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Eagle Bancorp 10-Q 2014

Documents found in this filing:

  1. 10-Q
  2. Ex-21
  3. Ex-31
  4. Ex-31
  5. Ex-32
  6. Ex-32
  7. Ex-32
egbn20140630_10q.htm Table Of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)

( X )

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

 

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended June 30, 2014

 

OR

 

(   )

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

 

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                    to_________

 

Commission File Number 0-25923

 

Eagle Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

   

Maryland 

 

52-2061461

 
   

(State or other jurisdiction of

 

 (I.R.S. Employer

 
   

incorporation or organization)

 

Identification No.)

 
   

 

 

 

 
    7830 Old Georgetown Road, Third Floor, Bethesda, Maryland 20814  
    (Address of principal executive offices)     (Zip Code)  

 

(301) 986-1800

(Registrant's 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 ☒No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes☒           No ☐

 

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.

Large accelerated filer ☐

Accelerated filer ☒

Non-accelerated filer ☐ 

Smaller Reporting Company ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act

Yes ☐     No ☒

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

As of August 1, 2014, the registrant had 26,024,326 shares of Common Stock outstanding.

 

 

EAGLE BANCORP, INC.

TABLE OF CONTENTS

 

PART I.

FINANCIAL INFORMATION

 
     

Item 1.

Financial Statements (Unaudited) 

3
 

Consolidated Balance Sheets

3
 

Consolidated Statements of Operations

4
  Consolidated Statements of Comprehensive Income 5
 

Consolidated Statements of Changes in Shareholders’ Equity

6
 

Consolidated Statements of Cash Flows

7
 

Notes to Consolidated Financial Statements

8
     

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

39
     

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

68
     

Item 4.

Controls and Procedures

  68
     

PART II.

OTHER INFORMATION

69
     

Item 1.

Legal Proceedings

  69
     

Item 1A.

Risk Factors

 69
     

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

  69
     

Item 3.

Defaults Upon Senior Securities

  69
     

Item 4.

Mine Safety Disclosures

  69
     

Item 5.

Other Information

  69
     

Item 6.

Exhibits

  69
     

Signatures

    72

 

 

 

Item 1 Financial Statements (Unaudited)


 

EAGLE BANCORP, INC.

Consolidated Balance Sheets (Unaudited)

(dollars in thousands, except per share data)

 

Assets

 

June 30, 2014

   

December 31, 2013

   

June 30, 2013

 

Cash and due from banks

  $ 8,602     $ 9,577     $ 7,765  

Federal funds sold

    9,480       5,695       10,634  

Interest bearing deposits with banks and other short-term investments

    97,400       291,688       172,849  

Investment securities available for sale, at fair value

    378,990       378,133       335,779  

Federal Reserve and Federal Home Loan Bank stock

    10,626       11,272       11,220  

Loans held for sale

    35,411       42,030       104,767  

Loans

    3,279,429       2,945,158       2,691,358  

Less allowance for credit losses

    (43,552 )     (40,921 )     (39,640 )

Loans, net

    3,235,877       2,904,237       2,651,718  

Premises and equipment, net

    17,797       16,737       16,706  

Deferred income taxes

    25,586       28,949       24,883  

Bank owned life insurance

    40,361       39,738       29,324  

Intangible assets, net

    3,379       3,510       3,690  

Other real estate owned

    8,843       9,225       12,213  

Other assets

    42,092       30,712       29,020  

Total Assets

  $ 3,914,444     $ 3,771,503     $ 3,410,568  
                         

Liabilities and Shareholders' Equity

                       

Liabilities

                       

Deposits:

                       

Noninterest bearing demand

  $ 945,485     $ 849,409     $ 767,808  

Interest bearing transaction

    128,415       118,580       107,013  

Savings and money market

    1,899,430       1,811,088       1,531,804  

Time, $100,000 or more

    186,063       203,706       203,117  

Other time

    208,534       242,631       278,494  

Total deposits

    3,367,927       3,225,414       2,888,236  

Customer repurchase agreements

    60,646       80,471       97,327  

Long-term borrowings

    39,300       39,300       39,300  

Other liabilities

    19,750       32,455       16,315  

Total Liabilities

    3,487,623       3,377,640       3,041,178  
                         

Shareholders' Equity

                       

Preferred stock, par value $.01 per share, shares authorized 1,000,000, Series B, $1,000 per share liquidation preference, shares issued and outstanding 56,600 at June 30, 2014, December 31, 2013 and June 30, 2013

    56,600       56,600       56,600  

Common stock, par value $.01 per share; shares authorized 50,000,000, shares issued and outstanding 25,985,659, 25,885,863 and 25,764,542 respectively

    255       253       251  

Warrant

    946       946       946  

Additional paid in capital

    245,629       242,990       239,584  

Retained earnings

    121,553       96,393       72,916  

Accumulated other comprehensive income (loss)

    1,838       (3,319 )     (907 )

Total Shareholders' Equity

    426,821       393,863       369,390  

Total Liabilities and Shareholders' Equity

  $ 3,914,444     $ 3,771,503     $ 3,410,568  

 

See notes to consolidated financial statements.

