Eagle Bancorp, Inc. (EGBN) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Eagle Bancorp, Inc. Second Quarter 2020 Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to one of your speakers today, Chief Financial Officer, Charles Levingston. Sir, please go ahead.

Thank you, Michelle. 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. Our Form 10-K for the 2019 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 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 the company's 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 or online on the company's website or the SEC website. I would like to remind you that it is our policy not to establish with the markets any earnings, margin or balance sheet guidance. Now I would like to introduce Susan Riel, the President and CEO of Eagle Bancorp.

Thank you, Charles. As is our custom, our Chief Credit Officer, Jan Williams, is also on the line with us this morning. Charles, Jan and I will be available later in the call for questions. Before I begin the discussion of our financial results, I would like to extend our thoughts and hope for all of those on the call, our community here in the Washington, D.C. Metropolitan Area and especially our customers and employees during this time of stress caused by COVID-19 pandemic. The impact on the health, social and economic aspects of our community has been significant, causing us to change the way we live and conduct business. However, we are committed to providing the excellent relationship-first service we are known for, while maintaining a safe environment for our customers and employees. We are equally committed to our role as a supporter of our local communities as we all work together to define the new normal. The second quarter results of 2020 we reported last evening was the first full quarter operating in the COVID-19 pandemic environment. That environment was both unusual and challenging. Considering all factors, we feel our company performed well. The net income for the second quarter of 2020 was $28.9 million as compared to $37.2 million a year ago. Both basic and fully diluted earnings per share were $0.90 for the second quarter as compared to $1.08 for both measures in the second quarter of '19. The net income of $28.9 million in the second quarter represented a 25% increase over the first quarter 2020 earnings of $23.1 million. The level of profitability and quality of our earnings remains strong, and we believe above peer group averages as the second quarter resulted in a return on average assets of 1.12%, a return on average common equity of 9.84%, and a return on average tangible common equity of 10.80%. The financial results for the second quarter were driven primarily by growth in average loans and deposits, top line revenue growth by noninterest income, maintenance of credit quality and improved efficiency and operating leverage. However, during the quarter, we did see a decline in the net interest margin which was impacted by the abundance of liquidity on our balance sheet by substantially lower interest rates during the quarter due to the actions of the Federal Reserve in March and by our participation in the Payroll Protection Program. For the second quarter 2020, total revenue grew by 7% as compared to the second quarter of 2019. While over the same 12-month period, noninterest expenses increased only about 5%. The efficiency ratio was 37.18% in the second quarter of 2020 as compared to 38.04% in the second quarter of 2019 and 43.83% for the first quarter of 2020. The significant improvement over the second quarter of 2019 was primarily due to increased levels of noninterest income primarily gains and fees generated from the sale of loans and modest growth in noninterest expense. Our continuing attention to operating leverage with strong revenue growth combined with lesser growth of our noninterest expenses has traditionally been a key factor for our profitability and it certainly was in the second quarter of this year. Compared to the first quarter of 2020, our second quarter efficiency ratio improved to 37.18% from 43.83% due to both higher noninterest revenue and lower legal expenses. We are pleased to report that the level of noninterest income was $12.5 million for the quarter, which is a 96% increase over the second quarter of 2019 and 128% increase over the first quarter of 2020. The growth as compared to the second quarter of 2019 included a $1.2 million increase in gains on the sale of residential mortgages; a $2 million -- $2.5 million increase in fees from the securitization, sale and servicing of FHA loans; and a $1.3 million increase in higher SBA -- SBIC income. As we have seen across the industry, the low interest rate environment has created tremendous demand for refi mortgages, and we have capitalized on that. Our residential mortgage division closed $308 million of loans in the second quarter of this year as compared to $152 million in the second quarter of 2019 and $193 million in the first quarter of 2020. We are particularly pleased with the success achieved by our FHA division during the quarter. As we have discussed previously, the