Eagle Bancorp, Inc. (EGBN) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Eagle Bancorp Second Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this is call is being recorded. I would now like to introduce your host for today's conference, Jim Langmead, Chief Financial Officer of Eagle Bancorp. Please go ahead, sir.

Thank you, Daniel. Good morning, everyone. Before we begin the formal comments, I’d like to remind you that some of the comments made during this call may be considered forward-looking statements. Our Form 10-K for the 2014 fiscal year, our quarterly reports on Form 10-Q, current reports on Form 8-K identify certain factors that could cause the company’s actual results to differ materially from those projected in any forward-looking statements made this morning. The company does not undertake to update any forward-looking statements as a result of new information or future events or developments. Our periodic reports are available from the company or online on the company’s website or the SEC website. I’d also like to remind you that while we think that our prospects for continued growth and performance are good, it is our policy not to establish with the markets any earnings, margin or balance sheet guidance. Now, I’d like to introduce Ron Paul, the Chairman and Chief Executive Officer of Eagle Bancorp.

Thank you, Jim. I’d like to welcome all of you to our earnings call for the second quarter of 2015. Thank you for calling in this morning. As usual, in addition to Jim Langmead, Jan Williams, our Chief Credit Officer is also on the line with us this morning. Jim and Jan are both available later in the call for questions. We are very pleased to announce that for the second quarter our earnings were $20.9 million which is another record level of quarterly net income which represents a 62% increase over the earnings for the second quarter of 2014 and an 8% increase over earnings for the first quarter of 2015. Net income available to common shareholders was $20.8 million which is also a 62% increase over the second quarter of 2014. Fully diluted earnings per share was $0.61 for the current quarter, representing a 27% increase from $0.48 in the second quarter of 2014 and equal to the $0.61 per diluted share for the first quarter of 2015. We are proud to announce that due to our disciplined and consistent management approach this is the 26th consecutive quarter of record increase in earnings going back to the fall of 2008. We continue to demonstrate balanced strong performance across all of the key measurement indicators. In the second quarter, we saw expanded revenue driven primarily by loan growth combined with the continued very strong net interest margin. Noninterest income was also favorable for the second quarter. Additionally, we realized growth in deposits, continued improvement in already favorable asset quality and through disciplined expense control improved an already very strong efficiency ratio. As you've heard many times, we continue to monitor and adjust all the dials that are required to consistently produce this kind of balance strong results. The earnings for the second quarter demonstrate our focus on improving operating leverage. Top line revenue growth was strong as total revenue increased 39% over the same quarter in 2014. The revenue growth was driven primarily by increased net interest income and we also had very good results for the origination and sale of residential mortgages. The 39% increase in revenue was accompanied by only 20% growth in operating expenses as we therefore significantly improved our efficiency ratio to 41.7% for the quarter as compared 48.3% in the second quarter of 2014. The efficiency ratio for the second quarter also showed improvement from the first quarter of 2015 level of 44.89% as top line revenue for the second quarter increased 2% while noninterest expense fell by 5.3% as compared to the first quarter. As noted in our last earnings call, we expected and did see some compression in net interest margin which was 4.33% for the second quarter compared to 4.41% in the linked first quarter of 2015. However, rather than being related to lower loan yields or higher cost to funds, the reduction in the NIM for the second quarter was caused by our carrying high levels of liquidity during the second quarter. This was illustrated by the average loan to deposit ratio which was 97% for the second quarter versus a 101% for the first quarter in 2015. At 4.33%, our margin is still significantly better than industry and peer groups' statistics. We maintain our disciplined approach to loan pricing and we also focus on maintaining a mix of large and small relationships in our customer portfolio which provides a balance of efficiency with pricing opportunities. In our portfolio today, the average loan size for our commercial real estate loans is $1.9 million and for C&I loans is $650,000. As a result, the yield on loan portfolio was improved to 5.29% in the second quarter as compared to 5.26% in the first quarter of 2015. However, we are very sensitive to the competitive interest rate environment and do expect to see some yield and margin compression as we go forward. On the liability side, we are actively managing our cost to funds which was reduced slightly to 37 basis points in the second quarter of 2015 from 38 in the first quarter. We also managed the asset liability mix. Deposit growth during the second quarter and the high levels of liquidity carried resulted in a loan to deposit ratio of 94% as of June 30, 2015. We will redeploy some of this liquidity into loans over the next few months. Organic loan growth was very strong during the second quarter at 4.3% or approximately $190 million net. The June 30th balance sheet shows an increase of about 2.4% in the second quarter due to the reclassification of $84 million on indirect auto loans from the loan portfolio to held for sale loans. We've contract to sell those loans with closing expected in late July 2015. The sale of these loans which were required in the Virginia Heritage merger last October was a strategic decision. They are yielding only 3%, are expensive to service and were not a good fit with our commercially oriented business model. We continue our long-term trend of loan growth with total increases over the past year of 39% and organic growth of 17% which excludes the impact of Virginia Heritage Bank merger. We continue to see activity and demand in the Washington metropolitan area and we've a solid loan pipeline at this time. Deposit growth was excellent at $241 million, or 5.2% during the second quarter with total deposits reaching $4.8 billion at June 30. We continue to emphasis core deposits and allowed some wholesale deposit runoff into out of our portfolio. DDA deposits increased to $174 million during the quarter and account for 28% of total deposits at June 30, 2015. Money market account balances are also increasing and we are up $34 million during the second quarter. Washington Metropolitan area is continuing to see steady growth of economic activity. The area is experiencing a continuing trend of private sector job growth outpacing the impact of reduced federal government spending. The region has averaged over 68,000 jobs in the last year and total employment has grown to 3.2 million people. The unemployment rate is 4.3%, well below the national average and the area has the third highest concentration of Millennials of any market in the country as demonstrated by the absorption of 16,000 multifamily units in Washington DC in the past year. Growth in gross regional product for the metro area is expected to be approximately 2% over the next year. Demand for housing and commercial space varies widely across the multiples of markets within the region. At Eagle Bank, we continually monitor the supply and demand by submarket and loan type to manage our exposure and new loan production. This knowledge of the market has been a key factor in our successful underwriting over the years and in maintaining our high credit quality. As I mentioned earlier for the second quarter of 2015, the efficiency ratio improved to a very favorable 41.7%, an improvement over 48.3% in the second quarter of 2014. Another measure of efficiency and expense control that we use is a percentage of noninterest expense to average assets. The ratio has improved to 1.91% in the second quarter of 2015 from 2.3% one year ago. The cost savings associated with the Virginia Heritage Bank merger have provided a significant benefit to our overall productivity and efficiency. We are still planning the closure of one additional branch from the former Virginia Heritage network and are considering one additional closure as we continually evaluate our branch system. We will continue our philosophy of not being branch junkies and will grow Eagle Bank by nurturing customer relationships and experience bankers and through state of the art technology. We are committed to maintaining a sound infrastructure which is sufficient to manage daily operations, control risk and fuel the growth of the bank. We are consistent in our outgo approach and continue to maintain a moderate level of interest rate risk. We look carefully at the repricing risk in our loan portfolio and the securities portfolio. While the average duration of the loan portfolio is 44 months based on maturities, it is only 28 months based on repricing trigger. 61% of the portfolio consists of variable or adjustable rate loans that are increased from 58% a year ago and better positions us for a rising rate environment. During the second quarter, we also improve slightly our positioning in regard to rising rate environment by increasing DDAs and reducing the percentage of money market accounts in our deposit mix. The key for us is to remain short on both sides of the balance sheet and maintain a neutral position. Our credit quality remains very strong during the second quarter. At June 30, 2015, DDAs as a percentage of total assets decreased to 44 basis points as compared to 58 basis points at March 31, 2015 and 80 basis points on June 30, 2014. Nonperforming loans was just 33 basis points of total loans at June 30, 2015. Both ratios are very favorable as compared to industry averages and the range of NPA levels we have maintained over the last several years. The absolute level of NPA is decreased by $10 million in the second quarter to $25.6 million. The bank has consistently taken and still uses an aggressive approach to reviewing individual loans for impairment and accrual status. The allowance for loan losses was 1.07% of total loans at the end of the quarter which is consistent with a level of reserves reported since the merger with Virginia Heritage. The increase in the absolute level of allowance is due to the loan growth in the second quarter together with consistent application of our allowance methodology. Net charge-offs for the second quarter were 21 basis points of average loans as compared to 20 basis points in the second quarter of 2014 and which is consistent with our average charge-off experience over the last several years. At June 30, 2015, the coverage ratio was increased to 329% and we believe that we are adequately reserved. Noninterest income during the second quarter was $6.2 million, a 64% increase in the second quarter of 2014 and decrease of 20% from the first quarter of 2015 which included some security gains and other items. As expected, the increase from the prior year is attributed to high volume in the residential lending division. Gains on the sale of mortgage were strong at $3 million for the second quarter. Volumes for the remainder of this year will undoubtedly be impacted by the changing interest rate environment. Gains on the sale of SBA guaranteed loans were $246,000 in the second quarter of 2015. We continue to view SBA loans as an attractive business but recognize that the revenue flows are lumpy and will vary from quarter-to-quarter due to the size and structure of the loans and the timings of sales. Our capital position and ratios are very strong as of June 30, 2015 due to $70 million subordinated debt placement in August of 2014 and $100 million common equity offered in March of 2015 and the continued additions to retain earnings from our consistent profitability. The total risk based capital ratio has increased from 12.71% in June of 2014 to 13.69% at June 30, 2015. The common equity Tier 1 ratio which we report now on the Basel III was 10.32% as of June 30, 2015. That ratio will remain strong even after the anticipated redemption of the SBA led funding for the fourth quarter of this year. Our sustained focus on developing, expanding and strengthening relationships is key to our continued growth. The introduction of the relationships first culture to the former VHB employees and customers is driving our increased penetration in the Northern Virginia market where we are gaining market share. Through a major arrangement we announced in May, we are significantly increased our visibility and presence in the North Virginia market through a support agreement with George Mason University which is one of the most important public institutions in Fairfax County and which has very strong ties in Northern Virginia business community. The agreement includes a naming right for the Eagle Bank arena formally known as Patriot Center which is university's sports and performance facility. This alliance with Mason covers a broader array of programs which include scholarships, internships, lectures and seminar series. We've received tremendous feedback about the partnership we are building with the university and are very excited about the opportunities it creates for us. It is another example of how Eagle Bank is supporting the communities in which we do business. That concludes my formal remarks. We will be pleased to take any questions at this time.

