Enterprise Financial Services Corp (EFSC) 2012 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Enterprise Financial 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). Thank you.

I will now turn the call over to Peter Benoist, Chief Executive Officer. Please go ahead, sir.

Good afternoon, everybody, and thank you for joining our Q4 earnings call.

Before we begin, I would like to dispense with our legal disclaimers and remind all listeners that, during this call, we'll be making forward-looking statements. Actual results may differ materially from results contemplated in our forward-looking statements and as a result of various important factors, including those described in our 2011 annual report and our Form 10-K and in subsequent filings with the SEC. Forward-looking statements speak only as of today, Thursday, January 24, 2013, and the Company undertakes no obligation to update them in light of new information or future events.

I'd also like to remind you that you can find a copy of our first-quarter press release, which includes reconciliations of non-GAAP financial measures referred to in this conference call, in the Investor Relations section of our website.

Joining me on the call this afternoon are Frank Sanfilippo, our Chief Financial Officer, and Steve Marsh, head of our Bank and our Chief Credit Officer, both of whom will also be making comments on our results for the quarter and for the year.

I'd characterize our Q4 results all in as solid. Core performance continued to show positive trends and was consistent with those exhibited throughout the year. Portfolio loans increased $119 million, or 6% unannualized, for the quarter and 11% for the full year. More importantly, commercial and industrial loans grew $82.5 million, or 9% unannualized, for the quarter, and 26% year-over-year as our focus on market share growth and continuing strength in the specialty lending areas of commercial finance, enterprise value lending, and life insurance premium finance all performed quite well. Commercial and industrial, or C&I loans, now represent 46% of our total loan book and we believe that, over the long-term, the sustainability and multi cross-sell opportunities that presented by high quality C&I business creates the best shareholder value over time.

While some of the fourth-quarter loan growth can be attributed to year-end tax planning, loan pipelines continue to remain strong as we enter into 2013. A continued focus on specialty lending strategies such as asset-based lending and structured finance, along with maintaining pricing discipline on traditional C&I credits, is intended to help mitigate competitive pricing pressures which we do expect to continue.

From a funding perspective, we continue to improve our deposit mix. Non-interest-bearing demand deposits grew $66 million, or 11% unannualized, during the quarter and 17% on a year-over-year basis. Demand deposits now represent 26% of our total deposit book.

Combined interest-bearing transaction on money market deposits increased $76 million, or 6% unannualized, during the quarter and now represent 52% of total deposits. We reduced higher-cost CDs 5% on a link-quarter basis and 29% since the end of last year.

While reported net interest margins increased 18 basis points for the linked quarter, primarily as a result of accelerations on the covered loan book, we did see a 6 basis point drop in our noncovered loan yields. Partially offsetting this, however, was a 5 basis point decline in deposit costs during the quarter. On a year-over-year basis, we reduced our overall cost of liabilities by 28 basis points.

You'll note in the release that we have changed our calculation of core net interest margin by adjusting the covered loan yields to the contractual note rate computed on the fair value of the loans. On this basis, core net interest margin declined 7 basis points during the quarter but on a year-over-year basis increased 8 basis points as a result of better earning asset mix and lower funding costs.

While asset quality deteriorated modestly during the quarter with nonperforming loans increasing $6.6 million, the nonperforming loans to total loan ratio remains very manageable at 1.84%. Noncovered other real estate decreased $3.2 million, or 26%, to $9.3 million during the quarter, and nonperforming assets increased slightly to 1.44% of assets from 1.40% in the prior quarter.

Net charge-offs increased to $5.8 million, or 1.15% of loans annualized during the quarter and were consistent with our expectations. Net charge-offs totaled $12.4 million, or 64 basis points of average loans, for the full year, compared to $18.1 million and 99 basis points in 2011. Steve Marsh will be commenting more fully on loan activity, loan pricing, and asset quality trends for the quarter and for the year.

You'll note that accelerations on the covered book were strong again in the quarter at just under $10 million, partially offset by an $8 million reduction in the FDIC loss share receivable. Accelerated payoffs were particularly strong in the First National Bank of Olathe portfolio during the quarter. On a life-to-date basis, our recovery efforts in the covered book have produced $67 million in net revenue to the Company, as our tables have shown. I'd remind you that this $67 million ignores funding costs and the cost of servicing the portfolio.

