Enterprise Financial Services Corp (EFSC) 2013 Q4 法說會逐字稿

Good day and welcome to the Enterprise Financial Services earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Peter Benoist. Please go ahead, sir.

Thank you, Jessica, and good afternoon, everyone, and thank you for joining our Q4 earnings call. 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 statements as a result of various important factors, including those described in our 2012 Annual Report on Form 10-K and in subsequent filings with the SEC.

Forward-looking statements speak only as of today, Thursday, January 23, 2014, and the Company undertakes no obligation to update them in light of new information or future events. I would also like to remind you that you can find a copy of our fourth 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.

I am joined by Keene Turner and Steve Marsh, and have also invited Scott Goodman, who runs our bank, to join us to give you some perspective on the current business climate in our markets.

We reported record net income and earnings per share in 2013. Our reported $1.73 per share was up 26% over the prior year. More importantly, our core operating results, netting out getting the positive impact of the loss share book, were up 30% over 2012 and currently represents 70% of the Company's full year reported pretax earnings.

We benefited greatly from positive credit leverage as asset quality continued its strong improvement during the year. However, core pretax, pre-provision earnings, adjusted for the FHLB prepayment fee, increased just under 4% on a year-over-year basis.

While net loan growth was modest at 1% for the full year due to managed runoff in the commercial real estate and construction LAD books, commercial and industrial loans increased a healthy 8% for the year. Our three-year compound annual growth rate in C&I loans is 21%, and this segment now represents 49% of total portfolio loans.

On a year-over-year basis, the Company's core net interest margin declined a modest 2 basis points as we continue to improve our funding costs, while maintaining our pricing discipline from the loan front. Goodman will give you some market color on loan pricing in a minute.

Total noninterest income increased 13% year-over-year, net of the change in FDIC loss share receivable and the effect of the branch sale gains. Strong improvements were shown in service charges on deposit accounts and state tax credit activity, which increased 20% and 13%, respectively.

Total operating expenses excluding one-time prepayment penalty increased 2.7% over the prior year and did not include the full-year effects of the closure and/or sale of six of our 21 branches as we completed our branch rationalization plan in the Kansas City and Arizona markets.

We completed the conversion of $20 million in trust preferred securities to common equity in the third quarter. And that, coupled with strong earnings, increased the Company's tangible common equity ratio to 7.78% -- well beyond our stated target of 7% for the year. For the full year, the Company's tangible common equity per share increased a healthy 20.6%.

All-in, a solid year of performance in our view, and one that positions us well to continue to take advantage of opportunities to enhance our growth strategies. I would like to turn it over now to Scott to give you a little market color. Scott?

Thank you, Peter. In general, growth was driven by continued momentum from our C&I related businesses and moderating payoff activity, primarily on commercial real estate related credits. Originations were solid for the quarter and at levels above our average for 2013.

On a market basis, we experienced growth both in St. Louis and Kansas City markets, with level performance in Arizona. St. Louis growth was centered around C&I and bolstered by good activity in our tax credit lending, life insurance, premium finance, and asset-based lending initiatives.

Kansas City showed modest growth in both C&I and commercial real estate, with a number of new relationships coming from expansion of our enterprise value lending or EVL niche in that market. As a reminder, EVL is our leverage lending senior debt offering to private equity sponsors, focused on midsized operating businesses.

Also of note in Kansas City, we successfully recruited three new experienced C&I relationship managers in the quarter, all of whom came from different local competitors.

Arizona posted decent origination activity in the quarter, but experienced a couple of larger payoffs resulting from aggressive fixed rate competition on commercial real estate.

Based on our current ninety-day funding pipeline, originations appear to be steady, complemented by moderating levels of payoffs on commercial real estate loans. The pipeline shows particular momentum in the EVL and life insurance premium finance lines of business.

The competitive environment in all of our markets is showing elevated levels of activity and continued emphasis on low rates. In Kansas City, the downward-turning rate pressure is eased somewhat, but remains at low levels and with more banks willing to participate at these levels.

