Eagle Bancorp 10-Q 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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 July 31, 2007, the registrant had 9,579,572 shares of Common Stock outstanding.
Item 1 Financial Statements
EAGLE BANCORP, INC.
Consolidated Balance Sheets
June 30, 2007 and December 31, 2006
(dollars in thousands)
See notes to consolidated financial statements.
See notes to consolidated financial statements.
(1) Earnings per share for June 30, 2006 have been 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 Six Month
Periods Ended June 30, 2007 and 2006 (unaudited)
See notes to consolidated financial statements.
EAGLE BANCORP, INC.
Statements of Changes in Stockholders Equity
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Six Months Ended June 30, 2007 and 2006 (unaudited)
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, 2006 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, 2006. The Company believes that the disclosures are adequate to make the information presented not misleading. The results of operations for the three and six months ended June 30, 2007 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 2007.
2. NATURE OF OPERATIONS
The Company, through EagleBank, its bank subsidiary (the Bank), conducts a full service community banking business, primarily in Montgomery County, Maryland and Washington, D.C. 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 mortgage loans and the origination of small business loans. The guaranteed portion of small business loans is typically sold through the Small Business Administration, in a transaction apart from the loans origination. The Bank offers its products and services through nine banking offices and various electronic capabilities. 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 done by the Bank. Prior to the formation of ECV, the Company directly engaged in occasional subordinate financing transactions, which involve higher levels of risk with commensurate returns.
3. CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, and federal funds sold (items with an original maturity of three months or less).
4. INVESTMENT SECURITIES
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 June 30, 2007 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 92% of total investment securities, is relatively short at 2.6 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.
5. INCOME TAXES
The Company employs the liability method of accounting for income taxes as required by Statement of Financial Accounting Standards No. 109 (SFAS), 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.
6. EARNINGS PER SHARE
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 June 30, 2007 there were 198,961 shares excluded from the diluted net income per share computation because their inclusion would be anti-dilutive.
Earnings per share for the three and six months ended June 30, 2006 have been adjusted for a 30% stock dividend paid in the form of a 1.3 to 1 stock split on July 5, 2006.
7. SHARE-BASED COMPENSATION
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 under the 1998 Plan.
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. No grants have been made under this plan in 2007.
The Company believes that awards under all plans better align the interests of its employees with those of its shareholders.
In January 2007, the Company awarded options to purchase 68,550 shares under the 2006 Plan which have a five-year term and vest over a three year period.
In January 2007, the Company awarded 20,390 stock appreciation rights to five senior officers under the 2006 Plan 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, subject to the achievement of specified 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 assumptions as shown in the table below used for grants during the six months ended June 30, 2007 and the twelve months ended December 31, 2006 and 2005.
Below is a summary of changes in shares under option (split adjusted) for the six months ended June 30, 2007. The information excludes restricted stock awards.
As of December 31, 2006, there was $446 thousand of total unrecognized compensation cost related to non-vested equity awards under the Companys various share based compensation plans. The $446 thousand cost is being amortized over the remaining service (vesting) period. Through June 30, 2007, $68 thousand has been recognized in compensation cost related to those grants. In total, the Company recognized $82 thousand ($0.01 per share) and $130 thousand ($0.01 per share) in share based compensation expense for the three and six months ended June 30, 2007 as compared to $34 thousand ($0.00 per share) and $204 thousand ($0.02 per share) for the same period in 2006.
8. NEW ACCOUNTING PRONOUNCEMENTS
In March 2006, the Financial Accounting Standards Board (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 Companys servicing asset was for the computed value of servicing fees on the sale of the guaranteed portion of SBA loans. Assumptions related to loan term and amortization are made to arrive at the initial recorded value. This asset is subject to impairment testing annually. The Company does not elect to measure this asset at fair value and believes this new accounting standard will have no impact on its financial condition or results of operations.
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 the Company in the first quarter of fiscal 2007. The Company is evaluating the impact if any of FIN 48 on results of operations and financial condition. The Company does not have any uncertain tax positions and believes this new accounting standard adopted during the first quarter of 2007 will have no impact on its financial condition or results of operation.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 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 157 applies under those previously issued pronouncements that prescribe fair value as the relevant measure of value, except SFAS 123R 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.
