Eagle Bancorp, Inc.

Good day, and thank you for standing by. Welcome to the Eagle Bancorp fourth quarter and year-end 2023 Earnings Commerce 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 will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Eric Newell, Chief Financial Officer of Eagle Bancorp. Please go ahead.

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 the call are forward-looking statements. We cannot make any promises about future performance. Our Form 10-K for the 2022 fiscal year and 10-Q for September 30, 2023, and current reports on Form 8-K, including the accompanying earnings presentation slides, 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 files 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 Riehl.

Thank you, Eric, and good morning, everyone. This last year presented many challenges through which Eagle Bank team persevered. I'm excited about the resiliency of our company in light of those challenges. We quickly reacted to uncertainties that crept into the banking sector in the first quarter through the failures from large banks. We were able to lean into our relationships first culture and focus on and respond to what our customers needed from us in that moment of uncertainty. While we experienced the large deposit outflow in the early part of 2023, I am thrilled that we reported total deposits at December 31 that were higher than the year ago period. I am proud of the Eagle Bank team and the strong and trusted relationships they have with our customers, our communities, and with each other. I am confident that we will be able to leverage those characteristics as we work to achieve our strategic initiatives in 2024. I touched on those initiatives in our third quarter call, but it is worth highlighting we have been and will remain focused on our deposit portfolio. Our goal in 2024 is to have a higher quality deposit portfolio with enhanced diversification. Successfully enhancing our deposit portfolio quality and growing deposits will allow us to reduce wholesale funding and enhance flexibility for pricing in dynamic interest rate environments. During the year, we will work on enhancing our capabilities to leverage our branch network and better instill sales behaviors, building and improving our treasury management capabilities, services, and products, and introducing a digital channel, primarily for deposit gathering efforts in and outside our footprint. We are working to grow our CNI portfolio. relative to total loans. We have evaluated areas of opportunity to grow our team, ensure those teams are compensated on the appropriate incentive plans, and grow and deepen relationships which can set us up for future years of portfolio growth. Finally, asset quality will remain an important part for us in 2024. Our history shows that Eagle Bank has recognized asset quality pressures earlier than our peers. We've taken a conservative and proactive approach by reassessing internal credit ratings for credits exhibiting weaknesses in primary cash flows where those cash flows are our primary force of repayment. This increased our classified assets in the fourth quarter. Jan will speak in more detail about the actions we took in the fourth quarter. which in part drove a higher provision for credit losses and impacted our net income. I am confident that our credit team will work with our borrowers to maximize collateral value while at the same time seeking to improve the credit posture of Eagle Bank through principal pay downs or enhancements on recourse and guarantors. Our team aligned with those workouts and surveillance efforts have up to 50 years of experience with CRE and have seen many deep downturns. Our strong capital level positions us well in the face of economic uncertainty, and we have proven over the years to be good stewards of our capital through strong capital management. I am excited about the prospects of Eagle Bank and the team. A lot of progress has been accomplished over the last six months. The senior staff is working closely with the entire Eagle Bank team to position ourselves for sustainable growth with improved and consistent profitability for years to come. While this upcoming year may throw us some curveballs, we will respond appropriately. Importantly, I am confident that we've identified the actions needed to be accomplished in 2024 to set us up for continued success. With that, I'll hand it over to Sam.