[Operator Instructions] And our first question comes from Casey Orr from Sandler O'Neill. Your line is now open. Please go ahead.

Good morning. And congrats on another great quarter. First was hoping we could dig more into the margin. Can you tell us about how much fair value accretion impacted the margin this quarter?

Casey the amount was about 6 or 7 basis points that impacted the margin very similar to what happened in the first quarter of the year. It is about $300,000 of fair value accretion that goes on month-to-month so if you annualize that over average assets I think you get about six basis points which have been pretty consistent so from quarter-to-quarter it had no effect but that's the absolute impact.

Okay. Thanks Jim, that's helpful. And then when we think about the excess liquidity you put on this quarter and your loan-to-deposit ratio now at 94%, is your intention to try to keep that at that level? Or are you comfortable growing that back closer to 100%?

Casey, obviously everyday of ebbs and flows of your liquidity position. I think we've always felt that 94% to 98% range is a comfortable range we have with the additional liquidity that we have available to us.

Okay, great. Then, Ron, in your opening comments you talked about expecting some yield and margin compression going forward. Just wondering; does that take into account the indirect auto loans coming off? Or is that just more of a general comment and not about what we might see in the third quarter when those loans are sold? Thanks.

Yes. It is general comments, obviously the indirect is only $84 million so in proportion to the overall loan portfolio. We do believe we have consistently said although candidly I have been wrong is that we anticipate the loan yields to compress based on competition, obviously now with the likelihood of rate increases who knows when that will happen and what impact that will happen obviously especially considering the short duration of most of our loan portfolio.

Okay, great, and one more question. Can you give us a little more color on what you saw this quarter on the deposit end and what specifically was driving the rise in demand deposits, which was very impressive? Thank you.

