Esquire Financial Holdings, Inc. quarterly report, Q2 FY2023

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Esquire Financial Holdings, Inc. — Q2 2023 Form 10-Q

Business context and reporting period. Esquire Financial is a bank holding company whose bank serves law firms and related litigation businesses nationally, small businesses through payment processing, and commercial and retail customers in the New York metropolitan area. This unaudited filing covers the quarter and six months ended June 30, 2023; comparisons are with the corresponding 2022 periods unless otherwise noted. Dollar amounts below are in millions except per-share data.

Financial results and condition

  • Q2 earnings: Net income was $9.1 million, up 43.5%; diluted EPS was $1.10 versus $0.78. Net interest income rose 46.9% to $20.1 million. Net interest margin expanded to 6.02% from 4.46%.
  • Six-month earnings: Net income was $21.3 million, up 82.1%; diluted EPS was $2.57 versus $1.43. Net interest income increased 54.7% to $39.4 million, and net interest margin was 6.02% versus 4.44%.
  • Revenue and expenses: Q2 total interest income was $22.1 million and noninterest income was $6.7 million; noninterest expense was $13.0 million. Six-month amounts were $42.4 million, $17.0 million and $25.5 million, respectively. Q2 payment processing fees increased 4.6% to $5.8 million. Six-month noninterest income included a $4.0 million gain on an equity investment.
  • Credit costs and asset quality: Provision for credit losses was $1.3 million in Q2 and $1.8 million for six months. The allowance was $14.2 million, or 1.34% of loans, at June 30, versus $12.2 million, or 1.29%, at year-end. The filing reports $4,000 of nonperforming assets; special-mention and substandard loans were $17.9 million and $1.1 million, respectively.
  • Balance sheet and funding: Total assets were $1.451 billion, up 3.9% from year-end. Loans held for investment were $1.057 billion, up 11.4%; deposits were $1.259 billion, up 2.5%. Stockholders’ equity was $178.9 million, up from $158.2 million. Noninterest-bearing demand deposits were $508.9 million, or 40.4% of deposits.
  • Liquidity and debt: Cash and cash equivalents were $106.2 million, down from $164.1 million at year-end. Management reported total available liquidity of $480.5 million, or 38% of deposits, including cash, reverse repos, borrowing capacity and available reciprocal client sweep balances. No FHLB or Federal Reserve borrowings were outstanding; the filing reports no material funded debt. Six-month operating cash flow was $15.1 million; investing cash outflow was $101.7 million, primarily reflecting $107.6 million of net loan growth, and financing cash inflow was $28.6 million. Cash declined $57.9 million.
  • Capital and returns: The Bank was described as well capitalized. At June 30, its total risk-based capital ratio was 15.52%, common equity Tier 1 ratio 14.27%, and Tier 1 leverage ratio 11.72%. Management reported Q2 return on average assets of 2.65%, return on average equity of 21.03%, and an efficiency ratio of 48.4%.

Material changes versus comparable periods

  • Loan growth and higher market rates drove interest income higher; the average loan yield rose to 7.73% in Q2 from 5.92%. About 60% of loans were variable-rate commercial loans tied to prime.
  • Deposit costs increased as rates rose and the company proactively raised rates on certain escrow accounts. Q2 interest expense increased to $2.0 million from $0.3 million; the average cost of interest-bearing deposits was 1.14% versus 0.18%.
  • Q2 noninterest expense increased 24.9% to $13.0 million, including higher compensation, professional services and data-processing costs. Management cited hiring, sales expansion, technology implementations and business growth.
  • At June 30, commercial loans were $634.9 million, up 15.0% from year-end, and multifamily loans were $298.7 million, up 13.8%. Litigation-related loans totaled $528.2 million, about half of the loan portfolio.
  • The securities portfolio remained affected by market-rate-related unrealized losses: available-for-sale securities had $19.9 million of gross unrealized losses and held-to-maturity securities had $8.9 million of unrecognized losses at June 30. Management attributed available-for-sale losses to interest rates rather than credit and reported no securities credit-loss allowance.

Outlook, commentary, risks and unusual items

  • Outlook: The filing gives no quantified earnings or revenue guidance. Management describes litigation lending and payment processing as growth opportunities and emphasizes technology investment, relationship banking and continued loan growth. It cautions that interim results are not necessarily indicative of full-year results.
  • Funding and concentration risks: Management identifies reliance on litigation-related lending and deposits, real-estate loan concentrations, competition for deposits, and the possibility that uninsured-deposit outflows could force securities sales at a loss. Uninsured deposits were $329.1 million, or 26% of deposits; management says about 85% were from clients with broader banking relationships. Litigation escrow and claimant-trust balances were $547.1 million, or 43.3% of deposits, and are described as insured at the beneficial-owner level when properly titled.
  • Market and credit risks: The filing cites banking-industry volatility following bank failures, inflation, rising rates, changing property values and borrower cash flows, and uncertainty in the economy. Management’s rate-sensitivity model estimates higher net interest income under rising-rate scenarios, but actual results may differ due to assumptions, market conditions and management actions.
  • Accounting change: The company adopted CECL on January 1, 2023. Adoption increased the loan allowance by $283,000 and established a $500,000 reserve for unfunded commitments; the after-tax reduction to opening retained earnings was $568,000.
  • Unusual item: A February 2023 restructuring and sale involving Litify, Inc. generated a $4.0 million gain in Q1. The remaining investment was carried at $1.6 million at June 30, with a related $1.1 million note receivable.
  • Contingencies and controls: Management said it knew of no pending legal matter expected to materially affect results. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting during the quarter. The filing reported no material change to previously disclosed risk factors.

Important facts for investors to verify

  1. How much future earnings growth depends on continued high rates, variable-rate commercial lending and the unusually strong reported net interest margin.
  2. The composition, duration and stability of deposits—especially litigation escrow balances, uninsured deposits and off-balance-sheet sweep funds—and the availability of stated liquidity in stress conditions.
  3. Credit quality trends in commercial litigation and real-estate portfolios, including migration in special-mention and substandard loans, charge-offs and allowance adequacy under CECL.
  4. Whether expense growth from hiring, technology investment and sales expansion produces sustained payment-processing and lending growth.
  5. The degree to which six-month earnings growth reflects recurring operations versus the $4.0 million Litify gain, and the collectability and valuation of related remaining consideration.
  6. The potential effect of securities unrealized losses and changing rates on capital, liquidity and any need to sell securities.