Enterprise Financial Services Corp (EFSC) 2021 Q2 法說會逐字稿

Good day, and welcome to the EFSC Earnings Call. At this time, I would like to turn the call over to President and CEO, Mr. Jim Lally. Please go ahead.

Thank you, Victoria, and good morning, and welcome to our second quarter earnings call. I appreciate all of you taking time listening and joining me this morning and Keene Turner, our company's Chief Financial Officer and Chief Operating Officer; and Scott Goodman, President of Enterprise Bank & Trust.

Before we begin, I would like to remind everyone on the call that a copy of the release and accompanying presentation can be found on our website and were furnished on SEC Form 8-K yesterday.

Please refer to Slide 2 of the presentation titled forward-looking statements and our most recent 10-K and 10-Q for reasons why actual results may vary from any forward-looking statements that we make this morning.

Please turn to Slide 3 for the financial highlights of the second quarter. Second quarter was an outstanding quarter for our company, reflected in our record earnings of $1.23 per diluted share. This compared favorably to $0.96 and $0.56 for the linked and prior year's quarter, respectively.

This level of earnings produced a return on average tangible common equity of 18.4%. During the quarter, we experienced solid organic loan and deposit growth. Loans, net of PPP paydowns grew $278 million or 17% on an annualized basis from the linked quarter.

More importantly though, this growth came from several different markets and specialized businesses. Scott will provide much more details around this, but I wanted to comment that our focus will be to continue to invest in our higher-growth markets in the Southwest and Southern California. An example of this is the recent team lift out to open a commercial banking office in Las Vegas, Nevada. This will be complemented by growth from our more mature Midwestern regions at a slightly higher than local GDP and the consistent high performance of our sponsor finance, tax credit and LIPF teams.

I would be remiss if I did not mention the continued stellar performance of our SBA team who have performed at a very high level since we announced the Seacoast transaction just about a year ago. Focus, execution and matching the needs of the markets with the features of the 7(a) program have led to this success. Deposits too saw a nice increase compared to the linked quarter, increasing by $124 million mainly driven by continued activity in our specialty deposit business.

Not only are we pleased to resume a growth posture during the second quarter but we continue to maintain both price and credit discipline amid the growth. On that note, our credit statistics remain stellar.

Compared to a year ago, we saw improvement in just about every asset quality category. These improvements are reflective of the modest allowance release during the second quarter. Keene will provide much more detail around this in his comments.

The strength of these operating fundamentals supported an increase of our dividend by approximately 6% and the repurchase of $12 million of stock during the quarter. In addition to all of this, I'm happy to report that we closed on the acquisition of First Choice Bancorp last week, less than 3 months after our announcement.

As we discussed during our first quarter call, we are extremely excited about this expansion in the Southern California market, and we'll discuss our progress there in future calls.

Turning to Slide 4, you will see that the systems and cultural integration of First Choice is a key area of focus for us for the remainder of the year. Our focus also includes loan and deposit growth, the leveraging of our PPP opportunities and executing on the workforce opportunities to further improve our business.

I would now like to turn the call over to Scott Goodman, who will provide much more detail on our growth and the performance within our markets and specialized businesses. Scott?

Thank you, Jim, and good morning, everybody. If you turn to Slide #5, as you heard from Jim, we posted solid organic loan growth of $278 million in the quarter or 17% annualized net of the activity on PPP. Overall, this reflects successful execution of a growing pipeline that had been building steadily this fiscal year across numerous different business units and specialty channels.

This detail is further broken out on Slide #6 and 7. But overall, our business owner clients are generally optimistic and actively positioning their companies for growth. And while some headwinds still exist and fully translating this activity to loan growth in all areas, our business model is now allowing us to lean into geographies and specialty lines that are benefiting from improved economic activity.

Following a prolonged period of successive quarterly declines in balances on lines of credit, average usage on these lines leveled out in Q2. With PPP forgiveness well underway and the COVID-related obstacles diminishing, businesses are more actively utilizing their buildup of cash reserves for working capital and investment purposes. And this behavior should eventually move us closer to a more normalized loan demand in the general C&I book.