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Operations (Unaudited)

(dollars in thousands, except per share data)

 

   

Six Months Ended June 30,

   

Three Months Ended June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Interest Income

                               

Interest and fees on loans

  $ 82,679     $ 72,022     $ 42,316     $ 35,998  

Interest and dividends on investment securities

    4,656       3,507       2,323       1,811  

Interest on balances with other banks and short-term investments

    254       382       116       173  

Interest on federal funds sold

    7       7       4       3  

Total interest income

    87,596       75,918       44,759       37,985  

Interest Expense

                               

Interest on deposits

    4,736       5,578       2,324       2,638  

Interest on customer repurchase agreements

    69       133       31       64  

Interest on long-term borrowings

    764       834       384       419  

Total interest expense

    5,569       6,545       2,739       3,121  

Net Interest Income

    82,027       69,373       42,020       34,864  

Provision for Credit Losses

    5,068       5,722       3,134       2,357  

Net Interest Income After Provision For Credit Losses

    76,959       63,651       38,886       32,507  
                                 

Noninterest Income

                               

Service charges on deposits

    2,411       2,236       1,219       951  

Gain on sale of loans

    2,864       10,417       1,021       4,768  

Gain on sale of investment securities

    10       23       2       -  

Increase in the cash surrender value of bank owned life insurance

    624       189       310       95  

Other income

    2,365       2,311       1,259       1,251  

Total noninterest income

    8,274       15,176       3,811       7,065  

Noninterest Expense

                               

Salaries and employee benefits

    26,623       22,535       13,015       11,335  

Premises and equipment expenses

    6,196       5,727       3,107       2,927  

Marketing and advertising

    877       741       415       394  

Data processing

    3,020       3,070       1,432       1,531  

Legal, accounting and professional fees

    1,773       1,362       799       589  

FDIC insurance

    1,107       1,196       563       614  

Other expenses

    5,637       6,751       2,804       3,295  

Total noninterest expense

    45,233       41,382       22,135       20,685  

Income Before Income Tax Expense

    40,000       37,445       20,562       18,887  

Income Tax Expense

    14,557       14,198       7,618       7,212  

Net Income

    25,443       23,247       12,944       11,675  

Preferred Stock Dividends

    283       283       142       142  

Net Income Available to Common Shareholders

  $ 25,160     $ 22,964     $ 12,802     $ 11,533  
                                 

Earnings Per Common Share

                               

Basic

  $ 0.97     $ 0.90     $ 0.49     $ 0.45  

Diluted

  $ 0.95     $ 0.88     $ 0.48     $ 0.44  

 

See notes to consolidated financial statements.

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Comprehensive Income (Unaudited)

(dollars in thousands)

  

   

Six Months Ended June 30,

   

Three Months Ended June 30,

 
   

2014

   

2013

   

2014

   

2013

 
                                 

Net Income

  $ 25,443     $ 23,247     $ 12,944     $ 11,675  
                                 

Other comprehensive income, net of tax:

                               

Net unrealized gain (loss) on securities available for sale

    5,163       (6,359 )     2,341       (5,415 )

Reclassification adjustment for net gains included in net income

    (6 )     (13 )     (1 )     -  

Net change in unrealized gain (loss) on securities

    5,157       (6,372 )     2,340       (5,415 )

Comprehensive Income

  $ 30,600     $ 16,875     $ 15,284     $ 6,260  

 

See notes to consolidated financial statements.

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(dollars in thousands)

 

 

                                           

Accumulated

         
                                           

Other

   

Total

 
   

Preferred

   

Common

           

Additional Paid

   

Retained

   

Comprehensive

   

Shareholders'

 
   

Stock

   

Stock

   

Warrant

   

in Capital

   

Earnings

   

Income (Loss)

   

Equity

 

Balance January 1, 2014

  $ 56,600     $ 253     $ 946     $ 242,990     $ 96,393     $ (3,319 )   $ 393,863  

Net Income

    -       -       -       -       25,443       -       25,443  

Net change in other comprehensive income

    -       -       -       -       -       5,157       5,157  

Stock-based compensation

    -       -       -       1,915       -       -       1,915  

Common stock issued 89,802 shares under equity compensation plans

    -       2       -       303       -       -       305  

Tax benefits related to stock compensation

    -       -       -       123       -       -       123  

Employee stock purchase plan 9,994 shares

    -       -       -       298       -       -       298  

Preferred stock dividends

    -       -       -       -       (283 )     -       (283 )

Balance June 30, 2014

  $ 56,600     $ 255     $ 946     $ 245,629     $ 121,553     $ 1,838     $ 426,821  
                                                         

Balance January 1, 2013

  $ 56,600     $ 226     $ 946     $ 180,593     $ 106,146     $ 5,465     $ 349,976  

