Eagle Bancorp, Inc.

Good day. Thank you for standing by. Welcome to the Eagle Bank Corp. Incorporated's first quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To remove yourself from the queue, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Charles Levingston, Chief Financial Officer. Please go ahead, sir.

Thank you, Norma. 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. We cannot make any promises about future performance, and it is our policy not to establish with the markets any formal guidance with respect to our earnings. None of the forward-looking statements made during this call should be interpreted as our providing formal guidance. Our Form 10-K for the 2022 fiscal year and current reports on Form 8-K identify certain risk factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made this morning. 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. This morning, Susan Reel, the president and CEO of Eagle Bancorp, will start us off with a high-level overview. Then Jan Williams, our chief credit officer, will discuss her thoughts on the local economy, loans, reserves, and credit quality matters. Then I'll return to discuss our financials in more detail. At the end, all three of us will be available to take questions. I would now like to turn it over to our president and CEO, Susan Reel.

Thank you, Charles, and good morning, everyone. While we are disappointed with the first quarter operating results, there are several positive items to point out. Capital, asset quality, loan growth, and expense control. First, our capital ratios continue to be strong and are well in excess of regulatory requirements. Our tangible common equity is $1.1 billion, which is 10.36% of tangible assets. This level of capital is relatively high when compared to our peers and gives us room to continue to lend. This foundation has also enabled us to continue to support our shareholders by paying a quarterly dividend and purchasing common stock. Based on last night's closing price, our current annualized dividend yield is 5.71%. And during the quarter, we repurchased 400,000 shares of common stock. On a combined basis, we returned capital of $32.2 million to our shareholders in the first quarter of the year. Second, our asset quality metrics remained strong, even against the backdrop of a challenging market. Non-performing assets as a percent of assets was eight basis points. unchanged from the prior quarter, and net charge-offs were under $1 million. Our long-standing commitment to strong underwriting and risk management has served us well during these times of economic turmoil. Additionally, we remain focused on disciplined loan growth. This quarter, we increased loans by $102 million. This was our sixth consecutive quarterly increase. thanks to the continued efforts of our CRE and CNI teams. As our clients know, we have the local expertise and we are more committed to the business community in the Washington DC market than larger banks based outside our area. We also continue to focus on controlling expenses. Our annualized non-interest expense as a percent of average assets was 1.44% this past quarter. Measured against our peers, this operating efficiency is another way that we provide value to our shareholders. For our customers, we provide value by meeting their liquidity and credit needs. At quarter end, we had an aggregate borrowing capacity of $1.7 billion. This gives us financial flexibility to provide the support and services our customers expect. Jaws will discuss our borrowing capacity in more detail later on. With that, I'll hand it over to Jan for a discussion of the market and credit quality.

Thank you, Susan, and good morning, everyone. The Washington, D.C. market area remains a source of strength. The unemployment rate in the Washington metropolitan statistical area fell to 3% in February, which gives us some favorable separation from the nationwide figure of 3.5% in March. Underlying this favorable unemployment figure is continued spending from the government, government contractors, local residents, and tourists. Even with good local economic data and trends, we continue to maintain our conservative underwriting standards, which are reflected in our credit quality metrics. NPAs, as Susan mentioned, were eight basis points on assets. This is unchanged from the prior quarter and remains the lowest ratio of NPAs we've had since 2005. Total NPAs were $8.7 million, up modestly by $288,000 over the prior quarter. Net charge-offs were $975,000, most of which was from one CNI relationship. Our coverage ratio improved to 11.6 times non-performing loans. And loans 30 to 89 days past due were 15.7 million, up from 2.2 million at the end of the prior quarter. The increase is entirely from one commercial credit for 14.1 million, which was brought current immediately following quarter end. For the quarter, we took an ACL provision of 6.2 million. and our ACL to total loans at quarter end was 1.01%, up from 0.97% last quarter. The provision this quarter was primarily driven by qualitative changes, which included increased risk in the Q&E portion of the credit model associated with an allowance for commercial real estate office properties. We have seen general weakness in the overall office and office construction markets. Suboptimal return to work participation continues to limit increases in occupancy while inflation erodes owner net operating income and limits owner pricing power on rent. There was some good news late last week regarding local return to work as the Biden administration instructed federal agencies to return substantially more employees to the office and increase meaningful in-person work. To monitor our credits, we continue to be proactive in reaching out to commercial clients to better understand the headwinds facing their income-producing properties. Aside from these qualitative considerations, the ACL provision for the quarter was also affected by higher period-end loans. Overall, in terms of credit, we remain cautious and will continue to apply our strong underwriting skills. Having said that, we see opportunities to continue to add high quality commercial loans to the portfolio and our pipeline. And in addition to our pipeline, unfunded commitments for $2.5 billion at quarter end. Our focus remains on adding local commercial income-producing properties and owner-occupied properties, and also growing our quality CNI portfolio. With that, I'd like to turn it over to Charles Levingston, our Chief Financial Officer.

