Enterprise Financial Services Corp (EFSC) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to the Enterprise Financial earnings call. [Operator Instructions] I would now like to turn the call over to Peter Benoist to begin. Please go ahead, sir.

Thank you, Maria, and welcome, everybody. Thank you for joining our second quarter call. I'd like to remind all listeners that during this call, we'll be making forward-looking statements. Actual results may differ materially from results contemplated in our forward-looking 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 statements speak only as of today, Thursday, July 25, 2013, 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 first 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 Frank Sanfilippo, our Chief Financial Officer; and Steve Marsh, who normally joins us. He's our Chairman and Chief Credit Officer, is on a well-deserved vacation, so I'll be pinch hitting for him as it relates to some of the credit issues. As our release indicated, we had a very strong quarter from an earnings perspective, with fully diluted earnings per share up 32% over the prior year period and a 9.4% increase from the record first quarter of this year. The primary driver for earnings in the quarter was a $4.3 million provision benefit resulting from strong improvement in asset quality in the noncovered portfolio. The quarter showed nominal inflows of nonperforming loans, low levels of charge-offs and nearly $5 million in problem loan resolutions, resulting in a 19% reduction in nonperforming loans on a linked quarter basis. As we indicated to you at the beginning of the year, a primary focus of the company during 2013 would be a significant improvement in…

Well, thank you, Peter, and good afternoon, everyone. In regards to our net interest income, I would add interest-bearing transaction deposit costs were 30 basis points in the quarter, down from 32 basis points in the linked first quarter. Including the impact of DDA, the cost was 20 basis points in the second quarter, down from 22 basis points in the linked first quarter. As noted in the release, given the tightening liquidity trends on our balance sheet over the past year, continued reductions in deposit costs is limited as we seek to increase deposits over and above our normal seasonal increases in transaction account balances during the last 6 months of this year. Given the drop in core loan yields for the quarter, the core net interest margin of 3.56% held up nicely versus the linked first quarter margin of 3.55% as the earning asset mix benefited from shifting excess liquidity into loans. As noted, continued pressure on loan yields and liquidity is expected to result in a slightly lower core net interest rate margin for the rest of 2013. Turning to covered assets, the yield on covered loans was 15.3% if you exclude the effects of accelerated cash flows due to prepayments, fairly consistent with the 15.9% in the linked first quarter. Accretion income related to accelerated cash flows was $4.7 million in the second quarter versus $7.2 million in the linked first quarter, but there were partial offsets to both of these in noninterest income. At June 30, 2013, we still have an estimated $62.4 million of accretable yield to recognize over the life of the portfolio. Our current projection of average covered loan balances is $158 million for 2013 versus the average year-to-date through June of $174 million and $99 million for 2014. These estimates do…

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

A question on the provision. I suppose if you're sort of guiding to modest loan growth and improved in credit, the likelihood of a 0 for the noncovered portfolio, a 0 provision or perhaps a negative provision, is that good odds, given your outlook?

Yes. I'd say our -- that's a really tough question to answer in one respect. We've always indicated that given the kind of bank we are, we're going to see lumpiness as it relates to credit quality on a quarter-to-quarter basis. So I wouldn't necessarily say it would be 0. But I would say that our expectation is continued improvement in asset quality in general. We've indicated what our loss rate is expected to be at 50 basis points, we probably picked that up. And in the context of the current reserves, we think they're adequate.

And then on the sales of the state tax credits and -- you've sort of alluded in the press release that visibility's a little uncertain. But I guess from a broader sense, is there any reason to believe that you'd book either more or less going forward than your historical rates?

No, it should -- this is Frank. We would not expect anything less than our historical rates. The only thing that flows through there, and that's really the reason why it's down from the second quarter of last year, is that our mark-to-market -- we have a portion of those that are mark-to-market. And with rates rising, we did have a negative -- I'll call it a negative adjustment -- fair value adjustment in there. But normally, as far as the volume of state tax credits and just the straight gains from those sales, should be consistent. They should not decline. It's just the mark-to-market that can somehow -- sometimes cause some volatility.

And I'd just add, Jeff. I think our '12 allocation's totally committed, it's totally sold.

All right. And then just one last one on the kind of the Gorman & Gorman acquisition and expectations on the single-family mortgage portfolio. I mean, is this -- that relationship more of a fee income generator than a portfolio loan? I guess I was trying to look for the indication on the residential real estate in the portfolio.

Yes, you're right. We're viewing it more as a fee play than a balance sheet play.

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

Peter, the capital level has been restored about a year sooner than you thought. Can you talk about capital priorities at this point, and maybe whether you think you guys would ever return to an M&A strategy maybe later this year or next?

Yes. I think our current focus right now is continuing, as Frank mentioned, to focus on the core bank and core bank profitability. We've indicated in the past, we're opportunistic as it relates to potential M&A. I would say our bias would be toward core deposit acquisition in that context in anticipation, at some point, of an economic recovery and loan growth picking up to some better degree than what we've seen so far. There is no contemplative deal activity at the moment, but we would be open to it. From a capital perspective, I think we feel pretty good about where we stand right now. And our strategy would be to only go to the markets to the extent we had a defined need. And other than that, I think we feel, based on our growth rates and what we're projecting from a growth rate perspective on the organic side, earnings ought to supply the sufficient capital to support our growth.

