Earnings Call Transcript - EGBN Q1 2022

Operator, Operator

Thank you for holding. Welcome to the Eagle Bancorp Inc. First Quarter 2022 Earnings Conference Call. All participants are currently in listen-only mode. Following the presentation, there will be a question-and-answer session. Charles Levingston, Chief Financial Officer, will now take the floor.

Charles Levingston, CFO

Thank you, Victor. 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. 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.

Susan Riel, CEO

Thank you, Charles. Good morning and welcome to our first quarterly earnings call. I'm pleased to report the bank had another successful quarter building on our strong finish to 2021. First, a few highlights from the quarter. Earnings were $1.42 per diluted share, up $0.13 from the prior quarter. It was our 89th consecutive profitable quarter. Loans increased by $48.2 million from the prior quarter. This was the second consecutive quarterly increase; at the same time, our credit quality metrics remained strong. Non-performing loans were 33 basis points on loans at quarter end, and net charge-off was just three basis points or $459,000. Exceptionally strong credit risk management has been a hallmark of Eagle since our founding, and it will continue to be a focus of ours going forward. Our favorable credit quality metrics, along with the continued recovery and reopening of the economy, led us to a reversal of $2.8 million from the allowance for credit losses on loans. This was our fifth consecutive quarterly reversal. Now, let's take a closer look at earnings. For the quarter, earnings were $45.7 million up $4.1 million from the prior quarter. Returns for the quarter were 1.46% on average assets and 14.99% on average tangible common equity. The primary drivers of the earnings increase from the prior quarter were a decrease in salaries and employee benefits. Specifically, the $5 million accrual reduction related to the share-based compensation awards and deferred compensation to our former CEO and Chairman during the quarter. We also transferred $1.1 billion of the available-for-sale securities portfolio to held-to-maturity. At quarter-end, $1.2 billion or about 39% of our securities portfolio was held to maturity. Charles will speak more about this transfer and putting more of our excess liquidity to work. Next, let's talk about loans. This quarter's loan growth was driven by our CRE and CNI lending teams. Given the opportunity to have more face-to-face interaction with our customers and our prospects, these calling efforts, which increased in the middle of last year, produced the loans that were booked in the first quarter. We believe that this team effort provides us with good momentum as we move through the year. Within our CRE and CNI portfolios, we successfully completed construction projects that migrated to income-producing CRE and owner-occupied loans. This migration reduced loans categorized as construction loans, with the decline partially offset by new and previously committed construction loans drawing down their funding over the course of the quarter. This migration of construction loans to income-producing CRE loans allows us to retain the loan, the interest income, and expand our lending relationships. Even with the successful completion of construction projects, our pipeline remained strong, and unfunded commitments were up slightly to $2.1 billion at quarter-end. As more opportunities arise, our total risk-based capital of 15.72% gives us ample room to continue to grow the loan portfolio. In regard to our residential lending division, volume was down as higher rates reduced consumer incentives to refinance. As a result, both gain on sale of mortgage loans and origination of mortgage loans were down in the first quarter. Jan will give more details on our credit quality metrics shortly. On legal matters, there have been no material developments relating to our ongoing government investigations, although we are hopeful these matters will be resolved in the near future. And for our shareholders, we remain focused on increasing value and returning cash through dividends. At the end of the quarter, our board declared a dividend of $0.40 per share, which is a payout ratio of 28% based on first-quarter earnings, and equates to an annualized dividend yield of 2.8% based on last night's closing stock price of $56.19 per share. With that, I would like to turn the speaking duties over to Jan Williams, our Chief Credit Officer.

