Enterprise Financial Services Corp (EFSC) 2015 Q2 法說會逐字稿

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

Thank you, Kevin, and good afternoon, everyone. Thank you for joining our second quarter conference call. Joining me on the call today are Scott Goodman, the President of our Bank, and Keene Turner, our Chief Financial Officer.

I'd 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 2014 Annual Report on Form 10K and in subsequent filings with the SEC. Forward-looking statements speak only as of today, Thursday, July 23, 2015 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 second 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.

Our second quarter results exhibited continued strong performance in our core fundamentals. Our reported earnings of $0.43 per diluted share represented a 19% increase over prior-year earnings and, importantly, core net income represented just under 90% of reported earnings.

Loans rebounded nicely in the quarter, increasing $107 million or 18% on an annualized basis, led by strong growth in commercial and industrial loans, which increased $70 million or 22% annualized. We experienced strong demand in our enterprise value lending or senior debt and life insurance premium finance specialty segments, as well as general commercial and industrial loan categories. Additionally, our portfolio loan yields increased 2 basis points on a linked quarter basis.

Core deposits, excluding certificates of deposit, increased 3.4%, or 13.6% on an annualized basis, as we saw good success in our targeted deposit calling strategies initiated during the first quarter. At the same time, our overall cost of interest-bearing deposits decreased 2 basis points linked quarter contributing to our ability to hold our current core net interest margins constant on a quarter-to-quarter basis and to expand core margins 5 basis points year over year.

Continual management focus on improving core performance has resulted in increases in core revenue of 5% and 9% linked quarter and year over year. At the same time, total expenses for the Company declined 2.5% in the linked quarter and have decreased 4.8% from the year ago period. The Company's core efficiency ratio has improved materially from 64.5% in the one year ago period to 57.6% in the second quarter.

The combination of strong loan growth, disciplined pricing, effective debt refinance and tight expense management has resulted in an improvement in core operating performance, producing a core return on average assets and average tangible common equity of 0.93% and 10.4%, respectively for the quarter.

From a capital perspective, we ended the quarter with a tangible common equity ratio of 8.94% and the Board of Directors again increased our quarterly stock dividend from $0.06 to $0.07 per diluted share.

We're pleased not only with the Company's strong performance in the quarter, but with the continued solid momentum that has been generated over the last several quarters. We attracted additional talent in both our St. Louis and Kansas City markets during the quarter as our client-centered, relationship-based business model continues to be an attractive alternative. While market competition remains intense, we're finding that our approach of selling client solutions as opposed to just competing on price is resonating well with our clients and with our prospects.

I'd like to turn it over now to Scott Goodman to give you more color on the markets, the competition, asset quality trends and our pipelines. Scott?

Thank you, Peter.

As you heard from Peter, loan growth for the second quarter was healthy with balances up $107 million. As you can see on slide number 3, this represents a trialing 12-month growth rate of 13%. The increase was spread across all our geographic regions and generally reflects elevated origination activity, complemented by some expected seasonal rebound in several niche lending sectors.

All major areas of the portfolio experienced growth for the quarter, including commercial real estate, construction and development, consumer and residential, with the largest increase coming from the C&I segment of the business. As slide number 4 shows, C&I contributed $70 million or 65% of our increase for the period and continues on a strong growth trajectory of 18% over a year ago.

The components of our growth are broken down by segment on slide number 5. The largest increase of $47 million came from enterprise value lending, or EVL, which is our senior debt product for structured private equity relationships in the M&A space.

Deal activity accelerated in the second quarter following a typically quiet first quarter for M&A. Our EVL teams in St. Louis and Kansas City have continued to expand their relationships with private equity sponsors of small and mid-sized portfolio companies and the Enterprise Bank & Trust brand has gained traction in this space.

In addition to our core markets of St. Louis, Kansas City and Phoenix, we are leveraging sponsor relationships which take us into other markets such as Indianapolis, Minneapolis, Charlotte, Nashville, Cleveland and Dallas. And while competition is elevated in this sector, we continue to garner risk-based pricing for these deals with coupons generally in the 50 to 100 basis points above general C&I.