Casey, as we've talked about the energy that the Eagle Bank team has put towards larger size deposits continues. The relationships they were building with various counties as far as municipal funds are something that is certainly helping us. We've done a great job of expanding existing relationships. So our average deposits per customer continue to expand. That by the way is the same thing on the loan side. So it is overall just the everyday blocking and tackling with the addition of the larger size deposits from municipalities and universities and the like.

How much would you say the municipalities and universities are as a percentage of your total deposits now?

I would off hand say about $150 million.

Right that 2% or 3%.

Great. I'll let someone else jump on. Thanks.

Casey, the one other thing I want to add to that is this year we've beefed up our incentive our incentive programs in terms of the new relationships and deposits in addition to loans from both the lenders and the branches. So I think it is an overall concentrated effort as well as the ongoing effort in North Virginia with the VHB merger.

Thanks, Ron. Did you say that was new this year, or how long --?

It is not new. It is something that we added to and expanded upon.

Thank you. And our next question comes from Catherine Mealor from KBW. Your line is now open. Please go ahead.

All right. Thanks, good morning, guys. One more question on the margin, so, Ron, your outlook for a little bit of margin compression in the back half of this year. What type -- how much of the deployment of your excess liquidity is factored into that? Or do you believe that, that is something that could -- as you deploy that excess liquidity into loans, that's going to effectively help, you stabilize the margin a little bit? Or do you think the decline in loan yields and higher funding costs are enough to offset that remix over the next couple of quarters?

I don't think that we are going to see an increase in cost to liabilities, but I do see that the competitive nature and again I keep using the word disciplined approach to the loan portfolio is occasional we are seeing other banks coming with crazy long -term low yields that we are not going to jump after. So it is all that that I think will make a difference along with the fact obviously offsetting it as you with deployment of the liquidity going from very low yield in fed funds to high yielding -- higher yielding loans.

Okay, got it.

Catherine let me just add that there is a bunch of moving parts in that as you know as we sell the indirect portfolio, the expectation is that those, that cash would over time go into higher yields and CRE and C&I. We also have the opportunity to move some of the liquidity into the investment portfolio, even if we don't get it into loan portfolio because at present our liquidity portfolio is a very high percentage of overall funds. So there is some opportunities that we have in the asset side in terms of mix that is responsive I think to your question.

And thinking more longer term kind of a bigger picture about your margin, can you just help us think about how you're positioned for when rates start to move? I know you're liability sensitive from a static perspective but that doesn't really take into account growth and how quickly your portfolio is going to mature. So just how do we think about, aside from over the next year, how you think your margin is positioned to behave as the rates start to move?

Yes. In terms of the interest rate risk position at June 30, we are actually more asset sensitive than we were in March. Part of that has to do with the liquidity being much stronger to help our sale portfolio being higher; our analysis says that if rates are up 100 basis points that our net interest income would only go down 0.3%, that's compared to 1.1% in March and 2.2% in December. So, overall we have been -- having -- we've had a moderate level of interest rate risk in our balance sheet over a long period of time, and never taken much interest rate risk but at June 30th, we are actually better positioned for rising rates than we would have been a quarter or a year ago.

Okay. That's very helpful. Maybe one last one on the expenses. Any outlook on the expenses going forward? There was a big or a notable decline in salaries this quarter. How should we think about that line going into the back half of the year?

Yes. That second quarter event, you are correct on -- there was decline in salary and benefits by about a $1 million. If you go back a year ago you will see a similar -- some of that is seasonal and relates the payroll taxes we paid on bonuses and incentives in 2014 that hit the books in 2015. You have issues relating to meetings, social security limit, so we do have a seasonal effect there. The other impact was that we had higher OREO expenses in the first quarter than in the second quarter, that's when the other expenses line -- so but overall I think we believe that managing operating expenses and keeping that efficiency ratio pretty close to where it is, is our goal. And we see that as Ron talks about dials to be another important management issues. Final comment I'd make is from the number of people standpoint which is also keeping our efficiency ratio in really good shape, other than the addition of the personnel from the Virgina Heritage transaction that we added in the fourth quarter of the year. We have not had much increase net in staffing. We ended June at 404 positions, salary wise we began the year at 401. So we are very sensitive to the number of personnel and improving process and continuing to focus attention on that efficiency ratio. So I know that's not specific dollar-and-cent answer to your question but that's hopefully that will give you some good color.

