Enterprise Financial Services Corp (EFSC) Q1 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Enterprise Financial First Quarter Earnings Conference Call. [Operator Instructions] I will now turn the call over to Peter Benoist, Chief Executive officer. Please go ahead, sir.

Thank you, Laurie, and thank all of you for joining our first quarter earnings call. Readers are cautioned not to place undue reliance on our forward-looking statements which reflect management's analysis and expectations only as of the date of such statements. Forward-looking statements speak only as to the date they are made, and the company does not intend and undertakes no obligation to publicly revise or update forward-looking statements after the date of this report, whether as a result of new information, future events or otherwise, except as required by federal securities law. You should understand that it is not possible to predict or identify all risk factors. Readers should carefully review all disclosures we file from time to time with the SEC which are available on our website. I'm joined, as is our custom, by Frank Sanfilippo and Steve Marsh. And I'll open with a few brief remarks, and then I'm going to turn it over to them. I'd characterize our first quarter results as solid, all in. Core loans remained relatively flat for the quarter, however, new loans and advances were equal to the year-ago first quarter. Pay downs on lines of credits, coupled with a lot of first quarter pull through at the end of last year accounted for the lack of net loan growth in the quarter. We have stayed focused on maintaining our pricing discipline and we continue to lower funding costs where appropriate. Our core margins, net of the impact of accelerations on the covered book, declined a modest 2 basis points in the quarter, however, price competition is stiff in all of our markets. We expect loan growth in the mid-single digits this year, which is significantly lower than the 11% growth rate posted last year, as our posture is to help protect margins and to maintain strong underwriting standards. We saw seasonal runoff in demand deposits in the quarter, and we continue to reduce the volume of higher cost CDs. A slightly smaller balance sheet, coupled with strong earnings, increased our tangible common equity to 6.7% from 6% at the end of the year. However, we do expect transaction account deposit volumes to build through the balance of this year. Frank will comment in more detail on the loss share book but the first quarter experienced significant accelerations from early payoffs, yet again, in part due to some modest improvement in the real estate markets. The strategy is to increase the level of fee income, our current emphasis for us at Enterprise with a primary focus on increasing cross-sell opportunities within our customer base. Our goal is to capitalize over time on the fact that our client satisfaction scores are at all-time highs and services per household have not been a major focus of our sales force. We also believe that the addition of the Gorman & Gorman Home Loans acquisition can add significant fee revenue as the housing markets continue to improve over time. We expect to close this transaction during the second quarter. We were also very pleased with the improvement in asset quality during the quarter, so I'm going to ask Steve to comment on further detail on that and on credit trends in general. Steve?

Okay. Thank you, Peter. Enterprise Bank ended the -- as Peter mentioned, Enterprise ended the first quarter with an organic portfolio of $2.1 billion, down 1% for the quarter. On a year-over-year basis, loans increased $168 million or 9%. Slow growth in the first quarter is really due to a couple of factors. One, volumes in the fourth quarter of 2012 were extremely large. The threat and the reality of tax law changes pushed a lot of sales activity from the first quarter of 2013 back into the fourth quarter of 2012. In addition to that, line usage is low as many of our customers remain cautious about the direction of the economy. As Peter mentioned, we expect growth to bounce back in the last 3 quarters so that we achieve mid-single-digit growth for the year. In credit quality, as a commercial bank with large loan relationships, asset quality, the numbers can be lumpy as we saw in the fourth quarter of last year. This quarter continues a long run of gradual improvement in credit quality. Nonperforming loans at 3/31/13 were $32 million. This is a decrease of 17% from year end, and it's a decrease of 32% from a year ago. By class, nonperforming loans still continue to be concentrated in the construction real estate and investor real estate categories. Past-due loans remain quite low at just 12 basis points. At 3/31/13, other real estate owned was $7.2 million. During the first quarter, Enterprise sold about $1.9 million worth of real estate and as been indicated, we're committed to moving to other real estate owned portfolios. Nonperforming assets in total were $1.26 million at the end of the quarter, down from $2.06 million at 3/31/12 a year ago. Charge-offs in the quarter were $3.7 million for an annualized rate of 72 basis points. Our provision was $1.9 million in the first quarter versus $5.9 million in the linked quarter. This lower level of -- the lower level of provision was really due to lower levels of downgrades and a favorable loss migration analysis. The loan allowance reserve is 5 point -- 1.56 of loans and the allowance covers 89% of our nonperforming loans. I do expect that we'll have continued credit quality improvement in this year in spite of a firm -- stiff pricing competition in a slow economy, expect single digit -- mid-single-digit loan growth. The reason I'm optimistic about the opportunity for growth for the year is really focused in our niches. Our life insurance premium finance segment continues to show good growth. We lifted out the commercial finance group from a competing institution, they've shown good traction attracting new relationships. Expect that to pick up M&A activity in the balance of this year as people digest the new tax laws. In addition, I think we have some capacity to do some additional commercial real estate loans for high quality projects. So overall, I'm optimistic about the loan growth prospects for the rest of the year. Frank, with that, Frank, I'll turn it over to you.

