Eagle Bancorp 10-Q 2006
Documents found in this filing:
Washington, D.C. 20549
For the transition period from to .
Commission File Number 0-25923
Eagle Bancorp, Inc
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act
Yes o No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
As of October 30, 2006, the registrant had 9,435,754 shares of Common Stock outstanding.
Item 1 Financial Statements
EAGLE BANCORP, INC.
Consolidated Balance Sheets
September 30, 2006 and December 31, 2005
(dollars in thousands)
See notes to consolidated financial statements.
EAGLE BANCORP, INC.
See notes to consolidated financial statements.
(1) Adjusted to reflect the 1.3 for 1 stock split in the form of a 30% stock dividend paid on July 5, 2006
EAGLE BANCORP, INC.
Consolidated Statements of Cash Flows
For the Nine Month Periods Ended September 30, 2006 and 2005 (unaudited)
(dollars in thousands)
See notes to consolidated financial statements.
EAGLE BANCORP, INC.
See notes to consolidated financial statements.
EAGLE BANCORP, INC.
1. BASIS OF PRESENTATION
The consolidated financial statements of Eagle Bancorp, Inc. (the Company) included herein are unaudited; however, they reflect all adjustments, consisting only of normal recurring accruals, that in the opinion of Management, are necessary to present fairly the results for the periods presented. The amounts as of and for the year ended December 31, 2005 were derived from audited consolidated financial statements. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. There have been no significant changes to the Companys Accounting Policies as disclosed in the Companys Annual Report on Form 10-K for the year ended December 31, 2005. The Company believes that the disclosures are adequate to make the information presented not misleading. The results of operations for the three and nine months ended September 30, 2006 are not necessarily indicative of the results of operations to be expected for the remainder of the year, or for any other period. Certain reclassifications have been made to amounts previously reported to conform to the classification made in 2006.
2. NATURE OF OPERATIONS
The Company, through its bank subsidiary, provides domestic financial services primarily in Montgomery County, Maryland and Washington, DC. The primary financial services include real estate, commercial and consumer lending, as well as traditional deposit and repurchase agreement products. The Bank is also active in the origination and sale of residential mortgages and small business loans. In July 2006, the Company formed Eagle Commercial Ventures, LLC as a direct subsidiary to provide subordinate financing for the acquisition, development and construction of real estate projects, whose primary financing would be provided by EagleBank.
3. CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, and federal funds sold.
Amortized cost and estimated fair value of securities available for sale are summarized as follows:
Gross unrealized losses and fair value by length of time that the individual available securities have been in a continuous unrealized loss position as of September 30, 2006 are as follows:
The unrealized losses that exist are the result of changes in market interest rates since original purchases. All of the bonds are rated AAA. The weighted average life of debt securities, which comprise 94% of total investment
securities amortized cost, is relatively short at 2.65 years. These factors, coupled with the Companys ability and intent to hold these investments for a period of time sufficient to allow for any anticipated recovery in fair value substantiates that the unrealized losses are temporary in nature.
The Company employs the liability method of accounting for income taxes as required by Statement of Financial Accounting Standards No. 109 (SFAS109), Accounting for Income Taxes. Under the liability method, deferred-tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse.
Earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period, including any potential dilutive common shares outstanding, such as stock options. As of September 30, 2006 there were no shares excluded from the diluted net income per share computation.
Earnings per share for all periods presented have been adjusted for a 30% stock dividend paid in the form of a 1.3 to 1 stock split on July 5, 2006.
The Company maintains the 1998 Stock Option Plan (1998 Plan) and the 2006 Stock Plan (2006 Plan). No additional options may be granted under the 1998 Plan. The 1998 Plan provided for the periodic granting of incentive and non-qualifying options to selected key employees and members of the Board. Option awards were made with an exercise price equal to the market price of the Companys shares at the date of grant. The option grants generally vested over a period of one to two years.
The Company adopted the 2006 Plan upon approval by shareholders at the 2006 Annual Meeting held on May 25, 2006. The Plan provides for the issuance of awards of incentive options, nonqualifying options, restricted stock and stock appreciation rights with respect to up to 650,000 shares (as adjusted for the 1.3 to 1 stock split paid on July 5, 2006). The purpose of the 2006 Plan is to advance the interests of the Company by providing directors and selected employees of the Bank, the Company, and their affiliates with the opportunity to acquire shares of common stock, through awards of options, restricted stock and stock appreciation rights.
