Eagle Bancorp, Inc. (EGBN) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Eagle Bancorp Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this is conference is being recorded. I would like to introduce your host for today's conference, Mr. Jim Langmead, Chief Financial Officer. Sir, you may begin.

Thank you. Good morning, everyone. Before we begin the presentation, I'd like to remind you that some of the comments made during this call may be considered forward-looking statements. Our Form 10-K for the 2014 fiscal year, our quarterly reports on Form 10-Q, 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'd also like to remind you that while we think that our prospects for continued growth and performance are good, it is our policy not to establish with the markets any earnings, margin or balance sheet guidance. Now, I'd like to introduce Ron Paul, the Chairman and Chief Executive Officer of Eagle Bancorp.

Thank you, Jim. I'd like to welcome you all to our earnings call for the third quarter of 2015. We appreciate you calling in this morning and your continued interest in EagleBank. As is our custom, in addition to Jim Langmead, also on the call with me this morning is our Chief Credit Officer, Jan Williams. Jim and Jan will both be available later in the call for questions. I am very pleased to announce our 27th consecutive quarter of record earnings for Eagle Bancorp. Net income for the third quarter was $21.5 million, a 52% increase over the $14.1 million in earnings for the third quarter of 2014, and a 45% increase over the operating earnings for the third quarter of 2014 of $14.8 million which excluded the expenses related to the Virginia Heritage merger which closed in the fourth quarter of last year. Net income available to common shareholders increased 53% as compared to the third quarter of 2014. Fully diluted net income per share was $0.63 for the quarter as compared to $0.57 per diluted share on an operating basis in the third quarter one-year ago and 11% increase. The strong earnings growth in the third quarter is a result of our continued, consistent, disciplined approach to our core banking activities, combined with significant improvements in the operating leverage and efficiency. After the successful integration of the Virginia Heritage merger, we continue our focus on making quality loans, generating deposits, and retaining and expanding relationships in one of the strongest markets in the country. This strategy continues to produce balanced results for all of the key performance indicators including increased top-line revenue, driven by loan and deposit growth, solid credit quality, superior efficiency ratio, and above peer net interest margin, and our strong cash flow position. This collective performance has resulted in our consistent growth in a host of profitability measures, with the most important being earnings per share. Return on average assets increased from 1.37% in the third quarter of 2014 to 1.47% for the most recent quarter. Return on average common equity is strong at 11.95%. It's down from 14.52% in the third quarter of 2014, only because our equity position has significantly increased and is now strong due to the capital increase from the completion of the Virginia Heritage merger in the fourth quarter of 2014, combined with the $100 million capital raise in the first quarter of this year. Our tangible common equity ratio is now very strong at 10.46%. Increases in earning assets, a strong net interest margin, and net interest income were the drivers of top-line revenue during the third quarter. Total revenues for the third quarter increased to $65.2 million which was a 32% increase over the third quarter of 2014. Non-interest expense growth over the same period was only 9%. This operating leverage is one of the key drivers of our improved profitability. During the third quarter, we continued the trend of balanced controlled growth in both loans and deposits that we have consistently demonstrated. Total loans were $4.8 billion at September 30 and have increased $1.3 billion or 39% since September 30, 2014. Of that growth $544 million or 16% was organic growth beyond the impact of the merger. Loan growth during the third quarter of 2015 was $226 million or 5%. We achieved the 5% organic growth while maintaining our discipline on pricing and terms. However, as we expected, and as we have previously discussed in these earning calls, we did see a slight decrease in yields on new loans booked in the quarter due to the competition in this continuing low rate environment. The increased loan volume during the third quarter was primarily in income producing real estate loans and C&I loans consistent with our business model. Deposits increased $101 million or 2.1% during the third quarter and were 4% higher on average in the third quarter than in the second quarter of 2015. Growth in deposits over the past 12 months has been 39% with 21% being organic growth in excessive deposits acquired in the Virginia Heritage merger. The deposit mix remained strong as DDA deposits increased $32 million during the third quarter and represent 28% of total deposits consistent with historical lows. This high percentage of DDA deposits is the result of our continued commitment to relationship building with our commercial customers in which cross sales of deposits, treasury management services, and ancillary products are the key to our marketing and retention strategies. For several quarters, we've been talking about our expectations to margin compression due to the low rate environment and increasing competition pressures. Our net interest margin for the third quarter was 4.23%, a decline of 10 basis points from the second quarter, but still a very strong margin which is well above peer and industry averages. The margin during the quarter was impacted by higher level of deposits and liquidity than anticipated and by slightly lower yields on the loan portfolio. The yield on new loans originated during the third quarter was 4.87%. The average yields on the loan portfolio was 5.19% in the third quarter down slightly from 5.29% in the second quarter of 2015. The mix of earning assets also impacted the margin during the third quarter as the strong deposit growth during the quarter created more liquidity which average $378 million for the period. However, we were always pleased to see increases in core deposits from our loyal long-term customers. We remain committed to our disciplined pricing approach and to the philosophy that maintaining an appropriate margin and risk-reward equilibrium is just as important in the long run as loan volume and balance sheet growth. We're also maintaining our disciplined approach to the outgo