In St. Louis, we are also seeing higher levels of activity as the larger regionals appear to be moving down market and leading with price.

On the fee side of our business, we have experienced strong performance with our core revenue up roughly 18% for the year. Service charges improved significantly, reflecting growth from treasury management on new relationships, and increased emphasis on cross-sell. Execution of our cross-selling is a focus of our sales teams. This is bolstered by the expansion of our fee business offering, including the mortgage acquisition of Gorman & Gorman and the buildout of our card services offerings. It's further supported through better execution provided by implementation of the salesforce.com CRM system.

Mortgage volumes have declined relative to market conditions in general, but leveled off at the end of the fourth quarter. The priority for 2013 was positioning and integration of the Gorman & Gorman acquisition. As we move forward, our plans for mortgage include a rationalization of the expense base and a focus on leveraging mortgage opportunities within our existing commercial and consumer client base.

We will be opportunistic in recruiting experienced mortgage loan officers as they look for a more stable environment.

Our tax credit brokerage business remains a solid with strong demand and stable margins.

And now I would like to hand it over to our CFO, Keene Turner, for a risk financial review.

Thank you, Scott, and good afternoon. I am excited to be here today to review highlights of our full year and fourth quarter 2013 results.

As you heard from Peter, 2013 was a record for Enterprise as we reported $1.73 of earnings per diluted common share. That is a 26% increase in earnings per share and a 32% increase in net income available to common shareholders compared to fiscal 2012.

Before I take you through the full year's results, I will highlight two transactions which impacted our full year and fourth quarter 2013 results, executed to better position us for 2014 and beyond.

We repaid $30 million of borrowings from the Federal Home Loan Bank of Des Moines on December 30, 2013, prior to the scheduled maturity date. These advances had a weighted average interest rate of 4.09% and a maturity of approximately 3 years.

We incurred a $2.6 million pretax expense, or $0.08 per diluted share during the fourth quarter. This prepayment was executed as part of our ongoing effort to manage interest rate risk and is expected to mitigate continued pressure on core net interest income. The prepayment penalty will be earned back through lower borrowing costs over the next three years.

Additionally, we completed the sale and exit of certain branches in our Kansas City market that were determined not to fit our long-term growth strategy within the market. Approximately $90 million of deposits and $8 million of loans were sold as part of this transaction and we recognized a gain in other noninterest income of approximately $1 million in the fourth quarter.

Additionally, expenses were required to be accelerated with the exit of certain branches that were not able to be sold. These expenses were approximately the same amount as the gain recognized and were reported during the fourth quarter in other noninterest expense. Despite these transactions, we remain focused on growing our presence in Kansas City and we expect to open a new branch location during the first quarter of 2014.

Now to our full discussion of the financial results. Earnings per share for the fourth quarter was $0.18. Net income on a core basis increased to $25.7 million or 13% on an annualized basis, with net interest margin maintained at 3.54%. Net interest income and margin were maintained through improvements in asset mix as portfolio of (inaudible) loans grew by $26 million and we continued to further reduce the overall cost of our deposits and funding.

The fourth quarter annualized loan growth of 5% continues to build on the progress we made during the third quarter and repeated our growth of portfolio loans in the mid-single digits. Additionally, we continued to benefit from the full effect of the third quarter conversion of subordinated debentures to common equity, maturing Federal Home Loan Bank advances, and other reductions of wholesale funds.

Seasonal deposit inflows of 14% on an annualized basis during the quarter facilitated the wholesale borrowing reduction alongside the sale of Kansas City branches previously discussed. Total deposit cost decreased 2 basis points to 42 basis points for the fourth quarter, and the overall funding improved another 6 basis points to 73 basis points.

As demonstrated by our actions, we continue to be focused on managing the cost of our funding base to maintain margin, while also positioning the balance sheet to support growth.

