Eagle Bancorp Inc

NASDAQ:EGBN

Earnings Call Transcript 2023-Q2

[Operator]

Good day, and thank you for standing by. Welcome to the Eagle Bancorp Second Quarter 2023 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. [Operator Instructions] Please be advised that today’s conference is being recorded.

I would now like to hand the conference over to your speaker today, Charles Levingston, Chief Financial Officer. Please go ahead.

[Charles Levingston, CFO]

Thank you, Latanya. 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. 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 providing formal guidance.

Our Form 10-K for the 2022 fiscal year, 10-Q for the 2023 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 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 Rail.

[Susan Riel, President & CEO]

Thank you, Charles. Good morning, everyone. I am pleased that our second quarter performance improved from the prior quarter and with the progress we are making in a very difficult operating environment. During the second quarter, we increased net income and earnings per share improved our funding mix by increasing deposits to reduce borrowings, maintained our high level of capitalization and kept our asset quality metrics strong.

Additionally, we continue to pay out our dividend and repurchase shares. Based on last night's closing stock price, our current annualized dividend yield was 6.47%. And during the quarter, we repurchased 1.2 million shares of our common stock at an average price equivalent to 67% of tangible value. On a combined basis, we returned capital of $42.9 million to our shareholders in the second quarter of the year.

In regards to earnings, we are actively pursuing opportunities for continuous improvement. One way we are seeking to increase earnings is by taking steps to reduce expenses. In the first half of the year, we ceased originating residential mortgages and closed 3 branches. Earlier this month, we also made the difficult decision to enact a reduction in force and identified other cost savings throughout the bank.

We also know that support for earnings comes from a strong commitment to underwriting and risk management. Throughout our history, these qualities have been a strength of Eagle and have served us well during times of economic turmoil. While loans grew for a seventh consecutive quarter, the increase was modest as we continue to focus on maintaining our risk-adjusted returns in an environment with high funding costs for deposits and borrowings.

Our team continues to be highly focused on deposit costs and is working hard to retain and expand existing relationships and attract new deposit accounts as well. This is not an easy task in this environment, but we have seen good results using reciprocal deposit platforms and helping other customers restructure their deposits. In regards to asset quality metrics, asset quality remains a strength. And while some metrics increase, they remain near historically low levels. Jan will discuss this next.

With that, I'll hand it over to Jan.

[Janice Williams, Chief Credit Officer]

Thank you, Susan, and good morning, everyone. The Washington, D.C. market area continues to be a source of strength to the bank. The unemployment rate in the Washington metropolitan statistical area fell again this quarter to 2.7% in May, which is just above the pre-pandemic low of 2.6% in December 2019. This gives us even more separation from the nationwide figure of 3.6% in June, which was up slightly and aligns more with the historical long-term difference relative to the national unemployment rate. This strength in the Washington area market can be seen in our asset quality metrics and our provision to the ACL.

NPAs were 28 basis points to total assets. While this is an increase over last quarter, total NPAs were $30.7 million on a portfolio of $7.8 billion. The increase was primarily from one commercial office node in Northern Virginia, of which a portion was charged off during the second quarter. There was one other notable charge-off located outside the Washington, D.C. area in Baltimore, and office property, bringing the total net charge-off for the quarter to $5.6 million. Loans 30 to 89 days past due were $41.4 million, up from $15.7 million at the end of the prior quarter. The current quarter past due is largely from one multifamily credit for $39.5 million.

For the second quarter, we had an ACL provision of $5.2 million, which was somewhat lower than the provision last quarter. This, combined with a relatively small increase in loans and the two charge-offs moved our ACL to loans at quarter end, down 1 basis point to 1%. Our coverage ratio was 2.7 times non-performing loans.

With regard to the lower ACL provision, the provision was primarily driven by a lower quantitative reserve, which is formula-based. This was partially offset by a higher reserve based on the Q&A portion of the credit model. The lower quantitative reserve was based on improvements in local unemployment data, as I mentioned earlier. The higher reserve in Q&A modeling was driven by a higher allowance for CRE office properties, partially offset by a lower allowance for accommodations and food service loans.

Suboptimal return to work participation continues to limit increases in office occupancy. However, both the federal government and Amazon HQ2 have announced plans to increase their in-office presence in the fall. This quarter, we're providing some additional geographic detail on CRE office loans secured by nonowner-occupied commercial real estate loans. These credits were 12.6% of the total portfolio as of June 30. We did not have any outstanding office construction loans at the end of the second quarter.

