Northeast Bancorp
NORTHEAST BANCORP /ME/ (Form: 10-Q, Received: 11/14/2011 16:34:16)
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 September 30, 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   x      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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of November 11, 2011, the registrant had outstanding 3,312,173 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

  
  

Item 1.

  

Financial Statements (Unaudited)

   3
     

Consolidated Balance Sheets (Unaudited)

September 30, 2011 and June 30, 2011

   3
     

Consolidated Statements of Income (Unaudited)
Three Months Ended September  30, 2011
Three Months Ended September 30, 2010

   4
     

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
Three Months Ended September 30, 2011
Three Months Ended September 30, 2010

   5
     

Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended September  30, 2011
Three Months Ended September 30, 2010

   7
     

Notes to Unaudited Consolidated Financial Statements (Unaudited)

   8
  

Item 2.

  

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

   26
  

Item 3.

  

Quantitative and Qualitative Disclosure about Market Risk

   39
  

Item 4.

  

Controls and Procedures

   39

Part II.

  

Other Information

  
  

Item 1.

  

Legal Proceedings

   40
  

Item 1A.

  

Risk Factors

   40
  

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   40
  

Item 3.

  

Defaults Upon Senior Securities

   40
  

Item 4.

  

[Removed and Reserved]

   40
  

Item 5.

  

Other Information

   40
  

Item 6.

  

Exhibits

   40

 

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Table of Contents

PART 1 – FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

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

 

     September 30, 2011     June 30, 2011  

Assets

    

Cash and due from banks

   $ 3,517      $ 3,227   

Short-term investments

     76,281        80,704   
  

 

 

   

 

 

 

Total cash and cash equivalents

     79,798        83,931   

Available-for-sale securities, at fair value

     143,229        148,962   

Loans held-for-sale

     6,405        5,176   

Loans receivable

    

Residential real estate

     94,037        95,417   

Commercial real estate

     130,422        117,761   

Construction

     2,079        2,015   

Commercial business

     20,576        22,225   

Consumer

     69,302        72,495   
  

 

 

   

 

 

 

Total loans, gross

     316,416        309,913   

Less allowance for loan losses

     710        437   
  

 

 

   

 

 

 

Loans, net

     315,706        309,476   

Premises and equipment, net

     8,396        8,271   

Acquired assets, net

     463        690   

Accrued interest receivable

     1,566        1,244   

Federal Home Loan Bank stock, at cost

     4,889        4,889   

Federal Reserve Bank stock, at cost

     871        871   

Intangible assets, net

     5,348        13,133   

Bank owned life insurance

     13,921        13,794   

Other assets

     6,621        5,956   
  

 

 

   

 

 

 

Total assets

   $ 587,213      $ 596,393   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Liabilities:

    

Deposits

    

Demand

   $ 45,361     $ 48,215  

Savings and interest checking

     87,488       89,804  

Money market

     44,914       48,695  

Brokered time deposits

     4,915       4,924  

Certificates of deposit

     211,055       209,480  
  

 

 

   

 

 

 

Total deposits

     393,733       401,118  

Federal Home Loan Bank advances

     43,803       43,922  

Structured repurchase agreements

     67,548       68,008  

Short-term borrowings

     1,009       2,515  

Junior subordinated debentures issued to affiliated trusts

     7,992       7,957  

Capital lease obligation

     2,035       2,075  

Other borrowings

     0       2,229  

Other liabilities

     4,905       3,615  
  

 

 

   

 

 

 

Total liabilities

     521,025       531,439  
  

 

 

   

 

 

 

Commitments and contingent liabilities

    

Stockholders’ equity

    

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

     4       4  

Voting common stock, $1.00 par value, 13,500,000 shares authorized; 3,312,173 issued and outstanding at September 30, 2011 and June 30, 2011, respectively

     3,312       3,312  

Non-voting common stock, $1.00 par value, 1,500,000 shares authorized 195,351 issued and outstanding at September 30, 2011 and June 30, 2011, respectively

     195       195  

Warrants

     406       406  

Additional paid-in capital

     49,841       49,700  

Unearned restricted stock award

     (154     (163

Retained earnings

     11,841       11,726  

Accumulated other comprehensive income (loss)

     743       (226
  

 

 

   

 

 

 

Total stockholders’ equity

     66,188       64,954  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 587,213     $ 596,393   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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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
September 30, 2011
          Three Months Ended
September 30, 2010
 

Interest and dividend income:

        

Interest on loans

   $ 5,137         $ 5,742   

Taxable interest on available-for-sale securities

     636           1,544   

Tax-exempt interest on available-for-sale securities

     0           118   

Dividends on available-for-sale securities

     3           9   

Dividends on Federal Home Loan Bank and Federal Reserve Bank stock

     12           9   

Other interest and dividend income

     47           12   
  

 

 

       

 

 

 

Total interest and dividend income

     5,835           7,434   
  

 

 

       

 

 

 
 

Interest expense:

        

Deposits

     837           1,523   

Federal Home Loan Bank advances

     258           466   

Structured repurchase agreements

     248           708   

Short-term borrowings

     5           171   

Junior subordinated debentures issued to affiliated trusts

     183           173   

Obligation under capital lease agreements

     26           28   
  

 

 

       

 

 

 

Total interest expense

     1,557           3,069   
  

 

 

       

 

 

 
 

Net interest and dividend income before provision for loan losses

     4,278           4,365   
 

Provision for loan losses

     400           459   
  

 

 

       

 

 

 

Net interest and dividend income after provision for loan losses

     3,878           3,906   
  

 

 

       

 

 

 
 

Noninterest income:

        

Fees for other services to customers

     340           367   

Net securities (losses) gains

     (53         12   

Gain on sales of loans

     656           948   

Investment commissions

     687           548   

Bank owned life insurance (“BOLI”) income

     127           127   

Other income

     21           73   
  

 

 

       

 

 

 

Total noninterest income

     1,778           2,075   
  

 

 

       

 

 

 
 

Noninterest expense:

        

Salaries and employee benefits

     3,717           2,456   

Occupancy and equipment expense

     849           678   

Professional fees

     415           228   

Data processing fees

     274           270   

FDIC insurance premiums

     117            176   

Intangible assets amortization

     336           0   

Merger expense

     0           72   

Other

     945           830   
  

 

 

       

 

 

 

Total noninterest expense

     6,653           4,710   
  

 

 

       

 

 

 
 

(Loss) income from continuing operations before income tax (benefit) expense

     (997 )         1,271   

Income tax (benefit) expense

     (403 )         387   
  

 

 

       

 

 

 
 

Net (loss) income from continuing operations

   $ (594 )       $ 884   
  

 

 

       

 

 

 
 

Discontinued operations (Note 10)

        

