Enterprise Financial Services Corp (EFSC) 2011 Q3 法說會逐字稿

Good afternoon, my name is Lacey and I will be your conference operator today. At this time, I would like to welcome everyone to the Enterprise Financial third-quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions).

Mr. Peter Benoist, you may begin the conference.

Great, thank you, Lacey, and welcome to everybody. Greeting from the home of the soon-to-be crowned World Series Champions, St. Louis Cardinals. We appreciate your taking the time to join us on the call.

Give me a minute. I want to read the forward-looking statement disclaimer and then we'll get into the details of the third quarter.

I would like to remind all listeners that during this call, we will be making forward-looking statements. Actual results may differ materially from results contemplated in our forward-looking statements as a result of berries important factors including those described in our 2010 Annual Report on Form 10-K and in subsequent filings with the SEC.

Forward-looking statements speak only as of today, October 27, 2011, and the Company undertakes no obligation to update them in light of the new information or future events.

I would also like to remind you that you can find a copy of our first-quarter press release -- that should be third quarter -- third-quarter press release which includes reconciliations of non-GAAP financial measures referred to in the conference call in the Investor Relations section on our website.

As is our normal custom, I have Frank Sanfilippo, our Chief Financial Officer, with me today and Steve Marsh, President of our bank and Chief Credit Officer, both of who will be making comments after I do and then we will open it up for questions.

I'd just start off by saying we are pleased to report fully diluted earnings per share of $0.49 for the third quarter. It is a 70% increase over the third quarter of a year ago. Our fully diluted earnings per share on a year-to-date basis are $1.46 and that represents a return on average assets of 1.12% and a return on average common equity of 17.25%.

More importantly, our core operating fundamentals excluding FDIC acquisitions showed continued improvement in the quarter, including commercial and industrial loans growing at a 12% annualized rate net of acquired assets and total loans up 2% on a quarter or 8% annualized. We do continue to expect full-year loan growth net of acquired assets in the 6% to 8% range.

The Company's deposit mix showed continued improvement with an 18% linked quarter increase in demand deposits, which now represent 20% of our total deposit base up from 15% from the year ago period. Money market balances increased 16% during the quarter, primarily as a result of First National Bank of Olathe acquisition and they now represent 40% of our total deposit base compared to 35% at the year ago period.

We continue to show good improvement in funding costs as interest-bearing deposit costs dropped 9 basis points linked quarter. Core net interest margins narrowed in the quarter primarily as a result of the decline in earnings asset yields. We would say that loan markets continue to remain very competitive for quality relationships and I have to ask Steve Marsh in his comments to expand a little further on market competition and what we are seeing on the loan side in all three of our markets.

I have also asked Frank to do some detailed comments on margins so he will get into that in a little more detail in his remarks.

Our Wealth Management business continued to show improvement with a 10% linked quarter increase in revenues and our tax credit brokerage revenues were up substantially on increased sales and favorable hedging treatment as rates during through the quarter.

On a year-to-date basis, Wealth Management and tax credit brokerage revenues combined have had a double-digit increase. Asset quality remained stable for the quarter with loss rates declining from the second quarter while nonperforming loans showed a slight uptick. Steve will comment in more detail on asset quality, but we continue to see modest but slow improvement as real estate markets remain moribund.

Before we move to the First National acquisition, I should note that we continue to add talent in all of our markets, and we are particularly pleased to have acquired the Commercial Finance Group that was formerly with Southwest Bank and Marshall & Ilsley. This team has a long history having been with Mark Twain Bancshares and Southwest Bank here in St. Louis and they represent another arrow in our quiver of special lending capabilities.

We also completed the acquisition of the former Liberty Bank branch in northwest St. Louis County. This $40 million plus deposit branch feels the geographic void in our St. Louis market in an area with strong consumer and business demographics.

Finally, First National Bank of Olathe represents a major move for the Company in the Johnson County area of our Kansas City franchise. We will get into the details but, strategically, this transaction accomplishes a number of our objectives.

First, it establishes Enterprise as a major player in the Johnson County market. Second, with over $1 billion in deposits in Kansas City, Enterprise is now ranked seventh in overall deposit market share. Third, it adds a solid core base of consumer deposits that have an average life in excess of 10 years. And fourth, it is accretive to earnings per share and returns on equity and assets.

