Enterprise Financial Services Corp. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet comparisons are to December 31, 2013, and operating results primarily to Q1 2013. 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
- Earnings: Net income was $5.8 million, or $0.30 per diluted share, versus $10.0 million, or $0.53, in Q1 2013. Return on average assets was 0.77% and return on average common equity was 8.26%.
- Revenue and margins: Net interest income was $30.4 million, down 18% on a tax-equivalent basis from Q1 2013. Noninterest income was $3.9 million, up $1.0 million year over year. Net interest margin was 4.39%, compared with 5.10%; core net interest margin was 3.44%, compared with 3.55%. The efficiency ratio rose to 61.54% from 50.95%.
- Credit costs and asset quality: Provision for loan losses was $4.3 million, including $3.3 million for purchase credit-impaired (PCI) loans. Portfolio-loan net charge-offs were $0.4 million. Nonperforming loans were $15.5 million, or 0.71% of portfolio loans, down from $20.8 million and 0.98% at year-end 2013. The allowance was $27.9 million, or 1.28% of portfolio loans, and equaled 180% of nonperforming loans. These nonperforming-loan figures exclude pooled PCI loans.
- Balance sheet and liquidity: Total assets were $3.14 billion; portfolio loans were $2.17 billion and PCI loans were $128.7 million. Deposits declined $82.8 million (3.3%) to $2.45 billion. Cash and cash equivalents fell $72.9 million to $137.7 million. FHLB advances increased from $50 million to $130 million; other borrowings were $183.7 million and notes payable were $6.6 million. Operating cash flow was negative $7.4 million, investing cash flow negative $37.1 million, and financing cash flow negative $28.4 million.
- Capital: Shareholders’ equity was $291.4 million. Tier 1 risk-based capital was 12.39%, total risk-based capital 13.65%, and the leverage ratio 10.29%. The Company reported that it and the Bank met applicable capital requirements and that the Bank was well capitalized.
Changes, outlook, and risks
- Year-over-year earnings declined as PCI balances and related income ran off, portfolio-loan yields and prepayment fees were lower, and expenses increased. Management attributed the linked-quarter earnings improvement mainly to lower expenses versus Q4 2013, which included a $2.6 million FHLB prepayment penalty and other costs.
- Portfolio loans grew 1.7% from year-end, led by commercial and industrial and owner-occupied commercial real estate lending. PCI loans declined 8.4%, primarily from principal repayments and accelerated payoffs.
- Management projected average PCI loans of $113 million in 2014 and $69 million in 2015, and cautioned that continued pressure on loan yields could modestly reduce core net interest margin through 2014. Interest-rate simulations indicated estimated next-12-month net interest income increases of 1.7%, 4.4%, and 6.9% under +100, +200, and +300 basis-point shocks, respectively, and a 0.9% decrease under a -100 basis-point shock.
- The remaining $5.0 million of 9% trust preferred securities converted to common stock in March; the Company issued 287,852 shares. It also prepaid $3.6 million of its term loan, reducing its contractual rate by 50 basis points. Management reported compliance with the term-loan covenants.
- FDIC loss-share estimates remain subject to quarterly remeasurement. The Company recorded a $1.5 million liability for expected payments at the end of two loss-share agreements. Other stated risks include credit and real-estate valuations, local economic conditions, interest-rate changes, competition, regulation, litigation, and funding pressures. Management said no pending or threatened legal proceedings were expected to have a material adverse effect; no material risk-factor changes from the latest 10-K were reported.
- Disclosure controls were assessed as effective at March 31, 2014; no material changes to internal controls were reported.
Important facts for investors to verify
- Whether PCI loan runoff and lower yields continue to pressure net interest income and core margin, and whether management’s PCI balance projections are achieved.
- Drivers of the deposit decline, use of increased FHLB funding, and ongoing access to liquidity sources and unused commitments.
- Credit performance and reserve adequacy, particularly commercial real estate exposures, PCI delinquencies, and the timing and valuation of foreclosed properties.
- Assumptions underlying FDIC loss-share receivables and the recorded clawback liability, as well as Level 3 state tax-credit valuations.
- Whether expense increases in risk management and loan-related legal costs persist, and how fee income varies with state tax-credit and other-real-estate sales.