Our financial performance continues to be favorably impacted by assets covered under FDIC loss share agreements. In our release, we began referring to these assets as purchase credit impaired or PCI loans, in light of the fact the FDIC loss share agreements will expire over time, beginning with our first acquisition in December of 2014.

Fourth-quarter pretax net revenue was strong at $2.9 million and brings the contribution for 2013 to $23 million. The fourth quarter results demonstrated how the continued decrease in the balance of purchase credit impaired loans combined with the volatility associated with accounting for the related components of loss sharing agreements can lead to variability.

To be more specific, the yield on PCI loans remained stable during the late quarter at 26%. However, balances declined $20 million during the fourth quarter to $125 million, and we wrote off $1.7 million of additional FDIC loss share receivables compared to the third quarter.

This performance reinforces my comments from our last earnings call. As we approach the expiration of loss sharing arrangements with the FDIC, and the underlying balance of the PCI loans continue to decline, the results on a quarterly basis will be uneven. However, PCI loans and covered assets continued to perform significantly better than expected at the time of acquisition and we expect material contribution to our financial results in 2014, despite the volatility.

We estimate the average balance of PCI loans will be $108 million for 2014 and, by comparison, the average balance for 2013 was [$169 million]. As we look forward, we continue to focus our efforts on improving the contribution of pretax earnings on a core basis.

For 2013, reported pretax income of $50 million and our earnings, excluding covered assets, was approximately $35 million. That is an increase of 30% from $27 million during 2012. The proportion of these core earnings and our reported pretax earnings increased to 70% for 2013 as compared to 63% for the prior year. Given the significant contribution from covered assets, we are pleased with the progress we made during 2013.

A major driver of the favorable progress in core contribution during 2013 was the substantial improvement of credit quality during the year. Net charge-offs for 2013 declined 48% to $6.4 million or 30 basis points of average portfolio loans, the lowest level we have seen since 2008.

Despite an overall negative provision for loan losses during 2013, the allowance covered nonperforming loans by 131% at December 31. The coverage further demonstrates the tremendous progress we made during the year on the credit front as nonperforming loans declined by 46% and were less than 1% of outstanding portfolio loans at the end of the year.

Fourth quarter core bank pretax earnings totaled $3.5 million, a decrease compared to $10.4 million for the third quarter of 2013, but a 70% increase over the fourth quarter 2012 results. The fourth quarter of 2013 results included a $2.5 million provision for loan losses compared to a $0.7 million benefit in the linked quarter, and was generally in line with charge-off and loan growth experience during the quarter.

Also, the quarter included additional expenses associated with the previously discussed repayment of Federal Home Loan Bank advances of $2.6 million, branch sale expenses of approximately $1 million, and an uptick in compensation related expenses for the achievement of certain short- and long-term incentives, which were not thought to be previously achievable.

Going forward, we expect to return to our previous run rate of noninterest expenses. We remain focused on actively managing and monitoring expenses as we execute our strategy. As such, growing the pretax earnings of the core bank remains our highest priority.

However, as I previously mentioned, we still expect covered assets to favorably contribute to 2014 earnings and we have teams in place dedicated to maximizing the earnings of these assets as they afford capital for our plans for growth. Capital levels were greatly enhanced during 2013 as a result of our strong earnings and conversion of subordinated debentures to common equity. Tangible common equity to tangible assets increased 176 basis points to 7.78% at December 31. And our tier 1 common ratio expanded by 238 basis points to 10.08% to end the year.

Our 2013 earnings resulted in a 13% return on average common equity and was in excess of 1% on average asset. We are proud of the 2013 earnings performance and are equally pleased with the progress we made to enhance our capital position and improve our credit quality metrics. We believe that our efforts to align these important components of our financial position at the end of 2013 bode well for our future growth plans.

Thank you again for joining us today and, at this time, we will open the line for any questions.

(Operator Instructions) Chris McGratty, KBW.

Peter, one of your competitors last night wrote down their [IA], given the expected [little] shorter life and the better performance of the credit book. Can you remind us the size of the indemnification asset and how you guys are thinking about that asset with the upcoming loss share?