The Company also maintains the 2004 Employee Stock Purchase Plan (the ESPP). Under the ESPP, a total of 253,500 shares (as adjusted for the 1.3 to 1 stock split paid on July 5, 2006) of common stock, were reserved for issuance to eligible employees at a price equal to at least 85% of the fair market value of the shares of common stock on the date of grant. Grants each year expire no later than the last business day of January in the calendar year following the year in which the grant is made.
The Company believes that awards under all plans better align the interests of its employees with those of its shareholders.
For periods prior to 2006, the Company used the average of the option term and the vesting period to estimate the life of the option.
The options granted in the first quarter of 2006 were for 34,099 shares under the ESPP which have a one-year term and vested immediately upon grant, and for 1,500 shares granted under the 1998 Plan which vest over a two year period.
In July, the Company awarded 12,039 stock appreciation rights to six senior officers to be settled in the Companys common stock following a three year service vesting period. The Company also granted performance based restricted stock, which vests at the end of a three-year period, which award is based on the achievement of specified net income goals. Restricted share awards are being recognized as compensation expense over a three year performance period based on the market value of the shares at the date of grant. This compensation expense will be evaluated quarterly as to share awards based on an assumption of achievement of target goals.
The fair value of each option grant and other equity based award is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants during the nine months ended September 30, 2006 and the year ended December 31, 2005.
Following is a summary of changes in shares under option for the periods indicated (the data for all periods has been adjusted to reflect the 1.3 for 1 stock spilt in the form of a 30% stock dividend paid on July 5, 2006).
As of December 31, 2005, there was approximately $134 thousand of total unrecognized compensation cost related to non-vested shares under the 1998 Plan. There was no unrecognized compensation cost under the ESPP. The $134 thousand cost is being amortized over the remaining service (vesting) period. Through September 30, 2006, $107 thousand has been recognized in compensation cost related to those grants. In February 2006, the Company granted options for 34,099 shares under the ESPP. These awards were vested 100% at grant and the fair value of the awards was expensed in the quarter ended March 31, 2006. This amount was $134 thousand. In late February 2006, the Company granted 1,500 shares under the 1998 Plan, whose fair value of $8 thousand is being amortized ratably over 2 years. In July, the Company granted stock appreciation rights and restricted stock shares whose fair value is estimated at $308 thousand and is being amortized over 30 months. The amortized fair value recognized for these grants for the quarter ended September 30, 2006 was $30 thousand.
In total, the Company recognized $67 thousand ($0.01 per share) and $271 thousand ($0.03 per share) respectively in share based compensation expense for the three and nine months ended September 30, 2006 as compared to no compensation expense recognized for the three and nine months ended September 30, 2005, as FAS123R was adopted as of January 1, 2006.
Prior to January 1, 2006, share based compensation at the Company was disclosed in a footnote, as `pro-forma information, in accordance with generally accepted accounting principles as opposed to recognition within the Statement of Operations. For the three and nine months ended September 30, 2005, the pro-forma share based compensation amounts were $113 thousand ($0.02 per share) and $626 thousand ($0.09 per share).
The estimated intrinsic value of outstanding and exercisable options at September 30, 2006 is $9.7 million and $9.6 million, respectively.
