Enterprise Financial Services Corp. — Q1 2018 Form 10-Q
Business context and period. The company is a financial holding company providing banking and wealth management services in the St. Louis, Kansas City and Phoenix markets. This unaudited report covers the three months ended March 31, 2018. Comparisons with Q1 2017 are affected by the February 2017 Jefferson County Bancshares acquisition: Q1 2018 includes a full quarter of its operations, while Q1 2017 does not.
Key financial results
| Metric | Q1 2018 | Comparable period / change |
|---|---|---|
| Net interest income | $46.2 million | $38.6 million in Q1 2017 |
| Provision for loan losses | $1.9 million | $1.5 million in Q1 2017 |
| Noninterest income | $9.5 million | $7.0 million in Q1 2017 |
| Noninterest expense | $29.1 million | $26.7 million in Q1 2017 |
| Income before tax | $24.7 million | $17.5 million in Q1 2017 |
| Net income / diluted EPS | $20.9 million / $0.90 | $12.4 million / $0.56 in Q1 2017 |
| Net interest margin | 3.80% | 3.73% in Q1 2017; core margin was 3.74% versus 3.63% |
| Efficiency ratio | 52.31% | 58.61% in Q1 2017; core ratio was 54.02% versus 56.01% |
| Operating cash flow | $22.2 million provided | $31.0 million used in Q1 2017 |
Management attributed stronger earnings chiefly to loan and deposit growth, the JCB acquisition, higher loan yields and core margin expansion. Core net income, a company-defined non-GAAP measure, was $19.6 million, up from $13.1 million a year earlier. Noninterest income included $1.0 million of recoveries from non-core acquired assets; core noninterest income grew 22% year over year.
Financial position, liquidity and credit
- At March 31, total assets were $5.38 billion, up $93.9 million from year-end 2017. Gross loans were $4.19 billion, up $93.8 million; portfolio loans increased $95.4 million, primarily in commercial and industrial and commercial real estate lending.
- Deposits totaled $4.28 billion, up $125.0 million, or 3%, from year-end. Growth included $102.5 million in money market accounts and $85.8 million in brokered certificates of deposit; demand deposits and interest-bearing transaction accounts declined. Core deposits, as defined by management, were $3.6 billion.
- Cash and cash equivalents were $143.1 million, down $10.2 million from year-end. Investing activities used $114.0 million and financing activities provided $81.6 million. The filing reports $1.27 billion of commitments to extend credit and $51.8 million of letters of credit; these contractual amounts are not necessarily expected cash requirements.
- Borrowings included $118.1 million of subordinated debt, $224.6 million of FHLB advances and $166.6 million of other borrowings. FHLB advances increased $51.9 million from year-end, while other borrowings declined $87.1 million. The company reported $465.9 million of additional FHLB capacity, $803.9 million of Federal Reserve borrowing capacity, and $174.0 million in aggregate correspondent-bank and American Financial Exchange lines. Management said parent-company liquidity and other available sources were sufficient for projected needs through the rest of 2018.
- Shareholders’ equity was $555.0 million. The company reported a 9.07% common equity Tier 1 ratio and 12.41% total risk-based capital ratio; the Bank met the regulatory “well-capitalized” definition. The tangible common equity-to-tangible-assets ratio was 8.13%.
- Nonperforming loans were $15.6 million, or 0.38% of portfolio loans, versus $15.7 million and 0.39% at year-end. The allowance for loan losses was $44.7 million, including $40.3 million for portfolio loans; the portfolio allowance equaled 0.98% of portfolio loans. Q1 portfolio net charge-offs were negative $0.2 million, reflecting net recoveries.
Changes, outlook and risks
- Year-over-year net interest income rose 19%; the reported margin expanded seven basis points. Management cited higher earning-asset yields and loan growth, partly offset by rising deposit and borrowing costs and runoff of higher-yielding acquired loans.
- Management expected 2018 portfolio loan growth of approximately 7%–9% and fee-income growth of 5%–7%. It expected expense growth at 35%–45% of projected revenue growth and projected an effective tax rate of 18%–20% for the remainder of 2018, with a full-year rate of 17%–19%. These are management estimates, not guarantees.
- Management expected to maintain core net interest margin over coming quarters, while cautioning that funding-cost pressure could impede that trend. It estimated $3 million–$5 million of 2018 income from accelerated cash flows and incremental accretion on non-core acquired loans.
- Interest-rate simulation estimated next-12-month net interest income changes of +2.0% under a +100 basis-point shock, +5.9% under +300 basis points, and -5.9% under -100 basis points. Management noted that a bear-flattener scenario could mildly reduce net interest income.
- Q1 net income included no comparable extraordinary tax-revaluation charge, but Q4 2017 included a $12.1 million deferred tax asset revaluation charge related to U.S. tax reform. Q1’s effective tax rate was 15.3%, versus 29.2% in Q1 2017. The quarter also recorded a $6.9 million after-tax securities-related other comprehensive loss, reducing equity; management attributed unrealized securities losses primarily to market interest-rate movements and found no security other-than-temporarily impaired.
- The company adopted several accounting updates in Q1; management reported no material financial-statement impact. Adoption of guidance on stranded tax effects shifted $0.8 million from accumulated other comprehensive income to retained earnings. The company stated that the expected-credit-loss standard’s impact had not yet been determined and that lease accounting adoption was expected to increase assets and use capital.
- Principal disclosed risks include credit quality and collateral values, local economic and real estate conditions, interest-rate changes, acquisition integration and customer retention, competition, regulation, and litigation or other contingencies. Management said no pending or threatened legal proceedings were expected to have a material adverse effect, and reported no material changes to the prior Form 10-K risk factors. Disclosure controls were judged effective as of March 31, 2018.
Important facts for investors to verify
- Whether reported loan and deposit growth persists, and whether brokered-deposit growth or higher funding costs affect liquidity and margins.
- Credit trends, including watch and classified loans, commercial real estate exposure, and the adequacy of the allowance as lending expands.
- Whether management’s loan, fee-income, expense and tax-rate estimates are achieved; distinguish GAAP results from company-defined core measures.
- The sensitivity of earnings and capital to changing rates, securities valuation changes, and funding needs if a substantial share of unused commitments is drawn.
- Progress on the expected-credit-loss and lease-accounting standards, and any revisions to provisional tax-reform accounting.