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EBTC > SEC Filings for EBTC > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for ENTERPRISE BANCORP INC /MA/

Form 10-Q for ENTERPRISE BANCORP INC /MA/


9-Nov-2012

Quarterly Report


Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's discussion and analysis should be read in conjunction with the Company's (also referred to herein as "Enterprise," "us," "we" or "our") consolidated financial statements and notes thereto contained in this report and the Company's 2011 Annual Report on Form 10-K.

Accounting Policies/Critical Accounting Estimates

As discussed in the Company's 2011 Annual Report on Form 10-K, the three most significant areas in which management applies critical assumptions and estimates that are particularly susceptible to change relate to the determination of the allowance for loan losses, impairment review of investment securities and the impairment review of goodwill. The Company has not changed its significant accounting and reporting policies from those disclosed in its 2011 Annual Report on Form 10-K.

Special Note Regarding Forward-Looking Statements

This report contains certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, including statements concerning plans, objectives, future events or performance and assumptions and other statements that are other than statements of historical fact. Forward-looking statements may be identified by reference to a future period or periods or by use of forward-looking terminology such as "anticipates," "believes," "expects," "intends," "may," "plans," "pursue," "views" and similar terms or expressions. Various statements contained in Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 3 - "Quantitative and Qualitative Disclosures About Market Risk," including, but not limited to, statements related to management's views on the banking environment and the economy, competition and market expansion opportunities, the interest rate environment, credit risk and the level of future non-performing assets and charge-offs, potential asset and deposit growth, future non-interest expenditures and non-interest income growth, and borrowing capacity are forward-looking statements. The Company wishes to caution readers that such forward-looking statements reflect numerous assumptions and involve a number of risks and uncertainties that may adversely affect the Company's future results. The following important factors, among others, could cause the Company's results for subsequent periods to differ materially from those expressed in any forward-looking statement made herein: (i) changes in interest rates could negatively impact net interest income; (ii) changes in the business cycle and downturns in the local, regional or national economies, including deterioration in the local real estate market, could negatively impact credit and/or asset quality and result in credit losses and increases in the Company's allowance for loan losses; (iii) changes in consumer spending could negatively impact the Company's credit quality and financial results; (iv) increasing competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services could adversely affect the Company's competitive position within its market area and reduce demand for the Company's products and services; (v) deterioration of securities markets could adversely affect the value or credit quality of the Company's assets and the availability of funding sources necessary to meet the Company's liquidity needs; (vi) changes in technology could adversely impact the Company's operations and increase technology-related expenditures; (vii) increases in employee compensation and benefit expenses could adversely affect the Company's financial results; (viii) changes in laws and regulations that apply to the Company's business and operations, including without limitation, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), the Jumpstart Our Business Startups Act (the "JOBS Act"), the notice of proposed rulemaking regarding Basel III and the additional regulations that will be forthcoming as a result thereof, could adversely affect the Company's business environment, operations and financial results; (ix) changes in accounting standards, policies and practices, as may be adopted or established by the regulatory agencies, the Financial Accounting Standards Board (the "FASB") or the Public Company Accounting Oversight Board could negatively impact the Company's financial results; (x) our ability to enter new markets successfully and capitalize on growth opportunities; (xi) future regulatory compliance costs, including any increase caused by new regulations imposed by the Consumer Finance Protection Bureau; and (xii) some or all of the risks and uncertainties described in Item 1A of the Company's 2011 Annual Report on Form 10-K could be realized, which could have a material adverse effect on the Company's business, financial condition and results of operation. Therefore, the Company cautions readers not to place undue reliance on any such forward-looking information and statements.

Overview

Executive Summary

Net income amounted to $3.1 million for the quarter ended September 30, 2012, an increase of $126 thousand, or 4%, over the same period in the prior year. Diluted earnings per share were $0.32 for the three months ended September 30, 2012, an increase of $0.01, or 3%, over the same period in the prior year. Net income for the nine months ended September 30, 2012


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amounted to $9.1 million, representing an increase of $1.1 million, or 13%, compared to the same nine month period in 2011. Diluted earnings per share were $0.95 for the nine months ended September 30, 2012, an increase of $0.09, or 10% compared to the same period in the prior year.