8. NEW ACCOUNTING STANDARDS
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of SFAS No. 133 and SFAS No. 140. This statement permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. It establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. In addition, SFAS 155 clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133. It also clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. SFAS 155 amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This Statement is effective for all financial instruments acquired or issued after the beginning of an entitys first fiscal year that begins after September 15, 2006. The Company does not presently have any derivative instruments and believes this new accounting standard will have no impact on its financial condition or results of operation.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets. This Statement amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable, and permits the entities to elect either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of SFAS No. 140 for subsequent measurement. The subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value eliminates the necessity for entities that manage the risks inherent in servicing assets and servicing liabilities with derivatives to qualify for hedge accounting treatment and eliminates the characterization of declines in fair value as impairments or direct write-downs. This Statement is effective as of the beginning of an entitys first fiscal year that begins after
September 15, 2006. The Company is evaluating the impact, if any, of the adoption of this Statement on its financial results.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 clarifies when tax benefits should be recorded in financial statements, requires certain disclosures of uncertain tax matters and indicates how any tax reserves should be classified in a balance sheet. FIN 48 is effective for us in the first quarter of fiscal 2008. We are evaluating the impact if any of FIN 48 on our results of operations and financial condition.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R) (SFAS 158). SFAS 158 requires an employer to recognize in its statement of financial position an asset for a plans over funded status or a liability for a plans under funded status, measure a plans assets and its obligations that determine its funded status as of the end of the employers fiscal year (with limited exceptions), and recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in our comprehensive income and as a separate component of stockholders equity. SFAS 158 is effective for us in the fourth quarter of fiscal 2007. The Company does not offer any defined benefit retirement plans and therefore believes this new accounting standard will have no impact on its financial condition or results of operation.
In September 2006, the SECs Office of the Chief Accountant and Divisions of Corporation Finance and Investment Management released SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB No. 108), that provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. This pronouncement is effective for fiscal years ending after November 15, 2006. The Company believes the adoption of SAB No. 108 will have no material impact on its financial position, results of operations, or cash flows.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157). This statement provides a single definition of fair value, a framework for measuring fair value, and expanded disclosures concerning fair value. Previously, different definitions of fair value were contained in various accounting pronouncements creating inconsistencies in measurement and disclosures. SFAS No. 157 applies under those previously issued pronouncements that prescribe fair value as the relevant measure of value, except SFAS No. 123(R) and related interpretations and pronouncements that require or permit measurement similar to fair value but are not intended to measure fair value. This pronouncement is effective for fiscal years beginning after November 15, 2007. The Company is evaluating the impact of this new standard, but currently believes that adoption will not have a material impact on its financial position, results of operations, or cash flows.
Item 2 - Managements Discussion and Analysis of Financial Condition and Results of Operation.
The following discussion provides information about the results of operations, and financial condition, liquidity, and capital resources of the Company and its subsidiaries. This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this report and the Management Discussion and Analysis in the Companys Annual Report on Form 10-K for the year ended December 31, 2005.
This report contains forward looking statements within the meaning of the Securities Exchange Act of 1934, as amended, including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies and regarding general economic conditions. In some cases, forward looking statements can be identified by use of such words as may, will, anticipate, believes, expects,
plans, estimates, potential, continue, should, and similar words or phases. These statements are based upon current and anticipated economic conditions, nationally and in the Companys market, interest rates and interest rate policy, competitive factors and other conditions which, by their nature, are not susceptible to accurate forecast, and are subject to significant uncertainty. Because of these uncertainties and the assumptions on which this discussion and the forward looking statements are based, actual future operations and results in the future may differ materially from those indicated herein. Readers are cautioned against placing undue reliance on any such forward looking statements.
Eagle Bancorp, Inc. is a growth oriented, one-bank holding company headquartered in Bethesda, Maryland. We provide general commercial and consumer banking services through our wholly owned banking subsidiary EagleBank, a Maryland chartered bank which is a member of the Federal Reserve System. We were organized in October 1997, to be the holding company for the Bank. The Bank was organized as an independent, community oriented, full service banking alternative to the super regional financial institutions, which dominate our primary market area. Our philosophy is to provide superior, personalized service to our customers. We focus on relationship banking, providing each customer with a number of services, becoming familiar with and addressing customer needs in a proactive, personalized fashion. The Bank currently has six offices serving Montgomery County and three offices in the District of Columbia. The Company opened its ninth community banking office in May 2006 in Chevy Chase, Montgomery County, Maryland. In July 2006, the Company formed Eagle Commercial Ventures, LLC as a direct subsidiary to provide subordinate financing for the acquisition, development and construction of real estate projects, whose primary financing is provided by EagleBank.
