Eagle Bancorp Montana, Inc.: Form 10-Q for the period ended Jun 30, 2018

Overview

The Company’s primary business activity is the ownership of its wholly owned subsidiary, Opportunity Bank of Montana (the “Bank”). The Bank is a Montana chartered commercial bank that focuses on both consumer and commercial lending. It engages in typical banking activities: acquiring deposits from local markets and originating loans and investing in securities. Its deposits are insured by the Federal Deposit Insurance Corporation. The Bank’s primary component of earnings is its net interest margin (also called spread or margin), the difference between interest income and interest expense. The net interest margin is managed by management (through the pricing of its products and by the types of products offered and kept in portfolio), and is affected by changes in market interest rates. The Bank also generates noninterest income in the form of fee income and gain on sale of loans.

The Bank has a strong mortgage lending focus, with a large portion of its loan originations represented by single-family residential mortgages, which has enabled it to successfully market home equity loans, as well as a wide range of shorter term consumer loans for various personal needs (automobiles, recreational vehicles, etc.). In recent years, the Bank has also focused on adding commercial loans to its portfolio, both real estate and non-real estate. We have made significant progress in this initiative. The purpose of this diversification is to mitigate the Bank’s dependence on the residential mortgage market, as well as to improve its ability to manage its spread. The Bank’s management recognizes that fee income will also enable it to be less dependent on specialized lending and it now maintains a significant loan serviced portfolio which provides a steady source of fee income. Fee income is also supplemented with fees generated from the Bank’s deposit accounts. The Bank has a high percentage of non-maturity deposits, such as checking accounts and savings accounts, which allows management flexibility in managing its spread. Non-maturity deposits and certificates of deposits do not automatically reprice as interest rates rise. Gain on sale of loans also provides significant noninterest income in periods of high mortgage loan origination volumes. Such income will be adversely affected in periods of lower mortgage activity.

Management continues to focus on improving the Bank’s core earnings. Core earnings can be described as income before taxes, with the exclusion of gain on sale of loans and adjustments to the market value of the Bank’s loan servicing portfolio. Management believes that the Bank will need to continue to concentrate on increasing net interest margin, other areas of fee income and control of operating expenses to achieve earnings growth going forward. Management’s strategy of growing the bank’s loan portfolio and deposit base is expected to help achieve these goals as follows: loans typically earn higher rates of return than investments; a larger deposit base should yield higher fee income; increasing the asset base will reduce the relative impact of fixed operating costs. The biggest challenge to the strategy is funding the growth of the Bank’s balance sheet in an efficient manner. Though deposit growth has been steady, it may become more difficult to maintain due to significant competition and possible reduced customer demand for deposits as customers may shift into other asset classes.

The level and movement of interest rates impacts the Bank’s earnings as well. The Federal Open Market Committee changed the federal funds target rate from 0.75% to 1.50% during the year ended December 31, 2017. The rate increased from 1.50% to 2.00% during the six months ended June 30, 2018.

On October 13, 2017, the Company successfully completed a public offering of its common stock, and issued 1,189,041 shares and received approximately $20.16 million in net cash proceeds.

On September 5, 2017, the Company entered into an Agreement and Plan of Merger with TwinCo Inc. (“TwinCo”), a Montana corporation, and TwinCo’s wholly-owned subsidiary, Ruby Valley Bank, a Montana chartered commercial bank. The merger agreement provided that Ruby Valley Bank would merge with and into Opportunity Bank of Montana and that TwinCo would merge with and into the Company. Ruby Valley Bank operated 2 branches in Madison County, Montana. The transaction provided an opportunity to expand market presence and lending activities, particularly in agricultural lending. The acquisition closed January 31, 2018, after receipt of approvals from regulatory authorities, approval of TwinCo shareholders and the satisfaction of other closing conditions. The total consideration paid was $18.93 million and included cash consideration of $9.90 million and common stock issued of $9.03 million.

Financial Condition

Comparisons of financial condition in this section are between June 30, 2018 and December 31, 2017.

