Eagle Bancorp, Inc. (EGBN) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Eagle Bancorp First Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today's conference Charles Livingston, Chief Financial Officer. Sir, you may begin.

Thank you, Terrance. Good morning. This is Charles Livingston, 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 maybe considered forward-looking statements. Our Form 10-K for the 2016 fiscal year, our quarterly reports on Form 10-Q and 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 would 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 would like to introduce Ron Paul, the Chairman and CEO of Eagle Bancorp.

Thank you, Charles, and thanks for your first kick-off of our earnings call and your new role as CFO. Welcome to all of you on the line for the discussion of our results in the first quarter of 2017. We appreciate you joining us this morning and your continued interest. Our Chief Credit Officer, Jan Williams is also on the line with us and she, Charles and I will be glad to answer any questions later in the call. We are very pleased to announce that earnings for the first quarter were $27 million, a 16% increase from the $23.2 million for the third quarter - for the three quarters ending March 31, 2016 and a 5% increase over the net earnings in the fourth quarter of 2016 of $25.7 million. These earnings included a $589,000 benefit or $0.02 per share for the accounting change related to the share based compensation transactions mentioned in last night's press release. Excluding this benefit, from the new accounting guidance net income was $26.5 million and earnings per diluted share was $0.77 for the first quarter of 2017 increased from $0.68 a year ago and $0.75 for the first quarter of 2016. We are very proud to continue our record of consistent growth and earnings with this being our 33rd consecutive quarter of record net income. We are pleased not only by the growth in net income but with the quality of our earnings and a high level of profitability which is reflected in a return on average assets of 1.62% during the first quarter which is an increase from 1.54% in the first quarter of 2016. This is the highest ROAA we have ever achieved. The return on average common equity was 12.74% for the first quarter improve from 12.39% a year ago. The highlights of our performance in the first quarter and the key drivers of the increased profitability were very favorable net interest margin, excellent credit quality with low levels of charge-offs and a continued focus on maintaining operating leverage resulting in a favorable efficiency ratio. Loan and deposit growth which generally a seasonally lower in the first quarter exhibited respectable increases for the period and I'm pleased to report that as of March 31, total assets exceeded $7 billion. Revenue for the first quarter was driven by growth in net interest income which represented a 7% increase over the first quarter of 2016 and was consistent with the fourth quarter of 2016. The higher net interest income was derived from the growth in the loan portfolio, higher average loan yields, and balance sheet management in accordance with our disciplined ALCO process. Total revenue increased 6% over the same quarter of 2016. We achieved the strong net interest margin of 4.14% for the first quarter of 2017. As was anticipated due to continuing low interest rates, the margin was lower than the 4.31% reported in the first quarter a year ago. However we are pleased that the margin was improved from 3.96% in the fourth quarter of last year. The improvement in the margin as compared to the fourth quarter of 2016 was due to two factors. First, we have higher low level in our mix of earned assets as we manage down the high levels of liquidity that we had carried in the third and fourth quarters of last year. More importantly, we continue to see a trend of improving loan yields. We still feel that we have better pricing power for medium and larger-sized loans than we did at this time last year, while we are maintaining our credit discipline. The average yield on loan portfolio was 5.13% for the first quarter of 2017. While this yield is the same as the first quarter of 2016, it is up from 5.08% and 5.11% respectively in the third and fourth quarters of 2016. Our earnings for the first quarter also benefited from our focus on maintaining strong operating leverage. Total revenue for the first quarter of 2017 increased 6% over the same period in 2016. Non-interest expense for the quarter was $29.2 million which was up only 