Taking stock | Northeast Bank's $30 million deal: A prime growth opportunity and an out for shareholders

When Northeast Bancorp in Lewiston announced earlier this year that it planned to merge with a deep-pocketed investor group, even some of its own shareholders raised an eyebrow. Typically associated with corporate name changes, new building signs and layoffs, the term “merger” was applied to a transaction that didn’t really look like one.

Three New England banking hotshots — including one known for his success buying up distressed loans at a discount — would, through an investment entity, purchase nearly $30 million in new and outstanding shares, ultimately giving them 60% ownership of the bancorp’s common stock. Add the fact that the deal names the investor trio to top executive posts, and it’s easy to appreciate the confusion over what appeared more like a sale.

But the actual terms of the transaction, in addition to the terminology, also caught people’s attention. The bancorp, parent company to Northeast Bank, made the unusual choice to sell the shares for less than what’s known as “tangible book value,” a measure of what common shareholders could expect to earn if all of the company’s tangible assets, such as buildings and land, were liquidated in a potential bankruptcy. Northeast sold the stock to the investors, operating as FHB Formation LLC, at $13.93 per share. The tangible book value of the stock was $14.60 per share. As Brad McCurtain, a critic of the deal and a longtime Northeast shareholder puts it, “They probably would be better off liquidating the bank and sending everyone home.”

McCurtain also doesn’t mince words in detailing his other complaints about the bank’s operations. The stock has consistently performed poorly, and the company’s return on assets, a key indicator of financial health, has failed to reach even a mediocre 1% in the more than two decades since the bank went public, he says. Which is why McCurtain, among other shareholders, can’t understand why bank President Jim Delamater earns a base salary just a shade lower than that of the president of Camden National Corp., a bank with more than triple the assets and superior returns.

Delamater, for his part, argues that the share price was fair, given the amount of capital the bank is raising, the “all-star” talent it’s attracting and the new lines of business the bank will pursue, including loan acquisition and servicing. “To bring in capital at that price was wonderful,” he says.

Approximately 75% of Northeast’s shareholders voted in favor of the deal and state officials have given their blessing. Bank officials are now crossing their fingers that federal regulatory approval is imminent. But even during a period of marked upheaval in the banking industry, the transaction is, for better or worse, uncommon.

Differing opinions

To its average customer or one of its 270 employees, Northeast Bank and its 10 branches will look exactly the same after the merger as they do today. The name won’t change, the headquarters will stay in Lewiston and the top executives’ faces will remain a common sight on Canal Street. But joining them will be the faces of Richard Wayne, Claire Bean and Heather Campion, the three Boston investors making up FHB Formation, who will travel to Lewiston periodically as the new CEO, COO/CFO and chief administrative officer of the bancorp, respectively.

Wayne co-founded Capital Crossing Bank of Boston, which made millions buying up other banks’ distressed commercial loans at a discount. Lehman Brothers bought Capital Crossing in 2007 for $210 million. Bean is the former CFO of Benjamin Franklin Bancorp of Franklin, Mass., while Campion is a former executive of Rhode Island-based Citizens Financial Group Inc. and was also a Carter administration speechwriter.

Essentially, the three investors are bringing a boatload of new money to Northeast, known in the industry as a “capital infusion.” But they’re also sticking around to personally oversee the management of the bank, and the FHB entity will dissolve into Northeast, moves more typical of a merger. Plus the investors will have majority interest with 60% ownership of the common stock, which has tones of an acquisition.

Hence the uncertain reactions. “It’s very unique,” Delamater says of the deal. “It comes across publicly as a merger.”

The $29 million transaction calls for Northeast to sell $16.2 million in new shares to FHB, which will in turn buy up 40% of the bank’s outstanding shares for $12.9 million. The deal also includes institutional investors, such as the $3 trillion New York powerhouse investment firm BlackRock and Boston-based Highfields Capital Management.

Existing shareholders will be able to either keep their Northeast shares, exchange them for cash or some combination of both. Those who invested in the last couple of years will certainly face a loss if they sell, according to McCurtain. Longtime investors such as himself will at least finally have the option to get out — the stock rarely trades, with about 2.2 million shares outstanding in early August, and plummeted more than 65% between January 2006 and January of this year — but at an unfavorable price, according to McCurtain. “I just don’t think it’s a very good deal,” he says.

Jim Nichols, a longtime investor who, along with clients of his Bangor investment management firm holds 7.5% ownership, says many of his counterparts will jump at the chance to sell. “Many people, including myself, have too much of this one small bank,” he says. Liquidity will only worsen in the long term after the new investors scoop up 40% of the outstanding shares, he says. But, Nichols adds, “The price seems low, but reasonable.”

Both Nichols and McCurtain voted for the deal, following years of exasperation with the bank’s weak stock performance and some discouraging financial indicators. McCurtain, president of Maine Securities Corp. in Portland, an investment broker/dealer specializing in the state’s publicly traded companies and municipal securities, says his firm has taken a loss on only one stock in the last 24 years: American Skiing Co. (coincidentally, another company with western Maine ties, through its ownership of the Sunday River ski resort in Newry). “This looks like it will be the second,” McCurtain says of Northeast.

In addition to mediocre returns on assets over the years, returns on equity have also failed to meet the bank’s peer group average, McCurtain says. But he cites another measure with equal vexation: the bank’s efficiency ratio.