Thank you, Steve, and good afternoon, everyone. I'm going to supplement some of Peter's comments in various areas that should be of interest to you. I'd like to start with covered assets. The yield on covered loans was 31.4% in the first quarter or 15.9%, excluding the effects of accelerated cash flows due to prepayments. Accretion income related to accelerated cash flows was $7.2 million in the first quarter, but there is a partial offset in noninterest income. At March 31, 2013, we still have $66 million of accretable yield to recognize over the life of the portfolio. Our current projection of average covered loan balances is $163 million for 2013 and $102 million for 2014. These estimates do change based on our quarterly recast of cash flows. There were several covered loan pools that showed impairment during our quarterly recast resulting in $2.3 million of provision for loan losses. However, approximately 80% of this was offset in noninterest income given our loss sharing agreements with the FDIC. The change in the FDIC loss share receivable, which is part of noninterest income, was a negative $4.1 million for the first quarter. There are 3 pieces to this number. The negative accretion of $3 million related to the accelerated cash flows previously noted, $1.8 million of income related to provision for loan losses on covered loans, also previously noted; and finally, the negative base accretion of $2.9 million. Remember that this negative base accretion is adjusting the indemnification assets downward over their respective lives to match the expected reimbursement of losses from the FDIC under the loss share agreements. We also recorded an additional $304,000 of clawback liability to the FDIC through noninterest expenses as projected losses of one of the banks continued to decline. In regards to net interest income, I would add 2 things. One, the interest-bearing transaction deposit costs were 32 basis points in the quarter, down from 35 basis points in the linked fourth quarter and we believe there is some still room for those to fall. Secondly, given the drop in core loan yields for the quarter, the core net interest margin, as Peter said, of 3.48% held up nicely versus the linked fourth quarter margin of 3.50% as the earning asset mix benefited from the late fourth quarter loan growth and we have lower deposit costs. Our views on capital levels have not changed, although hitting our 7% tangible common equity ratio target by the end of 2014 appears possible much sooner. We saw large improvements in the tangible capital ratios during the quarter due to strong earnings and a $200 million decline in tangible assets, primarily from seasonal outflows of deposits, as Peter had mentioned. We would not expect further asset declines in 2013 as some deposit growth will be necessary to fund future loan growth given our earning asset mix and liquidity management parameters. Thank you, and we will now open the line up for any questions you might have.

[Operator Instructions] Your first question comes from the line of Jeff Rulis of D.A. Davidson.

Peter, you talked about -- briefly about managing loan growth in part to protect margins. I guess, based on your mid-single-digit loan growth expectation, how has that translated to your expectations on margin itself?

I think as I indicated in my comments, we're seeing some pretty severe price competition in the marketplace. And we're cognizant of that in terms of how we're trying to price relationships, both on origination and a renewal basis. Having said that, as Steve mentioned, some of our credit verticals show good strength and less price competition. So in that respect, while we saw a modest decline in the core margin, our expectation is we'll see modest decline this year in our core margin but not a significant decline in core margin. At the same rate, obviously, our growth rate is going to slow from last year's rates just based on the fact that we're going to be passing on opportunities that I suspect either for credit reasons or pricing reasons, just don’t fit our criteria. Steve could comment in a minute. I think one of the things we're seeing in this market, and I think it's probably true in the Kansas City market, is much stronger prevalents of longer-term lower fixed rate pricing in the marketplace right now. And by that, I mean beyond 5 years and our intent is really not to participate at those rates for those terms. So I suspect we'll be passing some opportunities in that regard.

Yes, the only thing I would add to that is if we do a 7-year deal, it would be in conjunction with the swaps so that we're getting a floating rate. We would rarely go 7 years on fixed rates and we do see the competition doing a 7-year, even 10-year fixed rates. And that would be a type of project -- product that we're avoiding.

Okay. And then one other question on the -- you mentioned in the press release the sort of new management assignments. I guess, is there any tangible near-term impact either on expenses or revenue? Or is that a longer-term positioning?