Office properties are primarily located in the Washington, D.C. market with 24.1% in D.C., 33% in the Maryland levers and 34.9% in Northern Virginia with an additional 8% located outside of these markets. To monitor our income-producing CRE credits, we continue to be proactive in reaching out to commercial clients well in advance of maturities to better understand the headwinds that could be faced in these properties and work collaboratively with those borrowers to maximize returns to both the bank and the borrower.

Overall, in terms of credit, we remain cautious, and we will continue to exercise selectivity and to apply our customary strong underwriting standards. Having said that, we see opportunities to continue to add high-quality commercial loans to the portfolio and maintain our pipeline as other loans run off.

With that, I'd like to turn it over to Charles Levingston, our Chief Financial Officer.

[Charles Levingston, CFO]

Thank you, Jan. This was a good quarter in that the broader market and deposit volatility we experienced back in March has faded, and we were able to improve our funding mix. During the quarter, we continued our efforts to gather deposits organically. However, this quarter deposit growth came from time deposits, which were predominantly brokered.

While our preference is for organic growth, our ability to turn out deposit funding is a plus. Additionally, we took the opportunity to use these deposits to reduce borrowings and improve the rate and maturity mix. To do this, we paid down FHLB borrowings by $777 million and drew on additional BTF borrowings for $500 million. This result -- this resulted in a net reduction in short-term borrowings of $277 million.

The reason for the swap in borrowings is the BTFP had a 1-year term and a rate that was more attractive. The blended rate on our BTFP is now 5 -- 4.53% versus the FHLB of 5.34% as of June 30, 2023, for shorter-term funding. The broker deposits we added had terms of approximately 1.5 years at 4.84%. We also did see a decrease in average noninterest-bearing deposits. At quarter end, average non-interest-bearing deposits were 30% of deposits, down from 37% in the prior quarter.

On the plus side, our loan-to-deposit ratio came down to 101% and uninsured deposits were down to 29.4%. As it relates to the income statement, net interest income was down $3.2 million, and the net interest margin for the second quarter of 2023 was 2.49%, down 28 basis points. The decreases were a result of the continued movement from noninterest-bearing deposits to time deposits and overall higher funding costs.

As we mentioned last quarter, there is a lag in interest income from loans. As the Fed slows the pace of rate increases, the benefit from the variable rate loans resetting and from new loans at market rates will have more of an impact.

Moving through the income statement. Our provisions for the ACL and unfunded commitments were reduced, as Jan mentioned. Non-interest income was a bright spot this quarter. We had income of $2.8 million from an SBIC we invested in about 10 years ago. And at the end of the first quarter, we entered into some swap agreements that generated additional fee income of $959,000 for the quarter. The SBIC income is more of an infrequent item that we don't expect to be a recurring source of income this year.

Non-interest expense also showed improvement as the first quarter contains some seasonal compensation onetime expenses. In regards to the expenses, we have always prided ourselves on being highly efficient, and we aim to continue to operate in that man. Historically, our efficiency ratio has been in the 39% to 41% range. This past quarter, it was higher at 47.2%, but this still compares well to our proxy peers. However, we know we can do better and have undertaken an expense reduction effort to review all expenses throughout the bank, and we continue to make progress.

In the second quarter, we closed two branches, one in D.C. and one in Northern Virginia. The annual pretax cost savings and rental expenses is -- was $408,000. And as the leases were expiring or near expiration, the associated unamortized costs included in the second quarter was relatively low at $240,000. This reduces our banking physical footprint to 13 locations in the Washington, D.C. market, supporting assets of $11 billion. Early in the third quarter, the company also implemented a reduction in force and a review of other noninterest expense items that are expected to generate savings of $2.4 million in the second half of 2023, plus an additional reduction of $5.8 million in 2024.

[Janice Williams, Chief Credit Officer]

Let me pick up ourselves left off. On the bottom line, with net income up $4.5 million and EPS of $0.16. Lastly, capital is a core strength of the company. Our tangible common equity ratio at quarter end was 10.21% which was higher than all of our proxy peers last quarter. And we had an aggregate borrowing capacity through FHLB and BTFP of $1.84 billion. This gives us the financial flexibility to provide the support and services our customers expect.

Last week, Eagle Bank celebrated our 25th anniversary, and we remain committed to our original vision, which was to provide relationships first with a peer-leading level of efficiency. This vision enables us to provide superior service to clients, maintain our leadership position in the community and generate earnings for our shareholders.

In closing, I as well as our entire senior management team would like to thank our employees who work hard every day to make Eagle a success.

