Eagle Bancorp, Inc. (NASDAQ:EGBN) Q1 2024 Earnings Conference Call April 25, 2024 10:00 AM ET
Company Participants
Eric Newell – Chief Financial Officer
Susan Riel – President and Chief Executive Officer
Jan Williams – Chief Credit Officer
Conference Call Participants
Casey Whitman – Piper Sandler
Catherine Mealor – KBW
Christopher Marinac – Janney Montgomery Scott
Operator
Good day and thank you for standing by. Welcome to the Eagle Bancorp, Inc. First Quarter 2024 Earnings Conference Call. [Operator Instructions] 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, Inc. Please go ahead.
Eric Newell
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-K for the 2023 fiscal year and current reports on Form 8-K, 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. 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; our Chief Credit Officer, Jan Williams; and our Bank Chief Financial Officer, Charles Levingston.
I would now like to turn it over to Susan.
Susan Riel
Thank you, Eric. Good morning, everyone. The management team and I have worked through the first quarter to continue executing on our strategies that I discussed on our last earnings call in January. I will update you on these in a moment. But first, while our first quarter results reflect continued stability in pre-provision net revenue from the fourth quarter, net income was impacted by a loss recognized in our office portfolio. As Eric and Jan will review in more detail, the quarter’s net income was impacted by a charge-off on the Central Business District office relationship.
We are continuing to be proactive in identifying and addressing challenges. Eric will discuss how our allowance for credit losses is evolving, informed by more timely information about our markets. We’ve been proactive with our customers that have maturities upcoming to address the credit posture of EagleBank. The challenges of the first quarter demonstrated the benefits of the company’s prudent approach to capital preservation. Our common equity Tier 1 ratio at March 31 stood at 13.8%. Based on December 31 capital ratio, Eagle’s capital levels are in the top quartile of banks greater than $10 billion in total assets.
We are highly confident that our focus on preserving and growing pre-provision net revenue and our strong level of capital will allow us to work through our office portfolio challenges. The team has been hard at work during the quarter on executing on our strategies. Last quarter, I mentioned our strategy to diversify our deposit portfolio. To that end, last year, we introduced our direct banking channel as a soft launch. We’ve expanded that to our local markets in the first quarter and just two weeks ago started to market more widely outside of our footprint. The early results are promising.
Over the last 6 months with our deposit promotion strategies, we’ve opened 558 new relationships through all of our acquisition channels, including our new digital channel. Most of these customers are new to Eagle and our teams have been developing strategies to cross-sell these customers into other products to deepen the relationships. During the quarter, we also on-boarded a new team that has developed and built expatriate banking programs at their former organizations. Once up and running, we expect this line of business to nicely augment our deposit gathering efforts.
Another important strategy is the growth of C&I loans. This includes expanding the breadth and depth of services offered by our Treasury Management business to better support the growth of C&I loans. Our C&I pipelines are growing as we are seeing more activity in our government contracting and education segments. Our government contracting team was a source of revenue growth in the first quarter, and we continue to win new relationships in our Charter School segment, where we are establishing a strong presence.
In late February, we announced the July 2024 retirement of Lindsey Rheaume, who leads the C&I team. I am excited for Lindsey on his next chapter and appreciate his contributions to EagleBank. We expect to have identified a new leader later this spring. While I am disappointed at the quarterly results, I’m excited about the future. EagleBank was built on the premise of serving commercial real estate investors and commercial business customers in the metropolitan area around Washington, D.C. Our expertise allows us to better partner with our customers through challenges.
In combination with the new initiatives just discussed, we remain committed to our customers, providing them concierge service through our Relationship First culture. As we work through the cycle of credit, our strategies and focus will also be on growing pre-provision net revenue through growth of net interest income and fee income. Our objective is to have a strong foundation and be well positioned for sustainable growth with improved and consistent profitability regardless of the interest rate environment. I am confident that we’ve identified the actions needed to set us up for continued success.
With that, I’ll hand it over to Eric.
Eric Newell
Thanks, Susan. We reported a net loss for the quarter totaling $338,000 or a loss of $0.01 per diluted share. Driving the loss in the quarter was the $35.2 million provision for credit losses in the quarter. While net charge-offs totaled $21.6 million, the allowance for credit losses increased to $99.7 million at March 31 from $85.9 million at December 31. The resulting coverage to the ACL to total loans increased to 1.25% at March 31 from 1.08% at December 31. In our earnings release and deck, we are disclosing the ACL attributed to our performing office loan portfolio.
