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 December 31, 2018

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 ☑ No ___

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☑ No ___

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or an emerging growth company. See definition of “accelerated filer,” and “large accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ☐		Accelerated filer ☒

Non-accelerated filer ☐		Smaller reporting company ☒

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of February 1, 2019, the registrant had outstanding 8,227,945 shares of voting common stock, $1.00 par value per share and 811,946 shares of non-voting common stock, $1.00 par value per share.

Table of Contents

Part I.	Financial Information		3
	Item 1.	Financial Statements (Unaudited)	3
		Consolidated Balance Sheets December 31, 2018 and June 30, 2018	3

		Consolidated Statements of Income Three and Six Months Ended December 31, 2018 and 2017	4

		Consolidated Statements of Comprehensive Income Three and Six Months Ended December 31, 2018 and 2017	5

		Consolidated Statements of Changes in Shareholders' Equity Six Months Ended December 31, 2018 and 2017	6

		Consolidated Statements of Cash Flows Six Months Ended December 31, 2018 and 2017	7

		Notes to Unaudited Consolidated Financial Statements	8

	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	28

	Item 3.	Quantitative and Qualitative Disclosure about Market Risk	45

	Item 4.	Controls and Procedures	45

Part II.	Other Information		46

	Item 1.	Legal Proceedings	46

	Item 1A.	Risk Factors	46

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46

	Item 3.	Defaults Upon Senior Securities	46

	Item 4.	Mine Safety Disclosures	46

	Item 5.	Other Information	46

	Item 6.	Exhibits	46

		Signatures	47

Table of Contents

PART 1- FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

NORTHEAST BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share and per share data)
	December 31, 2018			June 30, 2018
Assets
Cash and due from banks	$	2,416		$	3,889
Short-term investments		135,200			153,513
Total cash and cash equivalents		137,616			157,402


Available-for-sale debt securities, at fair value		78,132			81,068
Equity securities, at fair value		6,711			6,619
Total investment securities		84,843			87,687

Residential real estate loans held for sale		1,510			3,405
SBA loans held for sale		289			3,750
Total loans held for sale		1,799			7,155

Loans:
Commercial real estate		633,439			579,450
Commercial and industrial		209,493			188,852
Residential real estate		92,566			100,256
Consumer		2,788			3,244
Total loans		938,286			871,802
Less: Allowance for loan losses		5,308			4,807
Loans, net		932,978			866,995


Premises and equipment, net		6,112			6,591
Real estate owned and other repossessed collateral, net		1,463			2,233
Federal Home Loan Bank stock, at cost		1,652			1,652
Intangible assets, net		649			867
Servicing rights, net		2,934			2,970
Bank-owned life insurance		16,839			16,620
Other assets		7,242			7,564
Total assets	$	1,194,127		$	1,157,736

Liabilities and Shareholders' Equity
Deposits:
Demand	$	68,324		$	72,272
Savings and interest checking		107,769			109,637
Money market		345,149			420,886
Time		464,349			352,145
Total deposits		985,591			954,940

Federal Home Loan Bank advances		15,000			15,000
Subordinated debt		24,128			23,958
Capital lease obligation		466			605
Other liabilities		20,451			24,803
Total liabilities		1,045,636			1,019,306

Commitments and contingencies		-			-


Shareholders' equity:
Preferred stock, $1.00 par value, 1,000,000 shares authorized; no shares issued and outstanding at December 31, 2018 and June 30, 2018		-			-
Voting common stock, $1.00 par value, 25,000,000 shares authorized; 8,236,917 and 8,056,527 shares issued and outstanding at December 31, 2018 and June 30, 2018, respectively		8,237			8,057
Non-voting common stock, $1.00 par value, 3,000,000 shares authorized; 811,946 and 882,314 shares issued and outstanding at December 31, 2018 and June 30, 2018, respectively		812			882
Additional paid-in capital		77,455			77,016
Retained earnings		63,535			54,236
Accumulated other comprehensive loss		(1,548	)		(1,761	)
Total shareholders' equity		148,491			138,430
Total liabilities and shareholders' equity	$	1,194,127		$	1,157,736

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

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NORTHEAST BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except share and per share data)

Three Months Ended December 31,

Six Months Ended December 31,

2018

2017

2018

2017

Interest and dividend income:

Interest and fees on loans

18,934

14,501

36,460

29,883

Interest on available-for-sale securities

425

267

784

533

Other interest and dividend income

970

492

1,851

1,022

Total interest and dividend income

20,329

15,260

39,095

31,438

Interest expense:

Deposits

3,982

2,129

7,664

4,305

Federal Home Loan Bank advances

125

148

242

319

Subordinated debt

573

517

1,174

1,025

Obligation under capital lease agreements

Total interest expense

4,686

2,803

9,094

5,670

Net interest and dividend income before provision for loan losses

15,643

12,457

30,001

25,768

Provision for loan losses

101

437

633

792

Net interest and dividend income after provision for loan losses

15,542

12,020

29,368

24,976

Noninterest income:

Fees for other services to customers

340

475

832

1,002

Gain on sales of SBA loans

942

341

1,793

1,361

Gain on sales of residential loans held for sale

104

255

279

545

Gain on sales of other loans

Net unrealized gain on equity securities

Gain (loss) on real estate owned, other repossessed collateral and premises and equipment, net