As we indicated in the release, we expect First National to add between $0.18 and $0.22 on a fully diluted basis to 2011 earnings.

You'll note that this transaction significantly decreased our tangible common equity ratio; however on a risk adjusted basis, tier one common equity to risk weighted assets remains at a respectable level. Frank will comment on the particulars of the transaction including its effects on goodwill and capital, but suffice it to say that we are extremely pleased with this transaction and its longer-term implications for us in the greater Kansas City market.

And with that I am going to turn the mike over to Frank.

Thank you, Peter, and good afternoon everyone. The net interest rate margin only tax equivalized to 4.56% in the quarter continues to benefit from the cupboard loan yield as our release indicated. These covered loan yields have and will continue to be choppy as the cash flows from our collection activities can be difficult to predict beyond a quarter.

Peter had commented on our core margins which in prior quarters was simply excluding the covered loans in assumed funding cost on those assets. With the acquisition of FNBO and its relative size, we are now also excluding the non-earning assets associated with these acquisitions and the deposits acquired. That estimated result showed a 3.37% net interest rate margin on a core basis in the third quarter versus 3.51% on a comparable linked quarter basis.

This decrease as Peter said was driven primarily by declining earning asset yields. Given a flatter yield curve there will obviously be pressure on bank rate margins. While price competition for quality new loan relationships is fierce, loan renewal rates are holding up fairly well and we still have some levers to pull with deposit costs and investing excess liquidity. So we would expect our core net interest margin in the near-term to stay in this range.

Most of our fee income categories have been covered in our release or Peter's comments; however, I would like to note that the other income category in the third quarter and year-to-date show a reduction from the comparable prior year periods. These reductions were driven by negative adjustments to our FDIC indemnification asset that flow through this category.

Nearly every quarter this year, we have reported accelerated discount accretion from paid off covered loans that have increased our covered loan yields and net interest rate margin. If the actual losses and related FDIC reimbursement wind up being less than our estimated fair values, the negative adjustments to the indemnification asset is recorded as a negative to other income. This adjustment was considered in the $0.08 impact that is noted in the release related to the accelerated cash flows on those loans.

Obviously our acquisitions of talent and FDIC [field banks] have driven our year-over-year comparison on non-interest expenses with volatility especially noted in the loan legal and ORE expense category. Fortunately, the revenue increases have more than offset the expense, leading to better efficiency ratios which have been about 47% to 48% in the last two quarters.

On the Olathe transaction, we will file our Form 8-K/A as required by SEC rules tomorrow. This document includes an audited statement of assets acquired and liabilities assumed as of the date of our acquisition which was August 12th of this year. The amounts of the statement are shown at fair value and provide the reader an understanding on the $43.9 million of goodwill created in this transaction. The notes to the statement indicate these amounts are provisional and will change over the next six months to a year as evidence is received to true up estimated fair values to actual if known.

Examples of this include the sale of foreclosed real estate for a price below or over the estimated fair values at 8/12, or August 12, or other settlement items with the FDIC as better information becomes available. Given the size of the purchase and intangibles created, my comments on capital levels will be as follows.

First, we raised $5 million of new capital in May, as you know. Now we have leveraged that capital with the Olathe transaction which should be accretive to earnings for the next several years and strengthens the franchise value of our KC operation over the long-term effects if executed well.

Secondly, regulatory capital ratios are strong, relative to the current definition of a well-capitalized institution.

Next at 7.62%, the tier 1 common technique ratio is acceptable in our opinion. As Peter said, this ratio properly adjusts for the lower risk we assumed with the covered assets acquired versus the tangible common equity ratio which does not. So at 4.72%, the tangible common equity ratio is low, relative to our peers and bank investor guidelines as a result of the Olathe transaction. But with continued earnings momentum generated by our FDIC acquisition activities, and our core business, combined with controlled asset growth, given the business environment, this ratio should increase over the next three or four quarters.