revenue stream from the FHA division is not smooth from quarter-to-quarter but tends to be irregular, almost lumpy, due to the size of the transactions as compared to the high-volume business of smaller transactions like the residential mortgage division. We were pleased with the mix of transactions during the quarter as we saw loans that were straight, refinanced to allow the borrower to refinance at a lower rate as well as where the FHA loan was the permanent financing to take out a construction or bridge loan we had originally financed. The small business investment core income recognized was from our investment in mezzanine financing of various small business projects, for which the bank also achieves Community Reinvestment Act regulatory benefits. The trend of loan growth continued as the average loan balance for the second quarter increased 10% over the average loan balance in the second quarter of 2019 and 5% over the first quarter of 2020. About 90% of the loan growth during the quarter was from loans generated under the Paycheck Protection Program, which was part of the CARES Act authorized by Congress in March of this year. As reported earlier, we approved almost $500 million in loans to just over 1,400 businesses under the program. The balance of PPP loans was $456 million at June 30. Other than the PPP loans, we had a net decrease of $276 million in the loan portfolio during the quarter. Decreases were seen in both C&I loans and income-producing CRE loan, as new loan activity was impacted by the COVID-19 environment. We believe the C&I portfolio decline was largely tied to repayments of lines of credit advances that were initially drawn in an abundance of caution by many businesses at the end of March as the COVID-19 pandemic began to show more signs of business concerns. We continue to see some demand in the marketplace, but are being very selective in bringing new relationships into the portfolio at this point in the economic and credit cycle. Our lending teams are spending most of their time, tending and nurturing existing relationships. As we mentioned in the press release and have discussed many times on these earnings calls, we focus more on average balances for deposits than the end-of-period balances because our earnings capacity is more closely aligned with the average balances for any period. Our experience during the second quarter really demonstrates that. The point-to-point end-of-period analysis shows a decrease in deposits of $206 million during the quarter with a balance of $7.9 billion at June 30. However, the average deposit balances for the quarter were $8.5 billion, which comprised an increase of $786 million or 10% over the first quarter of 2020 and increased $1.6 billion or 23% over the second quarter of 2019. In part, we attribute the second quarter 2020 disparity between average deposit balance changes and period-end balance changes to the large amount of deposit gains that occurred in the first quarter of 2020, plus 13%, which remained in the bank for much of the second quarter, and we believe was withdrawn late in the second quarter as the stock market recovered strongly in June and balances moved out of bank deposits. This increase in average deposit is likely the result of the flow of liquidity into the banking system created by the policy decisions of the Federal Reserve over the last 2 quarters. We have the benefit of these deposits because of our strong customer relationships with financial intermediaries, asset managers, law firms and title companies. However, these deposit balances do fluctuate. And in this case, the average balance for the quarter was significantly higher than the period end balance. On the asset side of the balance sheet, loan yields dropped 44 basis points during the second quarter with about 7 basis points attributable to the low-yielding PPP loans. The rest of the decrease in the loan yields is attributable to market conditions, which saw 105 basis point decline in average 1-month LIBOR during the quarter. At June 30, 2020, the significant portion of our loan portfolio that is variable or adjustable rate, 55% had a majority of its loans in interest rate floors, which we feel gives us some protection against the further declines in loan portfolio yields. The yield on total average earning assets decreased 64 basis points during the quarter. In addition to the drop in loan yields, the returns in the securities portfolio was negatively impacted by substantial prepayments of mortgage-backed securities in the quarter. The average loan-to-deposit ratio for the second quarter of 2020 was 94%, which is at the low end of the range we feel is prudent. We continue to maintain demand deposits at a very favorable level of 30% of average deposits for the quarter, which certainly benefits the margin. The efficiency ratio improved to 37.18% as compared to 38.04% in the second quarter of 2019 and 43.83% in the first quarter of 2020. As earlier mentioned, consistent with our focus on operating leverage, the improvement in the second quarter as compared to the first quarter of 2020 was due to both the increase in noninterest income