Net Income

    -       -       -       -       23,247       -       23,247  

Net change in other comprehensive income

    -       -       -       -       -       (6,372 )     (6,372 )

10% common stock dividend 2,340,518 shares

    -       23       -       56,161       (56,184 )     -       -  

Cash paid in lieu of fractional shares

    -       -       -       -       (10 )     -       (10 )

Stock-based compensation

    -       -       -       1,552       -       -       1,552  

Common stock issued 469,135 shares under equity compensation plans

    -       2       -       755       -       -       757  

Tax benefit on non-qualified options exercised

    -       -       -       270       -       -       270  

Employee stock purchase plan 13,420 shares

    -       -       -       253       -       -       253  

Preferred stock dividends

    -       -       -       -       (283 )     -       (283 )

Balance June 30, 2013

  $ 56,600     $ 251     $ 946     $ 239,584     $ 72,916     $ (907 )   $ 369,390  

 

See notes to consolidated financial statements.

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)

 

   

Six Months Ended June 30,

 
   

2014

   

2013

 

Cash Flows From Operating Activities:

               

Net Income

  $ 25,443     $ 23,247  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Provision for credit losses

    5,068       5,722  

Depreciation and amortization

    2,292       2,095  

Gains on sale of loans

    (2,864 )     (10,417 )

Securities premium amortization, net

    1,721       1,466  

Origination of loans held for sale

    (221,231 )     (683,248 )

Proceeds from sale of loans held for sale

    230,714       815,821  

Net increase in cash surrender value of BOLI

    (624 )     (189 )

Decrease (increase) in deferred income taxes

    3,363       (5,755 )

Decrease in fair value of other real estate owned

    505       -  

Loss on sale of other real estate owned

    100       458  

Net gain on sale of investment securities

    (10 )     (23 )

Stock-based compensation expense

    1,915       1,552  

Excess tax benefits from stock-based compensation

    (123 )     (270 )

(Increase) decrease in other assets

    (11,380 )     1,318  

Decrease in other liabilities

    (12,705 )     (5,290 )

Net cash provided by operating activities

    22,184       146,487  

Cash Flows From Investing Activities:

               

Decrease in interest bearing deposits with other banks and short-term investments

    43       5  

Purchases of available for sale investment securities

    (26,852 )     (91,791 )

Proceeds from maturities of available for sale securities

    11,956       25,869  

Proceeds from sale/call of available for sale securities

    17,485       22,148  

Purchases of Federal Reserve and Federal Home Loan Bank stock

    (53 )     (679 )

Proceeds from redemption of federal reserve and federal home loan bank stock

    699       153  

Net increase in loans

    (336,985 )     (211,384 )

Purchases of BOLI

    -       (15,000 )

Purchases of annuity

    -       (10,879 )

Proceeds from sale of other real estate owned

    108       2,350  

Bank premises and equipment acquired

    (3,194 )     (3,355 )

Net cash used in investing activities

    (336,793 )     (282,563 )

Cash Flows From Financing Activities:

               

Increase (decrease) in deposits

    142,513       (8,986 )

Decrease in customer repurchase agreements

    (19,825 )     (4,011 )

Payment of dividends on preferred stock

    (283 )     (283 )

Proceeds from exercise of stock options

    305       757  

Excess tax benefits from stock-based compensation

    123       270  

Payment in lieu of fractional shares

    -       (10 )

Proceeds from employee stock purchase plan

    298       253  

Net cash provided by (used in) financing activities

    123,131       (12,010 )

Net Decrease In Cash and Cash Equivalents

    (191,478 )     (148,086 )

Cash and Cash Equivalents at Beginning of Period

    306,960       339,334  

Cash and Cash Equivalents at End of Period

  $ 115,482     $ 191,248  

Supplemental Cash Flows Information:

               

Interest paid

  $ 5,770     $ 6,638  

Income taxes paid

  $ 20,200     $ 19,125  

Non-Cash Investing Activities

               

Transfers from loans to other real estate owned

  $ 330     $ 9,614  

 

See notes to consolidated financial statements.

 

 

 EAGLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Note 1.

Summary of Significant Accounting Policies

 

Basis of Presentation

 

The consolidated financial statements include the accounts of Eagle Bancorp, Inc. and its subsidiaries (the “Company”), EagleBank (the “Bank”), Eagle Commercial Ventures, LLC (“ECV”), Eagle Insurance Services, LLC, and Bethesda Leasing, LLC, with all significant intercompany transactions eliminated.

 

The consolidated financial statements of the Company included herein are unaudited. The consolidated financial statements reflect all adjustments, consisting 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, 2013 were derived from audited consolidated financial statements. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) 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 Company’s Accounting Policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. The Company believes that the disclosures are adequate to make the information presented not misleading. Certain reclassifications have been made to amounts previously reported to conform to the current period presentation.

 

These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. Operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results of operations to be expected for the remainder of the year, or for any other period.

