Business context and reporting period
Enterprise Financial Services Corp (EFSC), a financial holding company headquartered in Missouri, provides commercial and personal banking, wealth management, treasury, SBA and tax-credit-related services through Enterprise Bank & Trust. This Form 10-K covers the fiscal year ended December 31, 2020; quarterly figures below refer to the three months ended that date. The company operates across Arizona, California, Kansas, Missouri, Nevada and New Mexico.
EFSC completed its acquisition of Seacoast Commerce Banc Holdings on November 12, 2020, for approximately $169 million, primarily in EFSC shares. Seacoast added banking operations and a substantial SBA lending business; its results are included only from the acquisition date.
Financial performance and position
- Full-year earnings: Net income was $74.4 million, down 20% from $92.7 million in 2019. Diluted EPS was $2.76 versus $3.55. Return on average assets was 0.90% (1.35% in 2019).
- Revenue and margins: Net interest income increased 13% to $270.0 million, and noninterest income increased 11% to $54.5 million. Combined revenue was $324.5 million, up approximately 13%. Fully tax-equivalent net interest margin declined to 3.56% from 3.80%, reflecting lower rates and the shift toward lower-yielding PPP loans and short-term investments.
- Credit costs and asset quality: Provision for credit losses rose to $65.4 million from $6.4 million, principally due to CECL and pandemic-related economic forecasts. The allowance for loan losses was $136.7 million, or 1.89% of loans, compared with $43.3 million, or 0.81%, a year earlier. Net charge-offs were low at $1.9 million. Nonperforming loans increased to $38.5 million from $26.4 million; nonperforming assets were 0.45% of total assets.
- Expenses: Noninterest expense was $167.2 million, up 1%. The reported efficiency ratio improved to 51.51% from 57.48%, while the core efficiency ratio was 50.96% versus 52.36%. The reported improvement partly reflects lower merger costs than in 2019.
- Fourth quarter: Net income was $28.9 million, or $1.00 diluted EPS, versus $29.1 million and $1.09 in fourth-quarter 2019. Net interest income was $77.4 million versus $61.6 million; provision expense was $9.5 million versus $1.3 million.
- Balance sheet and funding: Total assets grew 33% to $9.75 billion; loans rose 36% to $7.22 billion and deposits rose 38% to $7.99 billion. Cash and cash equivalents were $537.7 million, up from $167.3 million. Core deposits were 93% of deposits, versus 86% in 2019; noninterest-bearing deposits were 34%.
- Debt and liquidity: Year-end subordinated debentures and notes were $203.6 million, FHLB advances $50.0 million, other borrowings $271.1 million, and notes payable $30.0 million. Available borrowing capacity included approximately $739 million from the FHLB, $921 million from the Federal Reserve, and $90 million in correspondent-bank lines. Unused commitments to extend credit were approximately $1.95 billion.
- Cash flow: Net cash from operating activities was $135.5 million; investing activities used $702.8 million; financing activities provided $937.8 million. The resulting increase in cash and cash equivalents was $370.4 million.
- Capital and shareholder returns: EFSC’s total risk-based capital ratio was 14.9%, CET1 ratio 10.9%, and leverage ratio 10.0%; the Bank remained well-capitalized. Book value per share was $34.57 and tangible book value per share $25.48. The company paid $0.72 per share in 2020 dividends and repurchased 456,251 shares. A quarterly dividend of $0.18 per share was declared for first-quarter 2021.
Material changes versus the prior comparable period
- EFSC’s 2020 results reflect Seacoast from November 12 onward and a full year of Trinity operations, versus a partial year in 2019. Consequently, year-over-year balance-sheet and revenue comparisons include acquisition effects.
- Despite revenue growth, net income declined because the provision for credit losses increased by approximately $59.0 million. CECL adoption on January 1, 2020 increased the loan allowance by $28.4 million and reduced retained earnings after tax by $18.1 million.
- Lower market rates reduced the yield on earning assets; the cost of interest-bearing liabilities fell to 0.64% from 1.38%, partly offsetting the margin pressure. PPP contributed $19.6 million of interest and fee income during 2020.
- Deposits and cash increased sharply amid Seacoast’s acquisition, customer liquidity and PPP-related funding. Loan growth included $698.6 million of PPP loans net of unearned fees at year-end.
- Nonperforming loans rose 46%; management attributed much of the increase to a $9.1 million hotel loan and recorded a $2.8 million specific reserve for a potential collateral shortfall.
Outlook, risks and unusual items
- The filing provides no quantified earnings or revenue guidance. Management said it expects to continue investing in revenue-producing associates and infrastructure to support growth, and anticipated continuing a regular quarterly dividend, subject to board action and regulatory constraints.
- Management identified the continuing COVID-19 impact, economic forecasts, unemployment, business failures and real-estate values as key uncertainties that could affect credit losses, profitability, liquidity and capital. At year-end, $63.0 million of loans remained in deferral status; $687.8 million had participated in deferral programs during 2020.
- Credit risks include commercial lending, real-estate collateral, hospitality exposure, sponsor finance and possible losses on SBA loans if the SBA finds origination or servicing deficiencies. PPP administration also presents compliance, litigation and guarantee risks.
- Interest-rate and reference-rate transition risks remain material. EFSC reported $2.5 billion of LIBOR-indexed loans, $239.2 million of LIBOR-indexed deposits and borrowings, and $992.2 million in LIBOR-indexed derivative notional. The company had not identified a replacement index for all affected contracts.
- Other notable exposures include goodwill of $260.6 million, uncertain tax positions of $3.1 million, and possible New Markets Tax Credit recapture indemnities. Management reported no ordinary-course legal proceeding expected to have a material adverse effect.
- The 2020 financial statements received an unqualified audit opinion, and management and the auditor concluded internal control over financial reporting was effective. Seacoast was excluded from the internal-control assessment because of its recent acquisition. The auditor identified the credit-loss allowance and Seacoast loan valuation as critical audit matters.
Important facts for investors to verify
- How much of reported loan, deposit and revenue growth is organic versus attributable to Seacoast, Trinity and PPP activity.
- Whether the CECL allowance and related economic assumptions adequately reflect pandemic-sensitive borrowers, including hospitality, sponsor finance and loans with repeated deferrals.
- Subsequent performance of the hotel credit, the $80 million of potential problem loans, and loans whose deferrals expired or were renewed.
- Seacoast integration progress, realization of expected benefits, and the valuation assumptions supporting acquired loans and goodwill.
- Progress in amending LIBOR-linked contracts and the effect of benchmark transition on loan yields, funding costs and hedges.
- Liquidity capacity under a stress scenario, including potential draws on approximately $1.95 billion of loan commitments and reliance on available borrowing facilities.
- Dividend sustainability and capital levels after acquisition-related growth, credit costs, future repurchases and regulatory requirements.