Good day. And welcome to the Enterprise Financial Services Corporation Third Quarter 2022 Earnings Conference Call. [Operator Instructions] Thank you. At this time, I would like to turn the conference over to Jim Lally, President and CEO. Sir, you may begin your conference.

Well, thank you, Erica and good morning. I welcome everyone to our third quarter earnings call. I appreciate all of you taking time to listen in. Joining me this morning is Keene Turner, our company's Chief Financial 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. The presentation and earnings release 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 our financial highlights of the second quarter. We’re very pleased with our third quarter as they reflect the cadence of consistency that we established since the beginning of the fourth quarter of 2021. These earnings are a product of the diversified franchise that we are building with a laser focus on establishing long-term relationships with privately held businesses while building a culture of operational excellence. For the quarter we were in $1.32 per diluted share, which compared favorably to the $1.19 that we earned in the second quarter. Our patience with respect to our loan and investment portfolios, coupled with our low-cost deposit base allowed us to take advantage of the rising interest rate environment. For the quarter, our net interest income increased to $124 million. This represented a 13% increase over the linked quarter. It was bolstered by our net interest margin of 4.10%. Our return profile improved as well. Pre-provision return on average assets was 1.96% versus 1.73% in the second quarter, and 1.81% a year ago. Return on…

Thank you, Jim. And good morning, everybody. As you heard from Jim, and as shown on slide 6, we posted solid loan growth of $122 million for the third quarter, resulting in a trailing 12-month growth rate of 8% net of PPP changes. Despite Q3 typically being a somewhat seasonally soft period for a number of our specialty business lines, in general, we're very pleased with the overall growth in this portfolio, being successful conversion of our regional C&I and CRE pipelines, and continuing steady execution of new opportunities within the specialty businesses. Loan details by segment are outlined on slide 7 and 8. And year-over-year growth has been contributed by nearly all segments of the business. Reduction in the residential real estate portfolio mainly reflects the addition of these loan types through the First Choice acquisition and our subsequent intentional shift away from short-term bridge or fix and flip lending in the California market. Most of this reduction occurred in prior quarters. For the third quarter, the largest contributors to growth were within our regional and commercial banking units in general C&I and commercial real estate categories. We have been able to successfully win a number of new larger C&I relationships during Q3 across most of our geographic markets, reflecting a steady and consistent sales process. Overall, C&I originations increased nearly 14% from the prior quarter, and are up nearly 65% from the same quarter last year. We also continue to see good activity in our real estate pipeline, particularly with our existing investor clients, and within the Western geographies. New development loans have slowed somewhat as developers consider elevated project costs and some shifting economic factors, but our existing construction portfolio continues to and perform well. A number of these projects are moving to a stabilized status and…

Thanks Scott. Any my comments begin on slide 14 of the webcast, we reported earnings per share of $1.32 in the third quarter on net income of $50 million. Earnings per share expanded 11% sequentially due to 8% growth in operating revenue, which totaled $134 million, or a $0.20 per share sequential increase. This growth was driven by 13% expansion of net interest income, while noninterest expense expanded into a more controlled rate, resulting in a 35% marginal efficiency rate for the third quarter. Turning to slide 15, net interest income for the quarter was $124 million, compared to $110 million in the second quarter, or a $14 million increase. Net interest income was favorably impacted by an improved earning asset mix, including higher average loan and investment balances, along with the benefit of rising interest rates driving asset yields higher. The increase in net interest income was primarily driven by a $16 million increase in loan income despite a $1.1 million reduction from PPP income. With a composition of our balance sheet as of September 30, we expect the full impact of the existing interest rate increases will result in quarterly net interest income in the range of $130 million to $132 million. We estimate another 100-basis point increase in interest rates will result in an additional $5 million in quarterly net interest income. As noted in the earnings release approximately 20% of the variable rate loan portfolio reprice is on the first day of each quarter and did not benefit from the third quarter interest rate increases. Moving on to slide 16, net interest margin on a tax equivalent basis was 4.10%, an increase of 55 basis points from the linked quarter, our balance sheet has been positioned to be asset sensitive and accordingly, it continues to benefit…

[Operator Instructions] Your first question comes from Jeff Rulis with D.A. Davidson.