process and continue our strategy of maintaining a neutral position to rate sensitivity and avoid taking excessive interest rate risk over the long-term. We monitor the duration of the loan portfolio just as we do with the securities portfolio. The average duration for the loan portfolio on a pricing basis is only 26 months. Excluding loans held for sale, 63% of our portfolio is in variable or adjustable rate loans, up from 57%. During the past year, we've increased the size of securities portfolio to $524 million in an effort to balance the overall yield on earning assets with a need for an appropriate level of overnight liquidity. With a strong loan pipeline at this point and we continue to see quality loan opportunities from customers and prospects that value our responsiveness, level of service, and certainty of execution. The Washington area economy is the fifth largest in the country and has strengthened over the last 18 months. We've seen growth of 53,000 new jobs in the 12 months ending September 30, as growth in the private sector has far outpaced the slowdown in federal spending. The strongest job growth is occurring in the sectors of healthcare and professional services. We continue to see an influx of younger workers in the Washington region and Washington region now has the third highest concentration of millennials among metropolitan areas in the country. Demand is not uniform across the whole region. What we're seeing is healthy activity in demand in certain submarkets, industries, and product types. The key to EagleBank'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 and location. As an example, in today's market we may be cautious about the suburban office projects but look more favorably on a boutique multifamily project near or around the metro station or other high traffic urban centers in Washington D.C. EagleBank sees the demand for financing these type of projects while many of the national or larger regional banks shy away from these projects. It is our knowledge of the individual submarkets, our relationships with quality developers, and our certainty of execution which allow us to generate loan volume and it is disciplined underwriting which allows us to maintain the credit quality and profitability of our loan portfolio. We continue our strong consistent performance for all credit quality indicators. At September 30, 2015, NPAs as a percentage of total assets were 41 basis points as compared to 91 basis points a year ago, and 44 basis points at June 30, 2015. Non-performing loans with 30 basis points of total loans at the end of the third quarter, down from 85 basis points at September 30, 2014. We continue to constantly evaluate the portfolio and take an aggressive approach placing loans on non-accrual status. Net charge-offs for the third quarter of 2015 period were only 16 basis points on an annualized basis of just 17 basis points for 2015 year-to-date. The allowance for loan loss was 1.05% of total loans at the end of the third quarter. The allowance figure is significantly lower than the level of 1.31% at September 30, 2014, due to the impact of fair value accounting on those loans acquired during the merger with VHB. The provision expenses dictated by the growth in the loan portfolio, consistent application of our allowance methodology, current economic climate, and our minimal charge-off history. At September 30, 2015, the coverage ratio was 348% as compared to 153% at September 30, 2014, and 328% at June 30, 2015. We believe that we are adequately reserved and our coverage ratio is in excess of averages for the industry and peer group banks. Non-interest income for the third quarter was $6.1 million, a 28% increase over the third quarter of last year, and a slight decrease of $6.2 million for the second quarter of 2015. The higher non-interest income was primarily driven by increased gains on the sale of residential mortgages which were $2.4 million for the quarter as compared to $1.3 million for the third quarter of last year. The efficiency ratio for the third quarter was 42.04%. This level has improved from 50.9% and 49.11% on an operating basis for the third quarter of 2014, and in line with 41.7% for the second quarter of 2015. The significant improvement in the efficiency ratio from a year ago is due to the cost savings achieved as a result of the merger with VHB, and our ongoing expense discipline and focus on maintaining favorable operating leverage. The benefit to the operating leverage is seen in the increase in top-line revenue of 32% from the third quarter 2014 to third quarter 2015, while operating non-interest expense have increased only 13% for the same timeframe. Expense control would continue to be a key factor for us. We constantly review all expense categories and look to rationalize our branch network and other facilities. In that regard, during the fourth quarter of 2015, we will close the Arlington, Virginia branch which was acquired in the VHB merger a year ago, and in the first quarter of 2016 we will close the Georgetown branch in Washington D.C. While these closures will enhance our efficiency, we're also constantly evaluating the need to continue to build a solid organization with the proper infrastructure to support growth and manage risk. We're proud of the third quarter performance which was a result of our ongoing commitment to delivering lending solutions and superior service to grow and to strengthen our customer relationships. The consistent execution of this strategy fuels of continued growth and success in the Washington Metro Area. The Bank gained 1,700 new customer relationships within the past year. The customers in our lending group are using on average 5.7 products per relationship. We are pleased to report that in the recently released FDIC deposit market share statistics, EagleBank continued to achieve growth that is well outpacing the region, and we still hold the largest market share in deposits of any community bank in the Washington metropolitan area. As of June 30, 2015, we'd also moved up to the overall number eight rank in market share for the region. It is critical to note that even with that position our market share is only 3%. So we still have a tremendous opportunity for growth in the region, particularly in Northern Virginia. The FDIC report also indicates our high level of efficiency with average deposits of $225 million per branch as compared to an average of $105 million per branch in the entire market. The growth of the bank and our market share is a reflection of how well our community has welcomed the EagleBank approach to relationship banking. That concludes my formal remarks. We'd be pleased to take any questions at this time.

[Operator Instructions]. Our first question comes from the line of Casey Orr of Sandler O'Neill. Your line is now open.

If we could dive into the margin a bit here. First, you mentioned in your prepared remarks that they yield on new loans, I believe was $4.87. Can you remind us how that compares to what you were seeing out earlier this year?

Yes, Casey, the year-to-date number for us is about $5.05 to $5.10. So that rate is lower by, call it 20 basis points in the third quarter compared to the year-to-date number.

Okay, thanks. And then, how should we be thinking about your liquidity deployment here. We didn't see a cash materially shrink this quarter. Could we see some of that get deployed into loans going forward to help stabilize the margin or should we expect continued margin compression from here? Thanks.

Casey, great question. We continued to accept deposits from core relationships because that's how we build the franchise value. So this always going to be ebb and flows as it relates to liquidity position, past two quarters we have had a lot of liquidity. Obviously in the past, in the last quarter, some of that liquidity was deployed into securities at lower yielding than the second quarter, which had some impact on the NIM. But we do have an incredibly strong pipeline and believe that that liquidity will be deployed.

Okay, great. And then switching gears, one last question on fee income, it looks like -- or looked like other income was up about $500,000 during the quarter. Can you tell us what drove that and if we should expect that to come back down next quarter?

Yes, Casey, I think you're referring to; we had roughly $1.8 million of other income in the non-interest category compared to around $1.3 million in the second quarter. I think it's due to two or three factors. There's a hodgepodge of fees in there, ATM fees, the insurance revenue was a bit higher, we're starting to get some traction in insurance and some of that is seasonal and when the renewals occur so I'd say the third quarter was a little bit higher for insurance, also the loan repayment fees. But the other factor we have some benefit programs that involve annuities, and those annuities have some guaranteed payment riders that were paid in the second quarter. So I think your second quarter number was down by about $300,000 because of that and that made the third quarter look higher. I think a run rate of around an average of $1.5 million; $1.6 million is a good number for you to use going forward.

Thank you. And our next question comes from Joe Gladue of Merion Capital Group. Your line is now open.

Just was hoping you'd give us a little color on just the competitive landscaping in regards to the loan pricing and is anyone out there doing anything rationale or that's sort of contributing to the decline in yield?

Well, I think the answer to that is always one that that spoils the group. But then, be that as it may. The position that we're in the market, being the size that we are with legal lending limit that we've, the relationships that we've, and all the other items that I mentioned. Let just pretty much stay disciplined in being able to say that we're not going to chase the one or two banks that might have a rate as your that we're not going to compete against. I'll say that that we're being more and more sensitive to the fact that we do believe rates will be going up. And therefore as I mentioned in my comments that fact that our portfolio is 63% now on variable or adjustable, which is up from previous quarters. So we're positioning ourselves on that which does lead to a slightly shorter duration that we're looking for, in our loan portfolio. But I can begin to tell you the pipeline that we have of all different sizes is as a result of the reputation that we built, understanding the market, understanding our customers, and satisfying their needs.

Okay. And I guess it's somewhat related just one of you touch on the -- I mean a outlook what -- any change to that, what do you think it look like?

Everybody is talking to everybody, which is consistent. Everybody wants more than they're entitled to. So our approach is very simple, keep your head down and keep doing what we've been doing for the past 18 years.

Thank you. Our next question comes from Dave Bishop of FIG Partners. Your line is now open.

Hi, sort of circling back to Joe's question, in terms of the environment obviously you're seeing strong loan growth especially on the commercial real estate fund, getting more and more questions these days in terms of what's the regulatory thought there and sort of concentrations increase clearly you guys have an expertise in the market within this products. Are you sensing any sort of change there are they raising any sort of cautionary flag in terms of the growth within the commercial real estate market?

Well anybody that's successful to Washington problem area is going to have a concentration real estate; a real question is how you manage it. And I think when the examiners do come in, they look at us from a regulatory perspective and they say okay yes, do have a concentration real estate but how do you manage it? The levels of our concentration that we've had in CRE has been this way for 18 years and it's not going to change. But as you drill down to the bottom and you looked at 15, 16 basis points in charge-offs year in and year out, I think it does take the question as to how we manage it and we manage it because we really, really understand the submarkets. We're not doing the single family housing development project way out West. We're staying local. As I mentioned, we're staying in the Metro sites, we're staying at urban areas, we're looking at boutique type projects. We did roll out obviously we raised $100 million which certainly address the BASEL 3 factor and from a capital perspective we feel very confident -- comfortable in that position.

Got it. And then in terms of addressing some of the comments in the preamble regarding some of those things said and just alluding to in terms of some of the submarkets, are you seeing any sort of supply/demand imbalance in any of those markets as you move out may be along 270 and towards the upper parts of Maryland or within Virginia. And are there any product types relative to the loan pipeline where you're seeing the strongest demand at this point?

Most of the demand we're seeing is really surrounding the urban, metro sites which has always been our focus not that much as we going up 270. Now, I would say pretty much stop in that Rockville Gaithersburg market, 66 if you go out, if you look at the rest of the market being very strong. The consistent theme though is count incentives in metro. Obviously what we're seeing Downtown is extraordinary whether it's the waterfront, whether it's the union market, whether it's the fourteenth and you but again this is all based on the high traffic very much millennial focused type of products. So whether its condo conversions or boutique type apartment buildings, which is really what our forte is, that's really what we're seeing the growth in and the occupancy levels are extraordinary. The recent report that came out over 97% occupancy level in these type of markets on the residential side.

Great. Just one final question in terms of the gain on loans sales this quarter. Any sense in terms of how loan sale margins held up this quarter relative to last?

I think, Dave, we're actually a little bit stronger. We've been focused on improving the profitability in that business unit. And I'd say the margins that we're getting in that business in 2015 are better than '14 because of our approach and the gross marketing spreads are over 2% that's really good for us. And so, yes, we think that business unit has provided more EPS for us in 2015 than in '14 that was intention. We're very happy with the performance of that business unit.

Thank you. Our next question comes from Matt Schultheis of Boenning. Your line is now open.

Couple of quick question with regard to the variable rate -- adjustable rate loans I think you said that was 63%. Are you swapping these to fix for customers.

We're not at this point, Matt, really involved in that kind of a derivative program. We're pretty happy with the fact we kept the duration of the portfolio pretty short and we've actually avoided going out, 10-year fixed rate I think which to your point, are you giving the customer that 10-year fixed rate and then swapping it to modify the cash flows but we're not doing that, we're not participating much in that longer-term fixed rate market. We think this would be absolutely poor time to do that with the expectation of where rates might go. So the answer is no, we're not doing that. We're not doing back-to-back swaps and some of the things that other institution. We think our core balance sheet is pretty short duration on both sides assets and liabilities we like that, we think we're well-positioned if rates go up, we're also well-positioned we think if rates stay where they've been because of the floors that we have in many of our loans.

Okay. With regard to some of the funding questions and some of the other questions that have already been asked. With the largest banks pushing deposits out because of the new liquidity rules, is this giving you an opportunity to look at new deposit relationships you haven't in the past or you unable to book these at levels that are economically profitable so you're passing them.

What we are -- as we've gone bigger and our capital position has gone stronger and our ratings, our public ratings have gotten better, we're seeing more and more relationships from municipalities, larger size law firms, from escrow agents et cetera, these co-relationships that we're looking to continue to build. So because our belief is not managing the portfolio quarter-by-quarter but long-term is that these liquidity factors will continue to grow which has resulted in liquidity position that we have and we do believe it will continue to.

I would also add, Matt, there is a lot of liquidity out there and we've been very disciplined in buying money and getting it on a core basis. So you may have noticed that our cost of money is down two basis points in the quarter. We think that's unusual given the fact that we've grown deposits in aggregate of 4% in the quarter. So we're really keeping an eye on the cost of funds and the mix continues to be as Ron's comments said very much in the DDA space which is obviously helpful for that cost.

Okay. Just on --

As an aside to that we started about year ago program that is really getting some great legs with assistance to our lenders that are actively working with our lenders on being able to get that cross-sell which is also helping and will continue to help our DDA growth.

Okay. Out of curiosity just find in case you buy size, if you will, you mentioned municipal deposits and generally Maryland and Virginia has fairly large municipalities and I was wondering is there cash management service able to do the cash management per se Montgomery County, Maryland, or would you be able to handle that?

I think at this point no. We're not active in that particular area with them. We do have deposits from several subdivisions within Maryland that you see government subdivisions in Virginia we've grown in the last 12 months since the merger. No, we're not active with cash management services for those municipalities.

We don't respond to the RFPs that have put out by the county and any of the counties. What we're doing is getting excess liquidity that these counties have that they're looking to put or being -- or have available different particular programs that we've been beneficiaries of.

Okay. And just one last question and it's -- as a caveat it does not happen in my model. So I'm wondering at what point does your -- do you get big enough and there are lack of qualified lenders for you to hire from other institutions that even just a world's largest numbers starts working against you and the balance sheet growth rate starts to noticeably slow.

It's a great question.

You may not have a sense to that either.

Well, we might have a sense, but we can say, I'll say that we're continuing to hire some very, very quality lenders. The beauty of the position we're in is that we have the ability to do $1 million loan and give that same attention on that $1 million loan to the $15 million loan and the lot of the lenders love that opportunity. If you look at a chart as to the size of Eagle versus a lot of the other ones, we're at the top size but our average size loan is still $2 million. So the lenders like the fact that we could go from large to small and still give that same level of attention. That's not going to change and that's really been the backbone of Eagle and will continue to be the backbone of Eagle. We've been very fortunate over the past quarter where we have been able to hire some good lenders which will help to increase that that revenue side. Can we continue at that the 5% loan growth that we had last quarter? Again that's ebbs and flows every quarter but we believe that mid-teens is a fair loan growth assumption.

Thank you. Our next question comes from Catherine Mealor of KBW. Your line is now open.

May be one final question on expense growth. Can you give us a sense as to what we should think about expense growth going into next year? You've got a couple of cost savings coming in with Arlington and Georgetown branches closing but you can do the higher high quality lenders and it's a nice growth. But what -- how should we think about the pace of expense growth going into the next year and how that impacts the efficiency ratio?

I think the expenses that you're going to see that put on the books predominately are going to be expenses with an offset to revenue. So you might be hiring a lender, and you might be hiring assistants to that lender but obviously that brings in loan growth more and more dependency on the technology that we have. So I think we're in a good position on the efficiency ratio and the operating leverage that obviously something we've been talking about for a longtime and we're seeing the benefits of it.

Yes, I would just add Catherine, that although it's not a specific dollar amount and we're not obviously going to give you that or a percentage. We're talking a lot with our teams and we're very team-oriented in the bank. And we've got all our people's heads into the fact that we're a very high performing bank and to say that way we've continued to exhibit that very pristine efficiency ratio. So the leverage that we're getting out of individuals, the process improvements we're working on, the need to really look at the use of technology in different ways, stop doing things that don't add value that's really where we're in this organization, there's no low hanging fruit, it's just a matter of eating it out and using the brain power, we have in all of our teams, to keep the rate of growth at a low level recognizing that we're continued to stay above interest rate, margin is going to be difficult, and key thing that efficiency ratio at that 42% level is going to be very, very important though.

And on the technology comment do you have a near-term needs for any kind of large technology or may be compliant, expenses or additions in the near future?

No, our core process that we mentioned in the past, believe that that technology and our people believe that the technology we have with FIS are going to be major providers, which serviced us up to $10 billion in assets. So we've got a lot of growth in the kind of systems that we have. We have, this year, implemented in a staged way, customer information systems, customer relationships, CRM systems, are going to be very useful to our team leaders and our loan folks and our deposit sales folks. We're also looking at other types of technology. Yes, we use it for compliance, we use it for in the finance area, and virtually the organization recognizes the benefit of technology and we're constantly employing it in a way that gives us effectiveness and efficiency.

Thank you. And at this time I show there are no further questions in the queue. I would like to turn the call back to Ron Paul for any closing remarks.

Just like to thank everybody for listening in on the call and beautiful day in Washington. So it's hard to believe that the next time we'll speak to each other is after the 1st of the year. So wish everybody a happy holiday, a happy and a healthy New Year, and we'll speak to you in January if not before. Thank you everybody.

Ladies and gentlemen, thank you for participation on today's conference. This concludes your program. You may now disconnect. Everyone have a great day.