(24

)

(64

)

Bank-owned life insurance income

110

111

219

223

Other noninterest income

Total noninterest income

1,545

1,228

3,098

3,186

Noninterest expense:

Salaries and employee benefits

5,699

5,173

11,208

10,427

Occupancy and equipment expense

957

1,150

2,084

2,260

Professional fees

656

425

1,190

867

Data processing fees

830

624

1,431

1,227

Marketing expense

130

253

157

Loan acquisition and collection expense

585

368

1,024

733

FDIC insurance premiums

162

160

Intangible asset amortization

109

218

Other noninterest expense

856

564

1,687

1,228

Total noninterest expense

9,903

8,563

19,257

17,277

Income before income tax expense

7,184

4,685

13,209

10,885

Income tax expense

2,059

1,381

3,550

2,995

Net income

5,125

3,304

9,659

7,890

Weighted-average shares outstanding:

Basic

9,048,397

8,924,495

9,022,161

8,883,003

Diluted

9,201,557

9,168,084

9,192,643

9,129,010

Earnings per common share:

Basic

0.57

0.37

1.07

0.89

Diluted

0.56

0.36

1.05

0.86

Cash dividends declared per common share

0.01

0.02

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

Table of Contents

NORTHEAST BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)

	Three Months Ended December 31,						Six Months Ended December 31,
	2018			2017			2018			2017

Net income	$	5,125		$	3,304		$	9,659		$	7,890

Other comprehensive income, before tax:
Available-for-sale securities:
Change in net unrealized gain (loss) on available-for-sale securities		633			(297	)		560			(175	)
Derivatives and hedging activities:
Change in accumulated (loss) gain on effective cash flow hedges		(1,104	)		160			(623	)		181
Reclassification adjustments included in interest expense		38			26			107			49
Total derivatives and hedging activities		(1,066	)		186			(516	)		230
Total other comprehensive (loss) income, before tax		(433	)		(111	)		44			55
Income tax (benefit) expense related to other comprehensive (loss) income		(117	)		(43	)		11			19
Other comprehensive (loss) income, net of tax		(316	)		(68	)		33			36
Comprehensive income	$	4,809		$	3,236		$	9,692		$	7,926

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

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NORTHEAST BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited)
(In thousands, except share and per share data)

																							Accumulated
																							Other			Total
	Preferred Stock				Voting Common Stock						Non-voting Common Stock						Additional			Retained			Comprehensive			Shareholders'
	Shares		Amount		Shares			Amount			Shares			Amount			Paid-in Capital			Earnings			Loss			Equity

Balance at June 30, 2017		-		-		7,840,460		$	7,841			991,194		$	991		$	77,455		$	38,142		$	(1,632	)	$	122,797
Net income		-		-		-			-			-			-			-			7,890			-			7,890
Other comprehensive income, net of tax		-		-		-			-			-			-			-			-			36			36
Conversions between voting common stock and non- voting common stock, net		-		-		69,255			69			(69,255	)		(69	)		-			-			-			-
Dividends on common stock at $0.02 per share		-		-		-			-			-			-			-			(177	)		-			(177	)
Stock-based compensation		-		-		-			-			-			-			485			-			-			485
Issuance of restricted common stock		-		-		12,000			12			-			-			(12	)		-			-			-
Cancellation and forfeiture of restricted common stock		-		-		(15,756	)		(16	)		-			-			(39	)		-			-			(55	)
Stock options exercised, net		-		-		111,375			111			-			-			(1,084	)		-			-			(973	)
Balance at December 31, 2017		-	$	-		8,017,334		$	8,017			921,939		$	922		$	76,805		$	45,855		$	(1,596	)	$	130,003

Balance at June 30, 2018		-		-		8,056,527		$	8,057			882,314		$	882		$	77,016		$	54,236		$	(1,761	)	$	138,430
Net income		-		-		-			-			-			-			-			9,659			-			9,659
Other comprehensive income, net of tax		-		-		-			-			-			-			-			-			33			33
Conversions between voting common stock and non- voting common stock, net		-		-		70,368			70			(70,368	)		(70	)		-			-			-			-
Dividends on common stock at $0.02 per share		-		-		-			-			-			-			-			(180	)		-			(180	)
Stock-based compensation		-		-		-			-			-			-			687			-			-			687
Issuance of restricted common stock		-		-		116,925			117			-			-			(117	)		-			-			-
Cancellation and forfeiture of restricted common stock		-		-		(7,877	)		(8	)		-			-			(126	)		-			-			(134	)
Stock options exercised, net		-		-		974			1			-			-			(5	)		-			-			(4	)
Adjustment for adoption of ASU 2016-01		-		-		-			-			-			-			-			(180	)		180			-
Balance at December 31, 2018		-	$	-		8,236,917		$	8,237			811,946		$	812		$	77,455		$	63,535		$	(1,548	)	$	148,491

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

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NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

