Eagle Bancorp, Inc.
Q3 2018 Earnings Call Transcript

Published: 18 Oct 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to Eagle Bancorp's Third Quarter 2018 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Charles Levingston, Chief Financial Officer of Eagle Bancorp. Sir, please begin.

[Charles Levingston:]

Thank you. 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 2017 fiscal year, our quarterly reports on Form 10-Q and current reports on Form 8-K identify certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made this morning. The company does not undertake to update any forward-looking statements as a result of new information or future events or developments. Our periodic reports are available from the company or online on the company's website or the SEC website. I would like to remind you that while we think that our prospects for continued growth and performance are good, it is our policy not to establish with the markets any earnings, margin or balance sheet guidance. Now, I would like to introduce Ron Paul, the CEO and Chairman of Eagle Bancorp.

[Ronald Paul:]

Thank you, Charles. I would like to welcome all of you to our earnings call for the third consecutive - for the third quarter of 2018. We appreciate you calling in this morning and your continued interest in EagleBank. As usual, Jan Williams, our Chief Credit Officer, is also on the call this morning. Jan and Charles will be available later in the call for questions. I am pleased to announce that we achieved another quarter of record quality earnings. Net income for the third quarter was $38.9 million, a 30% increase over the $29.9 million in earnings for the third quarter of 2017. Fully diluted net income per share was $1.13 for the quarter, also a 30% increase over $0.87 per diluted share for the third quarter a year ago. Our trend of long-term performance is the result of our continued, consistent approach to management of all key performance indicators, which lead to a high level of profitability and growth in earnings per share. We are extremely proud that our strategies have resulted in the achievement of a return on average assets of 1.93% and a return on average common equity of 14.85% for the quarter. As we have stated many times on these calls, our strategy is not to concentrate on only one performance factor, but produce balanced results across all performance indicators with the focus on growth in earnings per share. This approach has led to strong performance across-the-board including top line revenue growth of 4% for the quarter, driven by a superior net interest margin of 4.14% and healthy loan and deposit growth. For the quarter, we had a very attractive efficiency ratio of 36.37% and continue to maintain excellent asset quality in our loan portfolio with NPAs to total assets of only 20 basis points and net charge-offs of only five basis points of assets annualized. This collective performance has resulted in our consistent growth and profitability, measures with the most important, being earnings per share. As always, we are very much focused on increasing profitability than just growing the size of our balance sheet. We are extremely proud to have approved upon an already favorable level of profitability. Return on average assets increased to 1.93% for the third quarter of 2018 from 1.66% in the third quarter of 2017. Return on average common equity was 14.85% as compared to 12.86% for the third quarter of last year. Return on average tangible common equity was strong at 16.54%. The return on equity results are very strong when you recognize that our shareholders' equity increased $128 million over last year, another byproduct of our strong net income creating consistent additions to our retained earnings. The net interest margin from the third quarter was 4.14%, which was equal to the margin of the third quarter of 2017 and down only one basis point from 4.15% in the second quarter of 2018. Our NIM continues to be very favorable and well above our industry and peer averages. At the current rate environment, there is a lot of focus on deposit costs. At EagleBank, we are focused on both the overall cost of the funds and our yield on earning assets. It is our margin that drives our continued growth in net income, not just this one part of the equation. Our deposit beta is related to our business model as is commercially oriented bank in a major Metropolitan market. Our business model allows us to be very efficient, operating with only a few well-placed branches. Our commercial customers have large average account balances for both loans and deposits, which also enhances our efficiency. Our model, which is driven by the deposit mix from our commercial customers with operating accounts and compensating balance requirements, is what allows us to maintain a 33.7% of our deposits in DDA accounts. That level of DDAs have been consistent for several years and has not changed despite the rising rate environment over the last two years. Some banks business models focus on the retail sector, and they've made benefit from a lower cost of funds. In most cases, this benefit is more than offset by both lower asset yields and by the cost of expensive branch networks. Additionally, many retail-focused banks operate in less attractive markets with far less opportunity to generate the quality loans, with high yields that we produce in the Washington, D.C. Metropolitan area. Those loans are really the key to our business model, which gives us an asset beta, which is far superior to our peer group. Although the past two years, as the Fed has been raising short-term rates, we've been consistently increasing the average yield on our loan portfolio. This has been driven by two factors

[Operator:]

[Operator Instructions]. Our first question comes from Catherine Mealor of KBW.