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 adoption of SAB No. 108 had no material impact on the Companys financial position, results of operations, or cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument by instrument basis, is
typically irrevocable once elected. Statement 159 is effective for fiscal years beginning after November 15, 2007, and early application is allowed under certain circumstances. 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 as of the dates and periods indicated. 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, 2006.
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 (the Bank), 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 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 a 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 SFAS No. 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.
RESULTS OF OPERATIONS
The Company reported net income of $3.7 million for the six months ended June 30, 2007, as compared to net income of $4.0 million for the six months ended June 30, 2006, a decline of 8%. Income per basic share was $0.38 for the six month period ended June 30, 2007, as compared to $0.42 for the same period in 2006. Income per diluted share was $0.37 for the six months ended June 30, 2007, as compared to $0.40 for the same period in 2006.
For the three months ended June 30, 2007, the Company reported net income of $2.0 million as compared to $2.0 million for the same period in 2006. Income per basic share was $0.21 and $0.20 per diluted share for the three months ended June 30, 2007 and 2006.
Earnings per share for the three and six months ended June 30, 2006, have been adjusted to reflect a 1.3 for 1 stock split in the form of a 30% stock dividend paid on July 5, 2006.
The Company had an annualized return on average assets of 0.95% and an annualized return on average equity of 9.98% for the first six months of 2007, as compared to returns on average assets and average equity of 1.17% and 11.91%, respectively, for the same six months of 2006.
For the three months ended June 30, 2007, the Company had an annualized return on average assets of 1.02% and an annualized return on average equity of 10.50%.
The decrease in net income for the six months ended June 30, 2007 can be attributed substantially to an increase in interest expense of 54% while interest income increased by 19% as compared to the same period in 2006. Net interest income showed an increase of 2% on growth in average earning assets of 13%. For the six months ended June 30, 2007, the Company has experienced a 48 basis point decline in its net interest margin from 4.91% in 2006 to 4.43% in 2007. This change was primarily due to a flatter yield curve and reliance on more expensive sources of funds which has increased interest expenses at a faster rate than increases in interest income.
For the three months ended June 30, 2007, net interest income showed an increase of 3% as compared to the same period in 2006 on growth in average earning assets of 11%. For the three months ended June 30, 2007 as compared to the same period in 2006, the Company experienced a decline in its net interest margin from 4.82% to 4.45% or 37 basis points. The decrease for the quarter ended June 30, 2007, is primarily due to the same reasons stated above for the decline in the margin for the six month period ended June 30, 2007.
For the six months ended June 30, 2007, average interest bearing liabilities funding average earning assets increased to 77% as compared to 72% for the first six months of 2006. Additionally, while the average rate on earning assets for the six month period ended June 30, 2007, as compared to 2006 has risen by 36 basis points from
7.27% to 7.63%, the cost of interest bearing liabilities has increased by 89 basis points from 3.29% to 4.18%, resulting in a decline in the net interest spread of 53 basis points from 3.98% for the six months ended June 30, 2006 to 3.45% for the six months ended June 30, 2007. The 48 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 six months ended June 30, 2007, average noninterest sources funding earning assets was $172 million as compared to $185 million for the same period in 2006. The combination of higher levels of market interest rates and a slight decline in noninterest funding sources has resulted in an increase in the value of noninterest sources funding earning assets from 93 basis points for the first six months in 2006 to 98 basis points for the six months ended June 30, 2007.
Due to 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 86% of average earning assets in the first six months of 2006 to 87% of average earning assets for the same period of 2007. Investment securities for both the first six months of 2007 and 2006 amounted to 11% of average earning assets, while federal funds sold averaged 1% in the first six months of 2007 versus 3% of average earning assets for the same period of 2006. 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 $339 thousand for the first six months in 2007 as compared to $707 thousand for the same period in 2006. This decrease was largely attributable to an adjustment down in two factors evaluated within the component of the allowance related to environmental factors. The two specific factors warranting adjustment related to a decrease in the factor assigned to loan growth, consistent with a reduced overall rate of growth in the loan portfolio in the current year as compared to prior years, and a decrease in the factor assigned to a rising interest rate environment, consistent with the Federal Reserve Banks stabilization of the discount rate over the past year and consequent leveling of interest rates to borrowers.
