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Eagle Bancorp, Inc. (NASDAQ:EGBN)

Q2 2013 Earnings Conference Call

July 23, 2013 10:00 AM ET

Executives

James H. Langmead - EVP and CFO

Ronald D. Paul - Chairman, President and CEO

Analysts

Catherine Mealor - KBW

Scott Valentin - FBR Capital Markets

Christopher Marinac - FIG Partners

Casey Orr - Sandler O'Neill

Operator

Good day ladies and gentlemen, and welcome to the Eagle Bancorp Second Quarter 2013 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].

I will now introduce your host for today's conference, Jim Langmead, Chief Financial Officer of Eagle Bancorp. You may begin.

James H. Langmead

Good morning everyone. Before we begin the presentation, I'd like to remind you that some of the comments made during this call maybe considered forward-looking statements. Our Form 10-K for the 2012 fiscal year, our quarterly reports on Forms 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.

Ronald D. Paul

Thank you, Jim. I'd like to welcome all of you to our earnings call for the second quarter 2013. We appreciate you calling in this morning. As usual, in addition to Jim Langmead, Jan Williams, our Chief Credit Officer is also on the line with us this morning. Jim and Jan will both be available later in the call for questions.

I am very pleased to announce, that for the second quarter, the bank earned $11.7 million, which is a record level of quarterly net income and is a 50% increase over the second quarter of 2012. Net income available to common shareholders increased 51% over the second quarter of 2012, growing from $7.6 million to $11.5 million. Fully diluted earnings per share were $0.44 for the quarter, which represents a 29% increase from the $0.33 in the second quarter of 2012. The growth rate of earnings per share reflects the impact of the additional shares issued in the ATM offering and the underwritten equity offering which occurred during the second half of 2012. Additionally, per share data for all periods has been adjusted to reflect a 10% stock dividend paid on June 14, 2013.

We are pleased to announce that the bank achieved an improved net interest margin during the second quarter. It is equally important to recognize that consistent with previous quarters, our earnings growth was the outcome of strong results across all key performance measures, not just one factor.

In addition to the increased net interest margin, we realized outstanding growth in loans and deposits, improved strong asset quality, generated solid levels of non-interest income, and maintained an excellent efficiency ratio. We are proud to have produced these strong results in an increasingly competitive market and volatile interest rate environment.

The increase in earnings was driven by top line revenue growth, as net interest income was up 12.3% over the second quarter of 2012, and non-interest income increased 59% over the 2012 second quarter. Top line revenue for the second quarter was in line with first quarter of 2013, as decreases in gains from the sale of residential mortgages, were effectively offset by increases in net interest income, and gains on the sale of SBA loans.

As mentioned earlier, we are extremely pleased to note, that the net interest margin for the second quarter was 4.27%. This represents an increase from 4.2% in the first quarter of 2013, though down 12 basis points in the second quarter of 2012. Pricing on new loans, combined with anticipated repayments and amortization of older loans, led the average yields in this loan portfolio to be down marginally from previous periods.

We continue to apply our disciplined approach to loan pricing, and have not varied from that philosophy. As a result, the yield-on-loan portfolio was 5.52% in the second quarter, as compared to 5.65% in the first quarter of 2013. We are committed to preserving a strong margin in a market where increased competition and a rational pricing, including long term fixed rates, has led to margin compression among many in the industry.

While maintaining our pricing discipline, we produce good healthy growth in loans during the second quarter, with an increase for the period of $143 million or 6%. The loan portfolio, excluding loans held-for-sale, ended the quarter at $2.7 billion. The growth experienced during the quarter, was in income producing real estate loans, C&I loans, and owner occupied real estate loans. Construction loans decreased during the period. Combined with the results in the first quarter, loan growth for the first half of the year was $198 million, which is equivalent to a 16% annual growth rate. We are very satisfied with these results, as they represent a balance of both loan growth, and maintaining the margin. We continue to see loan demand in the market, and have a strong pipeline.

Deposits increased $76 million or 3% during the second quarter, reaching total deposits of $2.9 billion at June 30. We continue to emphasize core deposits and their impact on the cost of funding. DDA deposits increased $17 million during the quarter, and accounted for 27% of total deposits. Our sustained focus on developing, expanding and strengthening relationships is key to achieving and maintaining these high levels of DDAs. Money market account balances are also up, having increased $70 million during the second quarter.

