Q1 2024 Eagle Bancorp Inc Earnings Call

Participants

Eric Newell; Executive Vice President and Chief Financial Officer; Eagle Bancorp Inc

Susan Riel; President, Chief Executive Officer, Director; Eagle Bancorp Inc

Janice Williams; Senior Executive Vice President, Chief Credit Officer of the Bank; Eagle Bancorp Inc

Casey Whitman; Analyst; Piper Sandler Companies

Catherine Mealor; Analyst; Keefe, Bruyette & Woods North America

Christopher Marinac; Analyst; Janney Montgomery Scott

Presentation

Operator

Good day and thank you for standing by. Welcome to the EagleBancorp 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 EagleBancorp Inc. Please go ahead.

Eric Newell

Good morning. This is Eric Newell, Chief Financial Officer of Eagle Bancorp.
Before we get 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 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 Livingston.
I would now like to turn it over to Susan.

Susan Riel

Thank you, Eric, and 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 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 Ecobank. The challenges of the first quarter demonstrated the benefits of the Company's prudent approach to capital preservation.
Our common equity Tier one ratio at March 31 and Q3 stood at 13.8% based on December 31st, capital ratio equals capital levels or 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 six 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 onboarded a new team that has developed and built ex-patriot banking business programs at their former organization 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 loan. 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 schools segment, where we are establishing a strong presence in late February, we announced the July 2020 for retirement of Lindsay Graham, who leads the C&I team. I am excited for Lenzie 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 am 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'm 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 a penny 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 31st from $85.9 million at December 31st. The resulting coverage to the ACL to total loans increased to 1.25% at March 31st from 1.08% at December 31st. In our earnings release and deck, we are disclosing the ACO attributed to our performing office loan portfolio.
The ACL coverage to performing office loans is 3.67% at March 31st, increasing from 1.91% at December 31st. Office loans that are rated substandard have an ACO 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 31st, we believe the ACL is appropriate. Inputs relating to office loans are dependent on data on a dataset that has limited information on recent evaluations. And so as price discovery continues, we may see changes to the ACO 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 in the first quarter was 2.43%, declining two basis points from the fourth quarter. While the costs 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 four 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 31st, and deposits increased $1 billion or 14% from March 31st, last year. Noninterest expense totaled 40 to 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 assessments. 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 2020 for performance, which 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 and the investor deck on our office portfolio on pages 17 and 18, our 2024 expectations near Susan's comments on the strategic goals. We do not model any changes to interest rates in our forecasting, but expect the 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%. And lastly, capital remains a core strength for the Company. Our tangible common equity ratio at quarter end was 10.03%, which was impacted by higher interest rates and its impact on yield AOCI., our consolidated CET1 ratio is 13.8%. At March 31st, 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?

Janice 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 31st, and we individually evaluated the loan and charged off the collateral deficiency after cost of sales as well as through first to have 522,000 of collected interest from interest income during the quarter to date, we've seen appraisals as a 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 visualize the change of our internal risk ratings for office and non-office income-producing CRE office loans. Weighted average risk rating at March 31st was 4,500 compared to 46 hundred at December 31st and 37 hundred at March 31st last year. The most severe risk rating we have for loans is 9,000.
While the loss recognition is disappointing, 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 31st 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 capability for expected and unexpected losses in taking into account our ACL and CET. one 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 risk. Such mitigation action may include cash flow sweeps pay down with higher requirements in 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 the 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 today have included our boundaries keeping control of their properties. We have worked with our borrowers whenever possible to collaboratively sell assets and pay off the 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 31st, and total criticized loans increased $84.3 million to 627.1 billion at March 31st.
We noted in our disclosure on page 20 of our earnings presentation that 85% of classified and criticized loans are performing at March 31st 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 31st from 65.5 million at December 31st, with the aforementioned office loans migrating into 98 p. NPAs were 92.3 billion, which was 79 of links of total assets. Loans 30 to 89 days past due were 31.1 billion, 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 a residential construction project for which we receive 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. That's 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've made with our customers and will make with our future customers.
With that, I will now open it up for questions.

Question and Answer Session

Operator

(Operator Instructions) Casey Whitman, Piper Sandler.

Casey Whitman

January 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 it this quarter?
Yes.

Janice Williams

Look, at CAD48 million for a loan relationship. The AM project itself was 63% leased, which was the same as the appraisal dates 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% and 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 is in non-accruals right now?

Janice Williams

That's correct of that.

Casey Whitman

Was it already in special mention or substandard at year end?

Janice Williams

Yes.

Casey Whitman

Okay, right.
And then given the $10 million average size of your office, I think you said this is this was the biggest one in the central business district, but do you have any others sort of this size and some of the other markets?
There's a state to say that this was one of your largest across across the whole market.

Janice Williams

And there are other larger loans in other geographics areas and Montgomery County. There are a couple of large loans downtown Bethesda. I think we've been home 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, a total of $110 million, and there is one of size, about 35, 36 million that comes up for renewal in 2028. So it's pretty far down the road at the time remainder of 2024. There's nothing there's one small loan of about 1 million hits in 2025. So it fits pretty well pretty well split up and matures over a fairly stratified schedule over the next five years or so.

Casey Whitman

I appreciate that I'll just ask one more switching gears. Erik, just can you walk us through how much of that drop in noninterest-bearing this quarter you would attribute to seasonality and then maybe just some comments around where ultimately, I think now flaring as a percentage is going to land for Eagle in this quarter, I would attribute the majority of that drop at the period end due to seasonal tax payments that our customers have.

Eric Newell

I would note again, I had it in my prepared comments, but the average balance during the year was I mean, for turning the quarter was 190 million greater than the previous quarter at March 31st. I think that takes our non-interest bearing accounts to about 22% of deposits. But 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 a non interest. So total deposits of around 30% to 35%.

Casey Whitman

Okay.
Thank you for taking my questions. I'll let someone else jump on.

Operator

Catherine Mealor, KBW.

Catherine Mealor

Good morning. Just a follow up on on our credit system, which are, but I know it's hard because if you've got these appraisals coming in and the values all are all over the place, but have you okay, what you're what you've currently got in criticized classified and what's maybe maturing over the rest of this year. And that side was really helpful thereof on give a range of where you feel like it would be safe to model where the reserve ratio could go on and that might be hard because maybe this is more coming in charge-offs versus reserve builds for you from what we saw this quarter. But just kind of any any range, reasonable range of what you think kind of provisioning or the reserve build could be this year, which would be really helpful.

Janice Williams

But today on Kevin, we do think our ACL coverage is adequate for the risk that we have and will continue to incorporate new market data into our provision approach.
And we're looking at our forecast on ACL coverage at the end of 2024 to be between one 35 and one 45 of total loans. Our credit losses on office, it has really been based on appraisal risk and price discovery. And that area is still pretty it's been 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 there 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 and $40 million for the remainder of the year.

Catherine Mealor

Okay, great.
That's helpful.
Just kind of put a range on it on since you mentioned the value in this central business district office one was about 50%. What I mean and again, I know it's a range, but how how values are appraisals different in some of your other markets like Montgomery County or But does it I'm assuming it's not that that much of a decline. Just any kind of color you can give on what you're seeing in those appraisals?

Janice Williams

It has not been as severe in some 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're seeing are transactions that are at distressed levels in the CBD, which some appraisers are interpreting to be. The market is only distressed markets. And so they are using those higher factors for discounting and for cap rates have not happened in other markets to that level, I'm seeing a range of cap rates from 7% to I've seen as high as 9.5% on office properties. I'm seeing discount rates that have been anywhere from 7% to 10.5%. So there's pretty wide range out there. And I'm very much appreciative of the fact that we're not and I must appraise situation in the CBD for a while. I do think there's 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 and the rest of the year can were very helpful.

Catherine Mealor

Thank you so much, Jan. And the one question is on the margin. You reiterated your outlook for the margin to be two 50 to 2 70 for the year. Of course, it came in lower this quarter, but some of that was from that on the interest reversal. So what gets your margin. And 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. Is the take rate cuts? Are there things that you're doing just within your balance sheet and that you think can push that higher?

