Eagle Bancorp Inc Q2 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the Eagle Bancorp's Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today Chief Financial Officer, Charles Levingston. 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. While our growth and performance over this past quarter has been positive, we cannot make any promises about future performance, and it is our policy not to establish with the markets any formal guidance with respect to our earnings. None of the Forward-Looking Statements made during this call should be interpreted as providing formal guidance. Our Form 10-K for the 2020 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. Eagle Bancorp 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 our website and filed with the SEC contains reconciliations of this information to the most directly comparable GAAP information. Our periodic reports are available from Eagle online at our website or the SEC's website. This morning, Susan Riel, the President and CEO of Eagle Bancorp will start us off with a high-level overview; then Jan Williams, our Chief Credit Officer, will discuss her thoughts on loans and credit quality matters; then I will return to discuss our financials in more detail. At the end, all three of us will be available to take questions. I would now like to turn it over to our President and CEO, Susan Riel.

Thank you, Charles. Good morning everyone and welcome to our earnings call for the second quarter of 2021. I'm pleased to report another great quarter for the bank. Similar to last quarter, earnings again are at record levels. Equity has risen to an all-time high, asset quality remains high with favorable credit terms and efficiency remains a strength. A key difference from last quarter is that there was an increase in total loans, excluding loans held for sale and PPP loans. There was a modest increase of almost $60 million, but it breaks the downward trend. Focusing on earnings first, earnings for the quarter were $48 million or $1.50 per share. This was a 1.68% return on average assets and a 16.25% return on the average tangible common equity. The larger items impacting earnings this quarter included $4.7 million of accelerated interest income from the sale of PPP loans and a $4.6 million reversal from the allowance for credit losses on loans and reserved for unfunded commitments. Earnings over the last four quarters, which includes the third quarter of 2020 when the nation was still locked down, totaled $171.7 million or $5.35 per diluted share. These earnings continue to build our common equity, which at the end of the quarter was $1.3 billion or 11.92% of assets. Turning to asset quality, at the end of the quarter, NPAs were 50 basis points of assets. For the quarter, annualized net charge-offs were 30 basis points of average loans. These asset quality ratios combined with an improved economic outlook nationally and locally informed our decision to make a second conservative reversal from the allowance for credit losses, and reserve for unfunded commitments. With the reversal of $4.6 million for the quarter, the total reversal for the first half of 2021 was $7.4 million. After the reversal, our reserves were 1.32% of loans, excluding PPP loans. In terms of operating efficiency, we continue to be a leader with an efficiency ratio of 37.1% for the quarter. We are always prudent in our approach to expense management. For example, this quarter we closed our Rosslyn, Virginia branch, as it had an expiring lease, and our customers can be served from other Northern Virginia branches. The combined annual pre-tax cost savings and rental expense will be about $263,000 and there was no write-off of leasehold improvements, as these had been fully amortized upon the expiration of the lease. We are also pleased that all of the employees working at the branch have filled or will be filling positions within the company. Additionally, given the bank's robust capital levels, we requested and received board and regulatory approval to redeem $150 million of subordinated debt issued in 2016. Charles will have more details on this later. Before discussing loans, I would like to once again mention the contributions of the residential mortgage and FHA teams. Our residential mortgage team had another great quarter with loans of $248 million, and again on sales mortgage loans of $3.5 million. Even with mortgage volume off slightly from last quarter, we expect the residential mortgage division will continue to contribute meaningfully to the bottom line. Our FHA team also did well generating trade premiums of $2.6 million that are included in non-interest income. The revenue stream from the FHA division is not smooth from quarter to quarter. Comparatively, the FHA division has larger transactions and less volume than the mortgage division, which has smaller transactions and higher value. In regards to loans, last quarter on