Enterprise Financial Services Corp (EFSC) Q4 2013 Earnings Report, Transcript and Summary

Good day and welcome to the Enterprise Financial Services earnings conference call. (Operator Instructions) At this time, I'd like to turn the conference over to Mr. Peter Benoist. Please go ahead sir.

Thank you, Jessica, and good afternoon, everyone, and thank you for joining our Q4 earnings call. I'd like to remind all listeners that during this call, we will be making forward-looking statements, actual results may differ materially from the results contemplated in our forward statements, as a result of various important factors, including those described in our 2012 Annual Report, on form 10-K and in subsequent filings with the SEC. Forward-looking statement speak only as of today Thursday, January 23, 2014, and the company undertakes no obligation to update them in light of new information or future events. I'd also like to remind you that you can find a copy of our fourth quarter press release, which includes reconciliations of non-GAAP financial measures referred to in this conference call in the Investor Relations section of our website. I am joined by Keene Turner and Steve Marsh, and have also invited Scott Goodman, who runs our bank to join us to give you some perspective on the current business climate in our markets. We reported record net income and earnings per share in 2013. Our reported $1.73 per share was up 26% over the prior year. More importantly, our core operating results, netting out the positive impact of the loss share book, were up 30% over 2012, and currently represent 70% in the company's full year reported pre-tax earnings. We benefited greatly from positive credit leverage, as asset quality continued its strong improvement during the year. However, core pre-tax pre-provision earnings adjusted for the FHLB prepayment fee increase just under 4% on a year-over-year basis. While net loan growth was modest at 1% for the full year, due to managed run-off in the commercial real estate and construction [ph] LAV books, commercial and industrial loans increased to healthy 8% for the…

Thank you, Peter. In general, growth was driven by continued momentum from our C&I related businesses and moderating pay-off activity, primarily on commercial real estate related credits. Originations were solid for the quarter and that levels above our average for 2013. On a market basis, we experienced growth, both in St. Louis and Kansas City markets, with level performance in Arizona. St. Louis growth was centered around C&I and bolstered by good activity in our tax credit lending, life insurance premium finance and asset based lending niches. Kansas City showed modest growth in both C&I and commercial real estate with a number of new relationships coming from expansion of our enterprise value lending or EVL niche in that market. As a reminder, EVL is our leverage lending senior debt offering to private equity sponsors, focused on mid-sized operating businesses. Also of note, in Kansas City we successfully recruited three new experienced C&I relationship managers in the quarter, all of them came from different local competitors. Arizona posted decent origination activity in the quarter, but experienced a couple of larger pay-offs resulting from aggressive fixed rate competition on commercial real estate. Based on our current 90-day funding pipeline, originations appear to be steady, complemented by moderating levels of pay-offs on commercial real estate loans. The pipeline shows particular momentum in the EVL and life insurance premium finance lines of business. The competitive environment in all of our markets is showing elevated levels of activity and continued emphasis on low rates. In Kansas City, the downward trending rate pressure has eased somewhat, but remains at low levels and with more banks willing to participate at these levels. In St. Louis, we're also seeing higher levels of activity, as the larger regionals appear to be moving down market and leading with price. On…

Thank you, Scott, and good afternoon. I am excited to be here today to review highlight of our full year and fourth quarter 2013 results. As you heard from Peter, 2013 was a record for Enterprise, as we reported a $1.73 of earnings per diluted common share, a 26% increase in earnings per share and a 32% increase in net income available to common shareholders compared to fiscal 2012. Before I take you through the full year's results, I will highlight two transactions, which impacted our full year and fourth quarter 2013 results, executed to better position us for 2014 and beyond. We repaid $30 million of borrowings from the Federal Home Loan Bank of Des Moines on December 30, 2013, prior to the scheduled maturity date. These advances had a weighted average interest rate of 4.09% and maturity of approximately three years. We incurred a $2.6 million pre-tax expense or $0.08 per diluted share during the fourth quarter. This prepayment was executed as part of our ongoing effort to manage interest rate risk and is expected to mitigate continued pressure on core net interest income. The prepayment penalty will be earned back to a lower borrowing cost over the next three years. Additionally, we completed the sale and exit of certain branches in our Kansas City market that were determined not to fit our long-term growth strategy within the market. Approximately $90 million of deposit and $8 million of loans were sold as part of this transaction, and we recognized a gain in other non-interest income of approximately $1 million in the fourth quarter. Additionally, expenses were required to be accelerated with the exit of certain branches that were not able to be sold. These expenses were approximately the same amount of the gain recognized, and we're recorded during…

(Operator Instructions) And we'll now go to Chris McGratty from KBW.