combined with a reduction in noninterest expenses. For the quarter, we incurred a more reasonable level of legal expenses and a reduced accrual for expenses related to the resignation of our former Chairman and CEO. The previously disclosed government agency investigation and class action lawsuit are ongoing. However, the associated expenses were lower in the second quarter as subpoena production and testimony subsided, and we recovered on certain defense costs against an insurance claim for items otherwise expensed in previous years. We are maintaining our disciplined management of all other expenses while keeping in mind the need to continually improve our human capital and our IT infrastructure as we hover near to the $10 billion asset size and evaluate the additional regulatory requirements, which are effective above that level. We are very pleased that in June, we had 2 additions to our executive management team. Sam Pepper, who is our new Chief Operating Officer, has extensive experience with community banks in the Midwest and in New England. Jeff Curry, our new Chief Risk Officer, succeeds Susan Kooker, who retired in April. Jeff joins us from Deloitte, where he was an adviser to many bank clients on compliance and risk management functions. Since the acceleration of the COVID-19 pandemic in mid-March, we have been constantly reaching out to our borrowing customers to assist -- to assess the risk level of each borrower and offer support and where appropriate, negotiate loan modification. We feel that the credit quality of the portfolio is manageable at this point, but continue to monitor the potential deterioration and will adjust our assessments depending on the severity and duration of the economic downturn. Through June 30, 2020, we have approved payment deferral on 708 loans totaling $1.63 billion or approximately 20% of the loan portfolio. During the second quarter, we saw a modest uptick in some of the credit quality statistics, consistent with the current economic environment, and we are reacting accordingly. At June 30, 2020, NPAs as a percentage of total assets were 0.69% as compared to 0.45% at June 30, 2019, and 0.56% at March 31, 2020. The absolute level of NPAs was $67.2 million at June 30, 2020, as compared to $38.8 million at June 30, 2019, and $55.3 million at March 31, 2020. The bank has consistently taken an aggressive approach to reviewing individual loans for impairment and accrual status. The allowance for loan losses was 1.36% of total loans at the end of the quarter and has increased from 1.23% at the end of the first quarter of 2020. These allowance levels have both -- have been derived using the new CECL accounting standards. No allowance has been provided for the $456 million of PPP loans given that those loans are fully guaranteed by the U.S. -- United States Small Business Administration, which has diluted the allowance ratio by approximately 8 basis points. Annualized net charge-offs for the second quarter were 36 basis points of average loans as compared to 8 basis points in the second quarter of 2019 and 12 basis points in the first quarter of 2020. The charge-offs in the second quarter were primarily from 1 commercial relationship in the personal services industry. At June 30, 2020, the coverage ratio of reserves to nonperforming loans was 185% as compared to 193% in June 2019. Given the uncertainty about how long the COVID-19 pandemic will impact the Washington, D.C. Metropolitan Area, we continue to monitor the economy and our customer base. The most recent reports from the Fuller Institute and the Bureau of Labor Statistics indicate that during the period of March through May, the region lost about 337,000 jobs or about 10.2% of our employment base. Most of the jobs lost and business closings were in the accommodation and food service industries. So we will continue to closely monitor our exposure to that sector, which was 10% -- about 10% of the loan portfolio at June 30. Our exposure to the retail sector is about 1% of total loans. While the COVID-19 pandemic has certainly had an impact on the income statement, we feel our balance sheet remains resilient. Our capital position was again strong as of the end of the second quarter. The total risk-based capital ratio was 16.33% at June 30, 2020, and the Tier 1 capital to average assets ratio or leverage ratio was 10.63% at June 30 as compared to a year ago at 16.36% and 12.66% respectively. The reduction in the Tier 1 capital to average assets ratio was largely the result of share repurchase activity. Our capital ratios remain well in excess of both regulatory measures and internal policy levels. Like many, we are concerned about the recent resurgence of COVID-19 across several areas of our country. However, we remain cautiously optimistic about the strength of the regional economy. While we continually monitor that, our strong balance sheet, continued profitability and our dedicated customer-focused employees are why we feel we are well positioned to work through today's challenging environment. This concludes my formal remarks. We would be pleased to take any questions at this time.

