Earnings Call Transcript - EGBN Q2 2025

Operator, Operator

Good day, and thank you for standing by. Welcome to the Eagle Bancorp, Inc. Second Quarter 2025 Earnings Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Eric Newell, Chief Financial Officer of Eagle Bancorp. Please go ahead.

Eric Newell, CFO

Good morning. Before we begin the presentation, I’d like to remind everyone that some of the comments made during this call are forward-looking statements. The current market environment is uncertain, and we cannot make any promises about future performance and caution you not to place undue reliance on these forward-looking statements. Our Form 10-K for the fiscal year 2024, Form 10-Q for the quarter ended March 31, 2025, and current reports on Form 8-K, including the earnings presentation slides, identify risk factors that could cause the company's actual results to differ materially from any forward-looking statements made this morning, which speak only as of today. 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 the company online at our website or on the SEC's website. With me today is our Chair, President and CEO, Susan Riel; Chief Lending Officer for Commercial Real Estate, Ryan Riel; and our Chief Credit Officer, Kevin Geoghegan. I'll turn it over to Susan.

Susan Riel, CEO

Thank you, Eric. Good morning, everyone. As I mentioned in our first quarter earnings call, we anticipated taking a proactive approach to the resolution of challenged office loans and to addressing related valuation pressures. Our second quarter results reflect the expected outcome of that approach. While the financial impact is significant, we believe these actions were prudent and necessary given our belief that the changes affecting the office sector are long term and structural. At the same time, we are making tangible progress toward meeting our objectives outlined in our strategic plan. We are seeing steady growth from our C&I team and the shift in our portfolio mix towards C&I is underway. Importantly, we are beginning to see the results of our targeted relationship deposit efforts with core deposit growth contributing to a reduction in our wholesale funding reliance. While the second quarter performance is disappointing, these steps are deliberate and designed to more quickly normalize provision expenses in the future. The provision this quarter reflects not only continued market deterioration, but also our receipt of new valuation data on office properties. As a result, we are reserving for substandard performing office loans at 31.2%, with the total coverage ratio of the office portfolio at 11.5%. Much of the provisioning this quarter is tied to specific exit strategies. For example, we restructured our largest nonaccrual office loan into an AB note. Continuing payment performance allowed us to return the A portion of this loan to accrual status. We also made progress on other resolution strategies. Two nonaccrual office loans were moved to held for sale, and we've executed a letter of intent on one of those. We expect that sale to close in the third quarter. I'll now turn it to Kevin, who will talk more about our credit provision.

