Eagle Bancorp Inc Q4 FY2022 Earnings Call

Good day, and thank you for standing by. Welcome to the Eagle Bancorp Fourth Quarter and Year End 2022 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. Please be advised that today's conference call is being recorded. I would like to turn the conference over to your speaker for today, Charles Levingston, Chief Financial Officer. Please go ahead.

Thank you so much. 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, 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 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. This 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 the company 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 that despite facing economic headwinds, such as higher interest rates, inflation and the threat of recession, the bank ended the year with strong results. We were able to navigate these challenging conditions through our consistent focus on delivering value to our customers and effective cost management strategies. In the fourth quarter, we had our best quarter of loan growth for the year and credit quality metrics remained very strong. Loans increased by 4.5% from the prior quarter-end. This was the fifth consecutive quarterly increase. At the same time, NPAs were 8 basis points on assets at quarter-end. And we had a net charge-off of less than $1 million. Credit risk management has been a constant strength since our founding and it will continue to be a focus going forward. Additionally, our commercial lending teams continue to find new business opportunities to replenish our loan pipeline. And in addition to our pipeline, unfunded commitments were $2.6 billion at quarter-end, up $120 million from the prior quarter-end. Part of our success is our ability to understand, underwrite and close on significant commercial projects. With total risk-based capital of 14.99% and equity of more than $1.2 billion, we are uniquely well positioned to take advantage of opportunities in our market. Our clients know that we are more committed to the business community in the Washington D.C. market than larger banks based outside the area. This commitment also extends to the people in the communities in which we operate. We regularly provide much needed financing for affordable housing projects. This past quarter, there were two such projects. In October, we announced financing for a $42 million project with Howard University to bring a mixed-use development to the Shaw neighborhood of Washington D.C. And, in November, we announced financing for a $50 million affordable rent property with 259 units in Reston, Virginia. And to our shareholders, we remain committed to creating value. This past quarter, our Board declared a dividend of $0.45 per share, which equates to an annualized yield of 4.11% based on last night's closing stock price of $43.78 per share. We were also active in stock repurchases, buying back almost 740,000 shares at an average price of $44.82 per share. In aggregate, the total repurchase amount was $33.1 million. 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. We have been closely examining the local economy, and our teams on the ground report that the Washington D.C. market is still one of the most appealing and resilient in the nation. Despite ongoing economic challenges, local businesses are performing well, and we have not observed a significant decline in overall economic activity. This is evidenced by the unemployment rate in the Washington Metropolitan Statistical Area, which dropped to 3.1% in November, providing a favorable contrast to the national figure of 3.5% in December. Supporting this positive unemployment rate is sustained spending from the government, government contractors, and consumers. However, there are some areas where we are noticing a decrease in demand. Post-pandemic, economic activity in suburban regions continues to surpass that of the central business district in Downtown D.C. In Washington D.C., this is somewhat balanced by a strong tourism industry, though many parts of the federal government are still working remotely. The private sector presents a mixed scenario, with a drive toward more in-office work. Given this context, we are maintaining our conservative underwriting standards, which are reflected in our credit quality metrics. While our Downtown office properties are still performing well, we are actively reaching out to commercial clients to gain a better understanding of the challenges they face with their income-producing properties. Our credit metrics remain robust, with nonperforming assets at 8 basis points, the lowest since 2005. Total NPAs stood at $8.4 million, a decrease of $1.1 million from the previous quarter. This improvement stemmed mainly from nonperforming loans being fully paid off or returning to accrual status due to consistent payment performance, alongside net charge-offs of $896,000, primarily from one commercial and industrial relationship. With the reduction in NPAs, our coverage ratio for nonperforming loans improved to 1,151%, up from 997% in the previous quarter. The number of loans 30 to 89 days past due decreased to $2.2 million from $14.3 million at the end of the third quarter, largely due to one $11 million loan becoming current. For the quarter, we reported a negative provision of $464,000, and our allowance for credit losses to loans at the end of the quarter was 97 basis points, down from 1.04% last quarter. The reversal of the fourth-quarter provision was primarily driven by better quantitative metrics related to a decrease in the localization factor compared to the national unemployment forecast, although it was somewhat tempered by the increased risk in the quantitative and economic portion of the model amid heightened economic and business uncertainties and higher period-end loan balances. Overall, we remain cautious regarding credit and will continue leveraging our strong underwriting capabilities. That said, we see opportunities to add high-quality commercial loans to our portfolio. Our focus will remain on acquiring local commercial income-producing properties and owner-occupied properties, while also identifying opportunities for quality growth in commercial and industrial loans. Now, I will turn it over to Charles Levingston, our Chief Financial Officer.