Income from discontinued operations

     186           118   

Gain on sale of discontinued operations

     1,529           0   

Income tax expense

     592           41   
  

 

 

       

 

 

 

Net income from discontinued operations

     1,123           77   
  

 

 

       

 

 

 

Net income

   $ 529         $ 961   
  

 

 

       

 

 

 
        

Net income available to common stockholders

   $ 431         $ 900   
  

 

 

       

 

 

 
 

Weighted-average shares outstanding

        

Basic

     3,494,498           2,329,098   

Diluted

     3,513,545           2,349,115   

Earnings per common share:

        

Basic

        

(Loss) income from continuing operations

   $ (0.13       $ 0.36   

Income from discontinued operations

     0.25           0.03   
  

 

 

       

 

 

 

Net income

   $ 0.12         $ 0.39   
  

 

 

       

 

 

 
 

Diluted

        

(Loss) income from continuing operations

   $ (0.13       $ 0.35   

Income from discontinued operations

     0.25           0.03   
  

 

 

       

 

 

 

Net income

   $ 0.12         $ 0.38   
  

 

 

       

 

 

 

 

(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.

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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Table of Contents

NORTHEAST BANCORP AND SUBSIDIARY

Consolidated Statements of Changes in Stockholders’ Equity

Periods Ended September 30, 2011, and 2010

(Unaudited)

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

 

    Preferred Stock     Common Stock           Additional
Paid-in
    Unearned
Restricted
    Retained     Accumulated
Other
Comprehensive
       
Predecessor Company (2)   Shares     Amount     Shares     Amount     Warrants     Capital     Stock     Earnings     Income     Total  

Balance at June 30, 2010

    4,227      $ 4        2,323,832      $ 2,324      $ 133      $ 6,761      $ 0      $ 37,338     $ 4,346     $ 50,906  

Net income for three months ended Sept. 30, 2010

    0        0        0        0        0        0        0        961       0       961  

Other comprehensive income net of tax:

                   

Net unrealized loss on purchased interest rate caps and swap

    0        0        0        0        0        0        0        0       (199     (199

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

    0        0        0        0        0        0        0        0       (207     (207
                   

 

 

 

Total comprehensive income

                      555  

Dividends on preferred stock

    0        0        0        0        0        0        0        (53     0       (53

Dividends on common stock at $0.09 per share

    0        0          0        0        0        0        (210     0       (210

Stock options exercised

    0        0        7,500        7        0        54        0        0       0       61  

Accretion of preferred stock

    0        0        0        0        0        8        0        (8     0       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2010

    4,227      $ 4        2,331,332      $ 2,331      $ 133      $ 6,823      $ 0      $ 38,028     $ 3,940     $ 51,259  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

NORTHEAST BANCORP AND SUBSIDIARY

Consolidated Statements of Changes in Stockholders’ Equity

Periods Ended September 30, 2011, and 2010

(Unaudited)

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

 

    Preferred Stock     Common Stock           Additional
Paid-in
    Unearned
Restricted
    Retained     Accumulated
Other
Comprehensive
       
Successor Company (1)   Shares     Amount     Shares     Amount     Warrants     Capital     Stock     Earnings     Income (loss)     Total  

Balance at June 30, 2011

    4,227      $ 4        3,507,524      $ 3,507      $ 406      $ 49,700      $ (163   $ 11,726     $ (226 )   $ 64,954  

Net income for three months ended Sept. 30, 2011

    0        0        0        0        0        0        0        529       0       529  

Other comprehensive income net of tax:

                   

Net unrealized loss on purchased interest rate caps and swap

    0        0        0        0        0        0        0        0       (145     (145

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

    0        0        0        0        0        0        0        0       1,114       1,114  
                   

 

 

 

Total comprehensive income

                      1,498  

Dividends on preferred stock

    0        0        0        0        0        0        0        (53     0       (53

Dividends on common stock at $0.09 per share

    0        0        0        0        0        0        0        (316     0       (316

Stock-based compensation

    0        0        0        0        0        96        9        0       0       105  

Accretion of preferred stock

    0        0        0        0        0        45        0        (45     0       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

    4,227      $ 4        3,507,524      $ 3,507      $ 406      $ 49,841      $ (154   $ 11,841     $ 743      $ 66,188   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(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.

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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Table of Contents

NORTHEAST BANCORP AND SUBSIDIARY

Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

 

     Successor Company (1)            Predecessor Company (2)  
     Three Months Ended
September 30, 2011
           Three Months Ended
September 30, 2010
 

Cash flows from operating activities:

         

Net income

   $ 529          $ 961  

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

         

Provision for loan losses

     400            459  

Provision for real estate owned (“REO”) and acquired assets

     78            150  

Provision made for deferred compensation

     37            52  

Accretion of fair value adjustments for loans, deposits, and borrowings, net

     (1,274          0  

Amortization of intangible assets

     406            175  

BOLI income, net

     (127          (127

Depreciation of premises and equipment

     304            260  

Loss on sale of premises and equipment

     25            0  

Net loss (gain) on sale of available-for-sale securities

     53            (12

Stock-based compensation

     105             0   

Net gain on sale of insurance business

     (1,529          0  

Net change in loans held-for-sale

     (1,229          8,518  

Net amortization of securities

     373            31  

Change in other assets and liabilities:

         

Interest receivable

     (322          89  

Decrease in prepayment FDIC assessment

     116            125  

Other assets and liabilities

     (909          43  
  

 

 

        

 

 

 

Net cash (used in) provided by operating activities

     (2,964          10,724  
  

 

 

        

 

 

 
 

Cash flows from investing activities:

         

Proceeds from the sales of available-for-sale securities

     606             41  

Purchases of available-for-sale securities

     0            (5,001

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

     6,390            11,792  

Loan purchases

     (11,428          0   

Loan originations and principal collections, net

     4,973             3,351  

Purchases of premises and equipment

     (611          (261

Proceeds from sales of premises and equipment

     0            29  

Proceeds from sales of acquired assets

     329            347  

Proceeds from sale of insurance business

     9,726            0  
  

 

 

        

 

 

 

Net cash provided by investing activities

     9,985             10,298  
  

 

 

        

 

 

 
 

Cash flows from financing activities:

         

Net decrease in deposits

     (7,013          (1,183

Net (decrease) increase in short-term borrowings

     (1,506          7,610  

Dividends paid on preferred stock

     (53          (53

Dividends paid on common stock

     (316          (210

Issuance of common stock

     0            62  

Repayment of other borrowings

     (2,226          (121

Repayment on capital lease obligation

     (40          (38
  

 

 

        

 

 

 

Net cash (used in) provided by financing activities

     (11,154          6,067  
  

 

 

        

 

 

 
 

Net (decrease) increase in cash and cash equivalents

     (4,133          27,089  
 

Cash and cash equivalents, beginning of period

     83,931            20,436  
  

 

 

        

 

 

 

Cash and cash equivalents, end of period

   $ 79,798          $ 47,525  
  

 

 

        

 

 

 
 

Supplemental schedule of cash flow information:

         

Interest paid

   $ 1,656          $ 3,096  

Income taxes paid

     140            0  
 

Supplemental schedule of noncash investing and financing activities:

         

Transfer from loans to acquired assets

   $ 180          $ 179  

Transfer from acquired assets to loans

     0            56  

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

     1,114            (407

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

     (574          210  

 

(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.

