Eagle Bancorp 10-Q 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the Quarterly Period Ended June 30, 2008
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, a non-accelerated filer or a smaller reporting company. See definition of large accelerated filer, accelerated filer and smaller reporting company 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 August 4, 2008, the registrant had 9,888,898 shares of Common Stock, $0.01 par value, outstanding.
EAGLE BANCORP, INC.
EAGLE BANCORP, INC.
June 30, 2008 and December 31, 2007
(dollars in thousands, except per share data)
See notes to consolidated financial statements.
EAGLE BANCORP, INC.
For the Six and Three Month Periods Ended June 30, 2008 and 2007 (unaudited)
(dollars in thousands, except per share data)
See notes to consolidated financial statements.
EAGLE BANCORP, INC.
For the Six Month Periods Ended June 30, 2008 and 2007 (unaudited)
(dollars in thousands, except per share data)
See notes to consolidated financial statements.
EAGLE BANCORP, INC.
For the Six Month Periods Ended June 30, 2008 and 2007 (unaudited)
(dollars in thousands, except per share data)
See notes to consolidated financial statements.
EAGLE BANCORP, INC.
For the Three and Six Months Ended June 30, 2008 and 2007 (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, 2007 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/A (Amendment No. 2) for the year ended December 31, 2007. 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, 2008 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 classifications made in 2008.
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, including remote deposit services introduced in 2006. Eagle Commercial Ventures, LLC (ECV), a direct subsidiary of the Company provides subordinated financing for the acquisition, development and construction of real estate projects, where the primary financing is provided by the Bank. Prior to the formation of ECV, the Company engaged directly in occasional subordinated financing transactions, which involve higher levels of risk, together with commensurate returns. Refer to Note 4 - Higher Risk Lending Revenue Recognition below.
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. HIGHER RISK LENDING REVENUE RECOGNITION
The Company has occasionally made higher risk acquisition, development, and construction (ADC) loans that entail higher risks than ADC loans made following normal underwriting practices (higher risk loan transactions). These higher risk loan transactions are currently made through the Companys subsidiary, ECV. This activity is limited as to individual transaction amount and total exposure amounts based on capital levels and is carefully monitored. The loans are carried on the balance sheet at amounts outstanding and meet the loan classification requirements of the Accounting Standard Executive Committee (AcSEC) guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No. 1). Additional interest earned on these higher risk loan transactions (as defined in the individual loan agreements) is recognized as realized under the provisions contained in AcSECs guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No.1) and Staff Accounting Bulletin No. 101 (Revenue Recognition in Financial Statements). The additional interest is included as a component of noninterest income. The Bank currently has one higher risk lending transaction outstanding as of June 30, 2008 amounting to $1.9 million.
5. INVESTMENT SECURITIES
Amortized cost and estimated fair value of securities available for sale are summarized as follows:
(dollars in thosands)
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, 2008 are as follows:
(dollars in thosands)
The unrealized losses that exist are the result of changes in market interest rates since original purchases. Except for one municipal bond issue which has an underlying rating of AA, all of the remaining bonds are rated AAA. The weighted average duration of debt securities, which comprise 91% 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.
6. INCOME TAXES
The Company employs the liability method of accounting for income taxes as required by Statement of Financial Accounting Standards (SFAS) No. 109, 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. The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes in the first quarter of 2007. The Company utilizes statutory requirements for its income tax accounting, and avoids risks associated with potentially problematic tax positions that may incur challenge upon audit, where an adverse outcome is more likely than not. Therefore, no provisions are made for either uncertain tax positions nor accompanying potential tax penalties and interest for underpayments of income taxes in the Companys tax reserves.
7. 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. There were 420,467 and 198,961 shares for the six months ended June 20, 2008 and 2007, respectively, and 495,816 and 198,961 shares for the three months ended June 30, 2008 and 2007, excluded from the diluted net income per share computation because their inclusion would be anti-dilutive.
Set forth below are the bases for the computation of earnings per share for the periods shown.
8. STOCK-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. 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 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 2008.
The Company believes that awards under all plans better align the interests of its employees with those of its shareholders.
In January 2008, the Company awarded options to purchase 79,300 shares to employees and 34,000 shares to certain Directors under the 2006 Plan which have a five-year term and vest in three substantially equal installments on the date of grant, and the first and second anniversaries of the date of grant.