Thank you, Susan, and good morning, everyone. Our credit teams continue to assess and work with our customers that are or might potentially be experiencing stress or future issues that could cause stress on a loan by loan basis, predominantly in our office portfolio. We make every effort to work with our customers to improve their opportunity to succeed and protect the bank through early outreach and intervention. We had two notable events in the fourth quarter that impacted our provision expense. First, late in the quarter, we sold a multifamily construction non-performing note that I discussed in our call the past two quarters. The note was a 39.5 million multifamily loan in the DC metro market. The property was nearing stabilization However, there were significant impediments to a near-term resolution acceptable to the bank. Our team assessed a multitude of disposition and remediation strategies and determined that our best course of action was to sell the note to an unaffiliated third party. We recognized a $5.5 million loss as a result of the note sale. An important factor in evaluating the decision to sell the note with the assessment of the time to remediate and dispose of the property and the net present value of the carrying cost compared to the disposition value realized. Second, we had a charge off of $6.1 million, recognizing a collateral shortfall from an updated appraisal on a previously performing substandard office loan. As a result of the collateral deficiency, the loan was moved to non-approval in the fourth quarter. Non-performing loans fell to $65.5 million at December 31 from $70.1 million at September 30, with the aforementioned office loan migrating into non-performing and the multifamily construction loan migrating out of the portfolio. NPAs were $66.6 million, which was 57 basis points to total assets. Loans 30 to 89 days past due were $20.7 million, down from $46.4 million at the end of the prior quarter. The decrease was due to migration of the loan into non-performing status at December 31. During the quarter, the teams reviewed and conservatively reassessed internal risk ratings for loans where there may be some weakness or future weakness on the primary source of repayment as compared to how the project was initially underwritten. In many of these situations, we believe we are adequately collateralized based upon a recent appraisal and or we have guarantors with ample income and or assets to supplement repayment. However, management felt it was prudent to downgrade these credits based upon the weakness in the primary source of repayment. As a result of these efforts in the quarter, you will see an increase of special mention and substandard loans. As you have seen throughout our disclosures in 2023, we've used modifications as a tool for working with our customers. Our modifications are generally extensions of maturity and are short in duration between three and 12 months. They may require one or more credit enhancements, for example, the establishment of a payment and other reserves controlled by Eagle Bank, sweep accounts to control excess cash flow, principal curtails, additional collateral, and or other measures as deemed prudent in exchange for the extension accommodations. Our office exposure will be a continued focus for the team in 2024. The expectation of lower interest rates improves the prospects for commercial real estate, and will improve the prospects of remediation efforts of more challenged yields. Office loans secured by non-owner-occupied CRE credits are $949 million or 11.9% of the total loan portfolio at quarter end. These office properties are primarily located in the Washington, D.C. market with 24.5% in the District of Columbia, 35.4% in the Maryland suburbs, 32.7% in Northern Virginia, and 7.4% located outside these markets. For the fourth quarter, we had a provision to the ACL of 14.5 million. Driving this increase were losses on the note sale and the updated appraisal value on the substandard office loan. The ratio of ACL to loans at quarter end was up three basis points to 1.08. With that, I'd like to turn it over to Eric.