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

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NORTHEAST BANCORP AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

September 30, 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 September 30, 2011, the results of operations for the three-month periods ended September 30, 2011 and 2010, the changes in stockholders’ equity for the three-month periods ended September 30, 2011 and 2010, and the cash flows for the three month periods ended September 30, 2011and 2010. Operating results for the three-month period ended September 30, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2012. For further information, refer to the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2011 included in the Company’s Annual Report on Form 10-K.

 

2. Merger Transaction

On December 29, 2010, FHB Formation LLC (“FHB”) merged with and into Northeast, with Northeast as the surviving company (the “Merger”) 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.

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 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 Company’s articles of incorporation were amended on March 21, 2011.

 

   

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

Through the period ended September 30, 2011, the Company’s lending activities were predominantly conducted in south-central and western Maine and south-eastern New Hampshire. In its Maine and New Hampshire market areas, the Company originates single-family

 

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and multi-family residential loans, commercial real estate loans, commercial business loans and a variety of consumer loans. In addition, the Company originates loans for the construction of residential homes, multi-family properties, commercial real estate properties and for land development. The majority of loans originated by the Company are collateralized by real estate. The ability and willingness of residential and commercial real estate, commercial business and construction loan borrowers to honor their repayment commitments is generally dependent on the health of the real estate sector in the borrowers’ geographic area and/or the general economy. In the fourth quarter of the fiscal year ended June 30, 2011 (“Fiscal 2011”), the Bank launched its Loan Acquisition and Servicing Group from its recently-opened office in Boston, Massachusetts. The Bank’s loan purchasing business consists primarily of acquiring loans at a discount from their outstanding principal balances. These loans are generally secured by commercial real estate, multi-family residential real estate and other business assets and are purchased from sellers nationwide in the financial services industry or government agencies. At September 30, 2011, the Loan Acquisition and Servicing Group purchased loan balances outstanding totaled $12.3 million. In the future the Bank intends to grow this segment of its loan portfolio, both in absolute terms and as a percentage of its total loan portfolio.

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 loans 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. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

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 business and consumer. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies; trends in volumes 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 during the quarter ended September 30, 2011.

The qualitative factors are determined based on the various risk characteristic 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 grant 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.

Commercial real estate: At September 30, 2011, loans in this segment are primarily income-producing properties throughout Maine. In the future, the Bank intends to grow its loan purchasing business, through which it acquires loans from sellers nationwide. The underlying cash flows generated by the properties are 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 periodically obtains rent rolls and continually monitors the cash flows of these loans.

Construction loans: Loans in this segment are for owner-occupied real estate for which payment is derived from ongoing rentals or operations. Credit risk is affected by cost overruns and market conditions.

Commercial business 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 in the credit quality in this segment.

Consumer loans: Loans in this segment are generally secured and repayment is dependent on the credit quality of the individual borrower.

 

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Table of Contents

Allocated Component:

The allocated components relate to loans that are classified as impaired. Impairment is measured on a loan-by-loan basis for commercial business, 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 that 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 the 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 loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring (“TDR”). All TDRs are 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 portfolio.

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

 

     September 30, 2011      June 30, 2011  
     (Dollars in thousands)  

Residential real estate:

  

1-4 family

   $ 94,037       $ 95,417   

Second mortgages

     22,959         24,190   

Equity lines of credit

     25,405         25,870   

Commercial real estate

     130,422         117,761   

Construction

     2,079         2,015   
  

 

 

    

 

 

 

Total mortgage loans on real estate

     274,902         265,253   

Commercial business

     20,576         22,225   

Consumer

     20,938         22,435   
  

 

 

    

 

 

 

Total loans

     316,416         309,913   

Less: Allowance for loan losses

     710         437   
  

 

 

    

 

 

 

Loans, net

   $ 315,706       $ 309,476   
  

 

 

    

 

 

 

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

Successor Company

For the three months ended September 30, 2011:

 

     Residential
Real Estate
     Commercial
Real Estate
    Construction      Commercial
Business
     Consumer      Total  
     (Dollars in thousands)  

Balance at beginning of the period

   $ 34       $ 147     $ 0       $ 238       $ 18       $ 437   

Provision (benefit) charged to operations

     114         (9     0         158         137         400   

Add recoveries on loans previously

charged off

     0         0       0         22         15         37   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
     148         138       0         418         170         874   

Less loans charged off

     24         24       0         0         116         164   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of the period

   $ 124       $ 114     $ 0       $ 418       $ 54       $ 710   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Predecessor Company

For the three months ended September 30, 2010:

 

     Residential
Real Estate
    Commercial
Real Estate
     Construction     Commercial
Business
     Consumer     Total  
     (Dollars in thousands)  

Balance at beginning of the period

   $ 1,564     $ 1,412       $ 50     $ 1,051       $ 1,729     $ 5,806   

Provision (benefit) charged to operations

     (132     795         (50     113         (267     459   

Add recoveries on loans previously charged off

     0       1         0       1         14       16   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 
     1,432       2,208         0       1,165         1,476       6,281   

Less loans charged off

     61       134         0       80         144       419   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Balance at end of the period

   $ 1,371     $ 2,074       $ 0     $ 1,085       $ 1,332     $ 5,862   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

The following table sets forth information regarding the allowance for loan losses by portfolio segment as of September 30, 2011:

 

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

Allowance for loan losses:

                    

Individually evaluated for impairment

   $ 71       $ 69       $ 0       $ 231       $ 36       $ 0       $ 407   

Collectively evaluated for impairment

     53         45         0         187         18         0         303   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total allowance for loan losses

   $ 124       $ 114       $ 0       $ 418       $ 54       $ 0       $ 710   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                    

Individually evaluated for impairment

   $ 948       $ 1,031       $ 0       $ 916       $ 92       $ 0       $ 2,987   

Collectively evaluated for impairment

     141,453         129,391         2,079         19,660         20,846         0         313,429   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total allowance for loan losses

   $ 142,401       $ 130,422       $ 2,079       $ 20,576       $ 20,938       $ 0       $ 316,416   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth information regarding the allowance for loan losses by portfolio segment as of June 30, 2011:

 

