Eagle Bancorp, Inc. (EGBN) Q3 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Eagle Bancorp Third Quarter 2016 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 be given at that time. [Operator Instructions]. As a reminder, this conference call may be recorded. I will now turn the conference to Jim Langmead, Chief Financial Officer of Eagle Bancorp. You may begin.

Thank you, Nicole. Good morning, everyone. Before we begin the formal remarks, 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 2015 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 all of you to our earnings call for the third quarter of 2016. We appreciate you calling in this morning and your continued interest in Eagle Bank. As is our custom, in addition to Jim Langmead, also on the call with me this morning is our Chief Credit Officer, Jan Williams, our Executive Vice President Charles Livingston. Jim, Jan and Charles will all be available later in the call for questions. As you might have seen in the 8-K we filed yesterday, Jim Langmead has informed us that he intends to retire from full service on March 31, 2017. The Bank has significantly grown and prospered during the 11 years that Jim has been with us and the large part of this success is due to the efforts by Jim and leading his team in our finance division. Jim, we truly appreciate your contributions and we'll be forever grateful. He is not leaving us, though. Jim has agreed to continue to serve part time and continue to be part of our finance team going forward. We are pleased to announce that effective April 1st of next year, Charles Livingston will become our Chief Financial Officer. Succession planning is a key part of our management process and we have anticipated that Jim will want to step down and start winding down. Charles has been a key part of our finance division since joining the bank in 2012 and has a keen grasp of what it takes to oversee the financial operations of a $6.7 billion institution. His prized service includes tenure with the federal reserve banks of Atlanta and Philadelphia and with PricewaterhouseCoopers. Like me, Charles will continue to benefit from Jim's experience and advice. Now to the third quarter, for which I'm very pleased to announce was our 31st consecutive quarter of income growth and record earnings for Eagle Bank. Net income for the third quarter was $24.5 million, a 14% increase over the $21.5 million in earnings for the third quarter of 2015. Net income available to common shareholders increased 15% as compared to the third quarter of 2015. Fully diluted net income per share was $0.72 for the quarter as compared to $0.63 per diluted share for the third quarter a year ago. The earnings growth in the third quarter is the result of our continued, consistent, disciplined approach to core banking activities combined with our continued attention to operating leverage and efficiency. We continue our focus on originating quality loans, generating core 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 deposits and loan growth, solid credit quality, a superior efficiency ratio and above peer net interest margin and a strengthened capital position. This collective performance has resulted in our consistent growth and profitability, measures the most important, being earnings per share. Return on average assets increased to 1.5% for the third quarter of 2016 from 1.47% in the third quarter of 2015. Return on average common equity was 12.04%, an increase over 11.95% for the third quarter of last year. It is important to note the increasing profitability reflected by the higher return on common equity, even as we continue to increase our equity levels with quarter after quarter of net income, adding to the retained earnings position. Furthermore, during the third quarter, we approved our capital strength by the addition of Tier-2 capital, to the placement of $150 million of subordinated notes issued by the holding company. The offering of these notes was extremely well-received by the markets with the result that the notes were priced at 5% for the initial five-year fixed rate portion of the 10-year term. We believe this was the lowest interest rate achieved during 2016 for subordinated notes of this type by a bank holding company with a Triple B rating. While we were really very well capitalized prior to the offering, we've decided to up-size the placement to $150 million due to the attractive pricing available and our boards commitment always maintaining a very strong capital position. With the additional capital from the subordinated debt offering and the quarterly earnings, our already-strong capital ratios were further improved. At September 30, 2016, the total risk-based capital ratio was 15.05% as compared to 13.8% at September 30, 2015 and 12.71% at June 30, 2016. The tangible common equity ratio was 10.64% at September 30, 2016. The additional capital also served to lower our loan concentration ratios. The net interest margin for the third quarter was 4.11% which while below the 4.23% of the third quarter of 2015 is still a very strong margin and well above industry and peer averages. We estimate that net interest margin for the third quarter was negatively impact by 15 basis points due to the additional liquidity from the capital raise which occurred at the end of July. The proceeds of the offering were invested at a negative spread in the short term, but we fully expect the impact on the margin to be reduced as we redeploy the liquidity into higher yielding loans. Adjusted for the 15 basis point impact, our margin for the third quarter of 2016 would have been 4.26% versus 4.23% in the third quarter of last year. The liquidity during the quarter was also enhanced by the deposits of two new significant customer relationships. Our loan yields were stable in the third quarter at 5.08% versus 5.1% in the second quarter of 2016, while our cost of deposits was 36 basis points for the third quarter in 2016 versus 35 basis points for the second quarter. We are seeing a positive trend in the market for loan rates. Over the last couple of months, we have seen a noticeable improvement in pricing particularly for high quality CRE loans from existing customer relationships and this should build well for our yields going forward. We won't see the impact immediately, but we will over time as our newer loans begin to fund up. More than ever we are committed to our discipline pricing approach and to the philosophy that maintaining an appropriate margin and risk reward equilibrium is much more important in the long run than loan volume and balance sheet growth. The third quarter clearly showed the results of our continued focus on operating leverage and maintaining a favorable efficiency ratio. For the quarter, top-line revenue increased 9.1% over the third quarter of 2015, while non-interest expense was only up 5.2% over the like period a year ago. The efficiency ratio was 40.54% for the third quarter of 2016 as compared to 42.04% in the third quarter of 2015 and 50% in the third quarter of 2014. Prudent expense management is a key piece of our strategy and we continually measure our expense levels against industry benchmarks. We pay particular attention to our occupancy and administrative expenses while investing in high quality personnel and the training and technology these employees need to deliver the high level of customer