Enterprise Financial Services Corp. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. The company provides banking and wealth-management services in the St. Louis, Kansas City, and Phoenix markets. Unless stated otherwise, amounts are in millions.
Financial performance and position
| Metric | Q2 2017 | Comparison |
|---|---|---|
| Net interest income | $45.6 | Up 35% from Q2 2016 |
| Net interest margin, fully tax-equivalent | 3.98% | 3.93% in Q2 2016; 3.73% in Q1 2017 |
| Provision for portfolio loan losses | $3.6 | $0.7 in Q2 2016 |
| Noninterest income | $7.9 | Up 13% from Q2 2016 |
| Noninterest expense | $32.7 | Up 53%; includes $4.5 of merger costs |
| Net income / diluted EPS | $12.0 / $0.50 | $12.4 / $0.61 in Q2 2016 |
- For the six months, net income was $24.3 versus $23.4 in 2016, while diluted EPS declined to $1.06 from $1.16, reflecting increased shares and acquisition-related costs. Core net income, a non-GAAP measure, was $26.4 versus $19.4; core diluted EPS was $1.15 versus $0.96.
- Six-month net interest income rose 27% to $84.3. Reported net interest margin was 3.86%, down from 3.90% a year earlier; core margin rose to 3.70% from 3.53%.
- At June 30, assets were $5.04 billion, loans $3.89 billion, deposits $3.92 billion, and shareholders’ equity $548.8 million. Loans rose $736.6 million and deposits $687.9 million from year-end, primarily reflecting the JCB acquisition.
- Cash and cash equivalents were $117.8 million, down $81.0 million from year-end. Six-month operating cash flow was negative $7.6 million; investing cash flow was negative $72.6 million and financing cash flow negative $0.8 million.
- Debt and borrowings included $118.1 million of subordinated debentures and notes, $201.0 million of FHLB advances, and $217.2 million of other borrowings. The company reported a 9.34% common equity tier 1 ratio and 12.84% total risk-based capital ratio; the Bank met “well-capitalized” requirements.
Material changes and notable items
- The February 10 acquisition of Jefferson County Bancshares (JCB) was valued at approximately $171.0 million, funded with cash and 3.3 million EFSC shares. Preliminary acquisition accounting recorded $85.9 million of goodwill. JCB results are included from the acquisition date.
- Six-month merger-related expense was $6.1 million. The company said JCB system conversion was completed late in Q2 and expected further transaction cost savings during 2017.
- Portfolio loans grew $740.6 million from year-end; management identified $675 million as acquired and $63 million as organic growth. Core deposits excluding time deposits declined 3% from the linked quarter, with seasonality cited.
- Six-month portfolio loan net charge-offs were $6.0 million, including a $6.0 million commercial-and-industrial charge-off in Q2. Management attributed higher provision expense to that relationship, portfolio growth, and maintaining reserves. Nonperforming loans were $13.1 million, or 0.34% of portfolio loans, versus $14.9 million and 0.47% at year-end.
- The allowance for loan losses was $41.8 million, including $36.7 million for portfolio loans. The portfolio allowance ratio was 0.96% (1.15% excluding JCB-acquired loans), compared with 1.23% at June 2016.
Outlook, risks, and contingencies
- Management expected organic loan growth of at least 10% for 2017 and core quarterly expenses of $25–$28 million for the remainder of 2017. It expected core net interest margin to increase or remain stable, while cautioning that funding-cost pressure could offset improvement.
- Management estimated 2017 incremental accretion income from legacy non-core acquired loans of $6–$8 million. The filing notes such accretion varies with prepayments and runoff.
- Interest-rate modeling estimated next-12-month net interest income changes of +1.6%, +3.2%, and +4.6% under +100, +200, and +300 basis-point shocks, respectively, and −7.2% under a −100 basis-point shock.
- Off-balance-sheet commitments included $1.23 billion to extend credit and $81.2 million of letters of credit. Management said aggregate simultaneous funding was unlikely, but noted that the commitments could consume most current liquidity resources if funded. Additional borrowing capacity included $229.1 million from the FHLB, $917.2 million from the Federal Reserve, and $85.0 million in correspondent-bank lines.
- Key disclosed risks include credit quality and collateral values, local economic and real-estate conditions, interest-rate movements and funding costs, acquisition integration and customer retention, competition, regulation, and litigation or other contingencies. Management said no pending or threatened legal proceeding was expected to have a material adverse effect; risk factors were unchanged from the latest Form 10-K.
Most important facts for investors to verify
- Whether JCB integration delivers the anticipated cost savings and growth without further material merger costs.
- Whether loan growth, especially in commercial and real-estate lending, is matched by stable credit quality and adequate reserves after the significant Q2 charge-off.
- Whether deposit retention and funding costs support margin performance as acquired balances are integrated and rates change.
- The sensitivity of earnings and liquidity to deposit runoff, loan commitments, and the disclosed interest-rate scenarios.
- The effect of acquisition accounting, goodwill, and non-GAAP “core” adjustments on reported earnings; core measures are not substitutes for GAAP results.