ENTERPRISE FINANCIAL SERVICES CORP - Annual Report: 2019 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019
or
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number: 001-15373
ENTERPRISE FINANCIAL SERVICES CORP
(Exact name of registrant as specified in its charter)
Incorporated in the State of Delaware
I.R.S. Employer Identification # 43-1706259
Address: 150 North Meramec Avenue, Clayton, MO 63105
Telephone: (314) 725-5500
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 per share | EFSC | Nasdaq Global Select Market | ||
(Title of each class) | (Trading Symbol) | (Name of each exchange on which registered) | ||
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☒ | Accelerated filer | ☐ | |
Non-accelerated filer | ☐ | Smaller reporting company | ☐ | |
Emerging growth company | ☐ | |||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No x
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the Registrant was approximately $1,017,661,000 based on the closing price of the common stock of $41.60 as of the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2019) as reported by the Nasdaq Global Select Market.
As of February 19, 2020, the Registrant had 26,563,393 shares of outstanding common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018 are incorporated by reference into Item 7 of this Annual Report on Form 10-K. Additionally, the information required by Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K is incorporated by reference to the Registrant’s Definitive Proxy Statement for its 2020 Annual Meeting of Shareholders, which will be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
ENTERPRISE FINANCIAL SERVICES CORP
2019 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page | ||
PART I | ||
Item 1. | Business | |
Item 1A. | Risk Factors | |
Item 1B. | Unresolved Staff Comments | |
Item 2. | Properties | |
Item 3. | Legal Proceedings | |
Item 4. | Mine Safety Disclosures | |
PART II | ||
Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | |
Item 6. | Selected Financial Data | |
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk | |
Item 8. | Financial Statements and Supplementary Data | |
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | |
Item 9A. | Controls and Procedures | |
Item 9B. | Other Information | |
PART III | ||
Item 10. | Directors, Executive Officers, and Corporate Governance | |
Item 11. | Executive Compensation | |
Item 12. | Security Ownership of Certain Beneficial Owners, and Management and Related Stockholder Matters | |
Item 13. | Certain Relationships and Related Transactions, and Director Independence | |
Item 14. | Principal Accounting Fees and Services | |
PART IV | ||
Item 15. | Exhibits and Financial Statement Schedules | |
Item 16. | Form 10-K Summary | |
Signatures | ||
Glossary of Acronyms, Abbreviations and Entities
The acronyms and abbreviations identified below are used in various sections of this Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Item 7 and the Consolidated Financial Statements and the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K.
ASC | Accounting Standards Codification | FASB | Financial Accounting Standards Board | |
ASU | Accounting Standards Update | FDIC | Federal Deposit Insurance Corporation | |
Bank | Enterprise Bank & Trust | Federal Reserve | Federal Reserve Board | |
Board | Enterprise Financial Services Corp board of directors | FHLB | Federal Home Loan Bank | |
BOLI | Bank-Owned Life Insurance | GAAP | Generally Accepted Accounting Principles | |
C&I | Commercial and Industrial | JCB | Jefferson County Bancshares, Inc. | |
CCB | Capital Conservation Buffer | LANB | Los Alamos National Bank | |
CECL | Current Expected Credit Loss | LIBOR | London Interbank Offered Rate | |
CET1 | Common Equity Tier 1 Capital | MD&A | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |
CFPB | Consumer Financial Protection Bureau | PCD | Purchased Credit Deteriorated | |
Company | Enterprise Financial Services Corp and Subsidiaries | PCI | Purchased Credit Impaired | |
CRE | Commercial Real Estate | SBICs | Small Business Investment Companies | |
Dodd-Frank Act | Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 | SEC | Securities and Exchange Commission | |
EFSC | Enterprise Financial Services Corp | Trinity | Trinity Capital Corporation | |
Enterprise | Enterprise Financial Services Corp and Subsidiaries | |||
PART 1
Forward-Looking Information
Some of the information in this Annual Report on Form 10-K may contain “forward-looking statements” within the meaning of and intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements typically are identified with use of terms such as “may,” “might,” “will, “would,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “could,” “continue” and the negative of these terms and similar words, although some forward-looking statements may be expressed differently. Forward-looking statements also include, but are not limited to, statements regarding plans, objectives, expectations or consequences of announced transactions, known trends, and statements about future performance, operations, products and services. The ability to predict results or the actual effect of future plans or strategies is inherently uncertain. You should be aware that actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including, but not limited to: the ability to efficiently integrate acquisitions into our operations, retain the customers of these businesses and grow the acquired operations; credit risk; changes in the appraised valuation of real estate securing impaired loans; outcomes of litigation and other contingencies; exposure to general and local economic conditions; risks associated with rapid increases or decreases in prevailing interest rates; consolidation within the banking industry; competition from banks and other financial institutions; the ability to attract and retain relationship officers and other key personnel; burdens imposed by federal and state regulation; changes in regulatory requirements; changes in accounting regulation or standards applicable to banks; and other risks discussed under the caption “Risk Factors” in Item 1A of this Annual Report on Form 10-K, all of which could cause actual results to differ from those set forth in the forward-looking statements.
Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management’s analysis and expectations only as of the date of such statements. Forward-looking statements speak only as of 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 Securities and Exchange Commission which are available on the Company’s website at www.enterprisebank.com under “Investor Relations.”
ITEM 1: BUSINESS
General
Enterprise Financial Services Corp (“we,” “us,” or “our”), a Delaware corporation, is a financial holding company headquartered in Clayton, Missouri incorporated in December 1994. We are the holding company for Enterprise Bank & Trust, a full-service financial institution offering banking and wealth management services to individuals and corporate customers primarily located in Arizona, Kansas, Missouri, and New Mexico. Our executive offices are located at 150 North Meramec Avenue, Clayton, Missouri 63105, and our telephone number is (314) 725-5500.
Available Information
Various reports provided to the SEC, including our annual reports, quarterly reports, current reports, proxy statements, and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our website at www.enterprisebank.com under the “Investor Relations” link. These reports are made available as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Our filings with the SEC are also available on the SEC’s website at www.sec.gov. All website addresses given in this document are for information only and are not intended to be an active link or to incorporate any website information into this document.
Business Strategy
Our stated mission is “Guiding people to a lifetime of financial success.” We have established an accompanying corporate vision, “To be a company where our associates are proud to work, that delivers ease of navigation to our
customers and value to our investors, while helping our communities flourish.” These tenets are fundamental to our business strategies and operations.
Our business strategy is to generate shareholder returns by providing comprehensive financial services primarily to privately-held businesses, their owner families, and other success-minded individuals.
The Company offers a broad range of business and personal banking services, including wealth management services. Lending services include C&I, CRE, real estate construction and development, residential real estate, and consumer loans. A wide variety of deposit products and a complete suite of treasury management and international trade services complement our lending capabilities. Tax credit brokerage activities consist of the acquisition of Federal and State tax credits and the sale of these tax credits to clients. Enterprise Trust provides financial planning, estate planning, investment management, and trust services to businesses, individuals, institutions, retirement plans, and non-profit organizations.
Key components of our strategy include a focused and relationship-oriented distribution and sales approach, with an emphasis on growing fee income and niche businesses, while maintaining prudent credit and interest rate risk management, appropriate supporting technology, and controlled expense growth.
Building long-term client relationships - Our growth strategy is first and foremost client relationship driven. We continuously seek to add clients who fit our target market of businesses, business owners, professionals, and associated relationships. Those relationships are maintained, cultivated, and expanded over time by trained, experienced banking officers and other professionals. We fund loan growth primarily with core deposits from our business and professional clients in addition to consumers in our branch market areas. This is supplemented by borrowing or other deposit sources, including advances from the FHLB, and brokered certificates of deposits.
