trusts

     7,922             16,496   

Capital lease obligation

     2,114             2,231   

Other borrowings

     2,134             2,630   

Other liabilities

     3,317             4,479   
                     

Total liabilities

     542,485             571,701   
                     

Commitments and contingent liabilities

         

Stockholders’ equity

         

Preferred stock, $1.00 par value, 1,000,000 shares authorized; 4,227 shares issued and outstanding at March 31, 2011 and June 30, 2010, liquidation preference of $1,000 per share

     4             4   

Voting common stock, at stated value, 13,500,000 and 15,000,000 shares authorized at March 31, 2011 and June 30, 2010, respectively; 3,310,173 and 2,323,832 shares issued and outstanding at March 31, 2011 and June 30, 2010, respectively

     3,310             2,324   

Non-voting common stock, at stated value, 1,500,000 and 0 shares authorized at March 31, 2011 and June 30, 2010, respectively; 195,351 and 0 shares issued and outstanding at March 31, 2011 and June 30, 2010, respectively

     195             —     

Warrants

     406             133   

Additional paid-in capital

     49,535             6,761   

Unearned restricted stock award

     (172          —     

Retained earnings

     11,579             37,338   

Accumulated other comprehensive income

     32             4,346   
                     

Total stockholders’ equity

     64,889             50,906   
                     

Total liabilities and stockholders’ equity

   $ 607,374           $ 622,607   
                     

See accompanying notes to unaudited consolidated financial statements

 

(1) “Successor Company” means Northeast Bancorp and its subsidiary after the closing of the merger with FHB Formation LLC on December 29, 2010.
(2) “Predecessor Company” means Northeast Bancorp and its subsidiary before the closing of the merger with FHB Formation LLC on December 29, 2010.

 

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Table of Contents

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(Dollars in thousands, except share and per share data)

 

     Successor Company (1)            Predecessor Company (2)  
     Three
Months
Ended
March 31,
2011
     93 Days
Ended
March 31,
2011
           181 Days
Ended
Dec. 28,
2010
     Three
Months
Ended
March 31,
2010
     Nine
Months
Ended
March 31,
2010
 

Interest and dividend income:

                  

Interest on loans

   $ 5,649       $ 5,845           $ 11,210       $ 5,960       $ 18,034   

Taxable interest on available-for-sale securities

     832         872             2,854         1,733         5,171   

Tax-exempt interest on available-for-sale securities

     71         75             231         121         356   

Dividends on available-for-sale securities

     7         7             26         19         46   

Dividends on Federal Home Loan Bank and Federal Reserve Bank stock

     12         13             18         9         27   

Other interest and dividend income

     33         34             39         2         10   
                                                

Total interest and dividend income

     6,604         6,846             14,378         7,844         23,644   
                                                

Interest expense:

                  

Deposits

     774         816             2,796         1,682         5,507   

Federal Home Loan Bank advances

     284         299             918         457         1,336   

Structured repurchase agreements

     249         272             1,392         692         2,172   

Short-term borrowings

     60         67             376         165         486   

Junior subordinated debentures issued to affiliated trusts

     174         180             340         182         587   

Obligation under capital lease agreements

     26         28             55         28         88   

Other borrowings

     35         35             75         43         156   
                                                

Total interest expense

     1,602         1,697             5,952         3,249         10,332   
                                                

Net interest and dividend income before provision for loan losses

     5,002         5,149             8,426         4,595         13,312   

Provision for loan losses

     49         49             912         628         1,504   
                                                

Net interest and dividend income after provision for loan losses

     4,953         5,100             7,514         3,967         11,808   
                                                

 

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Table of Contents

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited) (Continued)

(Dollars in thousands, except share and per share data)

 

     Successor Company (1)            Predecessor Company (2)  
     Three
Months
Ended
March 31,
2011
    93 Days
Ended
March 31,
2011
           181 Days
Ended

Dec. 28,
2010
     Three
Months
Ended
March 31,
2010
    Nine
Months
Ended
March  31,
2010
 

Noninterest income:

                

Fees for other services to customers

     310       323             698         350        1,116   

Net securities gains (losses)

     47       47             17         (63     (20

Gain on sales of loans

     295       344             1,867         141        708   

Investment commissions

     709       734             1,174         467        1,455   

Insurance commissions

     1,458       1,495             2,661         1,741        4,705   

BOLI income

     126       131             250         125        376   

Bargain purchase gain

     296       15,216             —           —          —     

Other income

     148       156             330         292        510   
                                              

Total noninterest income

     3,389       18,446             6,997         3,053        8,850   
                                              

Noninterest expense:

                

Salaries and employee benefits

     4,824       4,991             6,670         3,469        10,392   

Occupancy and equipment expense

     903       930             1,556         907        2,566   

Professional fees

     378       387             527         211        797   

Data processing fees

     326       337             618         300        927   

Intangible assets amortization

     439       444             344         177        549   

Merger expense

     132       3,182             94         157        157   

Other

     1,337       1,455             2,138         1,051        3,052   
                                              

Total noninterest expense

     8,339       11,726             11,947         6,272        18,440   
                                              

Income before income tax (benefit) expense

     3       11,820             2,564         748        2,218   

Income tax (benefit) expense

     (153     (171          768         217        542   
                                              

Net income

   $ 156     $ 11,991           $ 1,796       $ 531      $ 1,676   
                                              

Net income available to common stockholders

   $ 58     $ 11,891           $ 1,677       $ 470      $ 1,493   
                                              

Weighted-average shares outstanding

                

Basic

     3,492,498        3,492,498             2,330,197         2,322,332        2,321,726   

Diluted

     3,559,873        3,560,278             2,354,385         2,342,153        2,331,227   

Earnings per common share:

                

Basic

   $ 0.02      $ 3.39           $ 0.72       $ 0.20      $ 0.64   

Diluted

   $ 0.02      $ 3.33           $ 0.71       $ 0.20      $ 0.64   

See accompanying notes to unaudited consolidated financial statements

 

(1) “Successor Company” means Northeast Bancorp and its subsidiary after the closing of the merger with FHB Formation on LLC on December 29, 2010.
(2) “Predecessor Company” means Northeast Bancorp and its subsidiary before the closing of the merger with FHB Formation LLC on December 29, 2010.

 

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Table of Contents

NORTHEAST BANCORP AND SUBSIDIARY

Consolidated Statements of Changes in Stockholders’ Equity

Periods Ended March 31, 2011, December 28, 2010 and March 31, 2010

(Unaudited)

(Dollars in thousands)

 

     Preferred Stock      Common Stock             Additional      Unearned            Accumulated
Other
       
     Shares      Amount      Shares      Amount      Warrants      Paid-in
Capital
     Restricted
Stock
     Retained
Earnings
    Comprehensive
Income
    Total  

Predecessor Company (2)

                           

Balance at June 30, 2009

     4,227       $ 4         2,321,332       $ 2,321       $ 133       $ 6,709       $ —         $ 36,698      $ 1,451      $ 47,316   

Net income for nine months ended March 31, 2010

     —           —           —           —           —           —           —           1,676        —          1,676   

Other comprehensive income net of tax:

                           

Net unrealized loss on purchased interest rate caps and swap

     —           —           —           —           —           —           —           —          (125     (125

Net unrealized gain on investments available for sale, net of reclassification adjustment

     —           —           —           —           —           —           —           —          2,006        2,006   
                                 

Total comprehensive income

     —           —           —           —           —           —           —           —          —          3,557   