Thanks. Good morning. Wanted to sort of unpacked the tax credit line item, a number of $3.6 billion loss is, so I just want to understand, is there a -- was there a fair value adjustment that offset actual revenue? And if so, could you tell us what the revenue associated with it was or if that's maybe not thinking about it correctly?

No, Jeff, this is Keene. You are thinking about it correctly. So there's a portfolio of credits that, as we originated into this type of business that we fair value to work through some of the expenses. And what I'll say then prior to the third quarter, and maybe a more normalized interest rate, tightening environment, we expected to always be able to, at least, mitigate out that expense with how aggressively specifically tenure so far moved up, right at the end of the third quarter. And with the fact that closings on projects were fairly minimal in the quarter, we took about a $12 million fair value decline or negative adjustment. And then the resulting Delta was offset by some new projects and sales and things like that. So that gets you to that essentially that minus $4 million for the quarter. And moving forward, I think with what's happened so far, in the year, I think we're prepared for anywhere from call it a negative and of another couple million in the fourth quarter to potentially a zero or a positive as we move forward here, just rates have moved on the long end of the curve, I guess, more than we've thought and we probably should have given some sensitivity to you guys in advance of this.

Okay, but as you said gains on the top line, more than offset that, but just I, so, I guess that kind of look at that as a breakeven or maybe a slight loss in the coming quarters or one to two, I mean, any visibility on how long that goes out till it resumes to, I mean, tough question, but --

Yes. So, yes, it's going to depend on what your view on interest rates are, and also, how much long, longer term rates, specifically tenure. So for move up, as we get shortly into the Fed moving the short end of the curve, I think, as we look out to call it 2023 that numbers unfortunately, if we get more rate increases, it might be kind of zero to something. And that's probably shy of the $10 million. But I think the opportunity here is we've revalued these credits, I'll say on the way down with the idea or in the back of our minds that maybe at some point, there's a recessionary impact later in '23 or early '24. And maybe the Fed moves down from where Fed Funds end up. This can also then be a hedge to maybe some slight declination of net interest income, or higher provisioning or both of those. So I know that's probably not as much clarity as you'd like, but it's going to be a more modest contributor to '22 and '23 than we originally thought. But I think net interest income is far outstripping that. And I think we'll take that trade as operating revenue strong. So maybe more color than an answer. But hopefully that's helpful.

No, that is, it is good detail there. So let's jump into that. The top line discussion. Just curious, do you have a September monthly average on margin versus the quarterly average of 4.10%?

Yes. So based on the September balance sheet and rate I think we think net interest income is roughly just north of $130 million with net interest margin, right around 4.35% that includes the quarterly resets, we talked about predominantly on the SBA portfolio, and then call it another 10 to 15 basis point increase in deposit rates based on where we sit today, and what we've done with sheet rates and exception pricing.

Okay, so the, maybe the 4.35% and NII north of $130 million that's kind of a Q4 figure. And then you also sort of outlined additional rate hikes will lead to, could you -- go ahead?

Yes, so another 100 basis points, which is, I think what it seems like it's lining up for in the fourth quarter, I mean, that's going to generate roughly $5 million of extra net interest income per quarter. And we're using like just under a 50% beta on earning assets and like a 35%, interest bearing deposit data for that.

[Operator Instructions] Your next question comes from the line of Andrew Liesch with Piper Sandler.

Hey, guys, good morning. Just want question on the long rope, okay, I hear some optimism in some areas, but also some cautious miss in others. I guess it's mid-single digit this quarter, is that the right way to think about growth, say over the next 12-months or maybe we get a little bit stronger growth here with the sponsor finance book. But if we're looking at 12-months from now, is mid-single digits right place to be.

This is Jim. I would tell you, we're very comfortable with that mid to high single on a go forward basis. The production levels have been solid, we're very pleased. We're not going to expand the credit window to get that reach. But we're very confident about our ability to continue performing that mid to high single going forward.

Got it. And then just one housekeeping question here on the margin. How much dis accretion was in that 4.10% number?

Andrew, the discount accretion that's in the 4.10% is pretty negligible, I'd have to pull that out of there. But at this point, we had a fair amount of burn off in the SBA portfolio. I think in the quarter, it's less than $1.00. So it's not moving the needle either way.

