Eagle Bancorp, Inc. (EGBN) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Eagle Bancorp Third Quarter 2017 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 follow at that time. [Operator Instructions] As a reminder, this conference call maybe recorded. I would now like to introduce your host for today’s conference, Mr. Charles Levingston, Chief Financial Officer. You may begin.

Thank you, Crystal. 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 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 in the earnings, margin or balance sheet guidance. Now, I would like to introduce Ron Paul, the Chairman and CEO of Eagle Bancorp.

Thank you, Charles. I would like to welcome all of you to our earnings call for the third quarter of 2017. We appreciate you calling in this morning and your continued interest in Eagle Bank. As is our custom in addition to Charles Levingston, also on the call with me this morning is our Chief Credit Officer, Jan Williams. Jan and Charles will be available later in the call for questions. I am pleased to announce that for the third quarter we achieved another period of growth and record earnings for Eagle Bank. Net income for the third quarter was $29.9 million, a 22% increase over the $24.5 million in earnings for the third quarter of 2016. Fully diluted net income per share was $0.87 for the quarter, a 21% increase over $0.72 per diluted share for the third quarter a year ago. This is our 35th consecutive quarter for which we have achieved record increasing earnings dated back to the first quarter of 2009. Our exceptional long-term performance is as a result of the continued consistent approach to growth initiatives and to our disciplined credit administration combined with our continued attention to operating leverage and efficiency. Our strategies continue to produce balanced results for all the key performance indicators, including top line revenue growth, with increased non-interest income, the superior efficiency ratio creating improved operating leverage, solid credit quality and above peer net interest margin and continued loan and deposit growth. This collective performance has resulted in our consistent growth and profitability measures by the most important being earnings per share. As we have said many times, we are much more focused on increasing profitability and just growing the size of the balance sheet. Return on average assets increased to 1.66% from the third quarter of 2017 from 1.5% in the third quarter of 2016. Return on average common equity was 12.86%, an increase over 12.04% for the third quarter of last year. Return on average tangible common equity was strong at 14.44%. The net interest margin for the third quarter was 4.14%, which was improved from 4.11% in the third quarter of 2016. The margin for the third quarter was down only slightly from 4.16% in the second quarter of 2017. Our NIM continues to be very favorable and well above industry and peer averages. Additionally, our loan portfolio yields increased in the third quarter to 5.19%, up 5 basis points over the 5.14% in the second quarter of 2017 and up 11 basis points over the third quarter of 2016. These increasing yields are due to a combination of factors, including the pricing power we have due to our position in the market and the mix of our loan portfolio, which is 67% variable or adjustable. So, the loan portfolio yields have improved, because in our adherence to the pricing policies as well as for the short-term interest rate changes driven by the actions of the Federal Reserve. The average cost of funds increased only 3 basis points over the second quarter of 2017 to 60 basis points. Importantly, our average cost of funds continues to benefit from a high level of DDA deposits in our liability mix. DDAs averaged 32.4% of total deposits in the third quarter. We remain committed to our disciplined approach to both loan rates and cost of funds, including the use of our ROV-based loan pricing models and the philosophy that maintaining an appropriate margin and risk reward equilibrium are more important in the long run than loan volume and balance sheet growth. The third quarter clearly shows the results of our continued focus on operating leverage and maintaining a very favorable efficiency ratio. For the quarter, top line revenue increased 11% over the third quarter of 2016 while non-interest expense was only up 2% over the same period a year ago. The efficiency ratio was 37.49% for the third quarter of 2017 as compared to 40.54% in the third quarter of 2016 and 39.10% in the second quarter of this year. Prudent expense management is a key piece to our strategy as we continually measure our expense levels against industry and internal benchmarks. Non-interest expenses as a percentage of average assets were only 1.66% for the third quarter as compared to 1.78% in the third quarter of 2016. Non-interest expense decreased by 1.6% from the second quarter to the third quarter of this year as we saw the benefit from our management of occupancy costs, marketing expenses and loan collection related expenses. Rationalization of our branch system is still an opportunity for increased efficiency. We are currently in the process of consolidating two of our branches in Rockville, Maryland into one new location. We constantly monitor all expense categories and search for ways to improve productivity. So while we continue investing in high-quality personnel training and technology, we also have redesigned the job functions of support staff to make our loan officers and relationship managers more efficient. Non-interest income was a bright spot with $6.8 million reported for the third quarter, up 6% from the third quarter a year ago. During the quarter, our FHA division produced $780,000 in revenue from the origination, securitization, sale and servicing of FHA backed Ginnie Mae securities. Our SBA group recognized $441,000 in gains on sale as compared to $101,000 a year ago. These increases were partially offset by decrease in gain on sale in our residential mortgage division of about $1 million. The softness in residential mortgage activity is consistent with industry trends. We are pleased by the activity and the future opportunities of our FHA and SBA specialty groups, but are mindful of the lumpy or uneven level of expected gains in those groups due to the nature and size of the individual transactions. That same lumpiness impacted our primary loan portfolio growth in the third quarter. Total loans amounted to $6 billion at September 30 and have increased $602 million, an 11% growth rate since September 30, 2016. However, our net loan growth during the third quarter of 2017 was $99 million or 1.6%. One of the factors contributing to the lower third quarter loan growth was the sale of $37 million of residential mortgages. Excluding that sale, loan growth would have been 2.3% for the quarter. While we achieved a modest gain of $168,000 from the sale of these loans, the primary reason for the divestiture was to move non-core assets out of the portfolio and redeploy the funds into higher yielding commercial type loans. While net loan growth in the third quarter was below trend, new loan production was strong with over $400 million of new loan commitments during the quarter. Additionally, unfunded loan commitments at September 30 increased $225 million during the quarter to $2.5 billion as compared to $2.3 billion at June 30, 2017. Of the unfunded commitments, $327 million were in loans, which have been recently approved with terms accepted by the customer, but a still pending closing. New