Dividends on preferred stock

     —           —           —           —           —           —           —           (159     —          (159

Dividends on common stock at $0.27 per share

     —           —           —           —           —           —           —           (626     —          (626

Stock options exercised

     —           —           1,000         1         —           7         —           —          —          8   

Accretion of preferred stock

     —           —           —           —           —           20         —           (20     —          —     

Amortization of issuance cost of preferred stock

     —           —           —           —           —           4         —           (4     —          —     
                                                                                       

Balance at March 31, 2010

     4,227       $ 4         2,322,332       $ 2,322       $ 133       $ 6,740       $ —         $ 37,565      $ 3,332      $ 50,096   
                                                                                       

Predecessor Company (2)

                           

Balance at June 30, 2010

     4,227       $ 4         2,323,832       $ 2,324       $ 133       $ 6,761       $ —         $ 37,338      $ 4,346      $ 50,906   

Net income for 181 days ended December 28, 2010

     —           —           —           —           —           —           —           1,796        —          1,796   

Other comprehensive income net of tax:

                           

Net unrealized loss on purchased interest rate caps and swap

     —           —           —           —           —           —           —           —          (27     (27

Net unrealized gain on investments available for sale, net of reclassification adjustment

     —           —           —           —           —           —           —           —          (1,863     (1863
                                 

Total comprehensive loss

     —           —           —           —           —           —           —           —          —          (94

Dividends on preferred stock

     —           —           —           —           —           —           —           (106     —          (106

Dividends on common stock $0.18 per share

     —           —           —           —           —           —           —           (419     —          (419

Stock options exercised

     —           —           7,500         8         —           54         —           —          —          62   

Accretion of preferred stock

     —           —           —           —           —           13         —           (13     —          —     

Amortization of issuance cost of preferred stock

     —           —           —           —           —           3         —           (3     —          —     
                                                                                       

Balance at December 28, 2010

     4,227       $ 4         2,331,332       $ 2,332       $ 133       $ 6,831       $ —         $ 38,593      $ 2,456      $ 50,349   
                                                                                       

 

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Table of Contents

NORTHEAST BANCORP AND SUBSIDIARY

Consolidated Statements of Changes in Stockholders’ Equity

Periods Ended March 31, 2011, December 28, 2010 and March 31, 2010

(Dollars in thousands)

(Continued)

 

     Preferred Stock      Common Stock             Additional     Unearned           Other        
     Shares      Amount      Shares      Amount      Warrants      Paid-in
Capital
    Restricted
Stock
    Retained
Earnings
    Comprehensive
Income
    Total  

Successor Company (1)

                         

Balance at December 29, 2010

     4,227       $ 4         2,331,332       $ 2,332       $ 313       $ 34,128      $ —        $ —        $ —        $ 36,777   

Net income for 93 days ended March 31, 2011

     —           —           —           —           —           —          —          11,991        —          11,991   

Other comprehensive income net of tax:

                         

Net unrealized loss on purchased interest rate caps and swap

     —           —           —           —           —           —          —          —          66        66   

Net unrealized gain on investments available for sale, net of reclassification adjustment

     —           —           —           —           —           —          —          —          (34     (34
                               

Total comprehensive income

     —           —           —           —           —           —          —          —          —          12,023   

Acquisition accounting adjustment

                         

Purchase accounting adjustment

     —           —           —           —           93         (443     —          —          —          (350

Restricted stock award

     —           —           13,026         13         —           168        (181     —          —          —     

Voting common stock issued

     —           —           965,815         965         —           12,489        —          —          —          13,454   

Non-voting common stock issued

     —           —           195,351         195         —           2,526        —          —          —          2,721   

Dividends on preferred stock

     —           —           —           —           —           —          —          (53     —          (53

Dividends on common stock at $0.09 per share

     —           —           —           —           —           —          —          (314     —          (314

Amortization of preferred stock

     —           —           —           —           —           45        —          (45     —          —     

Stock award earned

     —           —           —           —           —           —          9        —          —          9   

SAR Option activity

     —           —           —           —           —           526        —          —          —          526   

Options expense

     —           —           —           —           —           96        —          —          —          96   
                                                                                     

Balance at March 31, 2011

     4,227       $ 4         3,505,524       $ 3,505       $ 406       $ 49,535      $ (172   $ 11,579      $ 32      $ 64,889   
                                                                                     

 

(1) “Successor Company” means Northeast Bancorp and its subsidiary after the closing of the merger with FHB Formation on LLC on December 29, 2010.
(2) “Predecessor Company” means Northeast Bancorp and its subsidiary before the closing of the merger with FHB Formation LLC on December 29, 2010.

 

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NORTHEAST BANCORP AND SUBSIDIARY

Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

 

     Successor Company (1)            Predecessor Company (2)  
     93 days ended
March 31, 2011
           181 days ended
Dec. 28, 2010
    Nine months ended
March 31, 2010
 

Cash flows from operating activities:

           

Net income

   $ 11,991          $ 1,796     $ 1,676  

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

           

Provision for loan losses

     49            912       1,723  

Provision for REO

     56             113    

Provision made for deferred compensation

     57            105       146  

Write-down of available-for-sale securities

     —               —          103  

Write-down of non-marketable securities

     —               —          99  

Amortization of intangible assets

     444            344       549  

BOLI income, net

     (131          (250     (376

Depreciation of premises and equipment

     281            520       813  

Net securities gains

     (47          (17     20  

Net (gain) loss on sale of acquired assets

     (1          (16     219  

Net (gain) disposal, write-down and sale of fixed assets

     (4          —          117  

Net (gain) loss on sale of insurance business

     —               (104     (235

Net change in loans held-for-sale

     (525          6,401       (138

Net amortization (accretion) of securities

     301            90       (23

Bargain purchase gain

     (15,216          —          —     

Change in other assets and liabilities:

           

Interest receivable

     585            121       53  

Prepayment FDIC assessment

     —               —          (2,498

Decrease in prepayment FDIC assessment

     159            120       158  

Other assets and liabilities

     (702          (831     894  
                             

Net cash (used in) provided by operating activities

     (2,703          9,304       3,300  
                             

Cash flows from investing activities:

           

Proceeds from the sales of available-for-sale securities

     64,588            173       1,312  

Purchases of available-for-sale securities

     (51,029          (19,001     (59,188

Proceeds from maturities and principal payments on available-for-sale securities

     10,706            26,805       38,462  

Loan originations and principal collections, net

     10,955            14,440       2,989  

Proceed from sale of portfolio loans

     36,829            —          —     

Purchases of premises and equipment

     (463          (490     (645

Proceeds from sales of premises and equipment

     16            36       43  

Proceeds from sales of acquired assets

     184            483       418  

Proceeds from sale of insurance businesses

     —               154       534  

Investment in low income tax credit

     —                 (1,031
                             

Net cash provided by (used in) investing activities

     71,786            22,600       (17,106
                             

 

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NORTHEAST BANCORP AND SUBSIDIARY

Consolidated Statements of Cash Flows

(Unaudited) (Continued)

(Dollars in thousands)

 

     Successor Company (1)            Predecessor Company (2)  
     93 days ended
March 31, 2011
           181 days ended
Dec. 28, 2010
    Nine months ended
March 31, 2010
 

Cash flows from financing activities:

           