The ACL coverage to performing office loans is 3.67% at March 31, increasing from 1.91% at December 31. OpEx loans that are rated substandard have an ACL nearing 15%, reflecting new information we’ve received through appraisals on office properties. While Jan will touch on it more, the methodology for the ACL relating to office loans has been designed to incorporate new information as it becomes available. We remain focused on comprehensively considering risks as we establish the ACL. With the information available to us at March 31, we believe the ACL is appropriate.
Inputs relating to office loans are dependent on a data set that has limited information on recent evaluations. And so as price discovery continues, we may see changes to the ACL associated with this portfolio. Notwithstanding the higher provision expense, pre-provision net revenue remained relatively flat in the quarter at $38.3 million from $38.8 million in the linked period, reflecting the benefits of our recent strategic initiatives. Net interest income before provision totaled $74.7 million in the first quarter, increasing from $73 million in the fourth quarter. NIM in the first quarter was 2.43%, declining 2 basis points from the fourth quarter.
While the cost from interest-bearing liabilities increased early in the quarter when market rates had fallen, we took some opportunities to reduce rates paid on certain deposit types, which drove an improvement of 4 basis points in our savings and money market rates. I would note, while period-end deposit balances showed a seasonal decline due to tax payments, the average balance of total deposits increased by $190 million in the first quarter from the quarter ending December 31 and deposits increased $1 billion or 14% from March 31 last year.
Non-interest expense totaled $40 million, increasing $2.9 million from the previous quarter. Seasonal increases in salaries and benefits were only a portion of the driver of the increase with the majority attributed to a reversal of incentive compensation in the fourth quarter that did not reoccur in the first quarter. For the comparable period in 2023, salaries declined $2.4 million attributed to lower incentive accruals in 2024. FDIC insurance expense increased, reflecting in part our strategy to use modifications on portions of our loan portfolio, which increases our assessment.
During the quarter, we had relatively flat loan growth with loans up $26 million, driven by existing construction loans funding at quarter-end. In our quarterly investor deck, along with 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 view of PPNR for the full year remains largely unchanged from what we communicated in January 2024.
We augmented our disclosure this quarter in the investor deck on our office portfolio on pages 17 and 18. Our 2024 expectations mirror Susan’s comments on the strategic goals. We do not model any changes to interest rates in our forecasting, but expect that betas on our deposits have generally flattened. Of the $112.5 million of loan originations in the quarter, we had a weighted average rate of 7.56%. Lastly, capital remains a core strength of the company.
Our tangible common equity ratio at quarter-end was 10.03%, which was impacted by higher interest rates and its impact on AOCI. Our consolidated CET1 ratio is 13.8% at March 31. Senior management has been evaluating our options as it pertains to our subordinated debt maturity in September. Key factors as we consider those options include capital deployment opportunities, the interest rate environment and market conditions. Jan?
Jan Williams
Thank you, Eric. As mentioned, we recognized a loss on one Central Business District office relationship during the quarter. It’s important to note that the loan was current and accruing as we entered the quarter, but was nearing maturity and as a standard practice we ordered an appraisal. The appraisal had a cap rate of 8.5% and a discount rate of 10% – rates materially higher than other recent appraisals we’ve seen on office properties. At March 31, we individually evaluated the loan and charged off the collateral deficiency after cost of sales as well as reverse the $522,000 of collected interest from interest income during the quarter.
To-date, we’ve seen appraisals at the source of charge-offs rather than cash flows from underlying properties. The subject relationship is the largest we have in our Central Business District office portfolio. For the remainder of 2024, there are no other Central Business District office loans maturing, which would result in an updated appraisal. Our expectation is that price discovery will continue in the Central Business District and make appraisals more predictable going forward. 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.
On Page 17 of our earnings presentation, we visualized the change of our internal risk ratings for office and non-office income-producing CRE. Office loans weighted average risk rating at March 31 was 4,500 compared to 4,600 at December 31 and 3,700 at March 31 last year. The most severe risk rating we have for loans is 9,000. While the loss recognition is disappointed, it’s not entirely unexpected. We expect and are preparing for additional losses recognized through the cycle. We’ve been working as a team to identify anticipated losses through our ACL.
We’re now 1.25% of total loans, an increase from 1.08% of total loans at December 31. As data and information emerge that helps us inform our ACL methodologies, we will incorporate as deemed appropriate. To emphasize what Eric previously mentioned, and as we illustrate in our earnings presentation, we have significant loss-absorbing capabilities for expected and unexpected losses and taking into account our ACL and CET1 capital. We’ve also enhanced our office disclosure to include maturities.