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

Allowance for loan losses:

                    

Individually evaluated for impairment

   $ 0       $ 119       $ 0       $ 196       $ 0       $ 0       $ 315   

Collectively evaluated for impairment

     34         28         0         42         18         0         122   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total allowance for loan losses

   $ 34       $ 147       $ 0       $ 238       $ 18       $ 0       $ 437   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                    

Individually evaluated for impairment

   $ 0       $ 1,221       $ 0       $ 1,922       $ 0       $ 0       $ 3,143   

Collectively evaluated for impairment

     145,477         116,540         2,015         20,303         22,435         0         306,770   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total allowance for loan losses

   $ 145,477       $ 117,761       $ 2,015       $ 22,225       $ 22,435       $ 0       $ 309,913   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following is a summary of past due and non-accrual loans at September 30, 2011:

 

     30-59
Days
     60-89
Days
     Past Due
90 Days or
More-Still
Accruing
     Past Due
90 Days or
More-
Nonaccrual
     Total
Past
Due
     Total
Current
     Total
Loans
     Non-
Accrual
Loans
 
     (Dollars in thousands)  

Residential Real Estate:

                       

Residential 1-4 family

   $ 402       $ 559       $ 0       $ 2,323       $ 3,284       $ 90,753       $ 94,037       $ 2,733   

Second mortgages

     81         141         0         89         311         22,648         22,959         158   

Equity lines of credit

     0         0         0         47         47         25,358         25,405         47   

Commercial real estate

     375         24         0         384         783         129,639         130,422         2,797   

Construction

     0         0         0         121         121         1,958         2,079         121   

Commercial business

     124         0         0         932         1,056         19,520         20,576         1,224   

Consumer

     762         277         0         306         1,345         19,593         20,938         356   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,744       $ 1,001       $ 0       $ 4,202       $ 6,947       $ 309,469       $ 316,416       $ 7,436   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The following is a summary of past due and non-accrual loans at June 30, 2011:

 

     30-59
Days
     60-89
Days
     Past Due
90 Days or
More-Still
Accruing
     Past Due
90 Days or
More-
Nonaccrual
     Total
Past
Due
     Total
Current
     Total
Loans
     Non-
Accrual
Loans
 
     (Dollars in thousands)  

Residential Real Estate:

                       

Residential 1-4 family

   $ 257       $ 1,021       $ 0       $ 1,779       $ 3,057       $ 92,360       $ 95,417       $ 2,195   

Second mortgages

     60         0         0         89         149         24,041         24,190         158   

Equity lines of credit

     57         0         0         0         57         25,813         25,870         47   

Commercial real estate

     0         492         0         934         1,426         116,335         117,761         3,601   

Construction

     0         0         0         121         121         1,894         2,015         121   

Commercial business

     4         75         751         416         1,246         20,979         22,225         559   

Consumer

     566         338         0         508         1,412         21,023         22,435         527   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 944       $ 1,926       $ 751       $ 3,847       $ 7,468       $ 302,445       $ 309,913       $ 7,208   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Nonaccrual commercial loans at September 30, 2011 and June 30, 2011 include $2.1 million and $1.1 million, respectively, that were current in both interest and principal payments at that date, but were not considered impaired.

The following table provides additional information on impaired loans at September 30, 2011:

 

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

Impaired loans without a valuation allowance:

        

Residential real estate:

        

Residential 1-4 family

   $ 0       $ 0       $ 0   

Commercial real estate

     683         683         0   

Commercial business

     201         201         0   
  

 

 

    

 

 

    

 

 

 

Total

     884         884         0   

Impaired loans with a valuation allowance:

        

Residential real estate:

        

Residential 1-4 family

     146         146         4   

Commercial real estate

     348         348         69   

Commercial business

     715         715         231   
  

 

 

    

 

 

    

 

 

 

Total

     1,209         1,209         304   
  

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 2,093       $ 2,093       $ 304   
  

 

 

    

 

 

    

 

 

 

 

(1) Impaired loans are presented net of the fair value adjustments of $693 thousand resulting from the application of the acquisition method of accounting in connection with the Merger on December 29, 2010.

The following table provides additional information on impaired loans at June 30, 2011:

 

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

Impaired loans without a valuation allowance:

        

Commercial real estate

   $ 348       $ 348       $ 0   

Commercial business

     1,054         1,054         0   
  

 

 

    

 

 

    

 

 

 

Total

     1,402         1,402         0   

Impaired loans with a valuation allowance:

        

Commercial real estate

     873         873         119   

Commercial business

     868         868         196   
  

 

 

    

 

 

    

 

 

 

Total

     1,741         1,741         315   
  

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 3,143       $ 3,143       $ 315   
  

 

 

    

 

 

    

 

 

 

 

(1) Impaired loans are presented net of the fair value adjustments of $975 thousand resulting from the application of the acquisition method of accounting in connection with the Merger on December 29, 2010.

 

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Table of Contents

The following is a summary of information pertaining to impaired loans at September 30, 2011:

 

     Successor Company             Predecessor Company  
     Three Months Ended
September 30, 2011
            Three Months Ended
September 30, 2010
 
     (Dollars in thousands)  

Average investment in impaired loans:

          

Residential 1-4 family

   $ 49            $ 310   

Commercial real estate

     1,846              3,158   

Commercial business

     1,090              1,437   
  

 

 

         

 

 

 

Total average investment in impaired loans

   $ 2,985            $ 4,905   
  

 

 

         

 

 

 
 

Interest income recognized on impaired loans:

          

Residential 1-4 family

   $ 1            $ 1   

Commercial real estate

     21              39   

Commercial business

     4              11   
  

 

 

         

 

 

 

Total interest income recognized on impaired loans:

   $ 26            $ 51   
  

 

 

         

 

 

 
 

Interest income recognized on a cash basis:

          

On impaired loans:

          

Residential 1-4 family

   $ 1            $ 1   

Commercial real estate

     21              39   

Commercial business

     4              11   
  

 

 

         

 

 

 

Total interest income recognized a cash basis on impaired loans

   $ 26            $ 51   
  

 

 

         

 

 

 

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 business 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.

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 business 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.

 

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Table of Contents

The following table presents the Company’s loans by risk rating at September 30, 2011.

 

     Commercial
Real Estate
     Construction      Commercial
Business
 
     (Dollars in thousands)  

Loans rated 1-4

   $ 122,379       $ 2,079       $ 16,951   

Loans rated 5

     1,727         0         713   

Loans rated 6

     6,316         0         2,912   

Loans rated 7

     0         0         0   

Loans rated 8

     0         0         0   
  

 

 

    

 

 

    

 

 

 
   $ 130,422       $ 2,079       $ 20,576   
  

 

 

    

 

 

    

 

 

 

The following table presents the Company’s loans by risk rating at June 30, 2011.