Thanks, Jan. The headlines for the industry in the first quarter were about funding and funding costs. As the Federal Reserve continued to increase rates to fight inflation, we increased rates paid on deposits. and to the extent deposits decreased, we increased borrowings. To get more granular on deposits, the reduction in deposits occurred throughout the quarter, with approximately 70% occurring prior to the industry turmoil that started March 9th. Overall, we did not see clients closing accounts. In fact, we saw a normal amount of deposit accounts open during the quarter, but certain accounts moved from non-interest bearing to interest bearing late in the quarter. To date, we have seen deposit balances level off three weeks into the quarter. To replace the funding from deposits, we initially drew on the FHLB advances, bringing total advances up to $1.3 billion. When the BTFP program opened up, we considered the collateral terms and interest rate offered to be more attractive than advances from the FHLB. We then accessed an $800 million advance with a one-year term at a rate of 4.38%. This brought total borrowing up to $2.1 billion. I would also like to note that since quarter end, we have not accessed additional borrowings from either the FHLB or the BTFP. If we were to access additional funding, we have significant capacity available. At quarter end, our borrowing capacity was $1.7 billion. This included additional aggregate capacity of $689 million with the FHLB and BTFP, plus another $1 billion of unencumbered securities available for pledging. Additionally, the securities portfolio continues to provide cash flow. In the first quarter, the cash flow was $55.2 million. The increase in interest expense from the borrowings was the primary reason for the decline in net interest margin, as these borrowings replaced lower-cost deposits. And as mentioned earlier, certain accounts moved from non-interest-bearing to interest-bearing, which exacerbated the difference. Quarter over quarter, the net interest margin moved from 3.14% to 2.77%, a decline of 37 basis points. Another factor negatively impacting the margin was the lag in interest income from loans. Loans were up $102 million at quarter end, but the full interest benefit of higher rates on new loans will not be felt until next quarter. And variable rate loans will reset to higher rates but these loans take time to reprice. Looking at overhead, non-interest expense for the quarter was up $1.7 million, but this included about $1 million from a one-time reversal of legal accounts receivable. Additionally, while not impacting this quarter's expenses, we closed our Alexandria, Virginia branch in March, bringing the number of banking locations down to 15. The annual rental cost savings associated with this closing is just under $200,000. Continuing with expenses, we remain committed to strong and proactive management of costs. While our efficiency ratio climbed to 51.6% this quarter, it is more a reflection of a lower net interest margin than an increase in non-interest expense. A better indicator of our quarter-over-quarter expense management is non-interest expense as a percentage of average assets. For the first quarter, this was 1.44%. up from 1.37% the prior quarter. This ratio compares favorably to our peers, as Susan mentioned. Lastly, capital remains a core strength, which enables us to pay a healthy dividend and repurchase shares. To address another industry headline, the unrealized losses on the HTM portfolio are modest relative to our capital levels, which would still be strong and compare well to our peers if those unrealized losses were reflected in capital. With that, I'll hand it back to Susan for a short wrap-up. Susan?

Thanks, Charles. This year will be Eagle Bank's 25th anniversary. It is through the hard work and dedication of hundreds of team members that we have built our strong Relationships First culture. It is this culture that enables us to provide superior service to our clients and to maintain our leadership position in the community. This culture also includes our commitment to respect, diversity, and inclusion. Over the past 25 years, the foundation we have built with strong capital, strong asset quality metrics, and strong cost discipline has served us well and prepared us for the challenges we face today. With that, we will now open it up for questions.