Net increase (decrease) in deposits

     24,122            (9,580     (5,022

Advances from the Federal Home Loan Bank

     —               —          12,500  

Repayment of advances from the Federal Home Loan Bank

     (8,000          —          (2,000

Net repayments on Federal Home Loan Bank overnight advances

     —               —          (815

Net (decrease) increase in short-term borrowings

     (49,817          16,875       7,020  

Dividends paid

     (367          (525     (785

Issuance of common stock

     16,175            62       8  

Purchase of interest rate caps

     —               —          (325

Repayment on debt from insurance agencies acquisitions

     —               (496     (634

Repayment on capital lease obligation

     (39          (77     (110
                             

Net cash (used in) provided by financing activities

     (17,926          6,259       9,837  
                             

Net increase (decrease) in cash and cash equivalents

     51,157            38,163       (3,969

Cash and cash equivalents, beginning of period

     58,598            20,435       13,022  
                             

Cash and cash equivalents, end of period

   $ 109,755          $ 58,598     $ 9,053  
                             

Supplemental schedule of cash flow information:

           

Interest paid

   $ 2,971          $ 5,781     $ 10,550  

Income taxes paid

     28            846       340  

Supplemental schedule of noncash investing and financing activities:

           

Transfer from loans to acquired assets

   $ 27          $ 346     $ 2,034  

Transfer from acquired assets to loans

     —               56       45  

Change in valuation allowance for unrealized losses (gains) on available-for-sale securities, net of tax

     (3,366          (1,890     1,881  

Net change in deferred taxes for unrealized losses (gains) on available-for-sale securities

     1,734            974       (1,033

Additional supplemental information as a result of the merger on December 29, 2010 is disclosed in Note 2, “Merger Transaction,” in the Notes to Unaudited Consolidated Financial Statements.

See accompanying notes to unaudited consolidated financial statements

 

(1) “Successor Company” means Northeast Bancorp and its subsidiary after the closing of the merger with FHB Formation on LLC on December 29, 2010.
(2) “Predecessor Company” means Northeast Bancorp and its subsidiary before the closing of the merger with FHB Formation LLC on December 29, 2010.

 

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NORTHEAST BANCORP AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

March 31, 2011

 

1. Basis of Presentation

The accompanying unaudited condensed and consolidated interim financial statements include the accounts of Northeast Bancorp (“Northeast” or the “Company”) and its wholly owned subsidiary, Northeast Bank (the “Bank”). These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the accompanying consolidated financial statements contain all adjustments (consisting principally of normal recurring accruals) considered necessary for a fair presentation of the Company’s financial position at March 31, 2011, the results of operations for the three-month and 93-day period ended March 31, 2010, the 181-day period ended December 28, 2010 and the three- and nine-month periods ended March 31, 2010, the changes in stockholders’ equity for the 93-day period ended March 31, 2011, the 181-day period ended December 28, 2010 and the nine-month period ended March 31, 2010, and the cash flows for the 93-day period ended March 31, 2011, the 181-day period ended December 28, 2010 and the nine-month period ended March 31, 2010. Operating results for the nine-month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2011. For further information, refer to the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2010 included in the Company’s Annual Report on Form 10-K.

 

2. Merger Transaction

On December 29, 2010, the merger of the Company and FHB Formation LLC (“FHB”) was consummated. FHB is the entity through which a group of independent accredited investors (the “Investors”) purchased 937,933 shares of the Company’s outstanding common stock and 1,161,166 shares of newly-issued voting and non-voting common stock, at a price equal to $13.93 per share. As a result of this transaction, $16.2 million of new capital was contributed to the Company, and the Investors collectively own approximately 60% of the outstanding common shares of the Company. We have applied the acquisition method of accounting, as described in Accounting Standards Codification (“ASC”) 805, “ Business Combinations, ” to this transaction, which represents an acquisition by FHB of Northeast, with Northeast as the surviving company.

As a result of application of the acquisition method of accounting to the Company’s balance sheet, the Company’s financial statements from the periods prior to the transaction date are not directly comparable to the financial statements for periods subsequent to the transaction date. To make this distinction, we have labeled balances and results of operations prior to the transaction date as “Predecessor Company” and balances and results of operations for periods subsequent to the transaction date as “Successor Company.” The lack of comparability arises from the assets and liabilities having new accounting bases as a result of recording them at their fair values as of the transaction date rather than at historical cost basis. To denote this lack of comparability, the Company has placed a heavy black line between the Successor Company and Predecessor Company columns in the Consolidated Financial Statements and in the tables in the notes to the statements and in this discussion. In addition, the lack of comparability means that the periods being reported in the fiscal year ending June 30, 2011 in the statements and tables are not the same periods as reported for the fiscal year ended June 30, 2010.

Under the acquisition method of accounting, the Company assets acquired and liabilities assumed are recorded at their respective fair values as of the transaction date. In connection with the merger, the consideration paid, and the assets acquired and liabilities assumed recorded at fair value on the date of acquisition, are summarized in the following tables:

 

     (Dollars in Thousands)  

Consideration Paid:

  

FHB investors’ purchase of 937,933 existing Northeast shares, at $13.93 per Surviving Company share

   $ 13,065   

Existing Northeast shareholders’ retention of shares in Surviving Company, 1,393,399 shares at $13.93 per share

     19,410   
        

Total consideration paid:

   $ 32,475   
        

 

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     (Dollars in Thousands)  

Net Assets Acquired:

  

Assets:

  

Cash and short-term investments

   $ 58,598   

Securities available for sale

     153,315   

Loans

     369,498   

Premises and equipment

     7,905   

Bank-owned life insurance

     13,536   

Core deposit intangible

     5,924   

Other identifiable intangibles

     7,865   

Other assets

     14,409   
        
   $ 631,050   

Liabilities and Preferred Equity:

  

Deposits

   $ 378,523   

Overnight borrowings

     63,043   

Term borrowings

     125,409   

Junior subordinated debentures issued to affiliated trusts

     7,889   

Other liabilities

     4,400   

Preferred stock

     4,095   
        
   $ 583,359   

Total identifiable net assets

   $ 47,691   

Consideration paid

   $ 32,475   
        

Bargain purchase gain recorded in income

   $ 15,216   
        

In this transaction, the estimated fair values of the Company’s net assets were greater than the purchase price. This resulted in a bargain purchase gain of $15.2 million in the 93-day period ended March 31, 2011. The transaction resulted in a gain principally because intangible asset fair values were identified totaling $13.7 million, while the purchase price paid by the Investors was based on the Company’s tangible book value as of September 30, 2009. Direct costs associated with the merger were expensed by the Company as incurred. Through March 31, 2011, those expenses–principally legal, accounting and investment banking fees–amounted to $3.9 million, of which $3.3 million was incurred in the nine-month period ended March 31, 2011.

The fair value of the loan portfolio was $369.5 million, and included $4.6 million of loans with evidence of deterioration in credit quality since origination for which it is probable, as of the transaction date, that the Company will be unable to collect all contractually required payments receivable. In accordance with ASC 310-30 this resulted in a non-accretable difference of $1.9 million, which is defined as the loan’s contractually required payments in excess of the amount of its cash flows expected to be collected. The Company considered factors such as payment history, collateral values, and accrual status when determining whether there was evidence of deterioration of a loan’s credit quality at the transaction date. The Company’s previously established allowance for loan losses was not carried forward in the determination of loan fair value.

The core deposit intangible asset recognized as part of the transaction is being amortized over its estimated useful life of 9.7 years. Existing goodwill totaling $4.1 million, recorded in conjunction with previous insurance agency acquisitions, was eliminated when determining the fair value of net assets. Other insurance agency identifiable intangibles, principally the value of agency customer lists, were appraised by an insurance valuation specialist.

