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EFSC > SEC Filings for EFSC > Form 10-Q on 2-May-2014All Recent SEC Filings

Show all filings for ENTERPRISE FINANCIAL SERVICES CORP

Form 10-Q for ENTERPRISE FINANCIAL SERVICES CORP


2-May-2014

Quarterly Report


ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Some of the information in this report contains "forward-looking statements" within the meaning of and intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements typically are identified with use of terms such as "may," "might," "will, "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential," "could," "continue" and the negative of these terms and similar words, although some forward-looking statements are expressed differently. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including, but not limited to: credit risk; changes in the appraised valuation of real estate securing impaired loans; outcomes of litigation and other contingencies; exposure to general and local economic conditions; risks associated with rapid increases or decreases in prevailing interest rates; consolidation within the banking industry; competition from banks and other financial institutions; our ability to attract and retain relationship officers and other key personnel; burdens imposed by federal and state regulation; changes in regulatory requirements; changes in accounting regulation or standards applicable to banks; and other risks discussed under the caption "Risk Factors" of our most recently filed Form 10-K and within this Form 10-Q, all of which could cause the Company's actual results to differ from those set forth in the forward-looking statements.

Readers are cautioned not to place undue reliance on our forward-looking statements, which reflect management's analysis and expectations only as of the date of such statements. Forward-looking statements speak only as of the date they are made, and the Company does not intend, and undertakes no obligation, to publicly revise or update forward-looking statements after the date of this report, whether as a result of new information, future events or otherwise, except as required by federal securities law. You should understand that it is not possible to predict or identify all risk factors. Readers should carefully review all disclosures we file from time to time with the Securities and Exchange Commission which are available on our website at www.enterprisebank.com.

Introduction

The following discussion describes the significant changes to the financial condition of the Company that have occurred during the first three months of 2014 compared to the financial condition as of December 31, 2013. In addition, this discussion summarizes the significant factors affecting the results of operations, liquidity and cash flows of the Company for the three months ended March 31, 2014, compared to the same period in 2013. This discussion should be read in conjunction with the accompanying consolidated financial statements included in this report and our Annual Report on Form 10-K for the year ended December 31, 2013.


Executive Summary

Below are highlights of our financial performance for the quarter ended
March 31, 2014 as compared to the linked quarter ended December 31, 2013 and
prior year quarter ended March 31, 2013.


                                                      For the Quarter Ended and At
(in thousands, except per share data)   March 31, 2014      December 31, 2013     March 31, 2013
EARNINGS
Total interest income                 $         34,024     $          36,435     $        41,910
Total interest expense                           3,658                 4,064               5,011
Net interest income                             30,366                32,371              36,899
Provision for portfolio loans                    1,027                 2,452               1,853
Provision for purchase credit
impaired loans                                   3,304                 2,185               2,256
Net interest income after provision
for loan losses                                 26,035                27,734              32,790

Fee income                                       5,277                 7,276               5,718
Other noninterest income                        (1,355 )              (2,330 )            (2,804 )
Total noninterest income                         3,922                 4,946               2,914

FHLB prepayment penalty                              -                 2,590                   -
Other noninterest expenses                      21,102                25,609              20,285
Total noninterest expenses                      21,102                28,199              20,285
Income before income tax expense                 8,855                 4,481              15,419
Income tax expense                               3,007                   860               5,379
Net income                            $          5,848     $           3,621     $        10,040

Basic earnings per share                          0.30                  0.19                0.56
Diluted earnings per share                        0.30                  0.18                0.53

Return on average assets                          0.77 %                0.46 %              1.26 %
Return on average common equity                   8.26 %                5.07 %             16.91 %
Efficiency ratio                                 61.54 %               75.57 %             50.95 %
Net interest margin                               4.39 %                4.55 %              5.10 %

ASSET QUALITY
Net charge-offs                                    411                 1,763               3,731
Nonperforming loans                             15,508                20,840              32,222
Classified Assets                               80,108                86,020             103,948
Nonperforming loans to total loans                0.71 %                0.98 %              1.54 %
Nonperforming assets to total assets              0.81 %                0.90 %              1.26 %
Allowance for loan losses to total
loans                                             1.28 %                1.28 %              1.56 %
Net charge-offs to average loans
(annualized)                                      0.08 %                0.33 %              0.72 %

During the quarter the Company noted the following :
The Company reported net income of $5.8 million for the three months ended March 31, 2014, compared to $3.6 million in the linked fourth quarter, and $10.0 million for the same period in 2013. The Company reported diluted earnings per share of $0.30, $0.18 and $0.53 in the same respective periods. The increase in net income from the linked fourth quarter is primarily due to reduced noninterest expenses in the current


period. The decrease in net income from the prior year period is due to reduced revenue from our purchase credit impaired ("PCI") loans due to declining balances in these loan amounts, lower interest yields on our portfolio loans, lower investment security gains and higher noninterest expenses from increased salaries and benefits and loan legal costs.

