Enterprise Financial Services Corp. — Q1 2016 Form 10-Q
Business context and reporting period
Enterprise Financial Services Corp. is a financial holding company providing banking and wealth-management services through Enterprise Bank & Trust, primarily in the St. Louis, Kansas City and Phoenix markets. This unaudited report covers the three months ended March 31, 2016; balance-sheet comparisons are to December 31, 2015. Dollar figures below are in millions unless stated otherwise.
Financial performance and position
- Earnings: Net income was $11.0 million, or $0.54 diluted EPS, versus $9.3 million and $0.46 a year earlier; versus Q4 2015, net income rose from $10.7 million and diluted EPS from $0.52. Return on average assets was 1.22% and return on average common equity was 12.46%.
- Revenue and margins: Net interest income was $32.4 million, up 12% year over year. Fully tax-equivalent net interest margin was 3.87%, compared with 3.92% a year earlier and 3.91% in Q4 2015. Management’s non-GAAP core margin was 3.54%, up from 3.46% a year earlier. Noninterest income was $6.0 million, up 68% year over year, substantially reflecting the absence of a prior-year FDIC loss-share receivable reduction.
- Costs and credit provision: Noninterest expense was $20.8 million, up 4% year over year; the efficiency ratio improved to 54.02% from 61.14%. Portfolio-loan provision was $0.8 million versus $1.6 million. The PCI-loan provision reversal was $0.1 million, versus $3.3 million a year earlier.
- Loans and asset quality: Total loans were $2.90 billion, including $2.83 billion in portfolio loans, which grew 3% from year-end. Nonperforming loans were $9.5 million (0.34% of portfolio loans), up from $9.1 million (0.33%) at year-end but below $15.1 million a year earlier. The portfolio allowance was $34.4 million, or 1.21% of portfolio loans. Classified assets rose to $73.2 million from $67.8 million at year-end.
- Cash flow and liquidity: Operating cash flow was $4.1 million; investing cash outflow was $76.2 million, primarily reflecting loan growth and investment purchases; financing cash inflow was $84.1 million. Cash and cash equivalents ended the quarter at $106.2 million. The Bank reported $233.5 million of FHLB borrowing capacity, $847.3 million available from the Federal Reserve against pledged loans, and $60.0 million in correspondent-bank lines. These facilities are not equivalent to cash on hand.
- Funding and debt: Deposits increased 5.3% to $2.93 billion. Brokered certificates of deposit increased $118.4 million to $157.9 million, principally to fund loan growth. FHLB advances were $130.5 million, other borrowings $193.8 million and subordinated debentures $56.8 million. Total shareholders’ equity was $359.4 million. Regulatory ratios included 12.02% total capital, 9.20% common equity Tier 1 and a 10.51% Tier 1 leverage ratio.
Material changes versus comparable periods
- Year-over-year earnings benefited from loan-driven net interest income growth and the absence of the prior-year FDIC receivable reduction. Core net income, a company-defined non-GAAP measure, was $9.4 million, or $0.47 per share, versus $7.1 million, or $0.35, a year earlier; it was below Q4 2015’s $10.1 million, or $0.49.
- Portfolio loans increased $81.9 million from year-end, led by commercial and industrial loans, up $60.7 million. PCI loans declined $11.3 million to $63.5 million, largely from paydowns and accelerated payoffs.
- Net interest margin eased year over year despite higher core margin, as runoff of higher-yielding PCI loans weighed on reported results. Core expenses increased 7% year over year, largely due to additional client-service personnel.
- Equity increased $8.6 million from year-end, reflecting earnings and other comprehensive income, partly offset by $4.2 million of share repurchases and $1.8 million of dividends.
Outlook, management commentary and risks
- Management expected 2016 loan growth at or above 10% and quarterly noninterest expense of $19–$21 million. It expected to maintain or improve core net interest margin, while cautioning that higher funding costs and continuing PCI-loan runoff could offset improvement.
- The Board raised the quarterly dividend to $0.10 per share for Q2 2016, payable June 30 to shareholders of record June 15. The company repurchased 160,100 shares under its buyback program for approximately $4.2 million at an average $26.30 per share.
- Interest-rate sensitivity modeling estimated next-12-month net interest income changes of +1.7% for a 100-basis-point increase, +3.4% for +200 basis points, +4.9% for +300 basis points, and −3.1% for a 100-basis-point decrease. These are modeled estimates, not forecasts.
- Off-balance-sheet exposures included $997.1 million of commitments to extend credit and $71.5 million of standby letters of credit. The filing notes that commitments may expire undrawn or be revoked; aggregate utilization is not considered likely at one time.
- Key risks identified include credit and collateral valuation, local economic and real-estate conditions, interest-rate changes, competition, staffing, regulation, and litigation or other contingencies. Management said no pending or threatened legal proceeding was expected to have a material adverse effect, and reported no material change to previously disclosed risk factors. Disclosure controls were deemed effective.
- The fourth-quarter 2015 termination of FDIC loss-share agreements was an unusual item; management said the $2.4 million termination charge had been earned back by March 31, 2016 through PCI-loan accretion, recoveries and provision reversals. Core results exclude certain items and are non-GAAP measures.
Investor verification priorities
- Check the sustainability of loan growth and funding, particularly the increase in brokered CDs and the company’s 2016 loan-growth expectation.
- Assess credit trends beyond headline nonperforming loans, including rising classified assets, real-estate exposure, PCI-loan performance and allowance adequacy.
- Reconcile reported earnings and margins with management’s non-GAAP core measures, including PCI accretion and the effects of FDIC agreement termination.
- Review liquidity capacity alongside substantial unfunded credit commitments, and monitor interest-rate exposure and deposit-cost pressures.
- Track whether expense, margin and growth expectations are achieved; the filing cautions that interim results are not necessarily indicative of full-year performance.