Basically an indication of how much it costs the bank to earn each dollar, the efficiency ratio for Northeast has remained consistently high over the years. “They’ve just had a series of bad decisions at this bank,” McCurtain says. “They’ve got one of the highest efficiency ratios of any bank in the country.”

He attributes much of the drag on the ratio to a strategy that bank president Delamater paradoxically touts as integral to the company’s growth: the move into insurance services. To the tune of $13.8 million, Northeast has made 11 insurance acquisitions in roughly the last six years. The company overpaid for them and returns have failed to materialize, McCurtain says. Nichols agrees. “There’s been terrible frustration over getting into the insurance business over the last five years,” he says.

It’s all part of why both men question how much the executives at Northeast are earning. Delamater makes about $268,000 a year as a base salary, just a few thousand dollars shy of the $275,000 Gregory Dufour earns as president of Camden National Corp., a bank boasting better returns and $2.2 billion in assets compared to Northeast’s $622 million. Delamater’s base salary has jumped roughly 40% since 2004, though the compensation committee held the line on his and other executives’ pay after fiscal year 2009 “due to failure to meet performance objectives.” “Northeast pays their guys way too much,” Nichols says, adding that overly generous compensation is hardly rare in the industry today.

Delamater, meanwhile, says compensation at the bank compares well to its peer institutions, and takes pride in the fact that during his three decades at the bank, he’s shown commitment to owning shares as a significant part of his overall pay package. The deal calls for him to relinquish the administrative responsibilities of leading the parent company to head up the community banking division, which he says would free him up to return to his hands-on roots. “I’ve been here 30 years and I think I’ve had the most fun getting out in the street and knocking on doors,” Delamater says.

Looking ahead

Northeast Bank may not be enjoying the 10% annual growth in its insurance business that it predicted back in 2009, but it’s certainly not alone. Soft demand has permeated the market, exacerbated by the recession as cash-strapped policyholders accept the risks of forgoing coverage in exchange for a little extra money in their pockets.

Still, Northeast has managed 1% to 2% growth from the insurance unit, with about $35 million in premiums last year. “I like their strategy, I like their commitment to the insurance business,” says Michael White, a Pennsylvania industry specialist. “They are, at least in the ratings we can measure, right at the very top of their game.”

With $5.9 million in insurance brokerage income last year, Northeast ranks fourth in the nation among bank holding companies with between $500 million and $1 billion in assets, according to a rating report White prepared for the American Bankers Insurance Association, of which Northeast is a member. More than half of its noninterest income, or non-loan income, originates from the insurance brokerage, ranking it eighth nationally among the more than 600 bank holding companies surveyed for the report.

“In this particular market, getting a 1% or 2% net growth is considered to be phenomenal,” Delamater says. “If you look at agencies across the country, on average they’re declining.” The move into insurance has diversified the bank’s holdings and Delamater says he expects it to only grow as a percent of overall business. “We’re looking at this investment as doing exactly what we wanted,” he says. “It serves many of our customers very well.”

Reaping stronger returns will take time, as the economy bounces back, he acknowledges, but already the extra line of income has contributed to the bank’s financial health. “If you have to rely just on net interest income in our business, you’re really hamstrung,” Delamater says.

With insurance representing such a large portion of Northeast’s income — for every $5 it earns in net operating revenue, a little over $1 comes from insurance — a higher efficiency ratio is to be expected, White says. The ratio relates non-interest expenses, which include commissions paid to insurance salespeople, to operating revenue. Healthy sales lead to growing commissions, which bump up the ratio. “You cannot be in a commission business like [insurance] and expect to have a lower efficiency ratio,” White says.

As for the complaints about getting too low a price on the deal, Delamater makes this distinction: selling a bank at below tangible book value is unquestionably substandard. But “this is not a sale, this is a capital raise,” he says. “If you study the price of capital these days, to bring capital on at anywhere near book is wonderful.” Especially considering the new talent and potential for growth the deal brings, Delamater says. He expects many of the shareholders will hang onto their stock in the bank.

“Jim has found a pretty unique arrangement,” says shareholder Rick Liberty, a professional broker. Those who want to keep their shares can, while shareholders who choose to sell can get a fair price and even buy back in, Liberty points out. “That’s going to be a whole new investment,” he says. “It’s going to be a growth opportunity.”

Liberty credits Delamater with building value for shareholders over the years, and with finding growth opportunities in Maine’s relatively small market. “It requires a bank to think outside the dots,” he says, “and Jim has done a very good job of being cautious, of keeping the bank out of trouble.”

Should the Federal Reserve approve the deal, Northeast will also be on the road to paying back a $4 million loan it received through the Capital Purchase Program, part of the $700 billion federal Troubled Asset Relief Program, money Delamater says he would have passed on had he known the FHB investors would come along.

With the bank’s stock beginning to tick back up in recent months, Delamater eagerly awaits regulatory approval and a new era of growth for the bank. He’s also keen on making sure shareholders and the public understand the mechanics of the deal, given the confusion the word “merger” has spawned. “It’s a unique transaction,” he says. “I’ve found that people at first blush that reacted negatively, once they took the time to call me or speak to us and get the facts, they were quick to say, ‘Oh my God, I had no idea.’”

He likens the transaction with the FHB investors to the Red Sox welcoming All-Star players and new owners with deep pockets. Who wouldn’t agree that’s a good deal, he asks. “It’s quite a testament to your company that people of that ilk would say, ‘We like this plan.’”

Jackie Farwell, Mainebiz senior writer, can be reached at jfarwell@mainebiz.biz.