loan activity in the third quarter was somewhat offset by higher payoffs of construction financing for projects which have successfully reached completion and are refinanced by permanent financing sources. Even at our current size of over $7 billion, quarterly loan growth patterns are impacted by the timing of funding and payoffs of larger loans, which is what occurred in the third quarter. This is similar to the third quarter of last year when we only had $79 million of net loan growth during the quarter. We continue to maintain our loan pricing discipline and our strong underwriting standards, which have been cornerstones of our long-term success. We strategically plan and track the levels of our specific loan types, including C&I loans, CRE loans and ADC loans. Based upon our view of the market and consistent underwriting standards, we did increase our construction and development loan activity during the third quarter. At Eagle Bank because we are an active CRE lender we have for years been consistently adhering to all of the recommended practices, including disciplined underwriting, independent credit reviews and rigorous internal and external stress testing, enhanced monitoring of the entire loan portfolio and detailed tracking and reporting at both management and the board level. Given the capital raise during the third quarter of 2016 and the additional capital added each quarter through our consistent earnings combined with our longstanding disciplined approach to lending practice risk policies, procedures and practices. We are comfortable with our ADC and CRE loan concentration ratios and we will continue to strategically monitor these positions as we go forward. As mentioned earlier, we have a solid pipeline of loan commitments and continue to see demand in the market. The Washington area economy is the sixth largest in the country and has the fifth best growth rate. The region added 68,000 net new jobs in the 12 months ending August 31. The growth is in the private sector with the largest job gains in the fields of healthcare, professional services and education. For the next few years, economic growth in the region is expecting to be approximately 2% in line with the national economy. We continue to carefully monitor activity across the region and in each of the submarkets, industries and product types. The key to Eagle Bank’s underwriting has always been that we study and understand the various submarkets within the Greater Washington area and we monitor and control our portfolio composition by product type, industry and location. The research on real estate activity indicates for the last year for-sale housing in the DC area saw a 12% increase in sales volume and a 5% increase in average pricing. In the multifamily sector, 13,500 multifamily units were absorbed over the last 12 months more than double the region’s historical average. In the District of Columbia, where Eagle Bank is the most active, absorption in the second quarter of 2017 was twice that of the same period in 2016 and the occupancy rate in multifamily product was a healthy 94.2% occupancy. We continued to watch the submarkets carefully and are maintaining our disciplined underwriting and pricing strategies, which allow us to maintain the credit quality and profitability of our loan portfolio. We remained focused on our strategy that we believe will produce EPS growth over the long-term not just balance sheet growth. Total deposits reached $5.9 billion at the end of the third quarter. Deposits have grown 6% over the past 12 months since September 30, 2016 when we had significant excess liquidity. The deposit mix remains favorable as DDA deposits were over 32% of the average deposits for the quarter consistent with historical levels. Some parties have expressed concern that as interest rates rise, the level of DDA deposits would taper off. However, we have been able to maintain our percentage of DDAs due in part to the requirement for compensating balances in our loan agreements. We carefully managed our funding costs as the deposit mix during the third quarter as we saw to avoid substantial excess liquidity. The average cost of deposits increased by 4 basis points to 49 basis points over the second quarter of 2017 in a very competitive deposit rate environment. We did utilize additional FHLB advances during the third quarter to obtain a more advantageous cost in certain points on the yield curve, but our long-term strategy continues to be to develop core deposits from new commercial customers who maintain their deposits and also treasury management services and other ancillary products. In our ALCO management, we continue the strategy of maintaining a very moderate position for rate sensitivity and avoid taking excessive interest rate risks over long-term. We are slightly more asset sensitive than one year ago due to a shorter duration of the loan portfolio and that 68% to the loan portfolio is in variable or adjustable rate loans, up from 66% a year ago. The average duration of the loan portfolio on a pricing basis is only 23 months. The effective duration of the investment portfolio was 40 months at September 30, 2017 and the overnight liquidity position was about $440 million at that date. We continue our strong consistent performance for credit quality indicators. At September 30, 2017, NPAs as a percentage of total assets, was 24 basis points decreased from 41 basis points a year ago and as compared to 26 basis points at June 30, 2017. Non-performing loans was 27 basis points of total loans at the end of the third quarter improved from 41 basis points at September 30, 2016 and 29 basis points at June 30, 2017. We continued to consistently evaluate the portfolio and take an aggressive approach to placing loans on non-accrual status. We have no net charge-offs for the third quarter of 2017 as loans charged off were equally offset by recoveries. On an annualized basis, net charge-offs were just 2 basis points for 2017 year-to-date. The allowance for loan losses was 1.03% total loans at the end of the third quarter. The provision expense for the quarter was $1.9 million as indicated by the slow growth in the loan portfolio during the quarter, consistent application of our allowance methodology, the current economic climate, and our minimal charge-off history. At September 30, 2017, the coverage ratio was 379% as compared to 255% at September 30, 2016. We believe that we are adequately reserved and then our coverage ratio is in excess of averages for the industry and peer group. We are very pleased with the third quarter performance and with the continued growth and profitability. Our performance continues to compare favorably with peers at both the national and local levels. But we recently released FDIC deposit market share statistics for the Washington Metropolitan area show that for the 12 months ending June 30, 2017, the total market grew by 5.4% and Eagle Bank grew by 10.2% and that will still hold and that we still hold the largest market share in deposits of any community bank headquartered in the Washington Metropolitan area. It is a testament to the strength of the market when you think that over the last year we organically grew our deposits by 10.2% or $549 million and we only increased our market share from 2.9% to 3%. That gives you an idea of why we are so excited about the opportunities we have for continued success. Thank you again for joining in the call this morning and your continued support of Eagle Bank. That concludes my formal remarks and we will be pleased to take any questions at this time.

