Howard Bancorp reported a 2Q20 net loss of $(29.4) million compared to 1Q20 net income of $3.3 million.

This translates to EPS of $(1.57) in 2Q20 compared to $0.18 in 1Q20. There were several significant irregular or non-recurring items affecting 2Q20 results. The biggest was a goodwill impairment charge of $34.5 million or $1.84 per share. In addition, a litigation reserve and FHLB prepayment penalties amounted to $1.2 million pre-tax or a $0.05 cut to EPS. Offsetting these to some extent were securities gains of $3.0 million, which provided a boost of $0.12 to EPS. Included in 1Q20 results was a $788k expense related to the departure of the CFO. Excluding these nonrecurring items and the revenues and expenses from the discontinued mortgage operations from both quarters, “adjusted” EPS was $0.20 in 2Q20 and $0.14 in 1Q20. Adjusted 2Q20 results exceeded our $0.19 estimate by a penny and the median Street estimate by $0.07. The outperformance versus our estimate was due to higher net interest income and lower compensation costs, offset partially by a higher-than-expected loan loss provision.

Highlights from the quarter include:

  • Net interest income was $18.1 million in 2Q20, up 3.4% compared to the prior sequential quarter. Average earning assets climbed 7.4% from the prior quarter while the NIM contracted 12 basis points sequentially to 3.22%. Fair value adjustments on acquired loans contributed 9 bps to the NIM this quarter, up from 5 bps in the prior quarter. The main driver of the NIM contraction was a 40 bps decrease in the average yield on loans. Average CRE loan yields fell 54 bps sequentially and construction loan yields declined 58 bps sequentially. In addition, the addition of low-yielding PPP loans reduced average loan portfolio yields by 13 bps. Meanwhile, AFS securities suffered a 47 bps decline in average yields. This drove a 43 bps reduction in average earning asset yields. Meanwhile, the cost of interest bearing liabilities was down 34 bps compared to 1Q20, as a 30 bps drop in the average cost of deposits combined with a 49 bps drop in the cost of FHLB borrowings.
  • Noninterest income rose $1.4 million or 41.4% linked-quarter to $4.8 million. The increase was primarily due to $3.1 million in securities gains recognized during the quarter and a $1.0 million decline in mortgage banking activity after HBMD exited this business line. Lower economic activity also affected service charges on deposit accounts, which fell $0.2 million or 32.6% sequentially, and loan-related income, which declined $0.4 million or 69.9%.
  • Noninterest expenses increased $30.1 million or 227.1% sequentially. The main cause was a $34.5 million goodwill impairment charge. Also contributing to the increase was a $1.0 million accrual for legal expenses related to pre-merger First Mariner mortgage loans and $224k in FHLB prepayment penalties. Absent these items, “core” noninterest expenses were down $431k compared to 1Q20. Decreases $555k in compensation and $77k in data processing expenses were partly offset by a $181k increase in OREO expenses.
  • The provision for loan losses in 2Q20 was $3.0 million, down 12.9% compared to the $3.4 million recorded in 1Q20. HBMD still operates under the incurred loss model, rather than the CECL model adopted by many larger banks at the beginning of 2020. The bank experienced minor net charge-offs of $28k or 0.01% of average loans during the quarter, compared to $462k or 0.11% of average loans in 1Q20. The loan loss reserve climbed $3.0 million or 22.2% from the prior quarter to $16.4 million. Reserve coverage of total loans (excluding PPP loans) advanced to 0.96% from 0.76% at March 31, 2020, while reserve coverage of NPLs grew to 88.6% from 77.8%.
  • NPLs rose $1.3 million or 7.4% sequentially while OREO decreased $0.2 million or 8.0%. Total NPAs (including performing TDRs) advanced 5.5% LQ to 0.84% of total assets from 0.78% at March 31, 2020.
  • Gross loans held-for investment climbed $137.2 million or 7.8% from the prior quarter. The growth was driven by the $199.0 million in PPP loans originated during the quarter. Absent PPP loans, “portfolio” loans declined $56.5 million to $1.7 billion. The decrease was concentrated in C&I loans, which fell $36.1 million, and residential mortgages, which were down $23.0 million. This should result in roughly $6.6 million in fee income to the bank over the life of the loan, offset partially by $770k of deferred origination costs.
  • Total deposits advanced $41.8 million or 2.3% in 2Q20. This fell well short of the $137.2 million growth in gross loans held-for-investment but exceeded the $56.5 million drop in “portfolio” loans. Much of the deposit growth was in noninterest bearing accounts, which rose $188.1 million. With this strong growth in customer deposits, management allowed $109.8 million of brokered and other non-customer deposits to run-off. At the same time, HBMD reduced cash by $136.9 million sequentially and lowered short-term borrowings by $98.0 million The loans-to-deposits ratio jumped to 103.7% from 98.5% at March 31, 2020, driven largely by the PPP loans.
  • Tangible book value per share rose to $13.08 at June 30, 2020 from $12.91 at March 31, 2020. Tangible common equity-to-tangible assets was 10.09% at June 30, 2020 compared to 9.93% at March 31, 2019.
  • The total risk-based capital ratio rose 93 bps sequentially to 14.09% while the Tier 1 leverage ratio advanced 8 bps to 9.18%. All of the regulatory ratios remain well above the levels needed to be considered “well capitalized”.