So from a capital planning perspective, I would offer the following. First, we just closed this large transaction. We need to solidify its contribution to earnings over the next year or so and the goodwill will be moving around in that timeframe as well as noted. Secondly, there aren't no FDIC-assisted opportunities that we currently have on our radar. Third, we have $35 million in CPP preferred stock outstanding, $20 million plus in cash at the holding company with an ability to dividend excess capital from the bank while being cognizant of impacts to our classified assets to capital ratio. Fourth, there are [$25 million] of convertible trust preferred securities at a $17.37 strike price and a call date in 2013. Fifth, we have slower growth environment for the foreseeable future, but not as many places to deploy capital.

And finally, the current volatility in the equity markets concerns us. Therefore, we will continue to evaluate our options regarding capital and CPP redemption.

Thanks, and I will now turn it over to Steve Marsh to discuss loan growth and asset quality. Steve.

Thank you, Frank. At the end of the third quarter, September 30, loans stood at $2.2 billion. The $2.2 billion includes $343 million of loss share assets, assets covered by loss share agreements. That category jumped $162 million by virtue of the First National of Olathe acquisition.

Looking at just organic loan growth, loans were up about $41 million or 2% for the quarter, quite a bit of a change in composition of the portfolio as C&I was up $17 million or 3%. That is the fifth quarter that we have had growth in C&I -- than the C&I iBook. Construction and development was down $4.6 million so we continues to transition the portfolio away from construction development loans into what we consider to be safe for C&I lending.

Looking at the last 12 months, organic loans are up $71 million or 4%. C&I was up $113 million or 19% and construction development was down $66 million. So we have had some good change in composition there.

As both Peter and Frank mentioned, pricing pressure especially on new pieces of business has been very severe. The primary competitors in St. Louis and Kansas City have been the regional banks. Not as much competition as from the Community Banks over the last year or so.

Looking at the new -- looking at the loan growth about 50% was new relationships, new borrowers to Enterprise Bank, largely due to the relationship managers we've added over the last year. About 50% was from existing customers who needed additional financing.

In terms of geography, most of the loan growth was centered in St. Louis where we have a larger, older presence. As I have already mentioned, C&I growth was the largest sector that grew. We also had good growth in investment real estate and I know that it is an area that has had some difficulty in the past. We found that values are down and savvy investors are making acquisitions today. We have capacity in that category. We have the ability to get -- extract a little bit better pricing in that category and the loans we have made have been to existing relationships. So we did show some growth in investor real estate. I think the loan growth largely confirms our strategy of attracting good talent in our markets.

Turning to credit quality, nonperforming loan at September 30 were $48 million, up slightly from $43 million at the end of the second quarter. In terms of migration of new nonperformings, it was about $16 million. The largest segment of new nonperformers continued to be commercial real estate. Second-largest component was C&I.

We did have some paydowns of about $3.5 million. About $3 million went to other real estate owned so that we ended the quarter at about $48 million.

Nonperforming loans represented 2.17% of loans at the end of the quarter. This is virtually unchanged from the end of the second quarter which was 2.15% but down from 2.69% a year ago. So we have shown progress in that on the long term, but it is slow progress, which I think we have talked about previously.

Past dues were really just a handful of accounts. It was 2 basis points worth of loans that were past due. That used to be a better predictor of future problems, but still we believe smaller is better and the past due situation looks good.

Other state-owned jumped significantly primarily due to the acquisition of the First National and the book of the other real estate owned that came with it. So other real estate owned was $77 million which was up $42 million from the end of the second quarter. Of the $77 million, $56 million or 72% was covered by loss share agreements. So organically, the organic level of other real estate owned was really virtually unchanged from the end of the second quarter.

For the third quarter, we sold $12 million worth of other real estate owned for a gain of $517,000 to once again confirm that we are keeping those assets reasonable in light of the distress values. For the year, we have been able to sell a total of $25 million of other real estate owned for a gain of $1 million.

Charge-offs for the quarter were $4.8 million or an annualized basis would be 91 basis points. Provision was $5.6 million so we covered our charge-offs and grew the provisions slightly. The rest of the provision increase, it was up from $4.6 million at the end of the second quarter. The other part of the increase is really due to some downgrades in the portfolio.

Allowance for loan losses finished the quarter at 1.94 percentage of loans. The covered nonperforming loans, about 89%.

I am encouraged by the FDIC experience. The real estate sales have been better than we expected. That loan account has performed better than we expected. I am also encouraged by the organic loan growth and slow and steady improvement in overall credit quality.