Kevin Geoghegan, Chief Credit Officer

Thank you, Susan. As noted in the first quarter, we are continuing to take a proactive and disciplined approach to our workout strategies. Results for the quarter were impacted by a $138 million provision for credit losses. Of this total, $45.4 million is related to an increase in our office overlay, which is a qualitative reserve. Another $11.1 million is associated with individually evaluated loans and is a quantitative component of the model. As we continue to recognize valuation impairments, our established reserve methodology takes into account those losses. Performing office loans rated substandard and special mention have 31.2% and 15.6% of their balances in the reserve, respectively. Nearly $70 million of the provision was attributable to the exit strategies related to loans held for sale or expected sale opportunities. The allowance for credit losses increased to $183 million, representing coverage of total loans at 2.38%, increasing 75 basis points from the prior quarter. The ACL coverage ratio for performing office loans increased to 11.54% at the end of Q2 '25, up from 5.78% in the prior quarter. Nonperforming loans were $226.4 million at June 30, a net increase of $26 million for the quarter. On Slide 22 of our earnings release deck, we provide a walking bridge of nonaccrual loans from March 31 to June 30. Outflows of nonaccrual loans include the office loan that had an AB restructuring during the quarter, resulting in an A note moving from nonaccrual to accruing pass. A nonaccruing senior housing loan was approved for short sale and closed, and we did not finance that takeout. Finally, $10.5 million is attributable to a disposition of a nonperforming land loan. Inflows to nonaccrual include $54.2 million of office property, $41 million of land properties, $33.6 million related to a data center, which includes an office component, and a $9.1 million life sciences office property. All loans that come into nonaccrual have specific reserves if we have determined that there is a loss content associated with them. Nonperforming assets to total assets were 2.16%, an increase of 37 basis points from the prior quarter. Net charge-offs totaled $83.9 million in the second quarter. Loans 30 to 89 days past due were $34.7 million at June 30, decreasing from $83 million at March 31. Total criticized and classified loans at June 30 totaled $875.4 million, increasing from $774.9 million. The increase was driven by the migration into newly classified loans of $129 million of multifamily loans, $30 million of land loans, and offset by a $90 million reduction in office loan and collateral exposure. Most of these multifamily loans have naturally occurring or mandated affordable components that showed strain due to governmental mandates that inhibit effective landlord remedies, which resulted in lower operating income. We believe this inflow is idiosyncratic rather than systemic and not indicative of future loss content. They do not reflect the same structural or valuation issues present in the office portfolio. Importantly, the loan portfolio remains well diversified by industry and geography within the DMV, and we believe this diversification, combined with our strong credit underwriting and portfolio management provide us with well-positioned ability to manage through the current environment. Our more proactive approach for dealing with problem loans is designed to hasten the resolution of these credits in a more timely fashion. This will allow the bank to minimize losses and achieve our desired results of moving to a more normalized credit provisioning environment that maximizes earnings and shareholder returns. Each problem loan, however, is different and the trade-off between minimizing loss and quickly resolving the problem loan is something we evaluate on a case-by-case basis. These business judgments, informed by a myriad of market and borrower dynamics, are constantly evolving. That said, the bank is fully aware and fully appreciates the minimizing of uncertainty regarding the overall loss content in our office portfolio itself is a risk to franchise value. This is part of the overall consideration when we evaluate the best course of action for each problem credit. With reserve coverage on office portfolio growing and more problem credits being resolved, resolution of the remaining problem credits should have less of an impact on earnings over time. Although it is not possible to predict with any degree of certainty, we believe the third quarter will be better than the second quarter and are hopeful to return to a more normalized provisioning environment in the first quarter of '26.

