Good, thank you for standing by. Welcome to the Eagle Bancorp, Inc. first quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. If you require any further assistance, please press star zero. I would now like to introduce today's speaker, Charles Levingston, Chief Financial Officer. Please go ahead.
Thank you, Victor. Good morning. This is Charles Levingston, Chief Financial Officer of Eagle Bancorp. Before we begin the presentation, I would like to remind everyone that some of the comments made during this call may be considered forward-looking statements. While our loan growth and performance over this past quarter have been positive, we cannot make any promises about future performance, and it is our policy not to establish with the markets any formal guidance with respect to our earnings. None of the forward-looking statements made during this call should be interpreted as our providing formal guidance. Our Form 10-K for the 2021 fiscal year and current reports on Form 8-K identify certain risk factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made this morning.
Eagle Bancorp does not undertake to update any forward-looking statements as a result of new information or future events or developments, unless required by law. This morning's commentary will include non-GAAP financial information. The earnings release, which is posted in the investor relations section of our website and filed with the SEC, contains reconciliations of this information to the most directly comparable GAAP information. Our periodic reports are available from Eagle online at our website or on the SEC's website. This morning, Susan Riel, the President and CEO of Eagle Bancorp, will start us off with a high-level overview. Jan Williams, our Chief Credit Officer, will discuss her thoughts on the local economy, loans, reserves, and credit quality matters. I'll return to discuss our financials in more detail. At the end, all three of us will be available to take questions.
I would now like to turn it over to our President and CEO, Susan Riel.
Thank you, Charles. Good morning and welcome to our first quarterly earnings call. I'm pleased to report the bank had another successful quarter building on our strong finish to 2021. First, a few highlights from the quarter. Earnings were $1.42 per diluted share, up 13 cents from the prior quarter. It was our 89th consecutive profitable quarter. Loans increased by $48.2 million from the prior quarter. This was the second consecutive quarterly increase. At the same time, our credit quality metrics remained strong. Non-performing loans were 33 basis points on loans at quarter end, and net charge-offs were just 3 basis points or $459,000. Exceptionally strong credit risk management has been a hallmark of Eagle since our founding, and it will continue to be a focus of ours going forward.
Our favorable credit quality metrics, along with the continued recovery and reopening of the economy, led us to a reversal of $2.8 million from the allowance for credit losses on loans. This was our fifth consecutive quarterly reversal. Now let's take a closer look at earnings. For the quarter, earnings were $45.7 million, up $4.1 million from the prior quarter. Returns for the quarter were 1.46% on average assets and 14.99% on average tangible common equity. The primary driver of the earnings increase from the prior quarter was a decrease in salaries and employee benefits, specifically the $5 million accrual reduction related to the share-based compensation awards and deferred compensation to our former CEO and Chairman.
During the quarter, we also transferred $1.1 billion of the available for sale securities portfolio to held to maturity. At quarter end, $1.2 billion or about 39% of our securities portfolio was held to maturity. Charles will speak more about this transfer and putting more of our excess liquidity to work. Next, let's talk about loans. This quarter's loan growth was driven by our CRE and C&I lending teams. Given the opportunity to have more face-to-face interaction with our customers and our prospects, these calling efforts, which increased in the middle of last year, produced the loans that were booked in the first quarter. We believe that this team effort provides us with good momentum as we move through the year. Within our CRE and C&I portfolios, we successfully completed construction projects that migrated to income-producing CRE and owner-occupied loans.
This migration reduced loans categorized as construction loans, with the decline partially offset by new and previously committed construction loans, drawing down their funding over the course of the quarter. This migration of construction loans to income producing CRE loans allows us to retain the loan, the interest income, and expand our lending relationships. Even with the successful completion of construction projects, our pipeline remains strong and unfunded commitments were up slightly to $2.1 billion at quarter end. As more opportunities arise, our total risk-based capital of 15.72% gives us ample room to continue to grow the loan portfolio. In regards to our residential lending division, volume was down as higher rates reduced consumer incentives to refinance. As a result, both gain on sale of mortgage loans and origination of mortgage loans were down in the first quarter.