So with that, Peter, I will turn it back to you, but be happy to answer any questions.

Take you, Steve. Lacey, I think we are ready to go to questions.

(Operator Instructions). Chris McGratty.

Just a quick question. Your comments on the size of the balance sheet. Sounds like the organic growth expectations are a little bit more tempered, but should we -- in your capital discussions should we take it that balance sheet is going to be a little bit smaller over the next few quarters? Is there going to be some deleveraging?

I think what my comment really was it would be slow growth. So I wouldn't want to call it deleveraging necessarily.

Well, I guess I am alluding to the investment portfolio or some of the liquidity on the balance sheet.

I know our strategy is to continue to focus on funding cost and continue to bring them down. As Frank said, we think we see some move -- we see some additional movement there. We are in a period though where we see traditional year-end buildup in core deposits and we always see that in the fourth quarter which is why we are sort of struggling with the answer to your question in the near term.

So I don't know that we would call that deleveraging even though we are going to be pricing from a funding perspective on a basis that is not going to encourage growth.

I appreciate the tier 1 comment, but I guess the [floor] handle on the TC is a little bit --

I hear you.

Chris McGratty -- a little bit low. Maybe you could just talk about kind of the acquisition a little bit more. The earnings accretion seems significant, but I think what surprised me was the level of goodwill that you had in the kind of assumed earn back. Maybe you could just talk about the market and how you are doing that.

Yes, I would really like to because those details are provided in the 8-K/A tomorrow, I really had rather not go through any more details than what was already provided in the release if that is okay. So if you can look in that 8-K/A tomorrow, I think hopefully it walks you through basically how we arrived at the goodwill that we did and then let's have a conversation. But I think it will help you understand why it wound up where it was.

Okay, just one last one on credit. How should I be thinking about reserve levels and provisioning requirements versus expectations for charge-offs? Should we assume under provisioning, matching at this point or how do you see that playing out?

I would assume basically matching.

Yes. Because we -- our process for the allowances really loan by loan based on risk rating, we look at the level of the unallocated, that really doesn't bounce around much at all. So it is really driven by what the risk in the balance sheet and what happens with risk rating changes versus trying to match net charge-offs necessarily. So (multiple speakers) --.

Well, we sort of indicated that we know we think credit is relatively stable at this point. We may not -- maybe we don't like the level of nonperforming loans or OREO, but when we look at risk ratings they seem to be stable. When you look at the coverage on sort of noncovered, we're in good shape. So I mean we are not looking to do any building. I think in the context of just maintaining reserve, that is sort of our attitude right now unless we see a credit statistic change and we haven't seen that.

Okay, that's helpful. Thanks a lot.

(Operator Instructions). Brian Martin.

I guess maybe this is for Steve. The provision you talked about in the quarter, what were the downgrades? I guess specifically what areas we are seeing downgrades in in the portfolio this quarter?

Yes, it was spread out over a number of different relationships. Somewhat driven by appraisal, we reappraised the problem loans and the appraisals come in a little lower than expected. The downgrades was primarily related to real estate, that would be no surprise to you.

Okay. Maybe just one further question. Just classified trends and special mention trends, we saw some migration to the nonperforming bucket. Did you see a corresponding decrease in the special mention in the classifieds in the quarter? Or did those refill somewhat as well?

They stayed about the same. Yes. Stayed about the same.

So there were inflows to both the special mention and the classified?

Yes, that's correct.

And were any of those movements back to the special mention upgrade? I guess, positive migration if you will that (multiple speakers).

Yes, we have some -- we had some upgrades. Right. (multiple speakers) the other -- and I should have said -- I should've said this that all the nonperformers were previously identified as problems. There were not any surprises.

Okay, so the classifieds actually -- the classifieds were stable then. Okay, and then maybe just a question for Frank. Just on the margin and as far as the excess liquidity goes, where is the balance now? And I guess what's -- where do you see that level trending to? How much excess liquidity do you want to carry as you go forward? Versus where it is at now?

Right. I think the -- I guess the answer would be that clearly we have -- and we have I think it is 8% to 9% of our assets in sitting at the Fed. And we are hopeful that through continued deposit rate reductions that we would be able to actually see some of that goal go out or fund it with loan growth. We have had the loan growth, we are not seeing the exiting of balances like we thought as rates fell down.