4% as compared to the first quarter of 2016 and down from 2% from the fourth quarter of 2016. In total, non-interest income was down 3% in the first quarter of 2017 as compared to the first quarter of 2016. However, this decline was primarily due to a non-recurring gain on OREO which we reported in the first quarter of 2016. On a recurring basis, non-interest income was up 10% in the first quarter 2017 over 2016 due primarily to increased gain on the sale of residential mortgages which were $2 million for the first quarter of 2017 up from $1.2 million one year ago. Our FHA Group is continuing to work through the approval process with Ginnie Mae and we are still expecting significant fee income from this business line later in 2017. The efficiency ratio improved to 40.06 for the first quarter as compared to 40.80 a year ago, and 40.22 in the fourth quarter of 2016. At 29.2 million, non-interest expenses for the first quarter of 2017 were down 2% from the level of fourth quarter of 2016. During the first quarter of 2017 versus 2016 we benefited from our continued focus on expense management and its impact on operating leverage. We are seeing the benefit of the relocations within our branching system completed last year. Our average deposits per branch are now up 257 million as compared to the average for the Washington Metropolitan area of 112 million. At the same time, we are prudently adding staff in our lending units and the heart of the house operations and systems departments. So, while we continue to maintain the sound infrastructure needed to ensure quality of operations, meet all compliance requirements, and provide superior customer service, we also consistently realize the opportunities for improving operating leverage and feel we can maintain the efficiency ratio in the range achieved over the last several quarters. At March 31, 2017 the loan portfolio had increased 13% over the balance at March 31, 2016. We achieved net loan growth during the first quarter of 2017 of $147 million or about 2.6% despite approximately $125 million of payoffs in the last week of December and first week in January and the fundings of new loans late in the first quarter. Our loan pipeline continues a very good level and we continue to see loan demand throughout the Washington Metropolitan region. The positive balances at March 31, 2017 had grown $600 million or 12% since March 31, 2016. For the first quarter deposits increased $73 million or 1.3% over December 31, 2016 as we reduced an excess liquidity position. Our average overnight liquidity was up $275 million in the first quarter of 2017 as compared to $602 million in the fourth quarter of 2016. The change in the asset liability mix contributed the improved net interest margin during the first quarter. At March 31, 2017 core deposits which excludes CDs were 86% of total deposits and DDA deposits was still 32% of total deposits which is consistent with our business model and long-term strategy. We continue to strengthen and grow our core customer relationships to cross-sell of additional deposit products, treasury management and other related services. Continuing the favorable mix of non-interest-bearing deposits as we have grown has been a key component of our strong NIM. We continue our disciplined approach to pricing of both loans and deposits. We remain committed to maintaining a strong NIM and see no value in growing the balance sheet just for the sake of growth. Our primary focus will always be on growth in EPS. We have limited interest rate risk in a rising rate environment due to our relatively neutral position for asset and liability sensitivity. We maintain a short duration of loans, investments and deposits. The repricing duration of the loan portfolio is only 22 months and the investment portfolio 40 months. Variable and adjustable rate loans comprise 67% of the portfolio. We are ready pierced the floor rates of about 42% of the loans with floors and should burn through another 18% of the loans with floors with the next 25 basis point increase in rates should that day come. We continue to see an active economy and strong loan demand in the Washington Metropolitan area. The region has reduced growth of 56,000 net new jobs in the last year and most are in the higher income white-collar sectors. The most significant job growth over the last year has been in business services, healthcare and education. We continue to monitor the potential impact of activities of administration what is important to note that the federal government spending makes up 30% of our $491 