 

     Commercial
Real Estate
     Construction      Commercial
Business
 
     (Dollars in thousands)  

Loans rated 1-4

   $ 107,354       $ 2,015       $ 18,201   

Loans rated 5

     3,133         0         1,169   

Loans rated 6

     7,274         0         2,855   

Loans rated 7

     0         0         0   

Loans rated 8

     0         0         0   
  

 

 

    

 

 

    

 

 

 
   $ 117,761       $ 2,015       $ 22,225   
  

 

 

    

 

 

    

 

 

 

There were no restructured loans during the three months ended September 30, 2011, or restructured loans prior to the quarter but in default.

 

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 September 30, 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

   Carrying
Amount
     Principal
Amount
Due
     Contractual
Interest
Rate
    Maturity Date  
     (Dollars in thousands)  

NBN Capital Trust II

   $ 1,728       $ 3,093         3.17     March 30, 2034  

NBN Capital Trust III

     1,728         3,093         3.17     March 30, 2034  

NBN Capital Trust IV

     4,536         10,310         2.19     February 23, 2035  
  

 

 

    

 

 

      

Total

   $ 7,992       $ 16,496         2.56  
  

 

 

    

 

 

      

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 3.17% 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 2.19% 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 contractual rates and the impact of the interest rate swap referred to below, the annual interest expense on the trust preferred securities is approximately $680 thousand.

In the fiscal year 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 the Company’s 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 September 30, 2011 and June 30, 2011 are summarized below:

 

     September 30, 2011      June 30, 2011  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (Dollars in thousands)  

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

   $ 46,077       $ 46,139       $ 48,827       $ 48,737   

Mortgage-backed securities

     95,624         97,090         99,637         99,558   

Equity securities

     0         0         193         216   

Trust preferred securities

     0         0         466         451   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 141,701       $ 143,229       $ 149,123       $ 148,962   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

 

     September 30, 2011      June 30, 2011  
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
 
     (Dollars in thousands)  

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

   $ 63       $ 1       $ 7       $ 97   

Mortgage-backed securities

     1,467         1         212         291   

Equity securities

     0         0         23         0   

Trust preferred securities

     0         0         8         23   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,530       $ 2       $ 250       $ 411   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table summarizes gains and losses on available-for-sale securities for the three months ended September 30, 2011 and 2010.

 

     Successor Company            Predecessor Company  
     Three Months Ended
September 30, 2011
           Three Months Ended
September 30, 2010
 
     (Dollars in thousands)  

Proceeds from the sales of available-for-sale securities:

   $ 606          $ 1,075   

Realized gains

   $ 14          $ 12   

Realized losses

     (67          0   
  

 

 

        

 

 

 

Net (loss) gain

   $ (53        $ 12   

Net (loss) gain after income tax

   $ (35        $ 8   

 

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Table of Contents

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 September 30, 2011 and June 30, 2011:

 

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

September 30, 2011:

  

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

   $ 3,028       $ 1       $ 0       $ 0       $ 3,028       $ 1   

Mortgage-backed securities

     190         1         0         0         190         1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 3,218       $ 2       $ 0       $ 0       $ 3,218       $ 2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     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, 2011:

  

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

   $ 46,130       $ 97       $ 0       $ 0       $ 46,130       $ 97   

Mortgage-backed securities

     51,367         291         0         0         51,367         291   

Trust preferred securities

     174         23         0         0         174         23   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 97,671       $ 411       $ 0       $ 0       $ 97,671       $ 411   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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, 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 were other-than-temporarily impaired at September 30, 2011.

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 .”

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 three months ended September 30, 2011 or 2010.

The amortized cost and fair values of available-for-sale debt securities at September 30, 2011 and June 30, 2011, 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.

 

     September 30, 2011      June 30, 2011  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (Dollars in thousands)  

Due after one year through five years

   $ 46,077       $ 46,139       $ 48,827       $ 48,737   

Due after five years through ten years

     0         0         0         0   

Due after ten years

     0         0         466         451   
  

 

 

    

 

 

    

 

 

    

 

 

 
     46,077         46,139         49,293         49,188   

Mortgage-backed securities

     95,624         97,090         99,637         99,558   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 141,701       $ 143,229       $ 148,930       $ 148,746   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

6. Advances from the Federal Home Loan Bank

A summary of borrowings from the Federal Home Loan Bank (“FHLB”) is as follows:

 

September 30, 2011

Carrying
Amount

     Principal
Amounts
Due
     Contractual
Interest Rates
  Maturity Dates
(Dollars in thousands)           
  $15,386       $ 15,000       2.55% – 3.99%   2013
  5,131         5,000       3.08%   2014
  7,674         7,500       2.91% – 3.05%   2015
  10,446         10,000       4.26%   2017
  5,166         5,000       4.29%   2018

 

 

    

 

 

      
  $43,803       $ 42,500        

 

 

    

 

 

      

 

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Table of Contents

June 30, 2011

Carrying
Amount

     Principal
Amounts
Due
     Contractual
Interest Rates
  Maturity Dates
(Dollars in thousands)           
  $15,450       $ 15,000       2.55% – 3.99%   2013
  12,831         12,500       2.91% – 3.08%   2015
  10,468         10,000       4.26%   2017
  5,173         5,000       4.29%   2018

 

 

    

 

 

      
  $43,922       $ 42,500        

 

 

    

 

 

      

The FHLB had the option to call $25 million of the outstanding advances at September 30, 2011. The options are continuously callable quarterly until maturity.

 

7. Structured Repurchase Agreements

A summary of outstanding structured repurchase agreements is as follows:

 

September 30, 2011

Carrying
Amount

     Principal
Amounts
Due
     Contractual
Interest
Rate
    Embedded
Cap/Floor
   Amount of
Cap/Floor
     Strike Rate   Maturity
(Dollars in thousands)
  $20,668       $ 20,000         4.68   Purchased Caps    $ 40,000       Expired   August 28, 2012
  10,271         10,000         3.98   Sold Floors      20,000       Expired   August 28, 2012
  10,364         10,000         4.18   Purchased Caps      10,000       Expired   December 13, 2012
  10,485         10,000         4.30   Purchased Caps      10,000       Expired   July 3, 2013
  10,646         10,000         4.44   Purchased Caps      10,000       3.81%   September 23, 2015
  5,114         5,000         2.86   None         March 25, 2014

 

 

    

 

 

              
  $67,548       $ 65,000                

 

 

    

 

 

              

 

June 30, 2011

Carrying

Amount

     Principal
Amounts
Due
     Contractual
Interest
Rate
    Embedded
Cap/Floor
   Amount of
Cap/Floor
     Strike Rate   Maturity
(Dollars in thousands)
  $20,854       $ 20,000         4.68   Purchased Caps    $ 40,000       Expired   August 28, 2012
  10,346         10,000         3.98   Sold Floors      20,000       Expired   August 28, 2012
  10,441         10,000         4.18   Purchased Caps      10,000       Expired   December 13, 2012
  10,555         10,000         4.30   Purchased Caps      10,000       3.79%   July 3, 2013
  10,686         10,000         4.44   Purchased Caps      10,000       3.81%   September 23, 2015
  5,126         5,000         2.86   None         March 25, 2014

 

 

    

 

 

              
  $68,008       $ 65,000                

 

 

    

 

 

              

These structured repurchased agreements incorporate embedded interest rate caps as summarized in the table above. The interest rate caps reduced the Company’s balance sheet exposure to rising interest rates. For the structured repurchase agreements maturing July 3, 2013 and September 23, 2015, each agreement can be called quarterly after the expiration of the non-call period. The transaction in March 2009, which did not have embedded 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 these 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.

