Guest Post: Northeast Bank ($NBN) by Dave Anderson

[This guest post is by Dave Anderson who works for Anbec Partners, LP, which focuses on value and special situation investments. They are long shares of Northeast Bank.

Issues of the Oddball Stocks Newsletter will typically have a guest piece like this one. Try a sample of the Newsletter to see what it's like.]

Summary
Northeast Bank (NBN - $18.50) is an interesting opportunity at current prices due to its strong loan portfolio, capable underwriting, and a new income stream from a recent PPP relationship that is not reflected in its most recent earnings. While this is a summary write up, the company provides very useful information in their quarterly earnings presentations.

Despite its generic name, NBN is more than a sleepy regional bank. It is a sophisticated national player with strong capital allocators at the helm. The CEO, Rick Wayne, a skilled owner/operator, has an impressive track record purchasing loans in the secondary market and is committed to conservative underwriting standards. Board members include Chair Robert Glauber, the former Chairman and CEO of NASD (now FINRA), and Matthew Botein, the former co-head and Chief Investment Officer of BlackRock Alternative Investments.

While the stock has rebounded from a COVID-related decline, during which the Company re-purchased nearly 10% of the common stock, we believe there is still considerable long term value at current prices. And I believe that NBN is poised for strong earnings going forward given: (i) loan portfolio quality, (ii) insider purchases and share repurchases, (iii) balance sheet capacity to acquire and originate profitable new loans, and (iv) earnings from the new PPP loan relationship with Loan Source not yet reflected in financials.

Background
CEO Richard “Rick” Wayne co-founded Atlantic Bank & Trust Company in 1988. In 1993 the bank began purchasing quality assets in the secondary market, primarily from regulators who had taken over failed competitors. The strategy proved very successful. The bank went public in 1996, changed its name to Capital Crossing in 1999, and was ultimately acquired by Lehman in 2007 and surrendered its bank charter at that time.

In 2009 Wayne raised funds for FHB Formation, LLC with the intent of investing the capital in a financial institution. At the end of 2010, FHB Formation, LLC merged with Northeast Bancorp. NBN remained as the surviving entity. At the time, NBN was a sleepy community bank with ~$600M in total assets and net interest income of roughly $16M. The bank specialized in lending in its local region primarily in Maine. At 6/30/20 NBN had total assets of $1.3 billion, TTM net interest income of $60 million and a national loan footprint.

Today NBN operates three business segments: the Loan Acquisition and Servicing Group (“LASG”), Community Banking, and Small Business Administration (SBA) lending. LASG, which purchases and originates commercial real estate loans nationally, has historically been the earnings driver. But a new PPP/SBA business relationship with Loan Source, discussed in the 6/30/20 earnings call, could add meaningfully to future earnings.

Loan portfolio quality
In the 3/31/20 earnings call, management laid out the portfolio LTV and provided color on current reserves. Active insider purchasing in the spring (see below) would certainly seem to indicate their faith in the portfolio value.

Insider purchases and share repurchases
Insiders were active purchasers in March and April. Importantly, since May 2019 the Form 4s have been filed with the FDIC, not the SEC, making them less obvious to investors.

The Company aggressively repurchased common stock in late calendar Q1 and Q2 (NBN has a June 30 FY end) as shown below in the 6/30/20 investor deck provided by NBN.

Balance sheet capacity
As of 6/30/20, NBN has loan purchase/origination capacity of $500mm. If we assume NBN utilizes 50% of that capacity to add net new loans to the balance sheet, we get the following incremental net income. Note, this could be conservative given COVID-driven loan purchasing opportunities - see 3/31/20 earnings call comments from CEO:

In reviewing the historical growth of NBN’s LASG loan book note that, until recently, the bank had been constrained by certain capital requirements imposed by regulators at the time of NBN’s founding merger. After the 2019 corporate reorganization and a subsequent 2020 capital requirement change, NBN earning power has increased. As an example, prior to the 2019 reorg, Purchased Loans were limited to 40% of Total Loans. Post-reorg, that limit increased to 60% permitting NBN to bid more competitively while maintaining credit quality, according to the CEO.

In the 4/23/20 earnings call, Rick Wayne made the following comment:

“I'm pleased -- very pleased to report that the remaining regulatory conditions have been waived. The bank's Board has reduced the Tier 1 leverage ratio limit from 10% to 9% and the total capital ratio limit from 13.5% to 12%. The impact of this change is shown on Slide 4, where based on capital at March 31, loan capacity has increased by $143 million from $255 million to $398 million. With this change, we are now in conformity with the capital limits of many other banks, and we have additional capacity to prudently, and I say prudently, grow our balance sheet.”

New PPP loan relationship with Loan Source
In the 6/30/20 earnings call, management discussed their new relationship with Loan Source related to PPP loans. This relationship, in addition to providing meaningful one time gains (Fiscal Q4 2020) on sale of PPP loans (with potentially more to come), also includes ongoing servicing income (for the life of the PPP loans) and correspondent fees (to be amortized over the life of the loans). Other than the gain on sale, these components were not meaningfully reflected in the 6/30/20 earnings but will hit in the quarters to come and their impact is material:

Valuation Summary

Noteworthy Risks

• Reserves/LTV - Management gave a thoughtful response to an analyst’s question in the 3/31/20 earnings call regarding the values used in the LTV analysis shown above and NBN’s allowances for losses. You can see the detailed analysis here (as of 3/31/20) and additional portfolio data here (as of 6/30/20)
• Interest rate sensitivity
• New loans - how quickly can NBN appropriately deploy their capital. The CEO says he will not compromise on underwriting standards, and he does not have a history of write-downs.