billion regional economy. That level is expected to continue to decrease on a relative basis due primarily to growth in the private sector, not cutbacks at the federal level. While there is healthy loan demand, the market is very competitive and we still continue our careful underwriting of loans by industry, location and project type. We still see the possibility for oversupply of certain product types in certain sub markets. The demand for residential space is still strong in multiple markets in Washington DC proper. The key to our success over the years is our knowledge of the individual sub markets throughout the Washington Metropolitan area. Another absolute highlight for the first quarter of 2017 was our credit quality and favorable charge-off experience. Net charge-offs annualized were mere four basis points of average loans for the quarter as compared to nine basis points of average loans for the first quarter of 2016. At four basis points, the level of charge-offs were among the best levels the bank has ever achieved and were below on our annual average of nine basis points for 2016 and industry and peer group averages. At March 31, NPAs as a percentage of total assets were also at a low level of 22 basis points as compared to 42 basis points a year ago and 30 basis points at December 31, 2016. Non-performing loans as a percentage of total loans were 25 basis points as compared to 43 basis points at March 31, 2015 and 31 basis points at March 31, 2015. The absolute level of NPAs was reduced by $4.9 million in the first quarter of 2017 to $15.7 million. We continue to adhere to our conservative policy as to when to place a loan on non-performing status. The allowance for loan losses was 1.03% at the end of the quarter. Our credit quality remains solid as we continue to reduce the levels of charge-offs and classified loans while increasing the size of the portfolio through new loan growth. Consistent application of our reserve methodology, reduced charge-off, low levels of classified loans, and low growth results in a modestly lower allowance for the total loans. We continue to add the allowance at a rate far in excess of charge-offs. At March 31, 2017, the coverage ratio was 417% of non-performing loans as compared to 249% at March 31, 2016 and 330% at December 31, 2016. At these levels we believe the bank is adequately reserved. On another positive note, I'd also like to mention that due to favorable adjustments in the apportionment of revenue at the state level, we saw a reduction in the effective tax rate by approximately 1% during the first quarter of 2017. This reduction is not related to the new accounting rule on share-based transactions but rather the changing mix of our revenue between Marilyn, District of Columbia, and Virginia which has a lower tax rate. Due to our high levels of profitability and continued additions to retained earnings quarter-after-quarter, we sustain our strong capital ratios. During the first quarter of 2017, we again accreted capital at a higher percentage rate in the growth of the balance sheet thus improving our capital ratios. At March 31, 2017 the total risk-based capital ratio was 14.97%, increased from 14.89% at December 31, 2016 and 12.87% at March 31, 2016. The tangible common equity ratio improved from 10.86% a year ago to 10.97% at March 31, 2017, and as compared to 10.84% at December 31, 2016. The Tier 1 leverage ratio which seems to be getting more and more attention from the regulatory agencies also improved from 11.01% at March 31, 2016 and 10.72% at December 31, 2016 to 11.51% at March 31, 2017. We are very excited about the opportunities we see for the balance of 2017 as we strive to solidify our position as a leading community bank headquartered in Washington Metropolitan area. We're focusing on increasing our visibility in the area and our understanding of the local business community. In that regard, I would like to acknowledge two recent additions to the Board of Eagle Bank. Both Lynn Hackney and Leslie Ludwig have tremendous experience and a wealth of knowledge in the Washington Metropolitan area. We're thrilled that they have chosen to join the Eagle Bank team. We appreciate the support our shareholders and those of you who are on the call. We thank you all for your interest in Eagle Bank. I'd like to remind you that our Annual Shareholders meeting will be held at 10:00 AM on May 18, at Bethesda, Marriott Hotel. We hope to see many of you at the meeting. That concludes my formal remarks and we'll be pleased to take any questions at this time.