Eric Newell

Yes, no, I appreciate the question. And on that note, on the interest reversals of 520,000 that Jim mentioned, we estimate that to be about seven basis points impact on the margin. So had we not had that reversal. Our name would have been that would have come in at that 2.5% for the quarter, which is at the bottom end of that range, too. I'll answer your question about what gets us higher up in the range. I think a lot of that comes down to our success successes and we're starting to see that. And I think it's building momentum on deposit growth and from our digital channel, for example, and that healed well 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're growing the on the core deposit customer or the core deposit, then we're able to reduce usage of FHLB FHLB borrowings, for example, and to come. That has a higher cost than the deposits.
So I think a lot of that is our liability strategy.
We do have 301 for the full year of 24 was 340 million of some of the investments that are rolling off our books, which is earning us about 2%. So you have that 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 were I'm seeing on new loan originations are pretty close to what the market's 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 20, 25 and 2026.

Catherine Mealor

Thank you so much. Appreciate it.

Operator

Christopher Marinac, Janney Montgomery Scott.

Christopher Marinac

Hey, thanks. Good morning, Al and Eric. Just a quick one for you on the not accrued interest on so you're going to get that back, but you still have the look, the portion of a loan is still on nonaccrual, is that correct?

Eric Newell

Correct.

Christopher Marinac

Okay.
And then I guess for Jay and can you talk a little bit about sort of the on kind of the level that modified loans you have now? Or are you not really having any modified loans or simply renewing them with the reserve build and some charge-off where appropriate financing.

Susan Riel

And we have a full menu of options that were exercising. In some cases, we are doing modifications within the office portfolio in particular, if you've got a maturity issue, that'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 Fund, imagine at a hefty premium. So we are looking at situations where we do have to modify those loans to extend them and I think in other cases, we're looking at getting paydowns as part of that process. We're 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 potential for some upside down the road while minimizing the risk to the bank.
From ultimate BOSS perspective, the wildcard in all of that being appraisals. We're fortunate that we've 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. We'll be in a situation where we have an updated appraisal that's required and evaluated those loans within our range for what could be theoretically possible in the charge offering.

Christopher Marinac

Great.
And all of this is done within sort of the the current guidelines on on modified loans that the regulators put in place last year and really that you've used in past cycles to. So it's all consistent.

Susan Riel

Yes, absolutely.

Christopher Marinac

And then can you just give us a little more color about how often you're getting more collateral and more cash, but I thought your comment on the prepared remarks is really helpful.

Susan Riel

Just wanted to drill down further on how often that's happening and it's happening in more deals, and it's not happening and I think we have instituted cash flow sweep and a cumulated funding that on a go forward basis for office, you really need to be thinking about the cost of retenanting in addition to the cost of making payments. So we want to be sweeping cash flow that so that we not only have a payment reserve, but we also have a reserve to retenant the property. And I think we've been pretty successful at that in at least three of the large deals that we've worked through. We have had that in place and are currently working through that. We've had paydowns in a number of instances. We've had modifications where we've done an interest, only exception our 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'll 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've come up with and the circumstances that we're working through and as you're getting this collateral on cash, you're not seeing defaults occur.

Christopher Marinac

So it's not as if you're triggering people throwing keys at you.

Susan Riel

And then that seems to be a predominant message this morning now that I think is a situation that banks don't really want to be in.
We're not property manager to an end.
We're probably not very good at it since not our business. So by having the borrowers stay in with a chance to return some investment to their investors, I think, and good solution for everyone.
Great.

Christopher Marinac

And last question for me just has to do with kind of the existing reserve on office and if you have maturities as far out as 2028, does the reserve kind of have some loss content on that, that loan, even though it's not in the near term maturity wall, what it does in terms of the reserve methodology, it will have a quantitative and qualitative reserve.

Susan Riel

The additional overlay that we've been adding to the reserve is really more focused on loans that are on special mention or substandard, where there are additional reserves that we've added based on a probability default analysis and a loss given default. So I think that's just part of our general see from methodology or Q1.

Eric Newell

I know you got it yes.
I mean, I guess just to put a button on it, we're agnostic as to the maturities in the office loans when we're looking at it from a qualitative perspective and we're really focused on that internal risk rating for probability default loss given default.

Christopher Marinac

That's good point.
Great.
Thank you for all the background. We have greatly appreciated.

Eric Newell

Thank you.

Operator

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 your 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.