 

Nature of Operations

 

The Company, through the Bank, conducts a full service community banking business, primarily in Montgomery County, Maryland, Washington, D.C., and Northern Virginia. The primary financial services offered by the Bank 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, guaranteed by the Small Business Administration (“SBA”), is typically sold to third party investors in a transaction apart from the loan’s origination. As of June 30, 2014, the Bank offers its products and services through eighteen banking offices and various electronic capabilities, including remote deposit services and mobile banking services. Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker. Eagle Commercial Ventures, LLC, a direct subsidiary of the Company, provides subordinated financing for the acquisition, development and construction of real estate projects. These transactions involve higher levels of risk, together with commensurate higher returns. Refer to Higher Risk Lending – Revenue Recognition below.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results may differ from those estimates and such differences could be material to the financial statements.

 

Cash Flows

 

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold, and interest bearing deposits with other banks which have an original maturity of three months or less.

 

 

Loans Held for Sale

 

The Company engages in sales of residential mortgage loans and the guaranteed portion of SBA loans originated by the Bank. Loans held for sale are carried at the lower of aggregate cost or fair value. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of these loans are recorded as a component of noninterest income in the consolidated statements of operations.

 

The Company’s current practice is to sell residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing as of June 30, 2014, December 31, 2013 and June 30, 2013. The sale of the guaranteed portion of SBA loans on a servicing retained basis gives rise to an Excess Servicing Asset, which is computed on a loan by loan basis with the unamortized amount being included in Intangible assets in the consolidated balance sheets. This Excess Servicing Asset is being amortized on a straight-line basis (with adjustment for prepayments) as an offset to servicing fees collected and is included in Other income in the consolidated statement of operations.

 

The Company enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitments). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. To protect against the price risk inherent in residential mortgage loan commitments, the Company utilizes both “mandatory delivery” and “best efforts” forward loan sale commitments to mitigate the risk of potential decrease in the values of loans that would result from the exercise of the derivative loan commitments. Under a “mandatory delivery” contract, the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. If the Company fails to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, it is obligated to pay the investor a “pair-off” fee, based on then-current market prices, to compensate the investor for the shortfall. Under a “best efforts” contract, the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor and the investor commits to a price that it will purchase the loan from the Company if the loan to the underlying borrower closes. Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives but are effectively offset by whole loan purchase commitments from various investors. The period of time between issuance of a loan commitment to the customer and closing and sale of the loan to an investor generally ranges from 30 to 90 days under current market conditions. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the investor commits to purchase a loan at a price representing a premium on the day the borrower commits to an interest rate with the intent that the buyer/investor has assumed the interest rate risk on the loan. As a result, the Company is not generally exposed to losses on loans sold. Nor will it realize gains, related to rate lock commitments due to changes in interest rates. The market values of rate lock commitments and best efforts contracts are not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss should occur on the rate lock commitments.

 

In circumstances where the Company does not deliver the whole loan to an investor, but rather elects to retain the loan in its portfolio, the loan is transferred from held for sale at fair value.

 

Investment Securities

 

The Company has no securities classified as trading, or as held to maturity. Marketable equity securities and debt securities not classified as held to maturity or trading are classified as available-for-sale. Securities available-for-sale are acquired as part of the Company’s asset/liability management strategy and may be sold in response to changes in interest rates, current market conditions, loan demand, changes in prepayment risk and other factors. Securities available-for-sale are carried at fair value, with unrealized gains or losses being reported as accumulated other comprehensive income/(loss), a separate component of shareholders’ equity, net of deferred income tax. Realized gains and losses, using the specific identification method, are included as a separate component of noninterest income in the consolidated statements of operations.

 

 

Premiums and discounts on investment securities are amortized/accreted to the earlier of call or maturity based on expected lives, which lives are adjusted based on prepayment assumptions and call optionality if any. Declines in the fair value of individual available-for-sale securities below their cost that are other-than-temporary in nature result in write-downs of the individual securities to their fair value. Factors affecting the determination of whether other-than-temporary impairment has occurred include a downgrading of the security by a rating agency, a significant deterioration in the financial condition of the issuer, or a change in management’s intent and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) structure of the security.

 

The entire amount of an impairment loss is recognized in earnings only when (1) the Company intends to sell the security, or (2) it is more likely than not that the Company will have to sell the security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the security. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in shareholders’ equity as comprehensive income, net of deferred taxes.

 

Loans

 

Loans are stated at the principal amount outstanding, net of unamortized deferred costs and fees. Interest income on loans is accrued at the contractual rate on the principal amount outstanding. It is the Company’s policy to discontinue the accrual of interest when circumstances indicate that collection is doubtful. Deferred fees and costs are being amortized on the interest method over the term of the loan.