We've also experienced higher origination levels in the general C&I and commercial real estate sectors leading to healthy growth for the quarter. Steady and prescriptive calling efforts by our sales teams on targeted high-value businesses and top-tier real estate investors have been successful. And several larger new relationships with well established middle market companies in St. Louis and Kansas City were landed in the quarter. This is complemented by continued high activity calling on smaller businesses by our business banking team, which has opened over 200 new relationships year to date.

As I mentioned earlier, we experienced strong performance from all markets in the quarter, shown on slide number 6. The largest portion of growth came from Kansas City, which continues its upward trend in loans. Success there is attributable to focused calling by specialty teams centered around EVL and commercial real estate, together with traction from new talent added over the last 18 months.

St. Louis performance was characterized by growth in EVL and life insurance premium finance, combined with healthy originations of general C&I and investor CRE. In Arizona originations was steady for the quarter and payoffs declined with balanced new business in EVL, C&I and CRE.

Deposits, as shown on slide number 7, are up over the prior and linked quarter and we are focused on executing strategies designed specifically to improve both cost and levels of overall core funding. In general, increases are coming from new relationships, as well as several deposit-specific calling programs.

DDA, as a percent of overall deposits, has declined a modest 2% over the past year. The most recent impact of our strategies has come from programs targeted deposit-rich business types and have generally included interest-bearing options as we position for elevated focus from depositors on these features. We expect product structure and pricing options, combined with continued focus on DDA from new relationship activity to have a positive impact on our cost of funds over time.

The competitive environment remains robust with respect to both talent and clients. A steady, consistent and targeted communication process is critical to success in both of these areas. We continue to recruit opportunistically in all markets and have added experienced commercial RM and business banking talent in both St. Louis and Kansas City during the quarter. Competition for new business is intense and requires equally adept defense and offense to grow the portfolio. Despite these pressures, payoff levels have remained in line with expectations and were steady with the first quarter.

Most fixed-rate loans have already cycled through the low-rate environment and we continue to take a proactive approach in managing future maturities. Our prescriptive relationship review process also provides for ongoing in-depth discussions with our most profitable relationships creating better communications between our clients and bankers, less price sensitivity and fewer surprises relative to loan payoffs.

Performance in the fee income areas was solid for the quarter with core non-interest income up 15% from Q1. Our core fee businesses are steady and Keene will break this down more specifically for the quarter in his comments. A portion of the increase does relate to fees and the deployment of our existing new market tax credit allocation.

Furthermore, in June of this year Enterprise Financial CDE, our community development entity, was selected by the CDFI Fund of the US Treasury to receive an additional $65 million in allocation of new market tax credits. In this competitive process we were one of only 76 CDEs nationally to obtain an award in this round and the $65 million represents the third-highest allocation in the nation. This is the fourth allocation of new market credits for our Enterprise Financial CDE in the past 5 years for a total of $183 million. This program will continue to be a powerful source of fee income and a key differentiator in attracting new relationships to the Bank by providing much needed capital to businesses in low-income communities.

Credit quality overall remains in good shape, with all of our key indicators at better than peer levels and charge-offs back down for the quarter. Nonperforming loans at 69 basis points represents a slight tick up from the prior quarter end and mainly reflects the addition of three credits, two C&I deals and one commercial real estate. These are not related by industry and have been monitored through our watch process with well-defined workout strategies.

At this point now I'd like to hand it off to our CFO, Keene Turner, for the financial review.

Thank you, Scott.

For the second quarter we continued to build on our earnings momentum and trends for the last several quarters and our financial performance for 2015 continued to improve. Our 2015 return on average assets is 1.11% and our return on average tangible common equity is 12.5%.

Results for the second quarter were favorable, both on a reported and core basis. Slide 8 depicts the adjustments from $0.43 of diluted earnings per share to our core results of $0.38 of diluted earnings per share. Accelerations on purchase credit impaired loans contributed $0.05 per share to overall EPS, while we are focused primarily on continued progress on our financial priorities which relate to core performance trends.

Slide number 9 demonstrates the drivers of the changes in our core earnings per share in the linked quarter. Net interest income dollars grew and contributed an additional $0.02 per share while non-interest income contributed an additional $0.03. Expenses were stable in the quarter and we continued to provide sufficient levels for credit losses despite favorable asset quality measures.