In total, the ratio of net charge-offs to average loans was .13% for the first six months of 2007 as compared to .14% for the first six months of 2006. The continued management of a quality loan portfolio remains a key objective of the Company.
Total noninterest income was $2.2 million for the first six months of 2007 as compared to $1.7 million for the same period in 2006, a 30% increase. Excluding securities gains of $7 thousand during the first six months of 2007 and $156 thousand during the same period in 2006, noninterest income increased by 43% for the first six months of 2007 as compared to the same period in 2006. The increase was attributed primarily to higher amounts of gains on the sale of SBA ($349 thousand versus $169 thousand) and residential mortgage loans ($222 thousand versus $73 thousand), higher deposit activity fees ($713 thousand versus $667 thousand) and income from subordinate financing of real estate projects ($227 thousand versus $0). Activity in SBA sales to secondary markets can vary widely from period to period. Income from subordinated financing activities is also subject to wide variances, as it is based on the sales progress of a limited number of development projects. Total noninterest income for the second quarter of 2007 was $1.2 million compared to $845 thousand for the second quarter of 2006, an increase of 41%. Excluding securities gains of $156 thousand during the second quarter of 2006, noninterest income increased by 73%. The increase was due to the same factors mentioned above which affected the increase for the six month period. The efficiency ratio for the second quarter of 2007 was 66.33% as compared to 58.38% for the same period in 2006.
Total noninterest expenses increased from $10.4 million in the first six months of 2006 to $12.3 million for the first six months of 2007, an increase of 18%. The primary reasons for this increase were increases in staff levels, and related personnel cost, occupancy cost (due to a new banking office and an expanded lending center facility), higher software licensing costs and fees associated with a reinstated FDIC deposit insurance assessment. The efficiency ratio for the first six months of 2007 was 66.88% as compared to 59.25% for the same period in 2006. For the three months ended June 30, 2007, total noninterest expenses were $6.2 million, as compared to $5.2 million for
the same period in 2006, an increase of 21%. This increase was due to the same factors mentioned above which affected the increase for the six month period.
For the six months ended June 30, 2007 as compared to 2006, the combination of a slight increase in net interest income from increased volumes, a lower provision for credit losses and higher levels of noninterest income offset by a lower net interest margin and higher levels of noninterest expenses, resulted in an 8% decline in net income during the six month period. For the three months ended June 30, 2007, the same factors resulted in a .6% decline in net income, as compared to the same period in 2006.
The ratio of average equity to average assets declined from 9.79% for the first six months of 2006 to 9.65% for the first six months of 2007. 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 second quarter of 2007 versus 2006 (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 six months of 2007 was $16.2 million compared to $15.8 million for the first six months of 2006, a 2% increase. For the three months ended June 30, 2007, net interest income was $8.2 million as compared to $8.0 million for the same period in 2006, a 3% 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 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.
Interest Yields and Rates, and Net Interest Margin
(1) Includes Loans held for Sale
(2) Loans placed on nonaccrual status are included in average balances. Net loan fees and late charges in interest income on loans totaled $697 thousand and $916 thousand for the six months ended June 30, 2007 and 2006, respectively.
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 information.
During the first six months of 2007, a provision for credit losses was made in the amount of $339 thousand and the allowance for credit losses decreased $85 thousand, including the impact of $424 thousand in net charge-offs during the period (of which $350 thousand related to one large commercial loan relationship identified in the third quarter of 2006 and which the Company believes is fully reserved). The provision for credit losses of $339 thousand in the first six months of 2007 compared to a provision for credit losses of $707 thousand in the first six months of 2006. The lower level of the provision in 2007 is primarily attributable to an adjustment down (in the second quarter of 2007) in two factors evaluated within the component of the allowance related to environmental factors. The two specific factors warranting adjustment related to a decrease in the factor assigned to loan growth, consistent with a reduced overall rate of growth in the loan portfolio in the current year as compared to prior years, and a decrease in the factor assigned to a rising interest rate environment, consistent with the Federal Reserve Banks stabilization of the discount rate over the past year and consequent leveling of interest rates to borrowers.