Thank you. [Operator Instructions] Our first question comes from Catherine Mealor from KBW. Your line is open.

Thanks. Good morning.

Good morning, Catherine.

Good morning, Catherine.

In earlier comments, Ron, my first question is just on loan growth and so thinking about some of the commentary you just made, would you categorize the slower loan growth this quarter has really just the impact from higher pay-downs and then the sale of the residential mortgage loans that you talked about or did you see this quarter any kind of intentional slowdown in your loan growth in an effort to maintain the margin and maintain profitability?

Catherine, yes, if you exclude the residential piece of that $37 million, the loan activity that we have is as strong as it’s ever been. We are constantly monitoring the pricing versus the risk. We are increasing our analysis that we continually talk about to the 60%, 65% loan to cost. We are insisting on completion guarantees. On the C&I side, it’s tougher and tougher from a pricing perspective. But in terms of the overall loan growth, it is as strong as it’s ever been. We have to remember that when you do a construction loan, there is 35% of the amount of the purchase price and construction is funded into the project day 1. We are not day 1 over a period of time by the borrower. So, there is the period of time before they start drawing down on our loan. So, as it relates to both outstandings and for that matter what we have talked about before of being the opportunity of pushing our interest rates, that’s something that is a lag period on, because as I say that 35% equity has got to go in first. But in answering the bigger question, the loan demand, the loan growth on the C&I side, on the CRE side, both the ADC and core real estate is as strong as it’s ever been, if anything for us has been stronger because of the position that we are in and our willingness to do larger size deals, which the big banks don’t want to do and the smaller banks can’t do. And that’s where we are getting the pricing power as well.