Eric Newell, CFO

Thanks, Kevin. Our second quarter results reflect the impact of credit reserve building and loan resolution efforts resulting in a net loss for the quarter totaling $69.8 million or $2.30 per share. This compares to the prior quarter's net income of $1.7 million or $0.06 per diluted share. Eagle Bank continues to operate safely and soundly from a position of financial strength. There continues to be extensive loss absorption capacity on the balance sheet to address any reasonably foreseeable loss content or valuation risks posed by our office portfolio. Even with this quarter's credit-related losses, our capital position remains strong. Tier 1 leverage ratio decreased 48 basis points to 10.63%. Our common equity Tier 1 ratio decreased 60 basis points to 14.01%. And notably, our tangible common equity ratio increased 18 basis points to 11.18% at quarter end, which was supported by stronger investment portfolio valuations. Our book value per share decreased $1.96 to $39.03. Deposit growth and a high level of insured deposits underscore the strength and stability of our funding base. With $4.8 billion of available liquidity, we maintain more than 2x coverage of uninsured deposits, reflecting a well-positioned balance sheet. Average deposits have grown by $1 billion since the second quarter of 2024. During the quarter, there were meaningful positive developments in our core performance metrics. Pre-provision net revenue increased $2.3 million to $30.7 million in the second quarter. The increase in net interest income and lower noninterest expenses contributed to the pre-provision net revenue increase. This growth underscores the stability of our core earnings even with elevated provisioning. Net interest income rose to $67.8 million, which benefited from a combination of lower deposit and borrowing costs, a reduction in short-term borrowings, and an additional day in the quarter. These benefits helped offset pressure from lower loan yields and a shift towards time deposits. In addition to improvements in funding costs, we continue to see positive movement in our funding profile. We paid down FHLB borrowings by $440 million to $50 million at June 30. Additionally, we’ve reduced noncore broker deposits by $461.7 million and increased core deposits by $304.1 million over the same period. These changes reflect a deliberate effort to strengthen and diversify our funding base and reduce reliance on wholesale funding, consistent with our strategy. The decline in interest-bearing cash balances this quarter was a strategic decision aimed at optimizing our net interest margin. By intentionally reducing excess on-balance sheet liquidity and paying down short-term borrowings, we were able to improve NIM. This is consistent with our broader effort to manage the balance sheet dynamically while supporting long-term margin expansion. Our focus on expanding C&I lending continues to gain traction, demonstrating the resiliency and strength of our commercial banking franchise. In the second quarter, over two-thirds of our loan originations were C&I loans, building on the successes of the first quarter in advancing our strategic objective to diversify the loan portfolio. NIM expanded 9 basis points from the first quarter to 2.37%, primarily driven by the paydown of average borrowings and reduced funding costs on money market accounts and other borrowings. With improved deposit pricing, lower average borrowings and upward repricing of investment portfolio cash flows, we expect NIM to improve modestly through the balance of 2025. Noninterest income was $6.4 million for the second quarter of 2025 compared to $8.2 million in the prior quarter. The sequential decline was primarily the result of a $1.9 million loss from a repositioning trade executed to enhance long-term yields in the investment portfolio. We remain confident in our noninterest income forecast, underpinned by stable BOLI contribution and our expectation of fee-generating activities from growth in our treasury management sales. Noninterest expense decreased by $2 million to $43.5 million from the previous quarter. This improvement was attributed to lower legal, accounting, and professional fees. We continue to maintain tight control of expenses while making targeted investments to support our strategic objectives. We've updated our view on full year 2025 on Slide 11. Average earning asset growth has been adjusted to reflect our second quarter strategic decision to manage our excess cash. We revised our average loan growth outlook from 2% to 5% growth to flat, primarily due to higher-than-expected CRE payoffs earlier in the year. While our C&I teams have driven solid loan growth, these CRE payoffs have prompted us to reassess overall loan growth expectations. Importantly, this revision is not a result of market weakness or reduced demand, but rather aligns with our strategic objective to lower CRE concentration. We’ve raised our average deposit growth guidance from 1% to 4% growth to 4% to 6% growth, reflecting stronger-than-anticipated growth in digital deposits. And finally, we’ve adjusted the annual tax rate to reflect expectations associated with the loss this quarter. That updated range is reflected in the deck at 37% to 47%, reflecting tax planning actions that we've taken earlier in the year. Our capital return philosophy is shifting in tandem with current performance and strategic priorities. We declared a dividend this quarter. However, we are evaluating a near-term reduction or suspension and expect to take this action that appropriately considers current performance and outlook. This potential action is not motivated by any concerns we have regarding loss absorption capacity, which remains strong, but is a deliberate choice to preserve flexibility as we work through the remainder of our asset quality resolution strategies and position the bank for long-term value creation. As earnings normalize, we will reevaluate the most effective forms of capital return. I’ll turn it over to Susan for a short wrap-up.

Susan Riel, CEO

Thanks, Eric. We are pleased to see positive momentum towards achieving our strategic priorities, growing and diversifying our franchise, deepening relationship-based deposits, and driving operational excellence. What continues to distinguish Eagle Bank is our deep connection to the communities we serve and our relationship-first culture. In an evolving market like the DMV, staying close to our clients and our community remains a core strength that supports our resilience and relevance. Before we conclude, I want to express my sincere appreciation to our employees and customers. Your dedication and professionalism make all the difference. With that, we will now open things up for questions.

Operator, Operator

Our first question comes from Justin Crowley with Piper Sandler.