During the quarter ended June 30, 2007, a provision for credit losses was made in the amount of $36 thousand and the allowance for credit losses increased $25 thousand, including the impact of $11 thousand in net charge-offs during the quarter ended. The provision for credit losses of $36 thousand in the quarter ended June 30, 2007 compared to $592 thousand in the same period of 2006. The lower level of the provision in 2007 is attributable to the lowering of the environmental factors within the allowance analysis stated above.
At June 30, 2007, the Company had $1.5 million of loans classified as nonperforming, consisting of a single commercial loan relationship, as compared to $2.4 million at June 30, 2006, $2.0 million at December 31, 2006, and $1.6 million at March 31, 2007. The Company had no restructured loans at June 30, 2007, March 31, 2007, December 31, 2006 or June 30, 2006. 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 June 30, 2007 and December 31, 2006 and $798 thousand at June 30, 2006. The balance of impaired loans was $1.5 million which consisted entirely of the commercial loan relationship identified above, with specific reserves against those loans of $500 thousand at June 30, 2007, compared to $134 thousand of impaired loans at June 30, 2006 with specific reserves of $60 thousand. The allowance for loan losses represented 1.11% of total loans at June 30, 2007 as compared to 1.14% at March 31, 2007; 1.18% at December 31, 2006, and 1.10% at June 30, 2006.
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 evaluates 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 for 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 $1.5 million at June 30, 2007 compared to $3.2 million at June 30, 2006. The percentage of nonperforming loans to total loans was 0.22% at June 30, 2007, compared to .25% at March 31, 2007; .32% at December 31, 2006 and .41% at June 30, 2006.
The following table shows the amounts of nonperforming assets at the dates indicated.
The Company experienced a decrease in the level of nonaccrual loans at June 30, 2007 as compared to both March 31, 2007 and December 31, 2006. This resulted primarily from a partial charge-off in the amount of $350 thousand associated with a problem commercial lending relationship originally identified and provisioned for in the third quarter of 2006 and from the resolution of another problem loan in the third quarter of 2006. The current non-accrual loans of $1.5 million relates to the one commercial lending relationship mentioned above, and which the Company believes is fully reserved for any potential shortfall between collateral values and outstanding balance.
At June 30, 2007, there were an additional $4.4 million of performing loans considered potential problem loans, defined as loans which are not included in the past-due, nonaccrual or restructured categories, but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms which may in the future result in disclosures in the past- due, nonaccrual or restructured loan categories. Approximately $4 million of the potential problem loans consists of two loans to related borrowers. One of the guarantors on these related facilities filed for Chapter 11 bankruptcy protection in late July, 2007. The subject guarantors guaranty is secured by an indemnity deed of trust on real estate owned by the guarantor. Although the bankruptcy filing may impede the Companys ability to realize upon the assets securing the guaranty, and could adversely impact future cash flow and the ongoing collection of payments as and when due, which could result in the loans being reported as nonperforming in the future, management believes the related loans remain well secured, although there can be no assurance.
Total noninterest income consists primarily of deposit account service charges, gains on the sale of SBA and residential mortgage loans, other noninterest loan fees, income from bank owned life insurance (BOLI), investment gains and losses, other service fees and income from subordinate financing for the acquisition, development and construction of real estate projects. For the six months ended June 30, 2007, noninterest income was $2.2 million. This compared to $1.7 million of noninterest income for the six months ended June 30, 2006, an increase of 30%. Excluding securities gains of $7 thousand during the first six months of 2007 and $156 thousand during the same period in 2006, noninterest income increased by 43%. The increase was attributed primarily to higher amounts of gains on the sale of SBA and residential mortgage loans, higher deposit activity fees and income from subordinate financing of real estate projects. Activity in SBA sales to secondary markets can vary widely from
period to period. Income from subordinated financing activities is also subject to wide variances, as it is based on the sales progress of a limited number of development projects.
Total noninterest income for the second quarter of 2007 was $1.2 million compared to $845 thousand for the second quarter of 2006, an increase of 41%. Excluding securities gains of $156 thousand during the second quarter of 2006 and $7 thousand for the second quarter of 2007, noninterest income increased by 73%. The increase was due to the same factors mentioned above which affected the increase for the six month period.
The Company is an active originator of SBA loans and its current practice is to sell the insured portion of those loans at a premium. Income from this source was $349 thousand for the six months ended June 30, 2007 compared to $169 thousand for the six mont