Jan will give more details on our credit quality metrics shortly. On legal matters, there have been no material developments relating to our ongoing government investigations, although we are hopeful these matters will be resolved in the near future. For our shareholders, we remain focused on increasing value and returning cash through dividends. At the end of the quarter, our board declared a dividend of $0.40 per share, which is a payout ratio of 28% based on first quarter earnings and equates to annualized dividend yield of 2.8% based on last night's closing stock price of $56.19 per share. With that, I would like to turn the speaking duties over to Jan Williams, our Chief Credit Officer.
Thank you, Susan, and good morning, everyone. Our Washington, D.C. market continues to improve along many fronts. Lending from the government contractors and consumers remains strong. Construction projects are being completed and new projects are moving forward. Residential housing demand continues to exceed supply. Amazon continues to expand its presence in both leasing and in hiring in our market area. In March, mask mandates were dropped for most businesses and schools in the area, and we are seeing more businesses in D.C. return to work in the office, which has a positive ripple down effect for downtown businesses. Not surprisingly, unemployment in the Washington metropolitan statistical area remained low at 3.5% in February. With that background, our credit quality metrics continue to improve. Our ACL to loans at quarter end was 1.01%, down from 1.06% last quarter.
Nonperforming loans, as Susan mentioned, were 33 basis points of loans. Total nonperforming loans were $23.8 million, of which about 56% were CRE and 32% were commercial and industrial loans. The remaining NPLs were smaller PPP, SBA and residential loans. Charge-offs in the first quarter were just four loans with a gross charge-off of $514 thousand, partially offset by $55 thousand in recoveries, bringing us to net charge-offs of $459 thousand for the quarter or three basis points on an annualized basis. 30- 89 day past dues are also at very low levels. In terms of risk classifications during the quarter, the pass portion of the portfolio increased while special mention and classified credits were flat or down.
Even with our lower ACL to loans, our coverage ratio on non-performing loans is 301%, up from 257% in the prior quarter. OREO remained unchanged with the same three properties and a carrying value of $1.6 million. With regards to the reversal of $2.8 million from the allowance for credit losses, factors contributing to the reversal were improvements in the economic environment and related adjustments to the quantitative components of the CECL model, in particular the lower modeled probability of default as well as improvements in asset quality. We considered a number of qualitative and environmental factors including, among other things, the remaining potential risks to the hospitality and restaurant industries, as well as the potential risk in the office portfolio given potentially softer demand for office space in a post-pandemic world.
With that, I'd like to turn it over to Charles Levingston, our Chief Financial Officer.
Thank you, Jan. As you may have noticed, we have made some improvements to the earnings release format. On page one, our bullets are more dynamic, focusing on items of interest for the quarter. Right below that, we have a table of select highlights that shows trends from the prior quarter and the year ago quarter. In the text and tables, we focus more on changes from the prior quarter. We hope this helps you with your analysis and understanding.
Turning back to the numbers, for the quarter, net income was $45.7 million, which is up $4.1 million or 9.9% from the prior quarter, and assets were $11.2 billion, down $634 million or 5.4%. In regards to earnings, the primary differences to the prior quarter were net interest income increased by $2.3 million. The increase in net interest income from the prior quarter was driven by the deployment of excess liquidity into investment securities. As rates have increased, it has become more attractive to put more of our excess liquidity to work. The additional interest income from securities was partially offset by lower interest and fees on loans. While loan balances were up for the quarter, higher-yielding loans continued to be replaced by lower-yielding loans.
Additionally, the impact of rising rates, which ramped up throughout the quarter, has not yet fully impacted outstanding adjustable rate loans, a good portion of which are still at their rate floors. New loans, particularly those funded later in the quarter, have yet to have much impact. Non-interest income was down $3.1 million from the prior quarter. Our FHA group had a good year-end 2021, but FHA multifamily income, which can be inconsistent quarter to quarter, and revenue for that business was down to start the year. The impact of a higher rate environment also reduced gain on sale from investment securities, and residential mortgage activity was also reduced.
Lock commitments for residential mortgage loans were $137 million, down from $163 million in the prior quarter. Non-interest expense was down $8.3 million from the prior quarter. Legal, accounting, and professional fees were down $1.4 million. As Susan mentioned, the largest change to non-interest expense was a one-time reduction in salaries and employee benefits. Absent the $5 million accrual reduction, salaries and employee benefits were down $2.6 million, primarily on lower incentive bonus accrual, offset by increases in share-based compensation and payroll taxes.