So I think where we are at now is we are going to start moving it out of earning 25 basis points into earning anywhere either extending the investment portfolio a little bit to maybe getting 150, 160, going out five-year with bullets or possibly putting some of it also into just some floating CMOs that -- agency CMOs that might get us 60 basis points. Once again, that is one of the levers I think just incrementally to try to help the margin encounter some of the negative effects.

In the loan growth you guys talked about just what your expectations are for this year. I mean, we are three quarters of the way through I guess and maybe just maybe a flattish type of environment going forward. I guess is your expectation with the people you brought aboard, that there ought to be some continued organic loan growth? You know what I (multiple speakers).

Absolutely. Absolutely, we will continue to say that. We are seeing the results of the people we hired a year ago, nine months ago in the numbers here. And we'll see the results of the group that Peter referenced, we will see that in the next six months. You do get about a six- to nine-month lag on that, but we do very much expect to see organic growth from those hires.

So, positive organic loan growth is the expectation at this point for '12?

Yes.

All right and then maybe just two last things. Just with regard to capital and TARP and how that goes, you know, what -- maybe, Frank, you could just give us a little color on where the capital levels are at the bank? What your ability is to upstream and just what the plan is on TARP as far as a priority? And whether you have had discussions with your regulators as to what is an acceptable level of capital to move forward with that?

I think that from the -- I would tell you that the regulators -- you know if you have to dividend from the bank, I guess the feedback that I've heard from the regulators, they won't give you a firm number, but they -- the FDIC would certainly be looking at your classified asset to capital ratio. And they would like you -- that would tell you obviously it is better to be in the 40s. If it is in the 50s, we will have some pause, we won't say you can't do it, but we might -- we will have a little pause with it.

So I would tell you you want to keep it -- if you dividend out of the bank, you want to make sure you can either keep it or get it there pretty quick in the next quarter or two back underneath 50%. And currently we are -- I mean, you can see that in our Qs and Q in that from last quarter. We are underneath the 50% in the bank.

Okay. So you and as far as having the ability to upstream from the bank. You are able to do that at this point?

Yes we are. I just hope.

(multiple speakers)

I just wouldn't want to comment on the amount.

And do you have the capacity of what you can send up at this point?

I wouldn't disclose it, no, not at this point. I would like to keep it open, Brian, that is kind of why I went through all the different bullets on capital. I think you guys are all smart and you will come to your own conclusions as far as roughly what has to take place there. So we need to kind of balance everything and see where we are at before we commit to anything publicly or in writing.

And maybe just one thing I didn't understand, Frank, just on the goodwill. Is the number that you show in the press release and it will be in this 8-K tomorrow, is -- does that number move around, I guess? Is it a firm number where it's at or does that adjust? Is that kind of what you are indicating in your prepared remarks?

Right, I'll call it GAAP, but I know it is [AFC] now, but I still refer to it as GAAP. I mean it allows you -- the accounting guidance there on acquisitions allows you to -- that if you find out things up to a year after the acquisition date, that is better evidence in terms of what the fair values were as of the acquisition date, GAAP allows you to adjust your goodwill.

And we actually had that a little bit with our legacy acquisition. So as things become apparent after acquisition date, that you can say or support that difference existed as of the acquisition date, then you are allowed to change it.

It can and will move around. (multiple speakers)

Thanks.

Chris McGratty.

Just one quick follow-up on the margin. Frank, the covered yield, I think in the past you had said 16% to 17%. Is that still the -- is that still fair? I mean, it was a little bit about that this quarter, but how should we think about the yield in the covered book?

We haven't hit that yet. As I said, we've had accelerations that keep it bouncing around and as I said it is choppy. I mean I think that I would say 15% to 16%, 17%, you will be in the ballpark. It won't be that because like I said we will continue to have things that affect it, but I think as a baseline, I think you can use that.

Stephen Geyen.

Maybe just a follow-up on that. Just curious about the accretable yield adjustment. Was it all paydowns or was there also some improvement in the existing cover loans?

I believe it was all related -- substantially all related to paydowns -- payoffs.

Daniel Cardenas.