 

Management considers loans impaired when, based on current information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Loans are evaluated for impairment in accordance with the Company’s portfolio monitoring and ongoing risk assessment procedures.  Management considers the financial condition of the borrower, cash flow of the borrower, payment status of the loan, and the value of the collateral, if any, securing the loan. Generally, impaired loans do not include large groups of smaller balance homogeneous loans such as residential real estate and consumer type loans which are evaluated collectively for impairment and are generally placed on nonaccrual when the loan becomes 90 days past due as to principal or interest. Loans specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (ninety days or less) provided eventual collection of all amounts due is expected.  The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided solely by the collateral.  In appropriate circumstances, interest income on impaired loans may be recognized on the cash basis.

 

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 Company’s 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 Standards 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 certain of these higher risk loan transactions (as defined in the individual loan agreements) is recognized as realized under the provisions contained in AcSEC’s 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). Such additional interest may be included as a component of noninterest income. ECV recorded no additional interest on higher risk transactions during 2014 and 2013 (although normal interest income was recorded). ECV had six higher risk lending transactions with balances outstanding at June 30, 2014 and five such transactions outstanding at December 31, 2013, amounting to $8.0 million and $7.4 million, respectively.

 

 

Allowance for Credit Losses

 

The allowance for credit losses represents an amount which in management’s judgment, is adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The adequacy of the allowance for credit losses is determined through careful and continuous review and evaluation of the loan portfolio and involves the balancing of a number of factors to establish a prudent level of allowance. Among the factors considered in evaluating the adequacy of the allowance for credit losses are lending risks associated with growth and entry into new markets, loss allocations for specific credits, the level of the allowance to nonperforming loans, historical loss experience, economic conditions, portfolio trends and credit concentrations, changes in the size and character of the loan portfolio, and management’s judgment with respect to current and expected economic conditions and their impact on the existing loan portfolio. Allowances for impaired loans are generally determined based on collateral values. Loans or any portion thereof deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for credit losses, which is recorded as a current period operating expense. The allowance for credit losses consists of allocated and unallocated components.

 

The components of the allowance for credit losses represent an estimation done pursuant to Accounting Standards Codification (“ASC”) Topic 450, “Contingencies,” or ASC Topic 310, “Receivables.” Specific allowances are established in cases where management has identified significant conditions or circumstances related to a specific credit that management believes indicate the probability that a loss may be incurred. For potential problem credits for which specific allowance amounts have not been determined, the Company establishes allowances according to the application of credit risk factors. These factors are set by management and approved by the appropriate Board Committee to reflect its assessment of the relative level of risk inherent in each risk grade. A third component of the allowance computation, termed a nonspecific or environmental factors allowance, is based upon management’s evaluation of various environmental conditions that are not directly measured in the determination of either the specific allowance or formula allowance. Such conditions include general economic and business conditions affecting key lending areas, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, specific industry conditions within portfolio categories, recent loss experience in particular loan categories, duration of the current business cycle, bank regulatory examination results, findings of outside review consultants, and management’s judgment with respect to various other conditions including credit administration and management and the quality of risk identification systems. Executive management reviews these environmental conditions quarterly, and documents the rationale for all changes.

 

Management believes that the allowance for credit losses is adequate; however, determination of the allowance is inherently subjective and requires significant estimates. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Evaluation of the potential effects of these factors on estimated losses involves a high degree of uncertainty, including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Bank periodically review the Bank’s loan portfolio and allowance for credit losses. Such review may result in recognition of adjustments to the allowance based on their judgments of information available to them at the time of their examination.

 

Premises and Equipment

 

Premises and equipment are stated at cost less accumulated depreciation and amortization computed using the straight-line method for financial reporting purposes. Premises and equipment are depreciated over the useful lives of the assets, which generally range from five to seven years for furniture, fixtures and equipment, to three to five years for computer software and hardware, and to ten to forty years for buildings and building improvements. Leasehold improvements are amortized over the terms of the respective leases, which may include renewal options where management has the positive intent to exercise such options, or the estimated useful lives of the improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary maintenance and repairs are expensed as incurred. These costs are included as a component of premises and equipment expenses on the consolidated statements of operations.

 

 

Other Real Estate Owned (OREO)

 

Assets acquired through loan foreclosure are held for sale and are initially recorded at the lower of cost or fair value less estimated selling costs when acquired, establishing a new cost basis. The new basis is supported by appraisals that are no more than twelve months old. Costs after acquisition are generally expensed. If the fair value of the asset declines, a write-down is recorded through noninterest expense. The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in market conditions or appraised values.

 

Goodwill and Other Intangible Assets

 

Goodwill and other intangible assets are subject to impairment testing at least annually, or when events or changes in circumstances indicate the assets might be impaired. Intangible assets (other than goodwill) are amortized to expense using accelerated or straight-line methods over their respective estimated useful lives. The Company’s testing of potential goodwill impairment (which is performed annually) at December 31, 2013 resulted in no impairment being recorded.

 

Customer Repurchase Agreements

 

The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same securities. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, securities sold under agreements to repurchase are accounted for as collateralized financing arrangements and not as a sale and subsequent repurchase of securities. The agreements are entered into primarily as accommodations for large commercial deposit customers. The obligation to repurchase the securities is reflected as a liability in the Company’s consolidated balance of sheets, while the securities underlying the securities sold under agreements to repurchase remain in the respective assets accounts and are delivered to and held as collateral by third party trustees.

