Enterprise Financial Services Corp. — Q1 2017 Form 10-Q
Business context and period. Enterprise is a financial holding company providing banking and wealth-management services in the St. Louis, Kansas City and Phoenix markets. This unaudited report covers the three months ended March 31, 2017; year-over-year comparisons are to Q1 2016 unless noted. Results include Jefferson County Bancshares (JCB) from its February 10, 2017 closing date.
Financial performance and condition
| Metric | Q1 2017 / March 31, 2017 | Comparison |
|---|---|---|
| Net interest income | $38.6 million | $32.4 million in Q1 2016; up 19% |
| Net interest margin | 3.73% fully tax-equivalent | 3.87% in Q1 2016; core margin was 3.63% versus 3.54% |
| Noninterest income | $7.0 million | $6.0 million in Q1 2016; up 16% |
| Noninterest expense | $26.7 million, including $1.7 million merger costs | $20.8 million in Q1 2016 |
| Net income / diluted EPS | $12.4 million / $0.56 | $11.0 million / $0.54 in Q1 2016 |
| Core net income / diluted EPS | $13.1 million / $0.59 | $9.4 million / $0.47 in Q1 2016; company-defined non-GAAP measures |
| Assets / loans / deposits | $5.11 billion / $3.89 billion / $4.03 billion | Assets increased 25%, loans 23% and deposits 25% from December 31, 2016, primarily reflecting JCB |
| Cash and cash equivalents | $209.0 million | $198.8 million at December 31, 2016 |
| Shareholders’ equity | $537.9 million | $387.1 million at December 31, 2016 |
| Operating cash flow | $(31.0) million | $4.1 million provided in Q1 2016 |
Loan growth excluding JCB was $56.1 million in Q1, or 7% annualized. The allowance for loan losses was $44.6 million, including $39.1 million on portfolio loans; the portfolio allowance equaled 1.02% of portfolio loans. Nonperforming loans were $13.8 million, or 0.36% of portfolio loans, versus $14.9 million and 0.47% at year-end. There were no portfolio loans over 90 days past due and still accruing.
Deposits funded much of the balance-sheet expansion. At quarter-end, subordinated debentures and notes were $118.1 million, FHLB advances were $151.1 million, and other borrowings were $235.1 million. The company reported regulatory capital ratios of 12.76% total risk-based, 10.69% Tier 1 risk-based and 9.20% common equity Tier 1; the Bank met the well-capitalized definition. Tangible common equity to tangible assets was 8.28%.
Material changes and notable items
- JCB was acquired for approximately $171.0 million in aggregate consideration, comprising $29.3 million cash and $141.7 million in EFSC shares. The preliminary allocation recorded $83.6 million of goodwill. JCB added approximately $675.3 million of loans and $765.3 million of deposits at estimated fair value.
- Year-over-year net income rose 12%, supported by loan growth, the JCB acquisition and higher fee income. Net interest income increased $6.2 million, while higher funding costs and lower accretion income from legacy acquired loans weighed on margin.
- Q1 expenses included $1.7 million of merger-related costs. Core expenses increased 22% year over year, partly due to JCB and investments in revenue-producing personnel. The core efficiency ratio improved to 56.0% from 57.4%.
- Operating cash flow was negative, with the cash-flow statement showing a $51.7 million decrease in other liabilities. Investing activities used $39.5 million; financing activities provided $80.7 million. Cash increased by $10.2 million overall.
- Adoption of share-based compensation guidance reduced Q1 income tax expense by $1.3 million and included a $5.2 million reclassification within equity. The reported effective tax rate was 29.2%, compared with 34.8% in Q1 2016.
Outlook, risks and contingencies
- Management expects 2017 loan growth, excluding JCB, at or above 10%. It expects core expenses of $25 million to $28 million per quarter for the remaining quarters of 2017 and anticipates further JCB cost savings.
- Management expects to increase or maintain core net interest margin over coming quarters, but cautioned that funding-cost pressure could offset improvement. Estimated 2017 income from accelerated cash flows and incremental accretion on legacy non-core acquired loans was $5 million to $7 million.
- Principal risks cited include acquisition integration and customer retention, credit and collateral valuation, local economic conditions, interest-rate changes, competition, regulation and retention of key personnel. A modeled parallel rate increase of 100 basis points was expected to increase next-12-month net interest income 2.1%; a 100-basis-point decrease was expected to reduce it 6.6%.
- Unused credit commitments and standby letters of credit totaled approximately $1.27 billion at March 31, 2017. Management said aggregate drawdown at one time was unlikely. It reported no pending or threatened legal proceedings expected to have a material adverse effect.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting. The JCB purchase-price allocation remained preliminary; management noted estimates were subject to refinement.
Important facts for investors to verify
- Whether JCB integration, customer retention and projected cost savings progress as expected, and how the final purchase-price allocation affects goodwill and earnings.
- Whether organic loan growth reaches management’s target and whether credit quality, criticized loans and allowance adequacy remain consistent with reported trends.
- Whether deposit costs and borrowing needs pressure net interest margin, particularly as the loan and deposit base expands.
- Whether core expense guidance and accretion-income estimates are achieved; core measures are non-GAAP and should be assessed alongside GAAP results.
- The causes and recurrence of negative operating cash flow, and the liquidity implications of substantial unfunded commitments and pledged securities.