Got it. Alright. My other questions were on the fees and the margin. So I'm going to go step back. Thanks so much.

Your next question comes from the line of Damon DelMonte with KBW.

Hey, good morning, guys. How you doing today? I joined a little bit late. So I apologize if you address this in your prepared remarks. But can you just give a little color on the provision outlook? I know you've talked about the puts and takes for this quarter, but how do we kind of think about the reserve level and maybe expertise for loan growth and kind of what you're seeing on the credit front, as you try to kind of model out provision level?

Yes, Damon, I think in the quarter, when we look at it sequentially. I mean, we did provide for growth. And I think the coverage right now is like is 150 that obviously includes loan deterioration and substandard loans, which are still minimal, but so I think provisioning on new loans is call it right around that 110 to 125 basis points, depending on what category it's in, and then I think with the recovered, the coverage ratio, we have 150 and 170 sort of total and unguaranteed I think based on where we sit today, we feel like we're well positioned, if we see the horizon or the environment deteriorating further, and we get some of that data in the economic forecast that we can be further responsive to it, and deal with those provisions over the coming quarters fourth quarter, and then into '23. But we also feel like we're conservatively positioned, given what the portfolio looks like, and what all of the credit quality indicators are. So, again, I think we're at a point here, where if we start to get some less aggressive moves from the Fed, and that looks more like a softer landing. I think we think that 130 is a good number, I think if it continues to be aggressive tightening, we, our view would be in from a safety perspective that we probably go a little bit heavier on the provisioning and maybe move coverage up to account for higher interest rates in the portfolio and higher than they've been in recent years.

Got it. Okay. And then just to circle back on the margin, I know didn't get your prepared comments on this. But did you say to answer the one of the questions, what was the commentary around $130 million of NII in the 4.35% NIM? Is that what you're forecasting for the fourth quarter?

That's correct. That's based on everything that's happened today. Right, that's not increased, it's not any future increases. That's essentially the increases that we have in place hitting the repricing on October 1 for certain loans. And then also what we've rolled out in terms of deposit pricing on commercial consumer customers. Yes, so that's the fourth quarter number at $131 million. And then, like a 4.35% NIM. And so I'm giving you numbers. And obviously, that's, you've got to apply your level of boundaries on those. And then another 100 bps on the first fourth quarter would give us a roughly another $5 million of net interest income quarterly thereafter. And again, we're using 47% beta on earning assets and a 35% beta on interest-bearing deposits.

Your final question comes from the line of Brian Martin with Janney.

Hey, good morning, guy. Sorry, joined a bit late. So just wanted -- one last follow-up keen on the margin, just when you see the Fed pause. I guess can you talk about how you think the margin behaves then? I mean, I guess with your expectation maybe see a little bit of a decline in the margin, but the dollars of NII going up because of the growth? Is that kind of how you're thinking about it today?

Yes, I think it's certainly the directional trend. Deposit costs lagged quite a bit. They're certainly continuing to move. I don't know that they're necessarily catching up, but they're moving an asset rate wouldn't move up much more beyond it. I think some of it, Brian, depends on when the pause comes. So if, for example, you got two more 75 basis point increases, and then there was a pause, obviously, we get much more rapid expansion of net interest margin and net interest income, but then there would be slight margin compression from there. And I think the question is just can you out-earn that with growth in dollars quickly enough? But you're still -- I think our view is that margin based on where we think rates are going to go here at -- for the rest of '23 -- or sorry, '22, even if you got some of that compression, we'd be well north of 4% net interest margin even when it comes back down. And if our hope is that you get sort of one more bold Fed action and then we start to move back to like 25 basis points, and that will help create some stability while we earn through the shorter quarter days in early 2023 and then also can layer into some growth and have strong net interest income grow from there on out. So I think that would be ideal. I'm not sure we're taking a position one way or another on whether that's going to happen. But I think that generally is how we expect the balance sheet to behave.

Yes. No, that's helpful. I appreciate it, Keene. And then how about just on I think you guys probably covered a fair amount of the tax credit. But just the outlook just in business and if I heard the tail end of it, right, Keene, the outlook for the tax credit in '23, is maybe just a modest contribution at this point is how you're thinking about the world and then we'll see what rates change or how rates change?

