Eagle Bancorp, Inc. (NASDAQ:EGBN) Q3 2022 Earnings Conference Call October 20, 2022 10:00 AM ET
Company Participants
Charles Levingston – Chief Financial Officer
Susan Riel – President and Chief Executive Officer
Jan Williams – Chief Credit Officer
Conference Call Participants
Catherine Mealor – KBW
Operator
Good day and thank you for standing by. Welcome to the Eagle Bancorp Third Quarter 2022 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers’ presentation, there will be a question answer session. [Operator Instructions] Please be advised, that today’s conference is being recorded.
I would now like to turn the call over to Chief Financial Officer, Charles Levingston. Please go ahead.
Charles Levingston
Thank you, Lisa. 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. While our loan growth and performance over this past quarter have been positive, we cannot make any promises about future performance and it is our policy not to establish with the markets any formal guidance with respect or to our earnings. None of the forward-looking statements made during this call should be interpreted as our providing formal guidance.
Our Form 10-K for the 2021 fiscal year and current reports on Form 8-K identifies certain risk factors that could cause the Company’s actual results to differ materially from those projected in any forward-looking statements made this morning. Eagle Bancorp does not undertake to update any forward-looking statements as a result of new information or future events or developments unless required by law.
This morning’s commentary will include non-GAAP information. The earnings release, which is posted in the Investor Relations section of our website and filed with the SEC contains reconciliations of this information to the most directly comparable GAAP information. Our periodic reports are available from Eagle online at our website or on the SEC’s website.
This morning, Susan Riel, the President and CEO of Eagle Bancorp will start us off with a high-level overview, then Jan Williams, our Chief Credit Officer will discuss her thoughts on the local economy, loans, reserves and credit quality matters, then I’ll return to discuss our financials in more detail. At the end all three of us will be available to take questions.
I would now like to turn it over to our President and CEO, Susan Riel.
Susan Riel
Thank you, Charles. Good morning, everyone. I am pleased to report the bank had another successful quarter. In the third quarter we had our best quarter of loan growth this year and credit quality metrics remained steady and strong. Loans increased by $150 million from the prior quarter end. This was our fourth consecutive quarterly increase. This quarter’s loan growth was primarily driven by our CRE team which had another solid quarter.
At the same time, NPAs were nine basis points on assets at quarter end. And we had another net recovery for the quarter but little smaller this time at $57,000. Credit risk management is just a hallmark of Eagle since our founding and it will continue to be a focus going forward.
Additionally, our CRE and C&I pipelines are moving credits through as our lending teams continue to be active and successful in their calling efforts. And beyond our pipeline, unfunded commitments were $2.4 billion at quarter end, up $87 million from the prior quarter end.
As more opportunities arise, our total risk-based capital of 15.59% gives us ample room to grow the loan portfolio, and our equity of more than $1.2 billion, gives us the lending limit large enough to close on significant commercial projects.
Additionally, during difficult economic times, it is our ability to understand risk, work with our clients and structure deals appropriately that gives us an advantage over our competitors. Our clients know that we are more committed to the business community in the Washington, D.C. market than larger banks located outside of our market.
This commitment also extends to the people in the communities in which we operate. Over the years, we have had and continue to have success in providing much needed financing for affordable housing. For example, earlier this month, we announced financing for a $42 million project. This was a land transaction with Howard University to bring mixed-use development to the Shaw neighborhood of the Washington, D.C.
And for our shareholders, we remain focused on increasing value and returning cash through dividend. At the end of the quarter, our Board declared a dividend of $0.45 per share, which returned approximately $14.4 million to our shareholders. This dividend equates to an annualized yield of 3.8% based on last night’s closing stock price of $46.78 per share.
Before turning it over to Jan, I’d like to say that our Diversity, Equity & Inclusion Council continues to make progress. This quarter we awarded five scholarships to Eagle Bank teammates as part of our scholarship program. And in addition to our two employee resource groups, the women’s group and the Black Employees Network, we have two other groups in the planning stages.
We believe participation in these groups will be personally and professionally rewarding and we give the employees participating in these groups our full support.
Now, Jan Williams, our Chief Credit Officer will give us some insight into the market, loans and credit quality.
Jan Williams
Thank you, Susan. Good morning, everyone. Even with the increasing rate environment, our Washington D.C. market continues to show its strength. Not surprisingly unemployment in the Washington Metropolitan Statistical Area remained low at 3.6% in August, a little higher than the nationwide figure of 3.6% in September.
Spending from the government, government contractors and consumers continues to remain a strong and stabilizing part of the local economy. Construction projects are being completed and new projects are moving forward. Not only have we seen an uptick in unfunded commitments, we have also seen an increase in monthly construction funding as these projects ramp up.
