EGBN: NIM Compression, Higher Expenses Lead to Estimate Reductions; Reducing Target Price; Downgrading to Neutral Rating.
Eagle Bancorp, Inc. (EGBN – NASDAQ CM – Recent Price: $47.59)
Rating: Neutral / Buy Price: $43.00 / Target (Sell) Price: $49.00
4Q19 Results Summary: Eagle Bancorp reported 4Q19 net income available to common shareholders of $35.5 million, down 2.8% from the $36.5 million posted in 3Q19. On a per share basis, the company recorded 4Q19 results of $1.06 compared to $1.07 in the linked-quarter. The 4Q19 results was in-line with our $1.06 estimate, but a penny below the $1.07 median Street estimate. The quarter was characterized by higher-than-anticipated net interest and noninterest income, offset by higher-than-expected noninterest expenses and a higher effective tax rate. Highlights from the quarter include:
Loans held-for-investment dipped 0.2% sequentially to $7.55 billion. This was below the 1.7% growth we had projected, and down from the 2.3% growth recorded in 3Q19. The main drivers of the decline were the investor-CRE segment, which fell 2.9% sequentially, and the commercial & residential construction segment, which decreased 1.7%. Much of this decline was expected due to payoffs as a number of projects reached completion during the quarter. On the other hand, C&I lending grew 5.4% sequentially, owner-occupied CRE loans advanced 3.0%, and C&I construction rose 9.2%, offsetting most of the declines in investor CRE and commercial & residential construction. Despite the decline in period-end loans, average loans held-for-investment grew 0.5% sequentially. Management notes the loan pipeline remains strong, suggesting continued annual loan growth in the high single-digit range.
Deposits fell 2.4% linked-quarter, with the biggest decline occurring in time deposits, which saw an 8.3% reduction from the prior quarter. Interest bearing demand deposits, which decreased 5.9% in 4Q19 after rising 6.4% in the previous quarter, and savings and money market deposits, which fell 0.7%, also contributed to the linked-quarter decline. Meanwhile, noninterest bearing deposits advanced 0.6% LQ, rising to 28.6% of total deposits, up from 27.7% at September 30, 2019. Core deposits climbed to 82.2% of total deposits at December 31, 2019, up from 81.1% three months earlier. Conversely, CDs fell to 17.8%. of total deposits from 18.9%. The $178.1 million decline in total deposits exceeded loan shrinkage of $13.4 million in 4Q19, leading to an increase in the loans-to-deposits ratio to 104.5% at December 31, 2019 compared to 102.1% at September 30, 2019. While period-end deposit balances declined, average deposits balances for 4Q19 grew 5.4% compared to 3Q19 and 11.0% compared to the year-ago period. Given substantial fluctuations in individual depositor holdings on a day-to-day basis, the average balances may be more indicative of deposit trends.
- Net interest income slipped 0.3% linked-quarter as a 5.8% increase in average earning assets was offset by 23 bps of NIM compression to 3.49%. The NIM compression was driven by a 36 bps drop in average earning asset yields. Average loan yields fell 21 bps from the prior quarter, and loans became a smaller part of the earning asset mix due to increased liquidity. The cost of average interest bearing liabilities declined 23bps LQ, as the cost of interest bearing deposits slipped 20 bps from the prior quarter, and the cost of “other” short-term borrowing fell 98 bps. We expect the excess liquidity on the balance sheet to fall toward more normal levels in 1Q20 and beyond, providing some lift to average asset yields. As a result, we believe that EGBN’s NIM could see some modest improvement in 1Q20. As we noted last quarter, CDs repricing at lower rates going forward and loans reaching floors following last year’s rate cuts should help stabilize the NIM in 2020.
- Noninterest income advanced $420k or 6.7% sequentially to $6.7 million. Eagle recorded $37k in higher loan sale gains, as residential mortgage originations maintained the high level posted in 3Q19. Meanwhile, “other” noninterest income rose $701k, aided by an FHA deal that closed during the quarter and gains on SBA loan sales, but this was partially offset by a $264k decrease in securities gains.