this earnings call, I said EagleBank intends to more assertively pursue loan opportunities. This past quarter our funding for new loan originations and advances increased, while payoffs and paydowns decreased. As a result, loans excluding loans held for sale and PPP loans increased by $60 million. Jan will talk in more detail about this later. While still talking about loans during the quarter, we made a decision to sell $170 million of our PPP loans which generated nearly $4.7 million in accelerated net deferred fees and costs into interest income. The sale was to a well-regarded firm with significant expertise in the ongoing servicing and processing associated with PPP loans. Additionally, just below $116 million in loans were forgiven during the second quarter. The PPP loans retained totaled $238 million with those that had already started the forgiveness process on our platform or those that we decided to retain for customer service reasons. The sale of the PPP loans, and with the remaining loans moving through the forgiveness process, will enable us to free up personnel to focus on originating new business and continuing to provide a high level of service to our clients. In regard to our market, we serve a strong and robust market, anchored by the Federal government and government contracting, a growing technology presence, which includes Amazon's HQ2, many substantial domestic and international firms, several large hospital systems and a long list of universities. Our home market continues to see companies open, hotels are doing more business, tourists have returned and many of the restaurants are full. Internally EagleBank, which has been operating remotely where possible since the beginning of the pandemic will have its workforce return in a hybrid environment on September 13th. We also have a legal update, we are pleased to have initiated discussions with commission staff about a potential resolution or settlement regarding the Commission's investigation, which we first disclosed in July 2019. We hope to resolve the Commission's investigation as it relates to the Company within the next few months. This would be a welcome development for EagleBank and its stockholders. In addition, we are also pleased to have initiated discussions with the staff of the Federal Reserve Board about a potential resolution or settlement regarding the Federal Reserve Board's investigation. We also hope to resolve the Federal Reserve Board's investigation as it relates to the Company in a timely manner. We also disclosed in yesterday's press release that our CFO Charles Levingston received the Wells Notice in connection with the ongoing SEC investigation. Charles made a submission to the SEC in response to the Wells Notice and is cooperating with the SEC investigation. Charles is continuing to serve in his capacity as CFO. While we can't comment on the allegations against Charles, I want to stress that making the decision to have Charles continue to serve as CFO. The Board evaluated the circumstances, considered a number of factors and consulted with members of management and external advisors, including our independent auditors. The board's top priority is as it always has to act in the best interests of the Company and the Company’s stockholders. And we and the Board remain confident in the Company’s disclosure controls, accuracy of its financial reporting, and the professionalism of the Company’s finance function and personnel. We work closely with other members of the Company’s management, the Company’s disclosure Controls Committee, the Company’s independent auditors, the Company’s outside Disclosure Counsel, and other advisors and consultants to ensure that the company maintains strong internal controls over financial reporting. Given that the investigation is ongoing, we obviously cannot speculate or comment further on these developments at this time, nor are we able to speculate or comment on former employees and directors' potential interactions with the SEC. Accordingly, we cannot answer any questions about the investigation during our Q&A. Before turning it over to Jan, I would like to reiterate that we remain focused on building stockholder value. Book value rose to $40.87 per share, up 11% from a year ago, and tangible book was $37.58 per share, up 12% from a year ago. We also increased the quarterly dividends to $0.35 per share. This is up $0.25 from the prior quarter and $0.22 the quarter before that. Based on recent stock prices for Eagle, a dividend of $0.35 per share puts our dividend yield more in-line with our peers. I would like to thank all of our employees for their hard work and their commitment to support our clients. Additionally, we remain committed to a culture of respect, diversity and inclusion in both the workplace and the communities we serve. With that, I would like to turn the speaking duties over to Jan Williams, our Chief Credit Officer.