[Operator Instructions] And our first question comes from Andrew Taylor from KBW. Your line is open.

Good morning, everyone. So, first question just on the margin, obviously deploying the excess liquidity to help drive some of the expansion and offset the higher deposit cost. And as we move forward into this year, just directionally do you think we could see some pressure to the margin, do you think you have left the lever of excess liquidity or do you think that the better loan pricing that you're getting will be enough to offset the higher funding costs?

It’s a great question Drew, and it's the balance that we keep playing with is that obviously we are balancing our liquidity position, we want to stay about that 100% loan to deposit ratio. Liability costs clearly are going up but offset by that and I can't say it's going to be dollar to dollar but offset by that we certainly see the pricing power that we’re having on the loan side. As we always talk about, we never know who in the market all of a sudden is going to wake up one day and decide to boost liabilities, but right now we feel pretty comfortable on a stable - fairly stable liquidity pricing model and our ongoing ability of seeing the pricing. Obviously a lot of our loan pricing yields that we've been able to get over the past six months were just starting to begin to see that in the funding side both on the construction lending side and on the loans and process that we have in underwriting.

Okay, great. That's helpful. Maybe switching to over the fee income. Obviously, you mentioned FHA business and you also articulated a target of drawing fees to around 10% of operating revenues over the course of the year. Clearly the FHS business is the leather for you and I don't know - you touched on prepared remarks, any additional color on where you guys are in the approval process. Also maybe just talking about production volumes currently and how quickly that will be added over time?

We have a great pipeline in the FHA side. The team is working diligently on the approvals, on the Ginnie Mae side. We seem to have gone through and completed all of the process and procedures that they have asked us for. So it's really in their hands right now and I don’t want to say any day because I said that before but we certainly believe that it is imminent. We haven't gotten any kick back from them, answered all their questions, they've come in and done this scrubbing and it's just a matter now of time. Fortunately we do have a buildup of the pipeline and the ability of closing this FHA deals once we get the Ginnie approval.

Okay. That’s helpful. I’ll hop out. Thanks guys.

To the other thing I’ll just answer on that is that obviously from a funding perspective you’ll have loans that will come off the books on the loan side once we funded into the Ginnie side. So there is a balance between those as well.

Got it. Great, thanks guys. Good quarter.

And our next question comes from Casey Whitman from Sandler O’Neill. Your line is open.

Good morning. Just one follow-on for the fee income question. Wondering how is the pipeline for SBA lending, what’s your outlook for that group this year?

We had a fairly weak first quarter on SBA but the pipeline is still there. Unfortunately SBA is just such a choppy product and therefore you're always vulnerable to the premiums versus here with SBA but we - we feel pretty good on what we have especially on the construction side of SBA product. Casey again the same comment, when that 10%, 11% on average on the non-interest income.

Okay. Got it. And then just some question on the tax rate. Can you walk us through just how you’re thinking about it, how occurring is the tax changes, is it something that’s going to be predominately happen in the first quarter of every year because that's one I guess equity [comes decisions paid] [ph] out or do you think look at this over tax rate throughout this year?

I think that's right Casey. We are not issuing options as a practice much anymore, just a restricted stock awards and those are issued typically in the first quarter on a best-in [ph] scheduled and the angle of best-in schedule where you’ll see annually that difference between the book value and the fair market value booked as a tax expense and therefore taking as a deduction on those taxes. So yes, I think that’s right, it’s likely you’ll see that as a first quarter event.

Okay. So all is equal just with the state of apportionment taxes you alluded to earlier if you were running at - call it 38.5 tax rate prior to this quarter for the next three quarters you will be running closer to 37.5, call it?

I would say those effective tax rate can move a little - I think that impacted portion is an ongoing benefit to us. Between this 37.5, 38.5 range is likely where you’ll see that tax rate going forward all-times equal.

Great, very helpful. Good quarter.

And our next question comes from David Bishop from FIG Partners. Your line is open.

Good morning, gentlemen. Just curious what - I don't know if you have in terms of the average loan yields. How does that sort of trend over the course of the quarter maybe not the beginning of the quarter January versus March was a much of a change in terms of a yields within the commercial and commercial real estate markets?

For the first time David, we are seeing that opportunity of getting the pricing power that we've been working on for the past six months. So obviously the payoffs are going to be at one rate but the higher rate on the new funding. So that's something that we think - we've talked about before and we're seeing more and more at loan committee in terms of the borrower willing to pay off up where the benefit of Eagle on the certainty of execution and all the reasons that we've been able to maintain the asset side that we have over the year. So we see that continuing and we haven't gotten really any pushback from where we think is the appropriate rate.