Total loans under loss share agreements have declined 33% year-over-year to $201 million while covered other real estate has decreased $19 million, or 53%, over that same period as loan collections and other real estate sales activity continues to progress well.

Finally, from a capital perspective and as previously announced, we completed the redemption of all of the outstanding preferred stock under the treasury capital purchase program in November. The related warrants issued to the U.S. Treasury were repurchased this month.

I've asked Steve Marsh to comment more fully on loan growth, on asset quality, and also his comments on the general business climate as well. So I will turn it over to you, Steve.

Okay, thank you, Peter.

My comments are related to the organic portfolio. As Peter mentioned, we ended the year with a loan portfolio organic of $2.1 billion. For the year, we increased the loan book $209 million, or 11%. The growth was, as Peter mentioned, driven largely by growth in the C&I portfolio. For the year, C&I loans were up almost $200 million, or 26%.

Looking at just the fourth quarter, growth again was robust with $82 million in growth. In the fourth quarter, all loan categories increased but the main driver continues to be C&I growth. This is a continuation of our strategy to reposition our portfolio away from real estate to C&I where we feel we have deeper relationships.

On asset quality, nonperformings at the end of the year -- nonperforming assets were $38 million. This is up slightly from $32 million at the end of the third quarter.

In the quarter, six new nonperforming assets were added to the nonperforming book. They were distributed among all three regions, so two were in Arizona, two were in Kansas City, and two were in St. Louis. Of the six new ones, two were C&I, four where commercial real estate. So we feel -- the largest one was $4.7 million -- we feel that there is enough disparity there to allay any concerns about any future trends. Although we were disappointed the nonperformings were higher, this kind of activity is not unusual; this kind of lumpiness is not unusual in a commercial bank.

Looking at the entire year, nonperforming levels have improved from 2.19% at the end of last year to 1.84% at December 31, 2012.

By class, nonperforming loans are still concentrated in the real estate area. Peter talked about the real estate sales, so we -- at the end of the year, we were at $9.3 million of other real estate owned. This is down significantly from $17.2 million at the end of 2011.

During the quarter, we sold $7.9 million worth of other real estate owned for a loss of $1.0 million. For the entire year, the Bank sold organically $20.9 million for a gain of $144,000. We believe this indicates our commitment to realistically deal with the other real estate owned and we have a bias to sell.

Looking at the entire picture of nonperforming assets, nonperforming assets at the end of the year were 1.44%, down from 1.74% at the end of 2011, giving evidence to our claim that we feel better about credit quality.

Provision in the fourth quarter was $5.9 million. This is versus $1 million at the end of the third quarter. The increase was largely driven by the six nonperforming loans that I discussed earlier. At the end of the year, the allowance was 1.63% of loans and that allowance covered about 89% of our nonperformers, so we feel comfortable with that.

In general, looking at the quarter and the year, we are encouraged by the good growth, especially in C&I. In the fourth quarter, the growth really came from all three of our markets, Arizona, Kansas City, and St. Louis. Undoubtedly, as Peter mentioned, some of the spurt in loan growth at the end of the year was due to the financial year end and tax planning. We are unlikely to see that level of activity in the first quarter of 2013.

In Kansas City in the fourth quarter, structured finance, what we call enterprise value lending, was especially robust and it's good to see. That activity spread from St. Louis to Kansas City.

Another driver of growth in the quarter was the merger activity of the regional banks in our footprint, which continues to create dislocations, at least for the short-term future.

Life insurance premium finance was strong in the fourth quarter as it was in the entire year, and I think that's a good example of where our lending niches give us the opportunity to grow based on knowledge of the products rather than just pricing. Our pipelines remained strong for the first quarter, but I don't expect loan growth to be as strong in 2013 as we saw in 2012.

In terms of concerns, of course, nothing is ever perfect. Loan pricing remains very competitive, especially for high-quality C&I transactions. The economy is slow and many of our customers are concerned or cautious about expansion plans. And so that will be mitigant on usage of lines.

So at this point, I'd like to turn it over to Frank who will go through the numbers in more detail, happy to answer questions.

