Enterprise Financial Services Corp. — 2011 Form 10-K Summary
Business context and reporting period
Enterprise Financial Services Corp. is a bank holding company serving businesses and individuals in the St. Louis, Kansas City and Phoenix markets through banking and wealth-management businesses. This filing reports the year ended December 31, 2011, with restated 2010 comparisons. The 2011 financial statements received an unqualified audit opinion, but the auditor issued an adverse opinion on internal control over financial reporting.
Growth included FDIC-assisted acquisitions of Legacy Bank and First National Bank of Olathe, plus a BankLiberty branch and deposits. The company also raised $35.0 million in gross common-stock proceeds in May 2011, netting approximately $32.6 million.
Financial results and key metrics
| Metric | 2011 | 2010, restated |
|---|---|---|
| Net interest income | $112.7 million | $84.0 million |
| Noninterest income | $18.5 million | $18.4 million |
| Provision for loan losses | $16.1 million | $33.7 million |
| Noninterest expense | $77.7 million | $62.2 million |
| Net income | $25.4 million | $5.6 million |
| Net income available to common shareholders | $22.9 million | $3.1 million |
| Diluted EPS | $1.34 | $0.21 |
| Net interest margin, tax-equivalent | 4.12% | 3.76% |
| Efficiency ratio | 59.2% | 60.8% |
- Total assets rose 21% to $3.38 billion; total loans increased 16% to $2.20 billion. Non-covered loans grew 7%, while covered loans rose to $300.6 million, principally reflecting acquisitions.
- Deposits grew 21% to $2.79 billion. Core deposits reached 96% of deposits; noninterest-bearing demand deposits were 21% of total deposits, up from 16%.
- Loan quality improved on selected measures: nonperforming loans were $41.6 million, or 1.89% of total loans, versus $46.4 million, or 2.46%, in 2010. Net charge-offs were $19.2 million, compared with $34.0 million. The allowance was $39.6 million, or 1.80% of total loans, versus $42.8 million, or 2.26%.
- Cash from operations was $27.1 million. Investing activities provided $0.4 million; financing activities used $133.1 million. Cash and cash equivalents declined $105.5 million to $188.1 million.
- At year-end, shareholders’ equity was $239.6 million; subordinated debentures were $85.1 million, FHLB advances $102.0 million and other borrowings $154.5 million. The Bank was classified as well-capitalized; its Tier 1 risk-based capital ratio was 10.69% and leverage ratio 7.09%.
- Parent-company cash was $21.2 million. The Bank reported $139.4 million of additional FHLB borrowing availability, $379.6 million available from the Federal Reserve against pledged loans, and $35.0 million in unsecured federal-funds lines. These sources are subject to conditions and collateral requirements.
Material changes versus the prior comparable period
- Net income increased to $25.4 million from $5.6 million. Higher net interest income, lower loan-loss provision and acquisition-related growth contributed; noninterest expense also rose 25%, largely reflecting acquired operations and staffing.
- The tax-equivalent net interest margin expanded to 4.12% from 3.76%, helped by lower deposit costs and acquired FDIC-covered loans. Excluding covered loans, related non-earning assets and acquired deposits, the margin was 3.42%, below 3.53% in 2010.
- Non-covered commercial and industrial loans rose 29%; construction and residential real-estate loans declined. Nonperforming assets were $58.8 million, down from $72.6 million, while other real estate owned increased to $53.7 million from $36.2 million.
- The 2011 annual results include an estimated $6.8 million pretax earnings benefit from accelerated discount accretion on FDIC-covered loans, after related indemnification-asset offsets. The company recognized approximately $14.3 million of accelerated discount income, primarily due to prepayments.
- Fourth-quarter 2011 net income was $7.2 million and diluted EPS was $0.36, compared with $5.0 million and $0.29 in fourth-quarter 2010. Fourth-quarter 2011 noninterest income was $0.6 million and noninterest expense was $23.4 million.
Restatement, outlook, risks and unusual items
- Restatement and controls: The company discovered that it had recorded both accretable yield and contractual interest on certain acquired FDIC-covered loans; contractual interest should not have been recognized. This overstated interest income and loan carrying values. The 2010 restatement reduced net income from $9.1 million to $5.6 million and diluted EPS from $0.45 to $0.21; covered loans and total assets were each reduced by $5.1 million. The company also restated certain 2011 quarterly results. Management identified a material weakness in controls over acquired-loan accounting, concluded relevant controls were ineffective, and described remediation steps including new systems, reconciliations, added staff and external accounting support.
- Management outlook: Management expected 2012 non-covered loan growth similar to 2011, net interest margin of 4% or more, and quarterly noninterest expense averaging $20–$22 million. It expected similar net charge-offs and similar or lower additions to non-covered nonperforming loans, while noting continuing real-estate softness and volatility in covered-loan yields. These are forward-looking expectations, not guarantees.
- FDIC-covered assets: The FDIC generally shares 80% of covered losses under applicable agreements, subject to transaction-specific terms. Changes in expected collections affect both loan accretion and the FDIC loss-share receivable; management anticipated lower loss expectations could reduce or reverse accretion on that receivable.
- Litigation: Trust-related lawsuits involving Distinctive Properties notes sought damages exceeding $25 million in one case and approximately $800,000 in another; the company said it could not reasonably estimate potential losses. A securities class action filed in April 2012 alleged misstatements related to acquired-loan accounting; damages were unspecified and not estimable at filing.
- Other risks: Concentration in three regional markets and real-estate-secured lending, credit losses, liquidity and interest-rate exposure, acquisition integration, regulatory changes, and the identified control weakness. The company was late in filing this 10-K and said it was temporarily ineligible to use Form S-3, with eligibility not expected to return before April 2013 if future filings were timely.
- Common dividends were $0.21 per share for 2011. The company said it planned to retain most earnings to strengthen capital and support growth. Treasury Series A preferred stock carried cumulative dividends of 5% annually, payable ahead of common dividends.
Important facts for investors to verify
- Review Note 24 and the amended quarterly filings to understand the full restatement by period and the final accounting for acquired loans.
- Track remediation and independent testing of the acquired-loan accounting controls, and whether any further errors or restatements occur.
- Assess credit trends across covered and non-covered portfolios separately, including construction exposures, other real estate owned, charge-offs and allowance adequacy.
- Verify the sustainability of earnings excluding acquisition effects and accelerated covered-loan accretion, and monitor the FDIC loss-share receivable and its assumptions.
- Follow the Distinctive Notes and securities litigation, capital and liquidity levels, regulatory status, and progress toward regaining Form S-3 eligibility.