Eagle Bancorp Inc Q2 FY2022 Earnings Call

Good day and thank you for standing by. Welcome to the Eagle Bancorp Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to the Chief Financial Officer, Charles Levingston. Please go ahead.

Thank you, Carmen. 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 loan growth and performance over this past quarter have been positive, we cannot make any promises about future performance. 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 our providing formal guidance. Our Form 10-K for the 2021 fiscal year and current reports on Form 8-K identify certain risk 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 on 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 the local economy, loans, reserves, and credit quality matters. Then I'll 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. I'm pleased to report the bank had another successful quarter, demonstrating both our determination to continue moving forward and the strength and resilience of our operating model. Since the bank was founded, our operating model has focused on efficiency, credit quality, and a relationship-first culture, all of which have helped us become a leader in the Greater Washington DC market. These areas of focus have also helped us be successful through numerous economic ups and downs. In fact, it is our deep client connections and strong balance sheet that create opportunity and value for our customers. In the second quarter, there are a few highlights I'd like to review and comment on. First off, we are pleased to have reached an agreement in principle with the SEC. While this negatively impacted our earnings this past quarter, it represents a major step for us moving past a legal issue. With that said, earnings were $0.78 per diluted share. Absent the agreement in principle with the SEC, earnings would have been $1.20 per diluted share. Moreover, as discussed in the earnings release, we are in advanced discussions with the Federal Reserve Board to settle their investigation of the bank. We are unable to predict the timing of any outcome of the investigation, but assuming we are able to reach an agreement with the Fed, or we determine we have probable losses that are reasonably estimable prior to the filing of our upcoming 10-Q, we will reflect the necessary adjustments to the applicable second quarter financials in our 10-Q disclosure. Other good news for the quarter included an increase in loans, improved credit quality metrics, and a better mix of deposits. Loans increased by $41 million from the prior quarter, and excluding PPP loans, the increase was $68 million. This was the third consecutive quarterly increase. This quarter’s loan growth was primarily driven by our CRE team, which had another solid quarter. At the same time, our credit quality metrics remained strong; non-performing assets were 19 basis points on assets at quarter end, and we had a net recovery for the quarter of $674,000. Exceptionally strong credit risk management has been a hallmark of Eagle since our founding, and it will continue to be a focus going forward. In terms of funding, our funding mix improved, as average non-interest bearing deposits increased to 37.9% of average deposits. Additionally, our CRE and C&I teams' pipelines remained strong as the lending teams continued to be active in their calling efforts. Beyond our pipeline, unfunded commitments were $2.3 billion at quarter end, up $251 million from the prior quarter end. We are also proud of our commitment to the communities we operate in, and have also had success in providing much-needed financing for affordable housing. In April, we announced financing of a $54 million project to support affordable transit-adjacent apartments in partnership with Prince George's County and the Washington Metropolitan Area Transit Authority. This is also the first new construction project to benefit from Amazon's housing equity fund. In June, we announced two financings: a $48 million project for the Montgomery County housing opportunities commission and a $25 million project in the Columbia Heights neighborhood of DC. As more opportunities arise, our total risk-based capital of 15.81% gives us ample room to continue to prudently grow the loan portfolio. For our shareholders, we remain focused on increasing value and returning cash dividends. At the end of the quarter, our board declared a dividend of $0.45 per share. This is a $0.05 increase over the prior quarter dividend, equating to an annualized dividend yield of 3.7% based on last night's closing stock price of $49.05 per share. Before turning it over to Jan, I'd like to say that our Diversity, Equity & Inclusion Council continues to make progress. We recently launched a mentorship program, a scholarship program, and two employee resource groups. Our women's group was launched earlier this year, and our Black Employee Network launched earlier this month. We believe participation in these groups will be personally and professionally rewarding and give employees participating in these groups our full support. Now, Jan Williams, our Chief Credit Officer will give us some insight into the market, loans, and credit quality.

Thank you, Susan, and good morning, everyone. While the rate environment is changing, our Washington DC market continues to show relative strength. Not surprisingly, unemployment in the Washington Metropolitan Statistical Area remained low at 3.3% in May, a little better than the nationwide figure of 3.6% in June. Spending from the government, government contractors, and consumers continues to remain a strong part of the local economy. Construction projects are being completed, and new projects are moving forward. Where we do see some softening is in the office market in the central business district on the commercial real estate side and on the C&I side, in mergers and acquisitions, and delays in capital expenditures by C&I borrowers. The commercial and industrial softening has more to do with clients delaying financing decisions to see how economic conditions play out rather than any deterioration in their own financial position. With that background, our credit quality metrics continue to hold steady and improve. Our allowance for credit losses to loans at the end of the quarter was 1.02%, up slightly from 1.01% last quarter. Non-performing assets, as Susan mentioned, were 19 basis points on assets. Total NPAs were $20.3 million, down $5.1 million from the prior quarter, primarily on the sale of several notes from one commercial real estate relationship and one OREO sale, which generated a small gain. This improvement in credit has driven our coverage ratio of non-performing loans to 386%, up from 301% in the prior quarter. We had a net recovery of $674,000 for the quarter, with gross recoveries of $2.1 million, which were primarily from two partially charged-off, high-end single-family residential construction loans and charge-offs of $1.4 million, which were mostly the result of one commercial real estate relationship. Also, our loans 30 to 89 days past due fell to $3.9 million, down from $13 million in the prior quarter. In terms of risk classifications, during the quarter, the past portion of the portfolio increased while criticized and classified credits were down. With regards to the provision of $495,000 to the allowance for credit losses, no changes were made this quarter to our loss given default rate, as the abatement of pandemic issues has generally been offset with headwinds from higher interest rates and the potential for recession. We did make adjustments to the qualitative and environmental components of the CECL model, in particular adjustments for higher inflation and the related uncertainty in the broader economy. Partially offsetting these adjustments were adjustments for improvements in asset quality, particularly the release of specific reserves associated with a commercial real estate relationship where the notes were sold during the quarter. We also maintained previously added adjustments for loans in the accommodation and food service industry and for office properties in the Washington DC Central Business District. With that, I'd like to turn it over to Charles Levingston, our Chief Financial Officer.