Specialized lending and product niches - We have focused our lending activities in specialty markets where we believe our expertise and experience as a commercial lender provides advantages over other competitors. In addition, we have developed expertise in certain product niches. These specialty niche activities focus on the following areas:
• | Enterprise Value Lending/Senior Debt Financing. We support mid-market company mergers and acquisitions in many domestic markets. We market directly to targeted private equity firms, principally SBICs, and provide primarily senior debt financing to portfolio companies. |
• | Life Insurance Premium Finance. We specialize in financing whole life insurance premiums utilized in high net worth estate planning, through relationships with boutique estate planners throughout the United States. |
• | Tax Credit Related Lending. We are a secured lender on affordable housing projects funded through the use of federal and state low income housing tax credits. In addition, we provide leveraged and other loans on projects funded through the U.S. Department of the Treasury Community Development Financial Institution (“CDFI”) New Markets Tax Credit Program. In prior years, we were selected to distribute New Markets Tax Credits, and we continue to participate in the application process, as well as serve as a secured lender to other allocatees. |
• | Tax Credit Brokerage. We acquire 10-year streams of Missouri state tax credits from affordable housing development funds and sell the tax credits to clients and other individuals for tax planning purposes. We also have a minority ownership in a partnership that acquires, invests and sells, state low income housing tax credits. We lend the partnership money with 6 - 12 year terms and receive interest income and fee income when projects close and when credits are sold. |
• | Agriculture. We engage in lending to agricultural businesses, including farms, for both real estate loans and operational loans principally in Missouri, Illinois, and Kansas. Agriculture loans are secured with equipment, cattle, crops or other non-real property and at times the underlying real property. |
• | Enterprise Aircraft Finance. We provide specialized financing and leasing solutions for the acquisition of owner-operator fixed and rotor wing aircraft including aircraft used as a primary business asset as well as short-term floor plans. |
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Fee income business - We offer a broad range of treasury management products and services that benefit businesses ranging from large national clients to local merchants. Customized solutions and special product bundles are available to clients of all sizes. In response to ever increasing needs for data/information security and functional efficiency, we continue to offer robust cash management systems that employ mobile technology and fraud detection/mitigation services. Enterprise Trust offers a wide range of fiduciary, investment management, and financial advisory services to facilitate our providing these services. We employ attorneys, certified financial planners, estate planning professionals, and other investment professionals. Enterprise Trust representatives assist clients in defining lifetime goals and designing plans to achieve them, consistent with our long-term relationship strategy. Our card services include debit cards, credit cards, and merchant services. We also offer international banking, and tax credit businesses that generate fee income.
Capitalizing on technology - Our client technology product offerings include, but are not limited to, internet banking, mobile banking, cash management products, remote deposit capture, positive pay services, fraud detection and prevention, automated payables, check image, and statement and document imaging. Additional service offerings currently supported by the Bank include controlled disbursements, repurchase agreements, and sweep investment accounts. Our cash management suite of products blends technology and personal service, which we believe often creates a competitive advantage over our competition. Technology products are also extensively utilized within the organization by associates in all lines of business including operations and support, customer service, and financial reporting for internal management purposes and for external compliance.
Maintaining asset quality - We monitor asset quality through formal, ongoing, multiple-level reviews of loans in each market and specialized lending niche. These reviews are overseen by the Bank’s credit administration department. In addition, the loan portfolio is subject to ongoing monitoring by a loan review function that reports directly to the Credit Committee of the Bank’s Board of Directors.
Expense management - We manage expenses carefully through detailed budgeting and expense approval processes and measurement of the “efficiency ratio”. The efficiency ratio is equal to noninterest expense divided by total revenue (net interest income plus noninterest income).
Acquisitions and Divestitures
On March 8, 2019, the Company closed its acquisition of 100% of Trinity and its wholly-owned subsidiary, LANB. Trinity operated six full-service retail and commercial banking offices in Los Alamos, Santa Fe, and Albuquerque, New Mexico. Trinity shareholders received cash consideration of $1.84 per share of Trinity common stock and 0.1972 shares of EFSC common stock per share of Trinity common stock with cash in lieu of fractional shares. Aggregate consideration at closing was approximately 4.0 million shares of EFSC common stock and $37.3 million cash paid to Trinity shareholders. Based on EFSC’s closing stock price of $43.07 on March 7, 2019, the overall transaction had a value of $209.2 million.
On February 10, 2017, the Company closed its acquisition of JCB. JCB merged with and into the Company, and Eagle Bank and Trust Company of Missouri, JCB’s wholly-owned subsidiary bank, merged with and into the Bank. As part of the acquisition, approximately 3.3 million shares of the Company’s common stock were issued and approximately $29.3 million in cash was paid to JCB shareholders and holders of JCB stock options. Based on EFSC’s closing stock price of $42.95 on February 10, 2017, the overall transaction had a value of $171.0 million.
Competition
The Company and its subsidiaries operate in highly competitive markets. Our geographic markets are served by multiple large financial and bank holding companies with substantial capital resources and lending capacity. We face competition not only from other financial holding companies and commercial banks, but also from credit unions, investment managers, insurers, brokerage firms, technology companies, and other providers of financial services and products. Strong competition for deposit and loan products affects the rates of those products, as well as the terms on which they are offered to customers.
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Supervision and Regulation
The following is a summary description of the relevant laws, rules, and regulations governing banks and financial holding companies. The description of, and references to, the statutes and regulations below are brief summaries and do not purport to be complete. The descriptions are qualified in their entirety by reference to the related statutes and regulations.
The regulatory and supervisory structure establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of depositors, the deposit insurance funds and the banking system as a whole, rather than for the protection of shareholders or creditors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies concerning the establishment of deposit insurance assessment fees, classification of assets and establishment of adequate loan loss reserves for regulatory purposes.
Various legislation is from time to time introduced in Congress and Missouri’s legislature. Such legislation may change applicable statutes and the operating environment in substantial and unpredictable ways. We cannot determine the ultimate effect that future legislation or implementing regulations would have upon our financial condition or upon our results of operations or the results of operations of any of our subsidiaries.
The Dodd-Frank Act, by way of example, contains a comprehensive set of provisions designed to govern the practices and oversight of financial institutions and other participants in the financial markets. The Dodd-Frank Act made extensive changes in the regulation of financial institutions and their holding companies. Some of the changes brought about by the Dodd-Frank Act have been modified by the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (the “Regulatory Relief Act”), signed into law on May 24, 2018.
Notwithstanding the regulatory easing brought about by the Regulatory Relief Act, uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact on the financial services industry as a whole and the Bank’s business, results of operations, and financial condition. Many aspects of the Dodd-Frank Act have been implemented while other aspects remain subject to further rulemaking. These regulations will take effect over several years, making it difficult to anticipate the overall financial impact on the Company, its customers or the financial industry more generally. However, the Dodd-Frank Act has increased the regulatory burden, compliance costs and interest expense for the Company.
Financial Holding Company
The Company is a financial holding company registered under the Bank Holding Company Act of 1956, as amended (“BHCA”). As a financial holding company, the Company is subject to regulation and examination by the Federal Reserve, and is required to file periodic reports of its operations and such additional information as the Federal Reserve may require. In order to remain a financial holding company, the Company must continue to be considered well managed and well-capitalized by the Federal Reserve, and the Bank must continue to be considered well managed and well-capitalized by the FDIC, and have at least a “satisfactory” rating under the Community Reinvestment Act. See “Liquidity and Capital Resources” in the Management Discussion and Analysis for more information on our capital adequacy, and “Bank Subsidiary - Community Reinvestment Act” below for more information on the Community Reinvestment Act.
Stock Repurchase Plans: From time to time the Company may engage in stock repurchases. The Federal Reserve requires that bank and financial holding companies, where certain conditions are triggered, provide prior notice to, consult with, and in certain circumstances seek the approval of, the Federal Reserve or reserve bank staff prior to implementing a stock repurchase plan. In addition to the formal guidance, the Federal Reserve appears to have adopted an informal policy of requiring bank and financial holding companies to seek a safety and soundness “non-objection” from the appropriate regulatory staff prior to implementing a stock repurchase plan, regardless of the financial or capital position of the holding company. In some cases, examiners following this informal policy have required the holding company to produce additional information and materials for review.