Thank you, Jan. This was a good quarter for earnings coupled with strong loan growth and strong asset quality metrics. These results were in an unprecedented economic environment that saw aggressive Fed action on rates, continuing inflation pressures and the prospect of an oncoming recession. Fortunately, as Jan mentioned, we operate in a strong market, which has remained resilient and continues to grow. Typically, I'd start with a discussion on changes on the income statement, but the bigger changes this quarter are on the balance sheet, so I'll start there. The items of note are the strong loan growth, a small decrease in deposits and a pickup in short-term borrowings. And I'm very pleased to say we were active throughout the quarter with stock repurchases. On loans, quarter-over-quarter, the loan growth was strong with loans up $331 million or 4.5% for the quarter. But a lot of these loans came on near the end of the quarter as average loans were up by a smaller $97 million. As we manage our liquidity carefully, we drew on some FHLB advances late in the quarter and ended up carrying more cash balances at year-end than we normally would. In terms of deposits, we remained focused on relationship deposits as that is where we see more cost-effective funding and we continue to strive to improve our deposit mix. To this end, our relationship managers are focusing on deposit retention and deposit growth. Now, stock repurchases. This quarter, we repurchased just over 738,000 shares. This was 46% of the 1.6 million shares the Board authorized for 2022 and about 2.3% of the shares outstanding from the beginning of the year. In total, the aggregate purchase price was $33.1 million and the average share price was $44.82 per share. As the 2022 plan terminated at the end of the year, we have a new plan in place for 2023, which authorizes another 1.6 million shares for repurchase. Turning to the income statement. While net interest income improved marginally up $1.7 million, the most notable changes from the prior quarter were its components, interest income and interest expense. Interest income was up $17.6 million on a higher loan rates and higher loan balances. For the quarter, the average yield on loans was 5.7%, up 77 basis points, and average loans were up $96.6 million. Interest expenses were up $15.9 million on higher funding costs. But the impact was a bit muted by a reduction in interest-bearing liabilities. For the quarter, the cost of interest-bearing liabilities was 2.86%, up 111 basis points, while average interest-bearing liabilities were down $218.2 million. While borrowings were up, the majority of the increase in interest expenses were from higher rates paid on deposits. As the Fed moved aggressively to raise rates to combat inflation, we have subsequently raised rates each time. This quarter, our jump-in rates reflect the Fed raise in late September and two more during this quarter. As a result, our cost of interest-bearing deposits were up 107 basis points, as the average effective rate from Fed funds for the quarter was up 145 basis points. While this resulted in a relatively high beta for us, it was only slightly more than our modeling assumptions. And with our low overhead from our limited branch network, our efficiency ratio is still low at just under 43%. This level of efficiency is much better than our peers and represents a significant built-in cost advantage we retain even in the rising rate environment. Other items impacting the income statement were the decrease in income tax expense. This reduction was primarily driven by an update in our state apportionment of revenues. This resulted in less taxable income being apportioned to jurisdictions with higher tax rates. While expenses were up on incentive accruals for this quarter, our accrual allocation is generally lower in the first quarter and larger in the last quarter of the year, as we evaluate ongoing performance. On the bottom-line, earnings were $42.2 million, up 13.1% from the prior quarter, and fully diluted EPS was $1.32, up 13.8%. Lastly, equity at quarter-end rose to $1.2 billion, as earnings and higher carrying values on available for sale securities outpaced the reduction from funds returned to shareholders through stock repurchases and the declaration of the dividend. With that, I'll hand it back to Susan for a short wrap up.

Thanks, Charles. 2022 was a challenging year, but our Eagle team rose to the challenge. The year ended with solid loan growth and strong asset quality metrics. Even when facing economic headwinds, our commercial focus, coupled with the branch-light footprint, continues to be highly efficient and profitable. Additionally, our team understands that 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. Also, we remain committed to a culture of respect, diversity and inclusion in both the workplace and the communities we serve. Lastly, I would like to thank all of our employees for their hard work all year long and we look forward to an even better year in 2023. With that, we will now open it up for questions.

Thank you. The first question that we have is coming from Casey Whitman of Piper Sandler & Company. Go ahead, your line is open.