Justin Crowley, Analyst

I wanted to start out on credit, and I appreciate all the detail in the prepared remarks. With the reserve build and charge-offs in the quarter, can you just sort of help frame for us how you think about what inning we're in as far as providing for potential loss as you look to move some of these assets off the balance sheet? I know in the past, it's been more of as loans near maturity and the new appraisals come in, that's when we would tend to see the credit cost filter through. So curious, the scope of the actions taken this quarter in terms of the extent to which you looked out in the outer years of the office portfolio and other areas. Yes, thank you for the question. While I'm a baseball fan, I'm not going to compare our situation to any inning. I want to direct you back to our previous comments about our expectations for net charge-offs in the next quarter being similar to those in this quarter. However, due to our actions regarding reserves and provisioning, we do not anticipate a significant impact on the income statement.

Eric Newell, CFO

And Justin, to elaborate on that, regarding the cycle for office and office-related collateral, which I define as starting June 30, 2023, we have charged off $113 million to date. As of June 30, we hold total reserves for office amounting to $109.5 million. This reserve encompasses the office overlay as well as the quantitative components of the reserve and any loans that have been assessed individually.

Justin Crowley, Analyst

Right. And I would build on that too, and point to the maturity comment that you made, Justin, and say that there's more than half of the '26 maturities are being dealt with in the numbers that you're seeing now.

Operator, Operator

Our next question comes from Catherine Mealor with KBW.

Catherine Mealor, Analyst

I have a follow-up regarding the significant inflows to NPAs this quarter. I'm curious if we are at the peak and how we should interpret the pace of work. Your classified asset bucket is quite substantial, so what can we expect regarding how we manage that and how quickly we might see it transition into NPL? Could the pace be similar to what we experienced this quarter, or do you believe this quarter's activity was unusually high?

Justin Crowley, Analyst

Yes, Catherine, good question. Right now, we believe the degree of inflow going forward is not going to be nearly to the same degree that it was in this past quarter.

Catherine Mealor, Analyst

As we examine the classified asset ratio, is there a threshold that triggers regulatory restrictions? We have already reduced the dividend, but are there any additional regulatory constraints? Or are we still within a range where we can manage the situation?

Eric Newell, CFO

Yes, Catherine, I would just say that building on Kevin's comment, we're very diligent and deliberate in working that criticized and classified down. There's obviously a large inflow this quarter, and Kevin can characterize that inflow. But our expectation is that you're going to see that total portfolio decline towards the back half of the year and into 2026.

Catherine Mealor, Analyst

So as you see it, you believe this is your peak in classified and criticized at 11% today, do you think?

Eric Newell, CFO

Based on the information that we know today, we do believe that we’re close to the peak.

Catherine Mealor, Analyst

Maybe just a follow-up on the margin. Can you talk about where you think deposit costs can go near-term kind of with or without cuts? I'm curious with your deposit growth, where those costs are coming in today?

Eric Newell, CFO

We've been very successful in increasing deposits across all our business lines in the first half of the year. Our digital channel, which attracts more price-sensitive deposits, has seen significant growth. We're currently raising deposits at about 4.4%. It's important to note that a significant part of the portfolio we raised last year had a rate above 5%, and those will be maturing this summer, which is expected to positively affect our deposit costs in the third quarter. We've also achieved good renewal rates, which will help manage our funding costs for deposits in the later part of the year. Additionally, I want to mention the growth in our Commercial and Industrial (C&I) team. We've started to see solid growth in C&I deposits and relationship deposits in the second quarter, and we anticipate this trend to continue in the latter half of the year and into 2026. These deposits are less sensitive to pricing compared to the digital channel, which will be beneficial for our cost of funds.

Justin Crowley, Analyst

Also would layer in additional treasury and noninterest income.

Eric Newell, CFO

Yes, absolutely. The treasury management aspect in terms of fee income is going to be helpful to us in the second half of the year as well.

Operator, Operator

Our next question comes from Christopher Marinac with Janney Montgomery Scott.