Thanks, Jan. Net income for the quarter totaled $20.2 million, or $0.67 per diluted share. As Jan's comments just detailed, net income was meaningfully impacted by the provision expense of $14.5 million, increasing from $5.6 million in the previous quarter. Notwithstanding the higher provision expense, we are excited that we experienced continuous core deposit growth in the fourth quarter. with deposits ending the year at $8.8 billion, increasing $432 million compared to $8.4 billion on September 30th. The team's efforts throughout the year helped us show year-over-year deposit growth at year-end for the first time in six quarters. Broker deposits declined by $67 million and were down to 27% of deposits. Our mix of deposits and borrowings at quarter-end is now much closer to how it looked at looked at the end of December 2022 before the market disruption in March. At December 31, 2023, deposits of $8.8 billion compared to $8.7 billion at year-end 2022 and borrowings were $1.4 billion compared to $1 billion at year-end 2022 due in part to our bank term funding program borrowings totaling $1.3 billion. During the quarter, we had relatively flat loan growth, with loans up $52 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 90% from 95% the prior quarter. Net interest income totaled $73 million for the three months ending December 31, increasing from $70.7 million in the linked quarter, the first time in several quarters that we've experienced a period-to-period increase in net interest income, contributing to the increase with stability in our cost of interest-bearing funding while also benefiting from an increase in the yield on our earning assets. Interest-bearing liabilities benefited from lower-cost borrowings. Since the start of the first quarter of 2024, management has taken actions to reduce some of our deposit rates on non-maturity deposits to reflect lower market rates seen late in the fourth quarter and into the new year. Non-interest income totaled $2.9 million for the fourth quarter, a decline from $6.3 million in the late quarter. The main driver of the decline was swapped fee income and mark-to-market benefits from higher interest rates recognized in the third quarter that did not repeat in the fourth quarter due to lower swap activity and falling interest rates, in total contributing $3.7 million of the decline in total non-interest income. Non-interest expense totaled $37.1 million in the fourth quarter, relatively flat from the prior quarter. Salaries and benefits declined $3.1 million in the fourth quarter from the prior quarter due to truing up of incentives and lower salary expenses. Offsetting the decline in salaries and benefits is increased FDIC insurance costs, increasing $1.1 million from the prior quarter. Impacting our FDIC premium costs is our level of modified loans, which increase the basis points of premium paid on deposits. Eagle Bank was not impacted by the special assessment pursuant to systemic risk determination that was finalized in the fourth quarter. As Charles indicated last quarter, we expect to invest in the company in 2024 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 actions taken in 2023. This past quarter, Efficiency was 48.9%, which compares well to our proxy peers. We remain committed to identifying and executing strategies to find positive operating leverage. Starting this quarter, management will release its quarterly investor deck along with earnings, as you can see with our filing last night. In that deck, we provided insights to our expectations for full year 2024 performance. In future calls, we will update you as our expectations change. Our 2024 performance expectations mirror Susan's comments on the strategic goals for the year, mainly with deposit growth and continued improvement in the mix of our funding and reduced reliance on wholesale funding. Lastly, capital remains a core strength of the company. Our tangible common equity ratio at quarter end was 10.12%, benefiting from lower market rates decreasing the unrealized loss impact on capital. In the face of uncertainty with non-owner-occupied office market valuations, management believes it is prudent to gain more certainty before seeking approval from our board on another share repurchase program. With that, I'll hand it back to Susan for a short wrap-up.

Thanks, Eric. We are all excited about Eagle Bank's future. We have demonstrated our ability to improve the balance sheet and stabilize both earnings and margins. We also continue to meet our commitment to a relationship-first culture, strong conservative underwriting, and peer-leading efficiency. We are committed to our heightened surveillance of and engagement with our portfolio. In closing, our senior management team and I would like to thank our employees who work hard every day to make Eagle a success. With that, we will now open it up for questions.

As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again.

Please stand by while we compile the Q&A roster.

Our first question comes from Casey Whitman with Piper Sandler & Co. Your line is now open.

Hey, good morning. Hi, Casey. All right, so first, Jan, sorry if you mentioned this in your prepared remarks, but what is the remaining balance of that office loan that you partially charged office quarter?

Oh, let me think. Right around $20 million. Okay.

Thank you. And then sticking with office, I think last quarter you gave us the amount that was in sub-stated special mention. Do you have those numbers for us this quarter? Just within the office book?

Oh, with office? Yeah. I have 130 in office in special mention.

Okay. And what about substandard?

You have to give me a minute to run that total. I'll tell you that after I answer your question.

Okay. Would you say, though, that most of the moves this quarter into the criticized was office or maybe walk us through some of the other classes that might be experiencing modifications?

No. In terms of the additions to the substandard category, a little over two-thirds were C&I loans. There wasn't much on the CRA side that moved into that category, one office loan. Yeah.

OK. And then I had one more question with office. And I guess of the $950 million in office, how much of that is currently on extension or in modifications? Do you have that number?

I think the modifications are disclosed every quarter. I didn't run a total on what was modified in the last trailing 12 months. Eric, do you happen to have that? I don't have it with us, but it will come out with the disclosure docs.

Okay. Thank you. Appreciate that. And really appreciate the outlook slide and the presentation. So you guys have done a nice job managing expenses over the last

know a few years so can you just uh walk through a little bit more about some of the puts and takes into what's going on going into the expectation you put in there for some expense growth this year yeah i think this is eric casey um you know there's a little bit of just inflationary expense associated with salaries as well You know, there's actually probably a little more inflationary pressure on professional services and contracts more than even salaries at this point. As contracts, you know, that sometimes have two to three years come up for renewal, we are seeing some more meaningful increases there. So I think that that's driving some of the increases in the salaries or in the non-interest expense line. And we're also in our orientation of growing some of the, or executing some of the strategies that Susan mentioned. There is some additional people that we're going to add to the team throughout the year as well.