Thank you, Susan and good morning everyone. First, I would like to speak to the modest uptick in loan balances with exclusive of PPP and loans held for sale that Susan mentioned earlier. As credit has improved and with a large portion of PPP loans moving through the forgiveness stage, we are able to focus more of our efforts on quality opportunities we see in the market. In particular, we are focused on opportunities that offer good risk-adjusted returns. Having said that, the pricing of loans continues to be a factor in our appetite for new loans. Of course, there is always going to be a time lag between identifying and securing lending commitments and ultimately loan funding. Some of the uptick in loans may also be related to the timing on funding for new loans originated in the past several quarters. Booked and funded loan originations last quarter were on the lower side. However, we did have a few large loans with significant funding this quarter. One of the larger loans was an $80 million multifamily financing for the Montgomery County Housing Opportunities Commission and economically strong Bethesda, Maryland. As a community bank, we are very pleased to be able to offer support for these local efforts to bring affordable housing opportunities to our community. We also funded $26 million for the redevelopment of another very well-located property in Northwest Washington DC during the quarter. In regards to the reversal of the $4.6 million from the allowance for credit losses and reserved for unfunded commitments, the reversal primarily resulted from the improved outlook for the economy and employment forecasts as well as improvement in loan portfolio credit metrics. The unemployment rate for the Washington area which was 5.8% in February fell to 4.9% in May. At period end June 30th, loans 30 to 89-days past due fell to $3.9 million, the lowest level we have seen in more than a dozen years. With the reversal, the allowance for credit losses to total loans, excluding PPP loans was 1.32%, down 15 basis points from the prior quarter end. Even with our lower allowance for credit losses, our coverage ratio was stable with coverage of non-performing loans at 187%, which remains in the 180% to 200% range where it has been for the last six quarters. At quarter end, NPAs to assets were 50 basis points, down one basis point from the prior quarter end. In dollars, NPAs were $54.5 million down from $57.3 million in the prior quarter. The decline in NPAs was primarily from charge-offs of non-performing loans, a return to accrual status for some loans which exhibited sustained performance and charge-offs. Net charge-offs for the quarter were $5.6 million. The largest charge-offs with a partial charge-off related to a note sale secured by a smaller suburban office property at $3.5 million, but no sale closed in early July. The other charge-offs consisted of a partial charge-off of one other CRE loan now fully resolved, a few smaller C&I loans principally in the restaurant industry and one small SBA credit. With that, I would like to turn it over to Charles Levingston, our Chief Financial Officer.

Thank you, Jan. Net income for the second quarter of 2021 and second quarter of 2020 reflects operations in two very distinctly different environments, as the current quarter contains reversals from the allowance for credit losses and accelerated income from the PPP loan sale, whereas in the second quarter of 2020, we were still building those COVID-19 reserves. In the earnings release to adjust for the impact of the PPP sale, we added a table for net interest margin, which backed out the $4.7 million of accelerated net fees and costs from net interest income and we have also carried the adjusted net interest income down into the PPNR table. While adjusted PPNR for the second quarter of 2021 declined in comparison to the second quarter of 2020, it was a little change from the prior quarter end. On a linked quarter basis, the net interest income after the PPP sale was down $2.7 million from the prior quarter. This primarily reflects the decline in margin to 288 on an adjusted basis down from prior two quarters. Non-interest income was up $338,000 from the prior quarter. While mortgage gain on sales were down on the linked quarter basis, FHA trade premiums of $2.6 million more than made up for the difference. Non-interest expenses were down $1.3 million from the prior quarter. Most of the decline was in salaries and expenses and FDIC fees offset by the increases in legal and professional fees. Overall adjusted PPNR, absent the PPP accelerated income was down $1 million from the prior quarter. This quarter, deposit inflows finally abated and deposits at quarter end were $9 million, down $180 million from the prior quarter. This resulted in the reduction of excess liquidity as we continue to slowly and prudently build the investment portfolio. Investment securities at the end of the second quarter were $1.7 billion, up $311 million from the prior quarter end. Investments this quarter like last quarter, primarily included 20-year 2% agency mortgage-backed securities and callable agency bonds. Additionally, while it doesn't show up in the investments, this quarter we invested $300 million in a reverse repurchase agreement with a well-regarded nationally known investment bank to hit some additional earnings on our cash. Also, higher cost CDs continue to run off. In the second quarter of 2021, CDs with a total balance of $200 million and a weighted average rate of 1.21% matured. These CDs had a weighted average term of 16 months of issuance. Overall, our cost of funds in the first quarter of 2021 decreased to 37 basis points down from 42 basis points in the prior quarter. Going forward, our cost of funds will be positively impacted by the redemption of $150 million of our 2016 subordinated debt on August 1st, which is our first opportunity to call it a debt. The debt at a rate of 5% in the second quarter, which translates into pre-tax cost savings of $7.5 million on an annual basis and $1.9 million on a quarterly basis. This prediction however will accelerate about $1.3 million in deferred costs, so the impact in the third quarter will be minimal. To fund the repayments, we made a dividend of $100 million from the bank to the Bancorp early in the third quarter. The redemption of debt is possible because our earnings have consistently generated capital that has outpaced the need for capital to cover risk-based assets. The redemption of debt will not impact our Tier 1 or tangible capital at the Bancorp, but will reduce our capital at the bank level. With this reduction, we have enough capital to fund future loan growth as well as fund large commercial projects. With that, I will hand it back to Susan for a short wrap up.