The Company's growth contributed to increases in net interest income and the level of operating expenses for both the quarter and the year-to-date periods ended September 30, 2012. In 2012, the provision for loan losses decreased compared to the 2011 periods, while non-interest income decreased mainly due to lower gains on security sales in the current year. The increases in both the quarter and year-to-date pre-tax net income were partially offset by a higher tax rate in 2012, mainly due to higher taxable income in the current year.

Strong 2012 financial results to date reflect our continued growth. Deposits and loans outstanding have increased by $137.3 million, or 10%, and $53.6 million, or 4%, respectively, since December 31, 2011, which are annualized growth rates of 14% and 6%, respectively. During the quarter ended September 30, 2012, deposits increased $16.8 million and loans outstanding increased $11.6 million. Total assets amounted to $1.64 billion, which represented an increase of $148.4 million, or 10%, since December 31, 2011, and $22.5 million, or 1% since June 30, 2012. Additionally, investment assets under management increased $73.8 million, or 15%, since December 31, 2011, and $26.6 million, or 5%, since June 30, 2012, to $578.9 million at September 30, 2012.

Composition of Earnings

The Company's earnings are largely dependent on its net interest income, which is the difference between interest earned on loans and investments and the cost of funding (primarily deposits and borrowings). Net interest income expressed as a percentage of average interest earning assets is referred to as net interest margin. The Company reports net interest margin on a tax equivalent basis ("margin"). The re-pricing frequency of the Company's assets and liabilities are not identical, and therefore subject the Company to the risk of adverse changes in interest rates. This is often referred to as "interest rate risk" and is reviewed in more detail in Item 3, "Quantitative and Qualitative Disclosures About Market Risk," of this Form 10-Q.

Net interest income for the quarter ended September 30, 2012 amounted to $15.6 million, an increase of $909 thousand, or 6%, compared to the September 2011 quarter. Net interest income for the nine months ended September 30, 2012 amounted to $46.0 million, an increase of $3.0 million, or 7%, compared to the same period in 2011. The increase in net interest income was due primarily to revenue generated from loan growth which has been funded through non-interest bearing deposits, partially offset by a decrease in margin. For the three and nine months ended September 30, 2012, average loan balances increased $84.3 million and $95.7 million, respectively, compared to the three and nine month averages in 2011. The margin was 4.20% for the quarter ended September 30, 2012 compared to 4.32% for the quarter ended September 30, 2011. The margin was 4.31% for the quarter ended June 30, 2012. Year-to-date margins were 4.29% and 4.36% for the nine months ended September 30, 2012 and 2011, respectively. Consistent with industry trends, the 2012 margin continues to trend downward, as the yield on interest earning assets has declined faster than the rate on cost of funds, which is approaching a floor.

The provision for loan losses amounted to $800 thousand for the three months ended September 30, 2012 compared to $1.8 million for the same period in 2011. For the nine months ended September 30, 2012 and 2011, the provision for loan losses amounted to $2.2 million and $4.0 million, respectively. The decrease in the provision reflects modest credit stabilization within the loan portfolio compared to the 2011 periods. In making the provision to the allowance for loan losses, management takes into consideration the level of loan growth, adversely classified and non-performing loans, specific reserves for impaired loans, net charge-offs, and the estimated impact of current economic conditions on credit quality. The level of loan growth for the nine months ended September 30, 2012 was $53.6 million, compared to $86.2 million during the same period in 2011. The balance of the allowance for loan losses allocated to impaired loans amounted to $4.3 million at September 30, 2012, compared to $4.1 million at September 30, 2011. Total non-performing assets as a percentage of total assets were 1.50% at September 30, 2012, compared to 1.81% at September 30, 2011. For the year-to-date period ended September 30, 2012, the Company recorded net charge-offs of $1.4 million, the majority of which had reserves specifically allocated in prior periods. For the same period in 2011, net charge-offs were $800 thousand. Management continues to closely monitor the non-performing assets, charge-offs and necessary allowance levels, including specific reserves. The allowance for loan losses to total loans ratio was 1.84% at September 30, 2012, compared to 1.85% at December 31, 2011 and 1.84% at September 30, 2011.

