Eagle Bancorp Q2 2024 Earnings Call Transcript

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July 25, 2024

There are 6 speakers on the call.

Operator

Good day and thank you for standing by and welcome to Eagle Bancorp Inc. 2nd Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded.

Operator

I would now like to hand the conference over to your speaker today, Eric Newell, Chief Financial Officer of Eagle Bancorp, Inc. Please go ahead.

Speaker 1

Good morning. This is Eric Newell, 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 are forward looking statements. We cannot make any promises about future performance and caution you not to place undue reliance on these forward looking statements. Our Form 10 ks for the 2023 fiscal year and current reports on Form 8 ks, including the earnings presentation slides, identify risk factors that could cause the company's actual results to differ materially from those projected in any forward looking statements made this morning, which speak only as of today.

Speaker 1

Eagle Bancorp does not undertake to update any forward looking statements as a result of new information or future events or developments unless required by law. This morning's commentary will include non GAAP financial information. The earnings release, which is posted in the Investor Relations section of our website and filed with the SEC, contains reconciliations of this information to the most directly comparable GAAP information. Our periodic reports are available from the company online at our website or on the SEC's website. With me today is our President and CEO, Susan Riel and our Chief Credit Officer, Jan Williams.

Speaker 1

I would now like to turn it over to Susan.

Speaker 2

Thank you, Eric. Good morning, everyone. Before discussing our progress and continuing to execute our strategic objectives, I want to address our 2nd quarter results announced last night. The quarter's results were affected by a goodwill valuation, which Eric will elaborate on. It's important to note, as you should know, that this impairment does not impact our cash, liquidity, regulatory or tangible capital ratios.

Speaker 2

It is a non operating item that has been fully removed from our balance sheet, ensuring that any goodwill valuation risk will not affect our future results. That said, we are pleased to report that operating earnings in the 2nd quarter have significantly improved from the Q1. This improvement is largely driven by a lower provision for credit losses as we continue to prudently build reserves in response to uncertain market and economic conditions. We are rigorously focused on executing our strategic objectives of diversifying and growing our loan book and deposit franchise and capitalizing on value propositions for customer segments, which where we already have market presence. While achieving our loan mix goals is a multiyear endeavor, we anticipate ongoing progress in the interim, though achieving the goal may not be linear.

Speaker 2

We are already seeing encouraging results from our efforts to grow deposits and diversify our funding, although it is still early. Notably, we have onboarded a team to lead our expatriate banking services division, and we are excited about the future contributions this division will bring to our deposit diversification. Additionally, our direct digital channel continues to build momentum. As this channel grows, we aim to reduce our reliance on wholesale funding, thereby lowering the cost of our interest bearing funding. While we acknowledge the significant work ahead, we remain optimistic.

Speaker 2

Economic and interest rate uncertainties, particularly regarding office loans and other CRE exposures, have presented challenges. Eagle Bank has always been committed to serving commercial real estate investors and commercial business customers in the Washington, D. C. Metropolitan area, and it will continue to do so. Our strategy is designed to gradually diversify our loan portfolio while continuing to offer exceptional value to our commercial customers.

Speaker 2

We remain cautious about the office sector, understanding that a return to pre COVID absorption rates is unlikely in our region. Nevertheless, we are dedicated to working closely with our customers to find solutions that maximize the value of their collateral. Our objective is to establish a strong foundation for sustainable growth, achieving improved and consistent profitability regardless of the interest rate environment. I am confident that we have identified the necessary actions to set us up for continued success. With that, I'll hand it over to Eric.

Speaker 1

Thanks, Susan. We reported a GAAP net loss for the quarter totaling 84,000,000 dollars or a loss of $2.78 per share, recording a $104,000,000 impairment in the value of goodwill. Excluding the goodwill impairment, operating net income totaled $20,400,000 or $0.67 per diluted share, materially improved from the 338,000 operating loss experienced in the Q1. This impairment is a non cash accounting charge to earnings. It has no impact on the company's core net income and operating profit, cash flows or liquidity nor does it impact tangible or regulatory capital ratios, which already exclude goodwill.

Speaker 1

Our capital position remains strong. Tier 1 leverage capital increased 32 basis points to 10.6 percent at June 30. Common Equity Tier 1 capital increased 12 basis points to 13.9% at June 30. Our March 31 common equity Tier 1 capital ratio continues to exceed the CET1 capital ratios of 75 percent of all other financial institutions with assets greater than 10,000,000,000 dollars Tangible common equity continues to exceed 10%. Tangible book value per share increased $0.48 to $38.74 per share, representing an annualized 5% growth rate from the prior quarter.