Total assets were $826.83 million at June 30, 2018, an increase of $110.05 million, or 15.4%, from $716.78 million at December 31, 2017. The increase was largely due to the change in securities and loans receivable, net as a result of the acquisition of TwinCo. Securities available-for-sale increased $22.23 million, or 16.8%, to $154.27 million at June 30, 2018 from $132.04 million at December 31, 2017. Loans receivable, net increased by $68.18 million, or 13.4%, to $575.58 million at June 30, 2018, from $507.40 million at December 31, 2017. Total liabilities were $735.02 million at June 30, 2018, an increase of $101.85 million, or 16.1%, from $633.17 million at December 31, 2017. The increase was primarily due to an increase in deposits largely due to the TwinCo acquisition, as well as an increase in Federal Home Loan Bank (“FHLB”) advances and other borrowings. Total deposits increased by $92.62 million, or 17.8%, to $613.18 million at June 30, 2018, from $520.56 million at December 31, 2017. FHLB advances and other borrowings increased $8.50 million to $91.47 million at June 30, 2018 from $82.97 million at December 31, 2017.

Balance Sheet Details

Investment Activities

The following table summarizes investment activities:

(Dollars in Thousands)

Securities available-for-sale were $154.27 million at June 30, 2018, an increase of $22.23 million, or 16.8%, from $132.04 million at December 31, 2017. All categories of securities available-for-sale increased during the period with the exception of corporate obligations and mortgage-backed securities. The increases were mainly related to the acquisition of TwinCo. Corporate obligations decreased primarily due to maturities, and mortgage-backed securities decreased due to principal payments partially offset by net purchases.

Financial Condition – continued

Lending Activities

The following table includes the composition of the Bank’s loan portfolio by loan category:

(Dollars in thousands)

(1) Excludes loans held-for-sale.

Loans receivable, net increased $68.18 million to $575.58 million at June 30, 2018 largely due to the TwinCo acquisition. The TwinCo acquisition included $55.07 million of acquired loans. Excluding acquired loans, loans receivable, net increased by $13.12 million. Including acquired loans, commercial real estate loans increased $21.46 million, farmland loans increased $17.05 million, agricultural loans increased $15.58 million, commercial loans increased $6.65 million, residential 1-4 family construction loans increased $5.70 million, residential 1-4 family loans increased $2.40 million, consumer loans increased $923,000 and home equity loans increased $506,000. These increases were slightly offset by a decrease in commercial construction and development loans of $1.77 million. Total loan originations were $214.95 million for the six months ended June 30, 2018, with residential mortgage accounting for $134.50 million of the total. Commercial real estate loan originations were $27.91 million and commercial construction and development loan originations were $4.42 million. Residential 1-4 family construction loan originations were $9.68 million. Consumer loan originations were $4.87 million and home equity originations were $6.71 million. Farmland loan originations were $4.36 million and agricultural loan originations were $7.77 million. Commercial loans originations were $14.73 million. Loans held-for-sale increased to $11.70 million at June 30, 2018 from $8.95 million at December 31, 2017.

Financial Condition – continued

Lending Activities– continued

Nonperforming Assets. Generally, our collection procedures provide that when a loan is 15 or more days delinquent, the borrower is sent a past due notice. If the loan becomes 30 days delinquent, the borrower is sent a written delinquency notice requiring payment. If the delinquency continues, subsequent efforts are made to contact the delinquent borrower, including face to face meetings and counseling to resolve the delinquency. All collection actions are undertaken with the objective of compliance with the Fair Debt Collection Act.

For mortgage loans and home equity loans, if the borrower is unable to cure the delinquency or reach a payment agreement, we will institute foreclosure actions. If a foreclosure action is taken and the loan is not reinstated, paid in full or refinanced, the property is sold at judicial sale at which we may be the buyer if there are no adequate offers to satisfy the debt. Any property acquired as the result of foreclosure, or by deed in lieu of foreclosure, is classified as real estate owned until such time as it is sold or otherwise disposed of. When real estate owned is acquired, it is recorded at its fair market value less estimated selling costs. The initial recording of any loss is charged to the allowance for loan losses. Subsequent write-downs are recorded as a charge to operations. As of June 30, 2018, the Bank had $457,000 of real estate owned.