We are actively reviewing all CRE loans with maturities over the course of the next 18 months and taking action where appropriate to mitigate maturity risks. Such mitigation action may include cash flow sweeps, paydown requirements and return for extensions, enhanced guarantor support, payment reserves and additional collateral. Thus far, one of the most significant risks we have seen is the risk associated with office appraisals and the wide discrepancies in valuation over relatively short periods of time, largely as a result of differing perspectives on discount rates and cap rates for office assets, which have been somewhat unpredictable due to ongoing price discovery and market rates.
We are creating solutions for our clients as well. We’ve designed a bespoke evaluation process with our office portfolio maturities, and our goal is to have a mutually acceptable solution for our clients 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 performing debt and reposition property to residential use.
Each resolution is unique to the asset under evaluation. Total classified loans increased $26 million to $361.8 million at March 31, and total criticized loans increased $84.3 million to $627.1 million at March 31. We noted in our disclosure on Page 20 of our earnings presentation that 85% of classified and criticized loans are performing at March 31. Of the total increase in special mention loans, income-producing CRE was $47.7 million, of which $10 million was office and C&I was $10.7 million. Nonperforming loans increased to $91.5 million at March 31 from $65.5 million at December 31, with the aforementioned office loan migrating into nonperforming.
NPAs were $92.3 million which was 79 basis points of total assets. Loans 30 to 89 days past due were $31.1 million, up from $13.6 million at the end of the prior quarter. The increase was due to two loans. One has been brought current, and we have assessed the other as posing little risk of loss as it’s a residential construction project for which we received paydowns as units are sold, and there are more than sufficient units to satisfy the debt.
With that, I’ll hand it back to Susan for a short wrap-up. Susan?
Susan Riel
Thanks, Jan. I previously said our team showed its tenacity, client focus and perseverance over the last year. This quarter and this year are no different. We are committed to our continued heightened surveillance of and our engagement with our office portfolio. Our just over 25 years as a commercial lender in this market gives us the expertise to work with our clients challenged by higher interest rates. Our strong levels of capital give us the ability to be flexible and serve our customers and communities for another 25 years.
Our strategies are intended to drive growth in pre-provision net revenue, which in turn supports returns on assets and equity that can be invested in products and services designed for our customers and our communities, while providing appropriate returns on capital for our shareholders. In closing, our senior management team and I would like to thank our employees who work hard every day to make Eagle a success and the strong partnerships we have made with our customers and we will make with our future customers.
With that, I will now open it up for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Casey Whitman with Piper Sandler. Your line is open.
Casey Whitman
Hey. Good morning.
Susan Riel
Hi Carey.
Casey Whitman
For the one large office loan where you had to get a reappraisal, can you address the size of that loan in a specific amount of net charge-offs you took on this quarter?
Susan Riel
Yes. I would, $48 million loan relationship. The project itself was 63% leased, which was the same as the appraisal date 15 months ago. We keep current appraisals on these loans. I think the decline in value of the property over a 15-month period was pretty close to 50%, which pushed it into an area where we had a partial charge-off on it, about $20 million.
Casey Whitman
Okay. And so the remaining $28 million is in non-accruals right now?
Susan Riel
That’s correct.
Casey Whitman
Okay. Was it already in special mention or substandard at year-end?
Susan Riel
Yes.
Casey Whitman
Okay. Alright. And then given the $10 million average size of your office, I think you said this was the biggest one in the central business district. But do you have any others sort of this size in some of the other markets or is it safe to say that this was one of your largest across the whole market?
Susan Riel
There are other larger loans in other geographic areas. Montgomery County, there are a couple of large loans, Downtown Bethesda. I think we have been successful in those suburban markets and haven’t seen the issues hit as heavily as they have in terms of value degradation through appraisals in the central business district. We have one other – a total of four other loans in the central business district total of $110 million. There is one of size, about $35 million to $36 million that comes up for renewal in 2028. So, it’s pretty far down the road. The remainder of 2024, there is nothing. There is one small loan, about $1 million that hits in 2025. So, it’s pretty well split up and matures over a fairly stratified schedule over the next 5 years or so.
Casey Whitman
Okay. I appreciate that. I will just ask one more, switching gears, Eric, just can you walk us through how much of that drop in non-interest bearing this quarter you would attribute to seasonality? And then maybe just some comments around where ultimately you think not non-interest bearing as a percentage is going to land for Eagle?
Eric Newell
Yes. This quarter, I would attribute the majority of the drop at the period end due to seasonal tax payments that our customers have. I would note, again, I had it in my prepared comments, but the average balance during the year was – I mean during the quarter was $190 million greater than the previous quarter. At March 31st, and I think that takes our non-interest bearing accounts to about 22% of deposits. I would say that our goal is to obviously grow that. Our strategic objectives that Susan talked about and enhancing our deposit franchise and bringing in more low-cost deposits and operating accounts through all of our acquisition channels, but particularly in the Commercial segment, I would say our goal, our longer term goal would be to have non-interest total deposits of around 30% to 35%.