In January 2008, the Company awarded options to purchase 46,500 shares to six senior officers under the 2006 Plan which have a ten-year term. Of the total shares awarded, 21,500 vest in three substantially equal installments on the date of grant, and the first and second anniversaries of the date of grant. The remaining 25,000 shares awarded vest over a four-year period beginning on the fifth anniversary date of the grant.
In April 2008, the Company awarded options to purchase 1,000 shares to an employee under the 2006 Plan which have a five-year term and vest in three substantially equal installments on the first, second and third anniversaries of the date of grant.
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, 2008 and the twelve months ended December 31, 2007 and 2006.
Below is a summary of changes in shares under option (split adjusted) for the six months ended June 30, 2008. The information excludes restricted stock unit awards.
The expected lives are based on the simplified method allowed by SAB No. 107, whereby the expected term is equal to the midpoint between the vesting date and the end of the contractual term of the award.
Included in salaries and employee benefits the Company recognized $92 thousand ($0.01 per share) and $126 thousand ($0.01 per share) in share based compensation expense for the three and six months ended June 30, 2008 as compared to $82 thousand ($0.01 per share) and $130 thousand ($0.01 per share) for the same periods in 2007. As of June 30, 2008 there was $648 thousand of total unrecognized compensation cost related to non-vested equity awards under the Companys various share based compensation plans. The $648 thousand of unrecognized compensation expense is being amortized over the remaining requisite service (vesting) periods through 2015.
9. NEW ACCOUNTING PRONOUNCEMENTS
Recent Accounting Pronouncements Adopted
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 adopted SFAS No. 157 as of January 1, 2008 and the adoption did not have a material impact on the consolidated financial statements or results of operations of the Company.
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. The Company adopted the provisions of SFAS 159 on January 1, 2008 and the adoption did not have a material impact on the consolidated financial statements or results of operations of the Company.
In December 2007, the SEC issued Staff Accounting Bulletin No. 110 (SAB No. 110), Certain Assumptions Used in Valuation Methods, which extends the use of the simplified method, under certain circumstances, in developing an estimate of expected term of plain vanilla share options in accordance with SFAS No. 123R. Prior to SAB No. 110, SAB No. 107 stated that the simplified method was only available for grants made up to December 31, 2007. The Company continues to use the simplified method in developing an estimate of the expected term of stock options.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS 162). This Statement identifies the sources for generally accepted accounting principles (GAAP) in the U.S. and lists the categories in descending order. An entity should follow the highest category of GAAP applicable for each of its accounting transactions. The adoption did not have a material effect on the Companys consolidated financial statements.
Accounting Pronouncements Issued But Not Yet Effective
In December 2007, the FASB issued SFAS 141(R), Business Combinations (Revised 2007) (SFAS 141R). SFAS 141R replaces SFAS 141, Business Combinations, and applies to all transactions and other events in which one entity obtains control over one or more other businesses. SFAS 141R requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process required under SFAS 141 whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their estimated fair value. SFAS 141R requires acquirers to expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed, as was previously the case under SFAS 141. Under SFAS 141R, the requirements of SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, would have to be met in order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting and, instead, that
contingency would be subject to the probable and estimable recognition criteria of SFAS 5, Accounting for Contingencies. SFAS 141R is expected to have a significant impact on the Companys accounting for business combinations closing on or after January 1, 2009.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB Statement No. 51 (SFAS 160). SFAS 160 amends Accounting Research Bulletin (ARB) No. 51, Consolidated Financial Statements, to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies that a non-controlling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. SFAS 160 is effective for the Company on January 1, 2009 and is not expected to have a significant impact on the Companys financial statements.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (SFAS 161). SFAS 161 is intended to enhance the current disclosure framework previously required for derivative instruments and hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities to include how and why an entity uses derivative instruments, how derivative instruments and related hedge items are accounted for and their impact on an entitys financial positions, results of operations, and cash flows. This standard is effective for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged. While the Company does not currently utilize derivative instruments, it is currently evaluating the impact of this new standard on its financial position, results of operations and cash flows.
10. FAIR VALUE MEASUREMENTS
SFAS No. 157, Fair Value Measurements, defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follow:
Investment Securities Available for Sale
Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair value measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the securitys credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principle will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS 114, Accounting by Creditors for Impairment of a Loan, (SFAS 114). The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represents loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At June 30, 2008, substantially all of the totally impaired loans were evaluated based upon the fair value of the collateral. In accordance with SFAS 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.