Got it, okay. So, from that commentary then, we should see loan growth pickup I would say from here as compared to this quarter’s rate. And so then if that happens, how are you thinking about deposit costs in a period where growth improved from the levels we have seen the past couple of quarters. Your betas have been really good so far, but I would argue growth has been a little bit slower as well. So, that helps that.

Now, that’s because we are really good. In terms of the – let me just close the loop a little bit on the loan growth side, we still believe that we will be able to maintain that low double-digit loan growth. And again that’s balancing risk reward and understanding the market as I think we do as well as we do. In terms of the funding side, clearly the funding is one of the biggest issues that we have. No surprise, Washington DC is an incredibly competitive deposit world. We are always looking at different sources of funding whether as I mentioned the FHLB side, whether we are actively working more and more on the nonprofit world. The municipalities leave a meeting with the State of Maryland shortly to talk to – talk about the state funding into community banks. So, there is a lot of moving parts on that, but again I never want to say anything other than the deposit side is constantly a battle. We have increased our monitoring internally on making sure that the operating accounts of all of our companies continue. So, on the C&I side, on the CRE side, even on the CRE side, when it comes to the property management companies that, that apartment building might be using that property management company needs to deposit their money with us. So, it’s a lot of nickels and dimes from a lot of different places. But the bottom line is that we have plenty of sources of liquidity. It’s just a matter of balancing the time and the yield on that.

Yes. Catherine, this is Charles. Just adding on to that, we did expect obviously deposit rates to increase over the course of this year. We are seeing some of that. Clearly, I would also point to our average DDA balances at 32.4% this year as being some pretty solid defense as it relates to those rising deposit betas, in rights deposit cost rather. And additionally, our plenty of sources of alternative sources of liquidity of $1.3 billion in capacity at the home loan bank at which you saw about $200 million drawn on at the end of the quarter, but always exploring and trying to closely manage those cost of funds.

That’s very helpful. Thank you.

Thanks, Catherine.

Thank you. Our next question comes from Casey Whitman from Sandler O’Neill. Your line is open.

Good morning.

Good morning, Casey.

Great quarter. Tacking on the Catherine’s question is about the loan growth and the higher payoffs this quarter. Can you give us some specific numbers for the level of payoff this quarter versus historically and is your outlook that, that would slow down?

Sure. Charles?

Yes, sure. So, yes, in terms of the loan payoffs, we booked just under about $450 million of new loan book in the third quarter and a little under $300 million or so in maturities for the third quarter. These numbers are well and above look at third quarter last year where it was new loans book were closer to just under $300 million and maturities and payoffs were just around $220 million. So, again, we are seeing the velocity pickup as it relates to those new loans booked and loans paid off. So, additionally, there were some FHA loans, the FHA loans that we securitized and sold were part of that payoff.

If I could just kind of summarize a lot of this loan growth is that as Eagle has grown and as we have said over previous quarters that our desire especially in today’s point of the cycle whatever that means anymore, I am not even sure that we are willing to do larger sized deals with more equity in them. The lumpiness that we are going to have of the funding and the payoffs will always be disproportionate to where we are as the size of the bank. So, as an example, literally the last day of the month, we had approximately $50 million loan payoff. So, if you look at the average, it was there for the whole quarter, but from a point-to-point perspective, it dropped. So, the lumpiness of this I was just saying will continue, but it’s going to continue on – it’s clearly an upward tick especially with the construction funding that we just talked about.

Great, helpful. And then you talked about the improving loan yield this quarter, I am just curious as to what category or sized loans you are seeing the most pricing power on?

Totally counterintuitive. We are seeing as much pricing power on the larger sized loans maybe even more on the larger sized loans than the smaller sized loans in the real estate world. In the C&I world, it’s more and more competitive although we have been able to grow our C&I book because our understanding of the importance of certain covenants and being willing to waive other covenants. So – and again that’s where we are always going to be able to beat the big banks. So, the pricing power though on the higher end is clearly in the CRE, ADC side on, I’ll say, $10 million loans and greater.