The fair value of savings and transaction accounts was assumed to approximate their carrying value, since these deposits have no stated maturity and are payable upon demand. The fair values of certificates of deposit and term borrowings were determined by discounting their contractual cash flows at current market rates.

Commitments in Connection with Regulatory Approval of the Merger

The merger required the approval of the Maine Bureau of Financial Institutions (the “Bureau”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Those approvals contain certain commitments by the Company, including the following:

 

   

The Federal Reserve requires that Northeast (i) maintain a leverage ratio (Tier 1) of at least 10%, (ii) maintain a total risk-based capital ratio of at least 15%, (iii) limit purchased loans to 40% of total loans, (iv) fund 100% of

 

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loans with core deposits, (v) hold commercial real estate loans (including owner-occupied commercial real estate) to within 300% of total risk-based capital, and (vi) amend the articles of incorporation to address certain technical concerns that the Federal Reserve had relating to the convertibility and transferability of non-voting common stock.

 

   

The Bureau requires that, for a two-year period, Northeast obtain the prior approval of the Bureau for any material deviation from the business plan. The Bureau’s approval includes other conditions on capital ratios and loan purchasing that are either the same as or less stringent than those of the Federal Reserve.

The Company and the Bank are currently in compliance with all commitments to the Federal Reserve and Bureau.

 

3. Loans

The Company’s loan portfolio includes residential real estate, commercial real estate, construction, commercial and consumer segments. Residential real estate loans include one- to four-family owner-occupied, second mortgages and equity lines of credit.

Consumer loans include personal and indirect loans for autos, boats and recreational vehicles. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

The accrual of interest on all loans is discontinued at the time the loan is 90 days past due unless the credit is well secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual is reversed against interest income. The interest on these is accounted for on a cash basis or cost recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

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. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.

The allowance for loan losses is evaluated on a regular basis by management. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of general, allocated and unallocated components, as further described below.

General Component

The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate, commercial real estate, construction, commercial and consumer. Management uses a rolling average of historical losses based on a time frame appropriate to capture the relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. There were no changes in the Company’s policies or methodology pertaining to the general component of the allowance for loan losses in the fiscal year ending June 30, 2011.

The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:

Residential real estate – The Company generally does not originate loans with a loan-to-value ratio greater than 80 percent and does not originate subprime loans. All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.

 

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Commercial real estate – Loans in this segment are primarily income-producing properties located in Maine and New Hampshire. The underlying cash flows generated by the properties may be adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on the credit quality in this segment. Management obtains rent rolls annually and monitors the cash flows of these loans.

Construction loans – Loans in this segment primarily include speculative real estate development loans for which payment is derived from the sale of the property. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.

Commercial loans – Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.

Consumer loans – Loans in this segment are secured by autos, boats, recreational vehicles and deposits with the Bank, and are also unsecured. Repayment is dependent on the credit quality of the individual borrower.

Allocated Component

The allocated component relates to loans that are classified as impaired. Impairment is measured on a loan-by-loan basis for commercial, commercial real estate and construction 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. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential real estate loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring agreement.

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. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. 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.

The Company periodically may agree to modify the contractual terms of the loans. When a loan is modified and a concession is made to a borrower experiencing financial difficultly, the modification is considered a troubled debt restructuring (“TDR”). All TDRs are initially classified as impaired.

Unallocated Component

An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the loan portfolio.

The following is a summary of the composition of loans at the dates indicated:

 

     Successor
Company
           Predecessor
Company
 
     March 31, 2011            June 30, 2010  
(Dollars in thousands)                    

Residential real estate:

         

One- to four-family

   $ 92,627           $ 102,584   

Second mortgages

     25,299             27,316   

Equity lines of credit

     25,246             25,713   

Commercial

     117,562             121,175   

Construction

     2,941             5,525   
                     

Total mortgage loans on real estate

     263,675             282,313   

Commercial loans

     25,490             30,214   

Consumer installment loans

     23,891             69,782   
                     

Total loans

     313,056             382,309   

Less: Allowance for loan losses

     14             5,806   
                     

Loans, net

   $ 313,042           $ 376,503   
                     

 

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The following table sets forth activity in the Company’s allowance for loan losses for the periods indicated:

 

     Successor
Company
           Predecessor
Company
 
     93 Days
Ended
March 31,
2011
           181 Days
Ended
December 28,
2010
     Nine
Months
Ended
March 31,
2010
 
(Dollars in thousands)                           

Balance at beginning of period

   $ 5,980           $ 5,806       $ 5,764   

Add provision charged to operations

     49             912         1,723   

Recoveries on loans previously charged off

     20             121         136   
                              
     6,049             6,839         7,623   

Less: Loans charged off

     55             859         1,700   

Less: Allowance for loan losses eliminated in accordance with acquisition method of accounting

     5,980             —           —     
                              

Balance at end of period

   $ 14           $ 5,980       $ 5,923   
                              

Further information pertaining to the allowance for loan losses at March 31, 2011 follows:

 

     Residential
Real Estate
     Commercial
Real Estate
     Construction      Commercial      Consumer      Unallocated  
     (Dollars in thousands)  

Loans deemed to be impaired as of March 31, 2011

   $ 48       $ 1,791       $ —         $ 933       $ —         $ —     

Loans not deemed to be impaired as of March 31, 2011

   $ 143,124       $ 115,771       $ 2,941       $ 24,557       $ 23,891       $ —     

The following is a summary of past due and non-accrual loans at March 31, 2011:

 

     30-59
Days
     60-89
Days
     Past Due
90

Days or
More
     Total
Past Due
     Total
Current
     Non-
Accrual
Loans
 
     (Dollars in thousands)  

Residential Real Estate:

                 

Residential one- to four-family

   $ 732       $ 933       $ 1,131       $ 2,796       $ 89,831       $ 1,315   

Second mortgages

     —           —           151         151         25,148         150   

Equity lines of credit

     —           47         —           47         25,199         38   

Commercial real estate

     957         —           699         1,656         115,918         3,511   

Construction

     —           —           121         121         2,820         121   

Commercial

     42         1         443         486         25,004         629   

Consumer

     952         289         556         1,797         22,094         555   
                                                     

Total

   $ 2,683       $ 1,270       $ 3,101       $ 7,054       $ 306,014       $ 6,319   
                                                     

 

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The following table provides additional information on impaired loans at March 31, 2011:

 

     Recorded
Investments
     Unpaid
Principal
Balance (1)
     Allowance  
     (Dollars in thousands)  

Impaired loans without a valuation allowance:

        

Residential real estate:

        

Residential one- to four-family

   $ 48       $ 48       $ —     

Commercial real estate

     1,791         1,791         —     

Commercial

     933         933         —     
                          

Total

     2,772         2,772         —     

Impaired loans with a valuation allowance:

        

Residential real estate:

        

Residential one- to four-family

     —           —           —     

Commercial real estate

     —           —           —     

Commercial

     —           —           —     
                          

Total

     —           —           —     
                          

Total impaired loans

   $ 2,772       $ 2,772       $ —     
                          

 

(1) Impaired loans are presented net of the fair value adjustments of $1.79 million resulting from the application of the acquisition method of accounting in connection with the merger on December 29, 2010.