Thank you, Steve, and good afternoon, everyone. I am going to supplement some of Peter's comments in various areas that should be of interest to you.

Let's start with the covered assets. The yield on covered loans was 33.4% in the fourth quarter, or 14.9%, excluding the effects of the accelerated cash flows due to pre-payments. At December 31, 2012, we still have $79 million of accretable yield to recognize over the life of the portfolio. We do continue to increase the pre-payment rate assumption used to project cash flows each quarter as a result of these accelerations we keep seeing. And that is one reason why we have seen the base yield on this portfolio continued to rise during the last several quarters to the 14.9% we realized in the fourth quarter of this year.

The change in the FDIC loss share receivable, which is part of noninterest income, was a negative $8.1 million for the fourth quarter. The quarter results included $4.6 million of negative accretion net associated with those accelerated cash flows up in interest income and the provision recorded in the quarter. Excluding this amount, the negative accretion of $3.5 million for the quarter was consistent with negative accretion on the indemnification assets seen in prior quarters. Remember that this negative accretion is adjusting the indemnification asset downward over its respective life by Bank to match the expected reimbursement of losses from the FDIC under these loss share agreements.

In regards to net interest income, I would add a couple of things. I would note that the loan growth and the organic or noncovered portfolio more than offset the decline in the covered loan portfolio during 2012. This obviously helps maintain a stronger earning asset mix.

Interest-bearing transaction deposit costs were 35 basis points in the quarter, down from 38 basis points in the linked third quarter and we believe there is still some room for those to fall.

Finally, the securities yield in the quarter was down 19 basis points to 1.82% due to heavier prepayments on mortgage-backed securities with premiums and a higher mix of short-term agency securities at lower yields that we invested in to absorb some of that excess liquidity we had for most of the quarter.

Moving on to noninterest income, Wealth Management income was essentially flat with the linked third quarter. I would note, however, AUM has slowly increased over the past several quarters with new sales activity and market gains. And the higher AUA, or assets under administration, at quarter end, reflects a new large custodial account, some of which will decline in 2013.

The rest of other noninterest income was down $11.4 million from the linked third quarter. $10 million of that decrease related to the previously-mentioned change in FDIC receivable. $1.7 million of the decline related to net ORE losses in the fourth quarter versus net gains in the third, which Steve noted. And finally, we had a $700,000 increase in the gains on sale of tax credits which is typically seen in the first and fourth quarters of the year and is consistent with client state tax planning around year end.

Turning to noninterest expense, our run rate for the last three quarters prior to the fourth was around $21.3 million and our guidance for the fourth quarter was between $20 million and $22 million. The fourth-quarter noninterest expense was $22.6 million and the excess over guidance related to a $575,000 accrual for an FDIC clawback liability. Under the FDIC loss share agreements, there are provisions in these agreements driven off the FDIC's inherent loss estimate that is used during the bidding process for all bidders and our ultimate winning bid that allowed the FDIC to share in our economic gain at the end of the 10-year term. This accrual reflects that estimate on one of our bank agreements.

Compensation and benefits were $500,000 lower in the fourth quarter versus the linked third quarter due primarily to variable compensation true-ups. And then other noninterest expenses are up roughly $2 million on a link-quarter basis and reflect the clawback liability that I just discussed, some increase in loan, legal, and professional expense during the quarter, and about $600,000 in various year-end accruals that I would consider one-time in nature.

On capital, the decline in regulatory ratios reflect the TARP payoff and the decline in the TCE and Tier 1 common ratios from the linked third quarter reflect our increase in assets during the fourth quarter due to net deposit inflows that we have seen in prior four quarters. Our views on capital levels have not changed from prior guidance given in our last 10Q, that is we are targeting a 7% TCE ratio by end of 2014 assuming the payoff of TARP which obviously already happened, and continue less focus on acquisition activities. Obviously, earnings growth must be greater than asset growth to achieve this goal.

And finally, I would comment that the EPS calculation was impacted negatively by approximately $0.03 due to the accelerated accretion on our preferred stock with the unwind of TARP during the quarter.

That's all we have as far as comments, so we will now open it up for questions.