[Catherine Mealor:]

Maybe first on growth, really nice growth this quarter, can you talk a little bit about your outlook for growth for the rest of this year maybe into next? And are there any large paydowns that you foresee that could impact fourth quarter growth just as you see it today?

[Ronald Paul:]

Yes, Catherine, the lumpiness of the loan growth and loan payoffs is consistent and will be consistent. As far as large payoffs, we're constantly getting large payoffs, and we're putting on respectably large size loans. So it's very, very difficult to predict. I will say that the payoffs that we're getting are not payoffs as a result of the loan going somewhere else, it's as expected. So it might be to a Fannie or a Freddie type product on a multifamily product - project or might be new insurance company. So we're losing - we're getting those payoffs as we expected.

[Catherine Mealor:]

Got it. Okay. And so would you - as you kind of think about your growth and think about managing your margin and your credit risk, I mean, is it - kind of low double-digit growth still a growth rate that you target? Or do you feel like, moving forward, kind of, we're back into the high single-digit range as you try to - again, try to keep the margin where it is and monitor credit risk?

[Ronald Paul:]

We still believe that with the competitive nature out there and the extraordinary pricing that we're seeing from insurance companies, form debt funds that the high single digits is our expectation.

[Catherine Mealor:]

Okay. Great. And that one thing on the margin. I guess, I have two questions on the margin. The first is just on the loan yields side, saw some really nice increases in your loan yields as you talked about in your prepared remarks. Can you remind us, what percentage of your 64% variable is LIBOR versus prime? And in a quarter, like this past quarter, where we didn't see much moving in LIBOR, is it fair to expect a greater increase in loan yields, in further quarters where we have further rate hikes and maybe a more pronounced move in LIBOR?

[Charles Levingston:]

Yes, Catherine, the percentage of loans in our overall portfolio is about 44% that are indexed to LIBOR. We did see LIBOR move up about 14 basis points in the quarter on average, 17 basis points point-to-point in the quarter. We're also - obviously, we've seen - loans are being booked at higher rates this year relative to the prior years. For the first nine months of 2017 versus the first nine months of 2018, we were about 50 basis points higher in the loans we're booking. But yes, that sensitivity is going to continue to benefit us as we see more market moves in LIBOR and anticipating continued rate increases.

[Catherine Mealor:]

And is that - that 44%, is that on total loans or 44% of the 64%?

[Charles Levingston:]

On total loans.

[Catherine Mealor:]

Got it. Okay. Okay, great. And then on the other side of the balance sheet on the funding side, we've seen some big mix shift in your findings, so if - and really, we've seen money market deposits come down, I think about 11% or so since year-end and then the balance has come in CDs and noninterest-bearing deposit. So how do you think about that mix shift going forward? Is this a similar type of mix shift that we should see in the coming quarters?

[Charles Levingston:]

It may - I wouldn't think it - as dramatic as a change is that, but I think this is somewhat indicative of the changing marketplace and sabers being rewarded now these days for investing in instruments like CDs. I would expect to see shifts around the industry in a similar fashion as CDs have come kind of back into vogue. So I think that CDs are going continue to be an important part of our funding mix going forward. To the extent that you're going to see a more significant wholesale shift, I don't necessarily think that that's quite the case, obviously, those CDs provide us with the opportunity to lock in some attractive pricing. I'm pretty happy with the pricing locked in, in the second quarter with that CD campaign, and I expect I'll be pleased as rates continue to rise with what we've done here in the third quarter.

[Operator:]

Our next question comes from Casey Whitman of Sandler O'Neill.

[Casey Whitman:]

So you commented in your release on some expenses being put toward preparing to cross $10 billion, just - can you remind us where you are in that process? And then - and I realize, it's going to be probably small for you, but can you give us a sense for what we can expect the impact would be at this point on the revenue side?

[Charles Levingston:]

Yes. In terms of the impact on the expense side - trying not to answer directly, but the impact we've seen, I think we're seeing - what we saw this quarter is probably - is likely indicative, all things equal of what we're going to see going forward in the near term in terms of the buildout. Again, it's - hiring additional personnel to address that second line of defense from that ERM perspective, so more people are in the kind of the audit and risk functions and obviously, more investment in technology as the spotlight continues to brighten on that front. So I think that, that's where - really where you're seeing that impact in terms of preparing to cross that $10 billion threshold.