The following is a summary of information pertaining to impaired loans at March 31, 2011:

 

     Successor
Company
            Predecessor
Company
 
     93 Days
Ended
March 31,
2011
            181 Days
Ended
December 28,
2010
     Nine months
Ended
March 31,
2010
 

(Dollars in thousands)

                           

Average investment in impaired loans:

             

Residential one- to four-family

   $ 12            $ 330       $ 244   

Commercial real estate

     1,715              3,366         5,373   

Commercial

     976              1,738         2,723   
                               

Total average investment in impaired loans

   $ 2,703            $ 5,434       $ 8,340   
                               
 

Interest income recognized on impaired loans:

             

Residential one- to four-family

   $ 1            $ 2       $ 3   

Commercial real estate

     30              76         220   

Commercial

     16              20         86   
                               

Total interest income recognized on impaired loans

   $ 47            $ 98       $ 309   
                               
 

Interest income recognized on a cash basis:

             

on impaired loans:

             

Residential one- to four-family

   $ 1            $ 2       $ 3   

Commercial real estate

     30              76         220   

Commercial

     16              20         86   
                               

Total interest income recognized a cash basis on impaired loans:

   $ 47            $ 98       $ 309   
                               

No additional funds were committed to be advanced in connection with impaired loans.

Credit Quality Information

The Company utilizes an eight point internal loan rating system for commercial real estate, construction and commercial loans as follows:

Loans rated 1 – 4: Loans in these categories are considered “pass” rated loans with low to average risk.

Loans rated 5: Loans in this category are considered “special mention.” These loans are beginning to show signs of potential weakness and are being closely monitored by management.

Loans rated 6: Loans in this category are considered “substandard.” Generally, a loan is considered substandard if the current net worth inadequately protects it and the paying capacity of the obligors and/or the collateral pledged. There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.

Loans rated 7: Loans in this category are considered “doubtful.” Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of current existing facts, highly questionable and improbable.

 

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Loans rated 8: 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 on all commercial real estate, construction and commercial loans. 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.

The following table presents the Company’s loans by risk rating at March 31, 2011.

 

     Commercial
Real Estate
     Construction      Commercial  
     (Dollars in thousands)  

Loans rated 1-5

   $ 105,372       $ 2,941       $ 22,211   

Loans rated 6

     12,190         —           3,279   

Loans rated 7

     —           —           —     

Loans rated 8

     —           —           —     
                          
   $ 117,562       $ 2,941       $ 25,490   
                          

 

4. Junior Subordinated Debentures Issued to Affiliated Trust

NBN Capital Trust II and NBN Capital Trust III were formed in December 2003, and NBN Capital Trust IV was formed in December 2004, to issue and sell common and trust preferred securities, using the proceeds to acquire Junior Subordinated Deferrable Interest Notes (“Junior Subordinated Debentures”) from the Company. The Junior Subordinated Debentures are the sole assets of each of the trusts.

The following table summarizes the Junior Subordinated Debentures and the common and trust preferred securities issued by each affiliated trust at March 31, 2011. The Company has the right to redeem the Junior Subordinated Debentures at the redemption price specified in the associated Indenture, plus accrued but unpaid interest to the redemption date.

 

Affiliated Trusts

   Balances
At Fair
Value
     Contractual
Obligations
     Interest
Rate
   

Maturity Date

     (Dollars in thousands)             

NBN Capital Trust II

   $ 1,716       $ 3,093         3.11   March 30, 2034

NBN Capital Trust III

     1,716         3,093         3.11   March 30, 2034

NBN Capital Trust IV

     4,490         10,310         2.20   February 23, 2035
                            

Total

   $ 7,922       $ 16,496         2.54  
                            

NBN Capital Trust II and NBN Capital Trust 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 trust preferred securities of the trusts currently pay quarterly distributions at an annual rate of 3.11% for the stated liquidation amount of $1,000 per preferred security for NBN Capital Trust II and NBN Capital Trust III and an annual rate of 2.20% 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 trust preferred securities, but only to the extent of funds held by the trusts. Based on the current rates and the impact of the interest rate swap referred to below, the annual interest expense on the trust preferred securities is approximately $676 thousand.

During the twelve months ended June 30, 2010, the Company purchased two interest rate caps and an interest rate swap to hedge the interest rate risk on notional amounts of $3 million, $3 million and $10 million, respectively, of the Junior Subordinated Debentures. Each was a cash flow hedge to manage the risk to net interest income during a period of rising rates.

The notional amount of $3 million for each interest rate cap represents the outstanding junior subordinated debt from each trust. The strike rate is 2.505%. The Company will recognize higher interest expense on the Junior Subordinated Debentures for the first 200 basis points increase in three-month LIBOR. Once three-month LIBOR rate exceeds 2.505% 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 was September 30, 2009 and the caps mature in five years.

 

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The interest rate swap hedges Junior Subordinated Debentures resulting from the issuance of trust preferred stock by our affiliate NBN Capital Trust IV. The notional amount of $10 million represents the outstanding Junior Subordinated Debentures from this trust. Under the terms of the interest rate swap, Northeast pays a fixed rate of 4.69% quarterly for a period of five years from the effective date of February 23, 2010. We receive quarterly interest payments of three month LIBOR plus 1.89% over the same term.

See Note 13 for additional information on derivatives.

 

5. Securities

Securities available-for-sale at amortized cost and approximate fair values at March 31, 2011 and June 30, 2010 are summarized below:

 

     Successor Company          Predecessor Company  
     March 31, 2011          June 30, 2010  
     Amortized
Cost
     Fair
Value
         Amortized
Cost
     Fair
Value
 
     (Dollars in thousands)  

Debt securities issued by U.S. Government-sponsored enterprises

   $ 27,166       $ 27,165         $ 8,583       $ 8,649   

Mortgage-backed securities

     99,513         99,377           126,538         133,862   

Municipal bonds

     —           —             11,905         12,007   

Collateralized mortgage obligations

     —           —             7,331         7,423   

Corporate bonds

     —           —             994         1,030   

Equity securities

     197         212           1,044         776   

Trust preferred securities

     401         473           584         441   
                                     
   $ 127,277       $ 127,227         $ 156,979       $ 164,188   
                                     

The gross unrealized gains and unrealized losses on available-for-sale securities are as follows:

 

     Successor Company          Predecessor Company  
     March 31, 2011          June 30, 2010  
     Gross      Gross          Gross      Gross  
     Unrealized
Gains
     Unrealized
Losses
         Unrealized
Gains
     Unrealized
Losses
 
     (Dollars in thousands)  

Debt securities issued by U.S. Government-sponsored enterprises

   $ 9       $ 10         $ 66       $ —     

Mortgage-backed securities

     203         339           7,327         3   

Municipal bonds

     —           —             166         64   

Collateralized mortgage obligations

     —           —             92         —     

Corporate bonds

     —           —             36         —     

Equity securities

     16         1           5         273   

Trust preferred securities

     84         12           —           143   
                                     
   $ 312       $ 362         $ 7,692       $ 483   
                                     

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, at March 31, 2011 and June 30, 2010:

 

     Less than 12 Months      More than 12 Months      Total  
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 
     (Dollars in thousands)  

March 31, 2011:

                 

Debt securities issued by U.S. Government-sponsored enterprises

   $ 19,165       $ 10       $ —         $ —         $ 19,168       $ 10   

Mortgage-backed securities

     39,353         339         —           —           39,562         339   

Equity securities

     1         1         —           —           1         1   

Trust preferred securities

     74         12         —           —           72         12   
                                                     
   $ 58,593       $ 362       $ —         $ —         $ 58,803       $ 362   
                                                     

 

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     Less than 12 Months      More than 12 Months      Total  
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 
     (Dollars in thousands)  

June 30, 2010:

                 

Mortgage-backed securities

   $ 161       $ 3       $ —         $ —         $ 161       $ 3   

Municipal bonds

     2,608         20         830         44         3,438         64   

Equity securities

     190         10         473         263         663         273   

Trust preferred securities

     95         1         339         142         434         143   
                                                     
   $ 3,054       $ 34       $ 1,642       $ 449       $ 4,696       $ 483   
                                                     

Management of the Company, in addition to considering current trends and economic conditions that may affect the quality of individual securities within the Company’s investment portfolio, also considers the Company’s ability and intent to hold such securities to maturity or recovery of cost. Management does not believe any of the Company’s available-for-sale securities are other-than-temporarily impaired at March 31, 2011, except as discussed below.