Our core performance further advanced our return on average assets to 93 basis points. Year to date we are 91 basis points of return on average assets, a meaningful improvement from 77 basis points for the 2014 year-to-date period.

Portfolio loan growth resumed this quarter and we returned to our expected 10% year-to-date pace. As you heard from Scot, EVL contributed materially to the loan growth for the quarter. It also aided the continued defense of our 3.46% core net interest margin, which is depicted on slide 10. Loan growth, stable net interest margin and one additional day during the quarter supported a $0.7 million or 11% annualized growth in net interest income in the linked quarter. The resulting core net interest income was $26.3 million.

I think it is worthy to note that our margin performance overcame a headwind of 4 basis points from accelerations affecting the contractual cash flows on purchased credit impaired loans, which are included in core net interest income and margin.

To reiterate, the mix of our loan growth expanded the yield on portfolio loans by 2 basis points this quarter to 4.17%. However, we maintained our modestly asset-sensitive interest rate risk profile as 62% of our loans remain variable rate. Loan type drove the yield improvement, not the mix between fixed/variable or extensions of duration. Our average duration of portfolio loans remains at 3 years.

Our strong growth continues to accelerate our earnings power. I typically focus on quarterly trends in my comments, but I want to point out that core net interest income is $2 million higher than it was in the second quarter of 2014. This revenue growth has enhanced the run rate of core net interest income on an equivalent of $0.25 per diluted share on an annual basis.

Slide 11 depicts credit trends during the quarter. We provided $2.1 million to the allowance during the quarter, resulting primarily from loan growth of $107 million. As a result, our provision level increased in the linked quarter and correspondingly drove a 1 basis point increase in the level of allowance to total loans, which was 1.25% at June 30th. This increase reflects trends in overall credit factors, including peer coverage trend and our overall desire to preserve a high-quality balance sheet. To that end, our level of nonperforming assets, loans and coverages thereof, all remain favorable to peers and we continue to be focused on providing prudently for risk while our loan portfolio grows. We are comfortable with the levels of our nonperforming loans and coverages and our overall asset quality performance.

Slide 12 depicts an increase in core non-interest income of $0.9 million in the linked quarter. Despite that, the second quarter and the third quarter of fee income is usually seasonally lower due to our tax credit brokerage business being seasonally strong during the first and fourth quarter of each year. This increase was primarily due to items included in miscellaneous income, fees from tax credit allocations, fees for selling swaps to customers, and some improved levels of income in both our mortgage and card services businesses. Tax credit allocation fees will remain unpredictable from quarter to quarter due to the nature of the business. However, we're optimistic that we will continue to see positive trends in the latter businesses given interest rates and continued progress in cross-selling efforts.

On the next slide we demonstrate our five-quarter trend in operating expenses, which were essentially stable at $19 million for the quarter.

Combined with strong net interest income and strength in non-interest income, our core efficiency ratio declined below 60% to 58% for the quarter. I will point out again that our continued performance of expenses toward the lower end of our guidance has been driven largely by reductions in professional fees and loan legal expenses.

We're extremely pleased that our core efficiency has declined below 60% and we're especially encouraged that we have accomplished this principally by driving near double-digit revenue growth. That does not mean that there hasn't been hard work to reduce costs and redeployment to support that revenue growth. We're certainly proud of the accomplishment, specifically our ability to rapidly improve our efficiency and operating leverage, mostly through revenues. Nonetheless, we expect to continue to maintain this trend during 2015 as we target quarterly total expenses to be between $19 million and $21 million.

Slide 14 demonstrates the continued progress to consistently grow EPS. Specially, when compared to the second quarter of 2014, we have grown core EPS by 23%. It reflects the summary of all our efforts and we continue to have it as our principal focus.

I remind you of our financial priorities on slide 15 and our progress on each of them compared to the prior year. Our steady growth in net interest income dollars has been and remains our top priority. Our efforts have expanded core net interest income by 9% from the prior year and we were able to enhance core net interest margin despite continued headwinds from runoff of purchase credit impaired loans and a challenging interest rate environment.

Our expectation for growth in portfolio loans of at least 10% also remains unchanged and is expected to drive favorable trends in net interest income dollars.

