Enterprise Financial Services Corp. — Q2 2011 Form 10-Q
Business context and reporting period. The company provides banking and wealth-management services in the St. Louis, Kansas City and Phoenix markets. This filing covers the quarter and six months ended June 30, 2011. In January, the bank acquired certain assets and liabilities of Legacy Bank in an FDIC-assisted transaction with an 80% loss-share agreement on specified assets.
Financial results and position
Amounts below are in millions, except per-share data and ratios.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Interest income | $40.0 | $26.7 | $74.6 | $54.0 |
| Net interest income | $32.5 | $18.6 | $59.2 | $37.2 |
| Provision for loan losses | $4.6 | $9.0 | $8.2 | $22.8 |
| Noninterest income | $5.1 | $5.0 | $10.1 | $9.1 |
| Noninterest expense | $18.0 | $14.1 | $35.5 | $27.8 |
| Net income (loss) | $9.9 | $0.7 | $17.0 | $(2.3) |
| Diluted earnings (loss) per common share | $0.52 | $0.01 | $0.96 | $(0.24) |
- Tax-equivalent net interest margin was 4.95% in Q2, versus 3.46% a year earlier and 4.19% in Q1 2011. Management attributed much of the quarter’s uplift to FDIC-covered loans, which yielded 27.05%; excluding those loans and related funding, margin was 3.45%.
- Q2 pre-tax, pre-provision income, a company-defined non-GAAP measure, was $21.2 million, up 119% year over year. The efficiency ratio improved to 47.9% from 59.8%.
- At June 30, total assets were $2.94 billion; portfolio loans were $2.01 billion, deposits $2.41 billion, and shareholders’ equity $237.0 million. Cash and cash equivalents were $198.1 million, down from $293.7 million at year-end 2010.
- Borrowings included $85.1 million of subordinated debentures, $102.0 million of FHLB advances and $87.8 million of other borrowings. The company reported $35.0 million of preferred stock, including $32.9 million carrying value on the balance sheet.
- Six-month operating cash flow was $23.0 million; investing activities used $96.8 million and financing activities used $21.8 million. Cash decreased $95.6 million during the period.
- Company regulatory capital ratios at June 30 included Tier 1 risk-based capital of 14.55%, total risk-based capital of 15.98%, and leverage of 10.50%. Management said the company and bank met applicable requirements and were “well-capitalized.”
Material changes versus comparable periods
- Q2 net income rose to $9.9 million from $0.7 million; first-half results shifted from a $2.3 million loss to $17.0 million of income. Higher net interest income and lower loan-loss provision were key contributors; acquired covered-loan yields and related FDIC accounting materially influenced results.
- Portfolio loans increased $113.4 million, or 6%, from December 31, 2010. Uncovered loans grew $65.2 million in Q2; commercial and industrial loans increased $75.4 million, while construction and residential real-estate lending declined.
- Deposits increased $113.6 million, or 5%, from year-end. Noninterest-bearing demand deposits were $473.7 million, up 29% from year-end; management also reduced reliance on certificates of deposit.
- Nonperforming loans were $43.1 million, compared with $46.6 million at June 30, 2010. Net charge-offs were $8.8 million for the first half, versus $20.5 million a year earlier. Other real estate was $42.8 million, including $21.8 million covered by FDIC loss-share agreements.
- Noninterest expenses rose $7.7 million in the first half, reflecting compensation and staffing related partly to Arizona acquisition activity, as well as higher loan legal and other real-estate expenses.
- The company issued common stock in May, raising $35.0 million gross and approximately $32.6 million net. About $20.0 million of proceeds had been injected into the bank by June 30.
Outlook, commentary, risks and unusual items
- Management expected low- to mid-single-digit portfolio-loan growth in 2011, primarily in commercial and industrial lending, and expected gradual improvement in nonperforming assets excluding covered assets. It also said rising interest rates were estimated to benefit net interest income. These statements are forward-looking and subject to the risks described in the filing.
- Management credited stronger commercial lending and demand deposits, lower funding costs, improved asset quality and FDIC-assisted transactions for better operating results. It said it intended, absent significant acquisitions or another recession, to redeem the $35 million of U.S. Treasury preferred stock in 2012 using available cash and bank earnings.
- Legacy acquired loans and other real estate, and the associated FDIC indemnification asset, depend on estimates of fair value and future collections. Actual recoveries could differ materially from recorded estimates. The second-quarter covered-loan yield reflected cash flows on loan payoffs exceeding expectations; management said covered-loan performance and related accretion can fluctuate.
- Credit risks include substantial real-estate exposure, particularly construction and land-development lending, local economic conditions, collateral valuations and loan downgrades. The allowance was $42.2 million; management considered it adequate. Q2 net charge-offs were $5.2 million, with 77% related to construction, land-acquisition and development loans.
- Two lawsuits concerning investments in Distinctive Properties promissory notes seek approximately $26.0 million and $0.8 million, respectively, plus other damages and costs. The company denies the allegations and intends to defend them; it said a reasonably possible loss could not be estimated because the cases were at an early stage.
- Other notable matters: the company agreed to acquire certain assets and deposit liabilities of a BankLiberty branch, subject to regulatory approval, with operation anticipated in Q4 2011; and a director resigned at the Audit Committee’s request because a business relationship could have affected the auditor’s independence.
Important facts for investors to verify
- How much future earnings depend on unusually high covered-loan yields, FDIC indemnification-asset accretion and the timing of covered-asset collections.
- Trends in construction and real-estate credit quality, charge-offs, nonperforming loans, other real estate and the adequacy of the loan-loss allowance.
- The sustainability of commercial and industrial loan growth, deposit growth and lower funding costs, including continued reductions in certificate-of-deposit reliance.
- Liquidity available against $445.3 million of commitments to extend credit and $44.6 million of standby letters of credit; management noted $489.9 million of unused commitments overall.
- Developments in the Distinctive Properties litigation, the BankLiberty branch transaction and the planned 2012 preferred-stock redemption.
- Fair-value assumptions for state tax credits and acquired assets, and the effect of changing interest rates on margins and asset values.