Good afternoon. Quick question. On any changes that you would potentially see on goodwill going forward. I mean does that get worked through the income statement or can you give some color as to how that would get handled?

Right, no it is not. It basically is balance sheet only. So it goes from lowering or raising goodwill and the offset is whatever asset is impacted. It could be cash we receive more cash or it could be OREO, or loans.

Great. And then it sounded like you don't see a lot of FDIC assisted opportunities in your footprint right now. Given that, what is your current appetite for just more traditional M&A either whole bank or branch acquisitions?

I think our current focus is to absorb what we've got. And in that respect, that is what we're doing. We are not targeting, really targeting anything as it relates to what I will call nonassisted transactions in any of our markets at this point.

And how about in terms of just pure talent acquisitions? Have you seen having a lot of discussions with folks out there right now?

We continue to, yes. Steve could comment particularly in Kansas City at the moment. We are in some conversations there. And Steve may have some other comments in terms of talent.

Yes. It continues to be one of the competitive advantages of Enterprise is that for a relationship manager they like the size and capacity of a company like ours. So we are in conversations in Kansas City and St. Louis, especially, about adding new talent. Existing talent with experience in our footprint.

Great, thank you.

Brian Martin.

One last follow-up. Just the -- you talked about some of the pressure on the loan side this quarter and as you guys look to continue growing. I mean, how much more pressure do you expect to come on that side of the ledger?

I gave you my comments. Steve, you'll probably correct me. I think we know where the competitive pricing is. And we are talking about quality credits honestly. And we sort of -- we operate with the Mendoza line in terms of spreads. I think we have been disciplined about that in terms of how we are bidding new relationships. I would say our success rate as a result of that has probably gone from 75%, 80% to 65%, 70%.

And we have -- and I want Steve to comment -- no intention of breaking our Mendozas at this point.

Right.

But I think we do know where the regional banks are pricing on good credit today. I don't know that we see it getting worse. That would be my comment.

And the real hard-core pricing pressure is on that component of growth that's from -- that is new to our Company. We don't have huge pressure on the existing book of business because we take good care of our customers and they are comfortable that there is a predictable source of landing at Enterprise Bank. I think that means a lot to people.

So the real pricing pressure is when we are duking it out with new customers. Especially when we hire somebody from an old bank, the old bank tries hard to keep them.

Okay.

It is really at the margin of the new relationships at the margin.

I got you. Okay. And then just lastly, Frank, just the -- with the Olathe deal in there this quarter and just on the expenses, I mean we have most of the impact of Olathe in there, or does that still trend higher in the fourth quarter of the expense line? And maybe in the next year?

Yes, well, we really --. I mean we do have one and basically a half a quarter if you will of Olathe expenses in there. And we have not made our decisions yet on the branches which, obviously, will contribute to that cost.

So, I think that -- I mean, I think to be safe -- well, to be safe I mean you can -- you know it's kind of the run rate is in there. And because most of the people are related to branches, until we make the decision on the branches, you know I really can't give any guidance or indication of what will happen to that expense base. And so, we won't be able to update that really until -- because we have until middle of November -- we won't be able to update that really until year-end.

Right, but it would only go lower. Is that your thought if you -- depending on how you do things, or it would --?

Yes, higher. I think so on a run rate basis.

Yes, on a run rate basis.

On a run rate from this level or lower? Is what you would be thinking?

Right.

Thank you.

Stephen Geyen.

Maybe just a follow up on Arizona. Just curious, legacy [in Valide], are you mostly still and work out there or is there opportunities for organic growth and is that focused right now or -- and then maybe some thoughts on Wealth Management as well.

Yes, in terms of on the banking side in Arizona it still would be work out from the Legacy customers. We are getting around to meeting the customers. We are talking about the advantage of Enterprise Bank, but 80% of the work would be the work outside of it.

Focused on the market.

And just in terms of your question on Wealth Management, we are looking to add talent in Arizona. We are actually in some discussions right now. The same is true in Kansas City, and we are actually in some discussions right now in Kansas City on the producer side.

Thank you.

At this time, there are no further questions.

Very good. Hearing no other questions, we just want to thank all of you for your interest in Enterprise and for joining us this afternoon and we look forward to chatting with you in the next quarter. Thank you.

Thank you for participating at today's conference call. You may now disconnect.