Jan Williams, Chief Credit Officer

Thank you, Susan, and good morning, everyone. Our Washington, DC market continues to improve along many fronts. Economic activity from the government, government contractors, and consumers remains strong. Construction projects are being completed, and new projects are moving forward. Residential housing demand continues to exceed supply. Amazon continues to expand its presence in both leasing and hiring in our market area. In March, mask mandates were dropped for most businesses and schools in the area. And we're seeing more businesses in DC return to work, which has a positive ripple-down effect for downtown businesses. Not surprisingly, unemployment in the Washington metropolitan statistical area remained low at 3.5% in February. With that background, our credit quality metrics continue to improve. Our ACL to loans at quarter-end was 1.01%, down from 1.06% last quarter. Non-performing loans, as Susan mentioned, were 33 basis points of loan. Total non-performing loans were $23.8 million, of which about 56% were CRE, and 32% were commercial and industrial loans. The remaining NPLs were smaller, such as PPP, SBA, and residential loans. Charge-offs in the first quarter were just four loans, with the gross charge-offs of $514,000 partially offset by $55,000 in recoveries, bringing us to net charge-offs of $459,000 for the quarter, or three basis points on an annualized basis; 30 to 89 day past dues are also at very low levels. In terms of risk classifications during the quarter, the past-due portion of the portfolio increased while special mention and classified credits were flat or down. Even with our lower ACL to loans, our coverage ratio on non-performing loans is 301%, up from 257% in the prior quarter. OREO remained unchanged with the same three properties and a carrying value of $1.6 million. With regards to the reversal of $2.8 million from the allowance for credit losses, factors contributing to the reversal included improvements in the economic environment and related adjustments to the quantitative components of our model. In particular, the lower modeled probability of default, as well as improvements in asset quality. We considered a number of qualitative and environmental factors, including, among other things, the remaining potential risks to the hospitality and restaurant industries, as well as the potential risks in the office portfolio given potentially softer demand for office space in a post-pandemic world. With that, I'd like to turn it over to Charles Levingston, our Chief Financial Officer.

Charles Levingston, CFO

Thank you, Jan. As you may have noticed, we have made some improvements to the earnings release format. On page 1, our bullets are more dynamic, focusing on items of interest for the quarter. Right below that, we have a table of selected highlights that shows trends from the prior quarter and the year-ago quarter. In the text tables, we focus more on changes from the prior quarter. We hope this helps you with your analysis and understanding. Turning back to the numbers for the quarter, net income was $45.7 million, which is up $4.1 million or 9.9% from the prior quarter, and assets were $11.2 billion, down $634 million or 5.4%. Regarding earnings, the primary differences from the prior quarter were net interest income, which increased by $2.3 million and was driven by the deployment of excess liquidity into investment securities. As rates have increased, it has become more attractive to put more of our excess liquidity to work. The additional interest income from securities was partially offset by lower interest on fees on loans. While loan balances were up for the quarter, higher-yielding loans continue to be replaced by lower-yielding loans. Additionally, the impact of rising rates, which ramped up throughout the quarter, has not yet fully impacted outstanding adjustable rate loans, a good portion of which are still at the rate floors. New loans, particularly those funded later in the quarter, have yet to have much impact. Non-interest income was down $3.1 million from the prior quarter. Our FHA group had a good year-end 2021, but FHA multi-family income, which can be inconsistent quarter-to-quarter, was down to start the year. The impact of a higher rate environment also reduced gains on the sale of investment securities, and residential mortgage activity was also reduced. Lock commitments for residential mortgage loans were $137 million, down from $163 million in the prior quarter. Non-interest expenses were down $8.3 million from the prior quarter. Legal, accounting, and professional fees were down $1.4 million. As Susan mentioned, the largest change to non-interest expenses was a one-time reduction in salaries and employee benefits. Absent the $5 million accrual reduction, salaries and employee benefits were down $2.6 million, primarily on lower incentive bonus accruals, offset by increases in share-based compensation and payroll taxes. The $5 million accrual reduction also positively impacted the efficiency ratio, bringing it down to 35.3% for the first quarter of 2022, compared to 44.3% for the prior quarter, and it lowered the effective tax rate to 23.4%, compared to 26.3% for the prior quarter. The reduction in the effective tax rate from the prior quarter was because the one-time adjustment was not tax-deductible when recorded. Conversely, there was no negative tax impact when reversed. On the balance sheet, assets declined by $634 million. We had a small decline in deposits of $395 million at quarter-end and paid off a $150 million FHLB advance during the quarter. These reductions of liabilities, along with an increase in securities of $306 million, reduced some of our excess liquidity. The biggest movement on the balance sheet was that we transferred $1.1 billion of securities from available for sale to held to maturity. There's no impact of this transfer on the income statement. The unrealized loss associated with the held to maturity portfolio will amortize off with the life of those securities. In regard to the transfer of securities that are held to maturity, the impact of rising rates during the quarter created unrealized losses in the available-for-sale securities portfolio, which negatively impacted equity on the balance sheet. These unrealized losses reduced equity as well as both book value and tangible book value. During the quarter, we evaluated our securities portfolios and determined that certain securities will be maintained for the life of the instrument, and we made a decision to change the accounting designation to held-to-maturity. The securities transferred were generally municipal bonds, corporate bonds, bonds that we buy for CRA credit, and longer final maturity mortgage-backed securities. Having these securities designated as held-to-maturity will mitigate some of the impact of future changes in interest rates on equity, book, and tangible book values. With regards to interest rate sensitivity, we believe our asset-sensitive balance sheet remains well-positioned to take advantage of higher interest rates in the future. For net interest margin, we were up 10 basis points to 265 on a linked-quarter basis. The reduction of excess liquidity and the deployment of cash into securities had a positive impact. Looking at our cost of funds, it was unchanged at 26 basis points. While not much changed during the quarter, toward the end of March, we raised rates on most interest-bearing demand deposit accounts by five basis points, and FHLB advances of $150 million were repaid. Another measure impacting funding costs is average non-interest-bearing deposits to average deposits. The bank has historically done well averaging 36.1% this quarter, down slightly from 36.3% the prior quarter. Overall, in terms of rate sensitivity, we are asset-sensitive and should benefit from rising rates as loans come off the floor and reprice. A large percentage of our deposits are non-interest-bearing. With that, I'll hand it back to Susan for a short wrap-up.