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Acquisitions: With certain limited exceptions, the BHCA requires every financial holding company or bank holding company to obtain the prior approval of the Federal Reserve before (i) acquiring substantially all the assets of any bank, (ii) acquiring direct or indirect ownership or control of any voting shares of any bank if, after such acquisition, it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares), or (iii) merging or consolidating with another bank holding company. Additionally, the BHCA provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition, or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also is required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is described below.
Change in Bank Control: Subject to various exceptions, the BHCA and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank or financial holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the Company or controls a majority of the board of directors. In certain circumstances, control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities of the Company. The regulations provide a procedure for challenging rebuttable presumptions of control.
Permitted Activities: The BHCA has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company. Under the regulations implementing the Gramm-Leach-Bliley Act, a financial holding company may engage in additional activities that are financial in nature or incidental or complementary to financial activities. Those activities include, among other activities, certain insurance, advisory and securities activities.
Support of Bank Subsidiaries: Under Federal Reserve policy, the Company is expected to act as a source of financial strength for the Bank and to commit resources to support the Bank. In addition, pursuant to the Dodd-Frank Act, this longstanding policy has been given the force of law, and additional regulations promulgated by the Federal Reserve to further implement the statute are possible; however, the bank subsidiary support provisions of the statute are fully effective even absent implementing regulations. As in the past, such financial support from the Company may be required at times when, without this legal requirement, the Company may not be inclined to provide it.
Capital Adequacy: The Company is also subject to capital requirements applied on a consolidated basis, which are substantially similar to those required of the Bank (summarized below).
Dividend Restrictions: Under Federal Reserve policies, financial holding companies may pay cash dividends on common stock only out of income available over the past year if prospective earnings retention is consistent with the organization’s expected future needs and financial condition and if the organization is not in danger of not meeting its minimum regulatory capital requirements. Federal Reserve policy also provides that financial holding companies should not maintain a level of cash dividends that undermines the financial holding company’s ability to serve as a source of strength to its banking subsidiaries.
Bank Subsidiary
The Bank is a Missouri trust company with banking powers and is subject to supervision and regulation by the Missouri Division of Finance. In addition, as a Federal Reserve non-member bank, it is subject to supervision and regulation by the FDIC. The Bank is a member of the FHLB of Des Moines.
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The Bank is subject to extensive federal and state regulatory oversight. The various regulatory authorities regulate or monitor all areas of the banking operations, including security devices and procedures, adequacy of capitalization and loss reserves, loans, investments, borrowings, deposits, mergers, issuance of securities, payment of dividends, interest rates payable on deposits, interest rates or fees chargeable on loans, establishment of branches, corporate reorganizations, maintenance of books and records, and adequacy of staff training to carry on safe lending and deposit gathering practices. The Bank must maintain certain capital ratios and is subject to limitations on aggregate investments in real estate, bank premises, low-income housing projects, and furniture and fixtures. In connection with their supervision and regulation responsibilities, the Bank is subject to periodic examination by the FDIC and Missouri Division of Finance.
Capital Adequacy: The Bank is required to comply with the FDIC’s capital adequacy standards for insured banks. The FDIC has issued risk-based capital and leverage capital guidelines for measuring capital adequacy, and all applicable capital standards must be satisfied for the Bank to be considered in compliance with regulatory capital requirements.
On July 2, 2013, the Federal Reserve approved a final rule to establish a new comprehensive regulatory capital framework for all U.S. banking organizations. This regulatory capital framework, commonly referred to as Basel III, implements several changes to the U.S. regulatory capital framework required by the Dodd-Frank Act.
The Basel III final rule, effective January 1, 2015, established a new CET1 requirement and increased the minimum tier 1 capital requirement to 6.0%. In addition, all banking organizations must maintain a CCB consisting of CET1 capital in an amount equal to 2.5% of risk-weighted assets in order to avoid restrictions on their ability to make capital distributions and to pay certain discretionary bonus payments to executive officers. The CCB effectively increases the minimum CET1 capital, tier 1 capital, and total capital ratios for U.S. banking organizations to 7.0%, 8.5%, and 10.5%, respectively, as of January 1, 2019.
As required by the Basel III final rule, capital instruments such as trust preferred securities and cumulative preferred shares have been phased out of tier 1 capital for banking organizations that had $15 billion or more in total consolidated assets as of December 31, 2009, and grandfathered as tier 1 capital such instruments issued by smaller entities prior to May 19, 2010 (provided they do not exceed 25% of tier 1 capital). The Company’s trust preferred securities currently are grandfathered under this provision.
Prompt Corrective Action: The Bank’s capital categories are determined for the purpose of applying the “prompt corrective action” rules described below and may be taken into consideration by banking regulators in evaluating proposals for expansion or new activities. They are not necessarily an accurate representation of a bank’s overall financial condition or prospects for other purposes. A failure to meet the capital guidelines could subject the Bank to a variety of enforcement actions under those rules, including the issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on the taking of brokered deposits, and other restrictions on its business. As described below, the FDIC also can impose other substantial restrictions on banks that fail to meet applicable capital requirements.
Federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized banks. Under this system, the FDIC has established five capital categories (“well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”) and is required to take various mandatory supervisory actions, and is authorized to take other discretionary actions with respect to banks in the three undercapitalized categories. The severity of any such actions taken will depend upon the capital category in which a bank is placed. Generally, subject to a narrow exception, current federal law requires the FDIC to appoint a receiver or conservator for a bank that is critically undercapitalized.
The following table summarizes the prompt corrective action categories:
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Prompt Corrective Action Category | Total Risk-Based Capital | Tier 1 Risk-Based Capital | Common Equity Tier 1 Risk-Based Capital | Tier 1 Leverage Ratio |
Well-capitalized | 10.0% | 8.0% | 6.5% | 5.0% |
Adequately capitalized | 8.0% | 6.0% | 4.5% | 4.0% |
Undercapitalized | < 8.0% | < 6.0% | < 4.5% | < 4.0% |
Significantly undercapitalized | < 6.0% | < 4.0% | < 3.0% | < 3.0% |
Critically undercapitalized | Tangible equity / Total assets ≤ 2.0% | |||
A bank that becomes “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized” is required to submit an acceptable capital restoration plan to the FDIC. An “undercapitalized” bank also is generally prohibited from increasing its average total assets, making acquisitions, establishing new branches, or engaging in any new line of business, except in accordance with an accepted capital restoration plan or with the approval of the FDIC. Also, the FDIC may treat an “undercapitalized” bank as being “significantly undercapitalized” if it determines that those actions are necessary to carry out the purpose of the law.
All of the Bank’s capital ratios were at levels that qualify it to be “well-capitalized” for regulatory purposes as of December 31, 2019.
Consumer Financial Protection Bureau: The Dodd-Frank Act centralized responsibility for consumer financial protection including implementing, examining and enforcing compliance with federal consumer financial laws with the CFPB. Depository institutions with less than $10 billion in assets, such as our Bank, will be subject to rules promulgated by the CFPB, but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes.
The Bank is also subject to other laws and regulations intended to protect consumers in transactions with depository institutions, as well as other laws or regulations affecting customers of financial institutions generally. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement and Procedures Act, the Fair Credit Reporting Act and the Federal Trade Commission Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. The Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing customer relations.
UDAP and UDAAP: Banking regulatory agencies have increasingly used a general consumer protection statute to address “unethical” or otherwise “bad” business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act - the primary federal law that prohibits unfair or deceptive acts or practices and unfair methods of competition in or affecting commerce (“UDAP” or “FTC Act”). “Unjustified consumer injury” is the principal focus of the FTC Act. Moreover, the UDAP provisions have been expanded under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices” (“UDAAP”), which has been delegated to the CFPB for supervision. The CFPB has brought a variety of enforcement actions for violations of UDAAP provisions and CFPB guidance continues to evolve.
Mortgage Reform: The CFPB has adopted final rules implementing minimum standards for the origination of residential mortgages, including standards regarding a customer’s ability to repay, restricting variable rate lending by requiring the ability to repay variable-rate loans be determined by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions. While the Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB, the Regulatory Relief Act provided certain presumptions of qualified mortgage status for banks with assets of less than $10 billion, subject to certain documentation and product issues.