(Operator Instructions). Stephen Geyen, Stifel Nicolaus.

Frank, if you could give us some additional thoughts on -- you talked about the deposit costs coming down a little bit and pressure on the loan yields and maybe some runoff in the secured portfolio being reinvested or potentially being put to use in loan growth. How should we look at the margin for 2013?

Stephen, I am going to have to unfortunately leave that to you guys. We are not going to give any forward-looking guidance relative to the margin. We hope that we provided through the trends that we provide and the comments that we made today that you'll be able to draw your own conclusions at this point.

Maybe I will go at it from a different direction. What do you think the cash flows are in 2013 for the security portfolio?

I do not know that off the top of my head. I guess -- well -- yes, I don't know that off the top of my head.

Okay.

Follow-up with me on that.

Sure. A question on credit. I was just curious if there was any backfill in the watch list credits. Some of the watch list credits moved to nonperforming. What did -- how did the watch list end the quarter, relative to where you began?

It's about the same. No major change one way or another.

So do I understand that correctly that there was some backfill then? That some credits moved out that there was some additional backfill?

That's correct.

Okay. And last question, maybe for Frank, talking about the $575,000, I'm just curious if there is anything in particular that drives that or if it's just the whole performance of the portfolio. Is it driven by paid downs? Is it driven by credit? And is it likely to occur again in future quarters if there is a positive adjustment in the prepayment speeds?

The main thing that affects it, Stephen, are the level of estimated losses, which we re-project every quarter as part of our recasting process. And then it's really just formulaic in the agreements. And we plug in those numbers and we look at it quarterly. And then obviously, because of time, value, money, we want a present valuing than the amount you book. So we have to do that test under all four agreements each quarter. One of these hit this quarter, as described. And we will then just true that up each quarter going forward. So if losses continue to get better, or perform better, then yes, you could expect some increase there.

Okay, thank you.

Chris McGratty, KBW.

Frank, I think, in the past, you've given, or at least last quarter, you gave some expense guidance. Maybe I missed it in your prepared remarks, but can you maybe help us with a run rate going forward for the expenses?

I'll have to say again, we're not going to provide a specific run rate forward-looking statement. I guess, once again, given the comments I made, I did comment that about $600,000 of the run-up was related to various accruals that I considered one-time in nature. And then we had the $575,000 clawback, which is, as I described to Stephen previously, you could see something there. But other than that, I made no comment. So you will have to draw on it from the trends and what you normally see in fourth quarters.

Okay. And then is it fair to assume the same with the fee income guidance? I know the indemnification volatility is pretty significant. Any color on the magnitude going forward of the negative in fees or anything you can help us with there?

No, I would just say that, once again, commenting on what we said here in the quarter is that, with losses continuing to come down, you will see negative accretion.

Okay.

It's been at least fairly consistent the last couple of quarters, so I would use your trends and take your best estimate from there.

Fair enough. One last one, just on the longer-term strategy. It sounds like deals continue not to be considered. You're building the capital from 6% to 7% over at the next eight quarters. To me, that feels like balance sheet, the mix may change but the size may not change that much. Is that a fair assessment? I guess maybe you could walk us through the next step of growth for the Company.

I guess I would -- it is certainly an internal focus, so certainly less focus on acquisitions, so I think that is correct. And then as far as the growth, we have spent the last -- really we have seen it certainly over the last year where it's really just been a shift in earning asset mix, so you haven't seen assets grow. You've seen them shrink. The fourth-quarter assets grew. We sell a little bit of a reduction in the TCE ratio as a result. We typically do see swells in the fourth quarter where deposit inflows come in and then they run out to some degree in the first quarter.

So I would say, going forward, I think there is a little bit of room relative to our earning asset mix. Remember, you've got that covered book declining. We commented on growth in the organic book. And as a percentage of our earning assets, we are pretty well positioned from a loan perspective; it could get a little better. So you're going to have to see some balance sheet growth in order to continue to drive earning growth, which has to be greater than the asset growth. So does that make sense or does that --?

Yes, I'm just trying to reconcile it. Can you get to 7% with incremental balance sheet growth at this level of profitability? You're saying, on an organic basis, you can. Am I hearing you right?