The $5 million accrual reduction also positively impacted the efficiency ratio, bringing it down to 35.3% for the first quarter 2022, compared to 44.3% for the prior quarter, and it lowered the effective tax rate to 23.4%, compared to 26.3% for the prior quarter. The reduction in the effective tax rate from the prior quarter was because the one-time adjustment was not tax-deductible when recorded. Conversely, there was no negative tax impact when reversed. On the balance sheet, assets declined by $634 million. We had a small decline in deposits of $395 million at quarter end, and paid off a $150 million FHLB advance during the quarter.
These reductions of liabilities, along with an increase in securities of $306 million, reduced some of our excess liquidity. The biggest movement on the balance sheet, though, was that we transferred $1.1 billion of securities from available for sale to held to maturity. There's no impact of this transfer on the income statement. The unrealized loss associated with the held to maturity portfolio will amortize off with the life of those securities. In regards to the transfer of securities to held to maturity, the impact of rising rates during the quarter created unrealized losses in the available for sale securities portfolio, which negatively impacted equity on the balance sheet. These unrealized losses reduced equity, as well as both book value and tangible book value.
During the quarter, we evaluated our securities portfolio and determined that certain securities will be maintained for the life of the instrument and made a decision to change the accounting designation to held to maturity. The securities transferred were generally municipal bonds, corporate bonds that we buy for CRA credit, and longer final maturity mortgage-backed securities. Having these securities designated as held to maturity will mitigate some of the impact of future changes in interest rates on equity, book, and tangible book values. With regards to interest rate sensitivity, we believe our asset-sensitive balance sheet remains well-positioned to take advantage of higher interest rates in the future. For net interest margin, we are up 10 basis points to 265 on a linked-quarter basis. The reduction of excess liquidity and the deployment of cash into securities had a positive impact.
Looking at our cost of funds, it was unchanged at 26 basis points. While not much changed during the quarter, toward the end of March, we raised rates on most interest-bearing demand deposit accounts by 5 basis points, and FHLB advances of $150 million were repaid. Another measure impacting funding costs is average non-interest-bearing deposits to average deposits. The bank has historically done well, averaging 36.1% in this quarter, down slightly from 36.3% the prior quarter. Overall, in terms of rate sensitivity, we are asset sensitive and should benefit from rising rates as loans come off the floor and reprice, and a large percentage of our deposits are non-interest-bearing. With that, I'll hand it back to Susan for a short wrap-up.
Thanks, Charles. As we wrap up our commentary, I would like to thank all of our employees for all their hard work, and it's been really great to see people in person on a regular basis. All of us here at Eagle are encouraged to continue the momentum we had closing out 2021. We feel good about our company, our balance sheet, and our ability to provide our clients with a superior level of service in a highly competitive, strong, and dynamic market. As always, we remain committed to a culture of respect, diversity, and inclusion in both the workplace and the communities we serve. With that, we will now open things up for questions.
As a reminder, to ask a question, you will need to press star one on your telephone, and to withdraw your question, just press the pound key. Please stand by while we compile the Q&A roster. Our first question will come from the line of Casey Whitman from Piper Sandler. Your line is open.
Hey, good morning.
Hi, Casey.
Good morning, Casey.
Hi. Nice quarter. Just starting out, you saw you already started increasing your deposit rates. Just kind of curious, are you a first mover there, or are you seeing competitors, you know, in your market start to move as well? Then sort of tacking onto that, Charles, you mentioned your asset sensitivity. Just remind us sort of what kind of deposit betas we should assume for you guys as we get rate hikes.
Yeah, sure thing. Yeah, I think, you know, we're seeing kind of the prudent movement of rates, and that's the approach that we're taking. You know, I think the rates that we had for time deposits previously were not really compelling too many people to move into time deposits. With the Fed's first move, again, we wanted to be prudent about starting to layer in some time deposits as we're now facing forecasts of, you know, seven to eight, according to the futures markets, 25 basis points moved by the Fed before the end of the year.
