Enterprise Financial Services Corp (EFSC) 2014 Q1 法說會逐字稿

Good day and welcome to the Enterprise Financial Services Corporation Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Peter Benoist, please go ahead.

Thank you, Kevin, and good afternoon, everyone, and welcome to the Enterprise Financial first quarter earnings call. I'd like to 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 as a result of various important factors including those described in our 2013 Annual Report on Form 10-K and in subsequent filings with the SEC. Forward-looking statements speak only to as of today, Thursday, April 24, 2014, 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.

I am joined today by Steve Marsh, Chairman and Chief Credit Officer of our bank; Scott Goodman, the President and CEO of our bank; and Keene Turner, our Chief Financial Officer.

If you had a chance to review our release, you saw that we reported $0.30 in fully diluted earnings per share for the quarter characterized by solid loan growth, which, as Scott will detail, emanated from all three of our markets and while somewhat backended in the quarter has continued, and it bodes well for the second quarter.

We had another strong quarter in terms of asset quality with a 26% linked quarter decrease in nonperforming loans to 71 basis points of portfolio loans and nonperforming assets declining to 81 basis points of total assets. Reserve coverage on nonperforming loans increased to a healthy 180% and chargeoffs for the quarter were a modest 8 basis points.

On a linked quarter and year-over-year basis, though, we did see declines in both net interest margin and net interest income. On a linked quarter basis core margin, net of the impacts of PCI loans and the high level of prepayment fees experienced in the fourth quarter of last year, remained relatively flat. Year-over-year core margin trends reflect the impact of a lower level of interest rates on newly originated loans.

While Keene will give more detail on the trends in net interest income and net interest margins, suffice it to say that we continue to expect some modest margin compression resulting from intense price competition in all of our markets.

Our core pretax earnings nearly doubled from the prior fourth quarter, but declined 13% from the year-ago quarter as a result of compressed margins and modest loan growth in the first half of the year, as we avoided taking substantial loan pricing and duration risk principally in the commercial real estate segment of our portfolio.

Since June 30 of last year, the commercial real estate and construction segments of our loan portfolios have stabilized and commercial and industrial loans have shown an annualized growth rate of 13.5% and represent 49% of total portfolio loans. We believe these trends bode well for loan growth prospects in future quarters as well as driving a more asset-sensitive balance sheet.

I'd like to ask Scott Goodman to take a moment and characterize the nature of our loan activity during the quarter to give you some color on our markets and to comment on our fee businesses. Scott?

Thank you, Peter. In general, growth for the quarter was driven by continued success in C&I-focused relationships with some elevated emphasis on select commercial real estate opportunities and aided by continued downward trends on commercial real estate payoffs.

Growth in the C&I sector includes success in expanding our niche lines of business as well as traction on new relationship pull. Organic loan demand from existing clients remains modest, and line usage also remains stagnant compared to last quarter.

On a market level, we experienced good growth in both the St. Louis and Arizona markets offset by a slight decline in Kansas City. A majority of the St. Louis growth was attributable to new C&I originations with some contribution from commercial real estate.

We continue to see momentum around our niche lending areas, principally life insurance premium finance, up 10% on an annualized basis, and enterprise value lending, or EVL, which was up 30% annualized for the quarter. M&A seems to be driving a lot of activity primarily within our EVL niche but also in connection with portfolio-centered strategic acquisitions and succession planning.

We also experienced some growth in commercial real estate resulting from targeted calling on existing relationships. This commercial activity was complemented by decent growth in our consumer and residential portfolio product sets as we've begun to get some traction on our cross-selling efforts.

Following growth in Q4 of 2013, KC originations slipped modestly in the current quarter. On a positive note, paydowns moderated as well, and origination activity trended up throughout the quarter.

We are also getting traction on the expansion of our EVL niche to the Kansas City market. The positive trends resulted in net loan growth in the month of March, and the short-term pipeline is particularly strong in Kansas City with a good mix of commercial real estate and C&I opportunities.