Earnings Estimates:

Howard has excess liquidity on its balance sheet, much like most other banks in this environment. However, Howard made strides in reducing the excess liquidity in 2Q20 while other banks were still growing theirs. With gradual maturities of higher-cost CDs over the next few quarters, coupled with a boost in yields from the forgiveness of PPP loans and the associated acceleration of PPP fee income, we believe that HBMD may see just a few bps of additional NIM deterioration over the remainder of 2020. For 2021, we are modeling a few bps of NIM improvement each quarter as additional high-cost CDs roll off and PPP loans pay off. Of course, the reduction in PPP loans over the next several quarters will have a negative impact on loan and deposit balances. We expect the loan portfolio to shrink over the next three quarters before slowing PPP payoffs and the resumption of more normal economic activity allows the loan portfolio to resume growth. Deposit balances should follow a similar path.

The company has made significant progress on expense reduction initiatives such as branch consolidations and a core systems conversion. We believe the bulk of the savings from these efforts have been realized, but we still expect expenses to remain low, averaging in the $12.0 million to $12.5 million quarterly range through the end of 2021.

Management notes that asset quality measures have remained very good so far, and that government stimulus programs have likely helped a number of businesses that might otherwise have faltered. At the same time, HBMD has continued to build the credit loss reserve, and we believe that reserve build will continue in 3Q20. We have increased our estimate for the credit loss provision in 3Q20 to reflect this, but we have also boosted the provision for subsequent quarters as well, reflecting the greater length and depth of the COVID-19 pandemic compared to our outlook three months ago.

After making these adjustments, we are reducing our 2020 EPS forecast from $(0.94) to $0.73, mainly reflecting the loss incurred in 2Q20. If we exclude the goodwill impairment and other “non- core” items from 1Q20 and 2Q20 results, our estimate for “core” 2020 EPS is $0.78. We are raising our 2021 estimate from $0.82 to $0.91 and introducing a 2022 estimate of $1.07.

Outlook:

HBMD appears to us to be well positioned to make it through the current crisis while coming out on the other side with above average earnings growth and profitability. The bank’s position as the largest local bank in Baltimore and its performance with the PPP program should help the bank grow its customer base in the area. Meanwhile, the bank has taken steps to increase its presence in the Washington DC area. The bank’s significant portion of fixed-rate loans (roughly $1.0 billion of the portfolio is fixed rate) should dampen any ongoing downward trend in loan yields while higher- cost funding sources continue to mature, helping prevent significant further NIM compression. Expense reduction efforts have been successful and we expect little growth in expenses going forward. With the bank trading well below tangible book value, we believe HBMD remains an attractive investment.

Due to changes in our corporate structure and a desire to avoid conflicts of interest, we are discontinuing the practice of providing target prices and stock ratings in our reports. However, we still believe we have insights to offer and value to add for the small number of securities that we continue to provide research coverage for.

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