ENTERPRISE FINANCIAL SERVICES CORP annual report, FY2022

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Enterprise Financial Services Corp. — 2022 Form 10-K

Reporting period: Fiscal year ended December 31, 2022; comparisons are primarily with 2021. Enterprise Financial Services Corp. is a bank holding company operating Enterprise Bank & Trust, providing banking and wealth-management services across Arizona, California, Kansas, Missouri, Nevada, and New Mexico. The company’s growth includes the 2021 First Choice acquisition.

Financial performance and condition

  • Profitability: Net income was $203.0 million, up from $133.1 million; diluted EPS was $5.31 versus $3.86. Net income available to common shareholders was $199.0 million after $4.0 million of preferred dividends.
  • Revenue and margins: Net interest income was $473.9 million, up 32%; tax-equivalent net interest margin was 3.89%, compared with 3.41%. Total noninterest income fell 13% to $59.2 million. Net interest income plus noninterest income totaled $533.1 million on a GAAP basis.
  • Expenses and returns: Noninterest expense increased 12% to $274.2 million. The GAAP efficiency ratio improved to 51.44% from 57.47%, partly reflecting the absence of $22.1 million in 2021 merger expenses and $3.4 million in branch-closure expenses. The non-GAAP core efficiency ratio was nearly unchanged at 49.77%. Return on average assets was 1.52%, versus 1.16%.
  • Credit: The provision for credit losses was a benefit of $0.6 million, compared with $13.4 million of expense in 2021, which included $25.4 million of acquisition-related provision. The allowance was $136.9 million, or 1.41% of loans, versus $145.0 million, or 1.61%. Net charge-offs declined to $3.9 million from $11.6 million. Nonperforming loans were $10.0 million (0.10% of loans), down from $28.0 million (0.31%).
  • Balance sheet: Total assets were $13.05 billion, down 3.6%; loans were $9.74 billion, up 8.0%; and deposits were $10.83 billion, down 4.5%. Commercial and industrial loans were 39.6% of total loans; commercial real estate investor- and owner-occupied loans together were 47.5%.
  • Liquidity: Cash and cash equivalents fell to $291.4 million from $2.02 billion, as liquidity was deployed into loans and securities and deposits declined. Securities totaled approximately $2.25 billion; $734 million was pledged, with approximately $1.4 billion described as available to pledge or sell. Additional disclosed borrowing capacity included $752 million from the FHLB, $1.4 billion from the Federal Reserve, and $90 million in correspondent-bank lines. Estimated uninsured deposits were $5.9 billion.
  • Debt and capital: Subordinated debentures and notes were $155.4 million; FHLB advances were $100 million; other borrowings were $324.1 million. The Bank met the regulatory definition of “well-capitalized.” At year-end, EFSC’s CET1, total risk-based capital, and leverage ratios were 11.1%, 14.2%, and 10.9%, respectively; the Bank’s were 12.1%, 13.1%, and 10.5%.
  • Cash flow: Operating activities provided $216.6 million. Investing activities used $1.38 billion, primarily reflecting loan growth and securities purchases; financing activities used $563.2 million, including net deposit outflows, dividends, and share repurchases. Cash and cash equivalents declined by $1.73 billion during the year.

Material changes and notable items

  • The Federal Reserve raised its target rate seven times in 2022, a total of 425 basis points. Higher rates lifted loan yields and net interest margin, while raising deposit costs and reducing mortgage-banking and tax-credit income. Approximately 63% of loans were variable-rate at year-end.
  • Average earning assets benefited from a full year of First Choice operations, organic loan growth, and securities deployment. PPP income declined to $5.0 million from $27.3 million, and PPP loans fell to $7.3 million from $272.0 million.
  • Deposit costs rose to $31.1 million from $14.2 million. Compensation and benefits rose to $147.0 million, reflecting staffing, merit increases, and a full year of First Choice expenses.
  • The Durbin Amendment’s interchange fee cap became applicable in the third quarter of 2022; debit-card interchange income declined approximately $2.1 million.
  • Higher interest rates contributed to a $149.1 million after-tax other comprehensive loss, primarily from unrealized available-for-sale securities losses. Accumulated other comprehensive loss ended the year at $130.3 million, versus income of $18.8 million in 2021. Shareholders’ equity declined slightly to $1.52 billion.
  • The company repurchased 700,473 common shares at a weighted-average price of $47.00 and paid $0.90 per common share in dividends, up from $0.75 in 2021.

Outlook, risks, and contingencies

  • The filing provides no specific numerical earnings, growth, or margin guidance. Management expects continued investment in employees and infrastructure and notes that inflation, low unemployment, and hybrid work arrangements may pressure expenses. The company said it anticipated continuing comparable common dividends, but dividends remain subject to board discretion, earnings, capital, and regulatory restrictions.
  • Management identified potential sensitivity to further rate changes, deposit competition and funding costs, economic deterioration, commercial real estate and other credit exposures, and the adequacy of credit-loss reserves. The allowance depends on forecasts and judgment; management disclosed that using only its downside economic scenario would have increased the allowance by $40.5 million.
  • Interest-rate sensitivity modeling projected a 11.1% increase in next-12-month net interest income under a +300-basis-point shock and a 15.1% decrease under a -300-basis-point shock. These are modeled scenarios, not forecasts.
  • The company disclosed $3.11 billion of unused commitments to extend credit and $68.5 million of letters of credit; these are contractual maximum amounts and are not necessarily expected to be drawn. It also disclosed New Markets Tax Credit indemnity exposure and ongoing tax-audit uncertainty. Management stated that pending or threatened legal proceedings were not expected to have a material adverse effect.
  • LIBOR transition remained a stated operational and contract risk. At year-end, $1.4 billion of loans, $74.8 million of borrowings, and $466.9 million notional of derivatives were LIBOR-indexed; the company had selected SOFR for replacement contracts and was working through affected agreements.
  • The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting. The allowance for credit losses was identified as a critical audit matter because of model complexity and significant assumptions.

Important facts for investors to verify

  • Whether deposit balances, deposit pricing, and liquidity sources remain adequate as competition for funding evolves; review uninsured deposits and pledged collateral.
  • How variable-rate asset yields and deposit costs respond to subsequent rate changes, and whether actual results align with the disclosed sensitivity scenarios.
  • Whether credit quality, commercial real estate and sponsor-finance exposures, charge-offs, and the allowance remain consistent with management’s assumptions and forecasts.
  • The effect of unrealized securities losses on capital and flexibility to sell securities, and the company’s plans for securities classified as held-to-maturity.
  • Whether loan and earnings growth can offset the winding down of PPP income, reduced interchange revenue, and pressure on fee income and operating costs.
  • Progress on LIBOR-to-SOFR contract conversions, and any material developments in contingencies, tax matters, or acquisition integration.