Eagle Bancorp, Inc. (NASDAQ:EGBN) Q2 2018 Earnings Conference Call July 19, 2018 10:00 AM ET
Charles Levingston - Chief Financial Officer
Ron Paul - Chairman and Chief Executive Officer
Jan Williams - Chief Credit Officer
Casey Whitman - Sandler O'Neill
Catherine Mealor - KBW
Good day, ladies and gentlemen and welcome to the Eagle Bancorp Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder this call may be recorded.
And I would now like to introduce your host for today’s conference Mr. Charles Levingston, Chief Financial Officer. Sir, you may begin.
Thank you, Skyler. 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 maybe 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 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 formal earnings, margin, or balance sheet guidance.
Now, I would like to introduce Ron Paul, the Chairman and CEO of Eagle Bancorp.
Thank you, Charles. I like to welcome to all of you to our earnings call for the second quarter of 2018. As is custom, our Chief Credit Officer, Jan Williams is also on the line with us this morning. Charles and Jan will both be available later in the call for questions.
We are very pleased to announce that our second quarter earnings were $37.3 million, which is another record level of quarterly net income and represents a 34% increase over earnings for the second quarter of 2017, and a 4% increase over the earnings for the first quarter of 2018. Fully diluted earnings per share were $1.8 for the second quarter. A 33% increase over $0.81 in the second quarter 2017.
In the most recent quarter, we continue to demonstrate strong results in all key performance measurement indicators. We expanded topline revenue over the second quarter of 2017 by 9% and over the linked first quarter of 2018 by 3%, driven partly by continued strong net interest margin of 4.15 coupled with average earning asset growth of 12% in the second quarter of 2018 over the second quarter of 2017.
The asset growth was driven by 11% increases in both average loans and average deposits over the last year. Additionally, our favorable credit quality continued with low charge-offs and problem loans and continued attention to operating leverage results in the superior efficiency ratio of 38.55% in the most recent quarter. Our results in the second quarter demonstrate what we have repeatedly stated in these earning calls and in our frequent meetings with investors and analysts.
At Eagle Bank, we are more focused on growth in earnings and earnings per share than in size or growth rate of our balance sheet. In the second quarter, revenue growth was driven by increasing net interest income, which was up 12%. Over the same 12-month period, noninterest expenses increased only 7.6%. For the second quarter of 2018, annualized noninterest expenses represented only 1.66% of average assets, a level which is superior to industry and peer group averages.
The efficiency ratio of 38.55% in the second quarter of 2018, as compared to 39.1% in the second quarter of 2017 and 38.38% in the first quarter of 2018. Our continuing attention to operating leverage through strong revenue growth combined with lesser growth of our noninterest expenses has been a key factor in our increasing profitability. Our ability to continue to generate core deposits through our network of only 21 branches is a key factor in our efficiency ratio.
The net interest margin continued to be very favorable at 4.15% in the second quarter. As expected, we saw only slight compression from 4.16% for the second quarter of 2017 and 4.17% in the first quarter of 2018. The average yield on loan portfolio increased 23 basis points to 5.53% in the second quarter, as compared to 5.14% a year ago and 5.30% in the first quarter of 2018.
The average loan yield on our loan portfolio has consistently improved over the last several quarters due to the composition of our portfolio, which is 66% variable and adjustable rate, as well as our disciplined loan pricing on new loans. Our Alco strategy over the last few years has been to become slightly more asset sensitive and that has led to benefit from the rate increases driven by the Fed and other market factors.
In addition, the potentially small compression of loan yields caused by floor rates on a portion of our portfolio is now behind us, as we have pierced through the floor on 98% of the loans with floors. With the rates on 56% of the loan portfolio tied to LIBOR or prime, we expect continued increases in assets and loan yields should market rates continue to rise.
We were satisfied with our average cost of funds of 96 basis points for the second quarter, while this rate has increased by 39 basis points, as compared to the second quarter 2017 asset yields have kept pace and increased by 38 basis points over the same period and the NIM has remained stable.