 

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Table of Contents

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 $75.0 million and cash of $3.4 million as of September 30, 2011.

 

8. Stock-Based Compensation and Employee Benefits

A summary of the stock option activity for the three months ended September 30, 2011 and 2010 is as follows:

 

     Successor Company           Predecessor Company  
     September 30, 2011           September 30, 2010  
           Weighted                 Weighted  
           Average                 Average  
     Shares     Exercise Price           Shares     Exercise Price  

Outstanding at beginning of period

     764,549     $ 14.05            18,000     $ 11.08   

Granted

     0       0            0       0   

Exercised

     0       0            (7,500     8.25   

Forfeited

     (8,500     13.10            0       0   
  

 

 

         

 

 

   

Outstanding and at end of period

     756,049     $ 14.06            10,500     $ 13.10   
  

 

 

         

 

 

   

The following table summarizes information about stock option outstanding at September 30, 2011

 

            Options Outstanding  

Range of Exercise Prices

   Number
Outstanding at
September 30,
2011
     Weighted
Average
Remaining Life
     Weighted
Average
Exercise Price
 

$13.93-14.52

     756,049         9.3       $ 14.06   

The estimated amount and timing of future pre-tax stock-based compensation expense to be recognized are as follows for the years ending June 30:

 

(Dollars in thousands)    2012      2013      2014      2015      2016      2017      Total  

Stock Options

   $ 384       $ 384       $ 370       $ 351       $ 221       $ 48       $ 1,758   

Restricted Stock Award

     36         36         36         36         18         —           162   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 420       $ 420       $ 406       $ 387       $ 239       $ 48       $ 1,920   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2011, no stock options, resticted stock or performance-based stock appreciation rights were vested .

Refer to the Note 15 in the Company’s Annual Report on Form 10-K for fiscal year ended June 30, 2011 for further information about the Company’s employee benefits.

 

9. Capital Lease

In the fiscal year ended June 30, 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.

 

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Table of Contents

The future minimum lease payments over the remaining term of the lease and the outstanding capital lease obligations at September 30, 2011 are as follows:

 

(Dollars in thousands)  

2012

   $ 264   

2013

     264   

2014

     264   

2015

     271   

2016

     306   

2017 and thereafter

     1,174   
  

 

 

 

Total minimum lease payments

     2,543   

Less imputed interest

     508   
  

 

 

 

Capital lease obligation

   $ 2,035   
  

 

 

 

10.  Discontinued Operations

On August 31, 2011, the Company sold customer lists and certain fixed assets of its wholly-owned subsidiary, Northeast Bank Insurance Group, Inc (“NBIG”) to local insurance agencies in two separate transactions. The Varney Agency, Inc. of Bangor, Maine acquired nine agency locations including Anson, Auburn, Augusta, Bethel, Livermore Falls, Scarborough, South Paris, Thomaston and Turner, Maine. The Berwick, Maine agency office which will operate under the name of Spence & Matthews was acquired by Bradley Scott, a member of NBIG’s senior management team. The sale gain, net of income taxes, combined with the elimination of customer list and non-compete intangibles increased tangible equity by approximately $8.4 million. The following is a summary of the sale transaction:

 

     (Dollars in thousands)  

Sale proceeds

   $ 9,726   

Less:

  

Customer lists, net of accumulated amortization

     6,224   

Non-compete agreements, net of accumulated amortization

     1,155   

Fixed assets, net of accumulated depreciation

     157   

Severance and other direct expenses

     661   
  

 

 

 

Pre-tax gain recognized

   $ 1,529   
  

 

 

 

Operations associated with NBIG for the three months ended September 30, 2011 and 2010 have been classified as discontinued operations in the accompanying consolidated statements of income. The Company has eliminated all intercompany transactions in presenting discontinued operations for each period. Insurance commissions associated with NBIG were $965 thousand and $1.4 million for the three month period ending September 30, 2011 and 2010, respectively. Intangible and fixed assets associated with discontinued operations totaled approximately $7.4 million and $160 thousand, respectively, at June 30, 2011. In conjunction with the transaction, the Company repaid borrowings associated with NBIG totaling $2.2 million.

NBIG had previously sold customer lists and certain fixed assets of its agency offices in Jackman, Maine to Worldwide Risk Management, Inc. on December 22, 2010, in Rangeley, Maine to Morton & Furbish Insurance Agency on January 31, 2010, and in Mexico, Maine to UIG, Inc. on December 31, 2009.

 

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Table of Contents
11. Earnings Per Share (EPS)

EPS is computed by dividing net income allocated to common shareholders by the weighted average common shares outstanding. The following table shows the weighted average number of shares outstanding for the periods indicated. Shares issuable relative to stock options granted have been reflected as an increase in the shares outstanding used to calculate diluted EPS, after applying the treasury stock method. The number of shares outstanding for basic and diluted EPS is presented as follows:

 

     Successor Company            Predecessor Company  
     Three months ended
September 30, 2011
           Three months ended
September 30, 2010
 
     (Dollars in thousands, except per share amounts)  

Earnings per common share

         

Net Income

   $ 529          $ 961  

Preferred stock dividends

     (53          (53

Accretion of preferred stock

     (44          (7

Accretion of issuance costs

     (1          (1
  

 

 

        

 

 

 

Net income available to common shareholders

   $ 431          $ 900  

Dividends and undistributed earnings allocated to unvested shares of stock awards

     (1          0  
  

 

 

        

 

 

 

Net income applicable to common shareholders

   $ 430          $ 900  
  

 

 

        

 

 

 

Average common shares issued and outstanding

     3,494,498            2,329,098  
  

 

 

        

 

 

 

Earnings per common share

         

(Loss) income from continuing operations

   $ (0.13        $ 0.36   

Income from discontinued operations

     0.25            0.03   
  

 

 

        

 

 

 

Earnings per common share

   $ 0.12          $ 0.39   
  

 

 

        

 

 

 
 

Diluted earnings per Common share

         

Net income available to common shareholders

   $ 431          $ 900  

Dividends and undistributed earnings allocated to unvested shares of stock awards

     (1          0  
  

 

 

        

 

 

 

Net income applicable to common shareholders

   $ 430          $ 900  
  

 

 

        

 

 

 

Average common shares issued and outstanding

     3,494,498            2,329,098  

Diluted potential common shares

     19,047            20,017  
  

 

 

        

 

 

 

Total diluted average common shares issued and outstanding

     3,513,545            2,349,115  
  

 

 

        

 

 

 

Diluted earnings per common share

         

(Loss) income from continuing operations

   $ (0.13        $ 0.35   

Income from discontinued operations

     0.25            0.03   
  

 

 

        

 

 

 

Diluted earnings per common share

   $ 0.12          $ 0.38  
  

 

 

        

 

 

 

 

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.