Okay. And then can you remind us where you stand now with respect to the CRE in concentration – and construction in concentrations as a percentage of capital?

Yes. For the third quarter, we are going to see those increased a fair amount for ADC. These are numbers that are still being worked on as the call report really dictates and drives how those numbers play out, but the ADC number is probably going to be upwards of about 130% and the CRE concentration will probably going to be closer to 335 or so.

Casey, that’s going to mature, but one thing you also have to factor in is the volume of loans that we have under this construction heading which technically the construction is finished, they are leasing up, but for call report purposes you are still classifying them as construction loans. We are past the construction risk. We just haven’t been able to move them for call report purposes because of the way the instruction addresses.

Got it. Helpful. Thank you. Just last question, a housekeeping item is this quarter’s tax rate a good run-rate to you going forward assuming obviously no change in the corporate tax rate or is there – was there anything unusual in this quarter?

In the third quarter, we actually got involved in some low income housing tax credits. I’d say that’s probably worth about 0.7% or so of that tax rate performing it down by that amount, but I would expect it’s not going to be too far off from where we are given that benefit persists going forward. And then of course, you have got other noise as it relates to that first quarter vesting that we benefit from based on the new accounting rules that we released and went into effect earlier this year. So, you have got a little bit of movements in ebbs and flows there, but my best thought there would be relatively smooth.

Alright. I will let someone else hop on. Thanks for taking my questions.

Thanks, Casey.

Thank you. Our next question comes from Joe Gladue from Merion Capital Group. Your line is open.

Good morning.

Hey, Joe.

Just a couple of things. I guess last quarter you mentioned that the new loan yields had finally risen above average portfolio yields just in relation to that, has that gap kind of stay the same or is it increasing?

In fact, we are seeing a little bit of a situation where the gap has reversed again, if I look at the third quarter and new loans coming on we are at about 4.60% or so in terms of rates with deferred fees and costs, you are looking at closer to 5% and loans coming off are closer to 4.80% or so. So, there is a little bit overall, but then these are weighted averages based on funded amounts that are booked into Ron’s earlier point as these loans, as the construction loans fund up, which typically carry the higher yields. You would likely see higher yields on the portfolio as a whole.

Okay, alright. And I guess just wondering if you have any – what your feelings are on possibilities of benefiting from the disruption and the hiring of new banking teams or lending teams?

We are always out there looking, Joe. There has been a lot of consolidation, as you know, in the marketplace, which benefits our opportunities both from a customer side and from an employee base side. So, the answer is just that we are pretty robust on being out in the marketplace and boots on the ground from the customer and potential opportunities on the hiring side.

Alright. That’s it. Thank you.

Thank you. Our next question comes from Emily Chambers from FIG Partners. Your line is open.

Hi, there. Thanks for taking my question.

Good morning.

I think you answered a couple of my questions already which is great, but just specifically with the CRE loan growth, could you give us a sense of your outlook specifically for CRE loan growth?

I think the balance of our portfolio we are always looking to be pretty consistent to where we are. Again, we are going to have ebbs and flows depending on the particular funding, the particular pay off, but on again a consistent run-rate, I think we will be pretty standard to where we are right now. The opportunities are still tremendous. In Washington, as I am sure in a lot of cities, but Washington as many as anything I have ever seen is that there is submarkets that are just going crazy, 68,000 net new jobs. Obviously, there is an enormous amount of disruption right now as a result of the federal government uncertainty that relates to both the C&I lending and housing. And we think that, that’s going to add to the opportunities that we see in a strong market already. So, I think its key for us to stay within certain submarkets that we know really well. And we see as I mentioned earlier the vacancy rate is extremely low and there certainly has been a pullback in the amount of construction permits that have been issued. There is certainly growth going on right now because of permits that have been issued 1.5 years ago, but that absorption is there and therefore we believe that pricing power couple of years from now is going to be even stronger on the run-rate side.

Great. That was very helpful. I think you answered everything else. Thanks so much.

Thank you.

Thank you. And I am showing no further question from our phone lines. I would now like to turn the conference back over to Ron Paul for any closing remarks.

Again, I appreciate everybody being on the call. Thank you for your interest in the Eagle Bank and wishing everybody a happy holiday and we are looking forward to speaking to you in January. Thank you very much.

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