Importantly, we were able to marginally decrease our deposit rates, with the overall cost of funds declining from 42 basis points in the first quarter of 2013 to 38 basis points in the second quarter. As expected, the loan growth of loans was higher than deposits during the second quarter, and we are pleased to note that the loan-to-deposit ratio increased to 92.2% at June 30, 2013.

During the quarter, we successfully deployed some of our excess liquidity into the loan portfolio. This factor also contributed to the increase in net interest margin to 4.27% for the second quarter.

We continue our diligent ALCO approach and maintain a moderate level of interest rate risk. We look carefully at the repricing risk in our loan portfolio and the securities portfolio, while the average duration of the loan portfolio is 46 months based on maturities, it is only 25 months based on repricing triggers. 58% of the portfolio consists of variable or adjustable rate loans, and we feel that the portfolio is well positioned. In a rising rate environment, 31% of the portfolio reprices or matures within 30 days, and another 3% within the first year. In total, 74% of the portfolio reprices or matures within three years.

Our credit quality metrics improved during the second quarter. At June 30, 2013, NPAs as a percentage of total assets decreased to 1.05% and non-performing loans were 0.88% of total loans. Both ratios are very good and below the range of NPA levels we have maintained over the last several years. The absolute level of NPAs decreased in the second quarter to $35.7 million. With the NPA category, the decrease in non-performing loans was offset by increase in OREO assets. The bank has always taken an aggressive approach to reviewing individual loans and collateral, and we feel all the NPAs are appropriately valued.

The allowance for loan losses was 1.47% at the end of the quarter, which is the same as June 30, 2012, and down slightly from 1.52% at March 31, 2013. Net charge-offs for the second quarter were 24 basis points of average loans, which is also an improvement from the banks experience over the last several years. The provision expense of $2.4 million during the second quarter was dictated by the growth in the loan portfolio, consistent application of our allowance methodology, and recognition of both the improved local economy, and the quality of our loan portfolio. At June 30, 2013, the coverage ratio was 169%, and we believe, we are adequately reserved.

Non-interest income during the quarter was $7.1 million, and was again driven primarily by the residential lending division. Total non-interest income increased 59% over $4.4 million recognized in the second quarter of 2012. The total of $7.1 million did reflect a decrease on the $8.1 million recognized in the first quarter of 2013, as origination in sales volume in the residential lending division declined, as interest rate rose and refinance activities tapered off during the second quarter. The gains on the sale of residential mortgages were $3.3 million for the second quarter, which compared favorably to $2.6 million during the second quarter of 2012, but were down from $5.6 million in the first quarter of 2013.

As the level of refinanced transactions have slowed, purchase transactions have increased and now make up about 32% of our volume. We are hiring originators with strong ties into the realtor and builder markets, and continue to believe that purchase transactions will be important to this business line going forward. However, it's important to recognize that while gains in the sales mortgages have fallen, as [might be] expected, we have achieved increases in other sources of non-interest income.

Gains on the sale of SBA-guaranteed loans were $1.5 million for the second quarter, a category in which we had no gains in the second quarter of 2012, and recognized only 7,000 in the first quarter of this year. We see continued potential for fee income from this business line. Demand is strong, and premiums are at a very attractive level. Other service charges and fee income were $2.2 million over the quarter, which is a 16% increase over the second quarter of 2012. So even with decrease in the gains from the sale of mortgages, non-interest income still comprised 17% on revenue for the quarter.

Another positive indicator during the second quarter was the efficiency ratio of 49.33%. This was improved from 52.28% during the second quarter of 2012, and only marginally up from 48.56% in the first quarter of 2013. Revenue for the second quarter of 2013 increased 21%, while non-interest expenses increased only 11% from the second quarter of 2012. Non-interest expenses for the second quarter were flat, as compared to the first quarter of 2013, and in line with the revenue trend.