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Dividends by the Bank Subsidiary: Under Missouri law, the Bank may pay dividends to the Company only from a portion of its undivided profits and may not pay dividends if its capital is impaired. As an insured depository institution, federal law prohibits the Bank from making any capital distributions, including the payment of a cash dividend if it is “undercapitalized” or after making the distribution would become undercapitalized. If the FDIC believes the Bank is engaged in, or about to engage in, an unsafe or unsound practice, the FDIC may require, after notice and hearing, that the bank cease and desist from that practice. The FDIC has indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. The FDIC has issued policy statements that provide that insured banks generally should pay dividends only from their current operating earnings. The Bank’s payment of dividends also could be affected or limited by other factors, such as events or circumstances which lead the FDIC to require that it maintain capital in excess of regulatory guidelines.
Transactions with Affiliates and Insiders: The Bank is subject to the provisions of Regulation W promulgated by the Federal Reserve, which encompasses Sections 23A and 23B of the Federal Reserve Act. Regulation W places limits and conditions on the amount of loans or extensions of credit to, investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. Regulation W also prohibits, among other things, an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. Federal law also places restrictions on the Bank’s ability to extend credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties; and must not involve more than the normal risk of repayment or present other unfavorable features.
Community Reinvestment Act: The Community Reinvestment Act (“CRA”) requires that, in connection with examinations of financial institutions within its jurisdiction, the FDIC is required to evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. The Bank has a satisfactory rating under CRA.
USA PATRIOT Act: The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”) requires each financial institution to: (i) establish an anti-money laundering program; (ii) establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks; and (iii) implement certain due diligence policies, procedures and controls with regard to correspondent accounts in the United States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, the USA PATRIOT Act contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities.
Commercial Real Estate Lending: The Bank’s lending operations may be subject to enhanced scrutiny by federal banking regulators based on its concentration of commercial real estate loans. On December 6, 2006, the federal banking regulators issued final guidance to remind financial institutions of the risk posed by CRE lending concentrations. CRE loans generally include land development, construction loans, and loans secured by multifamily property, and non-farm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following guidelines for its examiners to help identify institutions that are potentially exposed to significant CRE risk, including concentrations in certain types of CRE that may warrant greater supervisory scrutiny: total reported loans for construction, land development, and other land represent 100% or more of the institutions total capital; or total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.
Volcker Rule: On December 10, 2013, the federal regulators adopted final regulations to implement the proprietary trading and private fund prohibitions of the Volcker Rule under the Dodd-Frank Act. Under the final regulations, banking entities are generally prohibited, subject to significant exceptions from: (i) short-term proprietary trading as
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principal in securities and other financial instruments, and (ii) sponsoring or acquiring or retaining an ownership interest in private equity and hedge funds. Revisions to the Volcker Rule in 2019, that become effective in 2020, simplifies and streamlines the compliance requirements for banks that do not have significant trading activities. The Regulatory Relief Act provided an exemption from the above restrictions for banks with less than $10 billion in assets.
Governmental Policies
The operations of the Company and its subsidiaries are affected not only by general economic conditions, but also by the policies of various regulatory authorities. In particular, the Federal Reserve regulates monetary policy and interest rates in order to influence general economic conditions. These policies have a significant influence on overall growth and distribution of loans, investments and deposits and affect interest rates charged on loans or paid for deposits. Federal Reserve monetary policies have had a significant effect on the operating results of all financial institutions in the past and may continue to do so in the future.
The current U.S. administration has put in place changes to the financial services industry, including changes to policies and regulations that implement current federal law, including the Dodd-Frank Act, as well as a focus on reviewing and revising regulations promulgated during the prior administration. These changes were furthered by the enactment of the Regulatory Relief Act. At this point we are unable to determine what impact potential policy changes might have on the Company or its subsidiaries.
Employees
As of December 31, 2019, we had approximately 805 full-time equivalent employees. Our employees are not covered by a collective bargaining agreement. We believe our relationship with our employees is good.
ITEM 1A: RISK FACTORS
An investment in our common shares is subject to risks inherent to our business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report. The value of our common shares could decline due to any of these risks, and you could lose all or part of your investment.
Risks Relating to Our Business
Our allowance for loan losses may not be adequate to cover actual loan losses.
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management’s estimate of probable losses within the existing portfolio of loans. The allowance, in the judgment of management, is sufficient to reserve for estimated loan losses and risks inherent in the loan portfolio. We continue to monitor the adequacy of our loan loss allowance and may need to increase it if economic conditions deteriorate. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments that can differ somewhat from those of our own management. In addition, if charge-offs in future periods exceed the allowance for loan losses (i.e., if the loan allowance is inadequate), we may need additional loan loss provisions to increase the allowance for loan losses. Additional provisions to increase the allowance for loan losses, should they become necessary, would result in a decrease in net income and a reduction in capital, and may have a material adverse effect on our financial condition and results of operations.
A new accounting standard will require an increase to our allowance for loan losses which may have a material adverse effect on our financial condition and results of operations.
The Financial Accounting Standards Board has adopted a new accounting standard that became effective for the Company beginning January 1, 2020. This standard, referred to as CECL, requires financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses in the period when the loans are recorded. This changes the prior method of providing allowances for loan losses that are probable, which will require us to increase our allowance for loan losses and increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in our allowance for loan losses would result in a decrease in net income and may have a material adverse effect on our financial condition and results of operations.
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An economic downturn could adversely affect our financial condition, results of operations or cash flows.
If the communities in which we operate do not grow, or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. Unpredictable economic conditions may have an adverse effect on the quality of our loan portfolio and our financial performance. Economic recession or other economic problems in our market areas could have a material adverse impact on the quality of the loan portfolio and the demand for our products and services. Adverse changes in the economies in our market areas may have a material adverse effect on our financial condition, results of operations or cash flows. As a community bank, we bear increased risk of unfavorable local economic conditions. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas even if they do occur.
Our loan portfolio is concentrated in certain markets which could result in increased credit risk.
A majority of our loans are to businesses and individuals in the St. Louis, Kansas City, Phoenix, Los Alamos, Albuquerque and Santa Fe metropolitan areas. The regional economic conditions in areas where we conduct our business have an impact on the demand for our products and services as well as the ability of our clients to repay loans, the value of the collateral securing loans, and the stability of our deposit funding sources. Consequently, a decline in local economic conditions may adversely affect our earnings.
There are material risks involved in commercial lending that could adversely affect our business.
Our business plan calls for continued efforts to increase our assets invested in commercial loans. Our commercial loans include loans that are secured by real estate (commercial property, multi-family residential property, 1-4 family residential property, and construction and land). Commercial loans generally involve a higher degree of credit risk than residential mortgage loans due, in part, to their larger average size and less marketable collateral. In addition, unlike residential mortgage loans, commercial loans generally depend on the cash flow of the borrower’s business to service the debt. Adverse economic conditions or other factors affecting our target markets may have a greater adverse effect on us than on other financial institutions that have a more diversified client base. Increases in non-performing commercial loans could result in operating losses, impaired liquidity and erosion of our capital, and could have a material adverse effect on our financial condition and results of operations. Credit market tightening could adversely affect our commercial borrowers through declines in their business activities and adversely impact their overall liquidity through the diminished availability of other borrowing sources or otherwise.
Increased regulatory oversight, uncertainty relating to the LIBOR calculation process and potential phasing out of LIBOR after 2021 may adversely affect the results of our operations.
On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates the LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR, whether LIBOR rates will cease to be published or supported before or after 2021 or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. Efforts in the United States to identify a set of alternative U.S. dollar reference interest rates include proposals by the ARRC of the Federal Reserve Board and the Federal Reserve Bank of New York. Uncertainty as to the nature of alternative reference rates and as to potential changes in other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and to a lesser extent securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings, including the rates we pay on our subordinated debentures. The Company has material contracts that are indexed to LIBOR. If LIBOR rates are no longer available, any successor or replacement interest rates may perform differently and we may incur significant costs to transition both our borrowing arrangements and the loan agreements with our customers from LIBOR, which may have an adverse effect on our results of operations. The impact of alternatives to LIBOR on the valuations, pricing and operation of our financial instruments is not yet known.