Based on management’s assessment of available-for-sale securities, there has not been another-than-temporary decline in market value of certain trust preferred and equity securities for the nine months ended March 31, 2011. During the nine months ended March 31, 2010, write-downs of available-for-sale securities was $103 thousand and are included in other noninterest expense in the consolidated statements of income.

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market conditions warrant such evaluation. The investment securities portfolio is generally evaluated for other-than-temporary impairment under ASC 320-10, “ Investments – Debt and Equity Securities .”

The Company adopted the provisions of ASC 320-10 for the year ended June 30, 2009, which was applied to existing and new debt securities held by the Company as of April 1, 2009. For those debt securities for which the fair value of the security is less than its amortized cost, the Company does not intend to sell such security, and because it is more likely than not that it will not be required to sell such security prior to the recovery of its amortized cost basis less any credit losses, ASC 320-10 requires that the credit component of the other-than-temporary impairment losses be recognized in earnings while the noncredit component is recognized in other comprehensive income, net of related taxes.

There were no other-than-temporary impairment losses on securities for the nine months ended March 31, 2011.

The amortized cost and fair values of available-for-sale debt securities at March 31, 2011 and June 30, 2010, by contractual maturity, are shown below. 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.

 

     March 31, 2011      June 30, 2010  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (Dollars in thousands)  

Due in one year or less

   $ —         $ —         $ 994       $ 1,030   

Due after one year through five years

     27,166         27,165         5,000         5,012   

Due after five years through ten years

     —           —           4,750         4,804   

Due after ten years

     401         473         11,323         11,282   

Mortgage-backed securities (1)

     99,513         99,377         133,868         141,284   
                                   
   $ 127,080       $ 127,015       $ 155,935       $ 163,412   
                                   

 

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6. Advances from the Federal Home Loan Bank

A summary of borrowings from the Federal Home Loan Bank is as follows:

 

March 31, 2011  

Amounts

At Fair

Value

   

Principal
Amounts
Due

   

Interest Rates

   

Maturity Dates For Periods Ended
March 31,

 

(Dollars in thousands)

             
  $10,240      $ 10,000        2.55% - 2.59%        2013   
  5,273        5,000        3.99        2014   
  12,790        12,500        2.91 – 3.08        2015   
  10,491        10,000        4.26        2017   
  5,180        5,000        4.29        2018   
                 
  $43,974      $ 42,500       
                 

 

June 30, 2010  

Principal

Amounts

Due

   

Interest Rates

   

Maturity Dates
For Periods Ended
June 30,

 
(Dollars in thousands)              
  $      3,000        4.99%        2011   
  5,000        3.99        2012   
  15,000        2.55 – 3.99        2013   
  12,500        2.91 – 3.08        2015   
  10,000        4.26        2017   
  5,000        4.29        2018   
         
  $    50,500       
         

The Federal Home Loan Bank had the option to call $25 million of the outstanding advances at March 31, 2011. The options are continuously callable quarterly until maturity.

 

7. Structured Repurchase Agreements

A summary of outstanding structured repurchase agreements is as follows:

 

March 31, 2011

Amounts

At Fair

Value

    

Principal
Amounts
Due

    

Interest
Rate

   

Imbedded

Cap/Floor

  

Amount of
Cap/Floor

    

Strike Rate

   

Maturity

(Dollars in thousands)
  $21,037       $ 20,000         4.68   Purchased Caps    $ 40,000         Expired      August 28, 2012
  10,420         10,000         3.98   Sold Floors    $ 20,000         Expired      August 28, 2012
  10,518         10,000         4.18   Purchased Caps    $ 10,000         Expired      December 13, 2012
  10,624         10,000         4.30   Purchased Caps    $ 10,000         3.79%      July 3, 2013
  10,705         10,000         4.44   Purchased Caps    $ 10,000         3.81%      September 23, 2015
  5,130         5,000         2.86   None         March 25, 2014
                           
  $68,434       $ 65,000                
                           

 

June 30, 2010

Amount

    

Interest Rate

   

Imbedded

Cap/Floor

  

Amount of

Cap/Floor

  

Strike Rate

   

Maturity

                  (Dollars in thousands)           
  $20,000         4.68   Purchased Caps    $40,000      Expired      August 28, 2012
  10,000         3.98   Sold Floors    $20,000      Expired      August 28, 2012
  10,000         4.18   Purchased Caps    $10,000      4.88%      December 13, 2012
  10,000         4.30   Purchased Caps    $10,000      3.79%      July 3, 2013
  10,000         4.44   Purchased Caps    $10,000      3.81%      September 23, 2015
  5,000         2.86   None         March 25, 2014
                  
  $65,000                

 

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No leveraging strategies were implemented in the fiscal year ending June 30, 2011. For the leveraging strategies implemented in the fiscal year ended June 30, 2009, the Company pledged mortgage-backed securities of $28.2 million, at inception, as collateral for $25 million borrowed in three transactions. The transactions maturing July 2013 and September 2015 of $10 million each had imbedded interest rate caps as summarized in the table above. The interest rate caps reduced our balance sheet risk to rising interest rates. They cannot be called by the issuer during the three years ended July 3, 2011 and during the four years ended September 23, 2012, respectively. Each agreement can be called quarterly thereafter. The transaction in March 2009, which did not have imbedded interest rate caps or floors, allowed the Company to extend its funding at a favorable interest rate. The issuer has no call option unless the Company no longer maintains regulatory “well-capitalized status” or is subject to a regulatory cease and desist order. Interest is paid quarterly. The interest rates are fixed for the term of the three agreements.

The Company is subject to margin calls on each transaction to maintain the necessary collateral in the form of cash or mortgage-backed securities during the borrowing term.

Payments would be received on the interest rate caps when three-month LIBOR exceeds the strike rate on the quarterly reset date. The amount of the payment would be equal to the difference between the strike rate and three-month LIBOR multiplied by the notional amount of the cap to be made 90 days after the reset date. The purchased interest rate caps expire at the end of the non-call periods noted above.

The collateral pledged for these borrowings consists of Federal National Mortgage Association, Federal Home Loan Mortgage Corporation and Government National Mortgage Association issued mortgage-backed securities with a fair value of $56.3 million and cash of $17.6 million as of March 31, 2011.

 

8. Stock-Based Compensation and Employee Benefits

Stock-Based Compensation

In connection with the transaction with FHB, the Company adopted the Northeast Bancorp 2010 Stock Option and Incentive Plan (the “Plan”), which provides for awards of stock-based compensation, including options, stock appreciation rights, restricted stock and other equity-based incentive awards. The maximum number of authorized shares of stock that may be issued under the plan is 810,054 shares. The Company’s previous stock option plans were terminated on the transaction date, and 10,500 outstanding vested options under those plans were exchanged for options to acquire shares of surviving company common stock, with terms that are substantially identical to the existing options.