Yes, I think that's right. I think if we stop having interest rate moves at the end of 2022, then I think next year, you can have some -- expect some net contribution from tax credit. I think if rates continue to move, particularly boldly, it could be a zero or a negative. So I don't think -- I'd be surprised next year unless we got some material decline in longer-term rates that the tax credit business would be kind of the $10 million or more than we thought it was going to be this year. And I think that's sort of -- I think when -- if you're thinking about in terms of how to model it, you have to pull it out of net interest income and put it into the fee line item vice versa. I think there's sort of some mutual parity there.

Got you. And the rate that we should be paying attention to is I mean you say if rates are going to change is what rate is it most sensitive to when we think about the outlook?

So for every 10-basis point increase or decrease in 10-year SOFR, that's about just roughly a $900,000 impact on fair value of tax credits.

Okay. Perfect. Okay. And then just the last one if you could move just on the -- it sounds like the loan growth is -- I guess, are you getting, it doesn't appear that there's a lot of cautiousness among your borrowers. If you -- the outlook still seems pretty favorable from what you said, Jim, as far as mid- to high single-digit growth. I mean is that any slowdown from what you were expecting earlier? Just given kind of what we're seeing and how the economy may play out next year? Or is that pretty consistent?

Yes. The only area that I would say that we're already starting to see it is in the larger development client where the math just isn't working. And those projects, you win it, quote unquote win it, they don't start funding up until six months down the road anyway. So I would tell you that business is impacted mid to late 2023. From a C&I perspective, our borrowers certainly recognize what's happening in the economy, but business is still decent. Business is good. Order books are growing, and they'll go ahead and purchase equipment is needed, they'll need working capital and things of that nature. So we feel good about our book. And the other thing too is the diversification of the book. So not any one region, not any one business has to operate at full tilt to reach these numbers. It's about each of them doing what they can do. And we did a deep dive with the teams to feel comfortable about where we're headed not only to finish this year, but into '23.

Yes. Okay. No, it seems positive. So and then just the last one was just on the deposits. It looked like the activity from last quarter slowed and it was more stable this quarter. Just your outlook to fund the loan growth on the deposit side. How are you thinking about the deposit growth or stabilization from here?

He, Brian, it's Scott. I can take that one. If you remember, last quarter, we had just a large client in the specialty deposit business that moved out, and that was really the main reason for the decline that quarter. I think you saw a little more consistency this quarter. But I think when you look at how our deposits are spread across channels, commercial, specialty business banking, a lot of that cash is used in the business needs to be accessible. I think we feel good about what we're seeing from a behavior standpoint and the ability to retain and grow that. And then as we bring on new relationships through C&I, obviously, that brings new deposits as well. I think specialty also is somewhat immune to what you see going on externally with chasing rates. So all those things, I think, bode well. We feel good about being able to fund the growth.

Okay. And the deposit beta, Scott, I guess you're thinking where does the deposit beta shake out as you get a couple more rate hikes here in the fourth quarter?

Yes. Brian, this is Keene. I think what we said, so far, deposit beta has been roughly 20%, obviously, just there's some lag in there, so that helps the optic of it. In the guidance I gave on another -- for the fourth quarter and then also for moving forward with further increases, we're at like a 35% beta that we're modeling that we think is a good number. And I think, over time, 20% and 35% converge. And the asset beta is strong at 47%, and we still have north of 40% DDA. So we think that, that's a really good recipe and equation. And we've gotten off of, as you remember back to the question about second quarter deposits, we've largely gotten away from Fed fund plus funding that we had in the last cycle. And we've been willing to move deposit rates as necessary to defend relationships and keep those intact. And with the way the balance sheet is positioned, I think we're in good shape to continue to maintain and grow net interest income and margin, and we'll probably give up just a little bit in terms of the deposit costs accelerating in these most recent quarters, but starting from north of a 4% net interest margin and growing. So we feel good about the earnings profile and being able to preserve that.

There are no further questions. At this time, I'll turn the call back over to management for any closing remarks.

Thanks, Erika, and thank you, everyone, for joining us today. Thank you for your interest in our company, and we'll speak again to you at the end of next quarter. Have a great day.

Thank you for participating. You may disconnect at this time.