To the extent that we can capture some of those time deposits and just again compel some folks to lock in some of those rates, I think that's useful for us. In terms of asset sensitivity, you know, we're looking just to provide some context at up 100 basis points, resulting in net interest income of an additional 1.9%, up 200 basis points at 6.2%, as we, you know, blow through some of the floors. Deposit betas on that front, on net, we're modeling about a 50 deposit beta.
You know, there's been some spirited discussion with regard to whether or not that may be even a little conservative, and we can count on lower. You know, the pace at which rates are moving up. I think we feel pretty comfortable with that as a measure at this point.
Okay. What kind of duration are we looking at for that held to maturity book now? Do you know for the screen?
I've got the duration on the overall portfolio right at 5.6 years, the total duration. The AFS duration is right at 4.8 years.
Okay. Got it. I'll just turn over to one other thing. I mean, your efficiency ratio is best in class. Just trying to get my arms around some of the quarterly expense moves that you guys have. Is this first quarter level of core expenses, which I'll call around $36 million, a pretty good starting point, just as I look in particular at the salaries and benefits line? And then, you know, I appreciate there's no material up in legal expenses, but is this a good run rate, I guess, just for that line item, or could we see some more, I don't know, volatility there in those expenses in particular?
As you know that the line item includes more than just legal fees, but it is accurate that the legal fees associated with our Aurelius Value related investigations and litigation matters have declined. The litigation matters have been settled and the fact-finding and document production phase of the government investigations we believe are complete at this point. Our outside counsel spend going forward should relate to the cost associated with resolving those matters, as well as any indemnifiable costs associated with our current and former officers once our D&O insurance has been fully exhausted.
The policy has some remaining limit still, but as we have disclosed in the past, it is nearing exhaustion, and it's really impossible to predict the exact timing of when the investigations will be wrapped up, when the policy will be exhausted or the actual amount of outside counsel costs as we don't control or have complete transparency into those indemnifiable costs. We continue to remain hopeful that the investigations will be resolved in the near future and, you know, we'll have a more reasonable legal cost and legal expenditure going forward after that.
Okay. On the salaries line, is this a pretty good starting point at around $22 million?
Yeah. It is. I think, you know, we again, you got to exclude the reversal which I think we're all comfortable with, or the reduction of that accrual. You know, last year was a very strong year, so the incentive bonus accruals were weighed heavy in that number. We're kind of just getting started here and as you know, we get a better feel for this year, that annual incentive accrual will come more into focus. For now, I think we're in an okay place there.
Okay. Holding the efficiency ratio in the low 40s%, though, is a reasonable place to be?
Yes.
Okay. All right. Nice quarter. Thanks for the call.
Thanks, Casey.
Next question comes from the line of Catherine Mealor from KBW. Your line is open.
Thanks. Good morning.
Good morning, Catherine.
Good morning, Catherine.
Maybe one more thing on the margin. As we think about excess liquidity, how quickly are you feeling like you'll be able to deploy this? We saw a big move this quarter. Maybe just kind of walk us through how you're thinking about that and maybe how deposit growth outlook plays into that assumption. Thanks.
Sure. Yeah. I think the deployment of that excess liquidity into the investment portfolio will continue at, you know, somewhere around this clip of the first quarter, all things being equal, obviously. We're seeing better opportunities in the investment portfolio for higher yielding instruments these days. Certainly more encouraged by that and looking to deploy the cash that's rolling off that securities portfolio back into the best and highest use, which, you know, we hope is loans. In the absence of that, there's some, again, some pretty healthy yields as it relates to the investment portfolio. I'm sorry, the deposit gathering, I think, was the second part of your question.
Yeah, we're continuing to look to incent depositors and maintain depositors here at the bank. In terms of growth, it's difficult to tell. You know, as rates rise and again, with the forecast of rates and rate moves, I think the futures market had a 90% probability of a 50 basis point move in early May with the FOMC. There are going to be more opportunities for depositors to place their funds into higher yielding instruments. We wanna make sure that we're playing appropriate defense on that front. Hopefully that gives you a little bit of color in terms of our thinking.
Yes. Yeah, no, that helps. Maybe on the security, so you're now at about 23% of average earning assets. Is there a limit in terms of the percentage of the balance sheet that you would wanna take that to?
