Enterprise Financial Services Corp. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014; unaudited. Enterprise is a financial holding company providing banking and wealth-management services, primarily in the St. Louis, Kansas City, and Phoenix markets. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net interest income | $27.4 | $32.6 | $86.6 | $102.8 |
| Provision for loan losses, net | $(1.8) | $2.2 | $3.4 | $(0.3) |
| Noninterest income | $4.5 | $3.7 | $11.8 | $5.0 |
| Noninterest expense | $21.1 | $21.0 | $62.7 | $62.4 |
| Net income | $8.2 | $8.4 | $21.2 | $29.5 |
| Diluted earnings per share | $0.41 | $0.44 | $1.07 | $1.55 |
| Net interest margin, tax-equivalent | 3.75% | 4.71% | 4.05% | 4.86% |
- Q3 return on average assets was 1.02%, return on average common equity 10.62%, and efficiency ratio 66.22%. For the nine-month period, these were 0.91%, 9.54%, and 63.73%, respectively.
- At September 30, total assets were $3,209.6, portfolio loans $2,294.9, PCI loans $113.9, deposits $2,509.8, and shareholders’ equity $308.8. Cash and cash equivalents were $123.8, down $86.8 from year-end 2013.
- Nine-month cash flows: operating activities provided $30.3; investing activities used $131.2; financing activities provided $14.1. The resulting net decrease in cash and cash equivalents was $86.8.
- Outstanding funding included $120.0 of FHLB advances, $56.8 of subordinated debentures, $181.1 of other borrowings, and $6.0 of notes payable. Deposits declined $25.2 from December 31, 2013.
- Regulatory capital ratios at September 30 included Tier 1 risk-based capital of 12.35%, total risk-based capital of 13.61%, and leverage of 10.47%. The company reported that it met “well-capitalized” requirements.
Material changes versus comparable periods
- Net income declined 2.5% year over year in Q3 and 28% for the first nine months. Management attributed the pressure principally to lower PCI loan balances and reduced accelerated cash flows, lower portfolio loan yields, and lower investment-security gains in the year-to-date comparison.
- Q3 net interest income fell $5.1 year over year; the nine-month decline was $16.2. The reported tax-equivalent margin fell to 3.75% for Q3 from 4.71% a year earlier. Core net interest margin, excluding incremental PCI accretion, was 3.41% versus 3.54% in Q3 2013.
- Portfolio loans increased $157.6, or 7.4%, from year-end, led by commercial and industrial lending. PCI loans declined $26.7, or 19%, over the same period.
- Credit indicators improved: nonperforming loans were $18.2 versus $24.2 a year earlier, and nonperforming assets were $20.5 versus $34.4. The allowance for portfolio loan losses was $28.8, or 1.25% of portfolio loans, and equaled 158% of reported nonperforming loans. Reported nonperforming loan measures exclude PCI loans accounted for on a pool basis.
- Noninterest income rose year over year in Q3, partly due to a $0.9 nonrecurring closing fee and a less-negative change in the FDIC loss-share receivable. Year-to-date noninterest income also benefited from these factors and higher BOLI income; the prior-year period included $1.3 of securities-sale gains.
Outlook, commentary, risks, and unusual items
- Management expects approximately 10% annualized portfolio-loan growth “for the foreseeable future.” It projected quarterly noninterest expense of $19–$21 and average PCI loan balances of $103 in 2014 and $83 in 2015.
- Management estimated 2015 pretax income from covered assets of approximately $6–$8, absent significant cash-flow accelerations or pool impairment. It cautioned that pressure on loan yields and further PCI runoff could reduce core margin through the remainder of 2014 and into 2015.
- Interest-rate simulations indicated estimated next-12-month net interest income changes of +3.1% for a +100-basis-point shock, +7.1% for +200, +11.1% for +300, and −1.1% for −100. The company noted the estimates are model-based; lower downward-shock scenarios were not shown given current rates.
- The company recorded a $2.6 liability related to expected payments to the FDIC at the end of two loss-share agreements; the amount remains subject to remeasurement. Q3 expenses also included higher FDIC clawback expense and severance costs associated with efficiency initiatives.
- Off-balance-sheet commitments included $879.3 of commitments to extend credit and $45.8 of standby letters of credit. Management said commitment amounts do not necessarily represent future cash requirements. The bank reported additional borrowing capacity of $216 from the FHLB and $634 from the Federal Reserve, subject to stated collateral and facility arrangements.
- Management identified credit and real-estate valuation risk, local economic conditions, interest-rate movements, competition, regulation, and litigation or other contingencies as risks. It reported no material change to the risk factors in its 2013 Form 10-K and no legal proceedings expected to have a material adverse effect. The company expected to remain well-capitalized upon Basel III implementation in 2015; this was management’s assessment, not a guarantee.
- Other notable items: the remaining $5.0 of 9% trust preferred securities converted to common stock in March 2014; a shelf registration effective August 2014 permits potential securities offerings of up to $50.0, subject to conditions. Management reported effective disclosure controls as of quarter-end.
Most important facts for investors to verify
- Whether portfolio-loan growth can offset lower yields and continuing runoff of higher-yielding PCI assets, and how that affects net interest margin and earnings.
- Credit quality trends, including criticized/classified exposures, collateral values, the allowance, and PCI delinquency and cash-flow assumptions; PCI loans are treated differently in reported nonperforming-loan measures.
- The durability of noninterest income and the effect of the nonrecurring closing fee, FDIC loss-share receivable estimates, and FDIC clawback obligations.
- Deposit mix and funding costs, capacity and terms of contingent borrowing facilities, and the scale and potential funding of off-balance-sheet commitments.
- Regulatory capital position and management’s assumptions for Basel III compliance, as well as interest-rate sensitivity under actual conditions.