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EFSC > SEC Filings for EFSC > Form 10-K on 17-Mar-2014All Recent SEC Filings

Show all filings for ENTERPRISE FINANCIAL SERVICES CORP

Form 10-K for ENTERPRISE FINANCIAL SERVICES CORP


17-Mar-2014

Annual Report


ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction
The objective of this section is to provide an overview of the results of operations and financial condition of the Company for the three years ended December 31, 2013. It should be read in conjunction with the Consolidated Financial Statements, Notes and other financial data presented elsewhere in this report, particularly the information regarding the Company's business operations described in Item 1.

Executive Summary
This overview of management's discussion and analysis highlights selected information in this document and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting estimates, you should carefully read this entire document. Results and corresponding ratios for the years ended December 31, 2012 and 2011 have been reclassified to reflect the adoption of ASU 2014-1 "Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects." The impact of ASU 2014-1 was a decrease to Other Non-interest Expense and a similar increase to Income Tax Expense of $0.9 million for the years ended December 31, 2013, 2012 and 2011, respectively.

2013 Operating Results
For 2013, we reported net income of $33.1 million compared to net income of
$28.3 million in 2012. After deducting preferred stock dividends in 2012, net
income available to common shareholders was $33.1 million, or $1.73 per diluted
share in 2013, compared to net income available to common shareholders of $25.1
million, or $1.37 per diluted share in 2012.

Income before income tax expense on the Company's Core Bank and Covered assets
for the twelve months ended December 31, 2013, 2012 and 2011 were as follows:

                                        Twelve months ended December 31,
(In thousands)                            2013              2012        2011
Income before income tax expense
Core Bank                        $     34,621             $ 26,495    $ 18,936
Covered assets                         15,459               16,335      19,289
Total                            $     50,080             $ 42,830    $ 38,225

Income before income tax expense for the Core Bank represents results without direct income and expenses related to Covered assets, as well as an internal estimate of associated asset funding costs. Core Bank pre-tax income grew $8.1 million or 31% in 2013 as compared to 2012 fueled by solid commercial loan growth and declining credit costs. Income from our Covered assets remained relatively stable at $15.5 million, a modest decrease of 5% despite declining balances in our PCI loans. Declining balances in our PCI loans were primarily due to continued early pay-offs of our PCI loans. Income from Covered assets remained relatively stable due to lower charge-offs than generally anticipated.

2013 Significant Transactions
During 2013, we completed the following transactions:

On January 9, 2013, the Company repurchased the warrants issued to the U.S Treasury as part of the Capital Purchase Program for approximately $1.0 million. After completing the warrant repurchase the Company exited the Capital Purchase Program.


On May 16, 2013, the Company finalized its acquisition of Gorman & Gorman Home Loans. The Company anticipates the acquisition will strengthen its mortgage business. As part of the transaction Gorman and Gorman and legacy Enterprise mortgage operations were combined into a single division named Enterprise Home Loans.

On August 15, 2013, the Company converted $20.0 million, 9% coupon, trust preferred securities to shares of common stock. As a result of the transaction, the Company reduced its long-term debt by $20.0 million and issued an aggregate of 1.2 million shares of common stock. The Company issued 25,060 shares of additional common stock as inducement for the conversion, which resulted in a $0.4 million, one-time, non-cash expense being recorded.

On December 6, 2013, the Company completed the sale and closure of four of its branches in the Kansas City region. Two of the branches, as well as $7.6 million of loans and $78.4 million of deposits, as well as $1.5 million of other assets were sold to another financial institution. The Company recorded a pre-tax gain of approximately $1.0 million upon completion of the transaction primarily attributed to a premium on the deposits that were sold.

On December 30, 2013 the Company prepaid $30.0 million of debt with the FHLB with a weighted average interest rate of 4.09%, and a maturity of 3 years, and incurred a prepayment penalty of $2.6 million before taxes.

Below are highlights of our Banking and Wealth Management segments. For more information on our segments, see Item 8, Note 21 - Segment Reporting.

