Eagle Bancorp, Inc.

Good day and thank you for standing by. Welcome to the Eagle Bancorp third 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 withdraw your question, please press star 1 1 again. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker today, Charles Levingston, Chief Financial Officer of Eagle Bank. Please go ahead.

Thank you, Liz. Good morning. This is Charles Levingston, Chief Financial Officer of Eagle Bank. 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 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 10-Q for the June 30, 2023, 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 Bank Corp. 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. I would now like to turn it over to our president and CEO, Susan Reel.

Thank you, Charles. Good morning, everyone. Before we start, I would like to welcome Eric Newell as a new member of our senior management team and as CFO of Eagle Bancorp. Adding Eric to our finance team gives us more talent and a deeper bench and enables us to accomplish our long-term goals to continue to serve and support our customers and build value for our shareholders. As Eric joined us late in the quarter, we will follow our normal format today with Jan discussing her thoughts on the local economy, loans, reserves, and credit quality matters. And then Charles returns to discuss our financials in more detail. At the end, the three of us and Eric will be available to take questions. I am pleased that our third quarter performance continued to build on the progress we are making in an uncertain operating environment. During the third quarter, we saw a stabilization of both earnings and margins and an improvement in the funding mix with deposit inflows and pay downs of short-term debt. On the deposit front, we are working diligently to build capabilities to drive growth in our core deposit base. We have a multi-pronged approach to build out a scalable and sustainable deposit growth strategy. I will highlight three areas of focus for the Eagle Bank team. First, enhancing our treasury management program and product suite will assist us in building and maintaining CNI relationships. Next, we are working to enhance our digital banking platform, allowing us to leverage our in-footprint brand and increase our market share of deposits in the DMV region, as well as develop opportunities to augment deposit growth outside of our footprint. Finally, we are looking at ways to better leverage our existing branch network to drive customer acquisition and exploring how to increase Eagle Bank's physical presence in lower-cost geographies, continuous to the Washington, D.C. metro market. With these initiatives, I am excited about the future of Eagle Bank's ability to grow and improve the deposit mix. This will contribute to the progress we have made in repositioning our balance sheet to meet the challenges of today's high-rate environment. In addition to the larger initiatives that I have highlighted, there are many other smaller initiatives we are working on as a team. On the other side of the balance sheet, we are also keeping our focus on asset quality. We have a proven history of superior asset quality and conservative underwriting that has worked well for us in times of market stress. We have pulled together special expert teams to assess our office and multifamily exposures. We are confident that the approach our teams are taking will put Eagle Bank and our borrowers in the best position in light of a difficult operating and interest rate environment. Before turning it over to Jan, I want to add that I am excited about the hiring of Karen Buck, our new Chief Administrative Officer who will be instrumental in providing leadership and guidance through the execution of these strategies. With that, I'll hand it over to Jan.

Thank you, Susan, and good morning, everyone. The Washington, D.C. market area continues to be a source of economic strength, even with the local government workers not yet returning to the office in great numbers. The unemployment rate in the Washington metropolitan statistical area rose to 2.9% in August, up from 2.7% in May. This mirrors the change in the nationwide figure, which grew from 3.8% in September, up from 3.6% in June. This strength in the Washington area market can be seen in our asset quality metrics. Non-performing assets were 72 million, which was 65 basis points of total assets. The increase of 41.4 million was primarily from one multifamily credit for 39.5 million, which we discussed as a past due last quarter. There were three charge-offs for the quarter, totaling 467,000. All three were SBA loans. The total net charge-off for the quarter was 340,000. Loans 30 to 89 days past due were $46.5 million, up from $41 million at the end of the prior quarter. The increase from the prior quarter was primarily from one office property in Northern Virginia and one assisted living facility in Maryland, offset by the migration of the previously mentioned multifamily credit moving to non-performing status. For the third quarter, we had a provision to the ACL of 5.6 million. This was somewhat higher than the provision last quarter, but even with the three charge-offs and higher loan balances, our ACL to loans at quarter end was up five basis points to 1.05%. Provision for unfunded commitments had a reversal. This was primarily from a reduction in unfunded commitments as construction projects were funded and added to our quarter end loan balances. With regards to the higher ACL provision, it was primarily driven by increases in qualitative reserves combined with a smaller increase in the quantitative reserve. The increase in qualitative reserves was driven by increases in early stage past dues and overall perceived weakness in the commercial real estate market. The increase in quantitative reserve was primarily due to loan growth during the quarter, particularly in longer life categories that carry corresponding higher reserves, as well as slowing prepayment speeds in certain loan categories due to higher interest rates, partly offset by modest improvements in the unemployment forecast. Focusing on CRE office loans secured by non-owner-occupied credit, These loans were 950 million, or 12% of the loan portfolio at quarter end, down 26 million from the prior quarter. These office properties are primarily located in the Washington, D.C. market, with 24% in the District of Columbia, 34% in the Maryland suburbs, and 34% in Northern Virginia. and an additional 7.6% located outside of these markets. We did not have any outstanding commercial real estate office construction loans at the end of the third quarter. To monitor our income-producing CRE credits, we continue to be proactive in reaching out to commercial clients well in advance of maturities to better understand the headwinds that their properties could be facing including a significantly higher interest rate environment, and work collaboratively to achieve results beneficial to both the bank and the borrower. Overall, in terms of credit underwriting, we remain cautious and we will continue to exercise selectivity and to apply our customary strong underwriting standards. Having said that, we see opportunities to continue to add high-quality commercial loans to the portfolio and to maintain our portfolio as other loans run off. With that, I'd like to turn it over to Charles.