On December 29, 2010, the Company granted an award of 13,026 shares of restricted stock to a senior executive in the Company’s Northeast Community Banking Division (“NCBD”). The holder of this award participates fully in the rewards of stock ownership of the Company, including voting rights and dividend rights. This award has been determined to have a fair value of $13.93 per share, based on the average price at which the Company’s common stock traded on the date of grant. Forty percent of the award will vest on December 29, 2012, and the remainder will vest in three equal annual installments commencing on December 29, 2013.

On December 29, 2010, the Company awarded options to purchase 594,039 shares of the Company’s common stock from the Plan to certain officers of the Company and/or the Bank. 259,218 of these options vest ratably over a five-year period, and have been determined to have a fair value of $3.85 per share. 21,601 options vest ratably over a three-year period, and have been determined to have a fair value of $3.85 per share. 10,801 options vest ratably over a four-year period, and have been determined to have a fair value of $3.85 per share. 64,803 options vest ratably over years three through five, and have been determined to have a fair value of $3.85 per share. 237,616 of these options are performance-based, and have been divided into three tranches, each of which will vest if certain qualitative conditions are satisfied and the Company’s stock price exceeds a specified hurdle price for a period of 50 of the previous 75 consecutive trading days. The performance-based options have been determined to have a fair value of $2.43 per share. The strike price for all awards is $13.93 per share, based on the average price at which the Company’s common stock traded on the date of grant. All have a contractual life of 10 years from the date of grant, and are subject to recoupment if (i) the Board determines that gross negligence, intentional misconduct or fraud by the awardee caused or was a significant contributing factor to a materially adverse restatement of the Company’s financial statements and (ii) the vesting of an award was calculated or contingent upon the achievement of financial or operating results that were affected by the restatement and the vesting would have been less had the financial statements been correct.

 

 

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The Company assumed a liability in the amount of $509,000 from FHB for the estimated cost of stock appreciation rights (“SARs”) with respect to 162,010 shares, awarded on December 29, 2010 to two individuals who had been actively involved with FHB from its inception in February 2009. 81,004 of the SARs were subject to certain time-based restrictions on exercisability (the “Time-Based SARs”), and 81,006 of the SARs were subject to certain performance-based restrictions on exercisability (the “Performance-Based SARs”). Following the amendment of the Company’s articles of incorporation on March 21, 2011, the Compensation Committee of the Company voted to accelerate the exercisability of the Time-Based SARs. The Time-Based SARs became immediately exercisable and were exercised on March 24, 2011. In connection with the exercise of the Time-Based SARs, the Company issued options to purchase 81,004 shares of the Company’s non-voting common stock with an exercise price of $14.52 per share. The option shares will become exercisable in five equal annual installments commencing on December 29, 2010. In addition, the Company entered into certain Amended and Restated Performance-Based Appreciation Rights Agreements, pursuant to which the Performance-Based SARs will become automatically exercisable (and shall be exercised) for $0.59 per share in the event that relevant performance thresholds are satisfied. In connection with the Amended and Restated Performance-Based Appreciation Rights Agreements, the Company issued options to purchase 81,006 shares of the Company’s non-voting common stock with an exercise price of $14.52 per share. The options will become exercisable upon the satisfaction of certain performance conditions. The net effect of the exercise of the Time-Based SARs and the execution of the Amended and Restated Performance-Based Appreciation Rights Agreements, together with the option issuance, on operating results for the quarter ended March 31, 2011 was $113 thousand, included in merger expense.

At March 31, 2011, none of the restricted stock, option or Performance-Based SAR awards granted on December 29, 2010 were exercisable.

Employee Benefits:

In connection with the merger, the Company entered into one-year employment agreements with four senior executives in the NCBD. In addition, three senior executives in the NCBD received retention payments equal to one year’s base salary, aggregating $450 thousand, paid in the quarter ended March 31, 2011.

In connection with the merger, the Company entered into three-year employment agreements with its Chief Executive Officer, Chief Administrative Officer and Chief Financial Officer. These provide for a base salary, annual bonuses as determined by the Compensation Committee, participation in Company-wide benefit programs, and also contain noncompetition and nonsolicitation restrictions.

Refer to the Note 13 in the Company’s Annual Report on Form 10-K for fiscal year ended June 30, 2010 for further information about the Company’s employee benefits.

 

9. Capital Lease

In fiscal year 2006, the Company recognized a capital lease obligation for its new headquarters known as the Southern Gateway building located at 500 Canal Street, Lewiston, Maine. The present value of the lease payments over fifteen years ($264 thousand per year for each of the initial ten years of the lease term and $306 thousand per year for each of the last five years) exceeded 90% of the fair value of the Southern Gateway building. The Bank’s commercial lending and underwriting, consumer loan underwriting, loan servicing, deposit operations, accounting, human resources, risk management, and executive administration departments occupy the approximately 27 thousand square feet of space.

The future minimum lease payments over the remaining term of the lease and the outstanding capital lease obligations at March 31, 2011 are as follows:

 

(Dollars in thousands)  

2011

   $ 264   

2012

     264   

2013

     264   

2014

     264   

2015

     292   

2016 and thereafter

     1,328   
        

Total minimum lease payments

     2,676   

Less imputed interest

     562   
        

Capital lease obligation

   $ 2,114   
        

 

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10. Insurance Agency Acquisitions

Northeast Bank Insurance Group, Inc., a subsidiary of the Bank, acquired one insurance agency in the fiscal year ended June 30, 2009, three insurance agencies in the fiscal year ended June 30, 2008 and four insurance agencies in the fiscal year ended June 30, 2007. Each acquisition was made as a purchase of assets for cash and a note, with the exception of the Palmer Insurance Agency (“Palmer”), which was the purchase of stock for cash and a note, and the Goodrich Insurance Associates (“Goodrich”), which was a purchase of assets for cash. Each agency operates at the location being used at the time of the acquisition except Goodrich, which was relocated to our agency office in Berwick, Maine; Hartford Insurance Agency (“Hartford”), which was relocated to our agency office in Auburn, Maine; and Russell Insurance Agency (“Russell”), which was relocated to the agency office in Anson, Maine.

All acquisitions were accounted for using the purchase method of accounting and resulted in increases in goodwill and customer list and non-compete intangibles on the consolidated balance sheet. All purchase and sale agreements, except the agreements relating to the Russell and Hartford, call for a reduction in the purchase price should the stipulated minimum commission revenue levels not be attained over periods of one to three years from the purchase date. During the year ended June 30, 2008, other borrowings and goodwill related to the Southern Maine Insurance Agency (“Southern Maine”) acquisition were reduced by $98.3 thousand in accordance with this stipulation. The customer list intangibles and estimated useful lives are based on estimates from a third-party appraiser. The useful lives of these intangibles range from eleven to twenty-four years. Non-compete intangible useful lives are amortized over a range of ten to fifteen years.

The debt incurred is payable to the seller of each agency. Each note bears an interest rate of 6.50% over terms as follows: the Palmer debt is payable over a term of seven years; the Sturtevant and Ham, Inc. (“Sturtevant”) debt is payable over a term of three years; the Southern Maine debt is payable over a term of four years; and the Russell debt is payable over a term of two years. Hartford, Spence & Matthews, and Hyler are payable over a term of seven years. Hartford, Spence & Matthews, Inc. (“Spence & Matthews”), and Hyler Agency (“Hyler”) have debt of $100 thousand, $800 thousand, and $200 thousand, respectively, which bears no interest and has been recorded at its present value assuming a discount rate of 6.50%. The Bank guaranteed the debt repayment to each seller.