The Company offers a broad range of commercial banking services to our business and professional clients as well as full service consumer banking services to individuals living and/or working primarily in our service area. We emphasize providing commercial banking services to sole proprietors, small and medium-sized businesses, partnerships, corporations, non-profit organizations and associations, and investors living and working in and near our primary service area. A full range of retail banking services are offered to accommodate the individual needs of both corporate customers as well as the community we serve. These services include the usual deposit functions of commercial banks, including business and personal checking accounts, NOW accounts and money market and savings accounts, business, construction, and commercial loans, equipment leasing, residential mortgages and consumer loans and cash management services. We have developed significant expertise and commitment as an SBA lender, have been designated a Preferred Lender by the Small Business Administration (SBA), and are the leading community bank SBA lender in the Washington D.C. district.
CRITICAL ACCOUNTING POLICIES
The Companys consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, the consolidated financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.
The allowance for credit losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two principles of accounting: (a) Statement on Financial Accounting Standards (SFAS) 5,
Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and are estimable and (b) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued when it is probable that the Company will not collect all principal and interest payments according to the contractual terms of the loan. The loss, if any, can be determined by the difference between the loan balance and the value of collateral, the present value of expected future cash flows, or values observable in the secondary markets.
Three components comprise our allowance for credit losses: a specific allowance, a formula allowance and a nonspecific or environmental factors allowance. Each component is determined based on estimates that can and do change when actual events occur.
The specific allowance allocates an allowance to identified loans. A loan for which reserves are individually allocated may show deficiencies in the borrowers overall financial condition, payment record, support available from financial guarantors and or the fair market value of collateral. When a loan is identified as impaired, a specific reserve is established based on the Companys assessment of the loss that may be associated with the individual loan.
The formula allowance is used to estimate the loss on internally risk rated loans, exclusive of those identified as requiring specific reserves. Loans identified in the risk rating evaluation as substandard, doubtful and loss, are segregated from non-classified loans. Classified loans are assigned allowance factors based on an impairment analysis. Allowance factors relate to the level of the internal risk rating with loans exhibiting higher risk ratings receiving a higher allowance factor.
The nonspecific or environmental factors allowance is an estimate of potential loss associated with the remaining loans (those not identified as either requiring specific reserves or having classified risk ratings). The loss estimates are based on more global factors, such as delinquency trends, loss history, trends in the volume and size of individual credits, effects of changes in lending policy, the experience and depth of management, national and local economic trends, any concentrations of credit risk, the quality of the loan review system and the effect of external factors such as competition and regulatory requirements. The environmental factors allowance captures losses whose impact on the portfolio may have occurred but have yet to be recognized in the other allowance factors.
Management has significant discretion in making the judgments inherent in the determination of the provision and allowance for credit losses, including, in connection with the valuation of collateral, a borrowers prospects of repayment, and in establishing allowance factors on the formula allowance and nonspecific or environmental allowance components of the allowance. The establishment of allowance factors is a continuing evaluation, based on managements ongoing assessment of the global factors discussed above and their impact on the portfolio. The allowance factors may change from period to period, resulting in an increase or decrease in the amount of the provision or allowance, based upon the same volume and classification of loans. Changes in allowance factors have a direct impact on the amount of the provision, and a related, after tax effect on net income. Errors in managements perception and assessment of the global factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs. Alternatively, errors in managements perception and assessment of the global factors and their impact on the portfolio could result in the allowance being in excess of amounts necessary to cover losses in the portfolio, and may result in lower provisioning in the future. For additional information regarding the allowance for credit losses, refer to the discussion under the caption Allowance for Credit Losses below.
Beginning in January 2006, the Company adopted the provisions of Statement on Financial Accounting Standards (SFAS) 123R, which requires the expense recognition for the fair value of share based compensation awards, such as stock options, restricted stock, performance based shares and the like. This standard allows management to establish modeling assumptions as to expected stock price volatility, option terms, forfeiture rates and dividend rates which directly impact estimated fair value. The accounting standard also allows for the use of alternative option pricing models which may impact fair value as determined. The Companys practice is to utilize reasonable and supportable assumptions which are reviewed with the appropriate Board Committee.
The Company reported net income of $5.9 million for the nine months ended September 30, 2006, as compared to net income of $5.5 million for the nine months ended September 30, 2005, an increase of 7%. Income per basic share was $0.62 for the nine month period ended September 30, 2006, as compared to $0.59 for the same period in 2005. Income per diluted share was $0.60 for the nine months ended September 30, 2006, as compared to $0.56 for the same period in 2005.
