Ladies and gentlemen, thank you for standing by, and welcome to the Eagle Bancorp, Inc. Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference may be recorded. I would now like to hand the conference over to one of your speakers today, Mr. Charles Levingston, Chief Financial Officer. Sir, please go ahead.

Thank you, Michelle. Good morning. This is Charles Levingston, Chief Financial Officer of Eagle Bancorp. Before we begin the presentation, I would like to remind everyone that some of the comments made during this call may be considered forward-looking statements. Our Form 10-K for the 2019 fiscal year, our quarterly reports on Form 10-Q, and current reports on Form 8-K identify certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made this morning. The company does not undertake to update any forward-looking statements as a result of new information or future events or developments unless required by law. This morning's commentary will include non-GAAP financial information. The earnings release, which is posted in the Investor Relations section of the company's website and filed with the SEC, contains the reconciliations of this information to the most directly comparable GAAP information. Our periodic reports are available from the company or online on the company's website or the SEC website. I would like to remind you that while we think our prospects for continued growth and performance are good, it is our policy not to establish with the markets any earnings, margin, or balance sheet guidance. Now, I would like to introduce Susan Riel, the President and CEO of Eagle Bancorp.

Thank you, Charles. I'd like to welcome all of you to our earnings call for the third quarter of 2020. We appreciate your calling in this morning and your continued interest in Eagle Bancorp. As usual, Jan Williams, our Chief Credit Officer, is also with us this morning. Jan, Charles, and I will be available later in the call for questions. I'm very pleased to announce that during this very trying time, Eagle Bancorp had a very successful third quarter. Despite the soft uncertain economy created by the pandemic and the very challenging interest rate and operating environment, our quarterly earnings were $41.3 million. That represents a 13.2% increase over the third quarter of 2019 and an increase of 43.3% over the second quarter of this year. And I am proud to say that for the period, we reached the highest level of quarterly revenue and net income our company has ever achieved. The return on average assets for the third quarter was 1.57%. The return on average common equity was 14.46%, and the return on average tangible common equity was 15.93%. At these levels, our profitability is among the highest for community banks in the United States. For the third quarter, earnings were $1.28 per fully diluted share, which is a 19.6% increase over the same period last year and a 42.2% increase over the earnings per share in the second quarter of 2020. The improved profitability in the third quarter, compared to the second quarter of 2020, was driven primarily by an increase in non-interest income, combined with a lower provision and reduced levels of legal expenses associated with our publicly disclosed investigations and class action litigation. As for the generation of the non-interest income, we were extremely pleased by the performance of the residential mortgage division, which produced $12 million in gains on sale of loans during the quarter. In addition, we also achieved gains from the securitization and sale of FHA loans from the successful sale of OREO property during the period and from the sale of SBA guaranteed loans. We strive for consistent performance across all financial measurement indicators and are pleased to note that we had continued growth in the balance sheet with assets reaching $10.1 billion at September 30. For the third quarter, we achieved strong deposit growth, maintained solid credit statistics and very favorable operating efficiency. The strong performance in these areas, in addition to the increase in non-interest income, more than offset the impact of further compression in the net interest margin and a slight decline in loan portfolio balances, notably in the construction loan portfolio. I would also like to speak in more detail about the results we had for non-interest income in the third quarter. Not surprisingly, the historically low-interest rate environment has been a real boon to the residential mortgage division for both refinance and purchase money loan activity. For the quarter, gains on sales were $12 million as compared to $1.9 million in the third quarter a year ago and $3 million in the second quarter of 2020. We did change the accounting methodology for recognizing gains