The following table sets forth information regarding nonperforming assets:

(Dollars in Thousands)

The commercial real estate non-accrual loans at June 30, 2018 relate to the TwinCo acquisition.

Financial Condition – continued

Deposits and Other Sources of Funds

The following table includes deposit accounts by category:

(Dollars in Thousands)

Deposits increased by $92.62 million, or 17.8%, to $613.18 million at June 30, 2018 from $520.56 million at December 31, 2017. The increase was mainly due to increased deposits as a result of the TwinCo acquisition. Noninterest checking increased by $33.94 million. Savings and interest bearing checking increased by $19.94 million and $1.83 million, respectively. Money market accounts increased by $16.99 million. Certificates of deposit increased by $19.92 million.

The following table summarizes borrowing activity:

(Dollars in Thousands)

FHLB advances and other borrowings increased by $8.50 million, or 10.2%, to $91.47 million at June 30, 2018 from $82.97 million at December 31, 2017. The borrowings were used to help fund the continued loan growth.

Shareholders’ Equity

Total shareholders’ equity increased $8.19 million, or 9.8%, to $91.81 million at June 30, 2018 from $83.62 million at December 31, 2017. This was primarily the result of stock issued in connection with the TwinCo acquisition of $9.03 million and net income of $1.91 million. These increases were partially offset by other comprehensive loss of $1.93 million and dividends paid of $983,000.

Analysis of Net Interest Income

The Bank’s earnings have historically depended primarily upon net interest income, which is the difference between interest income earned on loans and investments and interest paid on deposits and any borrowed funds. It is the single largest component of Eagle’s operating income. Net interest income is affected by (i) the difference between rates of interest earned on loans and investments and rates paid on interest bearing deposits and borrowings (the “interest rate spread”) and (ii) the relative amounts of loans and investments and interest bearing deposits and borrowings.

The following tables include average balances for balance sheet items, as well as, interest and dividends and average yields related to the average balances. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields include the effect of deferred fees and discounts and premiums that are amortized or accreted to interest income or expense.

(Dollars in Thousands)

(1) Includes loans held-for-sale.

(2) Interest rate spread represents the difference between the average yield on interest earning assets and the average rate on interest bearing liabilities.

(3) Net interest margin represents income before the provision for loan losses divided by average interest earning assets.

(4) For purposes of this table, tax exempt income is not calculated on a tax equivalent basis.

(5) Calculated based on actual days. Previously calculated on a 360 day basis

Analysis of Net Interest Income – continued

(Dollars in Thousands)

(1) Includes loans held-for-sale.

(2) Interest rate spread represents the difference between the average yield on interest earning assets and the average rate on interest bearing liabilities.

(3) Net interest margin represents income before the provision for loan losses divided by average interest earning assets.

(4) For purposes of this table, tax exempt income is not calculated on a tax equivalent basis.

(5) Calculated based on actual days. Previously calculated on a 360-day basis.

Rate/Volume Analysis

The following tables present the dollar amount of changes in interest income and interest expense for major components of interest earning assets and interest bearing liabilities. For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to: (1) changes in volume multiplied by the old rate; (2) changes in rate, which are changes in rate multiplied by the old volume; and (3) changes not solely attributable to rate or volume, which have been allocated proportionately to the change due to volume and the change due to rate.

(In Thousands)

(1) Includes loans held-for-sale.

Rate/Volume Analysis – continued

(In Thousands)

(1) Includes loans held-for-sale.

Results of Operations for the Three Months Ended June 30, 2018 and 2017

Net Income. Eagle’s net income for the three months ended June 30, 2018 was $1.33 million compared to $1.07 million for the three months ended June 30, 2017. The increase of $267,000, or 25.0%, was due to an increase in net interest income after loan loss provision of $2.21 million and a decrease in income tax expense of $169,000, offset by a decrease in noninterest income of $486,000 and an increase in noninterest expense of $1.62 million. Basic and diluted earnings per share were $0.24 for the current period. Basic and diluted earnings per share were $0.28 and $0.27, respectively, for the prior year comparable period.

Net Interest Income. Net interest income increased to $7.81 million for the three months ended June 30, 2018, from $5.88 million for the same quarter in the prior year. This increase of $1.93 million, or 32.8%, was the result of an increase in interest and dividend income of $2.05 million, slightly offset by an increase in interest expense of $121,000.

Interest and Dividend Income. Interest and dividend income was $8.98 million for the three months ended June 30, 2018, compared to $6.93 million for the three months ended June 30, 2017, an increase of $2.05 million, or 29.6%. Interest and fees on loans increased to $7.86 million for the three months ended June 30, 2018 from $6.17 million for the three months ended June 30, 2017. This increase of $1.69 million, or 27.4%, was due to an increase in the average balance of loans, as well as, an increase in the average yield of loans for the quarter ended June 30, 2018. Average balances for loans receivable, including loans held-for-sale, for the three months ended June 30, 2018 were $585.37 million, compared to $512.14 million for the prior year period. This represents an increase of $73.23 million, or 14.3% and was largely due to the TwinCo acquisition. The average interest rate earned on loans receivable increased by 55 basis points, from 4.84% to 5.39%. Interest and dividends on investment securities available-for-sale increased by $307,000, or 43.0% period over period. Average balances for investments increased to $154.67 million for the three months ended June 30, 2018, from $126.94 million for the three months ended June 30, 2017. This increase was also largely due to the TwinCo acquisition. Average interest rates earned on investments increased to 2.65% for the three months ended June 30, 2018 from 2.26% for the three months ended June 30, 2017.

Results of Operations for the Three Months Ended June 30, 2018 and 2017 – continued

Interest Expense. Total interest expense was $1.17 million for the three months ended June 30, 2018 compared to $1.05 million for the three months ended June 30, 2017. The increase of $121,000 or 11.6% was largely attributable to an increase in interest expense on deposits. The average balance for total deposits was $623.29 million for three months ended June 30, 2018 compared to $512.74 million for the three months ended June 30, 2017. This increase was largely due to the TwinCo acquisition. The overall average rate on total deposits was 0.32% for the three months ended June 30, 2018 compared to 0.29% for the three months ended June 30, 2017. The average balance for total borrowings decreased from $122.62 million for the three months ended June 30, 2017 to $102.13 million for the three months ended June 30, 2018. However, the average rate paid on total borrowings increased from 2.19% for the three months ended June 30, 2017, to 2.64% for the three months ended June 30, 2018.

Loan Loss Provision. Loan loss provisions are charged to earnings to maintain total allowance for loan losses at a level considered adequate by management of the Bank, to provide for probable loan losses based on prior loss experience, volume and type of lending conducted by the Bank and past due loans in the portfolio. The Bank’s policies require review of assets on a quarterly basis. The Bank classifies loans as well as other assets if warranted. While management believes it uses the best information available to make a determination with respect to the allowance for loan losses, it recognizes that future adjustments may be necessary. The Bank recorded $24,000 in provision for loan losses for the three months ended June 30, 2018 and $302,000 for the three months ended June 30, 2017. Management believes the level of total allowances is adequate.

Noninterest Income. Total noninterest income was $3.08 million for the three months ended June 30, 2018, compared to $3.57 million for the three months ended June 30, 2017. The decrease of $486,000 or 13.6% is primarily due to a decrease in net gain on sale of loans which decreased to $1.72 million for the three months ended June 30, 2018 from $2.26 million for the three months ended June 30, 2017. The decrease is primarily due to a decrease in gross margin on sale of mortgage loans for the three months ended June 30, 2018 compared to the three months ended June 30, 2017. The decrease in gross margin on sale of mortgage loans is due to interest rate movements in the mortgage market and strategic defensive posture due to competitive pressure.

Noninterest Expense. Noninterest expense was $9.24 million for the three months ended June 30, 2018 compared to $7.62 million for the three months ended June 30, 2017. The increase of $1.62 million or 21.3% is largely due to increased salaries and employee benefits expense of $875,000. The increase is due in part to higher commission-based compensation related to the continued loan growth and additional staff related to compliance with mortgage rules. Salaries and employee benefits expense was also impacted by the addition of staff related to the TwinCo acquisition.

Income Tax Expense. Income tax expense was $293,000 for the three months ended June 30, 2018, compared to $462,000 for the three months ended June 30, 2017. The effective tax rate for the three months ended June 30, 2018 was 18.0%.

Results of Operations for the Six Months Ended June 30, 2018 and 2017

Net Income. Eagle’s net income for the six months ended June 30, 2018 was $1.91 million compared to $1.83 million for the six months ended June 30, 2017. The slight increase of $77,000, or 4.2%, was due to an increase in net interest income after loan loss provision of $3.37 million and a decrease in income tax expense of $230,000, offset by an increase in noninterest expense of $2.51 million and a decrease in noninterest income of $1.02 million. Basic and diluted earnings per share were $0.35 for the current period. Basic and diluted earnings per share were $0.48 and $0.47, respectively, for the prior year comparable period.

Net Interest Income. Net interest income increased to $14.66 million for the six months ended June 30, 2018, from $11.36 million for the previous year’s six-month period. This increase of $3.30 million, or 29.0%, was the result of an increase in interest and dividend income of $3.66 million, partially offset by an increase in interest expense of $374,000.

Results of Operations for the Six Months Ended June 30, 2018 and 2017 – continued

Interest and Dividend Income. Interest and dividend income was $16.93 million for the six months ended June 30, 2018, compared to $13.27 million for the six months ended June 30, 2017, an increase of $3.66 million, or 27.6%. Interest and fees on loans increased to $14.73 million for the six months ended June 30, 2018 from $11.74 million for the same period ended June 30, 2017. This increase of $2.99 million, or 25.5%, was due to an increase in the average balance of loans, as well as, an increase in the average yield on loans. Average balances for loans receivable, including loans held-for-sale, for the six months ended June 30, 2017 were $579.19 million, compared to $493.39 million for the prior year period. This represents an increase of $85.80 million, or 17.4% and was largely due to the TwinCo acquisition. The average interest rate earned on loans receivable increased by 33 basis points, from 4.80% to 5.13%. Interest and dividends on investment securities available-for-sale increased $567,000, or 39.3% period over period. Average balances for investments increased to $165.55 million for the six months ended June 30, 2018, from $127.70 million for the six months ended June 30, 2017. This increase was also largely due to the TwinCo acquisition. Average interest rates earned on investments increased to 2.45% for the six months ended June 30, 2018 from 2.28% for the six months ended June 30, 2017.

Interest Expense. Total interest expense for the six months ended June 30, 2018 was $2.28 million compared to $1.90 million for the six months ended June 30, 2017. The increase of $374,000, or 19.7%, was due to an increase in total borrowings, as well as an increase in interest expense on deposits. Interest expense on FHLB advances and other borrowings and other long-term debt increased $210,000 for the six months ended June 30, 2018 compared to the same period in the prior year. The average borrowing balance increased from $103.24 million for the six months ended June 30, 2017 to $130.34 million for the six months ended June 30, 2018. However, the average rate paid decreased from 2.24% for the six months ended June 30, 2017, to 2.10% for the six months ended June 30, 2018. Borrowings have been used to help fund the continued loan growth. Interest expense on deposits increased $164,000 for the six months ended June 30, 2018 compared to the same period in the prior year. The increase is due to higher overall average balances for total deposits which increased from $515.05 million for the six months ended June 30, 2017 to $614.30 million for the six months ended June 30, 2018. This increase was largely due to the TwinCo acquisition. The overall average rate on total deposits was consistent period over period.

Loan Loss Provision. Loan loss provisions are charged to earnings to maintain the total allowance for loan losses at a level considered adequate by management of the Bank, to provide for probable loan losses based on prior loss experience, volume and type of lending conducted by the Bank and past due loans in the portfolio. The Bank’s policies require a review of assets on a quarterly basis. The Bank classifies loans as well as other assets if warranted. While management believes it uses the best information available to make a determination with respect to the allowance for loan losses, it recognizes that future adjustments may be necessary. The Bank recorded $526,000 in loan loss provisions for the six months ended June 30, 2018 and $603,000 in the six months ended June 30, 2017. Management believes the level of total allowances is adequate. As of June 30, 2018, the Bank had $457,000 in foreclosed real estate property and other repossessed property.

Noninterest Income. Total noninterest income decreased to $5.76 million for the six months ended June 30, 2018, from $6.78 million for the six months ended June 30, 2017, a decrease of $1.02 million or 15.0%. The decrease is largely due to a decrease in net gain on sale of loans which decreased to $3.16 million for the six months ended June 30, 2018 from $4.09 million for the six months ended June 30, 2017. During the six months ended June 30, 2018, $120.64 million mortgage loans were sold compared to $129.91 million in the same period in the prior year. In addition, gross margin on sale of mortgage loans for the six months ended June 30, 2018 compared to the six months ended June 30, 2017 declined. The decrease in gross margin on sale of mortgage loans is due to interest rate movements in the mortgage market and strategic defensive posture due to competitive pressure.

Noninterest Expense. Noninterest expense was $17.57 million for the six months ended June 30, 2018 compared to $15.06 million for the six months ended June 30, 2017. The increase of $2.51 million, or 16.7%, is largely due to increased salaries and employee benefits expense of $1.35 million. The increase in salaries expense is due in part to higher commission-based compensation related to the continued loan growth and additional staff related to compliance with mortgage rules. Salaries and employee benefits expense was also impacted by the addition of staff related to the TwinCo acquisition. In addition, the Company incurred acquisition costs of $365,000 during the six months ended June 30, 2018 related to the TwinCo acquisition.

Income Tax Expense. Income tax expense was $420,000 for the six months ended June 30, 2018, compared to $650,000 for the six months ended June 30, 2017. The effective tax rate for the six months ended June 30, 2018 was 18.1%. The tax was lower due to lower income before income taxes for the six months ended June 30, 2018 compared to the same period in the prior year, as well as the impact of the Tax Cuts and Job Act enacted in December 2017.

Liquidity and Capital Resources

Liquidity

The Bank is required to maintain minimum levels of liquid assets as defined in the regulations of the Montana Division of Banking and Financial Institutions and Federal Reserve Bank (“FRB”) regulations. The liquidity requirement is retained for safety and soundness purposes, and appropriate levels of liquidity will depend upon the types of activities in which the company engages. For internal reporting purposes, the Bank uses policy minimums of 1.0%, and 8.0% for “basic surplus” and “basic surplus with FHLB” as internally defined. In general, the “basic surplus” is a calculation of the ratio of unencumbered short-term assets reduced by estimated percentages of CD maturities and other deposits that may leave the Bank in the next 90 days divided by total assets. “Basic surplus with FHLB” adds to “basic surplus” the additional borrowing capacity the Bank has with FHLB. The Bank exceeded those minimum ratios as of both June 30, 2018 and December 31, 2017.

The Bank’s primary sources of funds are deposits, repayment of loans and mortgage-backed and collateralized mortgage obligation securities, maturities of investments, funds provided from operations and advances from FHLB and other borrowings. Scheduled repayments of loans and mortgage-backed and collateralized mortgage obligation securities and maturities of investment securities are generally predictable. However, other sources of funds, such as deposit flows and loan prepayments, can be greatly influenced by the general level of interest rates, economic conditions and competition. The Bank uses liquidity resources principally to fund existing and future loan commitments. It also uses them to fund maturing certificates of deposit, demand deposit withdrawals and to invest in other loans and investments, maintain liquidity and meet operating expenses.

Liquidity may be adversely affected by unexpected deposit outflows, higher interest rates paid by competitors and similar matters. Management monitors projected liquidity needs and determines the level desirable, based in part on commitments to make loans and management’s assessment of the Bank’s ability to generate funds.

Capital Resources

As of June 30, 2018, the Bank’s internally determined measurement of sensitivity to interest rate movements as measured by a 200 basis point rise in interest rates scenario, increased the economic value of equity (“EVE”) by 2.1% compared to an increase of 2.7% at December 31, 2017. The Bank is within the guidelines set forth by the Board of Directors for interest rate risk sensitivity in rising interest rate scenarios.

Beginning January 1, 2015, community banking organizations became subject to a new regulatory rule recently adopted by federal banking agencies (commonly referred to as Basel III). The new rule establishes a new regulatory capital framework that incorporates revisions to the Basel capital framework, strengthens the definition of regulatory capital, increases risk-based capital requirements, and amends the methodologies for determining risk-weighted assets. These changes are expected to increase the amount of capital required by community banking organizations. Basel III includes a multiyear transition period from January 1, 2015 through December 31, 2019.

The Banks’s Tier I leverage ratio, as measured under State of Montana and FRB rules, increased from 10.39% as of December 31, 2017 to 11.261% as of June 30, 2018. The Bank’s capital position helps to mitigate its interest rate risk exposure.

As of June 30, 2018, the Bank’s regulatory capital was in excess of all applicable regulatory requirements. As of June 30, 2018, the Bank’s total capital, Tier 1 capital, common equity Tier 1 capital and Tier 1 leverage ratios were 15.654%, 14.647%, 14.647% and 11.261%, respectively, compared to regulatory requirements of 9.875%, 7.875%, 6.375% and 4.00%, respectively. All of these ratios with the exception of the Tier 1 leverage ratio include the capital conservation buffer of 1.875% phased-in beginning January 1, 2018.

The Bank’s regulatory capital was impacted by the TwinCo acquisition through an increase in paid-in capital by the amount invested in the acquired bank which was partially offset by a cash dividend to Eagle in the amount of the cash portion of the agreed upon deal with TwinCo shareholders.

Liquidity and Capital Resources – continued

(Unaudited)

(Dollars in Thousands)

Interest Rate Risk

Interest rate risk is the potential for loss of future earnings resulting from adverse changes in the level of interest rates. Interest rate risk results from several factors and could have a significant impact on the Company’s net interest income, which is the Company primary source of income. Net interest income is affected by changes in interest rates, the relationship between rates on interest bearing assets and liabilities, the impact of interest fluctuations on asset prepayments and the mix of interest bearing assets and liabilities.

Although interest rate risk is inherent in the banking industry, banks are expected to have sound risk management practices in place to measure, monitor and control interest rate exposures. The objective of interest rate risk management is to contain the risks associated with interest rate fluctuations. The process involves identification and management of the sensitivity of net interest income to changing interest rates.

The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability committee, which is governed by policies established by the Company’s Board that are reviewed and approved annually. The Board delegates responsibility for carrying out the asset/liability management policies to the Bank’s asset/liability committee. In this capacity, the asset/liability committee develops guidelines and strategies impacting the Company’s asset/liability management related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends. The Company’s goal of its asset and liability management practices is to maintain or increase the level of net interest income within an acceptable level of interest rate risk. Our asset and liability policy and strategies are expected to continue as described so long as competitive and regulatory conditions in the financial institution industry and market interest rates continue as they have in recent years.

Interest Rate Risk – continued

The Bank has established acceptable levels of interest rate risk as follows: Projected net interest income over the next twelve months will not be reduced by more than 15.0% given a change in interest rates of up to 200 basis points (+ or -).

The following table includes the Bank’s net interest income sensitivity analysis.

Impact of Inflation and Changing Prices

Our financial statements and the accompanying notes have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of our operations. Interest rates have a greater impact on our performance than do the general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of the end of the period covered by this report, we conducted an evaluation under the supervision and with the participation of our management including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”) of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms, including to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is accumulated and communicated to management to allow timely decisions regarding required disclosure. Based on that evaluation, our CEO and CFO concluded that as of June 30, 2018, our disclosure controls and procedures were effective. During the last quarter, there were no changes in the Company’s internal control over financial reporting that have materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting.

There have not been any material changes in the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form10-K for the year ended December 31, 2017.