Banking Segment
Loans - Loans totaled $2.3 billion at December 31, 2013, including $140.5 million of purchase credit impaired ("PCI") loans (formerly referred to as Portfolio loans covered under FDIC loss share or Covered loans). Portfolio loans excluding PCI loans increased $31.3 million, or 1%, from December 31, 2012. Commercial & Industrial loans increased $78.7 million, or 8%, Consumer and other loans increased $23.9 million or 141%, Construction loans and Residential real estate loans decreased $30.9 million, or 10%, and Commercial Real Estate decreased $40.4 million, or 5%.

PCI loans decreased $60.6 million, or 30%, in 2013, due to loans that paid off, charged-off and principal paydowns. Based on the most recent remeasurement of expected cash flows, the Company expects the average balance of PCI loans to be approximately $108 million, $67 million, and $39 million in 2014, 2015, and 2016, respectively.
See Note 6 - Portfolio Loans and Note 7 - Purchase Credit Impaired Loans for more information.

                                                     December 31,
(in thousands)                                 2013                 2012
Commercial and Industrial               1,041,576     46 %     962,884     42 %
Commercial real estate - Investor Owned   437,688     19 %     486,467     21 %
Commercial real estate - Owner Occupied   341,631     15 %     333,242     14 %
Construction and land development         117,032      5 %     160,911      7 %
Residential real estate                   158,527      7 %     145,558      6 %
Consumer & other                           40,859      2 %      16,977      1 %
   Portfolio loans                      2,137,313     94 %   2,106,039     91 %
PCI loans                                 140,538      6 %     201,118      9 %
Total loans                             2,277,851    100 %   2,307,157    100 %


Deposits - Total deposits at December 31, 2013 were $2.5 billion, a decrease of $123.9 million, or 5%, from December 31, 2012 as the Company continued to experience run-off in its interest bearing deposits from lower cost pricing.

Non-interest bearing accounts decreased primarily due to the sale and closure of four branches in our Kansas City market.
Core deposits, which exclude brokered certificates of deposit and include reciprocal CDARS deposits, decreased $168.9 million, or 7%, for 2013 as compared to 2012. Interest bearing transaction accounts including money market accounts decreased $144.0 million, or 10%. Core deposits represented 94% of total deposits at December 31, 2013, compared to 96% at December 31, 2012. Due to the run-off in other deposit accounts brokered certificates of deposit increased to $139.5 million at December 31, 2013 compared to $94.5 million at December 31, 2012.
Asset quality - Nonperforming loans, including troubled debt restructurings, were $20.8 million at December 31, 2013, compared to $38.7 million at December 31, 2012. Nonperforming loans represented 0.98% of portfolio loans at December 31, 2013 versus 1.84% at December 31, 2012. Excluding non-accrual loans and PCI loans, there were $0.1 million of portfolio loans that were 30-89 days delinquent at December 31, 2013 as compared to $2.1 million at December 31, 2012.

Provision for portfolio loan losses was a benefit of $0.6 million in 2013, compared to $8.8 million in 2012. The decrease in the provision for loan losses in 2013 was due to lower net chargeoffs, lower levels of criticized loans due to less downgrade activity and lower levels of non-performing loans in 2013 as compared to 2012. See Note 6 - Portfolio Loans and Provision for Loan Losses and Allowance for Loan Losses in this section for more information.
Net Interest margin - The net interest margin (fully tax equivalent) was 4.78% for 2013, compared to 4.94% for 2012. See Net Interest Income in this section for more information.

PCI loans and other assets covered under FDIC shared loss agreements - The following table illustrates the net revenue contribution of covered assets for the most recent 3 fiscal years. This presentation excludes the cost of funding the related assets and the operating expenses to service the assets.

                                                           For the Years ended
(in thousands)                        December 31, 2013     December 31, 2012     December 31, 2011
Accretion income                     $          25,319     $          29,673     $          18,494
Accelerated cash flows                          20,318                25,230                14,294
Other                                              831                   758                   138
Total interest income                           46,468                55,661                32,926
Provision for loan losses                       (4,974 )             (14,033 )              (2,803 )
Gain on sale of other real estate                1,071                 2,081                   992
Change in FDIC loss share receivable           (18,173 )             (14,869 )              (3,494 )
Change in FDIC clawback liability                 (951 )                (575 )                   -
Pre-tax net revenue                  $          23,441     $          28,265     $          27,621

Net revenue from PCI loans was $23.4 million for the year ended December 31, 2013 a $4.8 million decrease from December 31, 2012. The decrease in net revenue was primarily due to lower accretion and accelerated cash flows from lower PCI loan balances, as well as a negative impact from the Change in the FDIC loss share receivable due to loan pay offs in which the losses on the loans were less than expected.