on residential mortgage loans locked on a best efforts basis to align with GAAP by recognizing revenue upon the loan being locked versus when the loan is closed. This increased the revenue in the third quarter by $1.6 million. But even excluding that impact, our residential mortgage division had a very strong quarter. Loan locks during the quarter were $593 million as compared to $282 million in the third quarter of 2019. During the quarter, we also recognized gains of $1.2 million from the sale of OREO assets. The fact that we were able to realize these gains is reflective of the disciplined and proactive approach we take to managing workout situations. Additionally, we had good production during the quarter by our FHA division of $912,000 from their securitization, sales, and servicing activities and $168,000 in premiums on the sale of SBA loans. We've spoken many times about how these fee income business lines tend to be cyclical. Like the residential mortgage division, they are not easily predictable, like the SBA and FHA groups, but we believe that over the long run, they add value to our franchise. We certainly saw that this quarter, and I would like to thank the employees in those groups for all of their efforts and congratulate them on a job well done. I would also like to recognize the impact that our emphasis on disciplined underwriting and conservative credit administration practices have had on our credit quality statistics, which continue at reasonable levels despite the slowdown in the economy. At September 30, nonperforming assets were 0.62% of total assets as compared to 0.66% a year earlier and 0.69% at June 30, 2020. At quarter end, nonperforming loans were 0.74% of total loans, a manageable number. Net charge-offs to average loans for the third quarter were 0.26% as compared to 0.08% one year ago and 0.36% in the second quarter of 2020. The charge-offs in the third quarter were due primarily to two commercial real estate loan relationships. At September 30, 2020, the allowance for credit losses was 1.40% of total loans, offset by 8 basis points by the amount of PPP loans in the portfolio. Also at September 30, the coverage ratio was 190% as compared to 128% a year ago. And we feel we are adequately reserved. The allowance level was determined in accordance with the CECL methodology adopted earlier this year. The third quarter 2020 analysis took into account an improved unemployment rate assumption and additional qualitative reserves for second deferrals as well as our higher mix of Accommodation & Food Services industry loans. The provision was $6.6 million in the third quarter compares to a provision of $3.2 million in the third quarter of 2019 and a $19.7 million in the second quarter of 2020. Additionally, our CECL reserve for unfunded commitments was reduced by $2.1 million. As to some specifics related to the COVID-19 pandemic, as of September 30, the balance of PPP loans was $456 million. We are starting to see more activity from our clients now that the treasury department and the SBA has streamlined the application process for forgiveness of all loans under $50,000, but expect that the attrition of these loans from our portfolio will take a couple of quarters, at least. Regarding loans that were deferred or modified, you will recall that in June, we had 708 loans totaling about $1.6 billion, which was 20% of total loans in that category. At which point, we formed a special task force to monitor and work with these customers. I am pleased to report that as of September 30, that pool of loans is down to 321 loans, about $851 million, which is 10.8% of total loans, which we will continue to work with our clients to remediate. We also continue to monitor the impact of COVID-19 on the health and safety of our staff and customers. We have a spotlight on the at-risk industry exposure in our loan portfolio, most notably the Accommodation & Food Services and retail industries, which together comprised 11.5% of the loan portfolio. However, we are still cautiously optimistic about the economy of the Washington, D.C. metropolitan area. While there certainly has been an impact from the COVID pandemic, the most realistic estimates are that the regional economy will shrink about 5.5% this year. At that level, the gross regional product would still be in excess of $500 billion per annum and the Washington metropolitan area is the 5th largest regional economy in the United States. The rebound in job growth began in June. And since then, the region has recovered approximately 100,000 of the jobs lost in the spring and we are on track to add another 40,000 jobs in 2021. We are carefully watching the vacancy rates for office space throughout the region, which shows some softening. However, housing