Susan Riel, CEO

Thanks, Charles. As we wrap up our commentary, I would like to thank all of our employees for their hard work, and it's been really great to see people in person on a regular basis. All of us here at Eagle are encouraged to continue the momentum we had closing out 2021. We feel good about our company, our balance sheet, and our ability to provide our clients with a superior level of service in the highly competitive, strong, and dynamic market. As always, we 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 things up for questions.

Operator, Operator

Please stand by as we compile the Q&A roster. The first question will come from the line of Casey Whitman from Piper Sandler. Your line is open.

Casey Whitman, Analyst

Hey, good morning.

Susan Riel, CEO

Hi, Casey.

Casey Whitman, Analyst

Hi. Nice quarter. Just starting out, I saw you already started increasing your deposit rates. I'm just curious, are you a first mover there? Or are you seeing competitors and your market begin to move as well? And then, tagging onto that, Charles, you mentioned your asset sensitivity. Just remind us sort of what deposit data we should assume for you as you get rate hikes.

Charles Levingston, CFO

Yeah, sure thing. I think we're seeing the prudent movement of rates, and that's the approach that we're taking. The rates we had for time deposits previously were not compelling many people to move into time deposits, and with the Fed's first move, we wanted to be prudent about starting to layer in some time deposits as we're now facing forecasts of seven to eight anticipated 25 basis point moves by the Fed before the end of the year. To the extent that we can capture some of those time deposits and compel some folks to lock in some of those rates, I think that's useful for us. In terms of asset sensitivity, just to provide some context, up 100 basis points will result in net interest income of an additional 1.9%, and up 200 basis points will yield 6.2% as we blow through to some of the floors. Deposit Betas on that front, on net, we're modeling about a 50 deposit Beta. There has been discussion regarding whether or not that may be conservative, and we feel comfortable with that as a measure at this point.