Northeast Bank Insurance Group, Inc. leases the office locations for Sturtevant, Southern Maine and Hyler, which are operating leases. The Bank acquired Palmer’s agency building and land in January 2007.

The results of operations of all agencies have been included in the consolidated financial statements since their acquisition date. There is no pro-forma disclosure included because the agencies individually, and in aggregate, were not considered significant acquisitions.

 

     Acquisitions  
Purchase price    2009      2008  
     (Dollars in thousands)  

Cash paid

   $ 715      $ 3,701   

Debt incurred

     —           2,824   

Acquisition costs

     3        37   
                 

Total

   $ 718        6,562   
                 

Allocation of purchase price:

     

Goodwill

   $ 100        1,545   

Customer list intangible

     480        3,905   

Non-compete intangible

     135        1,100   

Fixed and other assets

     3        12   
                 

Total

   $ 718      $ 6,562   
                 

 

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Table of Contents

In conjunction with the application of acquisition accounting for the recent merger, goodwill previously recorded for insurance agency acquisitions was eliminated.

Northeast Bank Insurance Group, Inc. acquired Solon-Anson Insurance Agency, Inc. on September 29, 2004. This acquisition was accounted for using the purchase method and resulted in a customer list intangible asset of $2.1 million which is being amortized over twelve years.

The customer list of our Mexico, Maine insurance agency office was sold to UIG, Inc. on December 31, 2009. The customer list and certain fixed assets of our Rangeley, Maine insurance agency office were sold to Morton & Furbish Insurance Agency on January 31, 2010. Since these offices were part of the Solon-Anson Insurance Agency, Inc. acquired on September 29, 2004, the customer list intangibles were allocated based upon the gross commission revenues for the Mexico and Rangeley offices as a percentage of the total commission revenue of the Solon-Anson Insurance Agency, Inc. The land and buildings in Mexico and Rangeley have been listed for sale by Northeast Bank Insurance Group, Inc. Impairment expense of $46 thousand and $91 thousand was recognized for the Mexico and Rangeley buildings, respectively, in order to adjust the carrying values to the expected sales price in the fiscal year ended June 30, 2010. The Rochester, New Hampshire office was closed in May, 2010, and servicing of customer accounts from that office was transferred to the Berwick, Maine office. The customer list, certain fixed assets and the office lease of the Jackman office were sold to World-Wide Risk Management Inc. on December 22, 2010.

The following summarizes entries made to record the sale for the nine months ended March 31, 2011:

 

     Jackman  
     (Dollars in thousands)  

Sale price

   $ 154   

Allocated customer list, net of amortization

     44   

Fixed assets, net of accumulated depreciation

     6   
        

Gain recognized

   $ 104   
        

The following summarizes entries made to record the sales for the year ended June 30, 2010:

 

     Mexico      Rangeley  
     (Dollars in thousands)  

Sale price

   $ 270       $ 280   

Allocated customer list, net of amortization

     154         146   

Fixed assets, net of accumulated depreciation

     —           5   
                 

Gain recognized

   $ 116       $ 129   
                 

 

11. Earnings Per Share (EPS)

EPS is computed by dividing net income allocated to common stockholders by the weighted average common shares outstanding. Net income allocated to common stockholders represents net income less income allocated to participating securities (see discussion below). Diluted earnings per common share is computed by dividing income allocated to common stockholders by the weighted average common shares outstanding plus amounts representing the dilutive effect of stock options outstanding and restricted stock, if applicable.

On July 1, 2009, the Company adopted new accounting guidance on earnings per share that defines unvested share-based payment awards that contain nonforfeitable rights to dividends as participating securities that are included in computing EPS using the two-class method. The two-class method is an earnings allocation formula and participating 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.

 

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Table of Contents
     Successor Company            Predecessor Company  
     Three
Months
Ended

Mar. 31,
2011
    93 Days
Ended

Mar. 31,
2011
           181 Days
Ended

Dec. 28,
2010
    Three
Months
Ended

Mar. 31,
2010
    Nine
Months
Ended

Mar. 31,
2010
 

Earnings per common share

               

Net Income

   $ 156      $ 11,991          $ 1,796     $ 531     $ 1,676  

Preferred stock dividends

     (53     (55          (104     (53     (159

Accretion of preferred stock

     (44     (44          (13     (7     (20

Amortization of issuance costs

     (1     (1          (2     (1     (4
                                             

Net income available to common shareholders

   $ 58      $ 11,891          $ 1,677     $ 470     $ 1,493  

Dividends and undistributed earnings allocated to unvested shares of stock awards

     —          (44          —          —          —     
                                             

Net income applicable to common shareholders

   $ 58      $ 11,847          $ 1,677     $ 470     $ 1,493  
                                             

Average common shares issued and outstanding

     3,492,498       3,492,498            2,330,197       2,322,332       2,321,726  
                                             

Earnings per common share

   $ 0.02      $ 3.39          $ 0.72     $ 0.20     $ 0.64  
                                             

Diluted earnings per Common share

               

Net income applicable to common shareholders

   $ 58      $ 11,891          $ 1,677     $ 470     $ 1,493  

Dividends and undistributed earnings allocated to unvested shares of stock awards

     —          (44          —          —          —     
                                             

Net income available to common shareholders

   $ 58      $ 11,847          $ 1,677     $ 470     $ 1,493  
                                             

Average common shares issued and outstanding

     3,492,498       3,492,498            2,330,197       2,322,332       2,321,726  

Dilutive potential common shares

     67,375       67,780            24,188       19,821       7,366  
                                             

Total diluted average common shares issued and outstanding

     3,559,873       3,560,278            2,354,385       2,342,153       2,329,092  
                                             

Diluted earnings per common share

   $ 0.02      $ 3.33          $ 0.71     $ 0.20     $ 0.64  
                                             

 

12. Fair Value Measurements

In accordance with ASC 820, “ Fair Value Measurements, ” the Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 - Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 also includes U.S. Treasury and other U.S. Government-sponsored enterprise securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 - Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities.

Level 3 - Valuations for assets and liabilities that are derived from other methodologies, including option pricing models, discounted cash flow models and similar techniques, are not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets and liabilities.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

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Table of Contents

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities carried at fair value at March 31, 2011 and June 30, 2010.

The Company’s exchange traded equity securities are generally classified within level 1 or level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.

The Company’s investment in municipal, corporate and agency bonds and mortgage-backed securities available-for-sale is generally classified within level 2 of the fair value hierarchy. For these securities, we obtain fair value measurements from independent pricing services. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, trading levels, market consensus prepayment speeds, credit information and the instrument’s terms and conditions.

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions: valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Subsequent to initial valuation, management only changes level 3 inputs and assumptions when evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalization and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows indicates that initial valuation needs to be updated.

The Company did not have any significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy during the nine months ended March 31, 2011.

The following summarizes assets measured at fair value for the period ended March 31, 2011 and June 30, 2010.

Assets Measured At Fair Value On A Recurring Basis

 

     Fair Value Measurements at Reporting Date Using:  

March 31, 2011:

   Total      Quoted Prices in
Active Markets for
Identical Assets
Level 1
     Significant
Other  Observable
Inputs

Level 2
     Significant
Unobservable
Inputs

Level 3
 
     (Dollars in thousands)  

Securities available-for-sale

   $ 127,227       $ 685       $ 126,542       $ —     

Other assets – purchased interest rate caps