[Operator Instructions]. Our first question comes from the line of Christopher Marinac with Janney Montgomery Scott.

I just wanted to ask about the charge-off in the quarter. I know you gave a little bit of color here this morning on the press release. Just want to know if that is something that is repeated by other borrowers or will be more one-off as you see.

Well, at this point, Chris, it appears that it's a one-off item, although depending upon the duration and severity of COVID, things could change. But as of right now, this was a chain of hair salons, and they were completely closed down and ultimately filed for bankruptcy, so we went ahead and took the loss.

Got it. And did you have any, I guess, preliminary trends that you can share with us about classified and criticized and kind of how they have changed from last quarter to now? And then maybe kind of what -- how that may play out as modifications go another quarter?

Criticized are up modestly, classified are down modestly. Overall, we have a slight uptick. We are keeping our eye on it as we go through deferrals and evaluate loans on an ongoing basis. We're pretty scrupulous about re-risk rating and adding to the watch list where necessary.

Okay. And then finally, I just wanted to ask if there's any kind of updated trend as we had late July on modification. Would they have been different than what you reported at the end of the quarter?

It's not materially different. It's been relatively flat. Through last Friday, we had 718 modifications as opposed to the 708 that were through June 30. The dollar increase was roughly $15 million, rounding at $17 million.

And our next question comes from the line of Steve Comery with G. Research.

[Technical Difficulty] FHA, multifamily. I know the press release said quarter-to-quarter where the numbers can be uneven, and I appreciate that. But maybe just sort of like a way we can think about maybe full year revenue opportunity to your revenue opportunity. Just some way to like under -- to like handicap what the revenue opportunity is there.

Sure. I'm sorry, Steve, we only caught a portion of that question, but I think I got the gist of it. Unfortunately, we've learned to exercise some caution when it comes to counting on revenues associated with that line of business as we telegraph that it can be pretty lumpy. We do feel good about our pipeline. We think we've got some -- are building some traction there. Certainly, what we experienced here in the second quarter was a pretty healthy pop. I wouldn't necessarily anticipate those kinds of levels going forward, but we are expecting some kind of contribution from that business over the next several quarters, whether or not it all gets kind of baked into two quarters from now or 3 quarters from now is really tough to say, unfortunately.

Okay. Fair enough. And then maybe if we can move onto the deferrals. So should I understand these deferrals as mostly like 60 or 90-day deferrals? And then should we expect some of them to expire during the third quarter? And then if that's the case, I guess, kind of what's the process as deferrals expire?

Yes. This is Jan. We are expecting that deferrals will -- which were originally predominantly 90 days, I think the SBA were a little longer. They were 180 days because of the SBA making the payments. But the overwhelming majority of everything else was a 90-day deferral. Yes, we would anticipate that those would be terminating over the next couple of months. I haven't seen a lot so far because most of them were done either in April or May, possibly June. So rolling into September -- rolling into July, not that many have come up at this point. But we have stood up an independent task force within the credit area that is devoted to evaluating the portfolio for COVID ramifications. It was handling all of the requests for deferrals at this point. And in evaluating whether or not it's prudent to move forward with the second potential 90-day deferral, whether that be on an interest-only basis or a complete payment deferral. The task force is made up of folks with strong credit skills. We'll be looking at remediation plans and whether those plans effectively will be able to return the credit to performing status at the end of a potential additional 90-day deferral, and that's really going to be determinative of whether those are even offered or not. I can give you a little additional color on our deferrals. We have at July 17, $1.65 billion in outstanding. That's about 20.5% of the portfolio. 87% of those deferrals are secured by real estate, cash or marketable securities. The weighted average loan-to-value on that 87% is 62%. So we feel like we have good protection there. Fair amount of room to move on loan-to-value. The more immediate issue is whether they're going to become nonperforming loans or not as cash flow and liquidity may be strained for some of these businesses. Hotels, we have $482 million deferred. The weighted average loan-to-value on those is 63%. Restaurants, $156 million deferred, $47 million of that is secured by real estate, cash or marketables. The average loan-to-value on the real estate securing that portion of restaurants is 61%. We also have pulled some other statistics. Churches, we have $87 million with deferrals. The weighted average loan-to-value there is 51%. Art, entertainment and recreation, we have $50 million deferred, $37 million is secured by real estate with a weighted average loan-to-value of 38%. Health care, we have $46 million deferred, $38 million is secured by real estate and marketables. The real estate weighted average loan-to-value is 64%. And then we have a very small amount in education, $4.5 million and $3 million of that is secured by real estate with a weighted average loan-to-value of 70%. So that will give you a little more color, I think, on loss potential in the deferral area. I think we are fortunate that we do have 87% of the deferrals secured by real estate, cash or marketables. And as we move through the evaluation of whether or not a second deferral is deemed prudent, we'll be looking at when we could expect these individual loans to cash flow and support ongoing performance.