Net interest income decreased $2.0 million in the first quarter of 2014 from the linked fourth quarter and $6.5 million from the prior year period, primarily due to lower balances on PCI loans, lower prepayment fees on portfolio loans, and lower interest rates on newly originated loans. These items were offset by lower interest expense primarily related to the prepayment of $30.0 million of FHLB borrowings at a weighted average interest rate of 4.09%.

The Company continued to experience improvements in asset quality. Nonperforming loans declined to 0.71% of portfolio loans at March 31, 2014, versus 0.98% of portfolio loans at December 31, 2013, and 1.54% at March 31, 2013. The Company's allowance for loan losses was 1.28% of loans at March 31, 2014, representing 180% of nonperforming loans, as compared to 1.28% at December 31, 2013 representing 131% of nonperforming loans, and 1.56% at March 31, 2013, representing 101% of nonperforming loans.

Fee income which primarily includes the Company's wealth management revenue, service charges and other fees on deposit accounts, sales of other real estate, and state tax brokerage activity declined by approximately $2.0 million as compared to the linked fourth quarter. This was primarily due to a $1.1 million reduction in gains on the sale of other real estate as well as $0.8 million decrease in gains on state tax credits. Sales of state tax credits can vary by quarter.

Noninterest expenses were $21.1 million for the quarter ended March 31, 2014, compared to $28.2 million for the quarter ended December 31, 2013 and $20.3 million for the quarter ended March 31, 2013. Noninterest expenses have decreased when compared to the linked quarter and increased from the prior year. The decrease from the linked quarter is primarily due to non-recurring expenses in the fourth quarter of 2013 from the FHLB prepayment penalty of $2.6 million, costs associated with the sale and closure of certain branches in our Kansas City region, as well as increased employee compensation expense associated with higher variable compensation. The increase in noninterest expenses over the prior year period is due to higher salaries and benefits costs related to investments in risk management functions, insurance and payroll taxes, as well as loan related legal expense primarily from the timing of reimbursements under FDIC loss share arrangements offset by lower occupancy costs from the branch closures in our Kansas City region.

Income Before Income Tax Expense

Income before income tax expense on the Company's Core Bank and Covered assets
for the three months ended March 31, 2014 and 2013 were as follows:

                                       Three months ended March 31,
(In thousands)                               2014                 2013
Income before income tax expense
Core Bank                        $       6,913                  $  7,950
Covered assets                           1,942                     7,469
Total                            $       8,855                  $ 15,419

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 for those covered assets. Core Bank pre-tax income declined $1.0 million, or 13%, in the quarter as the Company's interest income was reduced from lower loan yields on originations. Income from our Covered assets declined $5.5 million, or 74%, from


declining balances in our PCI loans as well as reduced net interest income from a reduction in accelerated cash flows and increased provision expense.

The Core net interest margin, defined as the Net interest margin (fully tax equivalent), including contractual interest on Covered loans, but excluding the incremental accretion on these loans, for the quarters ended March 31, 2014 and 2013 is as follows:

Three months ended March 31, 2014 2013 Core net interest margin 3.44 % 3.55 %

The Core net interest margin decline was due to lower loan yields from lower prepayment fees, lower balances of PCI loans which have higher contractual interest rates, as well as originations at lower interest rates. This was partially offset by lower costs of interest bearing liabilities including lower deposit costs and lower cost of borrowings from the aforementioned FHLB prepayment and conversion of $25.0 million, 9% coupon, trust preferred securities into common stock. Continued pressure on loan yields could lead to slight reductions in the core net interest margin throughout 2014. 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.

2014 Significant Transactions

During the first quarter of 2014, we completed the following significant transaction:

On March 14, 2014 the remaining $5.0 million, 9% coupon, trust preferred securities were converted to shares of common stock. As a result of this transaction the Company reduced its long-term debt by $5.0 million and issued 287,852 shares of common stock.