Our loan portfolio includes loans secured by real estate, which could result in increased credit risk.
A portion of our portfolio is secured by real estate, and thus we face a high degree of risk from a downturn in our real estate markets. If real estate values would decline in our markets, our ability to recover on defaulted loans for which
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the primary reliance for repayment is on the real estate collateral by foreclosing and selling that real estate would then be diminished, and we would be more likely to suffer losses on defaulted loans.
Additionally, Kansas and Arizona have foreclosure laws that may hinder our ability to timely or fully recover on defaulted loans secured by property in their states. Kansas is a judicial foreclosure state, therefore all foreclosures must be processed through the Kansas state courts. Due to this process, it takes approximately one year to foreclose on real estate collateral located in the State of Kansas. Our ability to recover on defaulted loans secured by Kansas property may be delayed and our recovery efforts are lengthened due to this process. Arizona has an anti-deficiency statute with regards to certain types of residential mortgage loans. Our ability to recover on defaulted loans secured by residential mortgages may be limited to the fair value of the real estate securing the loan at the time of foreclosure.
Our commercial and industrial loans, enterprise value lending / senior debt financing transactions are underwritten based primarily on cash flow, profitability and enterprise value of the client and are not fully covered by the value of tangible assets or collateral of the client. Consequently, if any of these transactions becomes non-performing, we could experience significant losses.
Cash flow lending involves lending money to a client based primarily on the expected cash flow, profitability and enterprise value of a client, with the value of any tangible assets as secondary protection. In some cases, these loans may have more leverage than traditional bank debt. In the case of our senior cash flow loans, we generally take a lien on substantially all of a client’s assets, but the value of those assets is typically substantially less than the amount of money we advance to the client under a cash flow transaction. In addition, some of our cash flow loans may be viewed as stretch loans, meaning they may be at leverage multiples that exceed traditional accepted bank lending standards for senior cash flow loans. Thus, if a cash flow transaction becomes non-performing, our primary recourse to recover some or all of the principal of our loan or other debt product would be to force the sale of all or part of the company as a going concern. Additionally, we may obtain equity ownership in a borrower as a means to recover some or all of the principal of our loan. The risks inherent in cash flow lending include, among other things:
• | reduced use of or demand for the client’s products or services and, thus, reduced cash flow of the client to service the loan and other debt product as well as reduced value of the client as a going concern; |
• | inability of the client to manage working capital, which could result in lower cash flow; |
• | inaccurate or fraudulent reporting of our client’s positions or financial statements; and |
• | our client’s poor management of their business. |
Additionally, many of our clients use the proceeds of our cash flow transactions to make acquisitions. Poorly executed or poorly conceived acquisitions can burden management, systems and the operations of the existing business, causing a decline in both the client’s cash flow and the value of its business as a going concern. In addition, many acquisitions involve new management teams taking over day-to-day operations of a business. These new management teams may fail to execute at the same level as the former management team, which could reduce the cash flow of the client available to service the loan or other debt product, as well as reduce the value of the client as a going concern.
Widespread financial difficulties or downgrades in the financial strength or credit ratings of life insurance providers could lessen the value of the collateral securing our life insurance premium finance loans and impair our financial condition and liquidity.
One of the specialized products we offer is financing whole life insurance premiums utilized in high net worth estate planning. These loans are primarily secured by the insurance policies financed by the loans, i.e., the obligations of the life insurance providers under those policies. Nationally Recognized Statistical Rating Organizations (“NRSROs”) such as Standard & Poor’s, Moody’s and A.M. Best evaluate the life insurance providers that are the payors on the life insurance policies that we finance. The value of our collateral could be materially impaired in the event there are widespread financial difficulties among life insurance providers or the NRSROs downgrade the financial strength ratings or credit ratings of the life insurance providers, indicating the NRSROs’ opinion that the life insurance provider’s ability to meet policyholder obligations is impaired, or the ability of the life insurance provider to meet the terms of its debt obligations is impaired. The value of our collateral is also subject to the risk that a life insurance provider could become insolvent. In particular, if one or more large nationwide life insurance providers were to fail, the value of our portfolio could be significantly negatively impacted. A significant downgrade in the value of the collateral supporting
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our premium finance business could impair our ability to create liquidity for this business, which, in turn could negatively impact our ability to expand.
Our construction and land development loans are based upon estimates of costs and value associated with the completed project. These estimates may be inaccurate and we may be exposed to more losses on these projects than on other loans.
Construction, land acquisition and development lending involves additional risks because funds are advanced based upon the projected value of the project, which is inherently uncertain prior to the project’s completion. Because of the uncertainties inherent in estimating construction costs, as well as the fair value of the completed project and the effects of governmental regulation of real property and the general effects of the national and local economies, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project. If we are forced to foreclose on a project prior to or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan or the related foreclosure, sale and holding costs. In addition, we may be required to fund additional amounts to complete the project and may have to hold the property for an unspecified period of time. If any of these events occur, our financial condition, results of operations and cash flows could be materially and adversely affected.
Our loan portfolio includes agricultural loans, and the ability of the borrower to repay may be affected by many factors outside of the borrowers’ control.
We engage in lending to agricultural businesses, including farms, for both real estate loans and operational loans. Agricultural markets are highly sensitive to real and perceived changes in the supply and demand of agricultural products. The agricultural economy in our states has been affected by declines in prices and the rates of price growth for various crops and other agricultural commodities. Farm income has seen recent declines, and in line with the downturn in farm income, farmland prices are coming under pressure. We monitor and review our agriculture portfolio to identify loans potentially affected by declines in agricultural commodity prices and lower collateral values. Any extended period of low commodity prices, drought conditions, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry could result in an increase in the level of problem agriculture loans and potentially result in additional provisions to increase our allowance for loan losses, and may have a material adverse effect on our financial condition and results of operations. The imposition of tariffs and retaliatory tariffs or other trade restrictions on agriculture products and materials that our customers import or export, could negatively impact our customers, their financial results and ability to service debt, which, in turn, could adversely affect our financial condition and results of operations.
We engage in aircraft financing transactions, in which high-value collateral is susceptible to potential catastrophic loss. Consequently, if any of these transactions becomes non-performing, we could suffer a loss of some or all of our value in the assets.
We have an aircraft financing platform and an associated portfolio of aircraft loans. These transactions are secured by the aircraft financed by the loans. Aircraft as collateral presents unique risks: it is high-value, but susceptible to rapid movement across different locations and potential catastrophic loss. Although the loan documentation for these transactions includes insurance covenants and other provisions to protect the lender against risk of loss, there can be no assurance that, in the event of a catastrophic loss, the insurance proceeds would be sufficient to ensure our full recovery of the aircraft loan. Moreover, a relatively small number of non-performing aircraft loans could have a significant negative impact on the value of our portfolio. If we must make additional provisions to increase our allowance for loan losses, we could experience a decrease in net income and possibly a reduction in capital, which could have a material adverse effect on our financial condition and results of operations.
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We may be obligated to indemnify certain counterparties in financing transactions we enter into pursuant to the New Markets Tax Credit Program.