And our next question comes from the line of Brody Preston with Stephens.

This is actually Andrew Terrell on for Brody this morning. Just may be to start on the accommodation and food services portfolio. I guess taking the deferral numbers you just gave relative to the outstanding balances, I get to, call it, close to 70% deferral rate. I'm curious, do you have handy what the reserve that you currently have against those loans are?

Not on a specific loan basis. I don't have that information with me.

I guess, just in aggregate, for the accommodation and food services portfolio?

Let me take a look and see if I have it split out that way. Charles, I don't know if you have got with you?

Don't have it on hand. No. Yes, maybe we can get back.

I may be able to get back to you on that. That's not information that we typically have provided in the past.

No, that's totally fine. Maybe moving over to the commentary you guys provided on loan originations. Can you give us maybe a sense of how far below normal levels, the originations were this quarter and then maybe what the current pipeline looks like?

Yes, sure. In terms of new loans generated in the quarter, just as an example, we've typically originated somewhere on average of just over $300 million, $325 million a quarter over the last, call it, five quarters. And in this quarter, the new loans originated were about $115 million. So it's about a little more than the third.

Got it. And then maybe last one for me, just kind of a housekeeping question. Do you have what the average PPP balances -- loan balances were in the quarter?

Well, the average PPP loan?

Yes.

Yes. I mean it's just a little over -- I believe, a little over $350,000 is my best recollection of what that number is. I think it just reaches that threshold of that first tier of the fee level.

I'm sorry, I meant the -- on the average balance sheet for the quarter, what the average outstanding PPP loans were.

Yes. $328 million.

And our next question comes from the line of Stuart Lotz with KBW.

Charles, I guess a question for you. Looking at the margin this quarter, you guys made great progress lowering deposit costs. And obviously, some of that was helped by deposit inflows. How are you thinking about as some of those noninterest-bearing deposits start to flow back out, how are you thinking about deposit costs into the back half of this year? Do you think we've reached the bottom? Or do you still have some more wiggle room to get deposit costs down?

Yes. If so, it's incremental. Our top-tier money market rate right now is 30 basis points. As you suggested, we did get out in front of it when we saw a lot of this activity happening. Obviously, we saw significant drops in short-term rates. LIBOR was down period end, call it 160 basis points, 150 basis points or so. Actually, I'm sorry, 160 basis points from 12/31, I believe. So I -- we've seen, obviously, some of the online banks start to come in our direction, which puts continued pressure on those folks. The only other aspect of our funding mix, where I do see a lot of room is certainly in our term deposits and our CDs. As those roll off and reprice, I would expect some additional relief there. But on the money market front, it does look like those may roll out. We also talked -- or you also mentioned DDA flows and noninterest-bearing flowing back out. Yes, to your point, a lot of the PPP loans that were funded, funded into operating accounts. So we did see DDA balances push up in the quarter as a result of that. I would expect, as those funds get utilized, that those would, as you suggested, flow back out. All things equal, may reduce that DDA balance on average. But yes, provided that there is obviously a significant amount of liquidity sloshing around there in the marketplace that we can counter that outflow of PPP, noninterest-bearing deposits with actually collecting new deposits. That could certainly be a helpful element as well if we're able to accomplish that.