As always, we intend to continue to take care of the balance sheet by maintaining our credit standards with low levels of problem loans and prudent allowance coverage levels; preserving an asset-sensitive interest rate risk profile as we continue to increase both the amount of net interest income we expect to earn over the next 12 to 24 months and the amount we will earn if interest rates increase; continuing to execute and further develop deposit-gathering strategies while managing capital levels over the longer term.

It's hard to believe we've already reported results for the first half of 2015. We are certainly proud of our demonstrated trends in increasing returns. We've maintained focus on serving the needs of our customers, stayed true to our business model and translated both to growing our profitability. We're also pleased with our ability to deliver significant growth in core EPS as a foundation for delivering long-term shareholder returns. We are committed to building both with incremental progress achieved each period to be accumulated over the long term. We believe this focus on further enhancing the value of our franchise and business model will continue to drive value as we execute our strategy.

Thank you for your interest in our company and for joining us today. At this time, we'll open the line for questions.

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

Thanks. Good afternoon.

Hi, Jeff.

Peter, a question on -- you mentioned bringing over some talent in the quarter. I don't know if you could itemize that in number of lenders and are there a specific lending focus of those individuals?

Yes, Jeff. We brought on a commercial lender in Kansas City. We brought on two here in St. Louis. I think the Kansas City hire was mid-quarter and the St. Louis hires were toward the end of the quarter.

Great. Okay. And I guess trying to revisit the loan growth guidance, Keene, you mentioned kind of sticking to the 10% seeing as kind of year to date you're pushing that number. Is there some expectation for runoff in Q4? I guess the pipeline sounds like it's fairly positive into Q3. Maybe you could just wrap some more color around your guidance versus the already year-to-date performance.

I guess I would say I think we would expect it to be a little bit more stable as we moved through the end of the year. Depending on when we get payoffs and when we actually get some deals closed, it does vary quarter to quarter. I don't think we expect to see quite as much disparity between the quarters as you saw in first versus second. I'd expect it to be a little bit more steady going into third and then we typically have a slightly stronger fourth quarter based on our history.

Got it. Okay. I'll step back. Thanks.

Thanks, Jeff.

Thank you.

Chris McGratty, KBW.

Good afternoon, everybody.

Hi, Chris.

Peter, maybe a question on capital for you. You've got the buyback and you guys are generating quite a bit of capital despite pretty good growth. What's the thought process on the 2 million share buyback at this point?

Well, I think on one hand we just wanted to have it in place from a board perspective. We did not have it in place, so positioning it, I think, was sort of issue number one, which we did last quarter. There's no near-term plan necessarily to exercise on it because our growth rates are pretty good right now. And I think our expectation is that core growth will continue to be pretty good, as we've indicated. So, I'd say it was more a positioning move from our perspective than any immediate capital move in terms of how we're thinking about it. Obviously, as you do know, we increased the dividend twice in the last two quarters, too. So, I think in that context we feel pretty good about our capital position.

Okay, that's helpful. And just on -- just given the loss share, we've seen some of your peers kind of terminate them. What's the thought process kind of at this point?

I think we've said this before. We certainly are aware of what's going on and we have interest if it makes sense to us economically. So, I think you've maybe seen a shift in the posture of the FDIC and I think we've seen institutions be able to do it under terms that are advantageous both to the FDIC and the institution and I think we're no different. So, we'd be looking at it that way. And those deals are, at least from a non-single-family perspective, will be out of coverage in the third quarter of next year, so we certainly are motivated to so something there if it makes sense.

Okay, great. The last question, more on the -- maybe for you, Keene, as well, on the positioning for higher rates. I think you talked about 62% of the book floats. I guess I'm a little bit surprised by the modest sensitivity to rates comment. I guess I would have presumed you guys -- [I mean if this is] conservatism on your behalf. I'm interested in kind of how you guys are thinking about the margin kind of going forward. Thanks.

Well, I guess that's really a couple of different questions. So in terms of margin, I think we still expect there'll be a little bit of headwind. That's principally driven by the underlying contractual cash flows on the PCI book. So we overcame 4 basis points this quarter. We overcame 5 basis points in the first quarter. So, we've mitigated effectively 9 basis points of margin compression year to date.