Yes. Hold on. We are looking it up.

The indemnification asset is about $34 million at the end of the year and we continue to make our estimates as they progress for each of the deals. One of the loss share agreements is expiring at the end of the year, as we noted, and we continue to make estimates about the losses on the loans and the amount we're going to receive from the FDIC. And we continue to make adjustments where necessary.

So if I interpret those comments, does that mean you feel comfortable with the likelihood that you won't have to write it down sometime this year?

Well, I think the answer is that you continue to see us making progress and writing that down as we reflect our estimate. So, at December 31, 2012, it was a $60 million IA and now we are down to $34 million. So there is some level that, as we continue to improve the performance that gets written down in the net revenues that you see in our summary table. So yes, we continue to look at it every quarter and make progress and adjusted it downward as necessary.

We wouldn't expect any significant surprises.

Okay. That is what I was kind of after. Thanks.

In terms of the core margin and how it has been incredibly stable and the actions you have taken to kind of take out some of the expensive funding, can you help us on expectations for core margin in 2014? And how should we be thinking about the size of the investment portfolio and the loan growth expectations, kind of putting it together? Thanks.

Why don't we take that in pieces? Scott's comments, as it relates to local competition, it really is -- margin pressure is coming from loan pricing. So in that context, our expectation is that it will continue. We don't think it will lessen dramatically this year. So we see modest compression in core margin in 2014.

Having said that, in terms of loan volume, I will let Scott comment. He talked about the pipeline. I think we are fairly encouraged, but you might want to say more about that.

Yes. I think origination activity is steady, particularly in the EVL and life insurance premium niches. I think we feel good about that.

I think we feel good about bringing three new RMs on board in Kansas City, which will give us some new prospects, particularly C&I business in Kansas City. I think we feel pretty good about protecting our existing base. We have been very successful in doing that.

So, the other piece is the payoffs, and as I mentioned, we have really seen that moderate. We have really taken a deep dive into the portfolio and on a loan by loan basis and tried to be proactive where we felt that was necessary.

And on the investment portfolio, I would say we expect to keep it around the same size of percentage of assets. I wouldn't expect to let it decline meaningfully nor do we have any plans to increase it meaningfully.

Okay. So it sounds like the pipelines are good from the loan perspective; payoffs, maybe less. So, net portfolio growth might be a little bit stronger in 2014 than 2013. Is that fair?

I think that's fair. Yes.

Jeff Rulis, D. A. Davidson.

Question on the wealth management. In the down year-over-year, I guess I just wanted to -- some of the removal of the locations in Arizona, is that likely the fact that why it was down?

Yes. A big component was Arizona. We have done some thinning here in St. Louis in terms of unprofitable accounts. You noticed a big drop in assets under administration. And that related to a single large custody account that rolled out in the fourth quarter.

It was basically a consolidation of a number of accounts at various institutions, one of which being ours. It had a big impact on the asset base. It did not have a big impact on the revenue base because it was a custody account.

Got it. Okay. So going forward, I guess if you look at 2014, do you look to build revenues or is it just a lower expense base, or a bit of both?

We are looking to build revenues. I think the fourth quarter was a good indication in terms of new business. We feel pretty good about that. So we are looking to build revenues.

Okay. Great. And then, just on the provision side, there was a couple construction loans added. Is that growth that elevated provision? I mean, elsewhere you had some OREO gains and some other movement. Maybe just a general comment on the credit as it relates to the provision.

Yes. This is Steve Marsh. The credit quality, we did see continued improvement in the fourth quarter and we expect -- you know, there is not a lot of room for further improvement. So I think the provision level and the allowance levels are kind of what we are expecting in 2014.

The non-performers that were added were real estate loans. They were previously identified as problem credit, so they didn't come as a surprise.

Okay. Then, one quick last one on the tax rate. Do you expect that to normalize in Q1 back in the 34%-ish range?