Assets and Liabilities Recorded as Fair Value on a Recurring Basis
The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis as of June 30, 2008:
Assets and Liabilities Recorded as Fair Value on a Nonrecurring Basis
The Company may be required from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below:
11. PENDING ACQUISITION
On December 2, 2007 the Company entered into a definitive agreement with Fidelity & Trust Financial Corporation (Fidelity) and its subsidiary Fidelity & Trust Bank for the Company to acquire Fidelity and for Fidelity & Trust Bank to be merged into EagleBank, with EagleBank being the surviving entity. A registration
statement (Registration No. 333-150763) relating to this transaction has been filed with the Securities and Exchange Commission.
The combination is structured as a stock-for-stock exchange, under which Fidelitys shareholders (based on the original conversion ratio) would have received 0.9202 shares of Eagle common stock for each share of Fidelity common stock owned. The original conversion ratio is subject to reductions (through the date of closing) under certain circumstances set forth in the merger agreement. Based on a partial, preliminary, estimated application of the adjustment factors forth in the merger agreement through June 30, 2008, and without adjusting for, among other things, additional reserves required to comport Fidelitys reserve policies with ours, Fidelitys shareholders would receive 0.6687 shares of Eagle common stock for each share of Fidelity common stock owned. Based upon the closing stock price for Eagle Bancorp Inc. on July 25, 2008 ($8.29 per share) and the preliminarily updated conversion ratio through June 30, 2008 of 0.6687 shares, the aggregate value of the transaction would be $23.3 million, or $5.54 per share of Fidelity common stock. The value of the transaction at closing may be higher or lower, and is currently expected to be lower, based on reductions in the conversion ratio which are expected to result from complete and final application of the adjustment provisions of the merger agreement. Changes in the aggregate value of the transaction will also occur based on changes in the value of Eagle common stock. Following the completion of the merger, Fidelity & Trusts shareholders will own approximately 22% of Eagle Bancorps outstanding common stock, based on the preliminarily updated conversion ratio through June 30, 2008. Two members of the Fidelity & Trust Financial Corporation Board will join the Eagle Bancorp, Inc. Board and four of their directors will join the EagleBank Board.
Eagle Bancorp, Inc. is the holding company for EagleBank which commenced operations in 1998. The bank is headquartered in Bethesda, Maryland, and conducts full service banking services through nine offices, located in Montgomery County, Maryland and Washington, D.C. The Company focuses on building relationships with businesses, professionals and individuals in its marketplace.
Fidelity & Trust Bank was founded and opened in November 2003. The Banks mission is to provide its customers with customized banking solutions and above all, outstanding customer service.
At June 30, 2008, EagleBank had $12.9 million advanced under a demand line of credit facility secured by the stock of Fidelity & Trust Bank, which is included in Loans on the Consolidated Balance Sheets. The outstanding line amount bears interest at the prime interest rate less 0.25%. The line of credit expires at September 30, 2008.
12. SUBSEQUENT EVENTS
In July 2008, the Board of Directors authorized proceeding with the preparation of a registration statement to be filed with the Securities and Exchange Commission for an offering of up to $30 million of noncumulative convertible perpetual preferred stock. The offering is expected to be made primarily to the Companys shareholders following consummation of the pending transaction with Fidelity & Trust Financial Corporation, in a manner that would allow shareholders of both companies to maintain their proportionate interest in the post-merger Company.
In August 2008, the Company entered into a $20 million line of credit facility with a five year term out option with a regional commercial bank. The purpose of the facility is to finance short-term working capital needs, including contributing amounts to the Bank as capital. The facility will mature in August 2010 and is secured by a pledge of all the common stock of the Bank. Advances under the facility will bear interest at a daily floating rate of the regional banks Prime Rate minus 0.25% (currently 4.75% per annum), with a fee of 0.10% per annum on the undrawn amounts, payable quarterly in arrears. The Company did not pay a commitment fee in connection with the closing of this facility. The new facility replaces a similar facility in the amount of $15 million from a correspondent bank which had matured in early July 2008. The Company had secured a commitment at the end of June 2008 to extend the existing facility but elected to accept the new facility commitment.
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, 2007, as amended.
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.