Our specialty business lines of SBA lending and sponsor finance, both performed exceedingly well in the quarter. The SBA business continued the momentum it had carried through from last year, up $70 million in the quarter and on an annualized growth pace of over 25% year-to-date. The favorable programs and increased awareness of the benefits of SBA loans are creating more activity from referral sources and better opportunities with business owners.

Sponsor Finance activity is extremely robust with deal flow already outpacing that of the full year of 2020. Capital inflows to the private equity markets, elevated purchase multiples and a growing number of willing sellers are creating higher volumes of senior loan requests from our sponsor network. Consistent relationship-based approach with our sponsor base has positioned us well to be the bank of choice for many of these deals, and resulting in $70 million of growth in this business during the quarter.

Both tax credit lending and life insurance premium finance also continued to post steady growth and performance as these businesses have proven to be somewhat immune to the COVID and economically induced obstacles that impact some of the other areas.

Affordable housing programs, in particular, continue to be well received across both sides of the political aisle and are either being expanded or implemented in many states. From a geographic standpoint, our Midwestern markets of St. Louis and Kansas City have the largest general C&I client bases and have been the most impacted by the aforementioned headwinds.

In both markets, we continue to retain high-value clients, growing net new relationships and seeing increased CRE activity. Both markets also showed improved trajectories in the quarter and are well positioned to grow near-term revenue. We continue to successfully reposition the New Mexico loan portfolio through selective retention and growth of profitable commercial real estate relationships while also nurturing a highly valued base of low-cost deposits there.

We're also beginning to phase in our proven C&I brand to better target the small and midsized private operating businesses in the New Mexico submarkets. Turning to Arizona. Arizona posted another quarter of strong loan activity in Q2 and has now grown over 25% year-over-year.

New business includes a mix of C&I, CRE acquisition, refi and development. Some examples include multifamily, neighborhood retail and self-storage on the commercial real estate side as well as relationships with an architectural service company and a local franchise operator. We believe that strong regional economies such as Phoenix, Las Vegas and Southern California provide long-term solid and consistent opportunities for organic loan growth.

Moving to the funding side. Total deposits were up $124 million for the quarter. The increase is attributable to steady net new relationship development. We're consistently opening more accounts than we're closing as well as growth in the deposit Specialty segments, which are outlined on Slide #8.

As a reminder, these specialties were mostly acquired through the Seacoast merger and have continued to perform at a high level since integration. These businesses, which include Community and Homeowners Associations, Commercial Property Management and Third-party Escrow also have a higher component of noninterest-bearing accounts, which have helped push our mix in this category to 36% of the total deposit base.

Now I'd like to hand the call over to Keene Turner for his comments. Keene?

Thanks, Scott, and good morning. My comments begin on Slide 9 and it shows our earnings per share trend for the quarter. We reported second quarter net income of $38 million compared to $30 million in the first quarter. We increased earnings from $0.96 per diluted share to $1.23 in the second quarter, which is a record level for the company. The increased earnings per share were driven by higher net operating revenue, which represented $0.18 per share, predominantly through an increase in revenue as well as contributed to moderately lower credit costs.

I'm extremely pleased that our second quarter performance reflects the efforts to accelerate our performance to pre-pandemic levels. Our organic loan growth has accelerated, and we continue to see the benefit from the Seacoast acquisition.

The recently announced acquisition of First Choice brings us an additional opportunity to accelerate both earnings and balance sheet growth.

Turning to Slide 10. Net interest income was $81.7 million compared to $79.1 million in the first quarter. Net interest income accelerated from loan growth and the deployment of additional liquidity into the investment portfolio.

While we continue to benefit from loan fee income on PPP forgiveness, the amount recognized has decreased in each of the last 2 quarters. To that end, loan yield, excluding PPP, trended modestly upward in the current quarter to 4.30%. Overall, we're pleased with net interest income and margin performance, which have both been as expected.