	Six Months Ended December 31,
	2018			2017
Operating activities:
Net income	$	9,659		$	7,890
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		633			792
Loss (gain) on sale and impairment of real estate owned and other repossessed collateral, net		64			(11	)
Net unrealized gain on equity securities		(10	)		-
Accretion of fair value adjustments on loans, net		(3,700	)		(4,830	)
Amortization of fair value adjustments on borrowings, net		115			104
Amortization of subordinated debt issuance costs		55			55
Originations of loans held for sale		(44,203	)		(49,309	)
Net proceeds from sales of loans held for sale		48,201			50,946
Gain on sales of residential loans held for sale		(279	)		(545	)
Gain on sales of SBA and other loans held for sale		(1,793	)		(1,382	)
Net decrease (increase) in servicing rights		36			(159	)
Amortization of intangible assets		218			218
Bank-owned life insurance income, net		(219	)		(223	)
Depreciation of premises and equipment		662			636
Stock-based compensation		687			485
Deferred income tax expense		-			498
Amortization of available-for-sale debt securities, net		197			450
Changes in other assets and liabilities:
Other assets		391			(1,376	)
Other liabilities		(4,948	)		(3,231	)
Net cash provided by operating activities		5,766			1,008
Investing activities:
Purchases of available-for-sale debt securities		(21,986	)		(9,222	)
Proceeds from maturities and principal payments on investment securities, net		25,203			12,951
Loan purchases		(84,137	)		(38,453	)
Loan originations, principal collections, and purchased loan paydowns, net		24,601			45,540
Purchases and disposals of premises and equipment, net		(183	)		(795	)
Redemption of Federal Home Loan Bank stock		-			180
Proceeds from sales of real estate owned and other repossessed collateral		756			1,264
Net cash (used in) provided by investing activities		(55,746	)		11,465
Financing activities:
Net increase (decrease) in deposits		30,651			(41,196	)
Dividends paid on common stock		(180	)		(177	)
Repayment of Federal Home Loan Bank advances		-			(5,000	)
Repayment of capital lease obligation		(139	)		(132	)
Repurchases for tax withholdings on restricted common stock		(134	)		(55	)
Stock options exercised, net		(4	)		(973	)
Net cash provided by (used in) financing activities		30,194			(47,533	)
Net decrease in cash and cash equivalents		(19,786	)		(35,060	)
Cash and cash equivalents, beginning of period		157,402			163,283
Cash and cash equivalents, end of period	$	137,616		$	128,223
Supplemental schedule of noncash investing activities:
Transfers from loans to real estate owned and other repossessed collateral, net	$	50		$	1,302

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

December 31, 2018

1. Basis of Presentation

The accompanying unaudited interim consolidated financial statements include the accounts of Northeast Bancorp (“Northeast” or the “Company”) and its wholly-owned subsidiary, Northeast Bank (the “Bank”).

These unaudited consolidated 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, results of operations, and cash flows for the interim periods presented. These accompanying unaudited financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2018 (“Fiscal 2018”) included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”).

2. Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2015-14, Revenue from Contracts with Customers (Topic 606) (“ASU 2015-14”) was issued in August 2015 which deferred adoption to annual reporting periods beginning after December 15, 2017, which was adopted during the three months ended September 30, 2018. The timing of the Company’s revenue recognition did not change. The Company’s largest portions of revenue, interest and fees on loans, interest and dividend income on securities and short-term investments, bank-owned life insurance income, and gain on sales of loans, are specifically excluded from the scope of the guidance. Additionally, fees for other services to customers includes loan servicing fee income which is accounted for under ASC Topic 860, Transfers and Servicing, (“Topic 860”), and is not subject to Topic 606. The other component of fees for other services to customers is deposit fees. The majority of the Company’s deposit fees are specifically related to a customer accessing its funds, in which case the revenue is currently recognized in a consistent manner with Topic 606. Revenue that is not specifically related to a customer accessing its funds (i.e. account maintenance fees), can be waived; however, the amount of waived fees is not considered material, and thus the revenue is consistently recognized with Topic 606. All other revenue is also recognized in a manner consistent with Topic 606. Because of the above, management believes that revenue recognized under the new guidance approximates revenue recognized under current GAAP.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). This guidance changes how entities account for equity investments that do not result in consolidation and are not accounted for under the equity method of accounting. Entities will be required to measure these investments at fair value at the end of each reporting period and recognize changes in fair value in net income. A practicability exception will be available for equity investments that do not have readily determinable fair values; however, the exception requires the Company to adjust the carrying amount for impairment and observable price changes in orderly transactions for the identical or a similar investment of the same issuer. This guidance also changes certain disclosure requirements and other aspects of current GAAP. The Company adopted this guidance during the three months ended September 30, 2018. This adoption resulted in a reclassification of $180 thousand from accumulated other comprehensive loss to retained earnings in the consolidated financial statements, with no net effect on shareholders' equity. In addition, the disclosure of the fair value of “Loans, net” in “Notes to Unaudited Consolidated Financial Statements – Note 10: Fair Value Measurements” is now calculated based on an exit pricing strategy versus an entry pricing strategy.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). The new guidance establishes the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. Entities will be required to recognize the lease assets and lease liabilities that arise from leases in the statement of financial position and to disclose qualitative and quantitative information about lease transactions, such as information about variable lease payments and options to renew and terminate leases. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within the fiscal year. The Company is currently evaluating the impact of the adoption of ASU 2016-02 to determine the potential impact it will have on its consolidated financial statements. The Company’s assets and liabilities will increase based on the present value of the remaining lease payments for leases in place at the adoption date; however, this is not expected to be material to the Company’s results of operations.