The Arizona growth was centered around origination of several significant new C&I relationships and was assisted by moderating payoffs as commercial real estate loans.

Momentum in the quarter improved toward the latter half, and fundings were backend loaded. In that regard, the 90-day pipeline would show us carrying this momentum forward in C&I, highlighted by continued niche lending expansion and some elevated commercial real estate volume.

We are seeing some opportunity to obtain fixed-rate yield under five years by expanding our relationships with seasoned developers and investors including some multi-family, health care, and low-income housing projects.

The competitive environment remains elevated in all of our markets with continued emphasis on low rates but also more widespread use of aggressive credit terms. These included issues such as extended amortizations, reduced or eliminated personal guarantees, and higher collateral advance rates.

Overall, competition is more intense around the middle market C&I and larger commercial real estate deals as the large and super regional banks remain down market with aggressive pricing.

On the fee side of our business, we're experiencing positive trends in wealth management resulting from new advisory relationships and some improvement on the transactional side of the business.

The decline in service charge revenue mainly reflects some seasonality but is overall better than expected due to cross-sell of new C&I relationships and continued focus on reducing fee waivers. The quarterly decline in the state tax credit business is purely seasonal and has continued to be a steady and profitable niche on an annual basis.

Lastly, we experienced a modest decline from fourth quarter in mortgage originations consistent with the environment. Although pre-approval applications and internal referrals are up year-to-date, these have not yet translated into closings, as buyers struggle to find inventory in our markets.

We continue to adjust our expense base in relation to the demand.

Now I'll pass it over to Keene Turner for the financial discussion.

Thank you, Scott, and good afternoon. As you heard from Peter, we reported $0.30 of earnings per diluted common share for the first quarter. First quarter results were solid, and there were several highlights, which I believe provide the momentum on which to build for the remainder of 2014.

The first quarter marks the third consecutive quarter of mid-single-digit annualized growth in our portfolio of loans. At 7%, or $37 million, we followed up fourth quarter loan growth of 5%, or $27 million, and 6%, or $32 million for the third quarter of 2013.

Asset quality continues to further improve and annualized net chargeoffs for the first quarter were 8 basis points compared to 33 basis points for the fourth quarter. As a point of reference, net chargeoffs for the year ended 2013 were 30 basis points.

During the first quarter of 2014, nonperforming loans declined to 0.71% of total loans, and nonperforming assets declined to 0.81% of total assets. The allowance for loan loss coverage of our nonperforming loans increased to 180% at March 31st.

Finally, non-interest expense returned to pre-fourth quarter levels at $21 million for the first quarter of 2014.

Net interest income on a core basis was $24.1 million, and the resulting net interest margin was 3.44%. Both measures declined from the fourth quarter levels due primarily to $600,000 less on a fully tax equivalent basis of loan prepayment penalties on a link-quarter basis. The reduced level of prepayment income impacted net interest margin by 9 basis points.

Additionally, exclusive of the impact of fluctuations of loan prepayment fees from the fourth quarter to the current quarter, net interest margin results met our expectations.

Assuming a similar level of prepayment, net interest margin would have been relatively constant as the reduced interest expense from the fourth quarter, federal home loan bank prepayment, offset some modest compression in core loan yields.

The core loan yield's performance is inclusive of approximately 5 basis points of net interest margin compression that results from continued runoff in higher-yielding PCI loans each quarter as the contractual interest income on those loans is included when we present our core net interest margin.

Margin discussion aside, we're focused on growth in dollars of net interest income, and it's important to note in that context, the majority of the loans booked in the first quarter were variable rate as we continue to have success in acquiring new and growing with our commercial and industrial customers.

Given where we are in the interest rate cycle, we believe that our model provides the natural advantage, over time, in the quality of loans we are banking not only from a relationship and credit perspective but also from an interest rate risk perspective. Compared to one year ago, variable rate loans increased 9% and are now 62% of total loans, and we continue to maintain an asset-sensitive interest rate risk profile.