remains fairly strong for both the multifamily and single-family sectors. In fact, there is a shortage of inventory in single-family homes. Through June of 2020, federal contract awards for COVID related matters in the region have been just over $3.5 billion. There is no doubt that federal government spending has been a stabilizing factor for our economy. Given the low interest rate environment, fostered by the Federal Reserve and the trend of margin compression across the industry, it is not surprising that in the third quarter, we saw a decrease of the net interest margin to 3.08%. The margin was down 18 basis points from the second quarter of this year and down 64 basis points from a year ago. The decrease in the margin was attributable to several factors. The yield on our loan portfolio decreased by 17 basis points to 4.46% for the third quarter as average market rates decreased during the period, reducing the yield on new bookings and we reacted to competitive pressure to reprice loans currently on the books. We are also feeling the impact of the lower percentage of higher-yielding construction loans in the portfolio. Long floors on the portion of the loan portfolio did provide a buffer against further decreases in loan yields. We were able to reduce both the cost of interest-bearing deposits and the aggregate cost of funds during the quarter, which fell by seven basis points. However, the total yield on interest-earning assets declined 25 basis points during the period, a significant factor being the increased level of on-balance sheet liquidity, whose yield was only 12 basis points. In addition to the very low level of market interest rates, relatively flat yield curve, and competitive lending environment, the margin was significantly impacted in the third quarter of 2020, by our asset liability mix and the level of liquidity we carried through the quarter. For the third quarter, the average loan-to-deposit ratio was 93%, while average overnight liquidity was above $1.3 billion. While we did increase our securities portfolio by an average of $86 million over the third quarter, we continue to maintain on-balance sheet liquidity, as we adhere to our conservative asset liability management strategy, as we monitor the effects of the COVID-19 pandemic. The efficiency ratio for the third quarter was 38.10% as we continued our prudent approach to expense management. This is compared to 38.34% in the third quarter of 2019 and 37.18% in the second quarter of this year. While the efficiency ratio is little changed from a year ago, we need to remember that revenue growth has been hampered by the low level of interest rate. For the third quarter, the ratio of non-interest expenses as a percentage of average assets was 1.40% as compared to 1.49% in the third quarter of last year. Of note, during the quarter, we enjoyed the benefit of lower legal fees, as legal accounting and professional fees were $3.1 million for the quarter as compared to $3.6 million in the third quarter of 2019 and $3.9 million in the second quarter of 2020. The net legal expenses for the quarter associated with the investigations and legal matters previously disclosed were $957,000. On the other hand, our occupancy expenses for the quarter were elevated as we took a $1.7 million charge to properly value a lease extension and our FDIC insurance expenses increased by $2.1 million over a year ago due to the growth in our balance sheet. Given our asset size exceeding $10 billion, we will continue to judiciously manage expenses, but will also make the prudent investments necessary to have our infrastructure meet all regulatory expectations and support the continued growth of our company. The company's capital position remains very strong as we continue to build it through the quarterly additions to retained earnings. At September 30, the total risk-based capital was 16.72% as compared to 16.08% one year ago, the common equity ratio was 12.11% compared to 13.16% one year ago, and the tangible common equity ratio was 11.18% compared to 12.13% in September 2019. These ratios recognize the impact of the share repurchase program. Our strong capital position was one of the factors behind our recent decision to lift the suspension of the share repurchase program, which the Board initially put in place back in the spring at the inception of the pandemic. And as you know, we did declare another $0.22 per share cash dividend for the third quarter. The Board is committed to maintaining a strong balance sheet and is very comfortable with our capital position. Thank you, again for joining the call this morning and for your continued support of Eagle Bancorp. That concludes my formal remarks. We would be pleased to take any questions at this time.