The Company is a growth oriented, one-bank holding company headquartered in Bethesda, Maryland. The Company provides general commercial and consumer banking services through its wholly owned banking subsidiary (the Bank), a Maryland chartered bank which is a member of the Federal Reserve System. The Company was 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 the primary market area. The Companys philosophy is to provide superior, personalized service to its customers. The Company focuses 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 its business and professional clients as well as full service consumer banking services to individuals living and/or working primarily in the service area. The Company emphasizes 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 the 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 the Company serves. 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. The Company has developed significant expertise and commitment as an SBA lender, has been designated a Preferred Lender by the Small Business Administration (SBA), and is a leading community bank SBA lender in the Washington D.C. district.
In December 2007, the Company announced the signing of a definitive agreement to acquire Fidelity & Trust Financial Corporation (Fidelity & Trust), parent of Fidelity & Trust Bank. At June 30, 2008, Fidelity & Trust had $461 million of assets. Fidelity & Trust Bank operates six locations, with one in Northern Virginia, three in Montgomery County, Maryland and two in the District of Columbia. The transaction is subject to regulatory and shareholder approvals and the satisfaction of other conditions, as set forth in the merger agreement. The transaction is currently anticipated to be completed in the third quarter of 2008.
Refer to Note 11 Pending Acquisition in the Notes to Consolidated Financial Statements for further information on this transaction.
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 investment securities available for sale 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) No. 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 (SFAS 114), 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 a reserve to identified loans. Loans identified in the risk rating evaluation as substandard, doubtful and loss, (classified loans) are segregated from non-classified loans. Classified loans are assigned specific reserves based on an impairment analysis. Under SFAS 114, 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. The portfolio of non classified loans is stratified by loan type and risk assessment. Allowance factors relate to the type of loan and level of the internal risk rating, with loans exhibiting higher risk and loss experience receiving a higher allowance factor.
The environmental allowance is also used to estimate the loss associated with pools of non-classified loans. These unclassified loans are also stratified by loan type, and environmental allowance factors are assigned by management based upon a number of conditions, including delinquencies, loss history, changes in lending policy and procedures, changes in business and economic conditions, changes in the nature and volume of the portfolio, management expertise, concentrations within the portfolio, quality of internal and external loan review systems, competition, and legal and regulatory requirements.
The allowance captures losses inherent in the portfolio which have not yet been recognized. Allowance factors and the overall size of the allowance may change from period to period based upon managements assessment of the above described factors and the relative weights given to each factor.
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 environmental allowance components of the allowance. The establishment of allowance factors involves 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 can 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 provision in the future. For additional information regarding the allowance for credit losses, refer to the discussion under the caption Allowance for Credit Losses below.
The Company follows the provisions of SFAS No. 123R, Share-Based Payment, which requires the expense recognition for the fair value of share based compensation awards, such as stock options, restricted stock units, 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 $3.5 million for the six months ended June 30, 2008, as compared to net income of $3.7 million for the six months ended June 30, 2007, a decline of 4%. Income per basic share was $0.36 for the six month period ended June 30, 2008, as compared to $0.38 for the same period in 2007. Income per diluted share was $0.35 for the six months ended June 30, 2008, as compared to $0.37 for the same period in 2007.
For the three months ended June 30, 2008, the Company reported net income of $1.9 million as compared to $2.0 million for the same period in 2007. Income per basic share and diluted share was $0.19 for the three months ended June 30, 2008, as compared to $0.21 per basic share and $0.20 per diluted share for the same period in 2007.
The Company had an annualized return on average assets of 0.81% and an annualized return on average equity of 8.40% for the first six months of 2008, as compared to returns on average assets and average equity of 0.95% and 9.88%, respectively, for the same six months of 2007.
For the three months ended June 30, 2008, the Company had an annualized return on average assets of 0.84% and an annualized return on average equity of 8.81%, as compared to an annualized return on average assets of 1.02% and annualized return on average equity of 10.50% for the same period in 2007.
For the six months ended June 30, 2008, net interest income showed an increase of 10% as compared to the same period in 2007 on growth in average earning assets of 14%. For the six months ended June 30, 2008 as compared to the same period in 2007, the Company experienced a decline in its net interest margin from 4.43% to 4.26% or 17 basis points. This change was primarily due to a smaller benefit from noninterest funding sources in the first six months of 2008 as compared to 2007 as the Federal Reserve lowered its targeted federal funds interest rate seven times between June 2007 and June 2008 to combat a slower economic environment.