Casey Whitman, Analyst

And what duration are we looking at for that held-to-maturity book now for the securities?

Charles Levingston, CFO

I've got the duration on the overall portfolio right at 5.6 years; the AFS duration is right at 4.8 years.

Casey Whitman, Analyst

Got it. I just wanted to clarify one of the things. Your efficiency ratio is best-in-class; I'm just trying to get my arms around some of the quarterly expense moves you guys have. Is this first-quarter level of core expenses, which I'll call around $36 million, a pretty good starting point as I look particularly at the salaries and benefits line? I appreciate there's no material upturn in legal expenses, but is that a good run rate for that line item, or could we see some more volatility there in those expenses in particular?

Charles Levingston, CFO

As you know, the line item includes more than just legal fees, but it is accurate that the legal fees associated with our value-related investigations and litigation matters have declined. The litigation matters have been settled, and we believe the fact-finding and document production phase of the government investigations are complete at this point. Our outside counsel expenses going forward should relate to the costs associated with resolving those matters, as well as any indefinable costs associated with our current and former officers once our D&O insurance has been fully exhausted. The policy has some remaining limit still, but as we've disclosed in the past, it is nearing exhaustion, and it's really impossible to predict the exact timing of when the investigations will be wrapped up, when the policy will be exhausted, or the actual amount of outside counsel costs, as we don't control or have complete transparency over those indemnified costs. However, we continue to remain hopeful that the investigations will be resolved in the near future, and we will have more reasonable legal costs moving forward after that.

Casey Whitman, Analyst

Okay. And on the salaries line, is this a pretty good starting point at around $22 million?

Charles Levingston, CFO

Yeah, it is. Again, you have to exclude the reversal of the accrual, which I think we're all comfortable with. Last year was a very strong year. The incentive bonus accruals were weighed heavily on that number as we're just getting started here, and as we get a better feel for this year, that annual incentive accrual will come more into focus. But for now, I think we're in an okay place there.

Casey Whitman, Analyst

Okay, so holding the efficiency ratio in the low 40s is a reasonable place to be?

Charles Levingston, CFO

Yes.

Casey Whitman, Analyst

Nice quarter, thanks for the call.

Charles Levingston, CFO

Thanks, Casey.

Operator, Operator

Next question comes from the line of Catherine Mealor from KBW. Your line is open.

Catherine Mealor, Analyst

Thanks. Good morning.

Susan Riel, CEO

Morning.

Charles Levingston, CFO

Good morning, Catherine.

Catherine Mealor, Analyst

Maybe one more thing on the margin, as we think about excess liquidity, how quickly do you feel like we'll be able to deploy this? We saw a big move this quarter; maybe just kind of walk us through how you're thinking about that and how deposit growth outlook plays into that assumption. Thanks.

Charles Levingston, CFO

I believe we will continue to deploy the excess liquidity into the investment portfolio at a pace similar to what we saw in the first quarter, assuming all other factors remain constant. We're currently finding better opportunities in the investment portfolio for higher-yielding instruments, which is encouraging. As we look to use the cash, we are shifting our securities portfolio back towards its optimal use, which we anticipate will be in loans. In the absence of that, there are still some attractive yields available in the investment portfolio. Regarding your question about deposit gathering, we are actively working to incentivize and retain our depositors at the bank. It's challenging to predict growth at this time. With interest rates on the rise, the futures market suggests there is a 90% chance of a 50 basis point increase in early May by the FOMC. This will create more opportunities for depositors to invest in higher-yielding options. Therefore, we want to ensure that we are adequately prepared for that situation. I hope this gives you some insight into our perspective.

Catherine Mealor, Analyst

Yes, that helps. And maybe on the securities, so you're now at about 23% of average earning assets. Is there a limit in terms of the percentage of the balance sheet that you would want to take that to?

Charles Levingston, CFO

I don't have a specific limit, Catherine. I think it really is looking at what's the best opportunity for return between the securities and the loans. So, I'm happy to keep climbing if that is where the money is doing us and the shareholders the best good.

