ENTERPRISE FINANCIAL SERVICES CORP quarterly report, Q3 FY2020

Enterprise Financial Services Corp. — Q3 2020 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2020. Comparisons are with the corresponding 2019 periods, or with December 31, 2019 for balance-sheet measures. The company provides banking and wealth-management services through Enterprise Bank & Trust.

Financial performance

Metric	Q3 2020	Q3 2019	Nine months 2020	Nine months 2019
Net interest income	$63.4 million	$63.0 million	$192.6 million	$177.1 million
Provision for credit losses	$14.1 million	$1.8 million	$55.9 million	$5.0 million
Noninterest income	$12.6 million	$13.6 million	$36.0 million	$34.8 million
Noninterest expense	$39.5 million	$38.2 million	$116.1 million	$127.1 million
Net income	$18.0 million	$29.1 million	$45.5 million	$63.6 million
Diluted EPS	$0.68	$1.08	$1.73	$2.45
Tax-equivalent net interest margin	3.29%	3.81%	3.52%	3.85%

• Q3 net income declined 38% year over year; nine-month net income declined 29%. Higher credit-loss provisions were the main reported pressure on earnings.
• Q3 return on average assets was 0.86%, return on average common equity was 8.06%, and the efficiency ratio was 52.02%. For the nine months, these were 0.76%, 6.96%, and 50.80%, respectively.
• Net interest income increased 1% in Q3 and 9% year to date, primarily as lower deposit and other funding costs offset lower asset yields. The company cited falling short-term rates and variable-rate loans, many indexed to LIBOR, as margin headwinds.

Balance sheet, cash flow, and capital

• Total assets were $8.37 billion at September 30, up 14% from year-end 2019. Loans were $6.13 billion, up $812 million; PPP loans were $819.1 million net of unearned fees and accounted for essentially all net loan growth. Excluding PPP, loans were slightly lower than at year-end.
• Deposits were $6.68 billion, up $905 million (16%), reflecting PPP-related balances, stimulus payments, and organic growth. Noninterest-bearing deposits were 29% of deposits; the loan-to-deposit ratio was 91.8%.
• Cash and cash equivalents were $392.2 million, versus $167.3 million at December 31, 2019. For the first nine months, operating cash flow was $100.2 million, investing cash flow was negative $813.9 million, and financing cash flow was positive $938.6 million.
• At quarter-end, reported borrowings included $203.5 million of subordinated debentures and notes, $250.0 million of FHLB advances, $209.0 million of other borrowings, and $30.0 million of notes payable. The company issued $63.3 million of 5.75% subordinated notes due 2030 in May.
• Shareholders’ equity was $882.3 million. The bank’s common equity tier 1 ratio was 12.0% and total risk-based capital ratio was 13.3%; it remained “well-capitalized.” Tangible common equity to tangible assets was 7.99%, down from 8.89% at year-end, primarily reflecting PPP-related balance-sheet growth.
• Management reported $545 million of additional FHLB borrowing capacity, $763 million available from the Federal Reserve against pledged loans, $90 million of correspondent-bank lines, and $374 million of American Financial Exchange credit. The parent company held $71 million of cash; management said available sources were expected to cover parent cash needs for the rest of 2020.

Material changes and credit quality

• The company adopted CECL on January 1, 2020. Adoption reduced retained earnings by $18.1 million after tax and increased the loan allowance by $28.4 million. Prior-year periods use the former incurred-loss method, limiting direct comparability.
• The allowance for credit losses on loans was $123.3 million, or 2.01% of loans, compared with $43.3 million, or 0.81%, at year-end. Management attributed elevated provision expense to pandemic-related forecast deterioration, with some improvement in forecasts during Q3 offset by added individual and qualitative reserves for higher-risk exposures.
• Nonperforming loans were $39.6 million, or 0.65% of loans, versus $26.4 million and 0.50% at year-end. Nonperforming assets were $44.5 million, or 0.53% of assets. Q3 net charge-offs were $1.0 million; nine-month net charge-offs were $2.5 million.
• Loans totaling $690.8 million had participated in short-term deferral programs; $139.4 million remained in deferral at quarter-end, including $86.1 million in second-round deferrals. Approximately 99% of loans then in deferral were expected to reach the end of their deferral period in Q4.
• Nine-month noninterest expense fell 9%, mainly because 2019 included substantially higher merger-related costs. Q3 expense rose 3% year over year and included $1.6 million of merger-related expense.

Outlook, risks, and unusual items

• The filing provides no specific earnings or revenue guidance. Management cautioned that COVID-19’s duration and economic effects remain uncertain and could affect credit losses, income, profitability, liquidity, and capital.
• Management’s credit-loss forecasts included baseline, upside, and downside scenarios, weighted 80%, 10%, and 10%. It identified renewed shutdowns, higher small-business bankruptcies or unemployment, and delayed or absent fiscal stimulus as risks that could increase future provisions. Improved forecasts or lower realized losses could instead permit provision reversals.
• The company agreed to acquire Seacoast Commerce Banc Holdings in an all-stock transaction, with each Seacoast share to receive 0.5061 EFSC shares. Closing was anticipated in Q4 2020, subject to remaining approvals and closing conditions. Management estimated initial tangible-book-value dilution of about 2%, with an earnback period under three years.
• A putative shareholder lawsuit challenged disclosures related to the Seacoast transaction and sought, among other relief, to enjoin closing. The company said it believed the claims were without merit and intended to defend the case; an injunction could delay or prevent the transaction.
• Other disclosed risks include PPP compliance and guarantee-related exposure, loan deferrals and borrower stress, real-estate collateral values, interest-rate and LIBOR transition risk, acquisition integration, and possible future goodwill or intangible impairment. Management reported no goodwill impairment as of September 30.

Investor verification points

1. Track whether PPP balances and related deposits persist or run off, and how loan growth develops excluding PPP.
2. Monitor deferrals, borrower performance, nonperforming loans, and allowance adequacy as economic forecasts and CECL estimates change.
3. Verify progress, approvals, litigation resolution, final consideration, and expected dilution for the Seacoast acquisition.
4. Assess margin trends as floating-rate assets reprice and deposit costs adjust; review LIBOR transition and hedge impacts.
5. Reconcile liquidity and capital measures, including PPP’s balance-sheet effects, borrowing capacity, and the CECL regulatory-capital transition.