We participate in and have previously been an “Allocatee” of the New Markets Tax Credit Program of the U.S. Department of the Treasury Community Development Financial Institutions Fund. Through this program, we provide our allocation to certain projects, which in turn for an equity investment from an Investor in the project generate federal tax credits to those investors. This equity, coupled with any debt or equity from the project sponsor is in turn invested in a certified community development entity for a period of at least seven years. Community development entities must use this capital to make loans to, or other investments in, qualified businesses in low-income communities in accordance with New Markets Tax Credit Program criteria. Investors receive an overall tax credit equal to 39% of their total equity investment, credited at a rate of five percent in each of the first three years and six percent in each of the final four years. However, after the exhaustion of all cure periods and remedies, the entire credit is subject to recapture if the certified community development entity fails to maintain its certified status, or if substantially all of the equity investment proceeds associated with the tax credits we allocate are no longer continuously invested in a qualified business that meets the New Markets Tax Credit Program criteria, or if the equity investment is redeemed prior to the end of the minimum seven-year term. As part of these financing transactions, we as the parent to Enterprise Financial CDE, LLC (“CDE”), provide customary indemnities to the tax credit investors, which require us to indemnify and hold harmless the investors in the event a credit recapture event occurs, unless the recapture is a result of action or inaction of the investor. No assurance can be given that these counterparties will not call upon us to discharge these obligations in the circumstances under which they are owed. If this were to occur, the amount we may be required to pay a bank investor could be substantial and could have a material adverse effect on our results of operations and financial condition.
If we fail to comply with requirements of the federal New Markets Tax Credit program, the U.S. Department of the Treasury Community Development Financial Institutions Fund could seek any remedies available under its Allocation Agreement with us, and we could suffer significant reputational harm and be subject to greater scrutiny from banking regulators.
Because we have been designated as an “Allocatee” under the New Markets Tax Credit Program, we are required to provide allocation fund qualifying projects under the New Markets Tax Credit Program, and we are responsible for monitoring those projects, ensuring their ongoing compliance with the requirements of the New Markets Tax Credit Program and satisfying the various recordkeeping and reporting requirements under the New Markets Tax Credit Program. If we default in our obligations under the New Markets Tax Credit Program, the U.S. Department of the Treasury may revoke our participation in any other CDFI Fund programs, reallocate the new market tax credits that were originally allocated to us, and take any other remedial actions that it is empowered to take under the Allocation Agreement they have entered into with us with respect to the New Markets Tax Credit Program, with the full range of such remedies being unknown. If we were to default under the New Markets Tax Credit Program, we could suffer negative publicity in the communities in which we operate, and we could face greater scrutiny from federal and state bank regulators, especially with regard to our compliance with the CRA. These developments could have a material adverse impact on our reputation, business, financial condition, results of operations and liquidity.
We face potential risks from litigation brought against the Company or its subsidiaries.
We are involved in various lawsuits and legal proceedings. Pending or threatened litigation against the Company or the Bank, litigation-related costs and any legal liability as a result of an adverse determination with respect to one or more of these legal proceedings could have a material adverse effect on our business, cash flows, financial position or results of operations and/or could cause us significant reputational harm, including without limitation as a result of negative publicity the Company may face even if it prevails in such legal proceedings, which could adversely affect our business prospects.
Liquidity risk could impair our ability to fund operations and meet debt coverage obligations, and jeopardize our financial condition.
Liquidity is essential to our business. We are a holding company and depend on our subsidiaries for liquidity needs, including debt coverage requirements. An inability to raise funds through deposits, borrowings, the sale of investment securities and other sources could have a substantial material adverse effect on our liquidity. Our access to funding sources in amounts that are adequate to finance our activities could be impaired by factors that affect us specifically
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or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include but are not limited to a decrease in the level of our business activity due to a market downturn, our failure to remain well-capitalized, or adverse regulatory action against us. Our ability to acquire deposits or to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole.
Costs and levels of deposits are affected by competition and environmental factors that could increase our funding costs or liquidity risk.
We rely on bank deposits to be a low cost and stable source of funding. We compete with banks and other financial services companies for deposits. If our competitors raise the rates they pay on deposits, our funding costs may increase, either because we raise our rates to avoid losing deposits or because we lose deposits and must rely on more expensive sources of funding. Higher funding costs could reduce our net interest margin and net interest income and could have a material adverse effect on our business, financial condition and results of operations.
Our utilization of brokered deposits could adversely affect our liquidity and results of operations.
Since our inception, we have utilized both brokered and non-brokered deposits as a source of funds to support our growing loan demand and other liquidity needs. As a bank regulatory supervisory matter, reliance upon brokered deposits as a significant source of funding is discouraged. Brokered deposits may not be as stable as other types of deposits, and, in the future, those depositors may not renew their deposits when they mature, or we may have to pay a higher rate of interest to keep those deposits or may have to replace them with other deposits or with funds from other sources. Additionally, if the Bank ceases to be categorized as “well-capitalized” for bank regulatory purposes, it would not be able to accept, renew or roll over brokered deposits without a waiver from the FDIC. Our inability to maintain or replace these brokered deposits as they mature could adversely affect our liquidity and results of operations. Further, paying higher interest rates to maintain or replace these deposits could adversely affect our net interest margin and results of operations.
We may need to raise additional capital in the future, and such capital may not be available to us or may only be available on unfavorable terms.
We may need to raise additional capital in the future in order to support growth or manage adverse developments such as any additional provisions for loan losses, to maintain our capital ratios, or for other reasons. The condition of the financial markets may be such that we may not be able to obtain additional capital, or the additional capital may only be available on terms that are not attractive to us.
Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial performance.
A substantial portion of our income is derived from the differential or “spread” between the interest earned on loans, investment securities, and other interest-earning assets, and the interest paid on deposits, borrowings, and other interest-bearing liabilities. Because of the differences in the maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates may not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. Our assets and liabilities may react differently to changes in overall interest rates or conditions. Significant fluctuations in market interest rates could materially and adversely affect not only our net interest spread, but also our asset quality and loan origination volume, deposits, funding availability, and/or net income.
We face potential risk from changes in governmental monetary policies.
The Bank’s earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve affect the levels of bank loans, investments, and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks, and its influence over reserve requirements to which member banks are subject. The Bank cannot predict the nature or impact of future changes in monetary and fiscal policies.
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The ability of our borrowers to repay their loans may be adversely affected by an increase in market interest rates which could result in increased credit losses. These increased credit losses, where the Bank has retained credit exposure, could decrease our assets, net income and cash available.
The loans we make to our borrowers may bear interest at a variable or floating interest rate. When market interest rates increase, the amount of revenue borrowers need to service their debt also increases. Some borrowers may be unable to make their debt service payments. As a result, an increase in market interest rates will increase the risk of loan default. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for loan and covered loan losses, and an increase in loan charge-offs, all of which could have a material adverse effect on our business, financial condition and results of operations.
By engaging in derivative transactions, we are exposed to additional credit and market risk in our banking business.
We use interest rate swaps to help manage our interest rate risk in our banking business from recorded financial assets and liabilities when they can be demonstrated to effectively hedge a designated asset or liability and the asset or liability exposes us to interest rate risk or risks inherent in client related derivatives. We may use other derivative financial instruments to help manage other economic risks, such as liquidity and credit risk, including exposures that arise from business activities that result in the receipt or payment of future known or uncertain cash amounts, the value of which are determined by interest rates. We also have derivatives that result from a service we provide to certain qualifying clients approved through our credit process, and therefore, these derivatives are not used to manage interest rate risk in our assets or liabilities. Hedging interest rate risk is a complex process, requiring sophisticated models and routine monitoring. As a result of interest rate fluctuations, hedged assets and liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation will generally be offset by income or loss on the derivative instruments that are linked to the hedged assets and liabilities. By engaging in derivative transactions, we are exposed to credit and market risk. If the counterparty fails to perform, credit risk exists to the extent of the fair value gain in the derivative. Market risk exists to the extent that interest rates change in ways that are significantly different from what we expected when we entered into the derivative transaction. The existence of credit and market risk associated with our derivative instruments could adversely affect our net interest income and, therefore, could have a material adverse effect on our business, financial condition, results of operations and future prospects.
If the Company or the Bank incur losses that erode its capital, it may become subject to enhanced regulation or supervisory action.