 

Marketing and Advertising

 

Marketing and advertising costs are generally expensed as incurred.

 

Income Taxes

 

The Company employs the liability method of accounting for income taxes as required by ASC Topic 740, “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 basis of existing assets and liabilities (i.e., temporary timing differences) and are measured at the enacted rates that will be in effect when these differences reverse. 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 Company’s tax reserves. In accordance with ASC Topic 740, the Company may establish a reserve against deferred tax assets in those cases where realization is less than certain, although no such reserves exist at June 30, 2014, December 31, 2013, or June 30, 2013.

 

Transfer of Financial Assets

 

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. In certain cases, the recourse to the Bank to repurchase assets may exist but is deemed immaterial based on the specific facts and circumstances.

 

 

Earnings per Common Share

 

Basic net income per common share is derived by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period measured. Diluted earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period measured including the potential dilutive effects of common stock equivalents.

 

Stock-Based Compensation

 

In accordance with ASC Topic 718, “Compensation,” the Company records as compensation expense an amount equal to the amortization (over the remaining service period) of the fair value computed at the date of grant. Compensation expense on variable stock option grants (i.e. performance based grants) is recorded based on the probability of achievement of the goals underlying the performance grant. Refer to Note 8 for a description of stock-based compensation awards, activity and expense.

 

New Authoritative Accounting Guidance

 

In January 2014, the FASB issued ASU No. 2014-01, "Accounting for Investments in Qualified Affordable Housing Projects." ASU No. 2014-01 permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense. This new guidance also requires new disclosures for all investors in these projects. ASU No. 2014-01 is effective for interim and annual reporting periods beginning after December 15, 2014. Upon adoption, the guidance must be applied retrospectively to all periods presented. However, entities that use the effective yield method to account for investments in these projects before adoption may continue to do so for these pre-existing investments. The Company currently accounts for such investments using the effective yield method and plans to continue to do so for these pre-existing investments after adopting ASU No. 2014-01 on January 1, 2015. The Company expects investments made after January 1, 2015 to meet the criteria required for the proportional amortization method and plans to make such an accounting policy election. The adoption of ASU No. 2014-01 is not expected to have a material impact on the Company's consolidated financial statements.

 

In January 2014, the FASB issued ASU No. 2014-04, "Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure." The objective of this guidance is to clarify when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU No. 2014-04 states that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, ASU No. 2014-04 requires interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. ASU No. 2014-04 is effective for interim and annual reporting periods beginning after December 15, 2014. The adoption of ASU No. 2014-04 is not expected to have a material impact on the Company's consolidated financial statements.

 

 

Note 2.

Business Combinations

 

On June 9, 2014, Eagle Bancorp, Inc. and its wholly owned subsidiary bank, EagleBank, entered into an Agreement and Plan of Reorganization (the “Agreement”) with Virginia Heritage Bank (“VHB”), pursuant to which VHB will be merged with and into EagleBank, with EagleBank surviving the merger (the “Merger”).

 

At the effective time of the Merger, each outstanding share of VHB common stock will be converted into a combination of shares of Company common stock and cash. The number of shares of Company common stock and amount of cash constituting the merger consideration is dependent on the average closing price of the Company common stock for the 20 trading days ending five trading days prior to closing (the “Company Average Share Price”). Each share of VHB common stock would be converted into cash and Company common stock as follows:

 

 

(1)

where the Company Average Share Price is at least $29.00 but not more than $35.50, (A) $7.50 in cash and (B) a number of shares of Company common stock equal to (1) $21.50 divided by (2) the Company Average Share Price, rounded to four decimal places;

 

 

(2)

where the Company Average Share Price is less than $29.00, (A) $7.50 in cash and (B) a number of shares of Company common stock equal to the quotient of (1) the Company Average Share Price less $7.50, divided by (2) the Company Average Share Price, rounded to four decimal places; and

 

 

(3)

where the Company Average Share Price is greater than $35.50, (A) an amount of cash equal to the product of (a) 0.8169 and (b) the Company Average Share Price and (c) 0.258621, and (B) 0.6056 shares of Company common stock.

 

Additionally, if at the time of the closing, the aggregate value of the shares of Company common stock to be issued is less than 45% of the aggregate consideration, then the cash portion of the consideration will be reduced by the amount necessary to cause the aggregate value of the shares of Company common stock to be issued to equal 55% of the Aggregate Merger Consideration, and the exchange ratio will be increased by the number of shares necessary to cause the aggregate value of the shares of Company common stock to equal 45% of the aggregate merger consideration. Such adjustments are expected to be necessary only if the Company Average Share Price is less than $13.64. Additionally, if prior to closing, the Company sells any shares of Company common stock or securities convertible into shares of Company common stock, other than pursuant to the exercise of currently outstanding options or warrants to acquire Company common stock, or pursuant to stock options issued after the date of the Agreement in the ordinary course of business, then each share of VHB common stock would be entitled to receive $7.50 in cash and $20.50 in Company common stock, provided that in no event will the number of shares issued under this provision exceed 19.9% of the pre-issuance shares of Company common stock.

