ENTERPRISE FINANCIAL SERVICES CORP quarterly report, Q2 FY2019

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Enterprise Financial Services Corp. — Q2 2019 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2019. EFSC provides banking and wealth-management services in Arizona, Kansas, Missouri and New Mexico. Unless stated otherwise, amounts below are in U.S. dollars; financial-statement figures are in millions.

Financial performance

  • Second quarter: Net income was $18.4 million, down 17% from $22.3 million a year earlier. Diluted EPS was $0.68 versus $0.95. Net interest income increased 31% to $61.7 million; noninterest income rose 23% to $12.0 million. Noninterest expense rose 68% to $49.1 million, including $10.3 million of merger costs.
  • First six months: Net income was $34.6 million versus $43.2 million; diluted EPS was $1.36 versus $1.85. Net interest income increased 22% to $114.1 million, while noninterest income increased 10% to $21.2 million. Noninterest expense increased 52% to $88.9 million, including $17.6 million of merger-related costs.
  • Margins and returns: Tax-equivalent net interest margin was 3.86% for Q2 and 3.87% for the six months, compared with 3.77% and 3.79%, respectively, in 2018. Six-month GAAP ROAA was 1.07% and ROAE 9.45%; management’s adjusted ROAA and ROAE excluding merger costs were 1.50% and 13.19%.
  • Cash flow: Operating cash flow was $20.6 million for the six months, versus $51.9 million in 2018. Investing used $196.0 million and financing provided $168.3 million; cash and cash equivalents ended at $189.4 million, down $7.2 million from year-end.

Financial position, credit and liquidity

  • Total assets were $7.18 billion at June 30, up $1.54 billion from December 31, 2018. Loans were $5.15 billion, up $799 million; deposits were $5.56 billion, up $971 million. Management attributed much of the growth to the Trinity acquisition.
  • Shareholders’ equity was $825.5 million, up $221.7 million. The company’s tangible common equity-to-tangible assets ratio was 8.43%, compared with 8.66% at year-end. The Bank’s total risk-based capital ratio was 12.44%, and it met the regulatory definition of well-capitalized.
  • Debt and borrowings included $141.1 million of subordinated debentures and notes, $389.4 million of FHLB advances, $161.0 million of other borrowings, and $37.1 million of notes payable. The $40 million term note issued to help fund Trinity had a March 2024 maturity. No amount was outstanding on the $25 million revolving credit facility.
  • The Bank reported $350 million of additional FHLB borrowing capacity, $1 billion available from the Federal Reserve under a pledged-loan agreement, $95 million of correspondent-bank lines and $296 million of American Financial Exchange credit. These are disclosed capacities, not cash on hand.
  • The allowance for loan losses was $43.8 million, or 0.85% of total loans, versus 1.04% a year earlier. Six-month net charge-offs were $2.8 million, compared with $0.4 million in 2018. Nonperforming loans were $19.8 million (0.39% of loans), versus $16.7 million (0.38%) at year-end; nonperforming assets were $30.4 million, or 0.42% of assets. Other real estate increased to $10.5 million.
  • Management said two loans totaling about $4.0 million were over 90 days past due but still accruing, were well secured, and were expected to resolve positively in Q3. The acquired Trinity loan portfolio was recorded at fair value with a $24.4 million credit mark and no initial allowance.

Material changes and unusual items

  • EFSC acquired Trinity Capital Corporation and Los Alamos National Bank on March 8, 2019, for approximately $209.2 million: $37.3 million in cash and 4.0 million EFSC shares valued at $171.9 million. Trinity added approximately $1.2 billion of assets and $1.1 billion of liabilities. The preliminary purchase accounting included $93.9 million of goodwill; the allocation remained subject to refinement.
  • Merger expenses of $17.6 million materially reduced reported first-half earnings. Management estimated these costs reduced diluted EPS by $0.54. The company’s pro forma first-half results, assuming Trinity had been acquired January 1, 2018, showed revenue of $144.9 million and net income of $49.0 million for 2019; these unaudited figures are not actual reported results and are not necessarily indicative.
  • Effective January 1, 2019, lease accounting adoption resulted in recognition of operating lease right-of-use assets and liabilities; June 30 balances were $14.2 million and $14.8 million, respectively. The company also adopted the premium-amortization standard for certain callable securities, with no material reported effect.
  • Unrealized gains on securities contributed to $22.4 million of first-half other comprehensive income. Management reported no securities as other-than-temporarily impaired.

Outlook, commentary and risks

  • Management expected 2019 organic loan growth in the high-single-digit percentage range, excluding Trinity-acquired loans, and high-single-digit growth in noninterest income excluding Trinity. It expected noninterest expense of $37–$39 million in each of Q3 and Q4, with efficiency improvements in the second half.
  • Management expected a full-year 2019 effective tax rate of approximately 18%–20%; the low end depended on executing tax-planning strategies. It also stated that cash at the parent and other available funding sources should cover projected parent-company needs for the rest of 2019.
  • Interest-rate simulations estimated net interest income would rise 2.8%, 5.5% and 8.2% under +100, +200 and +300 basis-point shocks, and fall 4.2% and 9.4% under -100 and -200 basis-point shocks. The company noted deposit competition, a flat yield curve and falling short-term rates could pressure margins.
  • LIBOR transition is a material exposure: the company reported $2.5 billion of LIBOR-based variable-rate loans and material LIBOR-indexed contracts, including borrowings and subordinated debentures. The timing and effects of replacement rates remained uncertain.
  • Off-balance-sheet commitments included $1.39 billion to extend credit and $52.1 million of letters of credit. Management said aggregate commitment amounts do not necessarily represent future funding needs.
  • A lawsuit inherited with Trinity seeks insurance coverage, defense costs and damages related to prior regulatory proceedings. The court had ruled for Trinity on timely notice, but damages were to be pursued at a trial anticipated in Q4 2019; ultimate outcome and recovery remained uncertain. Management did not believe other pending or threatened proceedings would have a material adverse effect.

Important facts for investors to verify

  • Whether Trinity integration, expense reductions and the stated second-half efficiency improvement materialize, and how much acquisition-related cost remains.
  • Organic loan and deposit growth, funding costs, margin sensitivity and the quality and retention of Trinity-acquired deposits.
  • Trends in past-due, nonperforming and classified loans, charge-offs, the adequacy of reserves, and resolution of the two $4.0 million past-due loans.
  • Final purchase-price allocation, acquired-loan discount accretion and goodwill, which were subject to estimates or refinement.
  • Capital, liquidity and funding capacity alongside the substantial unused credit commitments; progress and costs in transitioning LIBOR-linked assets and liabilities.
  • Outcome and timing of the inherited insurance litigation, as well as whether tax-planning assumptions supporting the low end of the tax-rate outlook are achieved.