We are controlling headcount and personnel costs, as we have mentioned in previous calls, have no plans to open any additional branch offices in the near term. This emphasis on expense control will continue to provide operating leverage, as we grow revenue at a reasonable pace. We continue to feel that an efficiency ratio in the low 50s, the high 40s, is appropriate for Eagle Bank, given our growth rate, and our commitment to always have the proper infrastructure to support growth, and manage risk. Our regulatory capital ratios are very strong, due to the capital raised last year, and the additions to capital from each successive quarter of earnings.

The growth in total stockholders' equity in the second quarter of 2013 was mitigated by declines in the unrealized value of the investment portfolio during the quarter. Our position went from a net unrealized gain of $4.5 million in March 31, 2013, to a net unrealized loss of $900,000 at June 30, 2013. This decline was the result of the rise in longer term interest rates, and a steeper yield curve in place at June 30, 2013, a trend which affected all fixed rate investment portfolios. The impact on the unrealized value, was limited by the quality and short duration of the portfolio. Even with this impact, total stockholders' equity increased by $7.5 million during the quarter, and tangible book value per share, increased from $11.72 at March 31, 2013 to $12 per share at June 30, 2013.

We declared and paid a 10% stock dividend during the second quarter, while it had no direct impact on capital position, we believe the additional shares have improved the overall liquidity in our stock. We remain significantly well above well capitalized levels, with the total risk based capital ratio of 12.53% to June 30, 2013, as compared to 11.53% at June 30, 2012. The tangible common equity ratio at June 30, 2013, was 9.07% which was improved from 7.76% at June 30, 2012. We are still reviewing the newly adopted Basel III capital rules, but at this point, did not expect any negative effect.

The economy of the Washington Metropolitan Area is still very strong. We have yet to see any significant impact in sequestration in the local economy, or in our portfolio. The housing market is strong, and home values are up 10% from the past year.

The unemployment rate is stable at 5.4% and over 40,000 new private sector jobs have been created in the region in the last year. At Eagle Bank, we remain committed to our core mission of building new customer relationships and broadening current relationships throughout the market. We have had expanded the total number of core customer relationships by 8% over the past year.

In closing, I would like to note that just this past week, we celebrated the 15th anniversary of the founding of Eagle Bank. We are very proud of what we have been able to accomplish during these 15 years, and the bright outlook for the future. I would like to thank our board, our employees, our shareholders, our community, and all of you on the call for your support of our company.

That concludes my formal remarks. We would be pleased to take any questions at this time.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Our first question is from Catherine Mealor of KBW. Your line is open.

Catherine Mealor - KBW

Hello everyone.

Ronald D. Paul

Hi Catherine.

James H. Langmead

Hello Catherine.

Catherine Mealor - KBW

So the loan growth was fantastic to see and a surprise, I thought that it was going to be a little bit slower, given your commentary recently on how competitive the market is. But as we look at the loan yield, and the fact that Q2 is still significantly above where I know a lot of your peers are, but we did see the first quarter of -- more of a double digit decline in loan yields. And so, how should we think about the direction of loan yields, how low they may go? Where are you putting on new loans? I guess you had average loan growth of 12%, that was with about 13 bps decline in loan yields. 23% in end-of-period loan growth, so should we envision that we could see another large decline in loan yields next quarter just with all of that end-of-period growth coming forward to next quarter? Thanks.

Ronald D. Paul

Thank you for the question. As we have discussed in our previous calls, we are certainly sensitive to the competition which drives the ship. But I will tell you that we are still maintaining a very disciplined approach, which is what we have been saying quarter after quarter, and we are not going to chase the low yielding loans. We are seeing some of these yields stabilize in the competitive market, but nonetheless it's still a very competitive market.

In terms of looking forward, obviously it can't quite go there. I do believe that we have a strong pipeline. We have seen our -- the loans that have been on the books for a while, that obviously were at higher rates, running off, as they will be expected to in the construction portfolio, and we are seeing quality loans coming on the books, as slightly lower yield. But again, to be expected, but I can't stress enough, Catherine, the disciplined approach that we are taking, as a result of that. You saw the decline from 21% loan growth, down to 16%, certainly nothing to be embarrassed about, and we feel confident that we have the very strong pipelines at yields that we are very happy with.