Thank you. As a reminder, to ask a question, you'll need to press star 11 on your telephone. To withdraw your question, please press star 11 again. Please wait for your name to be announced. Please stand by while we compile the Q&A roster. One moment for our first question. Our first question comes from the line of Katherine Mueller from KBW. Your line is now open.

Thanks. Good morning.

Good morning, Katherine.

Katherine. I wanted to start on just the deposit balances that we saw this quarter. And maybe if you could just give us a flavor for some of the granularity of some of that $1.2 billion that came off the balance sheet. And then remind us, just kind of in the granularity of your deposit book, you know, just maybe size of kind of top 10 depositors, you know, a percentage of the funding base that is, um, just to give us a sense of, to, to the granularity and, um, to your book. That'd be helpful. Thank you.

Sure. Sure thing, Catherine. Yeah. So, uh, you know, we did have, um, some of those deposits that came off, uh, were, uh, brokered in nature. Um, you know, in, in some instances we, um, We have these relationships that are custodial relationships where it's essentially excess cash in brokerage accounts that are then consolidated and deposited into our bank. In some situations, those cash balances in those brokerage accounts were going to investments. They were going out of the banking system, so those brokerage deposits were not able to be deposited with us. So that was in some cases some of those balances that left. With respect to, again, some of the larger depositors and some of our deposit balances, We did see some movement there, but by and large, again, it was a similar story where you had those balances moving out of the banking system into money market mutual funds or U.S. treasuries. That's generally what we saw. On the flip side, we did bring on some additional time deposits, On average, we increased time deposits by about $410 million, $411 million. You know, that provides a little bit more stability to the deposit base moving forward, obviously at a little bit of a higher cost, but that was some of the pluses on that as well.

Okay, that's helpful. And then just thinking about the margin going into next quarter, where were deposit costs towards the end of the quarter?

Sure. So, right, on average, right, we had 3.63% rate on our total interest-bearing deposits. You know, our highest money market yield right now is sitting at about 3.99%. That's the prevailing rate. Obviously, the Fed is looking at another rate increase. The probabilities are suggesting another 25 basis points here. on the 3rd of May, so we'll react accordingly there. But I want to be protective of the deposit base that we have and continue to provide a fair rate to our customers.

I think also, Catherine, what Tal said earlier is we obviously saw deposit outflows, but we've seen a leveling off of that. And our top depositors, we have not lost our deposit customers. We've seen some money go out, but we have not lost our customers. We've seen some growth in the deposit base, so we've added some customers also. So just important to know that we do see a leveling off. It's still early in the quarter, so it's hard to say whether that will continue. We're watching it closely. Great.

And have you seen more of a use of the ICS program yet? as a way to kind of, okay, good. And what is that? Do you have an amount of your deposit base that's in that program?

Yeah, I don't know that we've published that number, right? I can tell you that it was about a couple hundred million dollars that migrated this quarter, you know, from into the ITS program. But yeah, there were certainly conversations like all banks had following the turmoil in early March. And in most cases, folks were able to get comfortable with our balance sheet and our strong capital. In some instances, folks wanted to move their money into ICS, and so we did that. We have quite a bit of capacity there with the ICS program. I think it's upwards of close to $3 billion-plus or so, so yeah, that ICS program has been popular. So yeah, obviously those with a fiduciary responsibility are more interested in those programs than others, right? With our commercial customer base, some folks felt the need, they needed to protect those deposits with programs like ICS.

And one more, if I may, just on moving to credit. Jan, can you give us an update on, was there any movement in classified loans this quarter and any, and just kind of an update on how, I mean, you gave a little bit of update on the office book in your prepared remarks, but any kind of commentary that you can provide to us on just some specific credits if you're seeing any degradation in the portfolio? Thank you.

Sure, Kat. We had a decline of about $700,000 in classified loans. The watch list itself was reduced by 86 million. One of the office deals that we have had on our watch list, we were paid off on, and so we had that reduction. We have been very proactive in going out and meeting with our income-producing property customers. and having a special task force to address any issues that might come up there. It's really a case-by-case situation when you're looking at these properties. Depends on obviously Trophy and Class A properties are performing at a much stronger level than BC properties are. We're looking at when leases are going to roll over and getting ahead of that. What the current tenancies are, obviously multi-tenanted, the more stratified the better. The loan maturity date. When we're looking at loans that don't mature for another two and a half years, it's hard to say where rates will be at that point in time. So even though we are seeing a very soft market, definitely tenants driving the ball here. We haven't seen any past dues in our office portfolio. It continues to perform very well. But anything that's coming up for what would be a repricing, I think we're taking a very hard dive on and understanding what's going on with it.