Our first question comes from Casey Whitman with Piper Sandler. Your line is open. Please go ahead.

Hey, good morning.

Good morning, Casey.

Good morning, Casey.

So now that you guys have crossed the $10 billion asset threshold, I guess my first question would be, just can you remind us of how big of an impact Durbin would have on your fees and the timing of when that would occur?

Sure. Yes, Casey, that impact, based on my analysis, is somewhere in the neighborhood of about $1.3 million pretax, so just under $1 million or so. Again, not a significant consumer book of business with the bank. So the impact is minimal.

Okay. And that's annual, correct?

That's right. That's an annualized number, yes.

Okay and what about the timing of that?

Right. My most recent read is that if we maintain a balance of total assets in excess of $10 billion at year-end, that will kick in on the first of next year. I think that's right.

Understood. Thank you. As I consider expenses, it seems likely that you'll experience a decrease in occupancy costs in the fourth quarter. However, I probably ask this every quarter, but with exceeding $10 million, can we anticipate any additional expenses? Or do you feel confident about your current position?

Yes. I think, as we've mentioned in prior discussions and calls, we've been building towards the establishment of an infrastructure that can accommodate a $10 billion-plus bank. And so, we feel like we're in pretty good shape. I mean, there will be incremental costs associated with some additional people. But most of the systems, we feel like are generally in place. It's not going to be anything that's going to be exponential in terms of cost. We're growing into it.

Understood. Thank you. And then maybe I'll switch gears. As you think about capital, and as you guys mentioned, restating your buyback, can you walk us through sort of your thoughts about how aggressive you could be with it? And then maybe what your appetite might be for announcing a new program once I think this one expires at the end of the year?

Right. Yes. I mean, that's something that our Board is continually evaluating. I note that these days, we are trading below book value. So any kind of acquisition or repurchase of our stock is immediately accretive, which looks pretty attractive from my vantage. But it is something that our Board will continue to evaluate each time we come together.

Great. I'll ask one more question and let someone else jump in. Jan, can you walk us through where the watch special mentioned and substandard categories ended up this quarter? Did we observe any negative changes there, particularly within the average segments?

Yes, Casey, I think you should expect to see significant migration into the watch category, as we move anything in second COVID mod into a watch status, so that it's getting a heightened profile at the bank. So you'll see a significant shift, probably about net $520 million moving to a watch category.

Got it, but not into the special mention substandard?

Special mention will be up about $8 million, substandard up about $5 million.

Great. Thank you for the questions and stay safe.

Thank you.

Thanks, Casey.

Thank you. And our next question comes from the line of Steven Comery with G. Research. Your line is open. Please, go ahead.

Hey, good morning.

Hey, good morning, Steve.

Appreciate the commentary on the deferrals being $851 million versus $1.6 billion on $630 million. Kind of wondering if you guys had any breakdown as to how much of that was second request versus first request? And maybe just some general color on how EagleBank is handling second request?

Yes. To break that out for you, there are roughly $620 million in second deferrals, and two-thirds of that $620 million are partial deferrals, they're interest-only deferrals as opposed to full payment deferrals. I'll give you an example of what we're doing when we are considering second deferrals, looking to provide credit enhancements. For example, we had a large hotel loan that we agreed to do a principal deferral on. And in return, received a $25 million principal curtail that more than offset, from our perspective, the risk associated with an additional deferral. Another large relationship where we granted an interest-only second deferral was also anticipating a 10% principal reduction as part of that deferral. So we're not really in a situation where we're kicking the can down the road. We're actually using the opportunity to build stronger credit when these requests for their second 90-day deferral come through.

Thank you for that information. Moving on to the margin, there has been a notable decline in yields this quarter. I understand that the press release and Susan mentioned some floors in her prepared comments. Could you provide an update on how many loans in the portfolio have floors and what the extent of those loans is? Looking at the bigger picture, do you believe that the LIBOR declines are fully reflected in the current run rate, or should we anticipate further changes in Q4?

Yes. There's about $3 billion of the loan portfolio in floors that are at the floors, and that's pretty much all of the floors. So yes, I think that protection does continue. And Susan mentioned this in her comments to another challenge that I think we and a lot of institutions are facing, is having borrowers coming in and looking to renegotiate rates, right? And so that can be a challenge. You weigh the calculus of going out and identifying business to replace that versus the rate request in terms of what's being lowered. So, that can continue to be a challenge and provide some downward pressure. You had another part to your question. I'm not sure that I answered that the whole question, LIBOR? LIBOR, so yes, I do think to the extent that LIBOR only moved down a basis point over the period, that a lot of that downward float is baked in. So, yes, I think we've seen the majority of that at this point.

Okay. Thank you. Appreciate that. Maybe one more for me, just sort of a more general question on sort of loan demand. Loans were down on a period end basis, you did deploy a decent amount of liquidity in the securities book. Is the demand just not there? Or is the company being sort of more conservative with the credit it's extending?