Yes, that's very helpful. Thanks, guys.

But before we take the question, Casey to your question on government funding we just ran some quick and dirty numbers and it is about $75 million of municipality deposits that we've received since the end of the year.

Thank you. And your next question comes from Scott Valentin from FBR Capital Markets. Your line is now open. Please go ahead.

Thanks very much for taking my question. Just with regard to interest rate risk, I think you mentioned that you're I guess less liability sensitive. I'm just wondering how much -- when you think about managing the balance sheet going forward, how much does that consideration regarding sensitivity factor in? For instance you mentioned, Jim that the liquidity was up. Was that conscious or how can we expect the balance sheet to move? And is interest rate risk a big driver of your decisions regarding the balance sheet?

Well, we have average liquidity in the second quarter of almost $400 million compared to $250 million in the first quarter so that's $150 million pretty significant number. Clearly our goal is to make good loans, but we are also sensitive to the pricing of those loans. So it is really hard to know what from quarter-to-quarter that margins going to do but I think the fact that interest rate risk is very much concerning to bankers today, we are not out there doing 8 and 10 year fixed rate transaction in any big way. So I think we are going to continue keep the balance sheet duration at relatively short amounts, Scott, the loan portfolio as Ron mentioned had a pricing duration of 28 months at June 30th. That has not changed to whole lot, 44 months in the maturity that is not changed a lot, so we are very sensitive to interest rate risk. We want to make sure that that margin is real and stable and is not a reflection of adding a lot of long-term assets and putting that margin at risk when rates go up.

Okay. That's helpful. Then with regard to the indirect auto portfolio sale, aside from the margin benefit, you mentioned that there is an operating expense associated with servicing it. So when we think about operating expense going forward, are that a net positive, and can we expect to see maybe some benefit on the OpEx line once that closes at the end of July for the third quarter?

Well, it is not real significant. We do have some personnel in that area that we believe we are going to get a saving from not having an $83 million portfolio to process payments on. So we build that into the analysis but it is not a significant line item on noninterest expenses, Scott. Most of benefits, it is going to be -- be able to get better yields and get out of a portfolio that is not strategic, not part of our business planning and move more into businesses that are strategic to Eagle CRE and C&I lending.

The one additional comment I just want to add to that if I could is that we are actively talking and looking at hiring additional lenders because we do have some capacity in the back office side. So obviously those lenders would hit your salary side but also would significantly increase your revenue side. Again it is a timing issue.

Thank you. And your question comes from Christopher Marinac from FIG Partners. Your line is now open. Please go ahead.

Thanks. Good morning, Ron and Jim and team. I was just curious about sort of how quickly the loan portfolio is turning over just with the normal commercial book. Is it any faster or slower than it has been way back in time?

No. It is pretty consistent, Chris. I think that if you followed our both maturity side and more importantly the maturity on the interest rate side, it has been pretty consistent.

Okay. And then you've historically been very successful on the loan fee side. Is that still the same in terms of kind of what you're charging in general? And is that at all competitively a changing out there in the landscape?

We are certainly competitive in the market. But just anecdotally can just give you one quick story is that just couple of days ago a long-term customer of ours came to us and needed a quick decision on a piece of real estate. And he wasn't sensitive -- he wasn't extremely sensitive I should say on the interest rate side. And we were able to get a 4.75% yield on a three year note which is certainly probably 2.75% to 3.8% higher but again it was something that we were paid for because we dropped everything to get it in done, and we got out him out term sheet in four days. So that's the beauty and that's what Eagle Bank has built itself around, and we continue to see those opportunities regularly from core customers.

Thank you. And I am not showing any further questions at this time. I would now like to turn the call back to Ron Paul for any closing remarks.

Again I thank you all for attending and being on the call. Hope everybody enjoys this summer. And we will speak to you again next quarter. We are obviously always available for any questions should anybody have any. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.