Great. Thank you. I'll pop out of the queue.

Thank you. One moment for our next question. Our next question comes from the line of Casey Whitman with Piper Sandler. Your line is now open.

Hey, good morning.

Good morning, Casey.

So appreciate the color on the monthly deposit trends. Just around your comments with deposits being relatively stable in April, are you still seeing movement out of non-sparing, but just sort of going into interest-bearing versus out of deposits? Is that what you're sort of seeing this month, or did I mishear that? And then I was also wondering if you might have an idea of where sort of the percentage of non-interest-bearing might land this cycle, or is it sort of too early to tell?

Yeah, I think on both those fronts, it's a little premature for me to make a call. I can say, you know, again, things are leveling off. I bet You know, there were accounts that were closed in the fourth quarter, but there were also quite a few accounts that were opened. You know, it appeared to be fairly normal in that respect. Obviously, some balances moved. Again, it's hard for... for some of those folks who are looking at the offerings out there in the marketplace to resist with idle cash what they could be earning, again, outside the banking system, again, in these money market mutual funds and U.S. Treasuries. So I think that's where you're seeing some of the movement. But in general, I think a more stable interest rate environment is helpful for us, Again, we're not seeing the 75 basis point moves that we saw last year. We're down to 25 basis point moves with expectations of the Fed blinking later this year. We'll see what comes with that. But a more stable interest rate environment, I think, is helpful as it relates to any of that movement.

Got it. And just looking at your uninsured bucket, would you say a lot of those

relationships or you also have i guess loans with those with those guys where the relationship is actually pretty sticky or you might not have a number around that but would that be kind of an accurate statement yeah you know i i think you know i look at our ddas as our you know operating accounts if you will right if that's any indicator again we've been able to maintain you know roughly 30 plus percent you know this quarter it was 37.3 percent last quarter was a little heavier And those have been pretty consistent throughout the life of the bank. I'm relatively confident that we'll be able to maintain that kind of a ratio and maintain those customers and those deposits.

Okay. I'll move on to Jan. Just quickly back to office. Can you maybe just put some updated numbers around the exposure there that you give in the past, and if you had it, maybe the average loan size in that book or LPBs or just any sort of granularity you have there for us?

Okay, I will. In terms of the income-producing office, I'm going to leave owner-occupied out of this. We've got about $200 million in D.C., about $200 million in Montgomery County, about $200 million in Fairfax County, 50 each in Arlington and Alexandria, around 50 in Prince George's, and the balance really throughout the other Maryland and Virginia areas. equally weighted between Montgomery, Fairfax, DC, and everybody else. The actual loan-to-value is 58%. We're tracking that. That's based on the most recent appraisal. Now, some of these appraisals are four years old, so they haven't had the ride up of the last couple years and they may not be as susceptible to the ride down in terms of value of the property but we're looking at each property individually because there are so many different factors that really influence the value of a property right now radically different if it's leased as opposed to it's got a vacancy of 50% or 60%. If it's a medical office building, we haven't seen any issues there. Just each property we evaluate individually. And we do, as a matter of course, an evaluation on an annual basis. But this targeted task force is going deeper into the weeds on individual properties. And so far, knock on wood, we've had very good results reaching agreements with our borrowers in terms of sweeping cash or trying to move forward and do an extension with a reserve or some other credit enhancement involved. downtown DC still the place you're most worried about or with government workers potentially going back in a little bit a little bit less pressure I think the central business district itself is still really a relatively dead zone except for trophy buildings and class a which are doing fine If the federal government goes back to work, and we're hoping that that does happen, it'll be probably over a period of time, probably over the next 12 to 18 months, I would guess. Maybe even longer than that, because there are separate unions with each one of the agencies that have to go through the negotiating process. But that would certainly make the downtown area much more vital, and it would be a godsend for retail, which fortunately we don't have much of in our portfolio.