Catherine Mealor - KBW

Great. Thanks Ron. Maybe as a follow-up, have you seen any signs yet that the higher long term rates are going to transfer into any better pricing on your commercial portfolio, or too early to see any of that coming through?

Ronald D. Paul

Yeah we are still volatile. Every day is another story. But as I said before, we are really not going after that 10 year fixed-rate loan. We haven't done that in the past, so we are not looking to do that in the future.

Catherine Mealor - KBW

Okay. Thanks for the color.

Ronald D. Paul

Thank you.

Operator

Thank you. Our next question is from Scott Valentin of FBR Capital Markets. Your line is open.

Scott Valentin - FBR Capital Markets

Good morning. Thanks for taking my question. Just with regard to sequestration, you've mentioned you are not seeing any impact yet. I was just wondering, do you expect any impact, and if you do, will it be just at the margin and that would material?

Ronald D. Paul

Well, we thought that if there was any impact, we would have seen it already. We haven't seen it yet. Who knows what's going to happen in the future again, forward-looking statement, but as I mentioned before, the sequestration issue really. Our bet was always that that would be the larger bank impact, not us. We are not doing the big loans where there is cutbacks on Boeing and a variety of things, such as that. The larger office buildings, the 200,000, 300,000 square foot office building is not our market. So the sequestration issue hasn't had an impact. We didn't think it would and to date, it hasn't.

Scott Valentin - FBR Capital Markets

Okay. Then on the mortgage banking, I know the Washington D.C. area you mentioned earlier, probably faring better than the general economy across the U.S. Just wondering, do you think the area maybe -- is a little bit more inflated from rates, in terms of purchase volume, or do you expect any impact? I mean, the refis obviously will go down, but it seems like the region is holding up pretty well in terms of new purchase activity?

Ronald D. Paul

I will tell you, the new purchase activity is strong as ever. I was talking to a builder last night, as a matter of fact, who says that with the increase in rates, he is actually seeing people getting off the dime. People that have been thinking about buying, just saying, you know what, I really need to do it now, because rates are going to continue to go up, so I might as well pull the plug now. So that was the impact that he has seen.

Again, we are working more towards the purchase. As I've mentioned in previous calls, we have a tremendous relationship with a lot of our builders, condominium developers, and that's something that we have been spending a lot of time over the past 18 months, and believe that that will continue.

Scott Valentin - FBR Capital Markets

Okay. One final question, just on SBA loan sales, it has quickly grown to a material amount of income for you guys. I know you don't want to give forward-looking statements, but do you see continued growth opportunities there, maybe not the pace we've seen but, continued growth in that area?

Ronald D. Paul

Again, I don't want to sound like a broken record here, but over the past couple of quarters, we have talked about that we were going to be building our SBA department, and fortunately, it's really done very-very well. Interestingly enough, we have got a tremendous amount of deals internally, which is just also part of that cross-selling discussion that we had earlier. As you said, can't give any forward-looking statements, but I think that SBA will continue to be a big part of our business, and we are very proud of what has happened last quarter, and think that we have got a great opportunity going forward.

Scott Valentin - FBR Capital Markets

Okay. Thanks very much.

Operator

Thank you. Our next question is from Christopher Marinac of FIG Partners. Your line is open.

Christopher Marinac - FIG Partners

Thanks good morning. Ron, just to finish the mortgage [discussion] here, and again, not looking for an exact figure here obviously, just more directional. If we look out several quarters, will this low 30 purchase number be significantly different as the market transactions in your portfolio, and (inaudible)?

Ronald D. Paul

I am sorry, will you repeat the question?

Christopher Marinac - FIG Partners

The 32% purchase mortgage number that I believe I heard you say about the production split between purchase and refi, if we look out a couple of quarters, will that number be significantly different than what we just saw?

Ronald D. Paul

You've seen a trend that's grown fairly substantially. We were 8% probably a year ago, and we are now up to 32%. I think that will continue to grow. Again, we brought on a lot of our lenders that have great relationships within the realtor and builder community, and as I have mentioned again in previous quarters is that, we are spending more and more time with our real estate group that does the construction lending, and we are going to become the preferred lender to that particular borrowers. As a matter of fact, there is one on Northern Virginia that we do a lot of business with, and we are now one of their preferred lenders. So we see that as a great opportunity.