Speaker 1

On balance sheet and contingent liquidity also remains strong. Average deposits have grown 710 $300,000 from a year ago at June 30, 2023. Insured deposits totaled 73% of our total deposits remaining stable at 71% from a year ago. During the Q2, we increased our capacity to borrow from the Federal Reserve discount window by $1,370,000,000 Available liquidity from the Federal Home Loan Bank, Federal Reserve discount window, cash and unencumbered securities now total over $4,000,000,000 at June 30. Net charge offs declined $19,100,000 from the Q1 to a more normalized $2,300,000 in the 2nd quarter.

Speaker 1

We continue to build reserves given market and economic uncertainty. The allowance for credit losses increased to $106,300,000 at June 30, representing coverage of total held for investment loans of 1.33%, increasing 8 basis points from the prior quarter. Our earnings release and investor deck disclosed the ACL attributed to our performing office loan portfolio. The ACL coverage to performing office loans increased to 4.05 percent at June 30, increasing from 3.67% at March 31 and 1.91% at December 31. Office loans that are rated substandard have an ACL nearing 13%, reflecting continued evaluation of new information we have received through appraisals on office properties through June 30.

Speaker 1

Operating pre provision net revenue declined to $34,400,000 from $38,300,000 in the linked period. The driver of the decline was average interest bearing cash balances, which were $387,000,000 lower in the second quarter from the Q1. Early in January 2024, we borrowed $500,000,000 from the Federal Reserve Bank term funding program due to a favorable rate structure. These borrowings were repaid by the end of the Q1, the principal driver impacting the decline in average cash during the Q2. Net interest income before provision totaled $71,400,000 in the 2nd quarter, decreasing from $74,700,000 in the 1st quarter.

Speaker 1

NIM in the 2nd quarter was 2.40 percent, declining 3 basis points from the 1st quarter. Driving the decline was replacing bank term funding program borrowings with Federal Home Loan Bank borrowings at a higher market rate. Operating non interest expense adjusted to exclude goodwill impairment totaled $42,300,000 increasing from $40,000,000 in the previous quarter. Of the $2,300,000 increase, dollars 803,000 was due to higher marketing expense related to our digital banking channel. Other expenses make up the remainder of the increase and represent an increase in other real estate taxes.

Speaker 1

During the quarter, we had relatively flat loan growth with period end loans growing $19,000,000 In our quarterly investor deck released along with our earnings, we updated our view for the remainder of 2024 performance. We provided the components of pre provision net revenue and the effective tax rate. Our forecast for NIM for the full year is slightly lower from last quarter due to the first half actual, but we see opportunities for expansion in the second half of the year due to repricing cash flows off of the investment portfolio and opportunities to improve the funding mix. On a positive side, we expect total operating non interest expense for the calendar year to be lower. We do not model any changes to interest rates in our forecasting.

Speaker 1

Of the $175,000,000 of funded loan originations in the quarter, we had a weighted average rate of 7.99%. This compares to $112,500,000 of funded loan originations at a weighted average rate of 7.56% in the Q1. Jan?

Speaker 3

Thank you, Eric. I'm happy to report a reversion to a more normalized charge off level this quarter with net charge offs totaling $2,300,000 compared to $21,400,000 11 point $9,000,000 in the Q1 of 2024 and the Q4 of 2023, respectively. As a result of lower charge offs, our provision for credit losses was lower as well. We continue to build our reserves as a precautionary measure based on the uncertainty with respect to future market conditions, appraisal valuations and the economic climate. The methodology for determining the ACL relating to office loans has been designed to incorporate new information as it becomes available.

Speaker 3

We remain focused on comprehensively considering risks each quarter as we assess ACL adequacy. Performance of our office loan portfolio has not yet been a driver for charge offs, though valuation risk was the driver of 1st quarter loss. We've been continuing to assess strategies to qualitatively assess risk associated with valuation risk. During the quarter, we made refinements to our qualitative methodology to address perceived risks associated with historical and continued expectation of negative net absorption of office in our footprint. Management continues to evaluate other data to incorporate and capture valuation risk.

Speaker 3

With information available to us at June 30, we believe the ACL is appropriate. At the end of the Q2, total classified and criticized loans increased $89,100,000 to $716,200,000 which included an increase in classified loans of $46,500,000 dollars to $408,300,000 We note in our disclosure on Page 20 of our earnings presentation that 91% of classified and criticized loans are performing. 3 projects drove the increases in criticized loans, 2 of which are assisted living properties. We've seen weakness in this the assisted living segment of the market attributed to enhanced in home coverage from federal programs, reducing the prevalence of individuals needing assisted living facilities as well as increased human capital costs, together reducing project revenues and profitability. These loans are current as of June 30.