Thank you, Jan. First, I'd like to comment on some changes in the income statement from the prior quarter. Net interest income was up $2.5 million, with the increase driven by interest income, which was up $7.3 million on higher average loan balances, increasing yields on adjustable rate loans, and higher rates on new loans. Interest expense was up $4.8 million, primarily on higher deposit rates paid on savings and money market accounts. Our deposit rates were raised after the FOMC announcement in the second quarter. The impact of the deposit rate increase was partially offset by deposit outflows from the same accounts. Overall, the increase in deposit rates and reduced excess liquidity from deposit outflows helped increase the net interest margin to 2.94%, up 29 basis points from the prior quarter. The average loan yield for the quarter was 4.51%, up 16 basis points, but the average yield on interest-earning balances, which includes securities as well as the impact of the reduction in excess liquidity, was 3.39%, up 48 basis points. On the other side of the balance sheet, the cost of funds was 45 basis points, up 19 basis points. In terms of asset rate sensitivity, 58% or $4.1 billion of our loans are variable rate loans. And at quarter end, we have $1 billion of variable rate loans still at their floors. With the rate hike of 75 basis points that already occurred in June, $690 million of the $1 billion will come off the floor when these loans hit their pricing date. With another 75 basis points, we would see another $259 million of loans move off their floor. Looking at the provision for credit losses, we had a small provision of $495,000 in contrast to the five consecutive quarters of reversals. As Jan mentioned, this was largely driven by uncertainty in the overall economy, as our credit metrics improved this quarter. Non-interest income was down again this quarter, as rising rates impacted several revenue streams. Most notably, loan fees were down, as fewer fees were collected and mortgage volume was down as higher rates reduced consumer interest in refinancing or purchasing a home. The most notable difference between this past quarter and the prior quarter was in non-interest expense. The agreement in principle with the SEC and the one-time accrual of $13.4 million to this past quarter, and then the prior quarter salaries and benefits included a one-time accrual reduction of $5 million. Both of these items had no associated tax or benefit. These two one-time items in aggregate represent a swing of $18.5 million. This accounted for the majority of the decline in earnings of $20.5 million. Another contributing factor was the move from a reversal of the provision for credit losses to a small provision. This was a pre-tax swing of $3.3 million. On the balance sheet, assets declined from the prior quarter end by $291 million. The decline in assets was largely driven by a reduction in excess liquidity, as short-term funds declined by $314 million. These funds, along with new short-term borrowings of $130 million, were used to fund deposit outflows of $415 million. As I mentioned earlier, the deposit outflows were primarily from savings and money market accounts. This outflow improved our funding mix, as non-interest bearing deposits to average deposits rose to 37.9% this past quarter, up from 36.1% the prior quarter. This outflow also improved our loan-to-deposit ratio to 78%, up from 74% the prior quarter. Other notable changes on the balance sheet from the prior quarter were loans being up to $40.9 million, or $67.6 million, excluding PPP loans, and securities being down $30.1 million. The reduction in securities balances was primarily driven by lower carrying values on available-for-sale securities as interest rates continue to rise during the quarter. The markdown on available-for-sale securities also drove the quarter-over-quarter reduction in equity. Equity at quarter end was down $17.3 million. This potentially consists of the $30.1 million markdown on available-for-sale securities, offset by earnings of $25.2 million, less the $14.5 million in dividends declared. Capital ratios at quarter end remained strong. Those ratios based on risk-weighted assets declined slightly as risk-weighted loan balances increased. Those ratios based on assets increased slightly as some excess liquidity ran off. With that, I'll hand it back to Susan for a short wrap up.

Thanks, Charles. As we wrap up our commentary, I'd like to reiterate how our focus on conservative credit has served us well through many credit cycles. It is our strong relationship-first culture with our customers that allows us to provide superior service and to maintain our leadership position in the community. Lastly, as always, I would like to thank all of our employees for their hard work. All of us at Eagle remain committed to a culture of respect, diversity, and inclusion in both the workplace and the communities we serve. With that, we will now open it up for questions.