Yes. Absolutely. We expect that our full-year rate at right around 35% in 2013 would be about how we are thinking about it going forward.

Andrew Liesch, Sandler O'Neill.

Just one question for me, and it kind of revolves around the commercial real estate that you have in Kansas City, because I know that had been paying down, or it was tougher to keep some of those clients. But now it sounds like maybe that portfolio is moderating in general. I was kind of curious, what has been going on in Kansas City? Are these clients that you are comfortable keeping or are you just able to compete better now?

Yes. I think we feel good about the clients that we haven't Kansas City and the real estate portfolio. I do think a number of the ones that paid off last year were problems related to problem credits. Much of our growth there was C&I in the quarter, so we continue to emphasize on that, but relative to the payoffs, I think we feel good.

Brian Martin, FIG Partners.

One thought is the new relationship managers you guys brought on board in Kansas City, are those currently reflected in the fourth quarter's numbers or will they be -- are they more a first quarter and a 2014 event to the P&L?

Yes. Brian, we added them pretty much in the fourth quarter, so there really isn't production relating to those RMs in 2013. There is a senior VP and two VPs, so we feel like we are positioning them over a period of time to bring some business over and have some impact at some point during the year.

Okay. And then, Peter talked about the pricing being the key driver of the margin, kind of the pressure you are seeing there. The loan yield this quarter -- the portfolio loan yields were actually up a little bit for the first time in a number of quarters. I guess just trying to reconcile that there is still pricing pressure, but it looks like you are seeing some stabilization on the loan deals. Could you at least give us a little color surrounding that?

I think pricing -- I think we have mentioned in the past that we have tried not to play the rate game on commercial real estate, and that was a number in the past -- that you have seen in the past. We have replaced that, I think, with growth in some of our niches which tend to have higher pricing, EVL being a good example.

I think we have also been able to protect the base on pricing with -- a good number of our relationships are smaller operating businesses, and those are very relationship oriented. We haven't seen the pricing pressures that we have seen from some of the larger midmarket deals.

Okay, and I guess maybe just one last thought was the Gorman and Gorman. Keene, you talked about rationalizing some of the expenses. I mean, how would you characterize the expenses today in that business? I mean, how much opportunity is this for you to kind of (technical difficulty) -- still inflated in the fourth quarter is the way to think about it?

Yes. I think we saw it towards the end of the fourth quarter that it really stabilized. So I think the rationalization comes with that run rate. I think we still want to position the business, obviously, to grow relative to the opportunity. We feel there is an existing portfolio, given that has really been a reactive strategy for us in the past. So I think the idea would be to downsize expenses to a point where we still can be productive in that business relative to the existing clients.

Okay. And the last thing I had was just the covered portfolio. Keene, I thought you gave what the balance -- what your projection is for 2014. I guess (technical difficulty) if you gave it. I thought you did.

I did. It is $108 million that we are projecting on average for the year.

And that's for the full year?

Yes.

(Operator Instructions) Chris McGratty, KBW.

Peter, just to follow up on capital, given where you sit today, is there any contemplation that 2014 might -- you guys might entertain a bank acquisition?

Obviously, our focus is on talent acquisition and that is what we have been doing. That is our preferred option.

I would say we have gotten a little more focused on the potential for an acquisition. We are doing some work around that. And I will just say what I've said before. I think the drivers for us are really, can we find a circumstance where we can advance some strategic objectives. That would be important to us, and also, find an opportunity that adds franchise value as opposed to just adding assets.

So we are doing a lot of work around it. There is nothing in the hopper, but I think we need to keep our eyes open and we need to be aware, and that is what we are doing.

It appears there are no further questions, so I will turn the conference back over to our presenters for any additional or closing remarks.

I don't have anything to add, other than to thank you all for being with us and thank you for your interest in EFSC. And we look forward to seeing you at the end of the first quarter. Appreciate it. Thank you.

This concludes today's presentation. Thank you for your participation.