Slide 11 provides some clarity on the moving pieces for the quarter, which includes continued liquidity build once again. Most importantly, the fundamentals of net interest margin and principally for us, loan yield has continued to perform as expected and remained stable in the linked quarter, both inclusive and exclusive of PPP loans.

We don't see any near-term changes in either of the trends in liquidity or components of net interest income. We're encouraged with the 17% sequential loan growth is a robust start to essentially replacing the $8 million quarterly run rate of net interest income from PPP.

Although our ability to consistently achieve this level of growth in the third and fourth quarter remains uncertain. We're increasingly optimistic that we'll be able to continue to grow portfolio loans and net interest income at a more acceptable rate over time.

Slide 12 depicts our asset quality position as of June 30, which has continued to be stable as we move further away from the start of the pandemic. We've experienced a relatively low level of charge-offs outside of a slight increase last quarter. Net charge-offs were under $1 million or 5 basis points annualized, and the level of nonperforming assets was 44 basis points on June 30.

We continued the improvement in the macroeconomic forecast and the stable credit performance of our portfolio, resulted in a negative provision of $2.7 million in the second quarter. The provision combined with loan growth also caused a slight decrease in allowance coverage ratio.

Slide 13 reflects the moving pieces of the allowance for credit losses, which totaled $128 million or 1.77% of total loans at the end of June compared to 1.8% at the end of March. However, excluding guaranteed loans, the allowance to loan ratio was 2.09%. We continue to believe that maintaining a strong allowance is prudent due to the combined -- continued risk posed by COVID-19 and the potential impact of small businesses when government support programs like PPP come to an end.

Moving forward, the allowance and provisioning levels will continue to be impacted by forecasted economic metrics in addition to our credit performance.

On Slide 14, fee-based income was strong across all categories as we reported $16.2 million in the second quarter compared to $11.3 million in the first quarter, led by tax credit income that rebounded from the first quarter level. Elevated activity levels and service charges and card services also contributed to the quarter-over-quarter strength, while a private equity distribution and a gain on the sale of other real estate also bolster the quarter.

Turning to Slide 15, excluding merger charges, core operating expenses were higher in the second quarter at $50.5 million compared to $49.8 million in the first quarter. Most of this increase is reflective of the improving level of income in our fee-based businesses, specifically the increase in cash management and card services expenses in the period. This was partially offset by lower compensation due to seasonally higher payroll taxes in the first quarter.

Merger-related costs declined to $2 million on First Choice compared to $3 million in the first quarter, which was related to Seacoast. However, with the closing of First Choice, merger costs will increase over the next year periods as we work through integration.

Our capital metrics are shown on Slide 16. We grew tangible book value per share, 14% on an annualized basis to $26.85 per share with a return on average tangible common equity in excess of 18%. The strength of our balance sheet and our earnings profile supported our decision to repurchase shares through our recently announced share repurchase plan. During the quarter, we repurchased over 250,000 shares at an average price of $47, and we continue to opportunistically manage our capital position through share repurchases. We also announced a $0.01 per share increase in our dividend in the third quarter.

All these actions reflect our strong balance sheet position and increasing optimism and our ability to continue to sustain and expand our earnings. With all that said, our capital retention rate is high and affords us the opportunity to continue to be nimble and flexible as we move forward. We have successfully executed on our business model as well as a robust M&A strategy, and the results are reflected in our financial performance this quarter. We generated a pre-provision net revenue of $47 million or 1.9% on average assets, which is an increase of nearly $7 million from the first quarter.

Looking forward, the First Choice merger is the largest in our company's our history and following closely on Seacoast Commerce it further fuels our growth capabilities while strategically providing the ability to scale the balance sheet and grow EPS.

We have worked hard to create a sustainable foundation for the company with differentiated lending strategies, diverse fee income sources, a stable and low-cost deposit base and an efficient operating structure. We will be working in the coming periods on the integration of First Choice and expect it to further expand on our strong second quarter performance.

Thanks for joining the call today, and we're now going to open the line for analyst questions.

(Operator Instructions) Our first question comes from Jeff Rulis with David.