Net Interest Income
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.
                                                               Three months ended March 31,
                                                 2014                                                 2013
                                                                    Average                                              Average
                                                   Interest         Yield/                              Interest         Yield/
(in thousands)             Average Balance      Income/Expense       Rate       Average Balance      Income/Expense       Rate
Assets
Interest-earning assets:
Taxable loans (1)         $      2,107,805     $        22,381        4.31 %   $      2,060,818     $        24,182        4.76 %
Tax-exempt loans (2)                37,622                 665        7.17               46,809                 856        7.42
Purchase credit impaired
loans (3)                          134,466               8,652       26.09              189,230              14,644       31.38
              Total loans        2,279,893              31,698        5.64            2,296,857              39,682        7.01
Taxable investments in
debt and equity
securities                         403,523               2,215        2.23              547,672               2,212        1.64
Non-taxable investments
in debt and equity
securities (2)                      44,011                 484        4.46               43,551                 492        4.58
Short-term investments             121,087                  66        0.22               87,975                  47        0.22
     Total securities and
   short-term investments          568,621               2,765        1.97              679,198               2,751        1.64
   Total interest-earning
                   assets        2,848,514              34,463        4.91            2,976,055              42,433        5.78
Noninterest-earning
assets:
Cash and due from banks             15,869                                               18,327
Other assets                       263,606                                              270,982
Allowance for loan losses          (43,269 )                                            (46,082 )
             Total assets $      3,084,720                                     $      3,219,282

Liabilities and Shareholders' Equity
Interest-bearing
liabilities:
Interest-bearing
transaction accounts      $        214,984     $           112        0.21 %   $        260,224     $           138        0.22 %
Money market accounts              939,033                 742        0.32            1,007,642                 882        0.35
Savings                             80,759                  49        0.25               88,334                  59        0.27
Certificates of deposit            621,874               1,750        1.14              553,250               1,938        1.42
   Total interest-bearing
                 deposits        1,856,650               2,653        0.58            1,909,450               3,017        0.64
Subordinated debentures             61,362                 407        2.69               85,081                 952        4.54
Borrowed funds                     250,381                 598        0.97              356,713               1,042        1.18
   Total interest-bearing
              liabilities        2,168,393               3,658        0.68            2,351,244               5,011        0.86
Noninterest bearing
liabilities:
Demand deposits                    609,609                                              612,090
Other liabilities                   19,537                                               15,186
        Total liabilities        2,797,539                                            2,978,520
Shareholders' equity               287,181                                              240,762
      Total liabilities &
     shareholders' equity $      3,084,720                                     $      3,219,282
      Net interest income                      $        30,805                                      $        37,422
      Net interest spread                                             4.23 %                                               4.92 %
 Net interest rate margin
                      (4)                                             4.39                                                 5.10

(1) Average balances include non-accrual loans. The income on such loans is included in interest but is recognized only upon receipt. Loan fees, net of amortization of deferred loan origination fees and costs, included in interest income are approximately $196,000 and $504,000 for the three months ended March 31, 2014 and 2013, respectively.


(2) Non-taxable income is presented on a fully tax-equivalent basis using a 38% tax rate in 2014 and 39% tax rate in 2013. The tax-equivalent adjustments were $439,000 and $523,000 for the three months ended March 31, 2014 and 2013, 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.

                                                         2014 compared to 2013
                                                      Three months ended March 31,
                                                       Increase (decrease) due to
(in thousands)                                 Volume(1)         Rate(2)           Net
Interest earned on:
Taxable portfolio loans                      $        541     $    (2,342 )   $    (1,801 )
Tax-exempt portfolio loans (3)                       (163 )           (28 )          (191 )
Purchase credit impaired loans                     (3,787 )        (2,205 )        (5,992 )
Taxable investments in debt and equity
securities                                           (670 )           673               3
Non-taxable investments in debt and equity
securities (3)                                          5             (13 )            (8 )
Short-term investments                                 18               1              19
Total interest-earning assets                $     (4,056 )   $    (3,914 )   $    (7,970 )

Interest paid on:
Interest-bearing transaction accounts        $        (24 )   $        (2 )   $       (26 )
Money market accounts                                 (58 )           (82 )          (140 )
Savings                                                (5 )            (5 )           (10 )
Certificates of deposit                               222            (410 )          (188 )
Subordinated debentures                              (221 )          (324 )          (545 )
Borrowed funds                                       (276 )          (168 )          (444 )
Total interest-bearing liabilities                   (362 )          (991 )        (1,353 )
Net interest income                          $     (3,694 )   $    (2,923 )   $    (6,617 )

(1) Change in volume multiplied by yield/rate of prior period.

(2) Change in yield/rate multiplied by volume of prior period.

(3) Nontaxable income is presented on a fully tax-equivalent basis using the combined statutory federal and state income tax rate in effect for each year.

NOTE: The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Net interest income (on a tax equivalent basis) was $30.8 million for the three months ended March 31, 2014 compared to $37.4 million for the same period of 2013, a decrease of $6.6 million, or 18%. Total interest income decreased $8.0 million and total interest expense decreased $1.4 million. The tax-equivalent net interest rate margin was 4.39% for the first quarter of 2014, compared to 4.55% for the fourth quarter of 2013 and 5.10% in the first quarter of 2013.