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In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326) (“ASU 2016-13”). This guidance is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this guidance replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU will be effective for fiscal years beginning after December 15, 2019. Early adoption is available as of the fiscal year beginning after December 15, 2018. The Company is evaluating the provisions of the guidance, and will closely monitor developments and additional guidance to determine the potential impact on the Company’s consolidated financial statements. Management is in the process of identifying the methodologies and the additional data requirements necessary to implement the guidance and has engaged an existing third-party service provider to assist in implementation.

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”) which amends the scope of modification accounting for share-based payment arrangements. This update provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. This update was adopted during the three months ended September 30, 2018 and did not have an impact on the Company’s consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815) (“ASU 2017-12”). This guidance permits hedge accounting for risk components in hedging relationships involving nonfinancial risk and interest rate risk, and improves the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. The amendments in this guidance are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.

In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases (“ASU 2018-10”) and ASU 2018-11, Leases (Topic 842) (“ASU 2018-11”). The guidance provides clarification on the application of ASU 2016-02, specifically on certain narrow aspects of the guidance issued under ASU 2016-02, including comparative reporting requirements for initial adoption and, for lessors only, separating lease and non-lease components in a contract and allocating the consideration in the contract to the separate components. For entities that have not adopted ASU 2016-02 before the issuance of these updates, the amendments in this guidance are the same as the effective date and transition requirements in ASU 2016-02. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurements (Topic 820) (“ASU 2018-13”). This update modifies disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. This includes removing requirements related to transfers between Level 1 and Level 2, the policy of timing of transfers between levels, and the valuation process for Level 3 fair value measurements, modifying disclosure requirements related to investments in certain entities that calculate net asset value, and adding disclosure requirements for changes in unrealized gains and losses for recurring Level 3 fair value measurements and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in this guidance are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.

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3. Investment Securities

The following presents a summary of the amortized cost, gross unrealized holding gains and losses, and fair value of investment securities.

December 31, 2018

Amortized

Gross Unrealized

Fair

Cost

Gains

Losses

Value

(Dollars in thousands)

U.S. Government agency securities

57,056

(110

)

57,025

Agency mortgage-backed securities

21,853

(746

)

21,107

Equity investments measured at net asset value

6,947

(236

)

6,711

Total investment securities

85,856

(1,092

)

84,843

June 30, 2018

Amortized

Gross Unrealized

Fair

Cost

Gains

Losses

Value

(Dollars in thousands)

U.S. Government agency securities

57,129

(242

)

56,887

Agency mortgage-backed securities

25,276

(1,095

)

24,181

Equity investments measured at net asset value

6,866

(247

)

6,619

Total investment securities

89,271

(1,584

)

87,687

At December 31, 2018 and June 30, 2018, the Company held no securities of any single issuer (excluding the U. S. Government and government agencies) with a book value that exceeded 10% of shareholders’ equity.

When securities are sold, the adjusted cost of the specific security sold is used to compute the gain or loss on sale. There were no securities sold during the three and six months ended December 31, 2018 or 2017. At December 31, 2018, no investment securities were pledged as collateral to secure outstanding borrowings.

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.

December 31, 2018

Less than 12 Months

More than 12 Months

Total

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

Value

Losses

Value

Losses

Value

Losses

(Dollars in thousands)

U.S. Government agency securities

10,914

(20

)

18,009

(90

)

28,923

(110

)

Agency mortgage-backed securities

21,107

(746

)

21,107

(746

)

Equity investments measured at net asset value

5,147

(236

)

5,147

(236

)

Total investment securities

10,914

(20

)

44,263

(1,072

)

55,177

(1,092

)

June 30, 2018

Less than 12 Months

More than 12 Months

Total

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

Value

Losses

Value

Losses

Value

Losses

(Dollars in thousands)

U.S. Government agency securities

25,988

(126

)

30,899

(116

)

56,887

(242

)

Agency mortgage-backed securities

1,265

(27

)

22,916

(1,068

)

24,181

(1,095

)

Equity investments measured at net asset value

5,076

(247

)

5,076

(247

)

Total investment securities

27,253

(153

)

58,891

(1,431

)

86,144

(1,584

)

There were no other-than-temporary impairment losses on securities during the three and six months ended December 31, 2018 or 2017.

At December 31, 2018, the Company had 33 securities in an unrealized loss position. At December 31, 2018, all of the Company’s available-for-sale securities were issued or guaranteed by either government agencies or government-sponsored enterprises. The decline in fair value of the Company’s investment securities at December 31, 2018 is attributable to changes in interest rates.

In addition to considering current trends and economic conditions that may affect the quality of individual securities within the Company’s investment portfolio, management of the Company also considers the Company’s ability and intent to hold such securities to maturity or recovery of cost. At December 31, 2018, the Company does not intend to sell and it is not more likely than not that the Company will be required to sell the investment securities before recovery of its amortized cost. As such, management does not believe any of the Company’s investment securities are other-than-temporarily impaired at December 31, 2018.