In terms of asset sensitivity, I think what we're really looking at is driving improved earnings in all interest rate scenarios, so we want to get it now and later to the extent possible. So that's the reason for the positioning on modest asset sensitivity. And I'd also say, too, in how that works itself out and positions itself, the percentage has decreased or stayed relatively stable since we did the restructure at the end of the year, but that's principally due to the fact that we've also driven our expectations for base net interest income up during those periods as well given the strong loan growth we've had.

Okay. Thanks a lot.

Sure.

Andrew Liesch, Sandler O'Neill & Partners.

Hey, guys.

Hi, Andrew.

I'm interested in following up on a capital question with the dividend. Like, I'm just curious if there's like a payout ratio that you target or if maybe just this $0.07 level just felt like the right number.

I think the dividend's become part of our overall capital management strategy. As we continue to drive earnings up, I think you'll see us continue to reevaluate that periodically. We've declared $0.07 for the third quarter and we're going to continue to look at it as we move. I also wouldn't say we necessarily have a target payout ratio, but it's certainly a component along with the share repurchase program we referenced earlier that we'll utilize to flow or manage our capital build as market conditions persist.

Okay. And then just on the higher provision, it certainly sounds like you're just planning on just building a -- just socking away some reserves. But are you seeing anything in your markets that might concern you?

I'll take that, Andrew. No, I would say there's no major trends or signals that are concerning. The addition of the nonperformers this quarter were varied by industry and market, so the answer is no, no major signals.

Very good. Thanks so much.

Thanks, Andrew.

Thank you.

Brian Martin, FIG Partners.

Hey, guys.

Hi, Brian.

Maybe, Keene, could you just talk a little bit about expenses? I mean it sounds like you've brought these -- you've brought them down and kept them stable here, but I mean the collection costs and those other ones that you've kind of pulled from don't seem to be available anymore and you're still growing the Bank and investing in the franchise. I guess kind of the way to think about the expenses longer term as far as a growth rate, sustainable growth rate for the core bank, I mean is it kind of a 2% to 3% type of level? Is it a bit more or less than that?

I guess I would say absent any professional fees or loan legal, I think we expect them to trend toward the bottom of our guidance. We do have plans to make investments over time to continue our growth rate, but for the next two to three to four quarters I think we'd expect them to stay where they are. And our recruiting efforts, I think -- we continue to be in the market and trying to meet the right people and our expense targets wouldn't necessarily preclude us from making the right investments, at least in terms of acquiring talent. So, hopefully that gives you some color there.

Yes. Okay. And as far as just the funding costs, I mean loan-to-deposit ratio is kind of back up a little bit this quarter, I guess. Any pressure that that's going to create on funding the loan growth you're looking at in the second half of the year as far as how that impacts?

I think we're very comfortable with where we are. We certainly have become much more focused on deposit gathering. We tend to have a trend of gathering deposits more gradually, where our loans tend to grow pretty precipitously in one quarter and then maybe ease off the next. So, we tend to look at both on average and where we're going. So, I'm not -- I mean I don't really have a concern. I think we're encouraged by the fact that our growth in the deposits actually blended down our cost of deposits and our overall cost of funds. So, I think we're feeling fine about it and there's really no concern or real discussion about what impediment that might be to our loan growth.

Okay. And as far as -- you guys just talked about over the last couple quarters, but just the potential for M&A. I guess is that something you're still kind of looking at? Are there more or less opportunities? I know you kind of at least identified the targets that might fit for you, which I think was pretty limited, but any more update on M&A and its potential and so forth?

I wouldn't say that there's really any shift in our posture there. I think we continue to say that anything that, on a long-term basis, would meaningfully accelerate any of our financial priorities would be something we'd look at very carefully and be very intentional about. But otherwise, we're not really seeing any increased or decreased level of interest or activity right now. The environment remains about the same.

Okay, perfect. Thanks very much.

Thanks, Brian.

Daniel Cardenas, Raymond James.

Hey, guys. Good afternoon.

Hi, Dan.

So just kind of following up on the M&A question, I mean is the preference for you guys more on acquiring individuals and teams or would it be more on acquiring organizations?