Thanks, Charles. As we move into the second half of 2021, we will continue our efforts to deliver positive operating performance results and we will continue to strive to serve both our investors and our community to the best of our ability. But before we open up for questions, I would like to say that the Bank posted its second consecutive quarter of record earnings, NPAs are 50 basis points on assets. Loans past due 30 to 89 days are under $4 million. Common equity is almost 12% of assets. Total risk-based capital is almost 18%. We have just raised the dividend and we got approval to redeem $150 million in subordinated debt. The bank is doing well. We will now open up the call for your questions.

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

Hey good morning. Wondering maybe to get started with just the PPP related question. Following the sale of the portion of the PPP and accelerated fees how much is remaining in the PPP processing fees that have yet to be realized, that remaining $238 million balance? And also, what is your best guess for the timing of forgiveness for the remaining balance?

I will take that, Casey. Less on the balance sheet that we have got about $3 million or so a little less than $3 million in net deferred fees on the PPP portfolio for $238 million less. In terms of timing, your guess is as good as mine; they have been moving along at a pretty good clip. I imagine there are going to be some stragglers at the end, if they have waited this long. They may have their own challenges gathering that information. But I would expect over the next couple of quarters, we will see a meaningful decline in those PPP loans, but time will tell the tale.

Helpful thank you and nice to see the loan growth this quarter. You mentioned some of the pressure on the yields. But do you have the numbers around where new production was coming on this quarter versus last maybe?

Yes. So, as you can see, obviously, on an adjusted basis, our yield for the quarter on total loans is just above 450 to 452. New production is coming on weighted average coupon right. So ignoring the impact of the deferred fees and costs of right around just below 4% or so or weighted average basis is where we are coming in the second quarter. So obviously, that is going to, if that trend continues, we will create a little bit of a drag on the asset side of the balance sheet.

Understood. Last question I will let someone else jump on. But just on capital, you have raised your dividend a number of times recently, how are you guys ultimately thinking about the right level with, as you mentioned, your yield to kind of now more in line appears? Is there sort of a target payout ratio maybe we should think about, or how do you think about the level?

Yes. Obviously, we do hold a significant amount of capital. I think the rock and hard place of it for us is really that ADC, CRE concentration number. We do if you stack up against a larger peer group appear to have larger capital, but we want to be mindful of those ADC and CRE concentration limitations so that is somewhat of a gating factor. But we are going to be judicious about and imprudent about that capital management, we want to make sure that we are being good stewards of the capital that we are holding and return it to our shareholders where appropriate.

Understood and do you have that ADC capital level now or should we wait for the call for?

Yes. I would wait for the call report to have it finalized. But it is going to be slightly improved from the prior quarters in my expectation.

Thank you. I think you mentioned in the earnings narrative, the opportunity to originate loans for larger commercial projects. Just curious, has your appetite increased to do larger deals here, just given the strength of capital or maybe pullback and competition or just the quality or tenor of loans you are seeing in the market just to get some commentary in terms of the outlook for average loan size, how you see that playing out?

I think our appetite has definitely increased. But we also are seeing that in the market and as you know, the market is tight. The pricing is tight and there is a lot of competition. So we are out there and our teams are aggressively pursuing deals and we have had a good deal of success recently.