- Noninterest expenses increased $1.3 million or 3.7% compared to 3Q19. The biggest change occurred in FDIC insurance, which jumped $794k sequentially as a result of a $1.1 million credit received in the prior quarter. Professional service fees climbed $496k LQ due to extra legal expenses related to ongoing investigations by government agencies. We expect these expenses to remain elevated for at least another quarter or two. Employee compensation climbed $265k from already elevated levels, as staffing additions, merit increases, and incentives offset the drop related to $2.0 million in accelerated share-based compensation triggered by director resignations in 3Q19. Partially offsetting these increases were a $237k reduction in “other” noninterest expense and a $123k drop in premises and equipment expenses. The company’s efficiency ratio deteriorated modestly to 39.71% from 37.95% in 3Q19 (excluding nonrecurring events). The efficiency ratio remains much better than peer medians.
- Asset quality deteriorated again in 4Q19, but it remains good overall. In 4Q19, NPLs advanced roughly $7.6 million or 18.4%, resulting in an increase in the ratio of NPLs to total loans to 0.65% from 0.54% at September 30, 2019. OREO was unchanged from the prior quarter. As a result, NPAs/Assets rose from 0.47% to 0.56%. Eagle recorded $3.0 million in net charge-offs in 4Q19, resulting in a net charge-off ratio of 0.16% of average loans, up from 0.08% in 3Q19. The loan loss provision was $2.9 million in 4Q19 compared to $3.2 million in 3Q19. Reserve coverage of total loans held steady at 0.98%, unchanged from 0.98% at September 30, 2019.
- Capital levels were mixed in 4Q19, but capital levels remain well in excess of the minimums required to be considered “well capitalized”. The leverage ratio fell to 11.62% from 12.19% at September 30, 2019 while the total capital ratio rose to 16.20% from 16.08%. The company’s tangible common equity ratio, meanwhile, advanced to 12.22% at December 31, 2019 from 12.13% at September 30, 2019. Tangible book value per share rose to $32.67 from $32.02 over the same period.
- Eagle Bank continued with the $0.22 quarterly common stock dividend that was reinstituted in 2Q19. The company announced a share repurchase plan in August, authorizing the repurchase of up to 5.0% of the company’s stock (1.7 million shares) until the expiration of the repurchase authorization on December 31, 2019. Through December 31, 2019, the company repurchased 1,304,500 shares of stock at an average price of $42.06 per share. A new repurchase authorization for 5% of outstanding shares or 1.6 million shares, was announced on December 18th that will expire on December 31, 2020.
Earnings Estimates: Eagle’s 4Q19 EPS was in-line with our expectations. However, the quarter included several items that could affect our expectations for future periods. The decline in the NIM was partially driven by excess liquidity on the balance sheet. We believe the bank will be able to redeploy much of this liquidity into loans in 1Q20 and 2Q20, adding several basis points to average earning asset yields despite the Fed rate cuts in 2019. Still, the excess liquidity did not account for all of the decline in yields, and we do not expect the NIM to recover the entire 23 bps of compression recorded in 4Q19. As a result, we are projecting 9 bps of NIM recovery in 1Q20, and a fairly stable NIM for the remainder of 2020. This represents a lower NIM forecast than our previous model.
Loan growth was below our projection in 4Q19, due partly to payoffs and completions of construction projects. While we believe some of these were temporary or timing issues, and we still see solid high single-digit loan growth going forward, we have adjusted loan growth down slightly going forward to reflect both the lower growth in 4Q19 and a slightly lower growth outlook for the region as a whole.
We have also raised our expense projections going forward. This is mainly the result of elevated legal expenses related to ongoing investigations, along with higher personnel expenses due to staffing additions as the bank bolsters its ranks for the approaching $10 billion in assets threshold.
As a result of these changes, we are reducing our 2020 EPS estimate from $4.36 to $4.24 and lowering our 2021 EPS estimate to $4.45 from $4.53.
Stock Price Implications: Currently, EGBN trades at 148.6% of TBV, an 8.8% discount to the 162.9% multiple on similar-size banks in the Mid-Atlantic and Northeast regions. On a Price-to-Earnings basis, EGBN trades at 11.1x LTM EPS compared to 13.3x for the peer group. We still believe Eagle can generate superior profitability and above average loan growth, and that these factors warrant a premium valuation.
We are using the stock’s current 11.5x EPS multiple (down from the prior 11.9x multiple), applied to our $4.24 EPS estimate for 2020 to arrive at a $49.00 price target. This represents a $2.00 reduction from out prior $51.00 target. Our target price implies upside of 3.0% from the current price. Consequently, we are reducing our rating on shares of Eagle Bancorp to Neutral from Outperform.