Catherine Mealor, Analyst

Okay, got it. And then maybe one last on the margin. Just think about loan yields. I know this is an impossible question, but just thinking about the puts and takes. Your loan yields declined this quarter, and now you're at 437. So, you've got downward pricing still on new production, but obviously, the impact of higher rates will be a tailwind. Do you think we've hit the bottom in loan yields, or do you think we still have a little bit of decline before we start to get the lift from higher rates? How do you think about those two dynamics?

Charles Levingston, CFO

Yes. The tension really becomes between the excess liquidity, both on our balance sheet and in the marketplace, and the rising rates. I do think that the rising rate impact will positively influence our bond yields in terms of new loan pricing; though, credit spreads are still being somewhat held in check due to the excess liquidity in the marketplace. As a result, should there be broader disintermediation in the marketplace regarding deposits and liquidity, I think those credit spreads will widen out. That’s kind of my crystal ball view. But your guess is as good as mine; it's difficult to project. However, I do believe that there is a positive tailwind for us from the rising rate environment.

Catherine Mealor, Analyst

And remind us what percentage of the loan book is floating.

Charles Levingston, CFO

57%.

Catherine Mealor, Analyst

Okay, great. Thanks for answering all my questions. Appreciate it.

Charles Levingston, CFO

Sure.

Operator, Operator

Our next question comes from the line of Christopher Marinac from Janney Montgomery. You may begin.

Christopher Marinac, Analyst

Thanks. Good morning. I just wanted to get into loan yields and how they may have changed as March finished and how you see that playing out this quarter, even before the Fed makes our next move.

Charles Levingston, CFO

Sure. Again, as Catherine was discussing, the loan yields have certainly compressed in terms of what kind of loans are rolling off versus the yields of loans coming on. I would say we're right around a new origination yield of about 4% at this point.

Susan Riel, CEO

I agree with that, but I think a lot of what you're seeing in terms of funding now are loans that were approved, say, 60 to 90 days ago. The impact of rising rates hasn't fully been incorporated. The loans we are approving today may be at more advantageous rates to the bank reflecting the change in interest rates in the market. There is a natural delay between approving loans and having them booked and funded, which I think shows up as a lag in changes in rates.

Charles Levingston, CFO

It's worth noting, Jan and I were discussing just before the call that the majority of the loans we are booking still include a number of variable rate loans. So, those are still well-positioned to support loan yields going forward as rates rise.

Christopher Marinac, Analyst

Great, that's helpful. Thank you both for that. And then Jan, just a quick one about net charge-offs. Do you see anything on the horizon where charge-offs might change materially from here? I mean, I know we all expect some reversion over time, but I'm just curious in the next couple of quarters if anything changes at all.

Jan Williams, Chief Credit Officer

If you're one of those folks that subscribe to the belief that 30 to 89-day past dues are an indicator, they are as low as I've seen them in several years. So, I'm pretty comfortable with where we are. This isn't to say something couldn't happen out of the blue and shock me, but I think for right now, I’m cautiously optimistic that charge-offs will not become out of control.

Christopher Marinac, Analyst

Great, Jan. Good point. Thank you again.

Charles Levingston, CFO

Thanks, Chris.

Operator, Operator

Our next question will come from the line of Brody Preston from Stephens. You may begin.

Brody Preston, Analyst

Good morning, everyone.

Charles Levingston, CFO

Hey, good morning, Brody.

Brody Preston, Analyst

Hey, Charles. I think you said it earlier, and I saw in the press release last night that you've raised it an average of five basis points; is that on most interest-bearing products? Just because with CDs, I’ve seen rates from like 20 to 100 basis points increase from you all, depending on the maturity profile.