In our market, we have seen some Class C office space being converted to multi-families. Provided the area surrounding the property and the cost of conversion are attractive enough, we may undertake this type of project as housing demand continues to exceed supply.
Areas where we have seen some softening in demand or central business district office properties, capital equipment purchases and delays with M&A as C&I capital structures adjust to the rising rate environment. This softening in demand has more to do with clients delaying financing decisions to see how economic conditions play out rather than deterioration in their own financial position.
With that background, we continue to maintain our conservative underwriting standards, which are reflected in our credit quality matrix.
Our ACL to loans at quarter end was 1.04%, up slightly from 1.02% last quarter. NPAs, as Susan mentioned, were nine basis points on assets. Total NPAs were $9.6 million, down from $20.3 million from the prior quarter. This improvement was primarily from non-performing loans being paid in full or returning to accrual status as a result of sustained payment performance.
The improvement in credit has driven our coverage ratio of non-performing loans to 997%, up from 386% in the prior quarter and we had a net recovery of $57,000 for the quarter. Gross recoveries for the quarter were $179,000, spread out over 32 notes and charge-offs were $123,000 spread out over 5 notes.
Also, our 30 to 89-day past dues were $14.3 million, while this is up from $3.9 million at the end of the second quarter, it is still at a very low level and it’s similar to the end of the first quarter, which was $13 million.
With regard to the third quarter provision for credit losses, the increase of $2.5 million from the prior quarter was driven by three factors, higher period-end loan balances, an increase in impairment reserves on one individually evaluated loan and a modest weakening in the unemployment forecast coupled with an increase in the localization factor based on the national employment – unemployment forecast.
Partially offsetting these increases was an overall decrease from qualitative and environmental factors. This resulted from improved risk rating on certain hotel loans that more than offset an increased management overlay on Central Business District office properties in Washington, D.C.
With that, I’d like to turn it over to Charles Levingston, our Chief Financial Officer.
Charles Levingston
Thank you, Jan. First, I’d like to comment on some changes in the income statement from the prior quarter. The most notable difference between this past quarter and the prior quarter was the second quarter including one-time expenses from the settlements with the SEC and Federal Reserve.
It was these one-time items from the second quarter that drove second quarter earnings down. Absent these one-time items, adjusted second quarter net income was $38.6 million or $1.20 per share.
For the third quarter, net income was $37.3 million or $1.16 per diluted share. This was $1.3 million or $0.04 per share lower than adjusted second quarter net income. The largest factor contributing to the decreases of $1.3 million was the increase in the provision for credit losses, which increased by $2.5 million before any tax benefit. The other line items on the income statement had less impact but are meaningful, so I’ll break some of them down.
Net interest income increased by $1 million, but there were large underlying changes. Interest income was up $15.9 million on higher average loan balances, increasing yields on adjustable rate loans higher rates on new loans and the quarter had an extra day.
Interest expense was up slightly smaller $14.9 million, primarily on the higher deposit rates paid on savings and money market accounts. Our deposit rates were raised on August 1 after the FOMC announced its – after the FOMC announcement in late July. The impact of these deposit rates – of deposit rate increase on interest expense was partially offset by a smaller deposit base.
Our margin was also up slightly to 3.02%, an improvement of 8 basis points from the prior quarter. The increase in our NIM was limited as the increase in our cost of funds was not far behind the increase in yields. The average loan yield for the quarter was 5.10%, up 59 basis points and the average yield on interest-bearing balances, which includes securities was 4.01%, up 62 basis points.
On the other side of the balance sheet, the cost of funds was 0.99%, up 54 basis points. Some of the drag on the NIM is attributable to the slower repricing of variable rate loans versus the faster repricing of money market and savings accounts.
For non-interest income, we were down slightly this quarter by $256,000. Loan fees were down and mortgage volume continued to be light as rising rates further reduced consumer interest in refinancing or purchasing a home. For non-interest expense, the primary changes from the prior quarter, absent the settlement were all relatively small.
Data processing expenses were up $716,000 on expenses associated with network upgrades; salaries and employee benefits were down $267,000 as we trued up with annual incentive bonus accruals; legal accounting and professional fees were up $195,000 on higher consulting fees.
Before moving on to the balance sheet, I’d like to note that we did close one branch at quarter end. The estimated annual cost savings on rent, common area maintenance and taxes are $275,000. There were no notable unamortized expenses as the lease is set to expire on October 31. This reduces the number of bank branches to 16.