Yes, I wouldn't say significant near term, but I think just to take 2 seconds on it, our intent there was to make sure we're very focused on the front end of the business. From a sales perspective, it is a competitive market. So we elevated one of our fellows, Scott Goodman here in St. Louis, to the head of the bank here. Steve and I both agreed that -- and Steve, for those of you who don't know, has played really 3 roles at the company, the Chairman of the bank, he's the President of the bank, and he's the Chief Credit Officer. And we felt it would be appropriate to split those roles with Goodman taking the president role, and focusing on sales and client development. And Steve focusing -- not certainly all of his time, but a good majority of his time on credit origination from a risk and pricing perspective and credit quality generally just in terms of continuing to push the trends that we've seen in credit quality improvement over time.

Your next question comes from the line of Chris McGratty of KBW.

Frank, on the securities book, if look at end of period balances, you're down pretty substantial of $150 million. How should we think about, I guess, securities going forward? I think, your comment, if I heard you correct, was earning assets should grow over the balance of the year?

Yes, we -- Chris, we target the investment portfolio probably in the 15% to 20% of assets range. And so that's what I would expect. And with that moving within that range, just based on liquidity and -- primarily.

Okay. And on the -- in the past, I think you've given a little bit of guidance on the fee income. Obviously, it's pretty volatile. Can you help us out, Frank, at least on that big negative that's been jumping around the past couple of quarters on the fees?

I can't. As you know, we're trying to report the pieces to you so that hopefully you can track the trends on that. And then just from our commentary and trends, you have to come up with what those are. Obviously, it changes. I mean, if we can predict the level of losses that -- where it's going to head, we could be more exact, but we'd rather not do that.

Great. And then last one on the acquisition that's going to close, Peter, in the second quarter. Can you help us with potential revenue pick up and also kind of the associated expenses that might come with it?

Yes, I think from a -- just based on timing, the impacts in '13 are going to be relatively nominal. We're going to write up all the intangibles this year as well as it relates to the acquisition. So the impact will really be in '14. By and large, you may have a different comment, Frank, but that's my take.

I would agree.

And then in '14, I guess, what's the -- how should we be thinking about how big this is going to be?

Yes, I think that we probably should wait til later in the year, get the thing closed. And just in general, I think I shared with some of the group, or I think we shared it as part of the announcement. I mean, they're about triple the size of our -- right now, they're about people triple the size of us in terms of volume origination, and selling into the secondary market. So that's why we say we think it will be a significant increase for us. But obviously, the mortgage market can vary and -- over time, so we're probably not in a position at this point to forecast for '14 relative to that.

[Operator Instructions] Your next question comes from the line of Andrew Liesch of Sandler O'Neill.

Curious, can you give us, if you have the numbers in front of you, trends with classified loans in the quarter?

Yes. They would be down.

Yes, they would be down slightly.

Okay. And then, I guess just...

On a linked-quarter basis.

I was just trying to get a handle on that and how that might affect provisions going forward with the reserve ratio falling. Then, I was also thinking that when -- with loan growth coming on here, the provision for the non-covered portfolio would rise from this level. Am I thinking about that correctly?

I just think in general, Andrew, that what we stated is that we believe the overall trends in asset quality will continue to improve. And I think, we have given an indication of loan growth. And I think between those 2 things, I guess, I would leave it to you to estimate where the provision levels would be.

All right. And then just looking at the other expense line. I know there are some one-time or like maybe year end costs associated with them in the fourth quarter. And maybe just bashing out the clawback liability, it seemed like it came in this quarter just a little under $7 million, which has been lower than they have been in the last couple of years. Is this a good run rate? I was actually expecting it to be a little bit higher.

Yes, I don’t -- the only thing I wanted -- the only thing I did comment on relative to expenses was $1.2 million related to really an acceleration that FDIC had a change in policy on claiming expenses and we were able to accelerate and reverse $1.2 million of expenses, collection expenses related to that book. So basically, that's more of a one-time item. And at this point, that's all we would -- look at the trends that we've presented and leave it at that. We're not giving any forward-looking guidance relative to expenses at this point.

Your next question comes from the line of Brian Martin with FIG Partners.

Maybe can you just talk about -- it seemed like last year you guys were really getting some -- pushing some credit, sort of getting some charge-offs and getting things cleaned up. I mean, this quarter was a little bit lower. I guess, when you think prospectively with credit getting better, kind of going back to this downward trend, is that how we should think about losses prospectively and in particular, the charge outside is lower from current levels or stable, I guess?

So we would continue and I think we have shown propensity to be aggressive in dealing with nonperformers, seeing the other real estate owned. You see it in the level of nonperformance that have come down. I don't know if I can make any predictions about what the loss rates will be for the final 3 quarters, but we'll continue to be proactive in dealing and identifying problems and trying to get them soon.

Okay. And is there anything else -- with regard to the margin, as far as protecting it, Peter, is there any other steps you guys could take to protect this? Is there anything you could pay off or reduce that would serve the benefit that or protect it outside of the pricing, things you already mentioned?