The investments measured at net asset value include a fund that seeks to invest in securities either issued or guaranteed by the U.S. government or its agencies, as well as a fund that primarily invests in the federally guaranteed portion of SBA 7(a) loans that adjust quarterly or monthly and are indexed to the Prime Rate. The underlying composition of these funds is primarily government agencies, other investment-grade investments, or the guaranteed portion of SBA 7(a) loans, as applicable. As of December 31, 2018, the effective duration of the fund that seeks to invest in securities either issued or guaranteed by the U.S. government or its agencies is 4.66 years.

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ASU 2016-01, Recognition and Measurements of Financial Assets and Financial Liabilities, was adopted on July 1, 2018, and a cumulative effect adjustment of $180 thousand was recorded to reclassify the amount of accumulated unrealized losses, net, related to equity securities from accumulated other comprehensive loss to retained earnings. For the three and six months ended December 31, 2018, there were $50 thousand and $10 thousand of increases in net unrealized gains on equity securities recognized in the consolidated statements of income, respectively.

The amortized cost and fair values of available-for-sale debt securities by contractual maturity are shown below as of December 31, 2018. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

	Amortized Cost		Fair Value
	(Dollars in thousands)
Due within one year	$	20,094	$	20,003
Due after one year through five years		36,962		37,022
Due after five years through ten years		-		-
Due after ten years		-		-
Total U.S. Government agency securities		57,056		57,025
Agency mortgage-backed securities		21,853		21,107
Total available-for-sale debt securities	$	78,909	$	78,132

4. Loans, Allowance for Loan Losses and Credit Quality

Loans are carried at the principal amounts outstanding, or amortized acquired fair value in the case of acquired loans, adjusted by partial charge-offs and net of deferred loan costs or fees. Loan fees and certain direct origination costs are deferred and amortized into interest income over the expected term of the loan using the level-yield method. When a loan is paid off in full, the unamortized portion is recognized in interest income. Interest income is accrued based upon the daily principal amount outstanding, except for loans on nonaccrual status.

Loans purchased by the Company are accounted for under ASC 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"). At acquisition, the effective interest rate is determined based on the discount rate that equates the present value of the Company's estimate of cash flows with the purchase price of the loan. Prepayments are not assumed in determining a purchased loan's effective interest rate and income accretion. The application of ASC 310-30 limits the yield that may be accreted on the purchased loan, or the "accretable yield," to the excess of the Company's estimate, at acquisition, of the expected undiscounted principal, interest, and other cash flows over the Company's initial investment in the loan. The excess of contractually required payments receivable over the cash flows expected to be collected on the loan represents the purchased loan's "nonaccretable difference." Subsequent improvements in expected cash flows of loans with nonaccretable differences result in a prospective increase to the loan's effective yield through a reclassification of some, or all, of the nonaccretable difference to accretable yield. The effect of subsequent credit-related declines in expected cash flows of purchased loans are recorded through a specific allocation in the allowance for loan losses.

Loans are generally placed on nonaccrual status when they are past due 90 days as to either principal or interest, or when in management's judgment the collectability of interest or principal of the loan has been impaired. Loans accounted for under ASC 310-30 are placed on nonaccrual when it is not possible to reach a reasonable expectation of the timing and amount of cash flows to be collected on the loan. When a loan has been placed on nonaccrual status, previously accrued and uncollected interest is reversed against interest on loans. Interest on nonaccrual loans is accounted for on a cash-basis or using the cost-recovery method when collectability is doubtful. A loan is returned to accrual status when collectability of principal and interest is reasonably assured and the loan has performed for a reasonable period of time.

In cases where a borrower experiences financial difficulties and the Company makes certain concessionary modifications to contractual terms, the loan is classified as a troubled debt restructuring ("TDR"), and therefore by definition is an impaired loan. Concessionary modifications may include adjustments to interest rates, extensions of maturity, and other actions intended to minimize economic loss and avoid foreclosure or repossession of collateral. For loans accounted for under ASC 310-30, the Company evaluates whether it has granted a concession by comparing the restructured debt terms to the expected cash flows at acquisition plus any additional cash flows expected to be collected arising from changes in estimate after acquisition. As a result, if an ASC 310-30 loan is modified to be consistent with, or better than, the Company's expectations at acquisition, the modified loan would not qualify as a TDR. Nonaccrual loans that are restructured generally remain on nonaccrual status for a minimum period of six months to demonstrate that the borrower can meet the restructured terms. If the restructured loan is on accrual status prior to being modified, it is reviewed to determine if the modified loan should remain on accrual status. If the borrower's ability to meet the revised payment schedule is not reasonably assured, the loan is classified as a nonaccrual loan. With limited exceptions, loans classified as TDRs remain classified as such until the loan is paid off.

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The composition of the Company’s loan portfolio is as follows on the dates indicated.