Wealth Management Segment
Fee income from the Wealth Management segment includes Wealth Management revenue and income from state tax credit brokerage activities. Wealth Management revenue was $7.1 million in 2013, a decrease of $0.2 million, or 2% over 2012. The slight decrease was due to the termination of several less profitable relationships during the year. See Noninterest Income in this section for more information.


RESULTS OF CONTINUING OPERATIONS ANALYSIS

Net Interest Income
Comparison of 2013 and 2012
Net interest income (on a tax equivalent basis) was $137.4 million for 2013 compared to $143.8 million for 2012, a decrease of $6.4 million, or 4%. Total interest income decreased $11.4 million and total interest expense decreased $5.0 million.

Average interest-earning assets decreased $33.8 million, or 1%, to $2.9 billion for the year ended December 31, 2013. Average loans increased $75.9 million, or 3%, to $2.3 billion for the year ended December 31, 2013 from $2.2 billion for the year ended December 31, 2012 primarily due to strong C&I origination in 2013. Average securities and short-term investments decreased $109.7 million, to $603.1 million from 2012 as core deposits declined and portfolio loan volume accelerated slightly. Interest income on earning assets decreased $13.1 million due to lower volumes and increased $1.7 million due to higher rates. The decrease in volume was primarily due to the continued pay-off of PCI loans, offset by higher yields on the remaining balance of related loans. Portfolio loans saw a $7.6 million increase in interest income due to volume, offset by an $8.7 million decrease in interest income due to rates.

For the year ended December 31, 2013, average interest-bearing liabilities decreased $103.5 million, or 4%, to $2.2 billion compared to $2.3 billion for the year ended December 31, 2012. The decrease in average interest-bearing liabilities resulted from a $190.3 million decrease in average interest-bearing deposits. This decrease resulted from a $96.7 million decline in certificates of deposits, $68.4 million decline in average money market accounts and savings accounts, and a decrease of $25.2 million in interest-bearing transaction accounts. The significant decrease in certificates of deposits and money market and saving accounts was due to the Company's continued initiative to lower its cost of funds as well as continued historically low rates deterring clients from deposit accounts. For the year ended December 31, 2013, interest expense on interest-bearing liabilities decreased $4.3 million due to declining rates and $0.8 million due to the impact of lower volumes, versus the same period in 2012.

For the year ended December 31, 2013, the tax-equivalent net interest margin was 4.78%, compared to 4.94% in the same period of 2012. The decrease in margin was primarily due to lower yields on newly originated portfolio loans, the pay-off of higher-yielding PCI loans lessening their impact on the overall margin, offset by reduced rates on interest-bearing liabilities due to continued low interest rates, as well as the conversion of $20 million of our trust preferred securities with a 9% coupon rate to common equity.

The Core net interest margin, defined as Net interest margin (fully tax equivalent), including contractual interest on PCI loans, but excluding the incremental accretion on these loans, for the years ended December 31, 2013 and 2012 is as follows:

Twelve months ended December 31, 2013 2012 Core net interest margin 3.55 % 3.57 %

The Core net interest margin decline in 2013 from 2012 was due to lower loan yields partially offset by an improved earning asset mix and lower deposit and overall funding costs. The Company believes the Core net interest margin is an important measure of our financial performance even though it is a non-GAAP measure. Included in this MD&A under the caption "Use of Non-GAAP Financial Measures" is a reconciliation of net interest margin to Core net interest margin. The Average Balance Sheet and Rate/Volume sections following contain additional information regarding our net interest income.


Comparison of 2012 and 2011
Net interest income (on a tax equivalent basis) was $143.8 million for 2012 compared to $114.0 million for 2011, an increase of $29.8 million, or 26%. Total interest income increased $22.8 million and total interest expense decreased $7.0 million.