My name is Clark, I'm filling in for Jeff Rulis. I was just wondering if you could provide some more color on what the loan yields were on new production versus the existing portfolio? How does this will qualify for the total portfolio because it looks like yields are flat with new production in it, but it is holding up well?

Yes. This is Keene, and I appreciate the question. The new loan yields are actually helping us to maintain a stable yield. So they're actually slightly above. Now I'll caveat that by saying when you look at the categories in which we had growth in the second quarter, namely SBA and Sponsor Finance, those are typically higher yielding segments.

So at least as it relates to the current quarter and if we continue to see production heavily weighted that way, I would expect that we'll continue to be able to modestly expand loan yield moving forward with those categories. The caveat would be if we start to see additional production proportionately in life insurance and other areas that have a slightly lower loan yield that can bounce around a little bit, we are also seeing a modest benefit in continued improvement in the cost of deposits as we shift more heavily to DDA with growth in the specialties.

So I don't expect anything trending either way, but some of that ability to defend the loan yield does depend on what categories it's in.

Got it. And then just for clarification, what is the typical yield for the SBA portfolio currently?

Sorry, I was muted. I was actually looking for that. We'll have to circle back with you on that. I'm going to say it's over 4% at this point.

Our next question comes from Damon DelMonte with KBW.

My first question -- So my first question is just given that the First Choice deal closed, at least to my model earlier than I had expected. I thought it would be later in the third quarter. Can you give a little perspective, Keene, on what we could look for, for a quarterly expense rate?

Yes. Good question, Damon. So the forecast for First Choice expenses is around $13 million in 2021, and then it's about $14 million in 2022 pre-cost savings. So you're going to get almost a full quarter of that $13 million, obviously, here in the third quarter and then fourth quarter. With that said, we will start taking costs out.

So first quarter '22 run rate is just going to be over a little bit over $10 million and some of that phasing in. So I don't have exact color on how much cost savings we'll get this quarter versus next. But I expect that it will be enough to offset the normal growth rate you would expect in the underlying enterprise $50 million expense base.

Got it. Okay. And then just kind of a technical question. I think you had mentioned that there was like a PE distribution that was recorded this quarter. Was that in other noninterest income? And if so, how much was that?

That's correct. And I think that was around $1.5 million. We typically have some of that, that was a little bit larger one at one point in time, but that's something that over the course of the year, we would expect that level to occur in one or more quarters. So it certainly contributed to a strong fee income for the second quarter here along with a rebound in the tax credit revenue.

Our next question comes from David Long with Raymond James.

I wanted to talk a little bit more just about your traditional commercial and industrial line there. And can you talk about the competitive dynamics as you see them in that? Are you seeing increasing pricing pressures as a lot of banks are struggling to grow loans right now? And how are you reacting to that?

This is Scott. I can take that one. I think it's been competitive in the C&I sector. And so I don't know that I would say it's more competitive, but it is extremely competitive. St. Louis and Kansas City, in particular, deep markets for C&I, growth is typically moving relationships when there's an event. And I think we've seen some opportunities there. We've grown net new relationships pretty consistently. I think PPP in particular helped introduce us to some other operating businesses that -- now that forgiveness is behind a good number of those clients, some of those opportunities, I think, are more in front of us.

I think your question was more on pricing. I think we're seeing pricing is about as low as I've seen it. I don't know that there's much lower to go. We take a relationship-based approach, though. So we'll provide the working capital lines and the term debt, but we're also going to get the fee business, the long-term deposit business that, over time, we can produce a profitable and sticky relationships. So I'm not sure if that exactly answers your question, but that's kind of what we're seeing.

No, that's what I was looking for, just to get some additional color there on that part. So -- okay. And then I want to shift gears and talk about M&A for just a second with the First Choice deal now. Closed an integration ahead of you, the -- how soon can you be back in the M&A market? And maybe talk about what would be the ideal acquisition candidate now? And maybe even by geography, where do you feel like you'd like to add the critical mass?