With that, we will now open things up for questions.

[Operator]

Certainly. [Operator Instructions] And our first question will come from Casey Whitman of Piper Sandler & Co. Your line is open.

[Casey Whitman, Piper Sandler]

Hey. Good morning, everyone. Thank you for the call. Jan, maybe we'll start off on credit. Can you walk us through the decision and what kind of prompted you to put that one large office loan on nonaccrual? And maybe can you give us some of the underlying metrics like the LTV? Do you have the reserves established against the relationship? And how large is that charge-off what you took on it? Thanks.

[Janice Williams, Chief Credit Officer]

The charge-off was $3.5 million. We took the charge-off because this was one of the use very few single-tenant properties that we have in the portfolio, the tenant vacated. We have been sweeping income for the last 18 months as we work through the process of considering re-tenanting the property. And I think the highest and best use of the property is really a residential land at this point.

And we chose to have it reappraised with the highest and best use, the appraisal came in around $25 million. The outstanding loan was around $24 million. And we elected to go ahead and take a charge-off of $3.5 million. We're carrying it at 20.5%, but we also have cash collateral of about $4 million. We expect this to go through the development process, but it will probably take 12 months to 18 months to accomplish. So that's how we got there.

[Casey Whitman, Piper Sandler]

Okay. Is just one of the largest in the office portfolio or can you sort of give us an idea of what the size of your top relationships would be in that book?

[Janice Williams, Chief Credit Officer]

It ranges all the way up to $60 million, a few and far between at that level. The loans that I have maturing in the next 18 months total about $400 million. We're proactively reaching out to those borrowers. In the second quarter, we have -- I'm sorry, in the third quarter of this year, we have about $207 million that we're addressing.

Some of those are maturities based on short-term extensions as we put into place agreements that we've worked out with the sponsors, and that accounts for about 110. And then we have the other 90-ish that we aren't anticipating any particular issues with. However, I would anticipate that we will be dealing with extensions as the market for financing office, as you know, isn't there. So I would expect that we'll be dealing with extensions on a fair amount of the portfolio.

[Casey Whitman, Piper Sandler]

Okay. Do you have the updated LTV for the whole?

[Janice Williams, Chief Credit Officer]

56%.

[Casey Whitman, Piper Sandler]

Okay. Thank you, Jan. Moving on, you guys are pretty active with your buyback this quarter. It looks like you might have exhausted your authorization. So can you speak to your appetite going forward or putting a new in place just given the stock and tangible book, and you've got a lot of capital still?

[Charles Levingston, CFO]

Yeah. Sorry for my absence there. We -- at this point, you are correct, we did exhaust our 2023 program. At this point, we don't foresee, at least at this point this year, the addition of any new program or repurchases at this point.

[Casey Whitman, Piper Sandler]

Okay. I'll let someone else jump on. Thank you, guys.

[Operator]

And one moment for our next question. And our next question will come from Christopher Marinac of Janney Montgomery Scott. Your line is open.

[Christopher Marinac, Janney Montgomery Scott]

Hi. Thanks. Good morning. Just wanted to ask Charles about kind of what you see for the kind of terminal cost of funds. Are we getting to where that might sort of stabilize in the third quarter? And also may be part of that is kind of a mix of sort of your debt to total funding as you get there?

[Charles Levingston, CFO]

Yeah. I mean from your list to Goddeeris, right, it's -- we've got certainly this latest increase in short-term rates that the Fed ended yesterday to respond to still, however, the -- all of the brokered term deposits that we put on in the second quarter are all in the money at this point, right? So immersively, those will be impacted additionally by rising rates.

But again, competition is still pretty strong for deposits, we are going to be making great adjustments in order to respond. It likely will not be as aggressive necessarily as it has been in the past because I do think we're hitting the peak here. I think that's the conventional wisdom. So I would expect that there may be a little bit more lift there in cost of funds. However, I would also expect that we may be able to keep pace on the asset side. Hopefully, we're seeing a bottom here on the margin front.

[Christopher Marinac, Janney Montgomery Scott]

Got you. Thank you for that. And then, Jan, just a question for you about kind of classified and criticized for the whole portfolio kind of outside of your comments on the office side, what is happening there? And where do you think that may go in the next few quarters?

[Janice Williams, Chief Credit Officer]

Honestly, we have seen very little erosion in the entire portfolio, not much on the C&I side at all. A few small loans, 100,000, 200,000, 300,000, but nothing that's particularly distressing. On the CRE side, other than the office portfolio loans that we've discussed in the charge-off this quarter, the past due multifamily loan that was in the 30- to 90-day category. I'm not concerned about losses on that. There is a dispute amongst the partners, which is precipitating the problem on the past due side. So in theory, it's possible that could end up as a non-performing asset. But at this point, I don't believe that's what's going to happen.

