Description

Broncos727 submitted Eagle Bancorp nearly two years ago at roughly the same price and his thesis is one we agree with.  While much of what he wrote is still applicable, the story has been enhanced by a recent acquisition of a competitor’s bank branches: adding heft to the balance sheet and ultimately making this a more likely acquisition target in its own right. Eagle, like many small thrifts and commercial banks, has been pressured by a declining net interest margin in the face of a flattening yield curve, tepid loan demand, and in this case, an overcapitalized balance sheet. As a reminder, EGMT is a mutual to stock conversion and as such found itself with a surplus of capital at a time where it was disadvantageous to do so from a GAAP earnings standpoint.

Recent Acquisition

In July of this past year, the company acquired 7 branches from Sterling Financial for slightly less than a 4% deposit premium. The acquisition expanded their footprint into Southern Montana-most notably Billings and Missoula, cities in which they previously didn’t have a presence and roughly doubled their state-wide market share. Here are some of the details of what they acquired and their rationale for the transaction:

• 44mm in performing  loans (35% heloc, 32% 1-4 family, 18% commercial, 10% commercial real estate, 5% consumer) with a weighted avg yield of 5.5%
• 187mm in deposits costing .72% ( 35% money market, 25% CDs < 100k, 18% CD > 100k, 11% NIB demand, 7% NOW, 4% savings). 46mm of their CDS with a weighted avg rate of 1.38% were set to reprice within one year of the deal announcement.
• Greater than 20% accretive to earnings beginning in fy13
• Approximately 15% IRR
• 14% tangible book dilution expected to be earned back in 4-5 years

Below is a decent link to some economic statistics about Montana.

http://ceic.mt.gov/MTEconomistsResourcePage.asp

Snapshot from latest Quarter

• 508.1mm in assets

• 214mm in loans (38.5% commercial, 31% 1-4 family resi mortgages, 17.5% heloc, 7.1% commercial, 5.1% consumer, .8% residential construction)
• 414.7mm in deposits (44.6% checking and mma, 38.4% CDs, 18.% savings accounts)
• 53.4mm in equity
• NIM of 3.36%
• NPAs of .53% of total assets
• Allowances of .85% of total loans
• Non performing loans of .70%
• Tier 1 8.46%,  risk based 15.9%
• $13.71 book value, $11.68 tangible book

A proforma look at the combined company on an ‘as-if’ basis is below

There are some puts and takes but it seems that the company is doing somewhere between .80-$1.00 on an annualized basis. However, referring back to the statistics above, it appears the company is under-loaned against its deposit base at roughly 52%. We are operating under the assumption that the company is able to grow its loan book at 5% per annum for the next three years which should add roughly 35mm to their loan book. At current spreads, which we’d argue are depressed, they should be adding about .20 per share in net interest income.

 Summary

Eagle is a cheap bank with benign credit, trading at 88% of tangible book and 9-9.5x a conservative normalized earnings estimate.  Management is conservative as exemplified by their loan provisioning and loss history. The three year anniversary of their second step occurs in April of this year which means they are eligible to be acquired, and have enough skin in the game to think this is a feasible outcome. While we have no reason to believe this will occur, we are of the view that the industry will continue to consolidate and clean banks in healthy geographies (with franchise scarcity value) will be targets.  In such a scenario we believe that a 4% deposit premium isn’t unrealistic. As such, factoring in the earnings growth above, we’d expect a deal to occur in the $18-20 range.