Hey, good morning.

Good morning, Casey.

Good morning, Casey.

Yes. Could you start by providing details on the total office exposure? It seems from your comments that the central business district in D.C. may be a concern for you. Can you share the numbers related to that exposure? As you reach out to borrowers in that area, are you noticing any tangible signs of weakness? Please give us an overview of your office exposure.

Sure, Casey. We do have a portfolio of income-producing office properties. It's about $841 million. It's primarily in the suburban markets. But in the central business district itself, we have $166 million, and we have another $88 million in the construction portfolio, which are completed construction projects that are in lease-up. Right now, we are concerned because the market has been fairly slow. The good news is there's a fairly big separation in vacancy between Trophy and A properties, and then B and C properties. The B properties have a much higher vacancy rate today than either Trophy or A. So, the construction properties, while we're always concerned about properties that are in lease and haven't reached stabilization, they are at least in an A or Trophy category in D.C. So, the opportunities there are better than if they were B properties. So, some concern and certainly watching as the leasing takes place. I think overall the vacancy rate in D.C. has been about 20%, but again, it's stratified by different properties. We've gone into a situation where we will reach out to everyone who is in that office market and have lenders and/or their team leaders or the chief real estate lender accompany the lender to meet with the customer to understand what their challenges are, to understand what their rent roll looks like, and when leases are expecting to roll. The CBD is certainly the slowest market and I think that's generally impacting retail and office in the CBD. Fortunately, we don't have a ton of properties there. So, we're not as vulnerable as we could be. But I still think the early outreach and the planning as to how we're going to bridge these periods of time when leases roll has been a really good effort and continues. We don't have any properties, office properties that are non-performing or past due even 30 days at this point. So, we are trying to be as proactive as possible. That answer your question?

It does. Thank you. Are there any other concerns, I guess, in the CRE book outside office that we should be thinking about?

I think office is the main concern. And, of course, in the event we do hit a recession, there would be perhaps other concerns. Retail normally would be a concern in this environment, but we don't have a ton of retail in our portfolio. And what we have is mostly suburban grocery-anchored shopping centers. We don't have any big shopping malls or that type of thing in our portfolio. So, while, in general, I'd be worried about that, when you get specific to our portfolio, I'm not as concerned.

Got it. And just back to office quickly, I guess how big is the typical office loan you guys are doing? What's sort of the average loan size in the office book?

I'm sorry, could you repeat that?

What's sort of the average loan size of the office in the office book?

Well, I can tell you I did not bring that with me, but I can tell you the average loan to value is 53%. So, we've got a fair amount of room to move. I'll be happy to follow-up and give you the average loan size as well.

Great. Thank you. I'll move on to another question. Charles, the tax rate was quite low this quarter, but what can we expect for 2023? Will it stay around the 19% level or possibly be higher?

Not quite that low. Yes, not quite that low. My expectation is it will be somewhere in the neighborhood of 22% to 23%. Again, this is as a result of the updated analysis associated with the apportionment factors. But yes, I think that's probably a safe run rate as we look forward to all things to continue.

Okay. Got it. I'll just ask one more and let someone else jump on. But just as far as sort of FHLB advances go, is there the level you guys are targeting? Or is that just going to be dependent on loan opportunities? Curious just your strategy around that. And also how you're thinking about the loan deposit ratio? Are we kind of comfortable with that going back to like the 100% range, or is there any target? Or sort of just walk us through how you're thinking about just various funding sources.

The FHLB is primarily used as a liquidity management tool. As of a few days ago, we have fully paid it back and currently have a zero balance. Due to fluctuations in some of the commercial business we serve, we have historically needed to borrow from the FHLB for liquidity at the end of the quarter, and this may continue. However, it remains a liquidity management tool. Regarding our loan to deposit ratio, we have a significant investment portfolio with a book value of $2.9 billion. We expect to see cash flow coming from that, which will likely be used for new loans we are pursuing. Therefore, it's possible to reach the upper 90% range for the loan to deposit ratio, but it will take some time to get there.

Got it. I'll let someone else jump on. Thank you.

Yes.

Thank you. The next question will be coming from Catherine Mealor of KBW. Your line is open.

Thanks. Good morning.

Good morning, Catherine.

Good morning, Catherine.