Thanks, Jan. This was another good quarter in that we were able to improve our funding mix, one of our strategic goals. During the quarter, our efforts to gather deposits organically met with success as deposits increased by $658 million. This increase was led by savings and money market accounts up $339 million and time deposits up $255 million. At the same time, broker deposits declined by $38 million and were down to 29.6% of deposits. With deposits up $658 million, we took the opportunity to reduce our higher cost borrowings by paying down 100% of our FHLB advances. VTFP borrowings, which have a more attractive rate and collateral requirements, remain unchanged. On the balance sheet, our mix of deposits and borrowings at quarter end is now much closer to how it looked at the end of December before the market disruption in March. During the quarter, deposits climbed to $8.4 billion compared to $8.7 billion at the end of 2022. And short-term borrowings were reduced to $1.3 billion compared to $975 million at year-end. One item, though, that continues to change is the move by deposit customers into interest-bearing accounts. For the quarter, average non-interest-bearing deposits were down $310 million, or 12.1%. and interest-bearing deposits were up 742 million, or 12.5%, off a much bigger base. For the quarter, average non-interest-bearing deposits were 25% of deposits, down from 30% the prior quarter. Customers seeking out higher interest-bearing accounts and a rate increase I'll cross most of our product lines at the end of July, shortly after the Fed raised by 25 basis points, combined to increase our cost of funds by 19 basis points to 3.39%. This is a much lower increase than the prior quarter's increase of 58 basis points. As we are talking about cost of funds, I'll continue with commentary on our margin. This quarter, net interest income was down $1.1 million. and the net interest margin was 2.43% down six basis points. Interest income was adversely impacted by a reversal of $1.6 million because of the one multifamily loan in the District of Columbia entering non-performing status in the quarter. This reversal reduced our margin by six basis points and accounts for all the change from the prior quarter. Before moving on to the income statement, We experienced loan growth this quarter with loans up $150 million, but some of that was timing of existing construction loans funding at quarter end. This was the reason for the reversal of the provision on unfunded commitments. Even with the increase in loans, the strong growth in deposits drove our loan-to-deposit ratio down to 95% from 101% the prior quarter. Looking at the bottom line, Net income was $27.4 million for the quarter compared to $28.7 million the prior quarter. This stabilization of earnings is a result of our targeted efforts to improve the balance sheet mix, reduce the rate of expense growth, and maintain our strong asset quality metrics, which are reflected in the provision for credit losses. Additionally, as we mentioned last quarter, there is a lag in Fed rate changes impacting interest income on loans as compared to interest expense on deposits. As the Fed has slowed the pace of rate increases, the benefit from the variable rate loans resetting higher and from new loans at market rates is beginning to reduce the gap versus interest expense changes. Other items impacting quarter-over-quarter earnings were non-interest income which was down primarily because the prior quarter included non-recurring income of $2.8 million from an SBIC fund. And non-interest expense showed improvement, down $345,000 from the prior quarter, primarily due to lower overall expenses offset by higher FDIC fees, which were up $761,000 from the prior quarter on higher assessment fees. In regards to expenses, we have always prided ourselves on being highly efficient, and we aim to continue to operate in that manner. We recognize that we will need to invest in the company over the next several quarters to achieve our strategic goals, but we do not expect a meaningful increase in the run rate of expenses in 2024 due to cost savings we've realized year to date. This past quarter efficiency was 48.8%, which compares well to our proxy peers. Lastly, capital remains a core strength of the company. Our tangible common equity ratio at quarter end was 10.04%, which was higher than all but one of our proxy peers last quarter. And in terms of liquidity, we improved our aggregate borrowing capacity to $2.26 billion, which gives us the financial flexibility to provide the support and services our customers expect. With that, I'll hand it back to Susan for a short wrap-up. Susan?

Thanks, Charles. We are all excited about Eagle Bank's future. We have demonstrated our ability to improve the balance sheet and stabilize both earnings and margin. We also continue to meet our commitment to a relationship first culture, strong conservative underwriting, and peer leading efficiency. And last, but certainly not least, the recent additions to our leadership team gives us added depth and expertise to meet and succeed at meeting today's challenges. In closing, our senior management team would like to thank all of our employees who work hard every day to make EGLE the success it is. With that, we will now open up for questions.

As a reminder, if you'd like to ask a question at this time, please press star 1 1 on your touchtone telephone and wait for your name to be announced. To withdraw your question, please press star 1 1 again. Our first question comes from the line of Katherine Mueller with KBW. Thanks. Good morning. Hey, good morning, Katherine.