Okay. On the segment disclosure that you're going to give in the Q, can you give us any sense, the quarterly trends, maybe this quarter, first half of the year, just to help separate the contribution?

I'd ask that you wait for Monday for our filing.

Okay. And then on the Gorman impact, can you -- I think you said in the release, there's not going to be an impact this year. How should we think about P&L impact in '14?

Profit and loss.

Yes. I mean, I guess what -- the way I'd answer that, this is Frank, is that if you look at historically what that business has been able to do, what they've been able to do, it's -- $15 million, $20 million a month is what they've historically been able to do. And so what factors into that obviously is our ability to successfully integrate them, which we think will be able to penetrate some additional markets that are in our footprint that they didn't have before. And some of it does depend obviously on origination and refis, which they've shown some ability to have a good pretty much origination business as well. So that's how I guess I'd have to answer that, Chris.

Our next question comes from the line of Andrew Liesch of Sandler O'Neill.

My question just kind of relates to just loan demand and thoughts on different markets. It sounds like Kansas City's doing well. I'm just curious what may be driving that. And what opportunities do you see in Arizona and St. Louis?

This is Peter. Yes, I'd agree. I think we're pleased with the performance we're seeing on the C&I side in Kansas City. I think it's partly really beginning to see some leverage off the acquisitions we've done in the market and getting better market awareness, which I think has been helpful. It is a much more heavily concentrated real estate portfolio in Kansas City than St. Louis, which is why we saw the run-off to the degree that we did, I think, in this quarter. We saw it in St. Louis too. And again, it was competitive pricing more than anything else on the commercial real estate side. On a go-forward basis, the areas that I think, from a pipeline perspective, we're most encouraged by, would mainly relate to a lot of our specialty lending groups. Senior debt on M&A, that pipeline looks pretty strong for the second half. Life insurance premium finance also was strong in the second quarter, looks strong in the third and fourth quarters. The allocation of new market tax credits provides opportunity for us to do leverage loans, and that process has moved very quickly. And we see some good opportunity on leveraged loans in that regard, and we see those in all 3 markets: Arizona, Kansas City and St. Louis. And then finally, I'd mentioned asset-based lending, which again, those pipelines look pretty good. The issue on the ABL side for us is pricing. We see a lot of opportunity right now, but it seems to be getting pretty aggressive in all the markets. So while I'd put that one on the list, I'd put it probably fourth on the list in terms of growth opportunity. Doesn't mean we won't grow it. I think we will grow it. We have an opportunity to grow it pretty aggressively. But again, I think, as I indicated in the release and in my comments, pricing discipline is something we're sort of paying some attention to right now.

[Operator Instructions] Our next question comes from Brian Martin of FIG Partners.

Peter, could you just talk about your ability to -- as you look at this FDIC portfolio winding down and the organic growth that you're seeing, that was a little bit slower in the first half, but sounds like it picks up a bit in the second half, how you can outgrow that retreat, if you will, in the FDIC and kind of grow top line revenues as you look forward? How confident you are you're able to do that? And then secondly, maybe just on the -- if you guys give a little color, a thought on the -- I thought that on the -- your trust preferred, there was an element that was convertible, and how that may impact your capital targets here on the short term and pricing on that when that converts or when that could convert.

On your first question, I'd sort of repeat Frank's comment. You're going to see a lot of detail on the Q when it comes out. And I think we're presenting it at a conference in New York. You'll see a filing on Monday. That splits out core versus noncore, that it speaks more directly to your question. And when we see the acceleration of earnings from a core bank perspective, as it relates to our performance so far and our expectations as it relates to the attrition on the covered book, we feel pretty confident that we're in good shape in that respect. So I think you'll see more detail in the filing, and I think it will give you a lot more information in that respect. On convertible preferreds, they are callable in December, as I recall. And I think that was your question.

Yes. Okay, that covers it. Then maybe just the -- Frank, the accretion this quarter on the, I guess, kind of the base accretion that's in the first table in the press release, that was a touch lower than it had been in recent quarters. I guess is that -- that's how we should look at it going forward? That number is just going to continue to trend lower? I guess, that's my assumption. But again, am I thinking about that correctly?

No, I mean, but the balances were lower, Brian, I think. And as I mentioned the last 2 quarters, it's been -- I round it to 15%. And we're not giving forward-looking guidance on that yield, as I said in the past. I guess, for first quarter, I did anyway. To use -- just use trends to come up with your estimates. And we'll try to comment when we can on -- if there's any changes we should note for you.

[Operator Instructions] There are no further questions at this time. I'd like to turn the floor back over to management for any closing remarks.

Great. Thank you, Maria, and thanks to all of you for attending our call this afternoon and for your interest in the company. We really appreciate it. If you do have any other follow-up questions, feel free to call Frank or myself, and we wish you a great day. Thanks very much.

Thank you. This concludes today's Enterprise Financial earnings conference call. You may now disconnect.