Enterprise Financial Services Corp. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. EFSC is a financial holding company providing banking and wealth-management services in Arizona, Kansas, Missouri, and New Mexico. Unless otherwise noted, amounts are in millions.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $63.0 | $48.1 | $177.1 | $141.3 |
| Provision for loan losses | $1.8 | $2.3 | $5.0 | $4.5 |
| Noninterest income | $13.6 | $8.4 | $34.8 | $27.6 |
| Noninterest expense | $38.2 | $29.9 | $127.1 | $88.3 |
| Net income | $29.1 | $22.5 | $63.6 | $65.7 |
| Diluted EPS | $1.08 | $0.97 | $2.45 | $2.81 |
- Tax-equivalent net interest margin was 3.81% in Q3 (3.78% prior year) and 3.85% for nine months (3.78%). Core margin, excluding incremental accretion on acquired loans, was 3.69% and 3.76%, respectively, versus 3.74% in each prior-year period.
- Q3 return on average assets was 1.60%; return on average common equity was 13.66%. Nine-month figures were 1.26% and 11.00%, respectively.
- Operating cash flow was $66.6 million for the nine months; investing cash outflow was $297.8 million and financing cash inflow was $291.1 million. Cash and cash equivalents ended the period at $256.5 million.
Financial position, credit and capital
- Total assets were $7.35 billion, up 30% from year-end 2018. Loans were $5.23 billion, up $878 million (20%), and deposits were $5.62 billion, up $1.04 billion (23%). Trinity acquisition activity accounted for a substantial portion of the growth.
- Shareholders’ equity was $846.1 million. Total liabilities were $6.50 billion, including $461.4 million of FHLB advances, $141.2 million of subordinated debentures and notes, and $199.6 million of other borrowings and notes payable.
- Nonperforming loans were $15.6 million, or 0.30% of loans; nonperforming assets were $24.1 million, or 0.33% of assets. The allowance for loan losses was $44.6 million, or 0.85% of loans, compared with 1.04% a year earlier. Management said the allowance was adequate. The lower ratio reflects, in part, acquired Trinity loans recorded at fair value without an initial allowance.
- The Bank’s total risk-based capital ratio was 12.53% and its common equity Tier 1 ratio was 11.79%; the Bank met the regulatory definition of “well-capitalized.” EFSC’s corresponding ratios were 12.72% and 9.64%; tangible common equity to tangible assets was 8.54%.
- Liquidity sources include core deposits, securities, and borrowing capacity. The Bank reported $532 million of additional FHLB capacity, $1 billion available from the Federal Reserve under a pledged-loan agreement, and $90 million in correspondent-bank federal funds lines. The filing reports $1.5 billion of unused commitments.
Changes, acquisition and unusual items
- EFSC completed its acquisition of Trinity Capital Corporation and Los Alamos National Bank on March 8, 2019. Consideration was $209.2 million, comprising $37.3 million cash and approximately 4.0 million EFSC shares. The acquisition added $1.2 billion of assets and $1.1 billion of liabilities; recognized goodwill was $93.9 million.
- Nine-month net income declined to $63.6 million from $65.7 million, despite higher net interest income and noninterest income. The principal comparability item was $18.0 million of pretax Trinity merger-related expense ($14.0 million after tax); adjusted net income excluding merger expense was $77.7 million, a non-GAAP measure.
- Q3 net income rose year over year, while noninterest expense increased 28%, reflecting acquired operations and integration costs. Management said most planned acquisition cost savings were reflected in the Q3 period.
- EFSC repurchased 302,756 shares in Q3 at an average $39.03 per share. Nine-month dividends paid were $12.1 million.
Outlook, risks and contingencies
- Management expected 2019 and 2020 loan growth of 6%–8%, excluding Trinity-acquired loans; high-single-digit noninterest-income growth for those years, excluding Trinity; Q4 2019 noninterest expense of $37–$39 million; and a full-year 2019 effective tax rate of approximately 20%, excluding potential tax-planning strategies.
- Management cited deposit competition, falling short-term rates and the larger investment-asset mix as pressures on core net interest margin. Its interest-rate simulation estimated net interest income changes over the next 12 months of +6.0% under a 300-basis-point increase, +2.3% under +100 basis points, and -3.8% under -100 basis points.
- EFSC had $2.5 billion of LIBOR-indexed variable-rate loans and material LIBOR-linked contracts. The anticipated transition away from LIBOR after 2021 could affect pricing, valuations, funding and hedging; transition outcomes and costs were uncertain.
- CECL was scheduled for adoption January 1, 2020. EFSC had not finalized the expected financial-statement impact and anticipated a cumulative adjustment to the allowance and retained earnings.
- A lawsuit inherited with Trinity seeks insurance-related damages and defense costs. The company expected to pursue damages at trial, anticipated in Q1 2020, but said the outcome and timing of recovery were uncertain. Management did not believe other pending or threatened proceedings would have a material adverse effect.
- Other identified risks include acquisition integration and customer retention, credit and real-estate collateral values, local economic conditions, interest-rate changes, competition, regulation and litigation. Management stated disclosure controls were effective at September 30, 2019.
Investor verification points
- Track Trinity integration, realized cost savings, and the effect of acquisition-related goodwill and intangible amortization on reported earnings.
- Compare loan growth and credit quality, including classified assets, nonperforming assets, charge-offs and the adequacy of the allowance after acquired-loan accounting.
- Monitor core margin and deposit pricing as short-term rates and funding competition change.
- Confirm CECL’s final adoption impact and progress in replacing LIBOR-linked loan, debt and derivative contracts.
- Follow the inherited insurance litigation, including trial timing and any potential recovery; verify liquidity and capital capacity alongside the company’s lending commitments and borrowing usage.