On the liability side of the balance sheet, total deposit costs increased 2 basis points to 44 basis points for the first quarter primarily due to shifts we experienced out of DDA and into money market accounts. Deposit levels declined during the quarter from expected seasonality consistent with what we have historically experienced in previous first quarters.

We believe that our focused efforts to gather additional and diversified sources of deposits has helped this trend and is important for long-term success.

The overall cost of funding improved another 5 basis points to 68 basis points for the quarter and has been reduced 18 basis points from the prior-year quarter. This improvement demonstrates our efforts to continue to drive down our funding costs in order to mitigate declining asset yields while balancing maintenance of sufficient liquidity to support our growth plan.

Purchased credit impaired, or PCI loans, contributed $8.7 million of interest income during the first quarter but declined when compared to the fourth quarter of 2013. The yield on PCI loans remained stable in the link-quarter at 26%, but balances declined $15 million and totaled $110 million to end the quarter.

Additionally, accelerated cash flows were slightly lower at $3.9 million for the first quarter. Despite the continued runoff in PCI loan balances, the contribution from covered assets improved during the quarter to $1.9 million on a pretax basis compared to $1 million in the fourth quarter. Driving this increase was a reduced level of change in the FDIC receivable of $2.1 million, which was offset by slightly higher provision on PCI loans of $1.1 million.

We expect the average balance of PCI loans to be $113 million for 2014 and highlight that the yield has been relatively constant at 26% for the last four quarters.

Additionally, it's important to note that we continue to meaningfully reduce the balance of the FDIC loss-share receivables each quarter. The balance at March 31st was just under $30 million, a $4.5 million reduction during the first quarter and a $27 million reduction compared to March 31, 2013.

As our estimates of overall losses have declined, we write this receivable down to its expected value over the term of the loss-share agreement. However, we do expect some level of volatility in the provision for loan losses and the receivable balance, going forward. But we think that the magnitude of the swings will abate slightly beginning after the second quarter.

The carrying value of PCI loans with $110 million at March 31st, net of $42 million of accretable yield and $95 million of non-accretable difference. As loans work out and cash flows occur, over time, our positive experience with accelerated payoffs suggest that there is a potential for a portion of non-accretable difference to result in additional income.

As we look forward, we continue to focus our efforts on improving the contribution of pretax earnings on a core basis. Reported pretax income was $8.9 million for the first quarter and results, excluding covered assets or core contribution, was approximately 80%, or $6.9 million.

This trend continues our progress toward driving earnings growth from our core business while continuing to maximize the results of covered assets and PCI loans. Core pretax income increased $3.4 million during the quarter and exclusive of items that were isolated to the fourth quarter was relatively consistent performance except for a reduction to the provision for loan losses on the portfolio loans.

Continued asset quality improvement, mainly lower net chargeoffs in the quarter, which were only $400,000 compared to $1.8 million during the fourth quarter, evidenced the continued asset quality progress.

First quarter net chargeoffs of 8 basis points were aided by $1 million of recoveries. To the extent we're able to maintain our solid asset quality metrics and trends, we are optimistic that we will continue to be able to maintain a relatively low level of credit costs on our portfolio loans.

Our first quarter expenses returned to a more normal run rate at $21 million. Compared to pre-fourth quarter levels, compensation and benefits experienced some seasonal increases from payroll taxes and related items in addition to some investments made to bring several risk functions in house.

However, continued focus in other areas helped maintain overall expense levels. We remain focused on our expense run rate and any opportunities for improvement, and we continue to actively monitor and manage expenses as we execute our growth strategy.

I will conclude my comments with a quick summary of our capital position. Tangible common equities and tangible assets increased above 8% to 8.25% at March 31st. Our current capital level combined with the expected performance of our covered assets and our core bank provides a solid base from which to grow.