During the second quarter, we were successful in increasing our average CD levels by $235 million by offering higher rates at selected longer-term maturities. We did discuss this strategy in our last quarterly earnings call. While the cost of these CDs did contribute to our higher deposit data we were extremely pleased by our ability to meet our primary goal generating these CDs and lock in longer-term funding at attractive fixed rates.
We felt this was a prudent strategy in the current rising rate environment. The most significant feature in our deposit mix is that our commercial deposit structure has allowed us to maintain an average of 33% of deposits in non-interest-bearing accounts. We plan to continue to generate core deposits and remain competitive in our primary market of the Washington Metropolitan region, which is important both as a funding strategy and for franchise value.
Net growth in the loan portfolio, as compared to the second quarter of 2017 was 11% as measured either by average loans outstanding or by period-end numbers. At EagleBank, we focus on average balances because they are really what impact revenue over that period. We're very pleased with annual net growth rate of 11%, which was slightly above our strategic objectives and resulted in a balance of 6.7 billion in loans outstanding at June 30, 2018.
The net growth in average loan balance for the second quarter, as compared to the first quarter 2018 was 2.1%, which was slightly below our projections. New loan approvals where at typical levels, plus several closings were delayed past quarter-end. In addition, we realized almost $300 million in loan payoffs during the quarter, as compared to 168 million in the first quarter of this year.
The nature of our business is that of high-quality CRE loans, which we underwrite and funding, get paid off when the projects reach completion, and/or stabilization and our loans are repaid through the sale of the property or the property is refinanced by permanent lenders. We have mentioned on previous earning call that the number of larger loan transactions have grown proportionately with the size of the bank.
We do from time to time run into situations where loan transaction funding’s or payoffs during the quarter have a short-term impact on the portfolio balance. That is why it is important to focus on average balances and longer-term trends in both the loan portfolio and the deposit base. It is also important to remember that the long-term trends are driven not by larger-sized loans, but by our core relationships, which is an average C&I loan size of 700,000 and an average CRE loan of 3 million.
We continue to see development leasing and sales activity and loan demand in the Washington Metropolitan area and our loan pipeline remains very strong. Washington Metropolitan area has the fifth largest region, economy in the U.S., with an annual growth regional project of over $500 billion. The area continues to produce GRP growth of just about 2%, and the region is expected to add about 40,000 net new jobs during 2018.
Our ability to maintain our net interest margin continued to produce loan growth and retain our excellent credit quality is based on our rock-solid philosophy and strategy of sticking to lending in our primary market, which we know so well. It is important to note that we are well-positioned to expand our level of C&I lending, which has been running at about 35% of our portfolio, including owner occupied loans.
That percentage of the portfolio is up 2% from last year is significantly higher than most of our local peers and we feel confident that we can continue to grow our C&I loans in a healthy rate. Over the last several quarters, we have invested energy and resources and made several key hires in management changes in our C&I lending teams. Although market is very competitive, we are seeing opportunities in both small and middle market credits, due to our knowledge of the market, our nimbleness, and our reputation providing certainty of execution.
Most of our C&I customers are solid growth companies and we grow our relationship right along with them. While we know that lending is the primary engine that drives EagleBank, we shouldn't ignore the securities portfolio, which has grown significantly over the past year and average 643 million for the second quarter of 2018.
For the quarter, the securities portfolio produced over $4 million in interest income, a 43% increase over the second quarter of 2017. This was done through the combination of the higher interest rate environment and $122 million increase in the average portfolio size over the past 12 months. The portfolio is conservatively managed with a relatively short duration of 17 months.
In addition, we maintain significant liquidity at the federal reserve. That position averaged over $300 million during the second quarter and is a variable rate asset. During the quarter, these funds earned $1.3 million of interest income, 110% increase over the same quarter in 2017. Average deposits for the second quarter of 2018 increased 11%, as compared to the second quarter of 2017, and increased 3% over the first quarter of 2018.
As earlier mentioned, average DDA deposits are significant at Eagle, increasing $21 million during the quarter and averaged 33% for the second quarter. The high level of DBA deposits has been maintained since the inception of the bank and will continue to mitigate the potential increases in the overall cost of funds if rates continue to increase. A significant portion of these deposits are compensating balances, which are required by our loan agreements.