I don't have a specific limit, Catherine. I think it really is looking at what's the best, you know, opportunity for return, between those securities and the loans. I'm happy to keep climbing if that is where the money's doing us and the shareholders the best good.
Got it. Okay. Got it. Maybe one last on the margin, just thinking about loan yields. I know this is an impossible question, but just kind of thinking about the puts and takes. Your loan yields declined this quarter, and now you're at 4.37%. You've got downward pricing still on new production, but obviously we've got the impact of higher rates that will be a tailwind. I mean, do you think we've hit the bottom in loan yields, or do you think we still have a little bit of decline before we start to get the lift from higher rates? How do you think about that, you know, those two dynamics?
I think the tension really becomes between the excess liquidity both on our balance sheet and in the marketplace and the rising rates. I do think that the impact of rising rates will positively impact our loan yields. In terms of new loan pricing, though, that's where I think credit spreads are still being somewhat held at bay, if you will, as a result of a lot of the excess liquidity in the marketplace. You know, again, as rates rise, should there be more disintermediation in the marketplace as it relates to deposits and liquidity, you know, comes in a little bit, I think those credit spreads get out.
That's kind of my crystal ball view, but, you know, your guess is as good as mine. I think you're right.
Yeah.
It's kind of an impossible task to forecast that. I do think that there's a positive, you know, we'll have the wind at our backs in terms of an increased rate environment.
Yeah. Remind us what percentage of the loan book is floating?
57%.
Okay. Just checking. Yep. Okay, great. Thanks for answering all my questions. Appreciate it.
Sure.
Our next question will come from the line of Christopher Marinac from Janney Montgomery. You may begin.
Thanks. Good morning. I just wanna get into loan yields and how they may have changed as March finished and kind of how you see that playing out this quarter, even before the Fed makes their next move?
Yeah, sure. I mean, again, as you know, Catherine and I were discussing that, the loan yields have certainly, you know, come in with the in terms of what kind of loans are rolling off and the yields of loans rolling off versus yields of loans coming on. You know, I'd say we're kind of right around a, you know, new origination somewhere in the neighborhood of around a 4% yield at this point, so that's-
Charles, I would agree with that, but I think a lot of what you're seeing in terms of funding now are loans that were approved, say, 60, 90 days ago. The impact of rising rates hasn't fully been incorporated. Things that we're looking at today in terms of new loan approvals might be at more advantageous rates to the bank, reflecting the change in interest rates in the market. There's just a natural time delay between approving loans and having them booked and funded that I think shows up in a lag in changes in rates.
It's worth noting, Jan and I were talking about this just before the call, that the majority of the loans that we're booking, we're still seeing a number of variable rate loans that we're putting on. Those are still well positioned to support the loan yields going forward as rates rise.
Great. That's helpful. Thank you both for that. Jan, just a quick one about net charge-offs. Do you see anything on the horizon where charge-offs change materially from here? I mean, I know we all expect some reversion over time, but just curious kind of in the next couple quarters if anything changes at all?
Well, if you're one of those folks that subscribe to the belief that 30-89 day past dues are an indicator, they're as low as I've seen them in several years. I'm pretty comfortable with where we are, which isn't to say something couldn't come out of the blue and shock me. I think, for right now, I'm cautiously optimistic that charge-offs will not become out of control.
Great, Jan. Good point. Thank you again.
Mm-hmm.
Thanks, Chris.
Our next question will come from the line of Brody Preston from Stephens. You may begin.
Hey, good morning, everyone.
Hey, good morning, Brody.
Hey, Charles. I think you said it earlier, and I saw it in the press release last night, that five basis points. Is that you've raised it an average of five basis points, or is that at least five basis points on most interest-bearing products? Just because the CDs, obviously, I think I've seen anywhere from, like, a 20- to 100-basis point increase in CD rates from you all, depending on the maturity profile.
Right. The 5 basis points was really on money market savings accounts. You know, where the CDs are concerned, again, we're coming off lows where we weren't really writing CDs in. The rates that we had previously were not compelling anybody to take us up on those CD offers. Hence, you're gonna have a pretty significant move when you're coming back into the market. I think that, you know, the way that we've come back in, again, we're looking to prudently layer in, you know, and ladder in time deposits as we see, you know, rates continuing to rise and again, the future market expectations of rate increases. That's why it looks so dramatic in terms of a large rate increase on the CD front.