Yes. I would say, Steve, that the demand is certainly a little bit slower, and we are being cautious about the kinds of deals that we're approaching and self-selecting out of, or otherwise giving a hard look to. So, yes, our channel, our President of Commercial Lending, who says, there used to be the go, go, go days, and now it's just the go days. So, yes, I'd say that there has been a little bit of a pullback in some of that activity to date, but we're still seeing some flow.

Thank you. And our next question comes from the line of Catherine Mealor with KBW. Your line is open. Please go ahead.

Thanks. Good morning. I wanted to start on just a follow-up. I want to start on just a follow-up on the margin. I know a lot of what's driving the margin lower is just the level of excess liquidity that you've got on the balance sheet. Charles, how are you thinking about just the timing of how long this excess liquidity stays and any efforts to deploy that excess liquidity? Maybe kind of how that fits into your overall big picture view of the direction of the margin into next year?

Sure. Yes. We did see that liquidity picture turn pretty quickly earlier this year when the pandemic hit. And all of a sudden, there was this glut of liquidity that's remained on the balance sheet. We are being judicious about how we deploy that. We don't want it to all be pushed out into the investment portfolio at one point in time. And if one tender it as it were. But we want to be cautious to the extent that it could turn again at some point. At the same time, we want to put that money to work. We're trying to actively manage that excess liquidity to the extent we can. And again, on the other side, we still want to be able to bank our customers. So that's a little bit of the tension there. Obviously, a lever that can be used is price. And we certainly feel like we've pulled on that lever with our top-tier money market rate at about 25 basis points. So to the extent that there's more room to go down there to manage some of those funds down, that could be part of the solution. But in terms of deploying that liquidity, I think it's at a measured pace over the next several quarters to the extent that it sticks around.

Great. Okay. And then on the mortgage outlook, and this is a really strong mortgage quarter. How are you thinking about just kind of more seasonal normalized level as we look to fourth quarter?

No, I would say, Catherine, that as you well know, the mortgage volume depends on rates. And it's anyone's guess as to what will happen. I think the rates will stay low for a while. And so our activity will continue to be pretty high. So we're looking forward to that. And we feel confident that it will continue for a while.

Can you remind me of the number for this quarter regarding the gains from the fair value lock on the pipeline? Also, you mentioned a change in best efforts methodologies. Is there a way to quantify how much of this quarter's performance was due to accounting dynamics versus the actual rate and volume?

Yes. That number was $1.6 million.

Okay. Great.

Did that answer?

Great. Thank you so much.

Yes. No problem. Thank you, Catherine.

Thank you. And our next question comes from the line of Christopher Marinac with Janney Montgomery Scott. Your line is open. Please go ahead.

Thank you. Jan, I just wanted to go back to the watch comment that you made earlier. What happens to move something from watch into special mention going forward? And to what extent did the watch movement impact the reserve calculation at the end of September?

Well, Chris, those are good questions. We have internal metrics that we use to calculate when loans are going to be moved from watch to special mention. And I think it depends on the severity and duration of the impact. Right now, we're not looking at a whole lot of the second deferrals that are impacted in terms of their ability to make interest payments. So they're in the watch category, if there was a complete payment deferral, we would push that further. But I think overall, the majority, about $500 million of those second deferrals will show up in watch.

Okay. Is that something we will observe now, or will it be reflected in the fourth quarter reporting?

I am unsure what the end of the fourth quarter will look like. We have essentially reached the limit of the first deferrals except for about $220 million that remain outstanding. We do not expect to enter into second deferrals at this time, although situations may change. There seems to be more potential for positive developments as we consider the possibility of a second stimulus package in the fourth quarter. Currently, we have taken a cautious approach by monitoring many of these loans and placing them in the watch category, with the COVID task force reviewing the rationale for any potential second deferrals.