Average interest-earning assets increased $143.3 million, or 5%, to $2.9 billion for the year ended December 31, 2012 from $2.8 billion for the year ended December 31, 2011. Average loans increased $144.9 million, or 7%, to $2.2 billion for the year ended December 31, 2012 from $2.1 billion for the year ended December 31, 2011. Average securities and short-term investments remained relatively flat decreasing only $1.6 million, to $712.7 million from 2011 as core deposit growth was consistent with loan demand. Interest income on earning assets increased $10.9 million due to higher volumes and $11.9 million due primarily to higher yields on PCI loans during 2012 for a total increase of $22.8 million in interest income from 2011.

For the year ended December 31, 2012, average interest-bearing liabilities decreased $36.4 million, or 2%, to $2.3 billion compared to $2.4 billion for the year ended December 31, 2011. The decrease in average interest-bearing liabilities resulted from a $54.5 million decrease in average interest-bearing deposits. This decrease resulted from a decrease of $171.8 million in certificates of deposits, which was partially offset by a $72.4 million increase in average money market accounts and savings accounts, and an increase of $44.9 million in interest-bearing transaction accounts. The significant decrease in certificates of deposits was due to an initiative by the Company to lower its cost of funds. For the year ended December 31, 2012, interest expense on interest-bearing liabilities decreased $5.4 million due to declining rates and $1.6 million due to the impact of lower volumes, for a total decrease of $7.0 million versus the same period in 2011.

For the year ended December 31, 2012, the tax-equivalent net interest rate margin was 4.94%, compared to 4.12% in the same period of 2011. The increase in the margin was primarily due to better earning asset mix, higher yields on Covered assets, and lower funding costs. For the year ended December 31, 2012, the Core net interest margin increased to 3.57% as compared to 3.49% for 2011 due to improvement in our earning asset mix and lower funding costs. These factors were partially offset by declines in our earning asset yields. The Core net interest margin includes the contractual interest on PCI loans, but excludes the incremental accretion income on these loans. The Company believes the Core net interest margin is an important measure of our financial performance even though it is a non-GAAP measure. Included in this MD&A is a reconciliation of net interest margin to Core net interest margin. The Average Balance Sheet and Rate/ Volume sections following contain additional information regarding our net interest income.

The Core net interest margin, defined as Net interest margin (fully tax equivalent), including contractual interest on PCI loans, but excluding the incremental accretion on these loans, for the years ended December 31, 2012 and 2011 is as follows:

Twelve months ended December 31, 2012 2011 Core net interest margin 3.57 % 3.49 %


Average Balance Sheet
The following table presents, for the periods indicated, certain information
related to our average interest-earning assets and interest-bearing liabilities,
as well as, the corresponding interest rates earned and paid, all on a tax
equivalent basis.

                                                                                                For the years ended December 31,
                                                        2013                                                  2012                                                  2011
                                                                            Average                                               Average                                               Average
                                                           Interest         Yield/                               Interest         Yield/                               Interest         Yield/
(in thousands)                    Average Balance       Income/Expense       Rate       Average Balance       Income/Expense       Rate       Average Balance       Income/Expense       Rate
Assets
Interest-earning assets:
Taxable portfolio loans (1)      $      2,058,086     $         94,428        4.59 %   $      1,918,567     $         96,694        5.04 %   $      1,786,601     $         95,520        5.35 %
Tax-exempt portfolio loans (2)             45,932                3,738        8.14               34,860                2,580        7.40               32,935                2,542        7.72
Purchase credit impaired loans
(3)                                       168,662               46,468       27.55              243,359               55,661       22.87              232,363               32,926       14.17
                     Total loans        2,272,680              144,634        6.36            2,196,786              154,935        7.05            2,051,899              130,988        6.38
Taxable investments in debt and
equity securities                         462,015                8,689        1.88              568,264               10,192        1.79              473,620               11,510        2.43
Non-taxable investments in debt
and equity securities (2)                  44,158                1,979        4.48               34,432                1,577        4.58               22,434                1,086        4.84
Short-term investments                     96,912                  210        0.22              110,050                  257        0.23              218,287                  562        0.26
 Total securities and short-term
                     investments          603,085               10,878        1.80              712,746               12,026        1.69              714,341               13,158        1.84
   Total interest-earning assets        2,875,765              155,512        5.41            2,909,532              166,961        5.74            2,766,240              144,146        5.21
Noninterest-earning assets:
Cash and due from banks                    17,315                                                16,311                                                15,801
Other assets                              276,443                                               345,325                                               357,993
Allowance for loan losses                 (42,986 )                                             (40,240 )                                             (43,887 )
                    Total assets $      3,126,537                                      $      3,230,928                                      $      3,096,147