And then how are you thinking about the PPP? I know this quarter, I think it was a 2.90% yield. How are you thinking about realization of the PPP fees? And do you expect -- I think some of your peers are kind of saying, the majority of that will, I mean a lot is still uncertain, but a lot of that will probably flow through in 3Q and 4Q. How are you guys modeling that?

Yes. That would be my hope, I guess, I would say, right? It is going to be dependent upon the details of the forgiveness process. And I do think that there is some rails in there that that would suggest that that's not a bad bet that we can get a lot of those through here in the third and fourth quarter. There's also -- certainly, we've been having discussions as a lot of banks have about the potential that we could sell the portfolio that no decision has been made there. But it's something that certainly we're having internal discussions about as we get a little smarter about what the process is going to be for forgiveness and the kind of operational strain that, that might have. So yes, I think third and fourth quarter is a reasonable assumption at this point.

Okay. Got it. And sorry, last one for me. I'm sorry if I missed it. What percent of your book with floors is now at the floor following the Fed moves in March?

Yes, it's almost 100%, about $3 billion, a little over $3 billion.

Okay. So putting that all together, loan yields could probably stabilize by year-end, even with the churn of the portfolio? Is that how you're kind of thinking about?

Right. PPP, obviously. Yes. I mean, we're putting on loans now. Again, it was a modest quarter for production, as we discussed earlier. About $115 million in loans including the deferred fees and costs, call it, a $460 million that they're being originated at. So we could see some stability there.

And our next question comes from the line of Erik Zwick with Boenning and Scattergood.

I missed the first few minutes of the call, so my apologies if this has been asked already. I seem to recall so the legal fees this quarter were about $2.5 million. And I think when we had the conference call last quarter, you mentioned that those fees could potentially kind of slow in the summer months and then pick up in the back half of the year. Is that still the expectation? And how should we be thinking about those expenses in 3Q and 4Q?

Yes. I think that's right, Erik. We kind of discussed the potential for a little bit of a summer lull here and as activity might pick back up after those months, you could see some additional expenses. Although at this point, we don't anticipate fees at the levels that we certainly saw in the first quarter, with -- we anticipate that the lion's share of the subpoena production and witness testimony aspects of this which are costly have wrapped up and as we talked about internal investigations that we conducted that have been concluded in the first quarter. We don't necessarily expect or anticipate those kinds of levels. Although, again, I have to caveat, channeling my counsel here that we -- it is impossible to predict what the outcome might be, so -- with that caveat.

And then just appreciate some of the earlier discussion on the deferrals and then Susan, the detailed description you gave of how you look to kind of evaluate those borrowers who ask for extensions. And I guess, it sounds like an important part of it will be whether at the end of the second extension you think those businesses are back to more normal cash flows. I guess, are there potentially other considerations as well in terms of kind of those borrowers, other assets they have or for some businesses that might take a little bit longer to get back on their feet? I guess, at what point do you decide to continue to extend or have to take some sort of charge-off or even repossess them some real estate at some point? Just kind of curious of your thinking as how this plays out as it may be a multi-quarter event that even extends into 2021 at this point.

Well, I think you're correct that we're looking at more than just projections of the business being able to return to a cash-flowing operation that can support the debt. In considering any second modification, we're going to be adding, generally speaking, credit enhancements in the form of additional collateral and guarantor support, whenever that's possible. We want to try to put the bank and the customer in the best position to continue to operate well without taking on equity risk at the bank. So we are pushing through that process. And I do think evaluating the opportunity to continue to have payments made, whether from guarantors or pledged liquid assets is one factor. We're not interested in kicking the can down the road. If there isn't a viable exit, we'd rather just push something into nonperforming status sooner rather than later. So all of that timing will depend on what we see as we start processing second request and at this point, we haven't seen very many. It's too early in the quarter.

And I'm showing no further questions at this time. And I would like to turn the conference back over to Susan Riel for any further remarks.

I want to take the time to thank all of you for joining us today. I hope that you and your families stay healthy, and I look forward to speaking to you at the end of the third quarter.

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