For the three months ended June 30, 2008, net interest income showed an increase of 13% as compared to the same period in 2007 on growth in average earning assets of 16%. For the three months ended June 30, 2008 as compared to the same period in 2007, the Company experienced a decline in its net interest margin from 4.44% to 4.34% or 11 basis points. The decrease for the three months ended June 30, 2008 is due to the same reason stated above for the decline in the margin for the six months ended June 30, 2008.
For both the six months ended June 30, 2008 and 2007, average interest bearing liabilities funding average earning assets was 77%. Additionally, while the average rate on earning assets for the six month period ended June 30, 2008, as compared to 2007 has declined by 93 basis points from 7.63% to 6.70%, the cost of interest bearing liabilities has decreased by 103 basis points from 4.18% to 3.15%, resulting in an increase in the net interest spread of 10 basis points from 3.45% for the six months ended June 30, 2007 to 3.55% for the six months ended June 30, 2008. The 17 basis point decline in the net interest margin compares to an increase in the net interest spread as the benefit of average noninterest sources funding earning assets declined from 98 basis points for the six months ended
June 30, 2007 to 71 basis points for the six months ended June 30, 2008. This decline was due to the significantly lower level of interest rates during the six months ended June 30, 2008 as compared to 2007.
For the three months ended June 30, 2008 and 2007, average interest bearing liabilities funding average earning assets was 77%. Additionally, while the average rate on earning assets for the three months ended June 30, 2007, as compared to 2008 has declined by 108 basis points from 7.65% to 6.57%, the cost of interest bearing liabilities has decreased by 130 basis points from 4.18% to 2.88%, resulting in an increase in the net interest spread of 22 basis points from 3.47% for the quarter ended June 30, 2007 to 3.69% for the three months ended June 30, 2008. The net interest margin decreased 10 basis points from 4.44% for the three months ended June 30, 2007 to 4.34% for the three months ended June 30, 2007 and compares to an increase in the net interest spread as the benefit of average noninterest sources funding earning assets declined from 97 basis points for the three months ended June 30, 2007 to 66 basis points for the three months ended June 30, 2008, also due to the significantly lower level of interest rates in 2008 as compared to 2007.
Due to the need to meet loan funding objectives in excess of deposit growth, the bank has relied to a larger extent on alternative funding sources, such as Federal Home Loan Bank (FHLB) advances and brokered time deposits which costs have been judged reasonable as an alternative to more core funding. If significant reliance on alternative funding sources continues, the Companys earnings could be adversely impacted, depending on the cost of those funds when needed.
In terms of the average balance sheet composition, or mix, loans, which generally have higher yields than securities and other earning assets, increased from 87% of average earning assets in the first six months of 2007 to 89% of average earning assets for the same period of 2008. Investment securities for the first six months of 2008 amounted to 10% of average earning assets, a decline of 1% from an average of 11% for the same period in 2007. Federal funds sold averaged 0.6% in the first six months of 2008 versus 1% of average earning assets for the same period of 2007.
For the three months ended June 30, 2008 average loans increased by 2% to 90% of average earning assets as compared to 88% for the same period in 2007. Investment securities for both the three months ended June 30, 2008 and 2007 amounted to 10% of average earning assets. Federal funds sold averaged 0.4% of average earning assets for the three months ended June 30, 2008 as compared to 2% for the same period in 2007.
The provision for credit losses was $1.5 million for the first six months of 2008 as compared to $339 thousand for the same period in 2007. The higher provisioning in the first six months of 2008 as compared to 2007 is attributable to substantially higher levels of loan growth ($78 million for the six months ended June 30, 2008 versus $33 million for the same period in 2007) and to increases in reserve allocations on classified credits.
The provision for credit losses was $814 thousand for the three months ended June 30, 2008 as compared to $36 thousand for the three months ended June 30, 2007. The higher provisioning in the second quarter of 2008 as compared to the second quarter of 2007 is primarily attributable to higher levels of loan growth ($35 million for the three months ended June 30, 2008 versus $22 million for the same period in 2007), increases in specific reserves for problem and potential problem loans, and higher levels of net charge-offs in the second quarter of 2008 as compared to the second quarter of 2007.
