This may be the early stages of a banking love story, or at least a crush, and it goes to show that sometimes the process of digging up information and research on a company can lead you to an even better idea. That seems to be case with Eagle Bancorp (NASDAQ:EGBN), a stock which I've followed intermittently, but didn't really dig into until after writing an article on regional peer Sandy Spring Bancorp (NASDAQ:SASR).
I walked away from Sandy Spring thinking it was an okay idea, and the stock is up about 15% since then. While Eagle Bancorp is up less (about 11%) over the same stretch, this may be the stock to watch in the metro D.C. area. Management here runs a pretty tight ship, with a clear focus on organic share growth against regional rivals and disciplined underwriting. Even though the stock is near a new 52-week high as of this writing, my analysis suggests that this stock may be undervalued by 10% to 30%.
A Growth Story That's Still Early In The Telling
Eagle Bancorp is still a small bank. It has a grand total of 18 branches scattered around the metro DC area, with about $3.3 billion in assets and $2.8 billion in deposits. What it lacks in volume, though, it makes up for in density - Eagle Bancorp is the 11th-largest bank in the D.C. metro area, holding about 1.6% deposit share.
To put the company's growth into context, the company held about 0.5% share back in 2008, and a variety of well-known (and well-regarded) banks compete in the D.C. area, including Capital One (NYSE: COF), Wells Fargo (NYSE: WFC), Bank of America (NYSE: BAC), and SunTrust (NYSE: STI).
There really aren't any tricks or get-rich-quick schemes fueling Eagle Bancorp insofar as I can see. The bank has built itself in part on disciplined, focused loan underwriting and offering high service levels to customers - so much so that the bank has continued to gain share even as it refuses to match its rivals in the current cutthroat lending rate environment.
Commercial Lending Drives The Business For Now
As is often the case with smaller banks, Eagle relies on commercial lending for a large percentage of its loan book. Commercial real estate lending is nearly half of the loan book - almost double the normal rate for banks, and high relative to the likes of Wells Fargo, Bank of America, and BB&T (NYSE:BBT). What's more, not unlike Sandy Spring, a sizable percentage of the commercial real estate lending book is classified as "investment" as opposed to owner-occupied.
While that ups the risk, Eagle does take measures to protect itself from losses. Loan-to-value ratios are monitored carefully and the bank frequently reviews the status of these loans. In addition, the portfolio includes significant funded interest reserves and loan durations are kept relatively short. Elsewhere, in areas like construction and land loans (notoriously risky lending categories), the bank focuses on lending for renovation projects and securing personal loan guarantees as a way of de-risking the loan book. This served the company well during the bad times, as the non-performing asset ratio stayed below 2% and the company's return on equity barely slipped below 6% at the worst.
A Nearly Peerless Focus On Efficiency
I've often praised banks like U.S. Bancorp (NYSE:USB) and BB&T for their efficiency and cost-consciousness. Eagle Bancorp puts them to shame. This bank doesn't build branches until they need to, and as a result the deposits-per-branch ratio is double the regional peers. In fact, Arkansas-based wonder-bank Bank of the Ozarks (NASDAQ:OZRK) is the only bank that comes immediately to my mind as having a lower efficiency ratio than Eagle's recent 49% (though I'm sure there are others).
Eagle isn't letting a focus on costs get in the way of growth, though. The company has been hiring and building out its residential mortgage business, which has helped fuel increased non-interest income even as other banks are reporting lower mortgage sales. Likewise, the bank is more than happy to take advantage of mergers between rivals to pick up quality loan officers and other employees.
Well-Positioned To Continue Growing
All things considered, I think Eagle is in a good place to continue growing. While politicians and pundits may lament the ever-expanding federal government, it's hardly a bad thing for banks in the D.C. area as it means jobs and business creation. And while Eagle is seeing pressure on lending rates, the bank still managed to deliver 2% sequential loan growth in its last quarter, and with a net interest margin (4.2%) well above many of its peers.
As the bank grows, its cost of funds should improve - not that there's all that much further to go. What's more, the heavy allocation to commercial lending carries with it a heavier weighting to variable rate loans - about half of the loan book is variable rate, which should benefit the company's margins as rates begin to rise again in the future.
Although Eagle's Tier 1 capital ratio is fine (above 11%), it's lower than peers like Sandy Spring, Virginia Commerce (NASDAQ:VCBI), and United Bankshares (NASDAQ:UBSI) (the latter two are merging). What's more, it's loan/deposit ratio is also higher, suggesting that the company has comparatively less "dry powder" to expand lending.
That said, management has been talking about reducing deposit-gathering activity in the face of less loan demand, so it doesn't sound as though the company believes it's hurting for available capital to lend, nor does the mid-to-high teen year-on-year growth in loans and deposits in the last quarter. Likewise, I think the bank has the wherewithal to do a deal if the right opportunity comes up, but management appears to prefer to stick to organic growth after an unsuccessful proposed deal with ABVA-Alliance back in 2011.
Valuation Points To A Lot Of Potential
Bank valuation is certainly an inexact science (to put it mildly), but I believe there's further potential in these shares. Against a trailing return on equity of 12.3%, if Eagle Bancorp can lift its return on equity to 14% in 2017, these shares are worth about $27.60 today and about $30.50 if you are willing to go up to 15%. Given the bank's low vulnerability to fee-reducing regulations and consumer lending trends, I believe those ROE levels are achievable.
Looking at returns and book value, a target return on tangible assets of 1.4% for 2013 suggests a multiple on tangible book value in the area of 2.0x, or a fair value of $25.75 (about 10% above the price as of this writing).
The Bottom Line
Buying a stock at or near its 52-week high can be psychologically difficult, and that isn't made any easier by the 50% move over the past twelve months, nor the expressed intentions of rivals like PNC (NYSE: PNC), Wells Fargo, and BB&T to grow share in the D.C. area. On the flip side, waiting for a stock to come off its highs can be a recipe for frustration and lost opportunities, and I don't think Eagle Bancorp is worried about the "intentions" of its large regional rivals in the D.C. area.
All told, I believe Eagle is about 10% to 30% undervalued today, which is a pretty sizable bargain in the bank space, particularly after the big run these shares have already had. This may be the early years of an impressive bank growth story, though, and I'd hate to miss out on another Bank of the Ozarks-like story. While I'm overweight financials already, this is a tempting stock to add today.
Disclosure: I am long BBT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.