I want to start by discussing margins and the overall outlook. Many banks have suggested that this quarter, or possibly the next, marks the peak for net interest margins, with expectations for margins to remain flat or even decline later in the year as deposit costs rise. Considering your institution, you've experienced higher betas early on. How do you view the situation from a broader perspective? Do you believe there's still potential for margin expansion as the year progresses, or do you align with most peers in thinking that we are currently at or near peak net interest margins? Thank you.

Sure then, Catherine. I think, it will be pretty significantly dependent on Fed action. Right now, I think futures markets are suggesting a pretty high probability in the mid to high 90%-s that we're going to see 25 basis points in February and then another 25 in March. We're still asset sensitive. Over a 12-month period, 100 basis point shock on a static balance sheet sees net interest income expansion of 9.9%, almost 10%. So, I would expect there to be additional tailwinds to that. We're through the floors. So, I think there's positive momentum should rates continue to go up. So, hopefully that's responsive.

Yes, that's helpful. And maybe within that I'm just thinking about the deposit cost, do you have any more color you can give us on just kind of what current rates are, not for the full quarter, but maybe today or at quarter-end just for your different types of deposit costs? Like where current CDs coming on, where money market on average are at the end of the quarter, just to give us a sense as to where we might be going into the first quarter?

We recorded gross certificates of deposit for the quarter amounting to approximately $309 million. The weighted average coupon on these was a little over $409 million, with a weighted average maturity of 19 months, or just over a year and a half. Currently, our top-tier money market rate stands at $310 million, which we believe is quite competitive. We aim to encourage more deposits into the bank, especially as the broader banking system faces challenges in attracting funding with rising rates. We want to present a compelling reason for customers to keep their funds here, alongside the service and relationship banking we provide. Regarding deposits, we continue to project a beta of 70%, and we were just above that at around 74% this quarter. While I hope to maintain that level, it may become more challenging as rates increase and competition intensifies.

And any commentary on just anecdotes you're seeing within your noninterest-bearing accounts in your expectations for potential outflows out of that this year?

No, I mean, certainly, there was some initial movement away from noninterest-bearing deposits, but we've been able to maintain our position. Currently, about 41% of our average deposits are in demand deposit accounts, and we've observed a decent level of stickiness there. Our hope is to keep serving those customers and retain those deposits. However, it also becomes increasingly challenging for them to justify holding funds that aren't earning interest. That's another aspect we're facing in their business.

Of course. Okay, great. Very helpful. Thank you.

Thank you. Our next question is coming from Christopher Marinac of Janney Montgomery and Scott. Your line is open.

Hey, thanks. Good morning. I wanted to ask about the use of wholesale funds and just debt overall on the balance sheet. Would that percentage continue to rise? Or is there an upper bound to how high you'd like it to go?

I view the FHLB line primarily as a liquidity management tool. Those funds are now fully paid down. Historically, we have had to resort to overnight funding over the past few quarters to address fluctuations in our commercial deposits. This trend may continue depending on how successful we are in gathering deposits. Additionally, as I mentioned, cash will continue to roll off the investment portfolio, which may also influence our needs. Ideally, we aim to maintain a similar mix to our current average and succeed in gathering core deposits.

Great. That's helpful. And I was just going to ask about the core deposit. So, do you have any metrics that you're tracking in terms of net new accounts or just the core business accounts that, again, may not necessarily be a phenomenon in Q1, but just in general the opportunity to get new core funding in the bank for this next year?

I don't think we're publicly sharing those specific metrics. However, we are consistently working to ensure that both current and potential customers understand our strong value proposition regarding customer service and relationship banking. We are actively communicating this message in the marketplace. Our goal is to continue offering these services, increasing our deposits, and strengthening our relationships.

Great. Thank you. I understand. I appreciate that feedback. And then, just a quick question for Jan. As you think about sort of classified and criticized assets this year, would it be normal for those to modestly go up? Or is there a scenario that you could see them be stable all this year?

Well, there is a scenario where I could see it hold stable, but I think there may be some volatility in that. Right now, we don't have anything in the classified or criticized asset category this office, but we do have a special mention property that we're working through. Anything is possible, but we will be diligent in pursuing early intervention and working through any potential issues that do come up.

Great. That's helpful, Jan. Thank you very much.

Have a good day.

Thank you. I would now like to turn the call back over to President and CEO, Susan Riel, for closing remarks.

Thank you. We appreciate your questions and you're taking the time to join us today on this call. We look forward to speaking with you again next quarter. Have a great day.

Thank you all for joining. This concludes today's conference call. You all have a great rest of your day.