ENTERPRISE FINANCIAL SERVICES CORP quarterly report, Q2 FY2015

Full document

Enterprise Financial Services Corp. — Q2 2015 Form 10-Q

Business context and reporting period

Enterprise is a financial holding company providing banking and wealth management services primarily in the St. Louis, Kansas City and Phoenix markets. This unaudited report covers the quarter and six months ended June 30, 2015; balance-sheet comparisons are with December 31, 2014. Amounts below are in millions unless noted.

Financial performance and position

  • Quarterly earnings: Q2 net income was $8.7 million, or $0.43 diluted EPS, versus $7.2 million and $0.36 a year earlier. Net interest income was $29.3 million; provision for portfolio loan losses was $2.2 million; noninterest income was $5.8 million; and noninterest expense was $19.5 million.
  • Six-month earnings: Net income was $18.1 million, or $0.90 diluted EPS, versus $13.0 million and $0.66 in first-half 2014. Net interest income was $58.3 million, noninterest income $9.4 million, and noninterest expense $39.4 million. Portfolio loan-loss provision was $3.7 million; PCI loan provision was reversed by $3.3 million.
  • Margins and returns: Q2 fully tax-equivalent net interest margin was 3.85%, compared with 4.04% in Q2 2014; management’s non-GAAP core margin was 3.46%, versus 3.41%. For the first half, reported margin was 3.88% versus 4.21%, while core margin was 3.46% versus 3.42%. Q2 return on average assets was 1.06% and return on average common equity was 10.56%.
  • Balance sheet: Total assets were $3.37 billion, up 2.9% since year-end. Total loans were $2.63 billion, including $87.6 million of PCI loans. Portfolio loans grew 4.5% to $2.54 billion. Deposits rose 8.0% to $2.69 billion. Shareholders’ equity was $332.4 million, up 5.1%.
  • Credit quality: Nonperforming loans were $17.5 million, or 0.69% of portfolio loans, versus $19.3 million and 0.86% a year earlier. The allowance for portfolio loan losses was $31.8 million, or 1.25% of portfolio loans. First-half net charge-offs were $2.2 million. No portfolio loans were over 90 days past due and still accruing at quarter-end.
  • Cash flow: For the first half, operating activities provided $18.5 million, investing activities used $93.9 million and financing activities provided $74.5 million. Cash and cash equivalents declined $0.9 million to $99.8 million.
  • Debt and liquidity: At June 30, FHLB advances were $73.0 million, other borrowings $183.4 million, subordinated debentures $56.8 million and notes payable $5.1 million. The Bank reported available borrowing capacity of $271.7 million from the FHLB and $707.6 million from the Federal Reserve, plus $45.0 million of unsecured correspondent-bank lines. The parent company had $10.8 million cash, which management said was sufficient for projected needs through year-end.
  • Capital: The company reported total capital to risk-weighted assets of 12.68%, Tier 1 capital of 11.43%, common equity Tier 1 of 9.66% and a leverage ratio of 10.83%. The Bank met the regulatory “well-capitalized” definition.

Material changes versus comparable periods

  • First-half net income increased to $18.1 million from $13.0 million. Management attributed the improvement to a larger PCI provision reversal, higher noninterest income and lower expenses, including reduced problem-loan legal costs and expense management.
  • Management-defined core first-half net income rose to $14.8 million from $11.9 million. Core net interest income increased 8%, supported by loan growth and lower funding costs; core noninterest income rose 3%, and core noninterest expense fell 4%.
  • Reported first-half net interest income declined $0.8 million year over year. Management cited lower PCI loan accretion and historically low rates; the run-off of higher-yielding PCI loans also pressured margins.
  • Portfolio loans increased $108.6 million from year-end, led by commercial and industrial lending. PCI loans declined $11.5 million. Deposits increased $200.0 million, while FHLB advances fell $71.0 million and other borrowings fell $50.7 million.
  • Nonperforming assets improved to $19.4 million from $26.9 million at June 30, 2014. However, first-half portfolio loan-loss provision increased to $3.7 million from $2.4 million, primarily to support loan growth and reflect charge-off trends.

Outlook, management commentary and risks

  • Management anticipated quarterly noninterest expense of $19 million to $21 million for 2015. It cautioned that continued loan-yield pressure and PCI run-off could result in a modest decline in core net interest margin in the second half.
  • Management estimated average PCI loan balances of approximately $80 million and 2015 pretax income from PCI assets of $9 million to $12 million, absent cash-flow accelerations or pool impairment.
  • The Board increased the quarterly dividend to $0.07 per share for Q3 2015, from $0.06. It also authorized repurchases of up to 2 million shares; none were repurchased under the program in Q2.
  • The company received a $65 million New Markets Tax Credit allocation, bringing allocations received over five years to $183 million.
  • Contractual off-balance-sheet exposure included $1.028 billion of commitments to extend credit and $52.7 million of standby letters of credit. Management noted that commitments may expire undrawn and are unlikely to be funded in full simultaneously; the filing also identifies credit and liquidity risk associated with these commitments.
  • Key disclosed risks include borrower credit quality and real-estate collateral values, local and general economic conditions, interest-rate changes, competition, regulation, and litigation or other contingencies. Management said no pending or threatened legal proceeding was expected to have a material adverse effect. It reported effective disclosure controls and no material change in internal controls.
  • Interest-rate simulations estimated that a parallel +100 basis-point shock would increase next-12-month net interest income by 1.5%, while a −100 basis-point shock would reduce it by 1.3%. These are model estimates, not guidance.

Important facts for investors to verify

  • Review the composition, underwriting and performance of fast-growing commercial and specialized lending, and track delinquencies, classified assets, charge-offs and reserve adequacy.
  • Assess how much earnings depend on PCI accretion and FDIC loss-share accounting, including the sensitivity of expected cash flows and the remaining PCI yield.
  • Compare reported results with management’s non-GAAP “core” measures and review the reconciliations, particularly the impact of FDIC receivable changes and other excluded items.
  • Monitor net interest margin, deposit pricing and loan yields against management’s second-half margin commentary and expense outlook.
  • Evaluate the liquidity implications of credit commitments alongside available borrowing capacity, pledged securities and deposit growth.
  • Track regulatory capital after Basel III implementation and the use of capital for dividends and the authorized share-repurchase program.