For further information regarding loan quality statistics and the allowance for loan losses, see the sections below under the heading "Financial Condition" titled "Asset Quality" and "Allowance for Loan Losses."


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Non-interest income for the three months ended September 30, 2012 amounted to $3.0 million, a decrease of $225 thousand, or 7%, compared to the third quarter of 2011. Non-interest income for the nine months ended September 30, 2012 amounted to $8.9 million a decrease of $80 thousand, or 1%, compared to the 2011 year-to-date period. A decrease in gains on securities sales impacted both the quarter and year-to-date results, partially offset by an increase in gains on loan sales and higher "other income" in the current year. The increase in other income is primarily due to increases in insurance commissions in both the quarter and year-to-date periods.

Non-interest expense for the three months ended September 30, 2012 amounted to $13.0 million, an increase of $1.2 million, or 10%, compared to the same period in the prior year. For the nine months ended September 30, 2012, non-interest expense amounted to $38.8 million, an increase of $2.7 million, or 7%, compared to the same period in the prior year. Increases in salaries and benefits and technology expenses from the Company's strategic growth initiatives including branch growth, impacted both the quarter and the year-to-date periods. The year-to-date expenses were also impacted primarily by increases in legal and other professional services and occupancy expenses, partially offset by a reduction in FDIC insurance expenses.

Sources and Uses of Funds

The Company's primary sources of funds are deposits, Federal Home Loan Bank ("FHLB") borrowings, current earnings and proceeds from the sales, maturities and pay-downs on loans and investment securities. The Company may also from time to time utilize brokered deposits and overnight borrowings from correspondent banks as additional funding sources. These funds are used to originate loans, purchase investment securities, conduct operations, expand the branch network, and pay dividends to shareholders.

Total assets amounted to $1.64 billion at September 30, 2012, increases of $148.4 million, or 10%, since December 31, 2011 and $22.5 million, or 1%, since June 30, 2012. The Company's core asset strategy is to grow loans, primarily high quality commercial loans. Total loans increased $53.6 million, or 4%, since December 31, 2011 and amounted to $1.30 billion, or 80% of total assets, at September 30, 2012. Since June 30, 2012, total loans have increased $11.6 million, or 1%. Total commercial loans amounted to $1.13 billion, or 86% of gross loans, which was consistent with the composition at December 31, 2011.

The investment portfolio is the other key component of earning assets and is primarily used to invest excess funds, provide liquidity and to manage the Company's asset-liability position. Total investments increased $51.3 million since December 31, 2011 and amounted to $191.7 million at September 30, 2012, representing 12% of total assets, compared to 9% at December 31, 2011.

Since December 31, 2011, cash and cash equivalents have increased $43.1 million, primarily due to deposit growth exceeding loan and investment growth.

Management's preferred strategy for funding asset growth is to grow low cost deposits (comprised of demand deposit accounts, interest and business checking accounts and traditional savings accounts). Asset growth in excess of low cost deposits is typically funded through higher cost deposits (comprised of money market accounts, commercial tiered rate savings or "investment savings" accounts and certificates of deposit), wholesale funding (brokered deposits and borrowed funds), and investment portfolio cash flow.

At September 30, 2012, deposits amounted to $1.47 billion, an increase of $137.3 million, or 10%, from December 31, 2011 balances and $16.8 million, or 1%, since June 30, 2012. This increase since December 31, 2011 was primarily due to increases in checking account balances of $90.2 million, or 19%, specifically non-interest bearing accounts, and savings and money market account balances of $69.7 million, or 12%, partially offset by a decrease of $22.7 million in CDs. Management believes that the deposit growth is primarily attributed to a general inflow of funds into the deposit marketplace due to economic uncertainties and low returns on other investment options available to deposit customers, as well as customers seeking an alternative to larger regional and national banks.

Wholesale funding remained at low levels and amounted to $3.0 million at September 30, 2012, compared to $4.5 million at December 31, 2011. At both September 30, 2012 and December 31, 2011, wholesale funding was comprised of FHLB term borrowings.