December 31, 2018

Originated

Purchased

Total

(Dollars in thousands)

Commercial real estate

259,451

313,261

572,712

Commercial and industrial

202,150

788

202,938

Residential real estate

75,972

16,594

92,566

Consumer

2,788

SBA

67,282

Total loans

607,643

330,643

938,286

June 30, 2018

Originated

Purchased

Total

(Dollars in thousands)

Commercial real estate

249,428

276,051

525,479

Commercial and industrial

181,800

995

182,795

Residential real estate

86,202

13,926

100,128

Consumer

3,244

SBA

60,156

Total loans

580,830

290,972

871,802

Total loans include deferred loan origination costs, net, of $190 thousand and $223 thousand as of December 31, 2018 and June 30, 2018, respectively.

Past Due and Nonaccrual Loans

The following is a summary of past due and nonaccrual loans:

December 31, 2018

Past Due

30-59

Past Due

60-89

Past Due

90 Days or

More-Still

Past Due

90 Days or

More-

Total Past

Total

Nonaccrual

Days

Accruing

Nonaccrual

Due

Current

Loans

(Dollars in thousands)

Originated portfolio:

Residential real estate

1,141

247

1,640

3,028

72,944

75,972

2,595

Commercial real estate

238

309

2,237

2,784

256,667

259,451

2,351

Commercial and industrial

202,110

202,150

Consumer

121

250

2,538

2,788

216

SBA

1,325

1,273

2,660

64,622

67,282

1,793

Total originated portfolio

2,766

685

5,311

8,762

598,881

607,643

6,995

Purchased portfolio:

Residential real estate

202

16,392

16,594

202

Commercial real estate

5,363

1,205

2,612

9,180

304,081

313,261

4,755

Commercial and industrial

139

649

788

394

Total purchased portfolio

5,363

1,205

2,953

9,521

321,122

330,643

5,351

Total loans

8,129

1,890

8,264

18,283

920,003

938,286

12,346

June 30, 2018

Past Due

30-59

Days

Past Due

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

Nonaccrual

Loans

(Dollars in thousands)

Originated portfolio:

Residential real estate

493

181

1,355

2,029

84,173

86,202

3,212

Commercial real estate

210

335

249,093

249,428

1,428

Commercial and industrial

181,768

181,800

Consumer

178

3,066

3,244

134

SBA

831

59,325

60,156

1,405

Total originated portfolio

597

473

2,335

3,405

577,425

580,830

6,213

Purchased portfolio:

Residential real estate

202

13,724

13,926

202

Commercial real estate

659

274

3,086

4,019

272,032

276,051

5,180

Commercial and industrial

108

887

995

363

Total purchased portfolio

676

274

3,379

4,329

286,643

290,972

5,745

Total loans

1,273

747

5,714

7,734

864,068

871,802

11,958

Table of Contents

Allowance for Loan Losses and Impaired Loans

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. For residential and consumer loans, a charge-off is recorded no later than the point at which a loan is 180 days past due if the loan balance exceeds the fair value of the collateral, less estimated costs to sell. For commercial loans, a charge-off is recorded on a case-by-case basis when all or a portion of the loan is deemed to be uncollectible. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses consists of general, specific, and unallocated reserves and reflects management’s estimate of probable loan losses inherent in the loan portfolio at the balance sheet date. Management uses a consistent and systematic process and methodology to evaluate the appropriateness of the allowance for loan losses on a quarterly basis. The calculation of the allowance for loan losses is segregated by portfolio segments, which include: residential real estate, commercial real estate, commercial and industrial, consumer, purchased loans, and SBA loans. Risk characteristics relevant to each portfolio segment are as follows:

Residential real estate: All loans in this segment are collateralized by residential real estate and repayment is primarily dependent on the credit quality, loan-to-value ratio and income of the individual borrower. The overall health of the economy, particularly unemployment rates and housing prices, has a significant effect on the credit quality in this segment. For purposes of the Company’s allowance for loan loss calculation, home equity loans and lines of credit are included in residential real estate.

Commercial real estate: Loans in this segment are primarily income-producing properties. For owner-occupied properties, the cash flows are derived from an operating business, and the underlying cash flows may be adversely affected by deterioration in the financial condition of the operating business. The underlying cash flows generated by non-owner occupied properties may be adversely affected by increased vacancy rates. Management periodically obtains rent rolls and operating statements, with which it monitors the cash flows of these loans. Adverse developments in either of these areas will have an adverse effect on the credit quality of this segment. For purposes of the allowance for loan losses, this segment also includes construction loans.

Commercial and industrial: Loans in this segment are made to businesses and are generally secured by the assets of the business. Repayment is expected from the cash flows of the business. This segment also includes loans to non-bank lenders, which are generally secured by a collateral assignment of the notes and mortgages on loans originated by the non-bank lenders. Weakness in national or regional economic conditions, and a corresponding weakness in consumer or business spending, will have an adverse effect on the credit quality of this segment.

Consumer: Loans in this segment are generally secured, and repayment is dependent on the credit quality of the individual borrower. Repayment of consumer loans is generally based on the earnings of individual borrowers, which may be adversely impacted by regional labor market conditions.