Casey Whitman
Okay. Thank you for taking my questions. I will let someone else jump on.
Eric Newell
Thank you.
Operator
Thank you. And one moment for our next question. Our next question comes from Catherine Mealor with KBW. Your line is open.
Catherine Mealor
Thanks. Good morning. Maybe just a follow-up on our credit, just what’s your – I know it’s hard because you have got these appraisals coming in and the values are all over the place. But as you look at what your – what you have currently got in criticized classified and what’s maybe maturing over the rest of this year and that slide was really helpful. Is there – do you have a range of where you feel like it would be safe to model where the reserve ratio could go? And that might be hard because maybe this is more coming in charge-offs versus reserve builds from what we saw this quarter. But just kind of any range – reasonable range of what you are seeing kind of provisioning or the reserve build could be this year would be really helpful.
Susan Riel
Well, today, Catherine, we do think our ACL coverage is adequate for the risk that we have and we will continue to incorporate new market data into our provision approach. And we are looking at our forecast on ACL coverage at the end of 2024 to be between 1.35 and 1.45 of total loans. Our credit losses on office has really been based on appraisal risk and price discovery in that area is still pretty thin. Pretty much everything that’s transacted has been a distressed or for sale. So, it’s hard to know exactly where things will settle out that in the appraisal. They are really all over the place. But based on what we know today, I could give you my thoughts on a ballpark range for charge-offs for the rest of the year. I would estimate somewhere between $20 million and $40 million for the remainder of the year.
Catherine Mealor
Great. That’s helpful – just kind of puts the range on it. I know you mentioned the value in the central business district office one was about 50%. I mean again, I know it’s a range. But how are values or appraisals different in some of your other markets like Montgomery County, Bethesda, I am assuming it’s not that much of a decline. Just any kind of color you can give on what you are seeing in those appraisals.
Jan Williams
It has not been as severe in other areas. And even within the CBD, I don’t think it’s been as severe as what we saw in the most recent appraisal. I think in some instances, because there aren’t really any market trades going on out there right now, the bid and ask are too far apart for there to be a market transaction. What we are seeing are transactions that are at distressed levels in the CBD, which some appraisers are interpreting to be the market is only distressed market. And so they are using those higher factors for discounting and for cap rates. It has not happened in other markets to that level. I am seeing a range of cap rates from 7% to I have seen as high as 9.5% on office properties. I am seeing discount rates that have been anywhere from 7% to 10.5%. So, there is a pretty wide range out there. And I am very much appreciative of the fact that we are not in a must appraised situation in the CBD for a while. I do think there has been some erosion in the suburban properties, but not nearly at the same level. A, properties and trophy properties are not seeing the same level. I think we are – for the remainder of the year, have gone through everything that’s coming up over the year and have given it kind of in that ballpark number, I gave you our best estimate of what could move for the rest of the year.
Catherine Mealor
Okay. Very helpful. Thank you so much Jan. And maybe one question just on the margin. You reiterated your outlook for the margin to be 2.50 to 2.70 for the year. Of course, it came in lower this quarter, but I know some of that was from that the interest reversal. So, what gets your margin? I mean it feels like the low end of that range is kind of safe – is the safe place to be, but what gets the margin towards the mid to high-end of that range? Does it take rate cuts or are there things that you are doing just within your balance sheet that you think can push that higher?
Eric Newell
Yes. No, I appreciate the question. And on that note, on the interest reversal, the $522,000 that Jan mentioned, we estimate that to be about 7 basis points impact on the margin. So, had we not had that reversal, our NIM would have come in at 2.5% for the quarter, which is at the bottom end of that range. To answer your question about what gets us higher up in the range, I think a lot of it comes down to our successes, and we are starting to see that, and I think it’s building momentum on deposit growth from our digital channel, for example, and that – while there – it comes in at a higher price because that’s just how you acquire that type of customer, our success in building those into deeper relationships can have the effect of reducing our cost of funds. And as we are growing the core deposit customer or the core deposits, then we are able to reduce usage of FHLB borrowings, for example, and that has a higher cost than the deposits. So, I think a lot of it is our liability strategy. We do have 300 – for the full year of ‘24 it was $340 million of investments that are rolling off our books, which is earning us about 2%. So, you have the benefit of a higher yield even if it’s just sitting in cash at about 300 basis points of yield. I do think that the spreads that we are seeing on new loan originations are pretty close to what the market is giving us. So, I think a lot of it is our liability strategy, getting success, becoming more successful in that liability strategy in the back half of the year and really honestly setting us up for a good 2025 and 2026.