In total, the ratio of net charge-offs to average loans was 0.11% for the first six months of 2008 as compared to 0.13% for the first six months of 2007. The continued management of a quality loan portfolio remains a key objective of the Company. For the six months ended June 30, 2008, net charge-offs totaled $417 thousand versus $424 thousand for the six months ended June 30, 2007. Net charge-offs in the six months ended June 30, 2008 were attributable to charge-offs in consumer loans (39% of total), the un-guaranteed portion of SBA Loans (32% of total), and non-real estate commercial business loans (29% of total).
In total, the ratio of net charge-offs to average loans was 0.20% for the three months ended June 30, 2008 as compared to 0.01% for the same three month period of 2007. For the three months ended June 30, 2008, the Company recorded net charge-offs of $393 thousand as compared to $11 thousand of net charge-offs for the three months ended June 30, 2007. Net charge-offs in the three months ended June 30, 2008 were attributable to charge-offs in consumer loans (38% of total), the un-guaranteed portion of SBA Loans (32% of total), and non-real estate commercial business loans (30% of total).
Total noninterest income was $1.9 million for the first six months of 2008 as compared to $2.2 million for the same period in 2007, a decline of 13%. The decrease in the six months ended 2008 was attributed primarily to lower amounts of gains on the sale of SBA and residential mortgage loans of $279 thousand versus $571 thousand during the six months ended June 30, 2007, and no income from subordinate financing of real estate projects in 2008 versus $227 thousand in the prior year. Income from subordinated financing activities is subject to wide variances, as it is based on the sales progress of a limited number of development projects.
Total noninterest income for the three months ended June 30, 2008 declined 19% from the same period in 2007 from $1.2 million to $970 thousand. This decline was due to a lower volume of SBA and residential mortgage loan sales activity, which activity is subject to significant quarterly variances and no income from subordinate financing of real estate projects in 2008 versus $227 thousand in the prior year.
Total noninterest expenses increased from $12.3 million in the first six months of 2007 to $12.7 million for the first six months of 2008, an increase of 4%. The primary reasons for this increase were merit increases and related personnel cost increases, increased broker fees, higher internet and license agreement fees and increased legal, accounting and professional fees. The efficiency ratio, which measures the level of non-interest expense to total revenue (defined as the sum of net interest income and noninterest income) improved to 64.50% for the six months ended June 30, 2008, as compared to 66.88% for the six months ended June 30, 2007.
For the three months ended June 30, 2008, total noninterest expenses were $6.5 million, as compared to $6.2 million for the same period in 2007, an increase of 5%. This increase was due to the same factors mentioned above which affected the increase for the six month period. The efficiency ratio for the three months ended June 30, 2008 improved to 63.96% as compared to 66.33% for the same period in 2007. While the Company continues to make strategic investments in infrastructure, more attention to overall cost management is being emphasized.
For the six months ended June 30, 2008 as compared to 2007, the increase in net interest income from increased volumes, offset by the combination of a higher provision for credit losses, lower levels of noninterest income, a lower net interest margin and higher levels of noninterest expenses, resulted in stable net income during the three month period.
The ratio of average equity to average assets declined from 9.65% for the first six months of 2007 to 9.59% for the first six months of 2008. 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 (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 2008 was $17.8 million compared to $16.2 million for the first six months of 2007, a 10% increase. This increase in net interest income for the six months ended June 30, 2008 was attributable in part to an increased volume of earning assets of 14% offset somewhat by a 4% decline in the net interest margin from 4.43% to 4.26%. For the three months ended June 30, 2008, net interest income was $9.2 million as compared to $8.2 million for the same period in 2007, a 13% increase. This increase was attributable to an increased volume of earning assets of 16% offset somewhat by a 2% decline in the net interest margin from 4.45% to 4.34%. As earlier mentioned, the decline in the net interest margin in both the three and six month periods ended June 30, 2008 as compared to the same periods in 2007 was due to a lower benefit of noninterest funding sources as market interest rates were substantially lower in 2008 as compared to 2007. In an effort to combat a weaker economic climate, the Federal Reserve lowered its targeted federal funds rate from 5.25% at June 2007 to 2.00% at June 2008.
The tables below labeled Average Balances, Interest Yields and Rates and Net Interest Margin present the average balances and rates of the various categories of the Companys assets and liabilities for the six and three months ended 2008 and 2007. 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.
Average Balances, Interest Yields and Rates, and Net Interest Margin
(dollars in thousands)