David, this is Jim. Like I said, certainly, our focus near term is really getting First Choice integrated well. We've done a good job with Seacoast this year. We're seeing the benefits of doing something well. So that will be our focus. That being said, there are a select few companies that we would certainly take keen interest to the extent that there was an opportunity. And as I've said in previous calls, we approach it like we approach our sales process, which is a process, it's building relationships and understanding timing and things of that nature.

And there are a select few that we would say, okay, let's stop and take a closer look. As it relates to geography, I think what we said is closer to our current markets always makes sense. And so to the extent that we can build out from there, certainly, we would look. And -- but really, it's finding the best fit to continue growing the businesses and the culture that we've started. So we've shown that we can go to a new market if we need to, but certainly makes sense to build on what we have.

We'll take our next question from Brian Martin with Janney Montgomery.

Maybe, Jim, I don't know if you could talk a little bit about just the lift out of the Las Vegas team you talked about. Just give a little bit of color on there or maybe Keene, whomever or Scott?

Scott, handle that one, Scott, if you would.

Yes, sure. This is a team that we reached out to via a connection from Seacoast to their market leader. And I think as Jim mentioned, we hired a team of 3 pretty seasoned commercial bankers from a regional competitor, someone that we overlapped with in our Southwestern markets. Their focus is very similar to ours on private business, local commercial real estate, experienced range of between 10 and 20 years for all 3. And they really just -- they liked our model. They watched what we did with Seacoast and First Choice and it was very attractive to look up with us and grow. In the profile of Vegas and what we see there, we think it's a really good growth market for both C&I and CRE. So we're excited about it.

Got you. Okay. And then maybe one more, Scott, just you mentioned, I think, on the utilization that it kind of sounds like it stabilized here, I guess, it's your expectation that can pick up a bit in the second half? It sounds like that's the case or you see much change there in the near term?

Yes, Brian, I guess I just looked at it as a positive signal after so many successive quarters of declines on the lines of credit, it pretty much leveled out. And I think -- you combine that with, again, forgiveness on PPP. And I think we're seeing especially larger companies. You start to use their cash balances. So that tells me eventually liquidity is going to run through the system and should result in continued loan demand.

I think there's certainly optimism there from business owners about the economy. I think the headwinds are labor and supply chain, which should be shorter term. So it was just a signal to me that C&I will be headed in the right direction.

Got you. Okay. No, that's helpful. And then maybe just 1 or 2 for Keene. Keene, just the core margin in the quarter, I think you said things were pretty much as expected this quarter. Just how are you thinking about that over the next couple of quarters with the transaction closing and just kind of your commentary about loan yields kind of hopefully holding up on that front?

Yes. I think the underlying part of my comment there was absent any growth margin would theoretically drift lower a couple of basis points a quarter. I think there's certainly optimism that we're going to continue to get some core growth. And there were SBA and other specialties look like they'll continue to be strong. So I think that bodes well for stable underlying core NIM. And then First Choice, when we announced and we still believe the pro forma impact on margin is 10 to 15 basis points.

So sequentially, high level, given when it's closing here early in the third quarter when it's closed early in the third quarter, that's probably 10 basis points you'll see sequentially, and then it probably won't be a notable difference from 3Q to 4Q when you've got the full quarter.

So that would generally be my expectation on margin. And I do expect that we'll continue to be -- have solid defense of net interest margin despite whatever happens with overall excess cash moving forward just simply because the loan yield has been holding up, and we're really not seeing any pressure on the deposit side.

Okay. And then the core loan yield that you build off of, I guess, just when you frame up the core loan yield Keene, what level are you considering core today that gets added with Seacoast?

Yes. We -- the loan yield ex PPP is around 4.3%. So that's got 5 or so bps in it from PPP.

Got you. Okay. Okay. That's helpful. And just the last one for me, Keene was just on the fee income. Can you just -- I know you talked about the private equity distribution, but there's some other moving parts in there with mortgage. And I know you've got the CDE and then you've got swap fees. But just as you frame up kind of what's a realistic level to think about with all the moving parts just in general? Can you give any color on how we should think about that? I mean that's maybe a little seasonality in 4Q with the taxes. But just if you consider this a reasonable level or is it an elevated level this quarter given you do expect some continuing private equity distributions and some of the other CDE stuff?

