ENTERPRISE FINANCIAL SERVICES CORP annual report, FY2018

Full document

Enterprise Financial Services Corp. — 2018 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2018; quarterly figures below identify the fourth quarter. Enterprise Financial Services Corp. is a bank holding company whose principal subsidiary, Enterprise Bank & Trust, provides banking and wealth management services, primarily in the St. Louis, Kansas City, and Phoenix markets. Its lending includes commercial and industrial, commercial real estate, construction, residential, and specialized lending.

Financial performance and condition

  • Full-year earnings: Net income was $89.2 million, or $3.83 per diluted share, compared with $48.2 million, or $2.07, in 2017. Pretax income increased to $104.6 million from $86.5 million.
  • Revenue and margins: Net interest income was $191.9 million, up 8%; noninterest income was $38.3 million, up 11%. Net interest margin declined to 3.82% from 3.88%, while core net interest margin rose to 3.75% from 3.72%. The efficiency ratio improved to 51.70% from 54.35%.
  • Fourth quarter: Net income was $23.5 million and diluted EPS was $1.02, versus $7.5 million and $0.32 in fourth-quarter 2017. Q4 2018 net interest income was $50.6 million and provision for portfolio loan losses was $2.1 million.
  • Cash flow: Operating activities provided $108.8 million; investing activities used $331.6 million; and financing activities provided $266.0 million. Cash and cash equivalents increased $43.2 million to $196.6 million.
  • Balance sheet and funding: Total assets were $5.65 billion, up 6.7%; total loans were $4.35 billion, up 6.2%; and deposits were $4.59 billion, up 10.4%. Core deposits increased 9% to about $3.9 billion. Brokered certificates of deposit were $199.0 million.
  • Debt and liquidity: At year-end, subordinated debentures and notes totaled $118.2 million, FHLB advances $70.0 million, other borrowings $221.5 million, and notes payable $2.0 million. The Bank had $602 million of additional FHLB borrowing capacity, $989 million available under its Federal Reserve line, and $95 million in correspondent-bank lines. The parent company held $6.4 million in cash.
  • Credit quality and capital: Nonperforming assets were $17.2 million, or 0.30% of assets, compared with $16.2 million, or 0.31%, a year earlier. Nonperforming loans were 0.38% of loans in both years. Net charge-offs were $5.7 million, or 0.13% of average loans, down from $10.2 million, or 0.26%. The allowance for loan losses was $43.5 million, or 1.00% of loans. The Bank remained “well capitalized”; its total risk-based capital ratio was 12.26%.

Material changes versus 2017

  • Net income increased substantially, while the effective tax rate fell to 14.7% from 44.3%. The comparison reflects the lower federal corporate tax rate and tax planning in 2018, as well as a $12.1 million deferred-tax-asset revaluation charge recorded in 2017.
  • Net interest income grew with loan and balance-sheet expansion, but rising deposit and borrowing costs contributed to a six-basis-point decline in reported net interest margin. Deposit cost increased to 0.79% from 0.44%.
  • Noninterest income increased by $4.0 million, led by card services, deposit service charges, and other income. Noninterest expense rose 3% to $119.0 million; higher compensation and other expenses were partly offset by lower merger costs.
  • Portfolio loans increased 6.6%; C&I loans increased 11%. The allowance ratio declined from 1.04% to 1.00%. The reported $6.6 million net provision included a $3.2 million reversal on purchased credit-impaired loans.

Outlook, transactions, and risks

  • Management expected high-single-digit loan growth and noninterest-income growth in 2019, excluding the pending Trinity acquisition. It expected expense growth equal to 35%–45% of projected revenue growth and an effective tax rate of approximately 18%–20%. Management expected to maintain core net interest margin but warned that funding-cost pressure could offset improvement.
  • The pending acquisition of Trinity Capital and Los Alamos National Bank would expand the company into New Mexico. Trinity reported approximately $1.2 billion in assets at year-end 2018. Consideration was set at 0.1972 EFSC shares plus $1.84 cash per Trinity share; the filing estimated approximately $38 million cash and $175 million in EFSC stock. Closing was anticipated in Q1 2019, subject to shareholder approval and other conditions. The company arranged a $40 million five-year term loan principally to fund the cash portion and increased its revolving facility to $25 million.
  • In January 2019, the company entered into $62 million of interest-rate swaps, fixing the rate on a portion of floating-rate debt at a weighted average 2.62% for five to seven years. The board raised the first-quarter 2019 dividend to $0.14 per share.
  • Key risks include commercial and real-estate credit exposure, specialized cash-flow lending, local economic and agricultural conditions, rising funding costs and interest-rate sensitivity, reliance on deposits and wholesale funding, acquisition execution and integration, and regulatory, cyber, vendor, litigation, and tax-credit-program risks. CECL, effective for the company beginning January 1, 2020, may require higher expected-credit-loss allowances; the impact was not yet determined.
  • Management reported no pending or threatened ordinary-course legal proceedings expected to have a material adverse effect. Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting.

Important facts for investors to verify

  • Whether Trinity closed on the anticipated terms and timing, and the resulting dilution, funding needs, integration costs, and asset quality.
  • Whether loan growth and fee-income growth meet management’s 2019 expectations without weakening underwriting or asset quality.
  • How deposit competition and repricing affect funding costs, core net interest margin, and liquidity, including brokered-deposit renewals.
  • Whether nonperforming and potential problem loans, charge-offs, and the allowance remain appropriate as specialized and commercial exposures grow.
  • The eventual CECL adoption impact and the sustainability of the unusually low 2018 effective tax rate and earnings increase.