Got it. Okay. Thank you for that clarification. And then just on the FHLB borrowing repayment, it kind of ties into the liquidity question. You guys have put a lot of excess liquidity to work. Obviously, on a period end basis, there can be volatility in the deposit base just given the chunkiness of it. I mean, how should we be thinking about just average deposit trends are still pretty solid. How should we be thinking about the remainder of the FHLB advances? What's the duration on those, or could we see a similar kind of prepayment going forward?
Yeah. I think, you know, there's $150 million left and, you know, that was a callable ten-year, and the call option is at the option of the FHLB. I expect that if we don't go ahead and extinguish that one in short order that it gets called away. You know, again, that'll leave us with the availability of, you know, call it $1.2 billion or so in FHLB advances should the need arise.
Got it. Okay. Thank you for that. Jan, I heard you loud and clear on the credit quality. I guess I did just wanna circle back to the office portfolio. You know, the trends that we're kind of seeing, at least from a high level based on the data that we have access to, shows that, you know, D.C. is still lagging like a lot of the rest of the country is in terms of return to office. Are you seeing that holistically amongst your borrowers, or are you seeing, you know, your borrowers have more of their employees return to the office at this point?
I think we're really seeing a mixed bag. You know, the return to office, I would say, at this point seems to be predominantly the hybrid model, which happens to be what Eagle Bank is using, where you have some flex to work from home a certain amount of time in the week. We are seeing more and more people move towards full-time in the office and really even back to the office at all. I think that's gonna be good for other businesses that operate downtown. For example, Central Business District restaurants that cater to a lunch business have certainly been doing poorly over the last couple of years. I think overall, we haven't had weakness in the portfolio in the office segment.
We are watching it carefully, and I think probably the highest level of concern would be for Class B properties in the Central Business District. We're paying very close attention to those. I think what's a little bit different for us is that there are a number of longer-term leases that are in the market, government leases. You look at the new SEC facility that apparently is being recontemplated at this point, and the location hasn't been determined yet, but that's you know, 1 million sq ft of office. There's a lot of activity to fill office, but we're still cautious on it. We've put an overlay into our reserve to reflect the qualitative aspect of Central Business District downtown office buildings as we wait to see what happens.
Honestly, I think it's gonna be a question of whether the productivity in office is better, worse, or the same as remote working, and businesses will make that judgment as they go forward. The labor market is so tight right now that I think it's probably more difficult to have a mandatory return to office, but that could shift in six months. It's really tough to project. All we can do is hedge against the risk that we see.
Yep. Understood. Thank you for that. I guess this is my last one. I would ask you, just given the experience, the extensive experience you guys have with real estate, you know, what is the typical kinda outcome, or what would you expect maybe for some of those office buildings that, you know, maybe have stronger sponsors but, you know, aren't desirable in terms of office going forward from a lease-up perspective? Is it repurposing of those properties? You know, what's the most kinda logical repurpose that you see? Is it going from office to apartment over time? Just help me think about sort of the longer-term ramifications at this juncture.
I think it depends on the building, to be honest with you, and what the costs are of retrofitting to a, you know, a multifamily property. I think, D.C. is very anxious to assist in converting office to residential. We still have a shortage of housing in the D.C. metro area, so there are, I would say at this point, a smattering of conversions in process. There may be more, but I suspect that right now most folks are still getting paid on the leases that are in place, even if they're not being full-time occupied. So this will play out over time. I do think the most likely is conversion to multifamily with maybe a little retail space on the first floor.
Got it. Thank you for that. Thank you for taking all my questions. I appreciate it.
Mm-hmm.
Thanks, Brody.
Thank you. I'm not showing any further questions indicated at this moment. I'd like to turn the call back over to our President and CEO, Susan Riel, for any closing remarks.
We thank you and appreciate your questions and you taking the time to join us on the call. We very much look forward to speaking again in a few months.
This concludes today's conference call. Thank you for participating. Everyone can disconnect at this time.