Yes. I think the 16, at least as it relates to what I'll call a middle quarter is pretty strong. I would say it's probably a couple of million dollars excuse me, a couple of million dollars heavy with particularly the private equity distribution that's in there. I think that's the way I would think about it in kind of 3Q. And then 4Q, we would expect another strong performance from seasonal tax credit activity driving it a little bit up from that level.

So that's generally the way I'm thinking about it. Certainly, we're happy with the performance of the businesses that you mentioned that we're starting to see increased activity in and then some of the other businesses are a little bit episodic, so to speak, during the year.

We'll take our next question from Andrew Liesch with Piper Sandler.

One of the things, I was encouraged about was the deposit growth this quarter, especially on the specialty side. Anything you can point to specifically that drove that? And how does that pipeline look for more funding coming in?

Andrew, this is Scott. I can take that one. I think we're really encouraged by what we've seen really since we integrated that business, it's been steady. And if you look at what I'll call the 3 main business lines there, HOA, Commercial Property Management and Third-party Escrow, we're seeing growth pretty consistently and equally from all those channels.

So -- There's obviously still a lot of cash in the system, and we have really good relationships with some of the larger HOA companies. So we're continuing to get our fair share there. Third-party Escrow. That was a fairly new business with Seacoast, really brand new when we brought them on board, and they've really been able to execute their business plan. There is a couple of folks that have done that on other bank platforms that we're able to convert their relationships and bring in that business the way we plan.

So to me, there's optimism there, there's no reason why that can't continue. The pipeline shows it's steady and fairly low cost to fund. So I think we feel good about that long term.

Got it. Is there any seasonality in any of these businesses?

I would say there's minor seasonality in the HOA property management. And I would say it's just more related to summer, just less activity, but nothing major in terms of swings.

Okay. So I guess if growth can continue here if I look at the rest of the funding base, is there -- are there -- is there like any non-relationship funding that just could eventually replace these low-yielding accounts and going to improve the deposit mix over time? Like how are you looking at the holistic approach of funding here?

Yes, I think Keene comment.

Okay, go ahead. Sorry, go ahead.

Yes. I would just say, certainly, the reliance on wholesale funding has become a lot lower. There's broker sources that we're working on weaning ourselves off because they were -- some of that was contractual, certainly, brokered CDs, things like that.

So I think our view is that this can help stabilize the base and it will allow us to be much more disciplined and less aggressive with increasing deposit rates as rates increase. So whereas we might have been more sensitive on the deposit pricing side because of a high loan to deposit, I think this gives us more confidence on a broader basis as we move forward and also more confidence in our ability just to generate enough deposit growth to keep up with what we expect to be robust loan growth as the economy improves.

(Operator Instructions) We'll our next question from Jeff Rulis with B.A. Davidson.

Clark, again. I appreciate it. I was just wondering if you could provide any more detail on the nonperforming loan increases that happened this quarter. It looks like there was $6 million. Were these pandemic related?

Yes. Clark, this is Douglas Bauche, Chief Credit Officer. I would tell you that a portion of the increase in nonperforming loans was related to a $2 million loan that rode 90 days past due and was included in the nonperforming bucket, that loan subsequently has been paid off in full and closed out here in early July.

Otherwise, there was just really a particular ag-related credits that we saw going to nonperforming status. And beyond that, there really wasn't much activity.

Awesome. Great to hear. And then just my other thing that I had for you guys was -- In terms of sort of the dollar amount on the other real estate gain, is that miscellaneous income? Do you have that figure offhand?

Yes. It's less than $1 million, I believe, so might be $0.01.

That concludes today's question-and-answer session. I'll turn this back over to Mr. Jim Lally for any additional or closing remarks.

Thank you, Victoria, and thank you all for joining us today and your continued support of our company. I look forward to talking to all of you again at the end of the third quarter. Have a great day.

This concludes today's call. Thank you for your participation. You may now disconnect.