We continue to emphasize growth in core deposit focusing on strengthening existing relationships and developing new relationships through centers of influence in our community. During the second quarter, we continued our record of excellent credit quality. At June 30, 2018 NPAs as a percentage of total assets decreased to 16 basis points as compared to 26 basis points at June 30, 2017 and 19 basis points at March 31, 2018.
The current and prior period ratios are very favorable as compared to industry averages and improved as compared to our NPA levels over the last several years. The absolute level of NPAs decreased by $2.5 million in the second quarter to $12.3 million and compared to $18.5 million at June 30, 2017. The bank is consistently taking an aggressive position approach to reviewing individual loans for impairment and accrual status.
We continually monitor the supply and demand for commercial real estate by submarket and loan type to manage our exposure and direct new loan production. This knowledge of the market has been a key factor in our successful underwriting over the years and the maintaining credit quality, which continues to be the hallmark of EagleBank.
Our allowance for loan losses was 1% of total loans at the end of the quarter, which is driven by the consistent high-quality of loan portfolio and by the moderate loan growth in the second quarter together with consistent application of our allowance methodology. Annualized net charge-offs for the second quarter were 5 basis points of average loans, as compared to 2 basis points in the second quarter of 2017 and are well below the range of our average charge-off loan experience over the last several years.
At June 30, 2018, the average ratio of reserves to nonperforming loans was 612%, as compared to 356% at June 30, 2017. As mentioned earlier, for the second quarter of 2018, the efficiency ratio improved to a very favorable 38.55%, as compared to 39.1% in the second quarter of 2017. Non-interest expenses for the second quarter of 2018 were $32.3 million, up only 7.6% from the second quarter of 2017 as we adhere to the principles of operating leverage.
We maintained a favorable efficiency ratio not by scrimping, but by through rational management of expenses and are continually seeking ways to improve productivity without sacrificing responsiveness, customer service, the maintenance of quality operations, and sound infrastructure. The most significant advantage we clearly have is the lack of an extensive and expensive branch network.
The efficiency ratio of our network is clearly demonstrated by our average of $298 million of deposits per branch, which is 2.4 times the pure average of 125 million. At the same time, we continue our efforts in recruiting retention and management development programs. We will maintain a reasonable level of marketing expenses and professional fees related to sustaining and developing our technology infrastructure and risk management systems to support the growth of the bank.
Through our ALCO policies and practices, we maintain a very moderate level of interest rate risk. Over the past year, we continue to slightly increase our level of asset sensitivity as we have now pierced through 98% of the loans in the portfolio, which had force. We look carefully at repricing risk in our loan portfolio and the securities portfolio. With the weighted-average maturity of our loan portfolio is 38 months based on maturities, the pricing duration is only 16 months. 66% of the loan portfolio consists of variable or adjustable rate loans.
The effective duration of the investment portfolio is only 38 months. Noninterest income during the second quarter was $5.6 million, a 21% decrease from the second quarter of 2017, but an increase of 5% over the first quarter of 2018. The decrease from the prior year was attributable to substantially reduced gains on the sale of residential mortgage loans and SBA loans as compared to the second quarter of 2017.
During the second quarter of 2018, we had gains on the sale of residential mortgages of 1.5 million as our experience mirrors that of the entire industry. Gains on the sale of SBA loans were modest in the second quarter at 128,000. Like other fee-income producing loan units, the revenue from the SBA business continued to be lumpy, and gains on sale vary from quarter-to-quarter.
The FHA Multifamily division has had minimal production during the second quarter but has a solid pipeline of transactions we have been – and we have expected an increase in revenue production in the second half of 2018. For the second quarter, our capital position and ratios are very sound, due to the continued additions through retained earnings and our consistent profitability. We are proud to note that as of June 30, 2018, our total shareholder equity exceeded $1 billion for the first time and the quality of our earnings remained strong.