Under federal and state laws and regulations pertaining to the safety and soundness of insured depository institutions, the Missouri Division of Finance, the Federal Reserve Board, and the FDIC have the authority to compel or restrict certain actions if the Company’s or the Bank’s capital should fall below adequate capital standards as a result of future operating losses, or if its bank regulators determine that it has insufficient capital. Among other matters, the corrective actions include but are not limited to requiring affirmative action to correct any conditions resulting from any violation or practice; directing an increase in capital and the maintenance of specific minimum capital ratios; restricting the Bank’s operations; limiting the rate of interest the bank may pay on brokered deposits; restricting the amount of distributions and dividends and payment of interest on its trust preferred securities; requiring the Bank to enter into informal or formal enforcement orders, including memoranda of understanding, written agreements and consent or cease and desist orders to take corrective action and enjoin unsafe and unsound practices; removing officers and directors and assessing civil monetary penalties; and taking possession of and closing and liquidating the Bank. These actions may limit the ability of the Bank or Company to execute its business plan and thus can lead to an adverse impact on the results of operations or financial position.
Changes in government regulation and supervision may increase our costs or impact our ability to operate in certain lines of business.
Our operations are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders. Because our business is highly regulated, the laws, rules, regulations and supervisory guidance and policies applicable to us are subject to regular modification and change and could result in an adverse impact on our results of operations.
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We may be adversely affected by the soundness of other financial institutions.
Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to different institutions and counterparties, and we execute transactions with various counterparties in the financial industry, including federal home loan banks, commercial banks, brokers and dealers, investment banks and other institutional clients. Defaults by financial services institutions, and even rumors or questions about one or more financial services institutions or the financial services industry in general, have led to market-wide liquidity problems in prior years and could lead to losses or defaults by us or by other institutions. Any such losses could materially and adversely affect our results of operations or financial position.
We face significant competition.
The financial services industry, including but not limited to, commercial banking, mortgage banking, consumer lending, and home equity lending, is highly competitive, and we encounter strong competition for deposits, loans, and other financial services in all of our market areas in each of our lines of business. Our principal competitors include other commercial banks, savings banks, savings and loan associations, mutual funds, money market funds, finance companies, trust companies, technology companies, insurers, credit unions, and mortgage companies among others. Many of our non-bank competitors are not subject to the same degree of regulation as us and have advantages over us in providing certain services. Many of our competitors are significantly larger than we are and have greater access to capital and other resources. Also, our ability to compete effectively in our business is dependent on our ability to adapt successfully to regulatory and technological changes within the banking and financial services industry, generally. If we are unable to compete effectively, we will lose market share and our income from loans and other products may diminish.
Our ability to compete successfully depends on a number of factors, including, among other things:
• | the ability to develop, maintain, and build upon long-term client relationships based on top quality service and high ethical standards; |
• | the scope, relevance, and pricing of products and services, including technological innovations to those products and services, offered to meet client needs and demands; |
• | the rate at which we introduce new products and services relative to our competitors; |
• | client satisfaction with our level of service; and/or |
• | industry and general economic trends. |
Failure to perform in any of these areas could significantly weaken our competitive position, and could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations.
We have engaged in and may continue to engage in further expansion through acquisitions, and these acquisitions present a number of risks related both to the acquisition transactions and to the integration of the acquired businesses.
The acquisition of other financial services companies or assets present risks to the Company in addition to those presented by the nature of the business acquired. Our earnings, financial condition, and prospects after a merger or acquisition depend in part on our ability to successfully integrate the operations of the acquired company. We may be unable to integrate operations successfully or to achieve expected results or cost savings.
Acquiring other banks or businesses involves various risks commonly associated with acquisitions, including, among other things:
• | potential exposure to unknown or contingent liabilities of the target company; |
• | exposure to potential asset quality issues of the target company; |
• | difficulty and expense of integrating the operations and personnel of the target company; |
• | potential disruption to our business; |
• | potential diversion of our management’s time and attention; |
• | the possible loss of key employees and clients of the target company; |
• | difficulty in estimating the value of the target company; |
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• | payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short- and long-term; |
• | inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits; and/or |
• | potential changes in banking or tax laws or regulations that may affect the target company. |
We periodically evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, merger or acquisition discussions and, in some cases, negotiations may take place, and future mergers or acquisitions involving cash, debt or equity securities may occur at any time. In addition to the risks noted above, potential acquisitions may incur additional costs for diligence or break-up fees, even if the transaction is not consummated.
We may be unable to successfully integrate new business lines into our existing operations.
From time to time, we may implement other new lines of business or offer new products or services within existing lines of business. There can be substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. Although we continue to expend substantial managerial, operating and financial resources as our business grows, we may be unable to successfully continue the integration of new business lines, and price and profitability targets may not prove feasible. External factors such as compliance with regulations, competitive alternatives and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, financial condition and results of operations.
We may not be able to maintain our historical rate of growth or profitability, which could have a material adverse effect on our ability to successfully implement our business strategy.
Successful growth requires that we follow adequate loan underwriting standards, balance loan and deposit growth without increasing interest rate risk or compressing our net interest margin, maintain adequate capital at all times, produce investment performance results competitive with our peers and benchmarks, further diversify our revenue sources, meet the expectations of our clients and hire and retain qualified employees. If we do not manage our growth successfully, then our business, results of operations or financial condition may be adversely affected.
We may not be able to attract and retain skilled people.
Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most activities in which we are engaged can be intense, and we may not be able to hire or retain the people we want and/or need. Although we maintain employment agreements with certain key employees, and have incentive compensation plans aimed, in part, at long-term employee retention, the unexpected loss of services of one or more of our key personnel could still occur, and such events may have a material adverse impact on our business because of the loss of the employee’s skills, knowledge of our market, and years of industry experience and the difficulty of promptly finding qualified replacement personnel.
Additionally, executive leadership transitions and succession planning can be inherently difficult to manage and may cause disruption to our business. Executive leadership transitions inherently cause some loss of institutional knowledge, which can negatively affect strategy and execution, and our results of operations and financial condition could suffer as a result. The loss of services of one or more members of senior management could have a material adverse effect on our business.
Loss of key employees may disrupt relationships with certain clients.
Our client relationships are critical to the success of our business, and loss of key employees with significant client relationships may lead to the loss of business if the clients follow that employee to a competitor. While we believe our relationships with our key personnel are strong, we cannot guarantee that all of our key personnel will remain with us, which could result in the loss of some of our clients and could have an adverse impact on our business, financial condition and results of operations.
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We may incur impairments to goodwill.
As of December 31, 2019, we had $210 million recorded as goodwill. We evaluate our goodwill for impairment at least annually. Significant negative industry or economic trends, including the lack of recovery in the market price of our common stock, or reduced estimates of future cash flows or disruptions to our business, could result in impairments to goodwill. Our valuation methodology for assessing impairment requires management to make judgments and assumptions based on historical experience and to rely on projections of future operating performance. We operate in competitive environments and projections of future operating results and cash flows may vary significantly from actual results. If our analysis results in impairment to goodwill, we would be required to record an impairment charge to earnings in our financial statements during the period in which such impairment is determined to exist. Any such change could have a material adverse effect on our results of operations and stock price.
Financial deregulation measures may create regulatory uncertainty for the financial sector and increase competition.
The Regulatory Relief Act, signed into law in May 2018, made changes in several keys areas that affect financial institutions. Notwithstanding the partial regulatory easing brought about by the Regulatory Relief Act, most of the provisions of the Dodd-Frank Act remain in effect, such as those concerning Volcker Rule, the U.S. Risk Retention Rules, Basel III capital requirements, the FSOC’s authority, the role, responsibilities and enforcement strategies of the CFPB, capital issues, and implementing regulations promulgated pursuant to the Dodd-Frank Act. Measures focused on deregulation of the U.S. financial services industry may have the effect of increasing competition for our credit-focused businesses or otherwise reducing investment opportunities. Increased competition from banks and other financial institutions in the credit markets could have the effect of reducing credit spreads, which may adversely affect the revenues of our credit and other businesses whose strategies including the provision of credit to borrowers. Determining the full extent of the impact on us of any such potential financial reform legislation, or whether any such particular proposal will become law, is highly speculative. However, any such changes may impose additional costs on us, require the attention of our senior management or result in limitations on the manner in which business is conducted.