Purchased: Loans in this segment are typically secured by commercial real estate, multi-family residential real estate, or business assets and have been acquired by the Bank’s Loan Acquisition and Servicing Group (“LASG”). Loans acquired by the LASG are, with limited exceptions, performing loans at the date of purchase. Repayment of loans in this segment is largely dependent on cash flow from the successful operation of the property, in the case of non-owner occupied property, or operating business, in the case of owner-occupied property. Loan performance may be adversely affected by factors affecting the general economy or conditions specific to the real estate market, such as geographic location or property type. Loans in this segment are evaluated for impairment under ASC 310-30. The Company reviews expected cash flows from purchased loans on a quarterly basis. The effect of a decline in expected cash flows subsequent to the acquisition of the loan is recognized through a specific allocation in the allowance for loan losses.

SBA: Loans in this segment are comprised of both commercial real estate and commercial and industrial loans to small businesses, underwritten and originated by the Bank’s national SBA group (“SBA Division”). Loans are underwritten and originated primarily in accordance with SBA 7(a) guidelines, and are partially guaranteed by the SBA. Loans are primarily secured by income-producing properties and/or assets of the businesses or borrowers. Adverse developments in national or regional economic conditions, and a corresponding weakness in consumer or business spending, will have an adverse effect on the credit quality of this segment.

The general component of the allowance for loan losses for originated loans is based on historical loss experience adjusted for qualitative factors stratified by loan segment. The Company does not weight periods used in that analysis to determine the average loss rate in each portfolio segment. This historical loss factor is adjusted for the following qualitative factors:

●

Levels and trends in delinquencies;

●

Trends in the volume and nature of loans;

●

Trends in credit terms and policies, including underwriting standards, procedures and practices, and the experience and ability of lending management and staff;

Table of Contents

●

Trends in portfolio concentration;

●

National and local economic trends and conditions;

●

Effects of changes or trends in internal risk ratings; and

●

Other effects resulting from trends in the valuation of underlying collateral.

The allocated component of the allowance for loan losses relates to loans that are classified as impaired. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than the carrying value of the loan.

For all portfolio segments, except loans accounted for under ASC 310-30, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. For the purchased loan segment, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to realize cash flows as expected at acquisition. For loans accounted for under ASC 310-30 for which cash flows can reasonably be estimated, loan impairment is measured based on the decrease in expected cash flows from those estimated at acquisition, excluding changes due to changes in interest rate indices and other non-credit related factors, discounted at the loan’s effective rate assumed at acquisition. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting the scheduled principal and interest payments when due.

The following table sets forth activity in the Company’s allowance for loan losses.

	Three Months Ended December 31, 2018
	Residential			Commercial			Commercial
	Real Estate			Real Estate			and Industrial		Consumer			Purchased		SBA		Total
	(Dollars in thousands)
Beginning balance	$	625		$	1,627		$	789	$	43		$	597	$	1,607	$	5,288
Provision (credit)		40			(76	)		83		(24	)		2		76		101
Recoveries		1			-			2		12			-		-		15
Charge-offs		(81	)		-			-		(15	)		-		-		(96	)
Ending balance	$	585		$	1,551		$	874	$	16		$	599	$	1,683	$	5,308

	Three Months Ended December 31, 2017
	Residential			Commercial		Commercial
	Real Estate			Real Estate		and Industrial			Consumer			Purchased		SBA		Total
	(Dollars in thousands)
Beginning balance	$	508		$	1,248	$	596		$	41		$	310	$	1,331	$	4,034
Provision (credit)		176			64		(40	)		19			210		8		437
Recoveries		1			-		5			25			-		-		31
Charge-offs		(112	)		-		-			(35	)		-		-		(147	)
Ending balance	$	573		$	1,312	$	561		$	50		$	520	$	1,339	$	4,355

	Six Months Ended December 31, 2018
	Residential			Commercial		Commercial
	Real Estate			Real Estate		and Industrial			Consumer			Purchased		SBA		Total
	(Dollars in thousands)
Beginning balance	$	605		$	1,527	$	620		$	39		$	587	$	1,429	$	4,807
Provision		139			17		246			(35	)		12		254		633
Recoveries		3			7		10			30			-		-		50
Charge-offs		(162	)		-		(2	)		(18	)		-		-		(182	)
Ending balance	$	585		$	1,551	$	874		$	16		$	599	$	1,683	$	5,308

	Six Months Ended December 31, 2017
	Residential			Commercial		Commercial
	Real Estate			Real Estate		and Industrial		Consumer			Purchased		SBA		Total
	(Dollars in thousands)
Beginning balance	$	472		$	1,219	$	394	$	53		$	303	$	1,224	$	3,665
Provision		217			93		144		6			217		115		792
Recoveries		8			-		23		31			-		-		62
Charge-offs		(124	)		-		-		(40	)		-		-		(164	)
Ending balance	$	573		$	1,312	$	561	$	50		$	520	$	1,339	$	4,355

Table of Contents

The following table sets forth information regarding the allowance for loan losses by portfolio segment and impairment methodology.