The return on average assets was 1.92% for the second quarter, as compared to 1.6 a year ago and our return on tangible common equity for the quarter equally strong at 16.71%, as compared to 14.22% for the second quarter of 2017. The total risk-based capital ratio was 15.59% as of June 30, 2018. The common equity tier 1 ratio was 11.89% at quarter-end and tier 1 capital ratio was 11.97% at June 30, as compared to 11.61 a year ago.
Our capital ratios remain well in excess of both regulatory measures and internal policy levels. And our capital accretion during the first half of 2018 was at a 15.4% annualized rate. We have a strong balance sheet and intend to maintain that through our plan and prudent growth.
That concludes my formal remarks and we’ll be pleased to take any questions at this time.
[Operator Instructions] And our first question comes from Casey Whitman with Sandler O'Neill. Your line is now open.
Good morning, Casey.
First question is around the deposit base. Just thinking about the betas in growth this quarter, I would just love to hear more about what the strategy is going forward for bringing in new deposits and how you feel your deposit betas will fair with the next rate hike, you know should we expect deposit betas to continue to move up or would you consider this quarter's move outside as you brought in longer-term funding?
Yes, I think that’s fair Casey. As Ron noted in his commentary, we embarked on a CD rating initiative that was successful in the second quarter raising an average of $235 million in additional CDs that change the mix a little bit and certainly, while – all the while rates were rising and obviously the terms on those were had fixed terms that will out longer, obviously than the money market, and also pushed rates up. In addition to those change in mix in the deposits and the move to more CDs, a significant element of the higher beta was, I think the convexity associated with higher and short-term rate. And as you know, we would expect there to be some tipping point with shorter rates moving up, and I think we saw that this quarter. I don't know that I would expect those betas to persist long-term, but I do expect more upward movement in money cost as rates increase.
I would also point out that we do still maintain 33% of our deposit mix in DDAs, which is a significant factor on our ability to control the cost of funding and our – the highly commercial orientation of our deposit base is significant element in that success. Of course, we’re always going to continue to focus on the development of building core relationships, you know we’ve recognized the importance of deposit growth and we actually made some measures to further formalize our efforts in gathering deposits. Just while I've got the mic here, I'll also mention that with the additional term associated with CDs, we have improved our interest rate risk position as we continue to sense that rates may move up, that’s improved slightly as well. So, hopefully that answers your question and then some.
Yes, thank you. I guess can you speak more towards what those fixed terms where, you know like what the average duration of CDs that you are putting on this quarter or if you don't have that just what the duration of the entire CD book is right now?
Yes, so the leveraged term of the entire book is about 11 months now. In terms of the CDs that we put on they were closer to 16 months on a weighted average basis. They were about little over $370 million in growth CDs that were put on an obviously there were some CDs that mature and went away over the quarter or two. But that's where that's in.
Okay. And then switching gears, so what are you guys seeing out there in terms of competition for CRE loans in the market? Have you seen other banks get more aggressive post tax reform?
I'm sorry Casey, could you repeat the question?
Yes, just wondering what you guys are seeing out there in terms of competition for CRE loans, has pricing gotten more challenging post tax reform?
Pricing has definitely gotten very competitive. We’re certainly seeing an enormous amount of opportunities, but we're being selective in what loans we’re working after both from a credit quality perspective and a pricing perspective. We're certainly getting our share of bites at the apple. The market has gotten more competitive. You’ve had debt funds et cetera that are coming in and trying to buy loans, but I will tell you that our pipeline is strong and it goes back to the basics of we’ve been able to show our certainty of execution and our nimbleness in understanding what the product is, and therefore we’re certainly getting our share of loans that we want.
Okay, great. And just looking at the loan yield this quarter were there any one-time benefits kind of boosting those deals like prepayment penalties or anything like that?
No. Nothing material. Just kind of normal course. Yes.
Got it. Thanks for taking my questions. I’ll let someone else jump on.
Our next question comes from Catherine Mealor with KBW. Your line is now open.
Thanks, good morning.
Good morning, Catherine.
Good morning, Catherine.
A couple more margin questions to follow-up from Casey’s. On the, Charles you said 370 million of new CDs come on this quarter do you see average rate of those?
