Eagle back in damage-control mode amid ethics investigations

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For the second time in two years, a community bank in the nation's capital has to prove to investors that it can overcome accusations of ethical violations as well as escalating legal expenses. And there is an extra wrinkle this time — credit quality concerns.

Shares in the $8.7 billion-asset Eagle Bancorp plunged 26% Thursday after CEO Susan Riel acknowledged that much of the $2.7 million Eagle paid for legal and professional fees in the second quarter was prompted by multiple government investigations of former Chairman and CEO Ron Paul’s relationship with District of Columbia Councilman Jack Evans. Riel declined to say which agencies were involved.

Eagle expects higher-than-usual legal and professional costs “at least through the remainder of 2019,” said Riel, who was appointed CEO in May after Paul’s surprise retirement.

“We really don’t know what they’ll be,” Riel said on a conference call with analysts the same day the Bethesda, Md., company's stock fell. “It’s hard for us to project that.”

Investors appear skeptical about Riel's assurances that Eagle executives “do not believe, at this point, that the resolution of these investigations will be materially adverse to the company."

The stock has remained stuck in neutral following Thursday’s swoon. Shares finished Tuesday at $40.07, up less than 1%. They had closed at $53.45 on Wednesday, the day before before the disclosure of the investigations and higher legal costs.

“The question is, what other shoes are there to drop? That’s always a concern in an investigation like this,” said Bert Ely, principal at Ely & Co., an Alexandria, Va., consulting firm.

Christopher Marinac, an analyst at Janney Montgomery Scott in Atlanta, said the market overreacted. In a note to clients, he described Riel’s disclosures about Eagle’s legal expenses as more of a “public relations issue” than a fundamental threat to the business, The selloff, he wrote, has created an opportunity for investors “willing to consider the positives and negatives of this story.”

Nevertheless, Marinac slashed his earnings-per-share estimates by 40 cents for 2019 to $4.15 and by $1.09 in 2020 to $4.01 — but he said he made the cuts deep mainly to highlight investors’ overreaction.

"I understand the disappointment," Marinac said in an interview. "The company can't say much, and that certainly creates uncertainty."

For shareholders to drive the stock down 26% when Eagle delivers consistent profits, a strong efficiency ratio and good credit quality, "just didn't compute with me," he said.

Eagle reported second-quarter net income of $37.2 million — unchanged from a year earlier but up 10.4% on a linked-quarter basis. Annualized net charge-offs totaled 0.08% of average loans.

“We are disappointed in the market response to our second quarter 2019 earnings announcement, and expect that our continued financial performance will exhibit our value to the marketplace going forward,” Mercedes Alvarez, Eagle’s director of marketing, wrote Tuesday in an email to American Banker.

One area where Eagle officials said they would tread more carefully is credit risk. Eagle announced steps to bolster its credit quality, including a plan to scale back the volume of construction loans on its books to about 120% of capital. According to Janney, Eagle's acquisition, development and construction lending amounted to about 130% of risk-based capital at March 31.

“We’re looking at what may be the end of a business cycle, a real estate cycle,” Chief Credit Officer Janice Williams said during Thursday's conference call. “We’re just prudently moving into more cash-flow-producing loans, as opposed to construction and for-sale-type arrangements.”

Earlier this month, Eagle announced that it had restructured its board, adding four members and creating a new risk committee to be led by Theresa LaPlaca, a former Wells Fargo executive.

“I have a feeling they were under pressure to create that committee,” Ely said. “They were probably getting some nudges from regulators. … There’s lots of concern about credit quality in the real estate [sector].”

Evans has been a fixture in Washington politics since the late 1980s. He has faced months of scrutiny over claims he solicited consulting work from firms that did business with the city. His troubles deepened in May, when a law firm hired by the Washington Metropolitan Area Transit Authority, a regional board Evans chaired, uncovered “multiple violations” of the transit authority’s code of ethics. Federal agents raided Evans home, in the city’s Georgetown district, last month.

To date, no charges of wrongdoing have been leveled against Eagle, but the transit authority report, by the New York firm Schulte Roth & Zabel, said the company, as well as another firm owned by Paul, had retained Evans as a consultant in 2016. That could be seen as problematic, since according to Schulte Roth & Zabel, the transit authority is a major Eagle customes, with about $24 million in deposits at the bank at the time the report was released on May 20.

Alvarez declined to comment on the report or state whether Eagle's bank did business with the transit authority. “It is EagleBank’s policy to keep clients’ information private,” she wrote.

Neither the WMATA nor Evans responded to a request for comment. Attempts to reach Paul were not immediately successful.

Eagle’s current difficulties come less than two years after a group calling itself Aurelius Value accused Paul of what it termed “an insider loan scheme.” Paul and Eagle pushed back hard, describing Aurelius Value as a short seller with a financial stake in seeing the company lose value.

Shares dropped briefly but recovered most of their lost value within a month. Similarly, Eagle’s quarterly legal fees spiked to $3 million following the Aurelius Value imbroglio but normalized until spiking again in the second quarter.

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Community banking Earnings Law and regulation Washington DC