For the three months ended September 30, 2006, the Company reported net income of $1.9 million as compared to $2.3 million for the same period in 2005, a decrease of 16%. Income per basic share was $0.20 and $0.19 per diluted share for the three months ended September 30, 2006, as compared to $0.25 per basic and $0.23 diluted share for the same period in 2005.
Earnings per share for all periods have been adjusted to reflect a 1.3 for one stock spilt in the form of a 30% stock dividend paid on July 5, 2006
The Company had an annualized return on average assets of 1.13% and an annualized return on average equity of 11.54% for the first nine months of 2006, as compared to returns on average assets and average equity of 1.23% and 12.07%, respectively, for the same nine months of 2005.
For the three months ended September 30, 2006, the Company had an annualized return on average assets of 1.05% and an annualized return on average equity of 10.84%.
The increase in net income for the nine months ended September 30, 2006 as compared to the same period in 2005 can be attributed substantially to an increase of 15% in net interest income, resulting from an increase of 18% in average earning assets and a decline in the net interest margin of 13 basis points. Since June 2004, the Federal Reserve Bank increased the federal funds target rate by 425 basis points to 5.25% in seventeen interest rate increases of 25 basis points each. Through the year ended December 2005, the impact of these interest rate increases was to contribute to gains in the Companys net interest margin as the higher interest rates impacted asset yields more than the higher interest rates impacted funding costs. For the nine months ended September 30, 2006, the Company has experienced a slight decline in its net interest margin as the funding mix has shifted to more interest bearing deposits and borrowed funds and as the costs of those funds increased. For the nine months ended September 30, 2006, average interest bearing liabilities funding average earning assets increased to 72% as compared to 70% for the first nine months of 2005. Additionally, while the average rate on earning assets for the nine month period ended September 30, 2006 as compared to 2005 has risen by 114 basis points from 6.25% to 7.39%, the cost of interest bearing liabilities has increased by 172 basis points from 1.76% to 3.48%, resulting in a decline in the net interest spread from 4.49% for the nine months ended September 30, 2005 to 3.91% for the nine months ended September 30, 2006. The 13 basis point decline in the net interest margin has been less than the decline in the net interest spread as the Company continues to benefit from a significant amount of average noninterest bearing funding sources. For the nine months ended September 30, 2006, average noninterest sources funding earning assets was $183 million as compared to $165 million for the same period in 2005. The combination of higher levels of market interest rates and the increase in noninterest funding sources has resulted in an increase in the value of noninterest sources funding earning assets from 52 basis points for the first nine months in 2005 to 97 basis points for the nine months ended September 30, 2006.
As a result of competitive pressures, rates paid on deposits, which have been increasing to meet funding needs, may continue to have increases in future periods, which may not be offset by further increases in interest rates on earning assets. As a result of such potential margin compression, the Companys earnings could be adversely impacted.
Loans, which generally have higher yields than securities and other earning assets, increased from 83% of average earning assets in the first nine months of 2005 to 86% of average earning assets for the same period of 2006. Investment securities for the first nine months of 2006 amounted to 11% of average earning assets as compared to
13% for the first nine months in 2005. This decline was directly related to average loan growth over the past twelve month period exceeding the growth of average deposit and other funding sources.
The provision for credit losses was $1.4 million for the first nine months in 2006 as compared to $1.3 million for the same period in 2005. This increase was largely attributable to specific reserves on a significant problem commercial loan relationship identified in August 2006 offset somewhat by slower growth in the loan portfolio in the first nine months of 2006, as compared to 2005. As discussed in the section on Allowance for Credit Losses, the Company had $357 thousand of net credit losses in the first nine months of 2006. This compared to net charge-offs of $55 thousand for the first nine months of 2005. At September 30, 2006, the allowance for credit losses was $7.0 million or 1.19% of total loans, as compared to $5.5 million or 1.09% of total loans at September 30, 2005 and $6.0 million or 1.09% of total loans at December 31, 2005. The provision for credit losses was $711 thousand for the three months ended September 30, 2006 as compared to $424 thousand for the same period in 2005, the increase being attributable to the problem loan relationship mentioned above. For the third quarter of 2006, the Company had net recoveries of $22 thousand as compared to net charge-offs of $83 thousand for the same period in 2005.