Opportunities and Risks

While the current economic environment continues to present significant challenges for all companies, management also


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believes that it has created opportunities for growth and customer acquisition. Strategically, our focus remains on organic growth and market expansion, while planning for our future by investing in our branch network, technology, progressive product capabilities, our communities and most importantly, in our people.

The Company's ability to achieve its long-term growth and market share objectives will depend upon the Company's continued success in differentiating itself in the market place. We believe that the Company has built a reputation within its market area based on consistently superior customer service and support for the local communities, differentiating itself through its people, who function as trusted advisors to clients. The Company's professionals are committed to upholding the Company's core values, including significant community involvement, which has led to a strong network with local business and community leaders. Management believes the Enterprise business model of providing a full range of diversified financial products, services and the latest technology, creates opportunities for the Company to be the leading provider of banking and investment advisory and wealth management services in its growing market area. These services are delivered by experienced local banking professionals who possess strong technical skills, have developed in-depth knowledge of our markets and have earned a trusted reputation within the community.

Enterprise faces strong competition to generate loans, attract deposits, and to grow its insurance business and investment advisory assets. National and larger regional banks have a local presence in the Company's market area. These established larger banks, as well as recent larger entrants into the local market area, have certain competitive advantages, including the ability to make larger loans to a single borrower than is possible for the Company, and greater financial resources. Numerous local savings banks, commercial banks, cooperative banks and credit unions also compete in the Company's market area. The expanded commercial lending capabilities of credit unions and the shift to commercial lending by traditional savings banks allow them to compete for the Company's targeted commercial customers. In addition, the non-taxable status of credit unions allows them certain advantages as compared to taxable institutions such as Enterprise. Competition for loans, deposit and cash management services, investment advisory assets, and insurance services also comes from other businesses that provide financial services, including consumer finance companies, mortgage brokers, private lenders, insurance companies, securities brokerage firms, institutional mutual funds, registered investment advisors, non-bank electronic delivery channels and internet based banks.

Notwithstanding the competition discussed above, management believes that customers continue to migrate from larger, national and regional banks to local, stable community banks, choosing to do business with local professional bankers who can offer them the flexibility, responsiveness and personalized service that a community bank such as Enterprise provides. Management views the Company's customer service culture, investments in the communities we serve, and diverse financial product offerings and delivery channels as key elements in positioning Enterprise to take advantage of these market opportunities created by the current challenging banking landscape.

The Company also seeks to increase deposit share, through continuous reviews of deposit product offerings and delivery options with targeted marketing strategies, including its online banking and mobile delivery capabilities. In addition, Enterprise carefully plans expansion into neighboring markets and new branch development. In February 2012, the Company opened its 19th branch office in the town of Pelham, New Hampshire. The Company has also obtained the necessary regulatory approvals for its new branches in Tyngsboro and Lawrence, Massachusetts. The Tyngsboro office will open in November 2012 and the Lawrence office is expected to open in the first quarter of 2013.

Management believes that Enterprise is also well equipped to capitalize on market potential to grow both the commercial and residential loan portfolios through strong business development efforts, while utilizing a disciplined and consistent lending approach and credit review practices, which have served to provide quality asset growth over varying economic cycles during the Company's twenty-three year history. The Company has a skilled lending sales force with a broad breadth of business knowledge and depth of lending experience to draw upon, supported by a highly qualified and experienced commercial credit review function.

Management continues to undertake significant strategic initiatives, including investments in employee training and development, marketing and public relations, technology and electronic product delivery, branch expansion and ongoing improvements and renovations to existing customer service locations and operations facilities. The current industry consolidation also provides management the opportunity to recruit experienced banking professionals with market knowledge who compliment the Enterprise sales and service culture. While management recognizes that such investments increase expenses in the short-term, Enterprise believes that such initiatives are an investment in the long-term growth and earnings of the Company and are reflective of the opportunities in the current marketplace for community banks such as Enterprise.

