Enterprise Financial Services Corp. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; balance-sheet comparisons are with December 31, 2012. Enterprise is a financial holding company providing banking and wealth-management services in the St. Louis, Kansas City, and Phoenix markets.
Financial performance and position
| Metric | Q1 2013 / March 31, 2013 | Prior comparable period / December 31, 2012 |
|---|---|---|
| Net interest income | $36.9 million | $30.6 million in Q1 2012 |
| Net interest margin, tax-equivalent | 5.10% | 4.33% in Q1 2012; 5.39% in Q4 2012 |
| Noninterest income | $2.9 million | $4.0 million in Q1 2012 |
| Noninterest expense | $20.5 million | $21.4 million in Q1 2012 |
| Net income | $10.0 million; diluted EPS $0.53 | $6.2 million; diluted EPS $0.31 in Q1 2012 |
| Total assets | $3.12 billion | $3.33 billion |
| Total loans, net | $2.22 billion | $2.26 billion |
| Total deposits | $2.49 billion | $2.66 billion |
| Shareholders’ equity | $243.7 million | $235.7 million |
| Cash and cash equivalents | $121.5 million | $116.4 million |
- Interest income rose $4.7 million year over year while interest expense fell $1.6 million. Reported pretax income was $15.2 million and income tax expense was $5.1 million.
- Operating cash flow was $1.8 million, compared with $14.9 million in Q1 2012. Investing activities provided $207.7 million, including $122.9 million of securities-sale proceeds; financing activities used $204.4 million. Cash increased $5.1 million during the quarter.
- Noncovered nonperforming loans were $32.2 million, down from $38.7 million at year-end and $47.2 million a year earlier. Noncovered allowance for loan losses was $32.5 million, or 1.56% of noncovered loans. Q1 noncovered net charge-offs were $3.7 million, an annualized 0.72% of average loans, versus 0.45% a year earlier.
- Noncovered other real estate was $7.2 million; total other real estate, including covered assets, was $24.8 million. Covered loans were $182.8 million, down 9% from year-end.
- Reported capital ratios improved from year-end: Tier 1 risk-based 11.61%, total risk-based 12.98%, Tier 1 common 8.30%, and leverage 8.83%. Management said the Company and Bank met applicable requirements and were well-capitalized.
Changes and management commentary
- Net income increased 62% year over year, supported by higher net interest income and lower noninterest expense. The efficiency ratio improved to 51.5% from 61.7%.
- Noninterest income fell 27%, primarily because of a more adverse change in the FDIC loss-share receivable and lower gains on other real estate sales. Higher state tax-credit gains partly offset the decline.
- Deposits declined 6% from year-end, partly reflecting the Company’s lower-cost deposit pricing strategy, seasonality, and expiration of the FDIC Transaction Account Guarantee program. Management reported total deposits of $2.5 billion.
- Portfolio loans were described as broadly flat from year-end and up 4% year over year. Average first-quarter loans increased 4% from Q4 2012; noncovered commercial and industrial loans grew 20% year over year.
- Trust wealth-management revenue rose 14% year over year to $1.9 million; assets under administration were $1.9 billion, up 13% year over year, primarily due to market appreciation.
Outlook, liquidity, risks, and contingencies
- No specific earnings or financial guidance was provided. Interest-rate simulations indicated a rising-rate environment would positively affect net interest income. Management cautioned that actual results may differ materially from forward-looking statements.
- Management said parent-company cash of approximately $9.5 million was expected to cover projected needs for at least one year. The Bank reported additional borrowing availability of $186.9 million from the FHLB and $710.7 million from the Federal Reserve, plus $45.0 million in unsecured federal-funds lines. These facilities are subject to their terms and collateral requirements.
- The Company had $741.8 million in commitments to extend credit and $46.1 million in standby letters of credit. Management noted that commitments may expire undrawn and do not necessarily represent future cash requirements.
- The Company recorded an $879,000 liability related to an expected payment to the FDIC under a loss-share agreement; the amount will be remeasured. FDIC loss-share accounting and covered-loan cash-flow estimates remain significant items to monitor.
- Three material legal matters are described: Distinctive Notes litigation seeking more than $44 million plus potential fees and treble damages; a related state-court matter seeking approximately $800,000 plus other damages, now referred to arbitration; and a securities class action seeking unspecified damages. The Company denied the allegations and said it could not reasonably estimate potential losses.
- Other risks identified include credit and real-estate valuation risk, local economic conditions, interest-rate changes, competition, regulatory changes, and litigation outcomes. Management reported effective disclosure controls as of March 31, 2013, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the improvement in earnings and net interest margin is sustainable, particularly given the unusually high covered-loan yield attributed to payoff cash flows exceeding expectations.
- Trends in deposits, loan growth, charge-offs, delinquency, and nonperforming loans, including the real-estate concentration of the portfolio and deterioration in covered-loan past-due balances.
- The assumptions behind the FDIC loss-share receivable and the $879,000 expected FDIC payment liability, and their potential effect on future earnings.
- Liquidity and funding resilience if deposits continue to decline or a material portion of unfunded commitments is drawn; also review borrowing capacity, collateral availability, and debt covenants.
- Developments and potential financial exposure in the Distinctive Notes and securities class-action proceedings; the filing does not provide a clear estimate of reasonably possible losses.