Total noninterest income was $2.9 million for the first nine months of 2006 as compared to $3.2 million for the same period in 2005, a decline of 8%. Excluding investment securities gains of $85 thousand for the first nine months in 2006 and $281 thousand for the same period in 2005, noninterest income declined by 2%. This decline was due primarily to lower amounts of gains on the sale of SBA loans which amounted to $689 thousand for the first nine months in 2006 versus $730 thousand for 2005. For the three months ended September 30, 2006, total noninterest income was $1.2 million as compared to $1.2 million for the same period in 2005. Excluding investment securities losses of $71 thousand for the three months ended September 30, 2006 and net securities gains of $269 thousand for the three months ended September 30, 2005, noninterest income increased by 33% for the third quarter of 2006 as compared to the third quarter of 2005. This increase was due substantially to an increase in income from the sale of SBA loans.
Noninterest expenses increased from $14.1 million in the first nine months of 2005 to $16.1 million for the first nine months of 2006, an increase of 14%. The increase was attributable primarily to increases in staff levels, and related personnel cost increases, increased occupancy costs, due in part to new banking offices, and to higher data processing costs, director fees, broker fees, software licensing fees and professional fees associated with a larger organization. The efficiency ratio, which measures the relationship of noninterest expenses to the sum of net interest income and noninterest income was 59.65% for the first nine months of 2006 as compared to 58.52% for the same period in 2005 and was 60.40% for the third quarter of 2006 as compared to 54.01% for the same period in 2005. These ratios increased due to both a decline in the net interest margin in 2006 as compared to 2005 and higher levels of noninterest expenses. Non-interest expenses were $5.7 million for the third quarter of 2006, as compared to $4.7 million for 2005, a 20% increase, due substantially to the same factors mentioned above for the nine month period.
The combination of increases in net interest income from increased volumes offset somewhat by a slightly lower net interest margin, lower levels of noninterest income, an increase in the provision for credit losses and increases in noninterest expenses, resulted in improvement in net income for the first nine months of 2006 versus 2005 of 7%.
For the three month ended September 30, 2006 as compared to 2005, the combination of increases in net interest income from increased volumes offset by a slightly lower net interest margin, higher levels of noninterest income before investment gains and losses, offset by net investment losses as compared to net investments gains in the 2005 period, and significant increases in both the provision for credit losses and increases in noninterest expenses, resulted in a decline in net income during the three month period of 16%.
The ratio of average equity to average assets declined from 10.22% for the first nine of 2005 to 9.75% for the first nine months of 2006. As discussed below, the capital ratios of the Bank and Company remain above well capitalized levels.
Net Interest Income and Net Interest Margin
Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans and investment securities. The cost of funds represents interest expense on deposits, customer repurchase agreements and other borrowings. Noninterest bearing deposits and capital are other components representing funding sources, which factors have been significant in the first nine months of 2006 versus 2005 (refer to discussion above under Results of Operations). Changes in the volume and mix of assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income. Net interest income for the first nine months of 2006 was $24.1 million compared to $20.9 million for the first nine months of 2005, a 15% increase. For the three months ended September 30, 2006, net interest income was $8.2 million as compared to $7.5 million for the same period in 2005, a 9% increase.
The table below labeled Average Balances, Interest Yields and Rates and Net Interest Margin presents the average balances and rates of the various categories of the Companys assets and liabilities. Included in the table is a measurement of interest rate spread and margin. Interest rate spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest expense on interest bearing liabilities. While net interest spread provides a quick comparison of earnings rates versus cost of funds, management believes that margin provides a better measurement of performance. Margin includes the effect of noninterest bearing sources in its calculation and is net interest income expressed as a percentage of average earning assets.
EAGLE BANCORP, INC.
AVERAGE BALANCES, INTEREST YIELDS AND RATES, AND NET INTEREST MARGIN
(dollars in thousands)
(1) Includes Loans held for Sale
Allowance for Credit Losses
The provision for credit losses represents the amount of expense charged to current earnings to fund the allowance for credit losses. The amount of the allowance for credit losses is based on many factors which reflect managements assessment of the risk in the loan portfolio. Those factors include economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company and Bank.