[Casey Whitman:]

Okay. And yes, I guess I was wondering just in terms of interchange revenues, would we expect a pretty...

[Charles Levingston:]

Got you. Right. I think given the commercial nature of our institution, sorry, Casey, I didn't quite understand initially. On the - I think that impact will likely be relatively modest given the commercial nature of our model. My back of envelope, and this is a little stale, but it was somewhere in the neighborhood of about $1 million annually, that interchange revenue would - that driven impact would be so that's kind of where we're at.

[Casey Whitman:]

Helpful. All right. And then moving on to credit, just wondering can you give us any color, you had a modest uptick in nonaccruals loans, but I guess just more broadly, are you seeing any early warning signs over the next credit cycles in your markets? Or everything's still good there?

[Janice Williams:]

Casey, I think our portfolio, on the whole, is performing quite well. The uptick, I think, is really a product being at such low levels to start with, that any move, a couple million dollars really has the percentage impact larger than you would expect if we were traveling from 25 to 28 basis points. But I think on the whole, we haven't seen any erosion in credit quality, but nevertheless, we're being very proactive and just making sure that our underwriting standards are consistent and strong. And I think we're in a good shape as far as credit goes. You'll probably remember the last downturn and over the years, we may have had some upticks in nonperforming assets from time to time, but ultimately, they have not resulted in charge-offs, so I think on the whole, we're feeling pretty confident about where we are.

[Operator:]

Our next question comes from Steve Comery of G. Research.

[Steven Comery:]

Just want to ask about loan yields, they're up nicely to 5.6% on an average - 5.69% on an average basis. I was wondering if you can kind of give us a feel for where originations are coming on during the quarter.

[Charles Levingston:]

Yes. So on the quarter, we had originations coming on just a little over 5% on average, that's the coupon rate before we're seeing the impact of deferred fees in cost, but you can add another cost of 35 basis points or so on top of that for the yields.

[Steven Comery:]

Okay. That's helpful. And then I just wanted to circle back to the comment Ron made during the prepared remarks, and that was about loan sales and kind of the process was hard in the FHA. I was kind of wondering if you could give a little more detail there on exactly like what the issues have been, how you're working through them. And kind of, what your expectations going forward are?

[Ronald Paul:]

Sure. The FHA/HUD process is very, very cumbersome. It's reams and reams of paper and reams and reams of questions that are asked on a regular basis. We have our top quality people that are constantly up in New York, working with HUD and FHA on the processing but it is a long struggle to get there, it's very profitable so it's certainly worth the enormous amount of effort. And it's also building the reputation that we can do that within this market. So we feel good about it, but it is a very cumbersome process.

[Steven Comery:]

Okay. I mean, do you think you're sort of developing any ability to work through this easier? Or is it just kind of the same?

[Ronald Paul:]

Probably a little bit of both. I think that we have experienced people that are in that department that understand what the process is, but nevertheless, depending on who's looking at the package, you're continuously getting more and more questions.

[Steven Comery:]

Okay. Fair enough, so it sounds like it's just the nature of the process rather than anything you guys are doing specifically?

[Ronald Paul:]

Very, very much. So it's kind of like the residential side a while ago, where you would send a package to somebody and then they would take it back for one question that you didn't answer right or didn't fill in the blank. So it's just a cumbersome process but it's absolutely worth the effort.

[Operator:]

Our next question comes from Joe Stephens of Stephens Capital.

[Joe Stephens:]

Ron, first of all really good quarter. Most of my questions were already asked and answered, but you even said yourself that you were not pleased with your noninterest income growth, so could you just give us a few thoughts on that?

[Ronald Paul:]

Sure. The noninterest income that we expect from the FHA/HUD program is something that we continuously think that we're going to be getting quarter-after-quarter, and it just slips because of the process that we just mentioned. On the residential side, the market is getting more and more competitive with online product, so that's been difficult. And then on the SBA side, it's interesting that a lot of our competition is taking some of the loans that we feel very strongly, should the SBA, and they are putting it into their portfolio, and we won't do that. So our SBA income has slipped. But it's mainly the FHA program that was the disappointment.

[Operator:]

At this time, I'd like to turn the call back over to Mr. Ron Paul for closing remarks.

[Ronald Paul:]

Thank you all again for attending our call and looking forward to speaking to you at the end of next quarter. Thank you very much.

[Operator:]

Ladies and gentlemen, Thank you for your participation in today's conference. You may disconnect, have a wonderful day.