Speaker 3

These projects originally expected stabilization with permanent financing through HUD. Stabilization is taking longer than expected, and therefore, our internal risk ratings reflect the heightened risks associated with these projects. A hotel loan, which migrated into special mention status, is also experiencing slower than anticipated stabilization due to the impact of COVID and the resulting delay in the stabilization timeline. While operations are improving and the loan remains current and performing according to terms, the project has yet to reach stabilization. Nonperforming loans increased to $98,200,000 at June 30 from $91,500,000 at March 31, largely driven by the $5,000,000 loan now reported as held for sale.

Speaker 3

NPAs were $98,900,000 which was 88 basis points to total assets, an increase of 8 basis points from the prior quarter. Loans 30 to 89 days past due were $8,400,000 at June 30, declining from $31,100,000 at March 31. As Eric mentioned, we continue to see benefit from additional data on valuation from appraisals on office collateral. While volatility in discount rates and cap rates continues to be evidenced in appraisals, valuation outside the central business district have generally seen smaller negative valuation adjustments recently. As a reminder, for the remainder of 2024, there are no other Central Business District office loans maturing, which would result in an updated appraisal.

Speaker 3

It's important to note that we believe Central Business District office is not indicative of our total office portfolio, and our office portfolio is not indicative of our income producing CRE portfolio. Our office disclosure was enhanced in the last quarter and continues to be in our earnings debt. We continue to assess all CRE office loans with maturities over the course of the next 18 months and taking action where appropriate as part of our efforts to mitigate maturity risks. Such mitigation action may include cash flow sweeps, pay down requirements and return for extensions, enhanced guarantor support, payment reserves and additional collateral. We are creating solutions for our clients as well.

Speaker 3

We've designed a bespoke evaluation process with our office portfolio maturities and our goal is to have a mutually acceptable solution for our client as well as an improved credit posture for the bank. Our solutions to date have included our borrowers keeping control of their properties. We have worked with our borrowers whenever possible to collaboratively sell assets and pay off associated debt, provide paydowns and interest only periods bridging rent commencement on new leases provide extensions on existing subperforming existing performing debt and reposition property to residential use. Each resolution is unique to the asset under evaluation. With that, I'll hand it back to Susan.

Speaker 2

Thanks, Dan. Throughout the past year, our team has consistently demonstrated resilience, client dedication and unwavering perseverance. With over 25 years rates. Our robust capital position provides substantial loss of yields and capacity and enables us to remain agile and continue serving our customers and communities well into the future. Our growth strategies aim to enhance pre provision net revenue, thereby supporting returns on assets and equity.

Speaker 2

This approach allows us to reinvest in innovative products and services for our customers and communities, while also delivering strong returns for our shareholders. In closing, I would like to extend a heartfelt thank you to our employees whose hard work every day makes Eagle a success. We also deeply value the strong partnerships we have forged with our current customers and look forward to building relationships with our future customers. With that, we will now open things up for questions.

Operator

And thank you. And our first question comes from Catherine Mealor from KBW. Your line is now open.

Speaker 4

Thanks. Good morning.

Speaker 3

Good morning, Catherine.

Speaker 4

I want to start with credit. It was great to see no additional movement in the office book into classifieds. And thank you for the commentary on the other 3 loans that did move, but nice to see some stabilization in office. I wanted to ask, as I look at the slide that shows, I think it's the 254,000,000 dollars in maturities coming in the back half of the year. Jane, do you have just roughly how much of that is already on classified or criticized?

Speaker 4

And maybe and so some of that risk already kind of in those numbers? Or is there a risk that we could see more inflection or more downgrades as those loans mature?

Speaker 3

There are some of those loans, maybe 60% that are already criticized or classified. We have taken a hard look at all of our maturities that are coming through. A significant amount of that are short term extensions that we made when we initially put a modification in place for that borrower. For example, the large loss that we took in the Q1 on that Central Business District property was extended for a year. So it will be looked at again at the end of this year.

Speaker 3

We also have a loan that we placed in nonperforming status in the Q4 of last year, that's an office property that we took a write down on. Those particular properties and really all of our nonperforming real estate book have current appraisals. They would be within less than a year. So we feel we've already absorbed the loss that would come from that area. It's always possible that there could be further deterioration or some kind of valuation risk associated with the appraisal on those properties.

Speaker 3

But I'm hopeful that based on the consistency I'm starting to see in appraisals, still some volatility. A lot of it is down to the individual property, but the discount rates seem to be coming a little bit closer together. And while there's still volatility in cap rates, the discount rate seems to be what's really been moving valuations in the last 3 or 4 months. So I'm cautiously optimistic that you're not going to be seeing the kind of incident that we had earlier in the year maturity related.