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

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

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

Well, I think the answer is that you've continued to see us making progress and writing that down as we reflect our estimates. So at December 31, 2012, there was a $50 million IA and now we're down to $34 million. So there is some level that as we continue to improve the performance that it's written down in the net revenues that you see in our summary table. So yes, we continue to look at it every quarter and make progress and then adjust it downward to net reserves.

In terms of the core margin, and how it's been incredibly stable and the actions you've taken to kind of take out some of the expenses funding. Can you help us on expectations for core margin in 2014? And kind of how should we be thinking about the size of the investor portfolio in the loan growth expectations, kind of putting it together? KBW: In terms of the core margin, and how it's been incredibly stable and the actions you've taken to kind of take out some of the expenses funding. Can you help us on expectations for core margin in 2014? And kind of how should we be thinking about the size of the investor portfolio in the loan growth expectations, kind of putting it together?

Why don't we take that in pieces. Scott comments as it relates to local competition. It really is margin pressure is coming from loan pricing. So I think in that context our expectation is that it will little continue. We don't think it will lessen dramatically this year. So we see modest compression in core margin in '14. Having said that, in terms of loan volume, I'll let Scott comment, he talked about the pipeline, I think we're very encouraged, but you might want to say more about that.

Yes, I think our origination activity is steady, particularly in the EVL and life insurance premium niches, I think we feel good about that. I think we feel good about bringing three new RMs onboard in Kansas City, which will give us some new prospects, particularly C&I business in Kansas City. And I think we feel pretty good about protecting our existing base. We've been very successful in doing that. So the other piece is the pay-offs, and as I mentioned, we've really seen that moderate. We've really taken a deep dive into the portfolio on a loan-by-loan basis, I and try to be proactive where we felt that was necessary.

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

So it sounds like the pipelines are good from the loan perspective, pay-offs maybe less, so net portfolio growth might be a little bit stronger in '14, than '13, is that fair? KBW: So it sounds like the pipelines are good from the loan perspective, pay-offs maybe less, so net portfolio growth might be a little bit stronger in '14, than '13, is that fair?

I think that's fair.

We'll now go to Jeff Rulis from D.A. Davidson.

A question on the wealth management, it's down year-over-year, so some of the removal of the locations in Arizona, is that likely the fact that that why it was down?

I think component was Arizona. We've done some thinning here in St. Louis in terms of unprofitable account. It noticed a big drop in assets under administration, and that related to a single large custody account that rolled out in the fourth quarter. It was basically a consolidation of a number of accounts of various institutions, one of which being ours. It had a big impact on the asset base. It did not have a big impact on the revenue base, because it was a custody account.

So going forward, I guess if you look at '14, do you look to I guess build revenues or is it just a lower expense base or a bit of both?

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

And then, I guess just on the provision side, there was a couple of construction loans added. Does that just drove the elevated provision? I mean elsewhere you had some OREO gains and some other movement, maybe just a general comment on the credit as it relates to the provision?

This is Steve Marsh. The credit quality, we did see continued improvement in the fourth quarter and we expect, there's not a lot of room for further improvement, so I think the provision level and the allowance levels are kind of what we're expecting in 2014. The non-performance that were added were real estate loans. They were previously identified as a problem credit, so they didn't come as a surprise.

And then one quick last one, on the tax rate, do you expect that to normalize in Q1 back in the 34-ish range?

Yes, absolutely. We expect that our full year rate at right around 35% in 2013 would be; how we think about it going forward.