Additionally, in line with tangible common equity trends, our regulatory ratios continue to be strong and position us well at the end of the first quarter.

At this time, I thank you for joining us today, and we'll open the line for any questions.

Thank you. (Operator Instructions) Jeff Rulis, D.A. Davidson.

With the TCE now above 8%, I guess, has that prompted any more M&A discussions internally? Or revisiting the dividend, I guess, has that led to more aggressive, sort of, capital usage discussions?

Yes, Jeff, this is Peter. I think we've indicated in prior calls that on the M&A side we are more intentional. We are having discussions. There's nothing active currently, but I'd say we are putting more attention toward that, given capital ratios and potential opportunities. We're looking in market, we're not looking out of market, in that respect, but we continue to focus on that subject.

In terms of the dividend, no. We've not really formally addressed the question of the dividend at this point.

And then maybe one for Keene on the non-interest expense. You guys mentioned kind of finding a base here. Does that suggest that we see modest growth from here? I mean, the semi-comp was up a bit in the first quarter, but at that $21 million base, I guess, have to see that.

I think we're comfortable at the $20 million to $22 million level that we've guided to before. My comments were really aimed at making sure that we were clear on the components of how that's shifted over the last several quarters.

Okay, then, maybe just one last one on the credit side. It seems like you've had some pretty good success reducing that NPA number. I guess the makeup of remaining NPAs, is it more granular in that it would be more difficult to kind of show the same pace of cleanup? Or how do you see that group of NPAs in terms of size and ability to produce the number?

So, this is Steve Marsh. As we've talked about in prior calls, we're a business-oriented bank, and so it's kind of lumpy. I think we're comfortable with the existing level. I wouldn't expect that we'd continue on a downward trend at the same rate that we've been going down.

Fair enough. Thanks.

Chris McGratty, KBW.

Peter, on the -- maybe I missed it on the growth. You talked about a lot of the growth in the quarter was at the end of the first quarter. Is that to suggest that we should see an acceleration in the rate of loan growth over the balance there?

Yes, I think we're implying that, Chris. It was backended, Scott mentioned that, and I think what was encouraging -- I made my comment formally -- that we're seeing it in all three markets. I think Scott also alluded to it, particularly in the Kansas City market where we're seeing some very good strength right now. So, yes, I think we're encouraged by the trend and would expect it to continue.

Great. And a question on M&A -- it seems like conversations are picking up. You guys do have some earnings pressure with the runoff portfolio, but you've built a C&I platform that I think a lot of banks would be interested in.

Peter, this is your second stint with the Bank, as running it. How do you think about long-term outlook for the Company in terms of independence?

Well, I think we're running this, obviously, for the shareholder, and in that context, we're very aware of the fact that we're a public company, and we're for sale every day of the week. So in that respect, both the management team and the Board is very realistic about the environment.

Having said that, we built this model because we think it can outperform over the longer term. I've spent a lot of time on these calls talking about strategy in the context of where we see the potential for outperformance, and that's what we're working on as a management team.

So I think, in that respect, our current view is, as long as we can continue to deliver from a shareholder perspective, that issue will take care of itself. If we can't do that, then we may be looking at other alternatives.

Fair enough. Thanks a lot.

(Operator Instructions) Andrew Liesch, Sandler O'Neill & Partners.

So it looks like about five years ago at the end of this year is when the Valley Capital deal took place. Are there any loans left with the loss sharing agreement on that right now?

We don't have a -- there's very few, and I think we're well reserved, well positioned for that, so that really should be a non-event for us.

Okay, and then just based on your comments on, like, the dividend, it sounds like, I would imagine, you haven't discussed share repurchases, either. Is that correct?

That is correct.

Got you. Those are -- the rest of my questions you guys have already covered. Thanks so much.

Thanks, Andrew.

(Operator Instructions) Brian Martin, FIG Partners.