Management has developed a comprehensive analytical process to monitor the adequacy of the allowance for credit losses. This process and guidelines were developed utilizing among other factors, the guidance from federal banking regulatory agencies. The results of this process, in combination with conclusions of the Banks outside loan review consultant, support managements assessment as to the adequacy of the allowance at the balance sheet date. Please refer to the discussion under the caption Critical Accounting Policies for an overview of the methodology management employs on a quarterly basis to assess the adequacy of the allowance and the provisions charged to expense. Also, refer to the following table which reflects the comparative charge-offs and recoveries of prior loan charge-offs.
During the first nine months of 2006, a provision for credit losses was made in the amount of $1.4 million and the allowance for credit losses increased $1.1 million, including the impact of $357 thousand in net charge-offs during the period. The provision of $1.4 million in the first nine months of 2006 compared to a provision of $1.3 million in the first nine months of 2005.
During the three months ended September 30, 2006, a provision for credit losses was made in the amount of $711 thousand and the allowance for credit losses increased $733 thousand, including the impact of $22 thousand in net recoveries during the three month period. The provision for credit losses of $711 thousand in the three months ended September 30, 2006 compared to $424 thousand in the same three months of 2005. The higher level of the provision in the third quarter of 2006 is primarily attributable to reserves provided for a significant commercial lending relationship (approximating $1.9 million) identified as a problem loan in the quarter which is partially secured by real estate and other business assets.
At September 30, 2006, the Company had $2.1 million of loans classified as nonperforming as compared to $2.4 million at June 30, 2006, $491 thousand at December 31, 2005 and $211thousand at September 30, 2005. The Company had no restructured loans at either, September 30, 2006, December 31, 2005 or September 30, 2005. Significant variation in these amounts may occur from period to period because the amount of nonperforming loans depends largely on the condition of a small number of individual credits and borrowers relative to the total loan portfolio. The Company had no Other Real Estate Owned (OREO) at either September 30, 2006, December 31, 2005 or September 30, 2005. The balance of impaired loans was $2.1 million (which includes the $1.9 million commercial loan relationship identified above) at September 30, 2006, with specific reserves against those loans of $678 thousand, compared to $211 thousand of impaired loans at September 30, 2005 with specific reserves of $27 thousand. The allowance for loan losses represented 1.19% of total loans at September 30, 2006 as compared to 1.09% at both December 31, 2005 and September 30, 2005. This increase in the ratio of the allowance was due to two factors as follows: additional reserves provided in the third quarter of 2006 for a large problem commercial loan relationship identified in August 2006 and to a slight increase in the environmental factors of the non-specific reserve component related to various factors including potential impacts of higher interest rates on debt service capacity and on real estate values.
As part of its comprehensive loan review process, the Companys Board of Directors and the Bank Directors Loan Committee and or Board of Directors Credit Review Committees carefully evaluate loans which are past due 30 days or more. The Committee(s) make a thorough assessment of the conditions and circumstances surrounding each delinquent loan. The Banks loan policy requires that loans be placed on nonaccrual if they are ninety days past due, unless they are well secured and in the process of collection.
The maintenance of a high quality loan portfolio, with an adequate allowance for possible loan losses will continue to be a primary management objective in the Company.
The following table sets forth activity in the allowance for credit losses for the periods indicated.
The following table reflects the allocation of the allowance for credit losses at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses or charge-offs and does not restrict the use of the allowance to absorb losses in any category.
(1) Represents the percent of loans in each category to total loans
The Companys nonperforming assets, which are comprised of loans delinquent 90 days or more, non-accrual loans, restructured loans and other real estate owned, totaled $2.1 million at September 30, 2006, compared to $491 thousand at December 31, 2005 and $211 thousand at September 30, 2005. The percentage of nonperforming loans to total loans was 0.35% at September 30, 2006, compared to 0.09% at December 31, 2005 and 0.04% at September 30, 2005.
The following table shows the amounts of nonperforming assets at the dates indicated.
The increase in the level of non-accrual loans at September 30, 2006 as compared to December 31, 2005 was due to the one large commercial loan relationship previously mentioned that was identified in August 2006. Also in the third quarter of 2006, a non-accrual real estate secured loan at June 30, 2006 was returned to accrual status based on s