Got it. And maybe on opposite side on the deposit side, has seen some pressure there. Is that more just a of function of what’s happening in the market or is that just a need to sort of fund that expected loan growth that you’re seeing?

Well a lot of that is just funding the expected loan growth. When you're growing 12% loan growth and need big chunks of deposits, you're dealing with different type of depositors then so the municipalities as an example, the larger more sophisticated type of borrower - I’m sorry, a depositor is something that is sensitive to what the market is and what they can get elsewhere. So, that's certainly something that we - that we are fighting. Although I will say that certainly over the past couple of weeks you've seen a stabilization of that requirement and the opportunity but our main focus is still the DDAs and the core side we have a new team that we put in place over the past six months, commercial deposits, operation people that are just really focusing more and more and going back to our customers to be able to increase deposit growth. So we believe that the liability side hopefully will stabilize.

Great. Thanks for the color.

And our next question comes from Austin Nicholas from Stephens. Your line is open.

Good morning. You talked about the FHA approval on the Ginnie Mae. Is there any impact from the new administration or changes in those government entities that could be slowing things down a bit or is it more just a natural ongoing kind of bumpiness in those businesses?

I think that the FHA Ginnie process is pretty down on the totem pole right now. I don't think so, I think if anything that could be an encouragement of getting this program funded because I think they need to see that the opportunities in getting that into the market. So the answer is no, this is just unfortunately the bureaucratic process that we're going through that I can only tell you is extremely painful but genuinely believe that in a relatively short period of time that this will get funded and will be a great opportunity for us on the non-interest income side.

Got you. Thanks Ron, that’s helpful. And then maybe just looking at the D.C. market, you noted oversupply of certain products in certain sub-markets and Eagle's ability to kind of target the markets that are more attractive and given your footprint and your deep penetration down in that kind of Central D.C. area. Where are those areas that you think there may be oversupply and where are you seeing more opportunities versus others?

I think we are an incredibly awesome place at the bank because we could satisfy the larger borrower but never losing sight of the smaller borrower. And our ability and I mentioned earlier the certainty of execution is such a key part to this market because we're dealing with one-off type ideals, we're not the ones that you're going to look to borrow to be on the front page of the glossy annual report. So I’ll say the Class A apartment buildings that are down by the ballpark right now are not typically the deals that we’re looking at. The B+ maybe to B- type of projects are still our sweet-spot and that's where we're seeing constant demand both on the multi-family side and even a little pick up on the office side. We were never - we would never be on the suburban office market in the suburbs but there is been a little bit of pickup in activity on the leasing side again that 3,000, 5,000 foot type user. So we're seeing that. We are also seeing a big increase in our C&I side. We are probably working on more C&I loan request that we seen in a long time with some of the pricing power that we talk about not nearly the pricing power that we have on the real-estate side. So, sub-markets I would say are certainly Western Virginia, and when I say Western, I’ll talk about Lowndes County market, is it is an abundance of product out there. We are really not there but if you look at downtown, the Millennial growth downtown is just a game changer and we've been able to capitalize on that over the past couple of years. So on the B+ we're seeing a little bit of a slowdown in the ability to push rents. On the A product - again I could just from a real estate background, on the A product you're seeing a flattening of rents. There is a tremendous amount of units coming up on the market over the next 18 months but again in the world that we're playing in on that the B type product is a enormous demand. And also remember that B type product is an older type product that they're renovating the building. Their largest size unit. So you have roommates which is an opportunity to be able to offset the increase in the pricing, so the $4 foot rental rate you can have a roommate that’s going to help subsidize that. So we feel pretty good in this space that we play in.

Got you. That was really helpful. Appreciate it. I think that's all I have got. Thanks guys.

And at this time I'm showing no further questions.

Well thank you all again for listening to the call. We appreciate it and we're looking forward to speaking with you at the end of next quarter. Thank you very much.