ENTERPRISE FINANCIAL SERVICES CORP quarterly report, Q2 FY2020

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Enterprise Financial Services Corp. — Q2 2020 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2020. Enterprise Financial Services Corp is a financial holding company providing banking and wealth-management services in Arizona, Kansas, Missouri and New Mexico. Dollar amounts below are in millions unless otherwise indicated.

Financial performance and position

  • Q2 earnings: Net interest income was $65.8, up 7% year over year, while provision for credit losses rose to $19.6 from $1.7. Net income fell to $14.6 from $18.4; diluted EPS was $0.56 versus $0.68. Return on average assets was 0.72% and return on average common equity was 6.78%.
  • First-half earnings: Net interest income was $129.2, up 13%; provision for credit losses was $41.9 versus $3.2. Net income declined to $27.5 from $34.6, and diluted EPS was $1.04 versus $1.36. Return on average assets was 0.71% and return on average common equity was 6.38%.
  • Revenue, margins and expenses: Q2 noninterest income was $10.0, down 17%; first-half noninterest income was $23.4, up 10%. Noninterest expense was $37.9 in Q2 and $76.6 for six months, down 23% and 14%, respectively, largely because 2019 included Trinity merger costs. Tax-equivalent net interest margin was 3.53% in Q2 and 3.65% for six months, versus 3.86% and 3.87%. Q2 core efficiency ratio was 50.66%, compared with 53.30%.
  • Balance sheet at June 30: Assets were $8,357.5, up $1,023.7 from December 31, 2019. Loans were $6,140.1, up $825.7 (16%), including $807.8 of PPP loans net of unearned fees. Deposits were $6,699.6, up $928.6 (16%). The loan-to-deposit ratio was 91.6%.
  • Credit quality: Allowance for credit losses on loans was $110.3, or 1.80% of loans, compared with $43.3 at year-end (0.81% as reported in MD&A). Nonperforming loans were $41.5, or 0.68% of loans, versus $26.4 at year-end; nonperforming assets were $46.3, or 0.55% of assets. First-half net charge-offs were $1.5.
  • Cash flow and liquidity: First-half operating cash flow was $58.9; investing cash flow was negative $832.7, mainly reflecting loan growth; financing cash flow was positive $955.3, including deposit growth. Cash and cash equivalents ended at $348.7, versus $167.3 at year-end. The Bank reported $562 of additional FHLB borrowing capacity, $879 available from the Federal Reserve, $90 in correspondent-bank lines and $367 of American Financial Exchange credit. Management stated parent-company cash of $68 and other sources were expected to cover projected needs through the remainder of 2020.
  • Debt and capital: Subordinated debentures and notes totaled $203.4; FHLB advances were $250.0; other borrowings were $196.5; and notes payable were $31.4. The company issued $63.3 of 5.75% fixed-to-floating subordinated notes due 2030 during Q2. Bank regulatory capital ratios were 13.00% total risk-based, 11.75% Tier 1 and CET1, and 9.48% leverage; the Bank met the well-capitalized standards. Tangible common equity to tangible assets was 7.81%, down from 8.89% at year-end.

Material changes and notable items

  • COVID-19-related economic deterioration drove higher expected credit losses under CECL. CECL adoption on January 1 added $28.4 to the loan allowance and reduced retained earnings by $18.1 after tax; it also increased the reserve for unfunded commitments by $2.4.
  • The Company had $685.7 of loans in short-term deferral programs at June 30: $361.4 deferring principal and interest and $324.3 deferring principal only. Management reported that loans receiving deferrals were moved to risk rating level six for additional monitoring.
  • PPP activity materially affected reported growth and ratios. PPP loans totaled $807.8 net of unearned fees; the Company reported $4.1 of PPP interest and fee income in Q2. Management said PPP growth increased loans, deposits, EPS and return on assets, while reducing margin and certain leverage and capital ratios.
  • Management’s CECL model used baseline, stronger-growth and moderate-recession scenarios weighted 80%, 10% and 10%. It identified possible further shutdowns, small-business bankruptcies and higher unemployment as risks that could lead to additional provision expense.
  • The Company transferred securities with $163.6 book value and $175.1 fair value from available-for-sale to held-to-maturity. The report says no securities were considered other-than-temporarily impaired. A Q2 review found no goodwill or intangible impairment despite market capitalization falling below book value.
  • No specific earnings or financial guidance was provided. Management described uncertain COVID-19 effects and warned that worsening economic conditions could increase credit costs and adversely affect revenue, profitability, liquidity and capital. The Company also cited PPP compliance, SBA-guarantee and related litigation risks. Management reported no pending or threatened legal proceedings expected to have a material adverse effect.

Important facts for investors to verify

  1. How PPP forgiveness, fee recognition and the runoff of PPP-related deposits affect future loan growth, earnings and net interest margin.
  2. Whether COVID-19 deferrals convert into delinquencies, nonperforming loans, charge-offs or further allowance needs; track the $685.7 deferred balance and the assumptions underlying the CECL forecast.
  3. Whether reported asset-quality trends reflect economic deterioration, CECL reclassification of acquired loans, or both; reconcile the 1.80% allowance-to-loans figure with the filing’s year-end comparison.
  4. How much liquidity capacity remains available after pledged collateral and potential draws on the $1.7 billion of unused credit commitments.
  5. Future capital and funding costs following the subordinated-note issuance, including the decline in tangible common equity to tangible assets and the impact of continued balance-sheet growth.