Yes, the average rate, the leverage rate on those is about 2.2%.
Great and then on the loan yield, as we think about, you said loan yields were up 23 bips this quarter, which was great, and was basically higher if you were to offset the higher beta. So, as you think about where new pricing is and then when you think about the June hike, is it fair to assume that loan yields can increase at this similar pace or even a higher pace in future quarters or do you think competition is enough to even settle [ph] a little bit to [indiscernible] that. That linked quarter increased in loan yields could modify just a bit?
I think that we will be able to push interest rates on our loan portfolio as the market shows and obviously the fed does that increase. I think again it comes down to the fact that we are able to see the loans that we want to be able to get and go after them and it’s not just about the pricing side that has allowed us to be able to get these loans, it is the creativity, it is understanding the market, it is understanding what the developer wants. We’re seeing a lot of opportunities on the C&I side as we continue to grow.
As I mentioned in my remarks, there is a number of positions that we recently hired to be able to continue to grow the C&I book and we're seeing opportunities there as well. Albeit very competitive, I certainly don't want to minimize that, but I think we get paid for the certainty of execution and understanding the needs of the borrower.
I also think that we have a certain amount, really a fair fairly high level of buoyancy in loan yields based on the variable and floating rate loans in the existing portfolio. So, I think we can take advantage of that and as new loans are coming in, the risk premium is essentially unchanged, what we're seeing is that it’s going to get some lift off of the index. So, I think we feel pretty confident that we’re going to be able to achieve that.
And it gets back to the variable nature of our loan portfolio being as large as this that as rates go up so does our yield.
Got it. Okay. And on growth, I mean, it seems like you're positive on growth – from your commentary Ron, I mean it is competitive but, you know your pipeline is strong, is there any change to your outlook for your growth target. It has historically been, you know double-digit grower, that's kind of probably kind of low double-digit, high single digit recently, but is there any change to your outlook to be able to be still kind of on average about 10% grower over the back half of this year?
I think consistent with what we’ve been saying is, I see us being in the very, very high single-digit on the loan growth side. I think that the opportunities that are out there, again we’re able to get. I think that this particular quarter we just had an extraordinary amount of payoffs, very unusual, I think it was 300 million versus 168 million the same quarter last year. So, clearly, we’re seeing the portfolio, the ebbs and flows of that portfolio, but that’s the good news of the fact that that’s what our portfolio is. And the fact that the loans are being paid off is a good news story because it shows that the market is vibrant and that we’re seeing the activity that we want to see both on the ability to place new loans and be able to execute on them.
Got it. And then one more on the margin. I mean, if you can give us some direction here, but the way I am going to ask it is, is there a scenario next quarter or the coming quarters where your deposit betas still are increasing to your point Charles, but at a lesser pace that we saw this quarter and your loan yields continue to increase at a similar pace to where your NIM actually could increase or are we still at a point of the cycle where there is still a downward pressure on the margin?
I got to think, Catherine, that to think of the margin at a stable to slightly decreasing levels is probably still the right trajectory in the near-term that’s just my take.
But still only slightly down. You feel that the dynamics within your portfolio is still, but you had a really high deposit base this quarter, but your NIM was only down two bips, right? So, I think there is a big focus today on your funding side, but I don't think we should forget about what’s happening on the asset side. So, I feel like you can really push the beta pretty high on your funding side and still really keep the margin only flat to even maybe down a couple of bips, I just want to make sure if I'm thinking about that correctly?
Yes, absolutely. You know to Jan's point with 66% adjustable or variable rate loans and piercing through those floors, which are a nonfactor at this point, we’ve got a fair amount of asset sensitive, a fairly asset sensitive position here. So, we can push it, yes.
Great. Okay. Thank you for the color.
At this time, I’m showing no further questions. I would like to turn the call back over to Mr. Ron Paul for closing remarks.
I appreciate everybody being on the call, and thank you, have a great summer. And I want to congratulate everybody at EagleBank. This is our 20th anniversary and obviously very proud and pleased as to what we’ve done for so many people. So, thank you very much to everybody, and again enjoy the summer.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.