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 September 30, 2011 and June 30, 2011.

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.

 

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Table of Contents

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 transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy during the three months ended September 30, 2011.

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

Assets Measured At Fair Value On A Recurring Basis

 

$ 48,737 $ 48,737 $ 48,737 $ 48,737
     Fair Value Measurements at Reporting Date Using:  
     Total      Quoted Price
in Active
Markets for
Identical
Assets Level 1
     Significant
Other
Observable
Inputs Level 2
     Significant
Unobservable
Inputs Level 3
 
     (Dollars in thousands)  

September 30, 2011:

  

Securities available-for-sale

           

Debt securities issued by U.S. Government sponsored enterprises

   $ 46,139       $ 0       $ 46,139       $ 0   

Mortgage-backed securities

     97,090         0         97,090         0   

Other assets – purchased interest rate caps

     13         0         13         0   

 

$ 48,737 $ 48,737 $ 48,737 $ 48,737
     Fair Value Measurements at Reporting Date Using:  
     Total      Quoted Price
in Active
Markets for
Identical
Assets Level 1
     Significant
Other
Observable
Inputs Level 2
     Significant
Unobservable
Inputs Level 3
 
     (Dollars in thousands)  

June 30, 2011:

  

Securities available-for-sale

           

Debt securities issued by U.S. Government sponsored enterprises

   $ 48,737       $ 0       $ 48,737       $ 0   

Mortgage-backed securities

     99,558         0         99,558         0   

Equity securities

     216         216         0         0   

Trust preferred securities

     451         451         0         0   

Other assets – purchased interest rate caps

     46         0         46         0   

Assets Measured At Fair Value On A Nonrecurring Basis

The Company’s impaired loans and acquired assets are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs based upon appraisals of similar properties obtained from a third party. For Level 3 input, collateral values are based on management’s estimates pending appraisals from third party valuation services or imminent sale of collateral.

 

$ 48,737 $ 48,737 $ 48,737 $ 48,737
     Fair Value Measurements at Reporting Date Using:  
     Total      Quoted Price
in Active
Markets for
Identical
Assets Level 1
     Significant
Other
Observable
Inputs Level 2
     Significant
Unobservable
Inputs Level 3
 
     (Dollars in thousands)  

September 30, 2011:

  

Impaired Loans

   $ 905       $ 0       $ 0       $ 905   

Acquired Assets

     463         0         0         463   

Premises

     358         0         0         358   

 

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$ 48,737 $ 48,737 $ 48,737 $ 48,737
     Fair Value Measurements at Reporting Date Using:  
     Total      Quoted Price
in Active
Markets for
Identical
Assets Level 1
     Significant
Other
Observable
Inputs Level 2
     Significant
Unobservable
Inputs Level 3
 
     (Dollars in thousands)  

June 30, 2011:

  

Impaired Loans

   $ 1,426       $ 0       $ 0       $ 1,426   

Acquired Assets

     690         0         0         690   

Premises

     361         0         0         361   

Liabilities Measured At Fair Value On A Recurring Basis

 

$ 48,737 $ 48,737 $ 48,737 $ 48,737
     Fair Value Measurements at Reporting Date Using:  
     Total      Quoted Price
in Active
Markets for
Identical
Assets Level 1
     Significant
Other
Observable
Inputs Level 2
     Significant
Unobservable
Inputs Level 3
 
     (Dollars in thousands)  

September 30, 2011:

  

Derivative financial instrument

   $ 699       $ 0       $ 0       $ 699   

 

$ 48,737 $ 48,737 $ 48,737 $ 48,737
     Fair Value Measurements at Reporting Date Using:  
     Total      Quoted Price
in Active
Markets for
Identical
Assets Level 1
     Significant
Other
Observable
Inputs Level 2
     Significant
Unobservable
Inputs Level 3
 
     (Dollars in thousands)  

June 30, 2011:

  

Derivative financial instrument

   $ 503       $ 0       $ 0       $ 503   

The following table shows the change in the fair value of derivative financial instruments measured on a recurring basis using significant unobservable inputs (Level 3) for the three months ended September 30, 2011.

 

(Dollars in thousands)       

Beginning balance at July 1

   $ 503   

Unrealized loss during three months ended September 30, 2011

     196   
  

 

 

 

Ending balance at September 30

   $ 699   
  

 

 

 

The Company’s derivative financial instruments are generally classified within level 3 of the fair value hierarchy. For these financial instruments the Company obtains fair value measurements from independent pricing services. The fair value measurements utilize a discounted cash flow model that incorporates and considers observable data that may include publicly available third party market quotes, in developing the curve utilized for discounting future cash flows.

Fair Value Estimates

Cash and Cash Equivalents - The fair value of cash, due from banks, interest bearing deposits and FHLB overnight deposits approximates their relative book values, as these financial instruments have short maturities.

Available-for-sale Securities - The fair value of available-for-sale securities is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers.

FHLB and Federal Reserve Stock - The carrying value of FHLB stock and Federal Reserve stock approximates fair value based on redemption provisions of the FHLB and the Federal Reserve.

Loans and Loans held-for-sale - Fair values are estimated for portfolios of loans with similar financial characteristics. The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimates of maturity are based on the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic conditions, lending conditions and the effects of estimated prepayments.

 

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Fair value for significant nonperforming loans is based on estimated cash flows and is discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are developed using available market information and historical information.

Management has made estimates of fair value using discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, management has no basis to determine whether the fair value presented would be indicative of the value negotiated in an actual sale.

The fair value of loans held-for-sale is estimated based on bid quotations received from loan dealers.

Interest Receivable - The fair value of this financial instrument approximates the book value as this financial instrument has a short maturity. It is the Company’s policy to stop accruing interest on loans past due by more than ninety days. Therefore, this financial instrument has been adjusted for estimated credit loss.

Derivative financial instruments : Fair value for interest rate caps and interest rate swap agreements are based upon the amounts required to settle the contracts.

Deposits - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW accounts and money market accounts, is equal to the amount payable on demand. The fair values of time deposits are based on the discounted value of contractual cash flows.

The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

The fair value estimates do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. If that value was considered, the fair value of the Company’s net assets could increase.

Borrowings - The fair value of the Company’s borrowings with the FHLB is estimated by discounting the cash flows through maturity or the next repricing date based on current rates available to the Company for borrowings with similar maturities. The fair value of the Company’s short-term borrowings, capital lease obligations, structured repurchase agreements and other borrowings is estimated by discounting the cash flows through maturity based on current rates available to the Company for borrowings with similar maturities.

Junior Subordinated Debentures - The fair value of the Junior Subordinated Debentures is estimated based on current interest rates.

Due-to-Broker - The fair value of due-to-broker approximates carrying value due to their short term nature.

Commitments to Originate Loans - The Company has not estimated the fair value of commitments to originate loans due to their short term nature and their relative immateriality.

Limitations - Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These values do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature, involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial instruments include the deferred tax asset, premises and equipment and intangible assets, including the customer base. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

 

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The following table presents the estimated fair value of the Company’s significant financial instruments at September 30, 2011 and June 30, 2011:

 

143,229 143,229 143,229 143,229
     September 30, 2011      June 30, 2011  
     Carrying
Value
     Estimated
Fair Value
     Carrying
Value
     Estimated
Fair Value
 
     (Dollars in thousands)  

Financial assets:

  

Cash and cash equivalents

   $ 79,798       $ 79,798       $ 83,931       $ 83,931   

Available-for-sale securities

     143,229         143,229         148,962         148,962   

Regulatory stock (FHLB and Federal Reserve Bank)

     5,760         5,760         5,760         5,760   

Loans held-for-sale

     6,405         6,446         5,176         5,209   

Loans, net

     315,706         322,730         309,476         316,361   

Accrued interest receivable

     1,566         1,566         1,244         1,244   

Other assets – purchased interest rate caps

     13         13         46         46   

Financial liabilities:

           

Deposits (with no stated maturity)

     177,763         177,763         186,714         186,714   

Time deposits

     215,970         218,350         214,404         216,767   

FHLB advances

     43,803         45,342         43,922         45,465   

Structured repurchase agreements

     67,548         68,895         68,008         69,364   

Other borrowings

     0         0         2,229         2,280   

Short-term borrowings

     1,009         1,009         2,515         2,515   

Capital lease obligation

     2,035         2,262         2,075         2,306   

Junior subordinated debentures issued to affiliated trusts

     7,992         8,014         7,957         7,979   

Other liabilities – interest rate swaps

     699         699         503         503   

 

13. Derivatives

The Company has stand alone derivative financial instruments in the form of interest rate caps which derive their value from a fee paid and are adjusted to fair value based on index and strike rate, and a swap agreement which derives its value from the underlying interest rate. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments and the value of the derivative are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Such differences, which represent the fair value of the derivative instruments, are reflected on the Company’s balance sheet as derivative assets and derivative liabilities.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and does not expect any counterparties to fail their obligations. The Company deals only with primary dealers.

Derivative instruments are generally negotiated over-the-counter contracts. Negotiated over-the-counter derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise prices and maturity.

Risk Management Policies – Hedging Instruments

The Company evaluates the effectiveness of entering into any derivative instrument agreement by measuring the cost of such an agreement in relation to the reduction in net income volatility within an assumed range of interest rates.

Interest Rate Risk Management – Cash Flow Hedging Instruments

The Company uses long-term variable rate debt as a source of funds for use in the Company’s lending and investment activities and other general business purposes. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore, generally hedges a portion of its variable-rate interest payments. To meet this objective, management enters into interest rate caps whereby the Company receives variable interest payments above a specified interest rate and swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments during the contract period.

At September 30, 2011, the information pertaining to outstanding interest rate caps and swap agreements used to hedge variable rate debt is as follows:

 

     Interest
Rate Caps
    Interest
Rate Swap
 

Notional amount (Dollars in thousands)

   $ 6,000     $ 10,000  

Weighted average pay rate

       4.69

Weighted average receive rate

       1.96

Strike rate based on 3 month LIBOR

     2.51  

Weighted average maturity in years

     3.00       3.42  

Unrealized gains (Dollars in thousands)

   $ 52     $ 253  

 

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The Company purchased two interest rate caps for $325 thousand which expire on September 30, 2014. The swap agreement provides for the Company to receive payments at a variable rate determined by a specified index (three month LIBOR) in exchange for making payments at a fixed rate.

During the three months ended September 30, 2011, no interest rate cap or swap agreements were terminated prior to maturity. At September 30, 2011, the unrealized loss relating to interest rate caps and swaps was recorded in derivative liabilities in accordance with ASC 815, “ Derivatives and Hedging .” Changes in the fair value of interest rate caps and swaps designated as hedging instruments of the variability of cash flows associated with long-term debt are reported in other comprehensive income. These amounts subsequently are reclassified into interest expense as a yield adjustment in the same period in which the related interest on the long-term debt affects earnings. None of the other comprehensive income was reclassified into interest expense during the three months ended September 30, 2011.

Risk management results for the three months ended September 30, 2011 related to the balance sheet hedging of long-term debt indicates that the hedges were 100% effective and that there was no component of the derivative instruments’ gain or loss which was excluded from the assessment of hedge effectiveness.

As of September 30, 2011, none of the losses reported in other comprehensive income related to the interest rate caps and swap agreements are expected to be reclassified into interest expense as a yield adjustment of the hedged borrowings during the three-months ended September 30, 2011.

 

September 30, 2011

   Liability Derivatives  
     (Dollars in thousands)  

Derivatives designated as hedging instruments under ASC 815:

     
       Balance Sheet Location    Fair Value  
   Other liabilities    $ 699   

 

June 30, 2011

   Liability Derivatives  
     (Dollars in thousands)  

Derivatives designated as hedging instruments under ASC 815:

     
       Balance Sheet Location    Fair Value  
   Other liabilities    $ 503   

See Note 7, Structured Repurchase Agreements, for additional information on purchased interest rate caps.

 

14. Recent Accounting Pronouncements

In April 2011, the FASB issued ASU 2011-02, “ A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. ” This ASU provides additional guidance or clarification to help creditors determine whether a restructuring constitutes a TDR. For public entities, the amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired, and should measure impairment on those receivables prospectively for the first interim or annual period beginning on or after June 15, 2011. Additional disclosures are also required under this ASU. The adoption of this ASU did not have a significant impa