 

The Company would also assume the 15,300 shares of VHB’s preferred stock which has an aggregate liquidation preference of $15.3 million and was issued in connection with the U.S. Treasury’s Small Business Lending Fund Program.

 

The Company will assume the VHB stock plans. Options to purchase shares of VHB common stock which are outstanding at the effective time will be “rolled over” into options to acquire the shares of Company common stock.

 

Consummation of the Merger is subject to various customary conditions which include: the approval by VHB’s shareholders of the Merger; no legal impediment to the Merger; the receipt of required regulatory approvals, including the expiration or termination of the waiting period under, the Bank Holding Company Act of 1956, the Bank Merger Act, and any other applicable law; and absence of certain material adverse changes or events. The Agreement contains certain termination rights in favor of both the Company and VHB, and further provides that, upon termination of the Agreement under specified circumstances, VHB be required to pay the Company a termination fee of $7.25 million.

 

 

Note 3.

Cash and Due from Banks

 

Regulation D of the Federal Reserve Act requires that banks maintain noninterest reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. During 2014, the Bank maintained balances at the Federal Reserve (in addition to vault cash) to meet the reserve requirements as well as balances to partially compensate for services. Late in 2008, the Federal Reserve in connection with the Emergency Economic Stabilization Act of 2008 began paying a nominal amount of interest on balances held, which interest on excess reserves was increased under provisions of the Dodd Frank Wall Street Reform and Consumer Protection Act passed in July 2010. Additionally, the Bank maintains interest-bearing balances with the Federal Home Loan Bank of Atlanta and noninterest bearing balances with six domestic correspondent banks as compensation for services they provide to the Bank.

 

Note 4.

Investment Securities Available-for-Sale

 

Amortized cost and estimated fair value of securities available-for-sale are summarized as follows:

 

 

           

Gross

     

Gross

   

Estimated

 

June 30, 2014

 

Amortized

   

Unrealized

     

Unrealized

   

Fair

 

(dollars in thousands)

 

Cost

   

Gains

     

Losses

   

Value

 

U. S. Government agency securities

  $ 43,772     $ 715  

 

  $ 99     $ 44,388  

Residential mortgage backed securities

    222,289       1,715         3,101       220,903  

Municipal bonds

    109,471       4,347         506       113,312  

Other equity investments

    396       -         9       387  
    $ 375,928     $ 6,777       $ 3,715     $ 378,990  

 

           

Gross

     

Gross

   

Estimated

 

December 31, 2013

 

Amortized

   

Unrealized

     

Unrealized

   

Fair

 

(dollars in thousands)

 

Cost

   

Gains

     

Losses

   

Value

 

U. S. Government agency securities

  $ 46,640     $ 843  

 

  $ 148     $ 47,335  

Residential mortgage backed securities

    234,206       1,143         6,675       228,674  

Municipal bonds

    102,423       2,017         2,700       101,740  

Other equity investments

    396       -         12       384  
    $ 383,665     $ 4,003       $ 9,535     $ 378,133  

  

 

Gross unrealized losses and fair value by length of time that the individual available-for-sale securities have been in a continuous unrealized loss position are as follows:

 

 

   

Less than

   

12 Months

                 
   

12 Months

   

or Greater

   

Total

 
   

Estimated

             

Estimated

           

Estimated

         

June 30, 2014

 

Fair

   

Unrealized

     

Fair

   

Unrealized

   

Fair

   

Unrealized

 

(dollars in thousands)

 

Value

   

Losses

     

Value

   

Losses

   

Value

   

Losses

 

U. S. Government agency securities

  $ 2,015     $ 5       $ 4,774     $ 94     $ 6,789     $ 99  

Residential mortgage backed securities

    25,330       125         100,557       2,976       125,887       3,101  

Municipal bonds

    7,304       42         20,044       464       27,348       506  

Other equity investments

    169       9         -       -       169       9  
    $ 34,818     $ 181       $ 125,375     $ 3,534     $ 160,193     $ 3,715  

 

   

Less than

     

12 Months

                 
   

12 Months

     

or Greater

   

Total

 
   

Estimated

               

Estimated

           

Estimated

         

December 31, 2013

 

Fair

     

Unrealized

     

Fair

   

Unrealized

   

Fair

   

Unrealized

 

(dollars in thousands)

 

Value

     

Losses

     

Value

   

Losses

   

Value

   

Losses

 

U. S. Government agency securities

  $ 4,782       $ 148       $ -     $ -     $ 4,782     $ 148  

Residential mortgage backed securities

    155,475  

 