Charles Levingston, CFO

Right, the five basis points was really on money market savings accounts, where the CDs are concerned. Again, we're coming off lows where we've worked to make CDs more appealing. Those rates we previously offered were not compelling for anyone to take us up on those CD offers. Hence, you're going to see a noticeable move when returning to competitive rates. I think the way we've come back in is looking to layer in and ladder in time deposits as we see rates continuing to rise and again, the future market expectations of rate increases.

Brody Preston, Analyst

Got it. Thank you for that clarification. And then just on the FHLB borrowing repayment that ties into the liquidity question. You guys have put a lot of excess liquidity to work, and obviously on a period-end basis, there can be volatility in the deposit basis given the chunkiness of it. But I mean, how should we be thinking about average deposit trends? They are still pretty solid. So, how should we be viewing the remainder of the FHLB advances? What's the duration on those, or could we see a similar kind of prepayment moving forward?

Charles Levingston, CFO

Yeah, I think there's $150 million left, and that was a callable 10-year advance. The call option is that of the FHLB? I expect that if we don't extinguish that one in short order, it will get called away. But again, that will leave us with the availability of about $1.2 billion in FHLB advances should the need arise.

Brody Preston, Analyst

Got it. Thank you for that. And then Jan, I heard you loud and clear on credit quality. I just want to circle back to the office portfolio. The trends we're seeing, at least from a high level based on the data we have access to, show that DC is still lagging like a lot of the rest of the country regarding return to office. Are you seeing that holistically among your borrowers? Are you seeing your borrowers have more of their employees returning to the office at this point?

Jan Williams, Chief Credit Officer

I think we're really seeing a mixed bag. The return to office at this point seems to predominantly be a hybrid model, which is similar to what Eagle Bank is using, where employees spend some time working from home during the week. However, we are seeing an increasing number of people move back to full-time in the office, which we believe will be beneficial for other businesses that operate downtown. For example, Central Business District restaurants that cater to lunch business have had a rough couple of years. Overall, though, we haven't seen weakness in the portfolio. In the office segment, we are monitoring it carefully, and I think the highest level of concern would be for Class B properties in the Central Business District. There are several longer-term leases that are in the market, namely government leases. Look at the new FCC facility that is being considered at this point and for which the location hasn’t been determined yet. Once again, there's a lot of activity to fill office space, but we are still cautious. We have put an overlay into our reserve to reflect the qualitative aspect of central business district office buildings as we wait to see what happens. Honestly, it's going to be a determination of whether productivity in the office is better, worse, or the same as remote working. Businesses will make that judgment as they go forward. The labor market is quite tight right now, making it difficult to insist on a mandatory return to the office, but that could shift in six months. It is indeed tough to predict. All we can do is hedge against the risks we see.

Brody Preston, Analyst

Yeah, understood. Thank you for that. I guess this is my last one. Given your extensive experience with real estate, what is the typical outcome or what would you expect for some of those office buildings that may have strong sponsors but aren't desirable in terms of going forward from a lease-up perspective? Is it repurposing of those properties? And what's the most logical repurposing you see? Is it going from office to apartments over time? Is someone thinking about the long-term ramifications of this situation?

Susan Riel, CEO

I think it depends on the building, to be honest with you, and the costs associated with retrofitting to a multi-family property. DC is very keen on assisting in the conversion of office to residential, as we still have a housing shortage in the DC metro area. I would say there are a few conversions that are in progress, and there may be many more. Most folks are still receiving rent on leases that are in place even if they're not fully occupied. This will play out over time. Conversions to multi-family with perhaps some retail space on the first floor appear to be the most likely scenario.

Brody Preston, Analyst

Got it. Thank you for that and for taking my questions. I appreciate it.

Operator, Operator

Thank you. I'm not showing any further questions in queue at this moment. I'd like to turn the call back over to our President and CEO, Susan Riel for any closing remarks.

Susan Riel, CEO

We thank you and appreciate your questions and you taking the time to join us on the call. We very much look forward to speaking again in a few months.

Operator, Operator

This concludes today's conference call. I thank you for participating. You may now disconnect.