Enterprise Financial Services Corp. — Q3 2012 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 filing covers the quarter and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods unless stated otherwise. Balance-sheet comparisons are with December 31, 2011.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net interest income | $37.5 million | $26.8 million | $102.2 million | $80.5 million |
| Provision for loan losses | $11.9 million | $8.1 million | $16.2 million | $16.2 million |
| Noninterest income | $7.8 million | $8.7 million | $12.7 million | $17.9 million |
| Noninterest expense | $21.3 million | $18.3 million | $64.1 million | $54.3 million |
| Net income | $7.9 million | $5.8 million | $22.9 million | $18.2 million |
| Diluted EPS | $0.39 | $0.29 | $1.14 | $0.98 |
- Margins and profitability: Tax-equivalent net interest margin was 5.21% in Q3, versus 3.79% a year earlier; the nine-month margin was 4.79%, versus 4.04%. Management attributed much of the improvement to unusually strong yields on FDIC-covered loans, including cash flows from loan payoffs above expectations. Q3 efficiency ratio was 47.0%, compared with 51.6% a year earlier; the year-to-date ratio was 55.8%, versus 55.2%.
- Balance sheet: Total assets were $3.19 billion, down from $3.38 billion at year-end 2011. Deposits were $2.55 billion, down 9%; portfolio loans were approximately $2.21 billion, broadly flat. Noncovered loans grew $90.1 million, or 5%, while covered loans declined to $221.4 million.
- Credit quality: Nonperforming noncovered loans fell to $32.1 million (1.61% of noncovered loans) from $41.6 million at year-end 2011 and $48.0 million a year earlier. Noncovered allowance was $34.2 million, or 1.72% of noncovered loans, and 107% of nonperforming loans. Q3 noncovered net charge-offs were $3.1 million, an annualized 0.64% of average loans. Covered-loan provision was $10.9 million in Q3, up from $2.7 million, reflecting higher estimated losses and deterioration in certain pools.
- Cash flow: For the first nine months, operating activities provided $37.9 million and investing activities provided $86.0 million; financing activities used $226.4 million. Cash and cash equivalents declined $102.5 million to $85.7 million. Financing outflows primarily reflected deposit reductions, partly offset by net FHLB borrowing.
- Debt, liquidity and capital: Balance-sheet borrowings comprised $85.1 million subordinated debentures, $126.0 million FHLB advances and $147.1 million other borrowings. The Bank reported $114.3 million of additional FHLB capacity, $637.8 million available from the Federal Reserve against pledged loans, and $45.0 million of correspondent-bank federal-funds lines. Company Tier 1 and total risk-based capital ratios were 12.75% and 14.12%; tangible common equity to tangible assets was 6.19%. The Company said it met applicable capital requirements and was well capitalized.
Changes, outlook and key risks
- Q3 net income increased year over year as net interest income rose 40%, helped by higher covered-loan income and lower funding costs. Noninterest income fell 10%, while noninterest expense increased 16%, including higher compensation, legal and professional, marketing and deferred-compensation costs.
- Nine-month noninterest income declined 29%, in part because of lower FDIC-receivable-related income and state tax-credit gains. The FDIC loss-share receivable declined from $184.6 million at year-end to $75.9 million; timing of covered-asset cash flows and revised loss expectations can materially affect results.
- Management expected FY2012 noncovered loan growth of 6%–8%; Q4 net interest margin above 4%; Q4 noncovered loan-loss provision of approximately $2–$4 million; and Q4 noninterest expense of $20–$22 million. Management also anticipated up to $8 million of Q4 noncovered net charge-offs under its accelerated problem-asset resolution strategy. It expected continued volatility in covered-loan yields and a Q4 covered-loan yield of approximately 13%–15%, excluding prepayment effects.
- The Company expected $4–$6 million of negative Q4 accretion on the FDIC loss-share receivable absent remeasurement or accelerated cash flows. Management said it did not expect to enter the unreimbursed second loss tranche of the FNB loss-share agreement in the next 12 months.
- The Company had regulatory approval to redeem all or part of the $35 million of U.S. Treasury preferred stock and anticipated completing the redemption in Q4 2012. A proposed Basel III framework could raise capital requirements and phase out trust-preferred securities from Tier 1 capital; final effects were not yet determinable.
- Contingencies and risks: The Company disclosed two lawsuits related to Distinctive Notes, including a claim seeking damages exceeding $44 million plus potential treble damages, and a putative securities class action alleging improper accounting for FDIC-covered loans. The Company denied the allegations and said it could not reasonably estimate potential losses. Other risks include credit and real-estate valuation, local economic conditions, interest-rate changes, regulation and litigation outcomes.
Important facts for investors to verify
- Whether covered-loan cash flows, loss estimates and FDIC reimbursements support the unusually high reported margin and the expected future accretion.
- Developments in the Distinctive Notes cases and securities class action, including any change in the Company’s inability to estimate potential loss.
- Progress in reducing nonperforming assets and the effect of the accelerated resolution strategy on charge-offs and provisions.
- Deposit trends, liquidity usage and the effect of preferred-stock redemption on capital ratios and the stated capital plan.
- Actual Q4 results against management’s margin, provision, expense, charge-off and loan-growth expectations.