    5,992         15,658       683       171,133       6,675  

Municipal bonds

    50,450         2,512         3,196       188       53,646       2,700  

Other equity investments

    -         -         165       12       165       12  
    $ 210,707       $ 8,652       $ 19,019     $ 883     $ 229,726     $ 9,535  

 

  

 

The unrealized losses that exist are generally the result of changes in market interest rates and interest spread relationships since original purchases. The weighted average duration of debt securities, which comprise 99.9% of total investment securities, is relatively short at 4.1 years. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. The Company does not believe that the investment securities that were in an unrealized loss position as of June 30, 2014 represent an other-than-temporary impairment for the reasons noted. The Company does not intend to sell the investments and it is more likely than not that the Company will not have to sell the securities before recovery of its amortized cost basis, which may be maturity. In addition, at June 30, 2014, the Company held $10.6 million in equity securities in a combination of Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) stocks, which are required to be held for regulatory purposes and are not marketable.

 

 

The amortized cost and estimated fair value of investments available-for-sale by contractual maturity are shown in the table below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

   

June 30, 2014

   

December 31, 2013

 
   

Amortized

   

Estimated

   

Amortized

   

Estimated

 

(dollars in thousands)

 

Cost

   

Fair Value

   

Cost

   

Fair Value

 

U. S. Government agency securities maturing:

                               

One year or less

  $ 8,003     $ 8,014     $ 19,025     $ 19,133  

After one year through five years

    29,290       29,811       27,615       28,202  

Five years through ten years

    6,479       6,563       -       -  

Residential mortgage backed securities

    222,289       220,903       234,206       228,674  

Municipal bonds maturing:

                               

After one year through five years

    39,300       40,933       25,718       26,008  

Five years through ten years

    66,561       68,577       76,705       75,732  

Ten years through fifteen years

    3,610       3,802       -       -  

Other equity investments

    396       387       396       384  
    $ 375,928     $ 378,990     $ 383,665     $ 378,133  

 

 

The carrying value of securities pledged as collateral for certain government deposits, securities sold under agreements to repurchase, and certain lines of credit with correspondent banks at June 30, 2014 was $263.5 million. As of June 30, 2014 and December 31, 2013, there were no holdings of securities of any one issuer, other than the U.S. Government and U.S. Government agency securities that exceeded ten percent of shareholders’ equity.

 

Note 5.

Derivatives

 

As part of its mortgage banking activities, the Bank enters into interest rate lock commitments, which are commitments to originate loans where the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Bank then locks in the loan and interest rate with an investor and commits to deliver the loan if settlement occurs (“best efforts”) or commits to deliver the locked loan in a binding (“mandatory”) delivery program with an investor. Certain loans under interest rate lock commitments are covered under forward sales contracts of mortgage backed securities (“MBS”). Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in noninterest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Bank determines the fair value of interest rate lock commitments and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates, taking into consideration the probability that the interest rate lock commitments will close or will be funded.

 

Certain additional risks arise from these forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Bank does not expect any counterparty to any MBS to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that, if the Bank does not close the loans subject to interest rate risk lock commitments, it will still be obligated to deliver MBS to the counterparty under the forward sales agreement. Should this be required, the Bank could incur significant costs in acquiring replacement loans or MBS and such costs could have an adverse effect on mortgage banking operations.

 

The fair value of the derivatives are recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change.

 

At June 30, 2014 the Bank had derivative financial instruments with a notional value of $25.3 million related to its forward contracts. The net fair value of these derivative instruments at June 30, 2014 was $223 thousand included in other assets and $159 thousand included in other liabilities. There were no derivative instruments in 2013.

 

 

Included in other noninterest income for the three and six months ended June 30, 2014 was a net gain of $241 thousand, relating to derivative instruments. The amount included in other noninterest income for the three and six months ended June 30, 2014 pertaining to its hedging activities was a net realized loss of $159 thousand. There were no derivative instruments or hedging activities in 2013.

 

Note 6. Loans and Allowance for Credit Losses

 

The Bank makes loans to customers primarily in the Washington, DC metropolitan area and surrounding communities. A substantial portion of the Bank’s loan portfolio consists of loans to businesses secured by real estate and other business assets.

 

Loans, net of unamortized net deferred fees, at June 30, 2014, December 31, 2013, and June 30, 2013 are summarized by type as follows:

 

 

   

June 30, 2014

   

December 31, 2013

   

June 30, 2013

 

(dollars in thousands)

 

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 

Commercial

  $ 726,611       22 %   $ 694,350       24 %   $ 636,623       24 %

Investment - commercial real estate

    1,302,479       40 %     1,119,800       38 %     1,003,723       37 %

Owner occupied - commercial real estate

    330,073       10 %     317,491       11 %     311,335       12 %

Real estate mortgage - residential

    123,587       4 %     90,418       3 %     78,813       3 %

Construction - commercial and residential

    642,264       20 %     574,167       19 %     515,511       19 %

Construction - C&I (owner occupied)

    38,368       1 %     34,659       1 %     28,807       1 %

Home equity

    108,931