On the balance sheet, assets declined from the prior quarter end by $244 million. The decline in assets was largely driven by a reduction in excess liquidity as short-term funds declined by $322 million. These short-term funds, along with new short-term borrowings of $220 million were used to fund deposit outflows of $408 million.
Regarding the reduction in quarter end deposits, we have some clients that typically draw down balances at the end of each month. So average balances are more indicative of normal funding. Average deposits for the quarter were down by a smaller amount of $277 million. As mentioned earlier, the reduction in deposits were primarily from savings and money market accounts.
As our noninterest-bearing accounts held steady, our average noninterest-bearing deposits to average deposits rose to 38.4% this past quarter, up from 37.9% in the prior quarter. Other notable changes to the balance sheet from the prior quarter end were loans being up $150 million and securities being down $135 million.
The reduction in security balances was primarily driven by lower carrying values on available-for-sale securities as interest rates continue to rise during the quarter and from pay downs.
If the overall interest rate environment continues to rise, carrying values will continue to decrease for the securities in the available-for-sale portfolio. The markdown available-for-sale securities also drove the quarter-over-quarter reduction in equities. Equity at quarter end was down $32.9 million. Essentially, this was driven by the markdown of the available-for-sale securities offset by earnings of $37.3 million and less to $14.4 million in dividends declared.
Regulatory capital ratios at quarter end remained strong and were not impacted by the mark on the available-for-sale securities. Common capital ratios were impacted by the markdown on the available-for-sale portfolio, which reduced equity, but the decrease was muted by the reduction in assets.
Common equity to assets was 11.4%, down 5 basis points. Intangible common equity to tangible assets was 10.53%, down 7 basis points.
With that, I’ll hand it back to Susan for a short wrap up.
Jan Williams
Thanks, Charles. As we wrap up our commentary, I’d like to say that we are encouraged by the increase in loans this quarter and the strength of our asset quality metrics. Also, it is our strong relationship based culture with our customers that allows us to provide superior service and to maintain our leadership position in the community.
Lastly, as always, I would like to thank all of our employees for all their hard work and all of us at Eagle remain committed to a culture of respect, diversity and inclusion in both the workplace and the communities we serve.
With that, we will now open it up for questions.
Question-And-Answer Session
Operator
Thank you. [Operator Instructions] The first question that I have is coming from Catherine Mealor of KBW. Please go ahead. Your line is open.
Catherine Mealor
Hi, good morning.
Charles Levingston
Hi, good morning, Catherine.
Susan Riel
Good morning, Catherine.
Catherine Mealor
I want to start with the deposit costs. Could you give us just some color around what maybe where deposit costs ended the quarter to get a better sense as to where we might go into next? And then, just kind of a broad picture on deposit cost, your betas have been higher than those the past couple of quarters, which is typical for you similar to last cycle.
Is there a case to be made that you are front-running some of this deposit cost increase and your betas should kind of I guess, slow more quickly than peers? Or do you believe you are just kind of a higher beta story and that’s the way it’s going to be over the next couple of quarters? Thanks.
Charles Levingston
Sure thing, Catherine, yes, it’s hard to really say right since the forecast that. We’ve got a variety of funding relationships with varying levels of sensitivity to rate movements. I mentioned in the past that we’re modeling our interest rate risk at an average beta of about 70%. Even with that beta, we are still seeing asset sensitivity as of 9/30 to the tune of 5.7% and increased interest income with a 100 basis point move up on a status balance sheet over a 12-month period.
Obviously, the real world is abstracted away from the modeling and there is a lag effect on the liability versus asset repricing in addition to other factors like payoffs. Our beta, as you mentioned, was just around 67% for the third quarter, which does align with that modeling. It’s our thought. We’ll endeavor to either match or beat that as we move forward, right?
So, it’s I think it’s important also to keep in mind our strong noninterest-bearing deposit balances, right, we’ve seen those increase to 38.5% of total deposits in the third quarter. And so, I’ll just also add that it’s not lost on us that funding for all banks is obviously going to be more difficult in this environment. But yes, we are going to keep plugging away and try and continue to fund the bank in the most efficiently possible.
Catherine Mealor
And would you expect deposit…
Charles Levingston
Catherine, I think we lost you.
Susan Riel
Janice can talk a bit.
Jan Williams
One thing I would say is that, in prior years, we’ve always focused on relationship banking and required deposit accounts in connection without any loan request. That’s something during the period of excess liquidity that we probably didn’t pursue as strongly as we could have. I think we’re refocusing on those basic required deposits and compensating balances as we move into the changing rate environment. And I expect that we will have the same success level that we had on that when we were using those tactics pre 2020.
Charles Levingston
Yeah, I think we’re working on trying to get Catherine back in the queue because we lost her.