I want to start with credit. Jan, I remember last quarter you talked about, I think it was something in the range of like $200 million of office loans that were maturing in the next or maybe it was like 400, but then 200 you were looking at this quarter in some kind of capacity. Can you just give us an update on what that process looked like and any kind of update in your office portfolio today versus last quarter? Thanks.

Sure. We worked through about 120 million in office loans the past quarter with longer-term extensions. These are loans that really we're going to be seeing more extensions on, I think, as there really isn't a market right now for office refinance. So what we're doing is working with each particular building sponsor, guarantors, each one is to a certain extent unique. We are exploring the continued uses of office and also alternative uses. I think we've been pretty successful in moving forward with that. That doesn't mean that we won't have more non-performing loans in the future, but I think based on the underwriting that we did initially, we have a fairly large amount of room to absorb declines in valuations. So I'm not anticipating that we're going to see significant charge-offs in that office sector right now. We're going to continue to work with customers and process extensions as merited and when in the best interest of the bank and the borrower.

Okay, great. That's very helpful. And then it was nice to see stability in the special mention and substandard categories. Can you remind us how much of your substandard loans are office?

I can. In the substandard category, we have 74 million. In the non-performing category, we have 23 million. Special mention, we have $85 million. Watch, we have $55 million.

Okay, great. All right, thank you. And then moving over to the margin, it was great to see the increase in total deposits, but you were still seeing a decline in the non-interest-bearing category. Can you talk about anecdotes or kind of trends of what you're seeing within that shift in your customer base, and as you just, I know it's so hard to forecast, but as you kind of sit here today, what's your gut on where you think those balances or that mix shift will bottom?

Yeah, sure. Obviously, we've had a long history of being able to maintain non-experient deposits around 30%. We're clearly in a very different environment these days with rates where they are, and some of the disintermediation that we've seen over the last 18 months or so has been just that, you know, these folks not wanting to sit on idle cash and have that cash earning for them. You know, my observation is most of that migration, if you just look at average balances quarter over quarter, has moved into term deposits. You know, and that kind of lends itself to this notion of the Fed staying higher for longer, but also people wanting to capture... the yields on those. My sense is that we have a very solid base of non-interest bearing deposits here. I would expect us to maintain around where we are, and at the same time, as Susan mentioned earlier in her remarks, there will be continued efforts to build out treasury management services in order to attract additional operating accounts. and to continue to pour more in as, you know, maybe we see some migrating and looking for some yield there. But, you know, my expectation is we're in a pretty happy place with where those are in terms of the baseline. Okay.

All right. Great. And actually, if I could go back to the OSHA, I forgot one thing I wanted to ask. Was part of the increase in the ACL

associated with your office book and can you remind us what your office uh reserve is today um we did have some portion of the um reserve that was associated with the office portfolio although we have no impairment reserves on the uh office portfolio right now so um i think A portion of the increase was associated with that to the extent that a loan would move from performing to non-performing. Obviously, if it's not impaired, the reserve that was associated with that would go away. I think our feeling about the market in general and our office overlay provides us some buffer there. We have, in terms of Substandard loans, the reserve is about 6% of the substandard loans that's allocable to office. And we have about 3% on the special mention. Watch is about one and a three quarters. And then the past portfolio is 130. Okay.

Really helpful. Thank you, Jim. Appreciate it.

Our next question comes from the line of Casey Whitman with Piper Sandler. Hey, good morning.

Good morning, Casey.

Just sticking with credit, maybe can we address just the two loans that moved past due this quarter? Can we talk about just the size of each of the loans and then any other details you can give us, Jan, around those two in terms of LTVs or any specific reserves you might have on them or any details on those two would be helpful.

Sure. They're both real estate secured. The nursing home assisted living facility is owner-occupied, so that was not part of our CRE portfolio. Based on a current appraisal, it's not an impaired loan, so there would not be an associated impairment reserve that would go with that. There's also on the office side that loan is They're each about $20 million. On the office side, that loan was in the process of having an extension done. It was extended for a year. And based on the appraisal that was done in December of 2022, there is no impairment.

Okay. All right, thank you. Susan, I wanted you to address some of your, I think in your prepared remarks you talked about just potentially expanding outside the DMV. Can you talk about some of the markets that might make sense for you and would that start with building out more of a branch network or just hiring lenders or sort of what's the broader strategy and how long might this take to execute?

Casey, we're still flushing some of that out, but we still will maintain our branch-like strategy, but looking at some contiguous areas on what they may bring as far as opportunities for branch deposit growth and potentially loan production also. So, we will take all of that into consideration as we explore those opportunities, but we are open to that.

Okay. Stay tuned. Back to you, Jan, just one more credit question. Can you address your shared national credit exposure? What kind of syndications do you have?

It's pretty minimal. We only have a couple of loans there. The largest one is part of the Wharf complex, and that's performing well. It's actually done very well this year. It is rated by the national team as special mention, so that's how it shows up on our books. When that rating changes, we will change it on our books as well. But that's been a pretty successful project in the D.C. area. And we also have a piece of a deal that is casino related in New England, and that's doing quite well and is in the PASS portfolio.

Okay. Thank you. That concludes today's question and answer session. I'd like to turn the call back to Susan Riehl for closing remarks. 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.

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