Got it. And then what kind of rate assumptions are you using to get to that margin outlook?

So we're not assuming any, and that's more just a decision that management's made to not complicate things. So it's not necessarily our expectation of what's going to happen, but there's no assumption in rate change here. And then with one caveat in that, you know, deposit data. some deposits that were repricing their current period or current rates that they would reprice up, but there's no expectation of rate change.

Okay. Last question. I mean, obviously some really nice deposit info this quarter. Is there any seasonality there where we shouldn't be surprised to see some leg down, especially in that non-disparing category in the first quarter, or is that not really the case?

Yeah, I think historically we've seen a little bit of seasonality where our DDA is higher at the end of the fourth quarter, and there could be some reduction here in the first quarter. Obviously, we're working on building new relationships and deposit growth, so we're hoping to see some of that. But I think from a historical perspective, there has been a little bit of a seasonality in the first quarter in deposits.

Got it. I'm going to let someone else ask questions, and Dan, if you get that substandard office number, let us know. Thanks. Okay.

Thank you. One moment for our next question. And our next question comes from Catherine Mueller with KBW.

Your line is now open.

Thanks. Good morning. Good morning, Catherine. Maybe one follow-up on just the credit conversation. Do you have the updated reserve for your office portfolio? And was there any changes specifically in that book that you took the higher reserve this quarter?

Yeah, I would say, you know, when we look at the office reserve, a lot of it is a qualitative overlay for us, just because we haven't seen a lot of losses to date. in the office portfolio from a quantitative perspective. And, you know, we're continually evaluating the adequacy. And, you know, from the office perspective, the majority of that portfolio continues to perform. And as Jan said, office wasn't a primary driver of classified migration. And when we think about the overall ACL and having it improve to 108 basis points of total loans coverage, You know, we're obviously constantly looking at the adequacy of office ACLs and will, as circumstances present themselves throughout this year, we'll do what we need to do to continue to have it adequate.

Great. And so, is there any way, I know there's going to be a big range on this, Is there any way you can help us think about what the LTV is currently on your office book? And as you're getting up, and I know this one credit, part of what drove, you know, part of why you charged it off was you had an updated appraisal. So just trying to think, as you're getting updated appraisals in that book, are you seeing that LTV on the overall portfolio start to move up?

You know, Catherine, every property is, pretty unique and it's hard to generalize about where an appraisal is going to come out. I think there's still a lot of price discovery going on in the market, so even appraisers are struggling with this. It really depends on the characteristics of an individual property. What class of building is it? What kind of leases are in place? whether or not the property has a parking lot that, for example, could be used as a conversion to residential, what type of piece of land. I mean, the worst possible scenario, based on what I'm reading, is a Class C building that's vacant that has a zero lot line. Mercifully, I don't have any of those. But it's very hard to generalize.

Yeah. OK. And then I think this is the question that Casey asked, but I just wanted to make sure that the current modifications, do you have that number? Not even just in office, but kind of generally maybe what percentage of loans have had a modification, you know, in the past year or so?

We do keep a record of a trail in 12, but I honestly haven't looked at the number for I don't think it's been pulled yet.

Okay. Would you think there'd be a big change from last quarter? We pulled last quarter. Did this quarter have a big change or you're probably pretty stable on that?

I think it's going to be pretty stable because some of what you're going to see is that loans that we may be modified for 90 days. might have been modified again during the same trailing 12 as we put into place a longer-term solution. So even if it was modified during the quarter, it's already going to be in the path of trailing 12. So it wouldn't be .

Yep.

OK, that makes sense.

OK, great. And then maybe switching over to the margin, just kind of big picture, I know that 250 to 270 margin guide assumes a flat rate environment. But if we start to see, assuming you're well positioned in a rate cut scenario, just given your ability to bring deposit costs down, but how are you thinking about the sensitivity and maybe maybe a deposit data on the way down that we should assume, or how are you thinking about how much asset we could potentially see once we start to see rate cuts?