Operator
[Operator Instructions]
Charles Levingston
Lisa, I think if we’re not able to get her back in the queue then maybe we can move on to any other questions that we have out there.
Operator
[Operator Instructions] Okay. Here she is. I want to bring her back.
Susan Riel
Welcome back, Catherine.
Operator
Catherine, your line is open. Please go ahead.
Catherine Mealor
Okay, great. I just pressed star 1 again. So am I back?
Charles Levingston
You’re back.
Catherine Mealor
All right. Okay. So, I guess talking and everyone could hear anything I was saying. So I guess my follow-up question on deposits before I get somewhere else was I appreciate all the commentary. I guess just big picture, you believe in the listing deposits kind of shrink for the past couple of quarters do you think you’ll be able to actually grow deposits as we move into next year given kind of all you just – you just laid out for us?
Charles Levingston
Yeah, that answer – that’s certainly the desire, right. Again, I think this is a difficult environment as the money supply is shrinking. I think a lot of banks are going to be challenged with finding those deposits. So, but yes, that is the desire.
Susan Riel
I also think Catherine, as we move and Jan was saying some of this as we lost you, but as we move back to our focus of gathering deposits for all of our relationships and requiring certain amounts of deposits that will help that also. And we are much further in that process now than we were for a while during the pandemic and the excess liquidity that we all had that may not have been a strong focus as it has been in the past and will continue to be.
Catherine Mealor
Great. Okay, great. And then on the other side, like the loan data was actually, I thought, really good. Just is that this 40% data we saw this quarter, is that kind of a level that you think we should see with the next couple of rate hikes or is there any kind of dynamics within maybe where new pricing is coming on that may kind of change that data as we move forward? .
Charles Levingston
Yeah, the only comment I would have on that, obviously, we’re – we’ve got about 60% of our loan portfolio is variable or adjustable rate. And obviously, we made mention, as I think many others have during this earnings call season of the lag associated with the repricing on the asset side of the balance sheet.
But generally, I think it should be fairly consistent quarter-over-quarter with — once the Fed pauses, if they do cause strength, if they if they level off, you could see some after effects there lingering a quarter or two after probably.
Catherine Mealor
Okay, great. And then we are hearing from some other companies that are so again, and there are different markets, but I’ve heard more commentary from banks this quarter saying they’re going to slow construction lending. And I didn’t get that sense from you all in your prepared remarks. Just any kind of thoughts on new construction credits and how you’re thinking about new originations in that book in this environment?
Jan Williams
Well, I think we are still entertaining construction requests. It’s really dependent upon the type of project. Multi-family is still a very strong product in our market. There is still a housing shortage. We are also seeing industrial properties that remain attractive to investors and continue to support distribution networks.
We are not looking for office right now but I think if we’re selective about it and continue to implement our underwriting standards as we have, I see no reason why we can’t be successful with continuing on the construction side.
Charles Levingston
We also think of ourselves in a pretty special market as it relates to additional demand for construction projects particularly on the multifamily side. There is always kind of net positive people moving into the DC market as we move past each subsequent election cycle, right, there is always people coming here, so.
Susan Riel
And that’s always been a strength of Eagle.
Charles Levingston
Yes.
Catherine Mealor
And then my last question is just on the buyback. You’ve got a lot of capital. Again, your construction and CRE to capital ratios are high, but there TC on an absolute basis, the regulatory ratios are very, very high. So any thoughts on reengaging the buyback given where your stock is trading?
Charles Levingston
Yes. Certainly, it’s something we’re always talking actively about and I’d point to – and compelling case can be made as you point out for where the valuations sit today. We certainly are managing capital, trying to return to shareholders in some way. We declared another $0.45 dividend here this quarter. But, yes, it’s something that’s we’re always talking about.
Catherine Mealor
And remind me, do you have – is your buyback currently outstanding an update or do you need to re up that in order to – your thoughts.
Charles Levingston
Yes. It expires – the program expires at the end of the year. The current year.
Catherine Mealor
Okay. So you need to get regulatory – or you need to get just Board approval before you engage?
Charles Levingston
Actually, we’ve received the Board approval already. So we would be able to initiate, as well.
Catherine Mealor
Great. Okay. Thanks so much.
Charles Levingston
Yes.
Operator
There are no more questions in the queue and I would like to go ahead and turn the call back over to Susan Riel, President and CEO for closing remarks. Thank you.
End of Q&A
Susan Riel
We appreciate the questions today and thank you for taking the time to join us on the call. We look forward to seeing you – to speaking with you again next quarter. Thank you.
Operator
Everyone, thank you for joining today’s conference call. You all have a great rest of your day.
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