Enterprise Financial Services Corp. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Unaudited consolidated results. The company provides banking and wealth-management services in the St. Louis, Kansas City and Phoenix markets.
Financial performance and position
| Metric | Q3 2011 / Sep. 30, 2011 | Comparable period / prior date |
|---|---|---|
| Net income | $9.7 million; diluted EPS $0.49 | Q3 2010: $5.0 million; $0.29 |
| Nine-month net income | $26.7 million; diluted EPS $1.46 | Nine months 2010: $2.7 million; $0.06 |
| Net interest income | Q3: $32.4 million; nine months: $91.6 million | Q3 2010: $24.3 million; nine months 2010: $61.5 million |
| Net interest margin, tax-equivalent | Q3: 4.56%; nine months: 4.57% | Q3 2010: 4.31%; nine months 2010: 3.75% |
| Provision for loan losses | Q3: $5.6 million; nine months: $13.7 million | Q3 2010: $7.7 million; nine months 2010: $30.4 million |
| Noninterest income / expense | Q3: $6.6 million / $18.3 million | Q3 2010: $6.1 million / $15.5 million |
| Total assets | $3.37 billion | $2.81 billion at Dec. 31, 2010 |
| Portfolio loans / deposits | $2.21 billion / $2.82 billion | $1.89 billion / $2.30 billion at Dec. 31, 2010 |
| Shareholders’ equity | $246.5 million | $183.3 million at Dec. 31, 2010 |
| Cash and cash equivalents | $267.4 million | $293.7 million at Dec. 31, 2010 |
For the first nine months, operating cash flow was $24.9 million, investing cash flow was positive $65.3 million and financing cash flow was negative $116.4 million; cash decreased $26.3 million. Financing included deposit and borrowing outflows, dividends and $32.6 million net proceeds from a May common-stock offering.
At September 30, borrowings included $85.1 million of subordinated debentures, $102.0 million of FHLB advances and $100.7 million of other borrowings. The company reported Tier 1 risk-based capital of 12.05%, total risk-based capital of 13.42%, leverage of 8.41%, and tangible common equity to tangible assets of 4.72%. It said the company and bank met applicable capital requirements and the bank was well-capitalized.
Material changes and operating drivers
- FDIC-assisted acquisitions of Legacy Bank in January and First National Bank of Olathe in August contributed substantially to balance-sheet growth. Olathe added significant deposits, loans, covered assets and goodwill; acquired balances and results affect comparisons with 2010. A BankLiberty branch transaction closed October 21, after quarter-end.
- Deposits increased 23% from year-end, to $2.82 billion. Management reported core deposits at 96% of total deposits and described efforts to reduce higher-cost or volatile funding. Brokered CDs were $126.6 million.
- Management cited continued commercial-and-industrial loan growth and reduced exposure to construction and residential real estate. It expected 6–8% growth in loans not covered by FDIC loss-share agreements for 2011.
- Quarterly pretax, pre-provision income was $20.0 million, down 6% from the linked quarter but up 22% year over year. Management attributed the sequential decline mainly to lower yields on covered assets.
- Q3 noninterest expense rose 18% year over year, largely from compensation and staffing to support acquisitions. The nine-month efficiency ratio improved to 49.7% from 56.4%.
Credit, liquidity, risks and outlook
- Allowance for loan losses was $42.9 million, 1.94% of total portfolio loans and 89% of nonperforming loans. Nine-month net charge-offs were $13.6 million, down from $26.4 million in 2010. Management considered the allowance adequate; it cited slightly higher loan-risk downgrades as the reason Q3 provision rose from Q2.
- Nonperforming loans were $48.0 million, or 2.17% of total loans including covered loans, versus $52.0 million and 2.69% a year earlier. Other real estate totaled $77.6 million, of which $56.2 million was FDIC-covered; the increase chiefly reflected acquired properties. Management expected gradual improvement in nonperforming assets excluding covered assets.
- FDIC loss-share agreements reimburse specified portions of losses on covered acquired assets. Covered-loan carrying values, expected collections and the related FDIC receivable rely on estimates; actual realizations may differ. Management noted that faster-than-expected payoffs of covered loans generated accelerated discount accretion worth about $0.08 of Q3 diluted EPS. Covered loans yielded 18.22% in the quarter, making this a notable, potentially nonrecurring earnings contributor.
- Liquidity sources included $267.4 million of cash and equivalents, $219.1 million of unpledged available-for-sale securities, $120.5 million of additional FHLB capacity, $358.4 million of Federal Reserve capacity and $35.0 million of correspondent-bank lines. Unused credit commitments and standby letters totaled about $559.5 million; management said aggregate simultaneous drawdown was unlikely.
- Interest-rate simulations indicated that rising rates would benefit net interest income. Management cautioned that results could differ due to credit quality and collateral values, local economic conditions, interest-rate movements, competition, regulation, personnel retention, litigation and other risks. It gave no specific earnings guidance; it cautioned that interim results are not necessarily indicative of full-year results.
- Two lawsuits related to investments in Distinctive Properties notes seek approximately $26.8 million in aggregate damages, plus other relief. The company said it could not reasonably estimate a possible loss and intends to defend the cases. In one case, a court dismissed certain RICO and fiduciary-duty claims on October 31, 2011, with leave to amend, but other claims remained; proceedings in both matters were affected by stays or pending motions.
- State tax-credit gains included fair-value changes on Level 3 assets; Q3 included a $975,000 positive fair-value adjustment. Management said no available-for-sale securities were other-than-temporarily impaired at quarter-end.
Key facts for investors to verify
- How much future earnings depend on FDIC-covered loan accretion, acquisition accounting and loss-share recoveries, versus recurring core operations.
- Credit trends, particularly construction and commercial real estate exposures, nonperforming loans, charge-offs, and the valuation and disposition of acquired other real estate.
- Whether the expected 6–8% growth in noncovered loans is achieved while maintaining underwriting quality and funding costs.
- Acquisition integration, final purchase-accounting valuations, and the effect of the subsequent BankLiberty transaction and FDIC value-appreciation payment.
- Developments and potential financial exposure in the Distinctive Properties litigation, which the filing says cannot yet be reasonably estimated.