I would agree with that. I would also say that the larger opportunities that are coming through seem to have an incredible amount of equity in them. I think there is still a lot of money sitting around looking for a place to deploy. So the credit metrics on these larger deals has been especially strong. On the other hand, the pricing is pretty darn tight on them. So it is a balancing act.

Just curious, towards the commentary what the loan pipeline was, currently relative to last quarter?

The loan pipeline. We have unfunded commitments to just under $2 billion currently. It is slightly elevated from where we were last quarter, which is close to $1.9 million, I believe.

Got it and then Charles, maybe from a credit perspective, obviously, the numbers moving in the right direction here. But when you get to a point, maybe look at the future where we start to see the positive loan growth. Just curious, if you can give us a sense where you think the ACL moving back to just update us what the day one ratio was and maybe what you would be reserving new loan growth at?

Right, our day one calculation was right, about 110 basis points, I believe and obviously, here we are sitting at 128 basis points is 132 when you exclude PPP. So there is, if we assume that day one is a normal environment, it is every environment is a little different, then there is a little bit more room to drift down if you can get back there.

Hey Charles, I just wanted to follow up on the loan portfolio. Could you just give us a reminder, what percent of loans are floating rate and what percent of the floating rate bucket is currently at floor levels?

Yes, so we have about, I think, excluding PPP, you are talking about close to 60%, just under 60% is variable rate that is about $4 billion or so. And just under $3 billion, have floors on them, about $2.8 million.

Okay and do you know, of those floors, what amount is currently at their floor levels?

I think there is a lot of uncertainty out there with what is going to happen in the office market longer term. In the near-term, we don't really have we have one office project that was substantial rehab and new construction that is in DC that is in lease and has been seeing increased activity lately. Everything else that we have on the office side in DC has really been income producing. So we haven't had any significant blip in performance and the leases roll over a fairly long period of time. So probably, if there is going to be an impact, it is not going to be immediate, maybe three years or so as lease rollover starts hitting. But I think that we are in pretty comfortable loan to values and we do stress tests on income producing CRE for significant declines in operating and increases in cap rate, et cetera. So it is an area where we are treading lightly. But we think leases in place to offer a buffer in a period of time to work through things. That said, there are a number of repositioning projects that are really more in closed in suburbs than they are in DC proper. But that is certainly something we are starting to see here as you see in other areas of the country.

Thank you good morning. Jan just wanted to drill down a little bit more on credit quality. Just curious what kind of trends that we might see coming soon on sort of special mention substandard loans and kind of how you think risk grades will play out in the next few quarters?

Well, I do think we are going to be seeing the loans that we automatically shifted onto the watch list, because of deferrals start to come off, because at the end of next quarter, substantially all of the deferrals would have been completed. So as we see these loans having sustained performance under contractual terms, we will be pulling them off of the list. As far as special mention and substandard though. Given the state of the portfolio right now, and the level of pass - that we have, that are really microscopic. I'm not seeing, - it to be a prediction, but I'm not seeing anything currently that would give me reason to think that you are going to have increases in classified loans.

Yes hey. Just had a quick follow-up Susan, in terms of I think he mentioned in the preamble, get an opportunity to participate I think with the Montgomery County affordable housing program at the larger credit. I know if you are in Howard County that is a real issue in terms of housing affordability. Are you seeing opportunities to maybe explore that or take advantage of that drumbeat and maybe some of the other DMV counties around here, surrounded by Montgomery County and Northern Virginia just curious that there is maybe some other opportunities to participate with some of the county governments to build out from the affordable housing initiatives that are being pushed?

We are constantly looking at that as a possibility. So there are opportunities, and our people are out there and dealing and looking to bring those on board.

And then, is there any visibility on a legal expense from here that would be presumably higher this next quarter or is it too early to say?

Yes, I think it is a little too early to say. I mean, clearly as we approach a resolution on these matters, the legal activity is going to increase. So that is something to be mindful of as you are thinking about it.

Just want to say in closing, we appreciate your questions and all of you taking the time to join us on the call. We hope everyone is enjoying the summer and we look forward to speaking to you again in a few months. Have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone have a great day.