Not off the top of my head. Not in terms of what -- anything we haven't already alluded to. I mean, I think as we indicated, we continue to focus on funding cost, we think there's a little bit of room there. The challenge for us, and I think Steve would agree, is to make sure that we're putting quality assets on the books at appropriate rates, and we're very focused on that. So in some respects, maybe we'll sacrifice a little bit of volume for margin but we think it's the right thing to do.

Okay. And when do you think you kind of reached the bottom as far as the funding cost go? I mean, it sounds like you still have a bit more room to move things lower. I mean, how quickly has that run out?

I guess I'd -- this is Frank, Brian. I would -- I guess, what I would tell you is just I've been tracking -- I've been trying to present these -- the transaction deposit costs and how they've been coming down, they came down 3 basis points recently. So I mean -- I said there's a little room to fall. So I just look at the trends and we're able to move them down 3 or so basis points a quarter, but yes, it is approaching bottom.

Okay. And as far as -- but I guess, the expectation is you're still going to continue to feel some repricing on the asset side. That's not, I guess, alleviating all that much?

It's a reality of the business.

[Operator Instructions] Your next question comes from the line of Daniel Cardenas of Raymond James.

Maybe you could give us a little bit of color as to what you're seeing on the M&A side. Are discussions picking up? And is there any regions in your footprint that's showing more premise than the other?

No, I think we've seen good activity in St. Louis and Kansas City, and less so in Phoenix. I think if you talked to the private equity company, they would say activity is stronger today than it was a quarter ago. So everybody was exhausted at the end of the fourth quarter. I think, everybody's pipelines were emptied out at the end of that period. And I think you'll see they're starting to build again. It's one of the reasons I made the comment in my prepared remarks that I think we'll see better M&A activity in the last 3 quarters than we saw in the first quarter. I don’t think the first quarter is typical of what we'll see for the balance of the year. And I think that's borne on if you talk to private equity companies. There's more activity on the books now in the pipelines.

And then as you look at yourselves, do you yourselves more focused perhaps on whole bank or non-bank type of transactions?

I think that's directed to me. This is Peter. I'd say at the present time, no. We're not very focused on whole bank acquisitions. I think our intent right now, as we've vindicated, is to really focus on core performance. We do believe there will be activity from an M&A perspective and clearly, you all know that as well. We don't believe in acquisitions as a strategy. I think, if tactically, there are other opportunities, which has always been our position that make sense for us, with a primarily focus on core deposit base that would be our interest, we would be opportunistic. But aside from that comment, no, we're not focused.

At this time, I'm showing no further questions. Are there any closing remarks?

I think you do have one more question.

Your next question comes from the line of Greg Cole of Sidoti & Company.

Just a broad question on the fee income generation and getting into new households. Can you talk about where you want -- which business lines you would like to see increasing revenue from? And how you plan on doing that just from a -- just getting into current accounts or going to -- just where that's coming from?

Sure. I alluded to the fact that our cross-sell penetration is not significant currently, and we see a lot of opportunities. A lot of that relates more to, what I call, the individual side as opposed to the commercial side of our customer base. And it does relate to things like card penetration, Wealth Management, is clearly an area. Credit, in general, just from a more high-end private bank credit perspective, we see a lot of opportunity there. And that's parlayed against the fact that our client satisfaction surveys are really quite good. So the presumption here is that we have a lot of warm prospects we really haven't touched yet, and we've got to get much more intentional about it. We've made significant technological investments in CRM, sales force particularly, which is uniquely designed to really elevate our game from a cross-sell perspective which we're going to do across all markets. And we think, over time, that will benefit us in terms of fee revenue from a card perspective, credit outstands and certain regards as it relates to, what I call, private bank types of credit, including mortgage as part of the Gorman acquisition, obviously, in terms of that being complementary to this. And over time, Wealth Management introduction is where we think there is opportunity to cross-sell.

Okay. And then how should we track this over time other than just pure revenue? Is there anything that you plan on looking at or showing us?

This is Frank, Greg. Potentially -- I guess, potentially at some point, we could get to a cross-sell ratio, something that we would actually publish. Absent that, I think the fee income ratio, pulling out the change in FDIC receivable, could be one thing you would track. And once again, we could be more intentional about showing that separately. Those would be 2 things that come to mind.

[Operator Instructions] I'm showing no further questions at this time.

Very good. I'd just comment -- thank all of you for your interest in EFSC. I think we're off to a good start this year. I don’t think we're unaware of the challenges that affect, not just Enterprise but the industry in general, but I think we're positioned well for them and we're optimistic about '13. And as we continue down the path, we thank you for your support and we look forward to talking to you next quarter. Thank you very much.

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