Oh. NO, Nbits is just the number of bits in N, for N a power of 2, and which is constant for the hash table, regardless of level. (I may be off by one here). I think it is log2(N)+1.
Level moves up and down as needed. However, at any point, we only have bf(key, level) and bf(key, level-1) in use.
The initial conditions are level = 1, M = N-1, and buckets 0 to N-1 are ready and empty. So the LF is initially 0 but we never shrink below N-1 anyhow. With linear hashing, we always grow the buckets linearly at the end, so the first bucket to split is bucket [0] and it splits between itself and new bucket M+1. (Then M is then advanced by 1).
At the time of the first split, presumably LF > LFmax has happened and let us assume for simplicity that it is over just a hair and we can assume LF = LFmax for convenience.
Then bucket [0] is expected to have LF records in it and after the split it will have kept an expected LF/2 of them with new bucket [N] getting the other expected LF/2. By the time the level is complete (so there are 2N buckets), each of them will again have an expected LF records in them (which is how the saw-tooth fits in). Then we start splitting again from bucket [0], M = 2N-1, and we work on building out the next level, which will end up with a total of 4N buckets if it is completed. Rinse. Repeat.