[Christopher Marinac, Janney Montgomery Scott]

Got it. And then would the level of charge-offs kind of revert back in the next quarter or two, or should we kind of expect something similar?

[Janice Williams, Chief Credit Officer]

I am not anticipating that they would be at the level that they are right now or they were in the second quarter. If I had felt that we would have charged off more, I suspect. But we're working our way through a number of office loan extensions that we think will be happening over the next couple of quarters. So it's always possible that I could be surprised by an appraisal.

[Christopher Marinac, Janney Montgomery Scott]

Great. Thank you all for taking the questions, this morning. I appreciate it.

[Charles Levingston, CFO]

Thanks, Chris.

[Operator]

One moment for our next question. And our next question will come from Catherine Mealor of KBW. Your line is open, Catherine.

[Catherine Mealor, KBW]

Thanks. Good morning.

[Charles Levingston, CFO]

Good morning.

[Catherine Mealor, KBW]

Can you just talk us through just anecdotally what you're seeing when you're working through some of these office loan extensions, where are you typically seeing in appraised value kind of relative to maybe where you were when the one was originally originated? Are you seeing your borrowers putting in new equity? Just kind of give us a flavor for what that process has looked like and what you may expect as you look at this next $110 million over the next quarter.

[Janice Williams, Chief Credit Officer]

Well, I would say that each property is pretty unique, and there could be an appraisal that shows no diminution in value because there's been good leasing and there's not a lot of rollover and its multi-tenanted and doesn't have any issues there. There could be a property that's well suited to being flipped to residential.

And I'm not going to have any issues there because the residential market is so strong here. But there could be like this one particular single-tenanted property. And off the top of my head, I can only think of one other single-tenanted properties that we have, but it's is something that has a unique high security facility and is located near Naptha. So I'm not expecting problems with that. It's case by case, every time I've seen big drops and I've seen no drop.

[Catherine Mealor, KBW]

Got it. Okay. And what is your current reserve on your office portfolio?

[Janice Williams, Chief Credit Officer]

The overall reserve is about 2%. The reserve on substandard is 6%. The reserve on watch list is 4.2%.

[Catherine Mealor, KBW]

And how much of your office portfolio is on watch versus substandard?

[Janice Williams, Chief Credit Officer]

As, let's say times and I think I don't have that total in front of me, but we did a pretty aggressive downgrade of the portfolio because of market conditions associated with also right now. We added to our watch list to three loans this quarter. So it's probably up about as said it's probably around $100 million.

[Catherine Mealor, KBW]

Okay. Great. Got it. And then is it -- was there any move in criticized or classified this quarter?

[Janice Williams, Chief Credit Officer]

Yes. We classified the one loan that we partially charged off moved to substandard and its balance is $20.5 million. I'm expecting that to go down next quarter, but we'll see. We moved a couple of other office loans to substandard that we're in the process of documenting extensions for. I would expect that with the agreements that we are negotiating, they will probably be upgraded to special mention -- when the deals are done, but that's going to take us probably another 30 days to get through.

[Catherine Mealor, KBW]

Okay. Great. So then is it fair to think -- your question or your answer to Chris a minute ago was that charge-offs should be lower just from what you see today, depending on how these extensions go. But is it fair to assume that the reserve should continue to build as you still see migration or are you going to work through some of these works portfolio?

[Janice Williams, Chief Credit Officer]

I think a lot of it is going to depend on what happens with federal government back to work in September and within Northern Virginia, it's really the HQ2 backdoor in-person work that I think is going to drive that particular submarket. So I think it's going to depend on what happens. And whether we get a recession, which, at this point, doesn't seem quite as likely, but it's going to depend. We will have been through over the next 18 months, close to half of the office portfolio in terms of renewals and extensions. So I think depending upon where rates shake out 18 months from now, if they're down, it obviously makes things easier. Just there are a lot of factors out there to consider.

[Catherine Mealor, KBW]

Thank you for taking my questions. I appreciate it.

[Operator]

And I'm showing no further questions. I would now like to turn the conference back to Susan Riel, President and CEO for closing remarks.

[Susan Riel, President & CEO]

I want to take this time to thank everyone for participating on the call and I look forward to speaking with you again next quarter. Have a good day.

[Operator]

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