Thank you. We have a question from Catherine Mealor with KBW. Your line is open.

Hey, good morning.

Hi, Catherine.

Good morning, Catherine.

I just want to start with the margin and maybe just help us, if you could, could you talk to us about where you saw deposit costs, perhaps in the back half of the quarter, maybe June or July to give us a sense as to where these are going next quarter? Thanks.

Sure thing. Yeah, I think you know what we saw in terms of the move on deposits in certainly in the back half of the quarter, we chose to increase rates. As you know, as we saw the FOMC make their move, we really thought it's prudent to continue to be proactive in maintaining our depositors. Our top money market rate right now does sit at about 125 basis points. I would anticipate that as rates move, we'll be making moves commensurate with what we've done here recently.

Okay. And then how about on just deposit balances? Was there anything this quarter that you felt was any kind of one-off? Or would you expect to continue to see deposit outflows in the back half of the year?

No, I wouldn't - I think that not necessarily right. So with the caveat that deposit competition could have more to say about that as rates move up, and we go forward. But, I think what we saw happen here in the second quarter was the result of some swift moves up in rate and some disintermediation, as it relates to what were previously lower-cost deposits shaking out of the balance sheet. At this point, we're focused on maintaining our customers and pretty happy with non-interest bearing deposits reaching almost 38% on an average basis for the quarter. So that's certainly a positive element in supporting our cost of funds.

Okay. So your view for the back half of the year is that the balance sheet is kind of flat to actually increasing deposits, or do you expect some of this decreasing coming off?

It's hard to say what the future might hold. But at this point, yeah, I don't see any catalysts necessarily glaring for any significant deposit outflows like we saw in the second quarter.

Okay, great. And then it's been great to see the dividend increases continue. But any reason why you're not more active in the buyback? And when do you think that may be something that you pull into your capital plan?

Yeah, we're evaluating our options as it relates to capital. Every quarter, this quarter we determined that an increase in the dividend rate by $0.05 was prudent, and we'll continue to evaluate that as we move forward.

Okay. I'll step out and then jump back in if there are any other questions. Thank you.

We have a question from Christopher Marinac from Janney Montgomery Scott. Please go ahead.

Hey, thanks. Good morning, I want to ask about your lending team and any additions that you've had on the production side or any turnover that has occurred year-to-date?

Well, we have had turnover earlier in the year, but that's leveled out. We haven't seen it recently. I think the second quarter was pretty strong in terms of maintaining our lending group intact. We've seen, I mean, that's not unusual. I think a lot of lenders make their move after bonus time in the first quarter. I think that we have been successful in bringing in some new lenders from larger banks. We do have a very strong team concept here and our market executives have been very consistent. We have good presence in pretty much Northern Virginia, DC, and Maryland. There's continuity in those relationships, that we're feeling pretty strong.

The only thing I would like to add is human capital continues to be a concern throughout the bank for us and for many with what's going on in our industry.

Well, thank you both for that. I appreciate it. And Jan, just as a general credit question, do you see any early indicators of any change and just potential shifts in special mention or other credit indicators? Just curious how that could play off the next two to three quarters?

You know, we really haven't. Our credit quality has continued to improve, and we're actually down in criticized assets and classified assets. Our past dues have never been better. It's ironic that there's the headwind from a potential recession, but we have seen no evidence of that in our loan book at this point.

Great. And just one more related question. I mean, LTVs on the real estate book, are they generally lower than they would have been going back to the past cycle, just kind of want a reminder of how you kind of think about LTVs?

The average loan to value in the real estate portfolio is 64%. Now, that doesn't mean we don't do 75% loan-to-value loans from time to time. It doesn't mean we don't have owner-occupied that go up to 80%. But we're very comfortable with where we are on average throughout the portfolio. We keep a very close watch on, in particular, where we are with office.

Great. Thank you very much for taking my questions.

And Catherine Mealor from KBW. Please go ahead. Your line is open.

Thanks. I wonder one follow-up on the margin conversation, just on loan yields. Chuck, could you try to just talk about what you're seeing in loan pricing? Also, maybe if you have any indication of where loan yields were kind of at the end of the quarter?

Well, sure, certainly. New volumes are coming on, I'd say right around 470 to 475 basis points or so. I expect, obviously, the markets are anticipating another 75 basis point move, I believe that's where the money is, later this month when the FOMC meets. I would expect that to continue to benefit. We are still asset-sensitive; a 100 basis points shock on a static balance sheet over 12 months results in about an additional 2.8% that I would say, an additional net interest income. I would anticipate additional positive impact as a result of those moves.

Okay, great. Very helpful. Thank you.

Thank you. And with that, I'll pass the call back to our CEO, Susan Riel for her final comments.

So I just want to say that we appreciate the time you've taken to be with us today and the questions you've been asking. We hope that you are enjoying the summer and look forward to speaking to you again in the fall. Thank you.

Thank you. And with that, ladies and gentlemen, we conclude our program. You may now disconnect. Have a wonderful day.