Got you. Okay. That's great, Jan. Thank you for that background. And then, Susan, just a quick one for you. On the legal expenses that we see, is there anything that you would expect going forward? I mean, would those retreat after what you've spent year-to-date? Or just any additional thought about that?

At this point, we don't have any view into what those legal expenses will be at this point. So we expect them to be ongoing. We will continue to have elevated legal expenses as a result of the investigations in the civil lawsuit, but we can't predict at this point what they will be.

Got you. Great. Thank you both for the information this morning.

Thanks, Chris.

Thank you.

Thank you. And our next question comes from the line of Brody Preston with Stephens, Inc. Your line is open. Please go ahead.

Good morning, everyone.

Hi, good morning, Brody.

Good morning, Brody.

I wanted to ask about the second deferral of about $500 million. I appreciate the breakdown by industry and collateral type, but I'm particularly interested in the hotels. Could you share the weighted average LTV for that, or did I miss it in the release?

Yes, the weighted average loan-to-value on the hotel deferrals is at 60%, the highest on the second deferrals is 75%. Everything else is below that level. I think I did mention that we had about a 25% pay down on our largest hotel loan as a principal curtail as part of the second deferral. So we're actively managing that portfolio.

Okay. Okay. Great. And then just as I think about crossing $10 billion, and I think you said it was like $1 million or so annualized in Durbin related impacts from crossing $10 billion. I mean, it just seems like just given how de minimis that is, I guess, maybe assuming there's better growth opportunities early next year. Is there any reason why you guys wouldn't just, I guess, maybe continue to grow the balance sheet and just push beyond that yourselves, without necessarily considering partnering with anybody?

Yes. I think that's right. We're going to continue to carry on. We'll always be opportunistic. There may be opportunities that present themselves. But at this point, we're fully prepared to continue to march forward.

Okay. Charles, I understand the floor renegotiations you might face. However, without any significant renegotiations, as you deploy liquidity, it appears there are opportunities to lower the pricing on the CD book and potentially the money market as well. So, as you deploy liquidity while those floors are in place, it seems like there could be a natural margin advantage that you might experience next year. Is that how you are approaching it?

There's some fairness to that. Certainly, we've seen some of the higher-priced brokered CDs that we booked in the middle of late 2018 start to roll out. I think there was $60 million or $70 million that around a 260 weighted average or so that we were able to unload that came to term here in the last quarter. So, we'll continue to see some roll-offs like that, which are very helpful.

I understand that loan balances declined this quarter, primarily due to construction, which is understandable in the current environment. However, you managed to grow owner-occupied and income-producing commercial real estate. I would like to know what opportunities you are seeing in that area and what drove growth this quarter.

That's a really good question. We are seeing opportunities on deals. I think the big driver right now is interest rates and people looking at refis. That's a really competitive market in terms of pricing for the prime properties that we're looking at. So, every deal is an evaluation. And we're not always the lowest-priced bank in town. We provide the best service and can sometimes command a premium for that. But there's an awful lot of price shopping going on right now.

Okay. And then I just had one last one. There's just between the liquidity, between the growth profile that you all have historically had, the really low efficiency ratio, strong profitability profile and the potential to buy back a decent slug of stock moving forward with excess capital. It just seems like there's a lot of tailwinds to your story and the one overhang is the investigation. And I understand that you can't necessarily speak to the specifics. But I was just hoping maybe you could help us better understand how frequent the conversations are? And do the conversations that you have with the investigators, do they ever give you a sense for when they feel like the investigation might conclude or not?

We really don't have any insight into that. We cannot provide any further guidance on the matter. We have completed the documentation phase and believe we have also finished the testimony phase. You can interpret that as you wish, but we cannot offer any additional guidance.

Okay, understood. Thank you all for taking my question this morning. I appreciate it.

Thanks, Brody.

Thank you. And I'm showing no further questions at this time. And I would like to turn the conference back over to Ms. Susan Riel for any further remarks.

I would like to thank everyone again for your support and your interest in our company, and we look forward to speaking to you again after the end of the year.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.