	December 31, 2018
	Residential		Commercial		Commercial
	Real Estate		Real Estate		and Industrial		Consumer		Purchased		SBA		Total
	(Dollars in thousands)
Allowance for loan losses:
Individually evaluated	$	260	$	148	$	2	$	4	$	-	$	313	$	727
Collectively evaluated		325		1,403		872		12		-		1,370		3,982
ASC 310-30		-		-		-		-		599		-		599
Total	$	585	$	1,551	$	874	$	16	$	599	$	1,683	$	5,308

Loans:
Individually evaluated	$	4,856	$	3,434	$	40	$	270	$	-	$	3,642	$	12,242
Collectively evaluated		71,116		256,017		202,110		2,518		-		63,640		595,401
ASC 310-30		-		-		-		-		330,643		-		330,643
Total	$	75,972	$	259,451	$	202,150	$	2,788	$	330,643	$	67,282	$	938,286

	June 30, 2018
	Residential		Commercial		Commercial
	Real Estate		Real Estate		and Industrial		Consumer		Purchased		SBA		Total
	(Dollars in thousands)
Allowance for loan losses:
Individually evaluated	$	322	$	139	$	8	$	6	$	-	$	112	$	587
Collectively evaluated		283		1,388		612		33		-		1,317		3,633
ASC 310-30		-		-		-		-		587		-		587
Total	$	605	$	1,527	$	620	$	39	$	587	$	1,429	$	4,807

Loans:
Individually evaluated	$	5,682	$	2,687	$	33	$	292	$	-	$	3,170	$	11,864
Collectively evaluated		80,520		246,741		181,767		2,952		-		56,986		568,966
ASC 310-30		-		-		-		-		290,972		-		290,972
Total	$	86,202	$	249,428	$	181,800	$	3,244	$	290,972	$	60,156	$	871,802

The following table sets forth information regarding impaired loans. Loans accounted for under ASC 310-30 that have performed based on cash flow and accretable yield expectations determined at date of acquisition are not considered impaired assets and have been excluded from the tables below.

December 31, 2018

June 30, 2018

Unpaid

Recorded

Principal

Recorded

Principal

Investment

Balance

Allowance

Investment

Balance

Allowance

(Dollars in thousands)

Impaired loans without a valuation allowance:

Originated:

Residential real estate

2,782

2,766

3,162

3,154

Commercial real estate

2,369

2,364

1,445

1,438

Commercial and industrial

Consumer

252

275

271

296

SBA

1,920

2,597

Purchased:

Residential real estate

202

217

202

217

Commercial real estate

6,456

8,782

6,601

9,330

Commercial and industrial

163

108

186

Total

14,078

16,499

14,386

17,218

Impaired loans with a valuation allowance:

Originated:

Residential real estate

2,074

2,146

260

2,520

2,497

322

Commercial real estate

1,065

1,057

148

1,242

1,234

139

Commercial and industrial

Consumer

SBA

1,722

313

573

112

Purchased:

Residential real estate

Commercial real estate

3,587

3,856

240

4,748

5,362

280

Commercial and industrial

404

463

359

349

407

307

Total

8,898

9,291

1,326

9,486

10,128

1,174

Total impaired loans

22,976

25,790

1,326

23,872

27,346

1,174

Table of Contents

The following tables set forth information regarding interest income recognized on impaired loans.

	Three Months Ended December 31,
	2018					2017
	Average		Interest			Average		Interest
	Recorded		Income			Recorded		Income
	Investment		Recognized			Investment		Recognized
	(Dollars in thousands)
Impaired loans without a valuation allowance:
Originated:
Residential real estate	$	2,907	$	12		$	3,992	$	38
Commercial real estate		1,816		(3	)		2,454		1
Commercial and industrial		15		-			-		-
Consumer		266		1			285		7
SBA		1,878		49			1,794		2
Purchased:
Residential real estate		202		-			566		-
Commercial real estate		6,419		68			9,814		102
Commercial and industrial		90		-			26		-
Total		13,593		127			18,931		150

Impaired loans with a valuation allowance:
Originated:
Residential real estate		2,090		31			1,904		42
Commercial real estate		1,171		19			1,388		27
Commercial and industrial		29		-			44		2
Consumer		40		-			32		1
SBA		1,736		1			806		-
Purchased:
Residential real estate		-		-			83		1
Commercial real estate		3,994		24			4,108		38
Commercial and industrial		381		1			228		3
Total		9,441		76			8,593		114
Total impaired loans	$	23,034	$	203		$	27,524	$	264

	Six Months Ended December 31,
	2018				2017
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
	(Dollars in thousands)
Impaired loans without a valuation allowance:
Originated:
Residential real estate	$	2,992	$	31	$	4,012	$	74
Commercial real estate		1,692		-		1,756		94
Commercial and industrial		10		-		-		-
Consumer		267		3		273		13
SBA		2,118		89		1,819		39
Purchased:
Residential real estate		202		-		729		-
Commercial real estate		6,479		127		9,441		182
Commercial and industrial		96		-		28		-
Total		13,856		250		18,058		402

Impaired loans with a valuation allowance:
Originated:
Residential real estate		2,233		54		1,811		63
Commercial real estate		1,195		41		1,392		49
Commercial and industrial		30		-		30		3
Consumer		33		-		36		2
SBA		1,348		7		811		3
Purchased:
Residential real estate		-		-		55		1
Commercial real estate		4,245		55		3,915		65
Commercial and industrial		370		1		183

NORTHEAST BANCORP /ME/ 10-Q