Hey, Peter, I guess, or I guess, maybe, Steve, could you just talk about the strengths you're seeing in Kansas City? I guess, is that tied to the kind of the market conditions getting better there? Or is it the new people you've hired? And maybe just -- in that context, the C&I growth you guys have put up over the last year, when you look at the $110 million or so of growth over the last 12 months, what part of that is coming from Kansas City versus coming from St. Louis?

Brian, it's Scott. I'll take that one.

Okay.

Yes, on Kansas City, I would say we did add talent, at least, at the end of last year, and I would say I can directly attribute the list to specific new RMs, but spreading out the portfolio has resulted in improved productivity, and increased market activity for the team, overall. And as I mentioned, the pipeline for Kansas City has really been building, and I would say it's a combination of both C&I and CRE. And that pipeline does include contributions from some of those new RMs. So I think those things take time, but I think we're seeing the activity build.

I think, as we look forward, EVL is a strategy that we've had good success in spreading over to Kansas City. We have dedicated folks up there that are focused on that niche; that are focused on their own markets and their own sponsors. So the growth there has been good.

Okay, and then, just, the growth over the last year, I mean, how much would you attribute to Kansas City versus, kind of, St. Louis?

I think on a weighting basis more of the growth has been in St. Louis and in Kansas City. But, as a reminder, last year we spent a good portion of that year recruiting and filling those open positions, shifting the management around. So I feel good about the way we were able to preserve the portfolio in Kansas City, and now we're really positioned for growth there.

Okay, all right. And then just, maybe, from a margin standpoint, just kind of the -- as rates begin to rise, I guess, kind of, the amount of variable rate loans versus fixed rate loans you guys have and just kind of how you're thinking that impact will affect you guys as rate tends to move higher?

This is Keene. We're -- I mentioned in my comments we're 62% variable rate, and we're very well positioned for rising interest rates. We have a fair degree of asset sensitivity, but we're cautious to be too asset sensitive given, kind of, the give up in the short term. So we're trying to balance that but, certainly, we're positioned for rising rates, and we feel good about where we are and, as I reiterated, I think we feel good that our model fits well with an expectation that rates will rise at some point.

Okay. In the new loans you're putting on today, I mean, because the prepayment has kind of affected things this quarter, at least on the yield side, what are new loans coming on the books at typically today?

Yes, Brian, I would say it's obviously extremely competitive. I think we've been -- we've had a good -- very effective at holding margin with existing clients. And I would say, particularly, in loan relationships under that $1.5 million, $1 million threshold, which is a good portion of our portfolio.

I think, as you move up into the larger middle market, large commercial real estate deals, we are seeing, for example, fixed rates in the five-year range in the mid-3s. Which is aggressive. I think if you look at larger C&I deals and the middle market, you're seeing maybe mid-2 to low-2 spreads over LIBOR on floating rate deals.

Okay, that's helpful. And then just from an M&A perspective, I mean, how -- you kind of mentioned that you're looking end market. As far as the capacity to -- how much capacity, I guess, do you guys see yourselves as having? And I guess what are the typical, size-wise, where is the sweet spot for what you're looking at?

Yes, Brian, this is Peter. It's a little tough to answer. I think, in this respect, we've indicated, I think, in the past as we focus on the topic, we're primarily interested in trying to find organizations that, I'm going to say, are complementary to us in terms of our business model, which narrows the field and limits the options quite a bit, to some degree.

What falls out of that from a size perspective can vary, but generally it would be, certainly, under $1 billion, and I'd say over $250 million.

Okay. Okay, all right, I appreciate it. Thanks very much.

Thank you, Brian.

(Operator Instructions) And there are no further (multiple speakers) --

Go ahead.

Go ahead.

I was just going to say, if that's it for the Q&A, we'd just like to thank you once again for your interest in EFSC, and if you have any follow-up questions, feel free to contact us individually -- Keene and myself, Scott or Steve, and we thank you very much for joining the call.

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation.