Enterprise Financial Services Corp. — Q3 2018 Form 10-Q
Business context and period. Enterprise is a financial holding company providing banking and wealth-management services through Enterprise Bank & Trust, principally in the St. Louis, Kansas City, and Phoenix markets. This filing covers the quarter and nine months ended September 30, 2018. Unless noted, amounts below are in millions. The 2017 comparison includes Jefferson County Bancshares (JCB) only from its February 2017 acquisition date.
Financial performance and position
- Third-quarter earnings: Net income was $22.5 million, up 38% from $16.3 million a year earlier. Diluted EPS was $0.97 versus $0.69. Pretax income was nearly unchanged at $24.3 million versus $24.2 million; the lower tax expense materially lifted net income.
- Nine-month earnings: Net income was $65.7 million versus $40.7 million; diluted EPS was $2.81 versus $1.75. Management-reported core net income, a non-GAAP measure, was $59.7 million versus $41.9 million, and core diluted EPS was $2.56 versus $1.81.
- Revenue, margin, and expenses: Nine-month net interest income was $141.3 million, up 9%; fully tax-equivalent net interest margin was 3.78%, down from 3.87%. Core margin rose to 3.74% from 3.71%. Noninterest income increased 19% to $27.6 million, including $0.6 million from an equity-partnership sale and $1.0 million of income from non-core acquired assets. Noninterest expense rose 2% to $88.3 million; the prior-year period included $6.5 million of merger costs. Core expenses rose 10% to $87.6 million.
- Loans and credit: Portfolio loans grew 4.5% from year-end 2017 to $4.25 billion, led by commercial and industrial and commercial real-estate lending. The allowance for portfolio loan losses was $41.9 million, or 0.99% of portfolio loans. Nine-month net charge-offs were $2.9 million versus $6.9 million a year earlier. Nonperforming loans were $17.0 million, or 0.40% of portfolio loans, compared with $15.7 million and 0.39% at year-end 2017; nonperforming loans were $9.0 million at September 2017.
- Deposits and liquidity: Deposits were $4.21 billion, up 1.3% from year-end; core deposits excluding time deposits declined 1%. Cash and cash equivalents were $156.1 million. Nine-month operating cash flow was $59.9 million, investing cash outflow was $229.8 million, and financing cash inflow was $172.7 million.
- Debt and capital: At September 30, FHLB advances were $401.0 million, other borrowings $161.8 million, and subordinated debentures and notes $118.1 million. FHLB advances increased $228.3 million from year-end, while other borrowings declined $91.9 million. Shareholders’ equity was $586.8 million. The Bank’s total risk-based capital ratio was 11.09% and leverage ratio 10.27%; it met the regulatory definition of well-capitalized.
- Other balance-sheet item: Accumulated other comprehensive loss widened to $16.6 million from $3.8 million at year-end, primarily reflecting unrealized securities losses. Management attributed these losses mainly to market interest-rate changes and reported no securities as other-than-temporarily impaired.
Changes, outlook, and risks
- Drivers and pressures: Loan growth and higher loan yields supported interest income, while higher deposit and borrowing costs and runoff of higher-yielding acquired loans pressured margins. Deposit service charges and card-services revenue contributed to fee growth. Management cited investment in revenue-producing staff and tax-credit amortization among drivers of higher core expenses.
- Management outlook: Management expected high-single-digit portfolio-loan growth in 2018 and 2019; high-single-digit core fee-income growth in 2019; and expense growth equal to 35%–45% of projected revenue growth in 2019, with further efficiency-ratio improvement. It expected to maintain core net interest margin over coming quarters, while warning that funding-cost pressure could hinder that trend. Estimated incremental accretion from non-core acquired loans was $2–$3 million in total for 2018 and 2019. Management expected an effective tax rate of approximately 18%–20% for the remainder of 2018 and 2019.
- Unusual tax item: Q3 tax expense was $1.8 million versus $7.9 million a year earlier. Finalization of 2017 tax returns and related tax planning produced a $2.7 million tax benefit associated with a $0.7 million nonrecurring excise-tax expense. The nine-month effective tax rate was 13.7%, versus 31.3% in 2017, reflecting tax reform and return finalization.
- Funding and commitments: The Bank reported $1.4 billion of unused commitments to extend credit and letters of credit; contractual commitments to extend credit were $1.315 billion and letters of credit $49.6 million. Management said aggregate funding of these commitments at one time was unlikely. Available contingent sources included $266.2 million of FHLB capacity, $1.1 billion of Federal Reserve capacity, and $95 million of correspondent-bank lines. The parent had $16.5 million in cash and a $20 million revolving facility with no balance outstanding, renewed through February 2019.
- Risks and contingencies: Disclosed risks include credit deterioration and real-estate collateral values, local economic conditions, interest-rate movements, competition, regulatory and accounting changes, and acquisition integration and retention. Management said no pending or threatened legal proceeding was expected to have a material adverse effect and reported no material change to the risk factors in its 2017 Form 10-K. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether loan growth and borrower performance remain sound, given higher nonperforming loans and the increase in loans 90 or more days past due and still accruing.
- Whether deposit pricing and reliance on brokered certificates and wholesale advances continue to pressure funding costs and net interest margin.
- How much of reported earnings growth reflects recurring operations versus tax benefits, nonrecurring income, and acquired-loan accretion; review the company’s non-GAAP reconciliations.
- Whether management’s loan-growth, fee-growth, expense, margin, and tax-rate expectations are realized.
- The effect of securities valuation changes, expected credit-loss accounting adoption, and substantial unfunded customer commitments on capital and liquidity.