Enterprise Financial Services Corp. 2013 Q2 10-Q
Reporting period: Quarter and six months ended June 30, 2013. The company is a financial holding company providing banking and wealth management services in the St. Louis, Kansas City, and Phoenix markets. Amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net interest income | $33.3 | $34.1 | $70.2 | $64.8 |
| Net income | $11.0 | $8.8 | $21.1 | $15.0 |
| Diluted EPS | $0.58 | $0.44 | $1.11 | $0.75 |
| Net interest margin | 4.75% | 4.81% | 4.93% | 4.57% |
| Core net interest margin | 3.56% | 3.62% | 3.55% | 3.60% |
| Noninterest expense | $21.4 | $21.4 | $41.9 | $42.8 |
- Quarterly net income rose about 26% year over year; six-month net income rose about 41%. The improvement included lower credit-loss provisions, including reversals, and higher six-month net interest income.
- Q2 noninterest income was a loss of $1.7 million, mainly reflecting a $6.7 million negative change in the FDIC loss-share receivable. Six-month noninterest income was $1.2 million, down from $4.8 million.
- Q2 effective tax rate was 34.4%; the six-month rate was 34.2%.
- Q2 efficiency ratio was 67.6%, versus 61.2% a year earlier; the six-month ratio improved to 58.6% from 61.5%.
Financial position, cash flow, and capital
- At June 30, total assets were $3.094 billion, down from $3.326 billion at December 31, 2012. Net portfolio loans were $2.210 billion; available-for-sale securities were $471.0 million.
- Total deposits were $2.368 billion, down from $2.659 billion at year-end. Management attributed the linked-quarter decline primarily to seasonality and the year-over-year decline partly to the end of the FDIC Transaction Account Guarantee program and deliberate reduction of higher-cost deposits.
- Cash and cash equivalents were $98.3 million, versus $116.4 million at year-end. For the first half, operating cash flow was $6.4 million, investing cash flow provided $213.6 million, and financing activities used $238.0 million; cash declined $18.0 million.
- At quarter-end, FHLB advances were $191.0 million, subordinated debentures $83.1 million, other borrowings $178.2 million, and notes payable $11.1 million. FHLB advances had increased from $80.0 million at year-end. The parent company reported approximately $7.8 million of cash and said it expected this to cover projected needs for at least a year.
- Regulatory capital ratios improved from year-end: Tier 1 risk-based 11.98%, total risk-based 13.25%, and leverage 9.58%. Tangible common equity to tangible assets was 6.89%; management expected it to reach 7% by year-end. The company and bank met the stated well-capitalized standards.
- Other comprehensive loss was $8.1 million in Q2 and $10.3 million for the first half, largely reflecting unrealized securities losses. Accumulated other comprehensive income shifted from $7.8 million at year-end to a $2.5 million loss at June 30.
Changes, outlook, and risks
- Portfolio loans were about $2.2 billion, flat with the prior quarter and up 3% from June 2012. Management expected 3% to 4% loan growth over December 2012 levels by year-end.
- Nonperforming non-covered loans fell to $25.9 million from $38.7 million at year-end and $40.6 million a year earlier. Nonperforming assets were $34.2 million, or 1.10% of assets. The allowance for non-covered loans was $27.6 million, or 1.33% of those loans. Q2 non-covered net charge-offs were $0.5 million; management expected an overall 2013 loss rate of approximately 0.50%.
- Q2 loan-loss provision was a $4.3 million benefit for non-covered loans and a $2.3 million benefit for covered loans. Management cited fewer risk-rating downgrades, fewer impaired credits requiring specific reserves, and favorable loss migration. It believed the allowance was adequate.
- Covered-loan accretion materially supported reported margins and interest income. Management said continued pressure on loan yields and liquidity was expected to result in a slightly lower core margin for the rest of 2013. The elevated covered-loan yield reflected cash flows from loan payoffs exceeding expectations.
- Management reported that rising interest rates would positively affect modeled net interest income. This is a sensitivity estimate, not a forecast of realized results.
- The company recorded a $1.3 million liability for an expected payment to the FDIC under a loss-share agreement; the liability remained subject to quarterly reassessment.
- State tax credits held for sale totaled $55.5 million, including $19.8 million measured using Level 3 fair-value inputs. Fair-value estimates depend on assumptions including discount rates.
- Off-balance-sheet commitments to extend credit were $742.4 million and standby letters of credit were $44.6 million. Management noted that commitments may expire undrawn and do not represent expected cash needs in full.
- A Distinctive Notes lawsuit sought more than $44 million from defendants. After quarter-end, the court dismissed the RICO and negligence claims against the company; contract claims by 41 plaintiffs remained. The company said it could not estimate a reasonably possible loss range and intended to defend the case. A separate related settlement was covered by insurance and had no financial-statement impact. A securities class action was dismissed with prejudice and was considered closed.
- Federal Reserve capital rules adopted July 2, 2013 may require additional capital or constrain dividends, repurchases, compensation, or growth; the company said the impact was not yet fully understood, though it believed current capital levels were adequate.
Important facts for investors to verify
- Whether credit quality and reserve releases remain sustainable, particularly given covered-loan delinquency exposure and the expected FDIC clawback.
- Whether deposit runoff and increased FHLB borrowing affect liquidity, funding costs, and planned loan growth.
- How quickly core net interest margin responds to loan-yield pressure, deposit pricing, and interest-rate changes, apart from temporary covered-loan accretion.
- The eventual outcome and potential exposure from the remaining Distinctive Notes contract claims; the filing provides no clear loss estimate.
- The sensitivity of state tax-credit valuations, securities values, and capital ratios to market-rate changes and final implementation of new capital rules.