Liabilities and Shareholders'
Equity
Interest-bearing liabilities:
Interest-bearing transaction
accounts                         $        232,010     $            461        0.20 %   $        257,193     $            721        0.28 %   $        212,257     $            811        0.38 %
Money market accounts                     939,857                3,080        0.33            1,026,444                4,679        0.46              997,415                7,987        0.80
Savings                                    88,633                  225        0.25               70,470                  275        0.39               27,106                  112        0.41
Certificates of deposit                   578,562                7,376        1.27              675,224                9,731        1.44              847,057               12,748        1.50
 Total interest-bearing deposits        1,839,062               11,142        0.61            2,029,331               15,406        0.76            2,083,835               21,658        1.04
Subordinated debentures                    76,297                3,019        3.96               85,081                4,082        4.80               85,081                4,515        5.31
Borrowed funds                            321,752                3,976        1.24              226,200                3,679        1.63              208,128                3,982        1.91
          Total interest-bearing
                     liabilities        2,237,111               18,137        0.81            2,340,612               23,167        0.99            2,377,044               30,155        1.27
Noninterest bearing liabilities:
Demand deposits                           614,413                                               627,197                                               494,609
Other liabilities                          15,907                                                10,655                                                10,844
               Total liabilities        2,867,431                                             2,978,464                                             2,882,497
Shareholders' equity                      259,106                                               252,464                                               213,650
             Total liabilities &
            shareholders' equity $      3,126,537                                      $      3,230,928                                      $      3,096,147
             Net interest income                      $        137,375                                      $        143,794                                      $        113,991
             Net interest spread                                              4.60 %                                                4.75 %                                                3.94 %
    Net interest rate margin (4)                                              4.78 %                                                4.94 %                                                4.12 %

(1) Average balances include non-accrual loans. Loan fees, net of amortization of deferred loan origination fees and costs, included in interest income are approximately $1.5 million, $1.5 million, and $1.0 million for the years ended December 31, 2013, 2012, and 2011 respectively.


(2) Non-taxable income is presented on a fully tax-equivalent basis using a 39% tax rate in 2013 and 36% tax rate in 2012 and 2011. The tax-equivalent adjustments were $2.2 million, $1.5 million, and $1.3 million for the years ended December 31, 2013, 2012, and 2011 respectively.

(3) Purchase credit impaired loans are loans acquired as part of our acquisitions of Valley Capital, Home National, Legacy, and/or FNBO.

(4) Net interest income divided by average total interest-earning assets.

Rate/Volume
The following table sets forth, on a tax-equivalent basis for the periods
indicated, a summary of the changes in interest income and interest expense
resulting from changes in yield/rates and volume.

                                     2013 compared to 2012                    2012 compared to 2011
                                   Increase (decrease) due to              Increase (decrease) due to
(in thousands)                Volume(1)     Rate(2)         Net        Volume(1)     Rate(2)        Net
Interest earned on:
Taxable portfolio loans      $   6,749     $ (9,015 )   $  (2,266 )   $   6,828     $ (5,654 )   $  1,174
Tax-exempt portfolio loans
(3)                                881          277         1,158           145         (107 )         38
Purchase credit impaired
loans                          (19,182 )      9,989        (9,193 )       1,626       21,109       22,735
Taxable investments in debt
and equity securities           (1,979 )        476        (1,503 )       2,039       (3,357 )     (1,318 )
Non-taxable investments in
debt and equity securities
(3)                                437          (35 )         402           553          (62 )        491
Short-term investments             (29 )        (18 )         (47 )        (257 )        (48 )       (305 )
Total interest-earning
assets                       $ (13,123 )   $  1,674     $ (11,449 )   $  10,934     $ 11,881     $ 22,815

Interest paid on:
Interest-bearing transaction
accounts                     $     (66 )   $   (194 )   $    (260 )   $     152     $   (242 )   $    (90 )
Money market accounts             (369 )     (1,230 )      (1,599 )         226       (3,534 )     (3,308 )
Savings                             60         (110 )         (50 )         169           (6 )        163
. . .
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