Obviously the 32% is a function of what happens in the refi market, should rates drop substantially and refis go up, that 32% could drop. But we think that is a great balance that we have and look forward to be able to maintain that great balance.

Christopher Marinac - FIG Partners

Okay. Then I guess secondly Ron, the loan-to-deposit ratio again changing this quarter on rising, where do you envision that, as time passes?

Ronald D. Paul

The 92% loan-to-deposit ratio is -- we have been anywhere from 86 to 98 or maybe even higher than that. As you know, we've built up a tremendous amount of liquidity at the beginning of the year, because of the concern on TAG. So we have been able to properly through the ALCO process, deploy that liquidity into higher yielding assets. We have always been around that 95% average, and certainly that's something that we strive for. But again, it's an ALCO process that we are constantly on top of.

Christopher Marinac - FIG Partners

Okay. Then this last question has to do with sort of your anticipated thoughts about deposit behavior, if and when short rates rise and do you have any, like this initial thought about how you may [be able to lag on deposit pricing, if we are in a different rate environment?

Ronald D. Paul

Jim?

James H. Langmead

Chris, we think our interest rate risk position remains pretty neutral. At the end of June, rate is up 100 basis points, we would lose about 1% of our net interest income. Little bit more than 1 at the end of March, it was a little less than 1. So, not a lot of change in that position. The bit of change we did have was due to lesser liquidity on the balance sheet at the end of June. But we think we are pretty well positioned. We are a relationship oriented bank, and awful lot of DDA accounts, awful lot of commercial orientation. Money market rates, we are paying a respectable yield on those. So our modeling does expected, if rates go up, we are going to have to move money market rates up. But overall, it's a relationship building business, we are not as price sensitive, we think, perhaps as others. We think we are in good position, if rates go up, rates stay the same, or rates go down. We have not taken much interest rate risk in the past, we are not in a position today to have much risk, and I think that's the way we will continue to operate.

Ronald D. Paul

And Chris, just a follow-up to that is, on the loan side, I think that relationship that we've always talked about is what's allowing us to be able to maintain the loan yields that we are getting, where your competition might be lot lower. People are just still looking for that relationship. And bear in mind obviously, we are talking about such incredibly low interest rates right now, that a deal shouldn't depend on 10-15 basis points. So the relationships that we have been able to build, has allowed us to maintain that loan yield.

Christopher Marinac - FIG Partners

Great. Thank you both for the color.

Ronald D. Paul

Thanks Chris.

Operator

Thank you. [Operator Instructions]. We have a question from Casey Orr of Sandler O'Neill. Your line is open.

Casey Orr - Sandler O'Neill

Good morning guys, good quarter.

Ronald D. Paul

Good morning Casey.

Casey Orr - Sandler O'Neill

I just had a quick follow-up on the SBA lending this quarter. Can you give me an idea of, I guess, what the volume of loans sold this quarter was, versus last quarter?

Ronald D. Paul

The volume was $12 million, $13 million in the second quarter, Casey. We had very little volume in the first quarter, and so you can calculate with that, roughly $1.4 million, $1.5 million gain that we had announced -- its better than 10% premium when selling those loans today.

James H. Langmead

Casey, just as a follow-up to that, what we are really excited about, is the effort that our entire group has put forth in the cross selling side, which is bringing us a lot of great business internally. That will expand itself, where we are still dependent on SBA type brokers for a period of time; not only internal opportunities are huge, which is smaller sized loans, much better premiums, but again, it's providing that customer service to the relationship, which is something that is our whole tagline.

Casey Orr - Sandler O'Neill

Got it. Thanks. One last, just thinking about the portion that you do keep on the balance sheet, what is the amount that you have outstanding now, and as a percentage of your commercial loans?

Ronald D. Paul

It's about $14 million.

Casey Orr - Sandler O'Neill

Great. I appreciate the color. Thanks.

Ronald D. Paul

Thanks Casey.

Operator

Thank you. And I am not showing any further questions in the queue. I'd like to turn the call back over to management, for any further remarks.

Ronald D. Paul

Just want to thank everybody. Hope everybody is having a good summer, and looking forward to speaking with you, in the beginning of October.

Operator

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

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