Yep. Okay, last question from me. Just thinking about your capital here, you were still active with the buyback. It looked like early in the quarter, but maybe before the events of March. So how are you weighing conserving capital against the sort of attractive math of buybacks here?

Yeah, so I think, you know, we're evaluating that on a quarter-to-quarter basis. We're obviously grateful that we've been able to return that value to the shareholders over the last quarter. But that's, you know, that's something that we'll take a look at and the board will make a decision as to how to proceed.

Understood. Thank you. Thank you.

Thank you. One moment for our next question. The next question comes from the line of Christopher Marinac with Janie Montgomery Scott. Your line is now open.

Hey, thanks. Good morning. I just want to go back to the point you just made about the loan-to-value and the appraisals. If you were stress testing your portfolio or if the regulators are having you do that, which I presume they are, do you need to get new appraisals on those? Is there a process where those will get updated in the next few quarters, and does that have any impact on reserves going forward?

It would not be a portfolio-wide process. new appraisal edict, what would happen is if there were any of the properties that looked like they were potential problems, our internal policy would have us ordering new appraisals on them. I think, Crystal, one of the problems is appraisers today, because we're in such a shifting market, I've seen Different people with an appraisal at $136 million, an as-is value of $90 million, a liquidation value of $70 million, a broker's opinion of value of $24 million. I mean, it's hard, really hard to get a handle on, for appraisers to get a handle on new because there just haven't been enough trades.

So does that beg the question that you need to have more collateral against these loans? Or I guess at the end of the day, how do we get comfort that you have sufficient?

Well, I think what we've seen typically on the few trades that have happened is that anywhere from a 20 to a 40 percent decline in value. If we had a property that was, which we don't, at 85 percent value at origination, I would be very worried about it. But if I had an office property that was tenanted that had a maturity date four years from now, I wouldn't really think I needed to get a new appraisal on it at this point because it's not going to reprice for a while. Remember, these are at fixed rates, and I would anticipate a year from now rates are going to be a bit lower than they are today. That's the expectation. I think a lot of investors feel that way because rather than going into long-term fixed-rate money right now, if they could locate it. They don't even want to go to agencies now because they're counting on the Fed doing some rate reductions in the next year, so they're holding off on that.

Got it. That's very helpful, Jan. Thank you very much. Charles, just a quick question for you on the deposit insurance and uninsured portions. Are those figures net of some of the ICS and IntraFi work that you've been doing, or is that a gross number that we saw yesterday?

Yeah, so that includes, that estimate includes or excludes, I should say, the ICS balances, right? So it's already baked in to that number.

Okay. So then the percentage we have has that included. So if you do additional work with those programs, that can lower it further in the future.

That's absolutely right. And in fact, some of that migration did reflect in a lower metric between quarters.

Okay. Do you have any plans about kind of bringing those deposits back like immediately or would you wait for rates to kind of change and perhaps do campaigns later? I'm just sort of curious on how we get that 14% back over time.

The 14% of deposits that float out of the bank

Right.

Yeah, like, you know, they're not currently with the bank, right? So, like, if – I just want to make sure I understand the question. That did not relate to ICS, right? Those ICS balances, when they move to ICS, they're still on our balance sheet as reciprocal in nature? Is that – No, I understand that.

No, my – yeah, the 14% was more of a big-picture question. It was like in general – I presume you want to get those back over time, and so I'm curious kind of when it happens.

Certainly, right. If I could wave a wand, I would bring them back today, right? But, yeah, that's the challenge of the market that we're operating in right now. Again, as I mentioned, I think a lot of that has to do with other earning opportunities out there in the marketplace. Again, I've cited money market mutual funds and treasuries as a culprit and a main competitor. You know, that's where I think having a lot more rate stability is going to be helpful for us moving forward. And, again, I'm grateful that some of these FOMC moves are, you know, now 25 basis points and not 75 every few weeks. I think that's, again, that's going to be helpful for us encouraging those deposits back our way going forward.

Great. Thanks for all the information this morning.

Thanks, Chris.

Thank you for your questions. I would now like to hand the conference back over to Susan Reel, President and Chief Executive Officer, for closing remarks.

We appreciate your questions and you taking the time to join us on the call today, and we very much look forward to speaking with you again next quarter. Thank you.

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.