And we'll now move to Andrew Liesch from Sandler O'Neill.

Just a one question from me, and it kind of just revolves around the commercial real estate that you have in Kansas City, because I know that isn't tank down or it was tougher to keep some of those clients, but now it sounds like maybe that was portfolios moderating in general, I was kind of curious, what's been going on in Kansas City? Are these clients that you're comfortable keeping or they're just able to compete better now?

I think we feel good about the clients that we have in Kansas City in the real estate portfolio. I do think a number of the ones that pay-off last year were problems related to problem credits. Much of our growth there was C&I in the quarter. So we continue to emphasize on that, but relative to the pay-offs I think feel real good.

And we'll move to Brian Martin from FIG Partners.

The new Relationship Manager you guys brought on board in Kansas City, are those currently reflected in fourth quarter numbers or will they be in the first quarter in the '14 event to the P&L? FIG Partners: The new Relationship Manager you guys brought on board in Kansas City, are those currently reflected in fourth quarter numbers or will they be in the first quarter in the '14 event to the P&L?

Brian, we added them pretty much in the fourth quarter. So they're really as in production relating to those RMs in '13. There is a Senior VP and two DPs, so we feel like we're positioning them over a period of time to bring some business over and have some impact at some point during the year.

And then, Peter talked about I guess the pricing kind of being the key driver on the margin, [technical difficult], just trying to reconcile if there is still pricing pressure, but it looks like you've seen some stabilization on the loan yields, and then if you could just give a little color surrounding that? FIG Partners: And then, Peter talked about I guess the pricing kind of being the key driver on the margin, [technical difficult], just trying to reconcile if there is still pricing pressure, but it looks like you've seen some stabilization on the loan yields, and then if you could just give a little color surrounding that?

I think pricing, I think we've mentioned in the past that we've tried not to play the rate game on commercial real estate and that was a number of the pay-offs that you've seen in the past. We've replaced that I think with growth in some of our niches, which tend to have higher pricing, EVL being a good example. I think we've also been able to protect the base on pricing with a good number of our relationships, our smaller operating businesses, and those are very relationship-oriented and haven't seen the pricing pressures that we've seen from some of the larger mid-market deals.

And I guess, maybe just one last thought was the Gorman and Gorman, just can you talk about rationalizing some of the expenses. I mean how do you characterize the expenses today in that business unit? I mean how much opportunity is there for you to kind of [technical difficulty]? FIG Partners: And I guess, maybe just one last thought was the Gorman and Gorman, just can you talk about rationalizing some of the expenses. I mean how do you characterize the expenses today in that business unit? I mean how much opportunity is there for you to kind of [technical difficulty]?

Yes, I think we saw towards the end of the fourth quarter that it really stabilized. So I think the rationalization comes with that run rate. I think we're still in a position to business obviously to grow relative to the opportunity we feel there isn't a existing portfolio, given that's really been a reactive strategy for us in the past. So I think the idea would be to downsize expenses to a point where we still can be productive in the business relative to the existing clients.

And last I have was just the covered portfolio, Keene, I thought you gave for the balance, what you're projecting is [technical difficulty], if you gave, that I thought you did? FIG Partners: And last I have was just the covered portfolio, Keene, I thought you gave for the balance, what you're projecting is [technical difficulty], if you gave, that I thought you did?

I did. It's a $108 million that we're projecting on average for the year.

And that's for the full year? FIG Partners: And that's for the full year?

Yes.

And we will take a follow-up question from Chris McGratty from KBW.

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

Obviously, our focus is on talent acquisition and that's what we've been doing. That's our preferred option. I would say, we've gotten a little more focused on the potential for an acquisition. We're doing some work around that. And I'll just say what I've said before, I think the drivers for us here are, really can we find a circumstance where we could advance some strategic objectives that would be important to us and also find an opportunity that adds franchise value as opposed to just adding assets. So we are doing a lot of work around it. There is nothing in the hopper, but I think we need to keep our eyes open and we need to be aware and that's what we're doing.

And it appears there are no further questions. So I will turn the conference back over to our presenters for any additional or closing remark.

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

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