Catherine Mealor
Thank you so much. Appreciate it.
Operator
Thank you. And one moment for our next question. Our next question comes from Christopher Marinac with Janney Montgomery Scott. Your line is open.
Christopher Marinac
Hi. Good morning. Eric, just a quick one for you on the non-accrued interest, so you are going to get that back, but you still have the portion of the loan that’s still on non-accrual, is that correct?
Eric Newell
Correct.
Christopher Marinac
Okay. And then I guess for Jan, can you talk a little bit about sort of the kind of the level of modified loans you have now or are you not really having many modified loans or simply renewing them with the reserve build and some charge-off where appropriate.
Jan Williams
Well, I think we have a full menu of options that we are exercising. In some cases, we are doing modifications within the office portfolio in particular, if you have got a maturity issue. It’s generally, once in a while, we see a payoff, but not that often. I think it’s difficult to get financing certainly from banks. Perhaps private financing is more available for office – imagine at a hefty premium. So, we are looking at situations. We do have to modify those ones to extend them. I think in other cases, we are looking at getting pay-downs as part of that process. We are working with each borrower and have been successful so far in providing an avenue for the borrower to continue to stay in the deal and have the potential for some upside down the road while minimizing the risk to the bank from ultimate loss perspective, the wildcard and all of that being appraisals. We are fortunate that we have projected out, as I mentioned to Catherine earlier, where we are on maturities that are coming up in the portfolio this year and where we will be in a situation where we have an updated appraisal that’s required and evaluated those loans within a range for what could be theoretically possible in the charge-off arena.
Christopher Marinac
Great. And all of this is done within sort of the current guidelines on modifying loans that the regulators put in place last year and really that you have used in past cycles, too. So, it’s all consistent.
Jan Williams
Yes. Absolutely.
Christopher Marinac
And then can you just give us a little more color about how often you are getting more collateral and more cash? I thought your comment on the prepared remarks was really helpful. I just want to drill down further on how often that’s happening?
Jan Williams
It’s happening in more deals than it’s not happening in. I think we have instituted cash flow sweeps and accumulated funding, but on a go-forward basis for office you really need to be thinking about the cost of re-tenanting in addition to the cost of making payments. So, we want to be sweeping cash flow that we not only have a payment reserve, but we also have a reserve to re-tenant the property. And I think we have been pretty successful with that. In at least three of the large deals that we have worked through, we have had that in place and are currently working through that. We have had pay-downs in a number of instances. We have had modifications where we have done an interest-only exception or extension because the borrower has entered into a long-term lease with a credit tenant for substantially all of the space and rent doesn’t commence for six months, so we will give them six months of making IO payments to make a return to amortization consistent with the rent payments. So, I think we are pretty bespoke in terms of the solutions that we come up with and the circumstances that we are working through.
Christopher Marinac
And as you are getting this collateral cash, you are not seeing defaults occur. So, it’s not as if you are triggering people throwing keys at you. I mean that seems to be a predominant message this morning.
Jan Williams
No. That, I think is a situation that banks don’t really want to be in. We are not property managers. And we are probably not very good at it. It’s not our business. So, having the borrowers staying with a chance to return some investment to their investors, I think is a good solution for everyone.
Christopher Marinac
Great. And then last question for me, just has to do with kind of the existing reserve on office. I mean if you have maturities as far out as 2028, does the reserve kind of have some loss content on that loan, even though it’s not in the near-term maturity wall?
Jan Williams
Well, it does in terms of the reserve methodology it will have a quantitative and a qualitative reserve. The additional overlay that we have been adding to the reserve is really more focused on loans that are on special mention or substandard where our additional reserves that we have added based on a probability of default analysis and a loss given default. So, I think that’s just part of our general CECL methodology. Eric, do you want to…?
Eric Newell
No. You got it. Yes. I mean I guess just to put a button on it, we are agnostic as to the maturities in – of the office loans when we are looking at it from a qualitative perspective, and we are really focused on that internal risk rating for probability of default, loss given default.
Christopher Marinac
No, that’s a good point. Great. Thank you for all the background we had, greatly appreciate it.
Eric Newell
Thank you.
Jan Williams
Thank you.
Operator
Thank you. This concludes the question-and-answer session. I would now like to turn it back to Susan Riel, President and CEO for closing remarks.
Susan Riel
We appreciate your questions and you taking the time to join us on the call. We look forward to meeting with you again next quarter. Thank you.
Operator
This concludes today’s conference call. Thank you for participating. You may now disconnect.