Any possible deterioration of the current economic environment could weaken the local New England economy and have adverse repercussions on local industries leading to increased unemployment and foreclosures, further deterioration of local


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commercial real estate values, or other unforeseen consequences, which could have a severe negative impact on the Company's financial condition, capital position, liquidity, and performance. In addition, the loan portfolio consists primarily of commercial real estate, commercial and industrial, and construction loans. These types of loans are typically larger and are generally viewed as having more risk of default than owner occupied residential real estate loans or consumer loans. The underlying commercial real estate values, customer cash flow and payment expectations and, in the case of commercial construction loans, the actual costs necessary to complete a construction project, can be more easily influenced by adverse conditions in the local or national economy, the real estate market, or the related industries. Any significant deterioration in the commercial loan portfolio or underlying collateral values due to a continuation or worsening of the current economic environment could have a material adverse effect on the Company's financial condition and results of operations. The risk of loss due to customers' non-payment of loans or lines of credit is called "credit risk." Credit risk management is reviewed below in this Item 2 under the headings "Credit Risk," "Asset Quality" and "Allowance for Loan Losses."

The value of the investment portfolio as a whole, or individual securities held, including restricted FHLB capital stock, could be negatively impacted by any renewed volatility in the financial markets or in credit markets, which could possibly result in the recognition of additional other-than-temporary-impairment ("OTTI") charges in the future.

The re-pricing frequency of interest earning assets and liabilities are not identical, and therefore subject the Company to the risk of adverse changes in interest rates. This is often referred to as "interest rate risk" and is reviewed in more detail under the heading Item 3, "Quantitative and Qualitative Disclosures About Market Risk," below.

Liquidity management is the coordination of activities so that cash needs are anticipated and met, readily and efficiently. Liquidity management is reviewed further below in this Item 2 under the heading "Liquidity."

Federal banking agencies require the Company and the Bank to meet minimum capital requirements. At September 30, 2012, the Company was categorized as "well capitalized"; however future unanticipated charges against capital could impact that regulatory capital designation. Moreover, in June 2012, U.S. banking regulators released notices of proposed rulemaking that would revise and replace the agencies' current regulatory capital requirements to align with the Basel III international capital standards and to implement certain changes required by the Dodd-Frank Act. The proposal is generally expected to require all U.S. banking organizations, including community banks, such as Enterprise Bank, to hold higher amounts of capital, especially common equity, against their risk-weighted assets.

For information regarding the capital requirements applicable to the Company and the Bank and their respective capital levels at September 30, 2012, and the recently released notices of proposed rule making see the section entitled "Capital Resources" contained in this Item 2 below.

In addition, any further changes in government regulation or oversight, including the implementation by the federal regulatory agencies of the various requirements contained in the Dodd-Frank Act and the proposed rules under Basel III could affect the Company in substantial and unpredictable ways, including, but not limited to, subjecting the Company to additional operating, governance and compliance costs, additional capital requirements, or potential loss of revenue due to the impact of an enhanced regulatory structure on the banking industry. Although several significant aspects of the Dodd-Frank Act expressly apply only to larger, "systemically significant" institutions, they may have the potential to influence the Company's business decisions, while other parts of the legislation apply either directly, or potentially indirectly, to activities of community banks, such as Enterprise.

The full extent of the regulatory impact resulting from the Dodd-Frank Act is still not known, as the various federal regulatory agencies continue to implement new regulations and the Government Accounting Office and other federal agencies continue to complete their studies regarding various financial services industry issues that were raised during the legislative process.

Additionally, certain provisions of the Dodd-Frank Act impact FDIC deposit insurance rates and assessment methodology. For further information see the discussion under the heading "FDIC Deposit Insurance Assessment" below.

Management has processes in place for the monitoring and management of compliance risk. Compliance risk includes the threat of fines, civil money penalties, lawsuits and restricted growth opportunities resulting from violations and/or non-conformance with laws, rules, regulations, prescribed practices, internal policies and procedures, or ethical standards.

The Company maintains a Compliance Management Program (CMP) designed to meet regulatory and legislative requirements. The CMP provides for tracking and implementing regulatory changes, monitoring the effectiveness of policies and procedures, conducting compliance risk assessments, and educating employees in matters relating to regulatory compliance. The Audit Committee of the Board of Directors oversees the effectiveness of the CMP.


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Operational risk includes the threat of loss from inadequate or failed internal processes, people, systems or external events, due to, among other things: fraud or error; the inability to deliver products or services; failure to maintain a competitive position; lack of information or physical security; or violations of . . .

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