Yes, earnings growth has to be greater -- right, has to be greater, right, than the asset growth that we experienced. So it's higher profitability on the same level of assets, or slightly growing level of assets.

Okay, fair enough. Thanks a lot.

Yes.

Andrew Liesch, Sandler O'Neill.

I remember you saying, maybe the last few months of 2012, that the markets were getting a little bit better and you're going to try to dispose of some of your -- and charge off your classifieds. Is that trend going to continue into early this year?

Yes, we would aggressively try to deal with the nonperformers and would be willing to take higher charge-offs if that allows us to get a nonperforming off the book. So that strategy will continue.

Got you. And then it looked like some of this noncovered loan growth came in towards the end of the quarter, but I'm curious if some of it is just tax planning purposes. Will those loan balances then pay down early in the first quarter so you really wouldn't get much benefit from there?

Yes, it was driven by -- it had to close by year end, but I don't expect them to go away in the first month or two. They were acquisitions that needed to get close by year end for the old tax rules. But the new loan that we made to the buyer should stick.

Got you. Okay, thank you. So, it seems like you will get the full-quarter benefit of that in the first quarter.

That is correct. And you're right, December was a heavy month. You're right.

Got you. Thank you very much for taking my questions.

Jeff Rulis, D.A. Davidson.

Maybe a couple of questions for Steve regarding the credit side. You outlined the number of NPAs added really from each of your markets. Would you say that that's a pretty accurate portrayal that that credit issue is popping up pretty balanced, or is there one region you would point to as ahead or behind?

Yes, in this quarter, the nonperforming loans really came from each of the regions, so it was pretty balanced where they came from.

And do you think that that's -- if you had to give a read on the credit landscape, you'd say that's accurate going forward?

Yes, Arizona continues to be weak in terms of especially real estate stuff and Kansas City tends to be a little bit weaker. So we were always a little more real estate-oriented in Kansas City because it was a little more of a growth market, a little more C&I in St. Louis.

I think it's fair to say, too, in Kansas City, we have a heavier investment in real estate credits.

Right.

Which is where we generally tend to see more of the issues.

And then Steve, any sort of larger resolutions anticipated, or is it --?

It is bad luck to comment on that. We do think one of them has a resolution this quarter is possible.

Got you. Don't want to scare any of those away by commenting.

Okay, and then just one quick one for Frank. The tax rate for 2013, is 32.5% a good number to use?

Yes, Jeff, I would -- if you looked at last year's fourth quarter, we usually see a reduction in the effective tax rate, at least we have the last -- now this past fourth quarter as well as last year due to some lapse of some -- we can release some FIN 48 reserves. We also had a reduction in our -- which is more of a one-time event -- we had a reduction in our state tax, deferred tax valuation reserve that we had on state of about $300,000. So I would think the effective tax rate you've seen earlier -- or blended for the year would be a better one, a good one to use.

Sure, okay, so run a little higher for the first three quarters and maybe somewhat of a true-up or an impact to lower that in the quarter.

Yes, that is what we've seen over the last eight quarters kind of run that way.

Okay. Thank you.

Brian Martin, FIG Partners.

I don't know who can comment on it, but just the covered portfolio, is this the runoff you expect? Is the run rate the last couple of quarters a good level to think about going forward I guess as we try and model that or --?

Brian, I think the last time, whatever -- and I'm trying to remember exactly when it was. We do have an 8-K out there from -- I know it is several months old now. And we will probably -- we will update that guidance probably in our K. But I think, if you look at those, the last two or three of these that we've provided over the past year, I think it can give you a sense. And it moves around some based on the pre-payments and the recasting of cash flows, but I don't believe it has drastically changed. So I think that can still give you a decent read on it.

Okay, I was curious. And maybe just if I heard it right from Steve, I guess, I don't know whether you look at the watch or substandard but when I look at the substandard or the classified assets in the quarter, Steve, I guess was there a material change in that number I guess, or is that what you were saying on the watch? I guess I just wanted to clarify.

It's about the same. That level is about the same.

Okay, so the classified asset didn't move much at all even though the --.

That is correct. That's correct.