Speaker 1

Catherine, this is Eric. I would add Catherine. I just want to add one note to what Jan mentioned. On those loans that we've previously had a charge off on, they're individually evaluated in our allowance for credit losses. And we are we evaluate the specific reserve on those quarterly and we have been setting aside some funds for those individually evaluated loans in the event that there could be a potential further degradation of value when it comes up for renewal.

Speaker 4

Great.

Speaker 1

This is a precaution.

Speaker 4

Yes, that's great. Okay. Good to know. And then I think last quarter you said that you thought the ACL would end somewhere around 135, 140 by the end of the year, which I think you're about there now and then charge offs would be kind of $20,000,000 to $40,000,000 for the remainder of the year. Is that any update to your guide on those two items?

Speaker 3

I think we are pretty close to where we would want to be on the reserve, but so much of that is the reserve level is determined by external data sources that it's tough to say for certain whether we will or won't have further increases looking at unemployment, GDP, the CRE index, all of those kind of move independently of Eagle Bank. So I would say that all things being equal, we're pretty close to where we would need to be.

Speaker 4

Okay, great. And then the line effect into charge offs?

Speaker 3

Charge offs, I'm feeling cautiously optimistic about. I think the biggest driver that we've seen on charge offs have not been performance related issues. They've been appraisal valuation related issues. That does seem to be tempering a bit. I do think there are a few more market based transactions as opposed to liquidation transactions, which are showing remarkably disparate valuations in terms of where they are.

Speaker 3

So the more that we see of market trades, although they are below what they were in 2022, 2021. Right now, I'm not seeing any enormous shift in that. I don't think we're going to see the same level of 55% drop in a year in the value of a property that we've already absorbed a 55% drop on. So I think we'll be in have much less valuation risk going forward.

Operator

And our next question comes from Christopher Marinac from Janney Montgomery Scott LLC. Your line is now open.

Speaker 5

Thanks. Good morning. Jan, can you continue on, I guess, on the appraisal process? What is the minimum that you have to do, I guess, by regulation? And then then what's the process that you've had in place for a long time?

Speaker 5

And what do you do with the appraisals that you've had in this last quarter? Just kind of want to understand kind of the impact we've seen already.

Speaker 3

Sure. Our policy is a little more stringent than what, Phyria would allow. We need to have an appraisal within 1 year for any of the loans that you're seeing that are nonperforming. And so we would update that appraisal on an annual basis. The updates of those appraisal that have been coming in recently, particularly in suburban markets, have not been as severe with respect to discount rates and cap rates as what we had seen on Central Business District earlier in the year and last year.

Speaker 3

So I have some level of cautious optimism. I don't think the recent suggestion that hopefully is realizable that interest rates are going to drop has been baked into that yet. So that could be an additional stabilizing factor. Just don't see the same level of fall off that we were seeing. We recently had a 3 mid-thirty $1,000,000 range project in the Virginia suburbs reappraised, and its valuation held up pretty well, all things considered.

Speaker 3

There certainly was no indication of an impairment with the loan. So that was encouraging.

Speaker 5

Great. And if you think about the differences between the suburban and the CBD, I mean, that is still kind of impacting you in a good way, right, because you're not all Central Business District and you've got a fair amount of that exposure in the suburban markets. And I guess just one follow-up related to that is it felt like maybe 6 months ago there was a lack of appraisals, but that's not the issue today. You really have a lot more live examples to lean on. That's right.

Speaker 5

I think,

Speaker 3

live live examples. We are getting better data collection. I think it's become a shared topic amongst banks as to where appraisals are coming in and what they're looking like. So through some of the groups that the bank belongs to, we're also getting the benefit of input from others. I think the rate cuts, if they happen, will also be a good force on the valuations.

Speaker 3

I couldn't help but notice REITs going up 10% in a 10 day period based on the theory that we were getting those drops in interest rates starting in September.

Speaker 5

Great. And just last one for me, Jan, is what's the capacity of borrowers to kind of make incremental paydowns or for them to put up more collateral support? Are you seeing further evidence of that?

Speaker 3

I think that everyone is different. And so the credit accommodation that we might ask for in return for an extension has got to be tailored to every situation being different. But in the most recent one that we're looking at, we got a pay down in return for an extension and that is more than adequate to have the loan carry itself. So I think each situation is different. I do believe that there's some more optimism now on the part of property owners and more willingness to put in what it would take to get them through the next year to 18 months and hopefully to a new place in the market.

Speaker 5

Great. Thanks for all the background. It's very helpful.

Operator

And thank you. And I'm showing no further questions. I would now like to turn the call back over to Susan Ria, President and CEO for closing remarks.

Speaker 2

Thank you, everyone. We appreciate your questions and you taking the time to join us on the call today. We look forward to speaking with you again next quarter. Have a great day.

Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.

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Earnings Conference Call
Eagle Bancorp Q2 2024
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