Yeah, in terms of, you know, how we model on sensitivity and what our approach to sensitivity is, you know, the really more of a neutral positioning that, because I just don't feel we get compensated appropriately enough to be liability sensitive, materially liability or asset sensitive, or else we'd probably all be in different jobs. But, you know, so I think our approach is to really be as neutral as possible. But given some of the nuances of our funding profile, I would say that we are positioned quite well in a downward rate environment too. pass along any changes to market rates to those folks that have funding with us. And in fact, I've had my prepared comments, but we've already taken some actions earlier in January to reduce rates and deposits. And so we're going to continue that effort throughout the quarter. before the Fed potentially could reduce rates.

Great. Okay, great. That's all I've got. Thank you so much.

And, you know, you mentioned, you asked a question about betas. I would say maybe in a future call, I could probably talk a little bit more about our thoughts on betas in a downward rate environment.

Yeah, and I know it's a It's everyone's best guess, right? I think that's a big question of how this is going to react on the way down. But given you have one of the higher betas on the way up, my hope would be that you would have at least one of the higher betas on the way down on a relative basis. And we'll see.

I hope that as well.

All right. Thank you so much.

Thank you. One moment for our next question.

And our next question comes from Christopher Maranek with Janie Montgomery Scott.

Your line is now open.

Hey, thanks. Good morning. I kind of want to leverage Catherine's question just to go a little bit deeper on kind of PP&R, ROA. You know, Eric, where you are now, do you see that gap narrowing the next year or two? And what are some of the best ways to kind of, you know, get there?

Yeah, to me, when we look at our pre-provision, that revenue ROA, I think it really is a revenue story and largely spread. I mean, if you look at our non-interest expense to average assets, we're industry leading there. And I think that's a testament to our commitment and focus on operational efficiency. So I don't think we can cut our way to excellence. And from my perspective, our focus strategically on deposit growth, improving the composition of that deposit, that will ease up on our funding costs and our focus on ensuring that we get the margin on loans that the market is giving us and our focus on that will help us on the asset side as well. We have about 300 and call it 330, 350 million that's rolling off the investment portfolio this year that will move into higher yielding assets as well. So I think that looking over the next 12 months on a PPR basis, it's really going to be a spread story.

Got it. And is some of that also loan yield in addition to deposits? And I certainly follow the funding piece.

Yeah, I think there's a little more visibility, at least from my perspective, having only been here for three or four months. on the funding side and seeing how we could really increase spread income by improving the composition and the qualities of our funding. We've spent a lot of time as a management team over the last 60 days looking at spread and really understanding how we compare to competition and making sure that we're getting loan spreads that the market is giving us and and assessing ourselves that way and making sure that our relationship managers are being compensated on profitability. So I do think that it's both sides of the spread calculation.

Got it. Thanks for that. And then, Jan, just a question for you on this sort of C&I migration. What's your general sense of the risk of loss on those loans, maybe in general, just kind of using history and how EGLE has performed with C&I in the past?

Well, I'll tell you, the migration is really, I think, a lot to do with the primary source of repayment focus and not really focusing on... additional guarantor support obviously the payments are being made or they'd be showing up on the past due report they are not so i think we've been pretty darn conservative in the way that we're assessing this and highlighting it in today's economic and regulatory climate i think there's a huge focus on primary source of repayment and we're following that i don't think it means that they're necessarily in worse shape than they were last quarter is a change in the way that we're evaluating them.

And is this the first quarter of that, or could you remind us sort of how long you've been instituting this new discipline?

This is the first quarter of that.

Okay. That's helpful. Great. Thank you for taking my questions. Sure.

Thanks, Chris.

Thank you. And I am showing no further questions at this time. I would now like to turn it back to Susan Reel for closing remarks.

We appreciate your questions and you taking the time to be with us on this call today. We look forward to speaking to you again next quarter. Thanks and have a great day.

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