Yes, Dan, this is Peter. Obviously, if you've heard our comments we're really focused on core fundamentals here in that context. So acquiring talent is something we're very interested in and we're very focused on. And if you said what's our preference, it's to acquire talent. We're firm believers in organic growth. We've talked a lot about opportunities in the marketplace relative to institutions that would have the kind of culture and capabilities that we have and it's just -- the field is limited, let's put it that way, from a target perspective. So, we do think the right strategy is to continue to hone in on trying to bring talent on the platform and growing the book organically.

And what's the market like for talent right now? Are you seeing a lot of opportunities to talk to folks or does that ebb and flow?

It's a long-term process for the right people. Some of the folks that we have dialogue with, we've had dialogue and continue to have dialogue with for extended periods of time. And it's a question of really being there at the right time at the right place. So, there's really no specific answer to that other than making sure we're communicating with the folks that we think could do exceptionally well on our platform and they're aware of our interest and when the right time occurs, we're the alternative for them. And we find with that kind of a strategy, that works pretty well for us.

Okay. And then the last question, is there any geography that you guys have a preference in expanding that talent base in?

Yes. I'd let Scott comment. I would say Phoenix is a market that, from a talent perspective, we'd like to have more success. I'd put it that way if you said what are we really focusing in on. But we're not making a distinction by market relative to our ability to attract talent.

I would just add to that I think our approach is more prescriptive than it has been in the past in terms of those ongoing conversations that are necessarily. The talent that we added in this quarter, for example. Our elevated profile in Kansas City over the last years with the growth we've had there has really opened up some discussions that wouldn't have been there in the past. And so the talent we've brought on there, they're experienced bankers and you're seeing some of the traction that we're gaining in that market because of that. The same issue in St. Louis. We've had an elevated profile here. We have the attention of all the talent that we want. We've been opportunistic because there's been some consolidation in St. Louis. So the bankers that we attracted here came from institutions that changed, that were acquired or had leadership changes and we had positioned ourselves with those discussions to take advantage of that.

Okay, great. Thanks, guys.

Thank you, Dan.

(Operator instructions). [Eric Grubelich], private bank investor.

Hi. Good afternoon. I just wanted to circle back on the discussion about the loan loss provision. You clearly have indicated that the provision in the quarter was nothing to do with the rise in problem loans, it was more due to loan growth. So my question is, is that rate of provisioning consistent with what you would see -- what we might see in the next couple of quarters based on your loan growth expectations for the year? Does that provisioning rate -- is that provision rate a good way to look at -- if you book another $100 million or $150 million worth of loan, is that a good rate to look at it against those new loans?

Eric, I think -- I wouldn't necessarily want to give you exact forward guidance on provisioning because there's obviously a lot more factors that go into it than just a pure coverage percentage. But I will say that over the last two years we've had a very similar level of allowance to our total loans within a couple of basis points. And so there's a lot of factors that have been moving around behind that. Some of that is dependent on the type of growth and also other movements in the portfolio, and obviously the level of charge-offs. But I would point you to the history and say we're likely not to make a dramatic shift in the course of the next couple quarters.

Okay, that's fine. Let me ask you just another question related to that. If the composition of your growth were even more tilted toward the EVL type of product compared to a garden variety commercial or commercial real estate loan, does that type of credit entail establishing a little bit larger reserve against that -- generally against that type of loan?

I guess I would say any portfolio that we've continued to put material growth into we tend to look at more conservatively because growth is one of the factors that we consider when we're looking at our allowance and how much investment we're making in it. So, each one is different by segment and we don't necessarily, in terms of the way we look at the loan portfolio categories, break out that separately from C&I. But the presence of the level of growth that we've had is certainly a risk factor that we tend to look at more conservatively when we evaluate and provide for our losses.

Okay. Thanks very much.

You're welcome.

And it appears we have no further questions at this time so I'll turn it back to our speakers for any additional or closing remarks.

We appreciate that, Kevin.

No, we don't have any further remarks other than just to say, again, thank you for your interest in Enterprise and for joining us this afternoon and we look forward to joining you again next quarter. Thanks very much.

This does conclude today's teleconference. You may now disconnect. Thank you and have a great day.