Interest rates remain at historically low levels and continue to negatively impact loan yields leading to lower net interest margins. As seen in the table above, changes in interest rates have led to a $2.4 million and $2.2 million reduction in interest income in our portfolio and PCI loans. Additionally, the run-off of higher yielding PCI loans continue to negatively impact net interest margin leading to a $3.8 million decrease in interest income due to volume. To partially mitigate lower yields on loans the Company has taken specific actions to lower deposit and other borrowing costs including the prepayment of $30.0 million of FHLB borrowings with a weighted average interest rate of 4.09%, the


conversion of $25.0 million of 9% coupon, trust preferred securities to common stock, and the prepayment of $3.6 million of the Company's term loan to lower the contractual interest rate by 50 basis points.

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

                                                                   For the Quarter ended
(in thousands)               March 31, 2014     December 31, 2013     September 30, 2013      June 30, 2013     March 31, 2013
Accretion income            $       4,560      $           5,332     $           6,252       $       6,623     $       7,112
Accelerated cash flows              3,916                  4,111                 4,309               4,689             7,209
Other                                 176                    229                   219                  59               324
Total interest income               8,652                  9,672                10,780              11,371            14,645
Provision for loan losses          (3,304 )               (2,185 )              (2,811 )             2,278            (2,256 )
Gain on sale of other real
estate                                131                     97                   168                 116               689
Change in FDIC loss share
receivable                         (2,410 )               (4,526 )              (2,849 )            (6,713 )          (4,085 )
Change in FDIC clawback
liability                             110                   (136 )                 (62 )              (449 )            (304 )
Pre-tax net revenue         $       3,179      $           2,922     $           5,226       $       6,603     $       8,689

Our current projection of average PCI loans is $113 million and $69 million for the years ended December 31, 2014 and 2015, respectively.

Noninterest Income
The following table presents a comparative summary of the major components of
noninterest income.

                                                Three months ended March 31,
(in thousands)                          2014        2013        Increase (decrease)
 Wealth Management revenue            $ 1,722     $ 1,943     $     (221 )      (11 )%
 Service charges on deposit accounts    1,738       1,533            205         13  %
 Other service charges and fee income     637         647            (10 )       (2 )%
 Sale of other real estate                683         728            (45 )       (6 )%
 State tax credit activity, net           497         867           (370 )      (43 )%
 Sale of securities                         -         684           (684 )     (100 )%
Change in FDIC loss share receivable   (2,410 )    (4,085 )        1,675        (41 )%
 Miscellaneous income                   1,055         597            458         77  %
Total noninterest income              $ 3,922     $ 2,914     $    1,008         35  %

Noninterest income increased $1.0 million, or 35%, in the first quarter of 2014 compared to the first quarter of 2013. The increase is primarily due to a $1.7 million increase in the change in FDIC loss share receivable from higher provision for loan losses and accelerated cash flows as demonstrated in the above table partially offset by $0.7 million reduction in gains on the sale of investment securities as the Company has not sold any securities in 2014.


Noninterest Expense
The following table presents a comparative summary of the major components of
noninterest expense:

                                                    Three months ended March 31,
(in thousands)                             2014        2013         Increase (decrease)
Employee compensation and benefits       $ 12,116    $ 11,463    $    653              6  %
Occupancy                                   1,640       1,916        (276 )          (14 )%
Data processing                             1,126         921         205             22  %
FDIC and other insurance                      699         859        (160 )          (19 )%
Loan legal and other real estate expense    1,134          33       1,101          3,336  %
Professional fees                           1,267       1,425        (158 )          (11 )%
Other                                       3,120       3,668        (548 )          (15 )%
Total noninterest expense                $ 21,102    $ 20,285    $    817              4  %

Noninterest expenses were $21.1 million in the first quarter of 2014, an increase of $0.8 million, from the same quarter of 2013. The increase over the prior year period is primarily due to an increase in salaries and benefits costs of $0.7 million due to investments in our risk management functions, higher payroll taxes and insurance costs as well as an increase of $1.1 million from the timing of loan related legal expenses. These amounts were partially offset by decreases in occupancy expenses from the closure of 4 branches in the Kansas City region as well as a $0.6 million decrease in other expenses primarily due to $0.4 million less recorded expense for expected payments to the FDIC associated with our loss share agreements.

The Company's efficiency ratio, which measures noninterest expense as a percentage of total revenue, was 61.5% for the quarter ended March 31, 2014 compared to 51.0% for the prior year period. The increase in the efficiency . . .

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