Okay. And then Peter, maybe just more of a bigger picture question, the C&I balances have grown real nicely the last year or even two years, I guess. Is there a concentration level that you don't want to go above on that C&I portfolio? I guess do you, at some point, begin to look at -- I know you've been shying away from the real estate that was part of the problem in the downturn, but I guess how do we think about that just longer-term? Do we expect that to continue to grow?

Yes, Brian, in the aggregate, I'd say no, but we do set limits by subsector within C&I based on risk assessments. So, we do have monitors on that in terms of limits beyond which we're not willing to go. I don't know that there's any particular sector we're concerned about right now from a risk perspective, but it is something we watch.

Okay. But that macro level, that 46% level is probably a decent level to maintain. You're not expecting to grow that a significant amount from the current level.

I wouldn't say significant, no.

Okay. And then just one last thing, with that year-end tax activity, the state tax activity, does that change the outlook? Usually it happens first and fourth quarter. Does that change the dynamics in the first quarter, that some of that got closed or are we thinking about that wrong?

No, it's still the first quarter and fourth quarter, primarily.

Okay.

So it is -- go ahead.

I'm sorry. So some of what came in the fourth quarter does not -- would not have been normally put into the -- you still expect the same trends in the first quarter that we'd normally see.

Correct. I think it's $6 million in credits we sold in the fourth quarter and I think there is another $6 million to $8 million in the first. So that is consistent.

We are not aware of any first-quarter pull --.

Big moves, yes.

-- From last quarter.

Right.

Okay. And then maybe just lastly, from a macro perspective, what are the priorities as you guys look at them in 2013? You have outlined the top two or three priorities for when we look back at the end of 2013 you are looking to accomplish, what are those?

Yes, I would say our focus is obviously on core profitability. And it is consistent with what we've said call after call -- quality C&I loan growth on a relationship-only basis; disciplined pricing as it relates to the loan book; continue to bring down funding costs to the best of our ability; being aware of liquidity issues; managing expenses as efficiently as we possibly can; and obviously, monitoring and maintaining risk levels that are appropriate.

Okay. That's all I had. Thanks, you guys.

Thank you.

Thank you.

(Operator Instructions). Greg Cole, Sidoti & Company.

Thanks for having me. A quick question on the accelerated cash flows. This is pretty much -- is it your covered loan clients, are they refi-ing with other banks? Is that really what is driving this?

There's some of that, certainly. Steve, would you --?

Sales of the real estate itself, refinancing to other banks. Really, sales would be probably the primary driver, that the property sold to a new buyer.

Okay. All right. Do you see that continuing, going forward, the level of sales?

Certainly, there will be accelerations going forward; that's clear. The difficult part is the level, Greg. So --

I think it is fair to say, as we commented, most of the accelerations were in the FNBO portfolio, which was the most recently-acquired portfolio. So, we'd expect probably that to continue, but to Frank's comment, it's really hard to predict these sales.

That truly is lumpy. That truly is lumpy.

Okay. All right. Then I know you mentioned multiple times on here today that C&I growth is your main priority above real estate. But you are nonperformers have dropped pretty substantially in the construction portfolio from last quarter to this quarter and are getting down towards a better level. Are you looking to -- do you have any interest in building that portfolio up?

Yes, on a selective basis. And you saw in the fourth quarter that we did do some construction loans and some investment real estate. So on a selective basis, very much so. If it's construction, it would have to be nonspeculative. We have some existing customers that are expanding and have some subdivisions that we're building out. So, construction will be there but it will be on a selective basis.

But we have never had a prohibition on construction loans or investment loans.

Okay.

The tax credit niche has some --. And that was some of the power in the fourth quarter of the real estate growth, that they were tax driven -- tax credit-driven deals.

Okay. All right. So nothing too major to help net interest margins out a little bit from that side?

Yes, even -- but the construction loans that we did to existing customers, you can get a little bit better pricing, as I'm sure you know. In investment real estate, you can get a little bit better pricing. So we did help there. It did help there.

Okay. All right. Thank you very much.

At this time there are no further questions. I will now return the call to management for any closing remarks.

Nothing specific. We think we're off to a good start this year. I think we are optimistic as it relates to our current view of the markets. We'd just like to again thank you for your interest in EFSC and for joining us on the call today. Thanks very much.

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