service that Eagle Bank is known for. Total loans were $5.5 billion at the September 30th and have increased $705 million, of 15% annual growth rate since September 30, 2015. Loan growth during the third quarter of 2016 was $78 million or 1.5%. New loan production during the quarter remained robust as commitments approaching $500 million were booked. Payoffs during the quarter particularly one loan of $32 million as well as ordinary course of business construction loan curtailments and payoffs particularly offset new loan production. As these recently committed loans fund up, the bank expects continued growth in the loan book. The pipeline remains strong. We continue to maintain our loan pricing discipline and our normal underwriting standards which have been the cornerstones of our long term success. As mentioned in the past, we strategically plan and track the level of our specific loan types including C&I loans, CRE loans and ADC loans. We know that CRE and ADC exposure continue to be an area of focus for the regulators, but also understand and firmly believe that the regulator's view of the 300% and 100% ratios as guidance and not a bright line that must not be crossed. At Eagle Bank, because we are an active CRE lender, we have the years and consistently adhering to all the recommended practices including disciplined underwriting, independent credit reviews, rigorous risk testing, enhanced monitoring of the entire loan portfolio and detail tracking and reporting at both management and the board level. Given the $150 million of Tier-2 capital raise during the third quarter and the additional capital added each quarter through our consistent earnings, combining with our long standing disciplined approach to lending policies, procedures and practices, we are very comfortable with our loan concentration ratios and our ability to generate quality loan volume in our market. At this point, our loan pipeline is as strong as it has ever been and we continue to see loan opportunities from customers and prospects that value our responsiveness and certainty of execution. The Washington area economy is the fifth largest in the country and also has the fifth best growth rate. The region added 98,000 net new jobs in the 12 months ending July 30th. We continue to see an influx of young workers and residents. The Washington region has the third highest concentration of millennials of any metropolitan area in the country. The private sector continues to produce very strong job growth and over the last six months, we have seen that federal government start hiring again. The stronger growth is occurring in higher paying jobs in the professional service sector and in healthcare. We are seeing significant activity in the biotech sector of Montgomery County in Maryland and in the IT sector of Northern Virginia. We carefully monitor activity across the region and continue to see healthy activity and demand in certain sub markets, industries and product types with softness in others. The key to Eagle Bank's underwriting has always been that we study and understand the various sub markets within the greater Washington area and we monitor and control our portfolio composition by product type and location. We remain generally cautious concerning the suburban office market, but look more favorably on a boutique multi-family project near metro station or other high traffic urban centers in Washington DC. This has been consistent over the past 18 years. It is our knowledge of the individual sub market, our relationships with quality developers and our certainty of execution, which allow us to generate loan volume and is our disciplined underwriting which allows us to maintain the credit quality and profitability of our loan portfolio. Deposit growth was strong during the third quarter as deposits increased $223 million or 4.2%. Deposits have grown 13% over the past 12 months since September 30, 2015. The deposit mix remains favorable as DDA deposits increased $37 million during the third quarter and represent 30% of total deposits at quarter end, consistent with historical levels. This high percentage of DDA deposits is the result of our continued commitment to relationship building with our commercial customers in which deposits, treasury management services and ancillary products are integral to our relationship's first approach. We are also maintaining our discipline approach to ALCO process and continue our strategy maintaining a neutral position for rate sensitivity and avoiding taking excess interest risks over the long term. We monitor the duration of our loan portfolio just as we do to securities portfolio. The average duration of the loan portfolio on a pricing basis is only 23 months. Excluding loans held for sale, 66% of our portfolio is in the variable or adjustable rate loans. The effective duration of the investment portfolio was less than three years at September 30, 2016 and the liquidity position was about $500 million at that date. We continue our strong consistent performance all credit quality indicators. At September 30, 2016, NPAs as a percentage of total assets was 41 basis points, unchanged from the 41 basis points a year ago and as compared to 39 basis points at June 30, 2016. Non-performing loans were 41 basis points of total loans at the end of the third quarter. We continue to consistently evaluate the portfolio and take an aggressive approach to placing loans on non-accrual status. Net charge-offs for the third quarter of 2016 period were only 14 basis points on an annualized basis and just 13 basis points for 2016 year-to-date. The allowance for loan losses was 1.04% the total loans at the end of third quarter. The provision expense from the third quarter was $2.3 million as dictated by the slower 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, 2016, our coverage ratio is 255%. We believe that we are adequately reserved and that our coverage ratio is an excess of averages for the industry and tier-group banks. Non-interest income for the third quarter was $6.4 million, a 5% increase over the third quarter of last year and a 15% decrease from the $7.6 million for the second quarter of 2016. The higher non-interest income was primarily driven by the increased gains on the sale of residential mortgages which were $2.9 million for the quarter as compared to $2.4 million from the third quarter of last year. Our SBA loan business remains robust, but as we have mentioned before, the volume and closings is somewhat choppy from quarter-to-quarter. We are very pleased with the third quarter performance and with the continued growth and profitability. We are equally pleased by the response from the Washington metropolitan area to our relationship's approached banking. The recently released FDIC deposit market share statistics show that for the 12 months ending June 30, 2016, the market grew by 5.2% and Eagle Bank grew by 8.9%, and that we still hold the largest market share in deposits of any community bank headquarter in the Washington metropolitan area. It is critical to note that even with that position, our market share is only 3.14%, so we still have a tremendous opportunity for growth in this strong dynamic region. Thank you for joining the call this morning and for your continued support of Eagle Bank. That concludes my formal remarks and we'd be pleased to take any questions at this time.

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

Good morning.

Good morning, Casey.

Good morning, Casey.

Great quarter. Just wondering, can you give us some more color on the higher level payoff you saw this quarter? What do you think drove that and how much was expected?

Sure. Just to give you a little flavor on that, Casey, first quarter we have $135 million of payoffs; second quarter we had $105 million of payoffs; third quarter we had $220 million of payoffs. A lot of that was construction lending that was expected to happen. It's just the normal ups and downs that we have. There's no anomaly in that third quarter. It's just the consistent running of the business and again a larger percentage of it was as a result of construction lending, but as expected, in the normal course of the construction project. Jim, anything you want to add to that?

No, I think that covers the detailed payoffs in the third quarter. We're about half of the entire nine-month period, so it would have been unusual, but these are projects completing as scheduled and I think that's a really good thing from a credit standpoint.

Okay, great. And then are you seeing as any pull back in the market just from the election uncertainty last quarter or now?

No, not really. As I think I might have mentioned in one of the previous earnings calls, we have a study that was done by one of the large firms in the area and going back to the Roosevelt administration, job growth in the Washington area regardless Republican/Democrat has increased since every presidential election. We haven't seen anything. There are typical discussions, but no slow down at all. Permits are still big and normal, course of business is pretty consistent.

Okay, great. Interesting. Thanks. And then your commentary, Ron, earlier on seeing improved pricing in I guess high quality CRE loans. What do you think has been driving that?

It's quite obvious to us that the large banks which as you know has always been our biggest source of business. But the large banks have pretty much shut off this thicket on real estate lending. As we've discussed previously, typically we've seen that in the smaller sized loans, but now we're seeing it in the larger sized loans as well. It could be an anomaly. We have the insurance companies that are getting more and more active in the market, but it really does come down to the consistent theme that we talk about and that's relationship-building. And we're constantly seeing the bigger developers that want to deal with people that they know are going to be here to discuss issues when they come up if they come up. So the larger sized loans - I literally went to see a project yesterday. It was a very significant project and if we go ahead with the deal, it's a 5% yield and it's from the very, very substantial developer, but it's at a price that would have been 4.5% three months ago.

All right. Great and nice quarter. Thanks.

Thanks, Casey.

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

Thanks. Good morning, everyone.

Hi, Catherine.

Good morning, Catherine.

I know it's early in the quarter, but do you have any senses to what level of pay downs you would be expecting this quarter? You expected to go back down to that $105 million to $130 million level that we saw on the beginning half of the year?

Catherine, I think that's exactly right. I think that the average level of payoffs of around $100 million or so for the quarter is something you can think about on an ongoing basis.

And Catherine, to further that, is obviously the past couple of years we've done larger-sized loans. So therefore the ebbs and flows of the impact that larger-sized loans have is a difference. Obviously you'll see that stabilize over the next X quarters as we continue to book these loans. There's nothing that we know of and we can keep pretty tight range on from an ALCO perspective, liquidity on payoff. There's nothing that we see again that's out of the ordinary within our portfolio at all.

Great. And then Ron, you mentioned that - I think you said in your prepared comments that there was an additional $500 million in commitment that were booked this quarter. Obviously that's not all going to fund at once, but if you think about the payoffs coming down to a more normalized level and then if the pipeline remains really strong and growth can stay as around level, I mean do you think that we are back to a double-digit growth rate next quarter and into next year? Or how should we think about net growth rate for all [ph] moving forward? And does your higher capital make you feel like you've got enough capacity to increase that growth rate any more so than before you have done and I think Ron has said that.

I think the growth rate that we anticipate is consistent with what we've been reporting in the past. Remember that the first quarter we had 3.2% loan growth, second quarter 4.8%, third quarter 1.5%. Again it's the ebbs and flows of a quarter, but we believe that the pipeline and the amount of $500 million that we've funded in commitments, obviously that will get funded up over the next 12 months, but it just indicates just how robust the market is right now on high quality well-priced loans.

Got it. And then maybe other question on the expenses. You've kept expenses amazingly flat at around $28 million despite some really nice revenue growth. Is there anything in the next couple of quarters going to next year that just national course of business is going to push that growth rate a little bit higher? How should we think about I guess the direction of - I'm assuming these things are going high. I can't imagine it going low from here, but maybe the efficiency rate goes lower, but how do we just think about the pace of growth we should expect on the expense pace over the next few quarters?

Jim, you can jump in, but we have nothing in the pipeline as far as new branches. We don't have anything in the pipeline as to new forms of business, so there's nothing that I could think of, Jim, unless you do on anything out of the ordinary that would change from 2016 year-to-date.

Catherine, yes, I think if you look at the different categories, the category that we've had, the highest rate of growth has been in the salary and employee benefit area. So we have been adding folks in the bank here throughout 2016. The most of that did occur in the second and third quarter. The level of salary and employee benefits will go up a little bit and it's that human capital as where we're adding resources. But as Ron mentioned on the premises and equipment area, that's going to be pretty flat. We've actually rationalized the branches, we reduced the square footage of different offices. And then on the other expenses, they've been relatively flat. We really got our arms around OREO [ph] expenses that can move around from quarter-to-quarter, but they've been very, very low of late and legal fees and professional fees and things of that nature have been really under good control. For the fourth quarter, we typically will finalize some incentive plans. We typically have more incentive approvals a little bit more in the fourth quarter, but overall, as Ron said, I think our rate of growth of expenses, I think you can plan for them to be in the low to mid-single digits. That's our expectation, keep that efficiency ratio in very good order, recognizing that the NIM compression is something that everybody is dealing with in this low interest rate environment.

Great. Thank you very much.

Thank you. Our next question comes from the line of Joe [ph] of Maryland Capital Management. Your line is now open.

Yes. Hi, good morning.

Good morning, Joe.

Good morning.

I actually just like to follow up on that expense question a little bit. You did mention, talked about the growth in [indiscernible] benefits in the quarter and said you're adding some stuff. Just wondering, I guess where are you heading to that?

Joe, we're adding it both on the offense and the defense. There have been some additions in the loan areas, relationship managers, portfolio managers of that nature. But we're also adding at - credit area has been one, our human resources area, our risk management area is others. So we're pretty balanced in the way in which we've been adding people into the organization, but it's both sides of the equation, the offense and the defense.

Okay. I guess also wondering, last quarter you talked a little bit about the gain on sell margins you're getting on loan sales and indicated that you were seeing some higher margins recently. I'm just wondering if those margins are holding up at the levels of previous quarters.

