ENTERPRISE FINANCIAL SERVICES CORP annual report, FY2016

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Enterprise Financial Services Corp. — 2016 Form 10-K

Business context and reporting period. The company is a financial holding company operating Enterprise Bank & Trust, serving business and individual clients in the St. Louis, Kansas City and Phoenix markets, with banking and wealth-management services. This annual report covers the fiscal year ended December 31, 2016; quarterly results below include the fourth quarter. Unless stated otherwise, dollar amounts are in millions.

Financial performance and condition

  • Earnings and revenue: Net income was $48.8 million, up 27% from $38.5 million in 2015. Diluted EPS rose to $2.41 from $1.89. Net interest income was $135.5 million, up 13%; noninterest income was $29.1 million, up 41%. Together, these revenue sources totaled $164.6 million, versus $141.1 million in 2015. Fourth-quarter net income was $13.6 million, compared with $10.7 million a year earlier.
  • Margins and returns: Net interest margin was 3.84%, down from 3.86%; management’s non-GAAP core margin increased to 3.51% from 3.46%. Return on average assets improved to 1.29% from 1.14%, and return on average common equity to 13.14% from 11.47%. The efficiency ratio improved to 52.33% from 58.28%.
  • Cash flow: Operating cash flow was $82.5 million, investing cash outflow was $358.1 million, and financing cash inflow was $380.2 million. Cash and cash equivalents ended the year at $198.8 million, up from $94.2 million.
  • Balance sheet and funding: Total assets were $4.08 billion, up 13%; portfolio loans were $3.12 billion, up 13%; and deposits were $3.23 billion, up 16%. Shareholders’ equity was $387.1 million. Core deposits grew, while brokered CDs increased to $117.1 million, or 4% of deposits.
  • Debt and liquidity: Subordinated debentures and notes totaled $105.5 million, including $50 million of new notes; other borrowings were $277.0 million, and there were no FHLB advances outstanding at year-end. The company had $52.2 million of parent-company cash and believed it sufficient for projected holding-company needs for at least a year. The bank reported additional borrowing availability of $439.7 million from the FHLB and $933.9 million from the Federal Reserve, plus $60 million in correspondent-bank lines.
  • Capital: The company’s total risk-based capital ratio was 13.48%, CET1 ratio 9.52%, and leverage ratio 10.42%. The bank was categorized as well capitalized; its total risk-based capital ratio was 11.53% and leverage ratio 9.81%.
  • Credit quality: Nonperforming assets declined to $15.9 million from $17.5 million, or 0.39% of assets versus 0.48%. However, nonperforming loans rose to $14.9 million from $9.1 million, and potential problem loans increased to $77.6 million from $50.3 million. Net charge-offs remained low at $1.4 million, or 0.05% of average portfolio loans. The portfolio allowance was $37.6 million, or 1.20% of portfolio loans.

Material changes versus 2015

  • Growth in portfolio lending and core deposits drove higher net interest income; total portfolio loans increased $367.7 million and deposits increased $448.8 million.
  • Reported earnings also benefited from acquired-loan accretion and other PCI-related activity following the 2015 termination of FDIC loss-share agreements. PCI assets contributed $15.0 million of pretax income in 2016; the company estimated 2017 incremental PCI accretion of $5–$7 million.
  • Noninterest expense increased 5% to $86.1 million, including $1.4 million of JCB merger costs and a $1.0 million facilities disposal charge. Employee compensation and benefits rose with investment in client-facing personnel.
  • Nonperforming loans increased despite lower total nonperforming assets; potential problem loans also rose, warranting attention.
  • The company issued $50 million of 4.75% fixed-to-floating subordinated notes in November 2016, maturing in 2026, and repurchased 185,718 shares under its public program. Common dividends paid rose to $0.41 per share from $0.26.

Outlook, commentary and risks

  • No broad earnings or revenue guidance is provided. Management emphasized relationship-led growth, fee income, specialized lending, deposit gathering, disciplined credit management and expense control.
  • On February 10, 2017, after year-end, the company completed its acquisition of Jefferson County Bancshares. Consideration included 3.3 million EFSC shares and approximately $29.3 million in cash; the transaction was valued at approximately $171 million. JCB reported $937 million in assets, $699 million in loans and $767 million in deposits at December 31, 2016. Integration, customer retention, acquired credit quality, cost savings and shareholder dilution are key execution considerations.
  • Management announced in February 2017 that CEO Peter F. Benoist would resign at the 2017 annual meeting and that James B. Lally would succeed him.
  • Principal disclosed risks include credit losses and commercial real-estate exposure; concentration in the company’s regional markets; interest-rate and deposit-funding risk; reliance in part on brokered deposits; acquisition integration; regulatory and compliance costs; cybersecurity and third-party service disruptions; and potential losses tied to specialized lending, aircraft finance and New Markets Tax Credit indemnities. Approximately $1.08 billion of commitments to extend credit and $79.0 million of letters of credit were outstanding at year-end; these are not equivalent to funded loans.
  • The financial statements received an unqualified audit opinion, and management and the auditor reported effective internal control over financial reporting as of December 31, 2016. Management stated that pending or threatened legal proceedings were not expected to have a material adverse effect.

Most important facts for investors to verify

  1. Whether the increase in nonperforming loans and potential problem loans leads to higher provisions, charge-offs or reserve needs.
  2. How much of 2016 earnings depended on PCI accretion and other noncore items, and whether recurring/core earnings sustain their growth.
  3. JCB integration results, realized cost savings, acquired-asset marks, goodwill and tangible-book-value effects, and dilution from the shares issued.
  4. Deposit retention and funding costs, particularly as brokered CDs mature and interest rates change; also monitor the company’s variable-rate loan exposure.
  5. Capacity to meet commitments and maintain capital and liquidity while funding loan growth and managing the acquisition and subordinated debt.