They are and for the third quarter of the year, the gross marketing gain was around 215 basis points. We're pretty happy with that. That's before the commission expense, but that is a higher number than it was in the third quarter a year ago. So the mix of business toward more FHA business away from jumbo business has helped that profit margin. So they're executing very well in the residential real estate area and that gross margin has been moving up generally. Third quarter, we had good results.

All right. I think that's it for me. Thanks.

Thanks, Joe.

Thank you. Our next question comes from the line of Austin Nicholas of Stephens Inc. Your line is now open.

Hey, guys. Good morning. Just a couple of questions here - most of them were already answered. Maybe just taking a step back, looking at some of the disruption that happened in the market over the last couple of months in terms of acquisitions. Do you see any ability to add high quality lenders from those institutions or any disruption that brings the business your way? Have you seen any movement there?

Yes. In the acquisition world, most of the banks put the key people under some type of an employment contract for a period of time. So we see that there might be opportunities as time goes on, but the bigger opportunity is really on the customer side. The uncertainties in merges always lead to some nervousness within the customer base especially in today's economic environment. So we have seen an increase in customer opportunities - many of which we know and many of which we've been looking to expand the relationship with, so we do see the opportunity immediately on the customer side and hopefully as time goes on the employment side.

Got you. That's helpful. Thank you. And then maybe just my other question, just on deposit cost, are you seeing any increased competition for deposits in your market compared to let's say six months ago? And then a number of other banks I've spoken to, I've seen or anticipating to see some increased deposit cost really to the LIBOR move. I guess are you seeing anything on either of those funds in terms of deposit cost?

Austin, yes. We're seeing a little bit. I think Ron mentioned in his remarks that our cost to deposits was up by one basis point in the quarter because actually the first quarter or that we call it the fourth quarter of last year, we went from 29 basis point cost to 32, to 35, to 36. So we are seeing some increase in that area and as you correctly know the changes in the LIBOR market related to the regulatory changes - primarily due to regulatory changes on the corporate area with commercial paper and such on the SEC changes in that market are having an impact and some of our cost to funds are based on LIBOR. So as you point out, LIBOR 1 and three month LIBOR have moved up more than the Fed funds effective rate and that is having some impact as we do have some cost of money that is based on LIBOR. But overall, that's all in our asset liability modeling and mix and we think our cost to funds continues to be very attractive, relative to the competition particularly given the growth rates that we've been able to achieve and in the third quarter in particular, the growth we had in our deposits was very, very strong. So happy with our result, but the direction of the cost of money is up a little bit.

Okay, great. Well, I appreciate the color on that, guys. I'll hop after anyone else. Thanks.

Thanks, Austin.

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

Hey. Good morning, gentlemen, how are you?

Good morning, Dave.

Hey, quick question. I think Ron, you know that some of the deposit growth was filtered by a couple of new larger relationships; I don't know if you could provide any color on that in terms of what - maybe you saw I think that maybe what segments in the market did that came from?

Just core C&I. Some municipality business that we're picking up. Going back to one of the earlier questions, I think that as a result of some of the recent acquisitions, we have some customers that are looking to get on board with Eagle that might have been with some of the previous banks that are now part of the larger bank. It's really across the board, but the two that I mentioned were just core C&I relationships that we've been working on for a period of time.

Got it. Then I wonder if you saw the headline, you coming out with Marriott [ph], seeing local there, just curious, maybe give an update how you think? Obviously I think that's a positive for the local marketing year, but maybe what you're seeing on a broader perspective in and around your core headquarters there on Montgomery county, any sort of update in terms of economic activity in third quarter?

We're telling all of our team at Eagle Bank that are working with us to leave their house 10 minutes earlier once the construction starts in the first at Marriott [ph] - but we're glad the Marriott [ph] certainly staying within our area. We continue to see growth as we mentioned Biotech as an example, the continued growth in health services, the Johns Hopkins, the National Cancer Institute, the NIH just continues to expand and that's literally two miles from where we are. Montgomery County is doing a major push on the tech side, so we are very, very bullish on the net job growth that we believe will continue in the marketplace.

Got it. Thank you for the color.

Thank you. I'm showing no further questions at this time. I'd like to turn the call over to Ron Paul for your closing remarks.

Well, thank you all for attending and listening to the call. I wish you all a happy and healthy new year since I guess the next call we'll have is in January and just as important again to Jim. Thank you for all your efforts that you've given Eagle Bank over the past 11 years and Charles, needless to say, looking forward to continue to work with you and expanding Eagle Bank as we have over the past 18 years. So thank you very much for everybody listening to the call.

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