The CFPB may reshape the consumer financial laws through rulemaking and enforcement of unfair, deceptive or abusive acts or practices, which may directly impact the business operations of depository institutions offering consumer financial products or services, including the Bank.
The Dodd-Frank Act, which was enacted in 2010, imposed significant regulatory and compliance changes, and represents a comprehensive overhaul of the financial services industry within the United States. Among other things, key provisions of the Dodd-Frank Act establish the CFPB and require the CFPB and other federal agencies to implement many new rules. While several provisions of the Dodd-Frank Act became effective immediately upon its enactment and others have come into effect over the last few years, many provisions still require regulations to be promulgated by various federal agencies in order to be implemented. Some of these regulations have been proposed by the applicable federal agencies but not yet finalized.
The CFPB has broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks, including the authority to prohibit unfair, deceptive or abusive acts and practices. In addition, the Dodd-Frank Act enhanced the regulation of mortgage banking and gave to the CFPB oversight of many of the core laws which regulate the mortgage industry and the authority to implement mortgage regulations. Any new regulations adopted by the CFPB may significantly impact consumer mortgage lending and servicing.
We are subject to numerous laws designed to protect consumers, including the CRA and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.
The CRA, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The CFPB, the U.S. Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Private parties may also have the ability to
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challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition, results of operations and future prospects.
We are subject to compliance with the Bank Secrecy Act and other anti-money laundering statutes and regulations, and failure to comply with these laws could lead to a wide variety of sanctions.
The Bank Secrecy Act, the USA PATRIOT Act of 2001, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports when appropriate. In addition to other bank regulatory agencies, the federal Financial Crimes Enforcement Network of the Department of the Treasury is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the state and federal banking regulators, as well as the U.S. Department of Justice, CFPB, Drug Enforcement Administration, and Internal Revenue Service. We are also subject to increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control of the Department of the Treasury regarding, among other things, the prohibition of transacting business with, and the need to freeze assets of, certain persons and organizations identified as a threat to the national security, foreign policy or economy of the United States. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including any acquisition plans. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could have a material adverse effect on our business, financial condition, results of operations and future prospects.
Declines in asset values may result in impairment charges and adversely impact the value of our investments and our financial performance and capital.
We hold an investment portfolio that includes, but is not limited to, government securities and agency mortgage-backed securities. Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect to the securities, defaults by the issuer or with respect to the underlying securities, changes in market interest rates and/or spread, and instability and other factors impacting the capital markets. Any of these factors, among others, could cause other-than-temporary impairments and realized or unrealized losses in future periods and declines in other comprehensive income (loss), which could have a material adverse effect on our business, results of operations, financial condition and future prospects. The process for determining whether impairment of a security is other-than-temporary often requires complex, subjective judgments about whether there has been significant deterioration in the financial condition of the issuer, whether management has the intent or ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value, the future financial performance and liquidity of the issuer and any collateral underlying the security and other relevant factors.
Our investment portfolio includes capital stock of the FHLB of Des Moines. This stock ownership is required for us to qualify for membership in the FHLB system, which enables us to borrow funds under the FHLB advance program. If the FHLB experiences a capital shortfall, it could suspend its quarterly cash dividend, and possibly require its members, including us, to make additional capital investments in the FHLB. If the FHLB were to cease operations, or if we were required to write-off our investment in the FHLB, our financial condition, and results of operations may be materially and adversely affected.
We primarily invest in mortgage-backed obligations and such obligations have been, and are likely to continue to be, impacted by market dislocations, declining home values and prepayment risk, which may lead to volatility in cash flow and market risk and declines in the value of our investment portfolio.
Our investment portfolio largely consists of mortgage-backed obligations primarily secured by pools of mortgages on single-family residences. The value of mortgage-backed obligations in our investment portfolio may fluctuate for several reasons, including (i) delinquencies and defaults on the mortgages underlying such obligations, due in part to high unemployment rates, (ii) falling home prices, (iii) lack of a liquid market for such obligations, (iv) uncertainties in respect of government-sponsored enterprises such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”), which guarantee such obligations, and (v) the
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expiration of government stimulus initiatives. If the value of homes were to materially decline, the fair value of the mortgage-backed obligations in which we invest may also decline. Any such decline in the fair value of mortgage-backed obligations, or perceived market uncertainty about their fair value, could adversely affect our financial position and results of operations. In addition, when we acquire a mortgage-backed security, we anticipate that the underlying mortgages will prepay at a projected rate, thereby generating an expected yield. Prepayment rates generally increase as interest rates fall and decrease when rates rise, but changes in prepayment rates are difficult to predict. In light of historically low interest rates, many of our mortgage-backed securities have a higher interest rate than prevailing market rates, resulting in a premium purchase price. In accordance with applicable accounting standards, we amortize the premium over the expected life of the mortgage-backed security. If the mortgage loans securing the mortgage-backed security prepay more rapidly than anticipated, we would have to amortize the premium on an accelerated basis, which would thereby adversely affect our profitability.
Technology is continually changing and we must effectively implement new innovations in providing services to our customers.
The financial services industry is undergoing rapid technological changes with frequent innovations in technology-driven products and services. In addition to better serving customers, the effective use of technology increases our efficiency and enables us to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers using innovative methods, processes and technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand our market areas. Many national vendors provide turn-key services to community banks, such as Internet banking and remote deposit capture, that allow smaller banks to compete with institutions that have substantially greater resources to invest in technological improvements. We may not be able, however, to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
A failure in or breach, or the inability to recognize a potential breach of our operational or security systems, or those of our third party service providers, including as a result of cyber-attacks, could disrupt our business, result in unintentional disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and adversely impact our earnings.
As a financial institution, our operations rely heavily on the secure processing, storage and transmission of confidential and other information on our computer systems and networks. Any failure, interruption or breach in security or operational integrity of these systems could result in failures or disruptions in our internet banking system, treasury management products, check and document imaging, remote deposit capture systems, general ledger, and other systems. The security and integrity of our systems could be threatened by a variety of interruptions or information security breaches, including those caused by computer hacking, cyber-attacks, electronic fraudulent activity or attempted theft of financial assets. We cannot assure any such failures, interruption or security breaches will not occur, or if they do occur, that they will be adequately addressed. While we have certain protective policies and procedures in place, the nature and sophistication of the threats continue to evolve. We may be required to expend significant additional resources in the future to modify and enhance our protective measures. Additionally, we face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems. Any failures, interruptions or security breaches in our information systems could damage our reputation, result in a loss of client business, result in a violation of privacy or other laws, or expose us to civil litigation, regulatory fines or losses not covered by insurance.
We rely on third-party vendors to provide key components of our business infrastructure.
We rely heavily on third-party service providers for much of our communications, information, operating and financial control systems technology, including relationship management, mobile banking, general ledger, investment, deposit, loan servicing and loan origination systems. While we have selected these third-party vendors carefully and perform ongoing monitoring, we do not control their actions. Any problems caused by these third parties, including as a result of inadequate or interrupted service, could adversely affect our ability to deliver products and services to our clients and otherwise conduct our business. Financial or operational difficulties of a third-party vendor could also hurt our operations if those difficulties interfere with the vendor’s ability to serve us, and replacing these third-party vendors
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could result in significant delay and expense. Accordingly, use of such third parties creates an unavoidable inherent risk to our business operations as well as reputational risk.
We are subject to environmental risks associated with owning real estate or collateral.
When a borrower defaults on a loan secured by real property, the Company may purchase the property in foreclosure or accept a deed to the property surrendered by the borrower. We may also take over the management of commercial properties whose owners have defaulted on loans. We may also own and lease premises where branches and other facilities are located. While we have lending, foreclosure and facilities guidelines intended to exclude properties with an unreasonable risk of contamination, hazardous substances could exist on some of the properties that the Company may own, manage or occupy. We face the risk that environmental laws could force us to clean up the properties at the Company’s expense. The cost of cleaning up or paying damages and penalties associated with environmental problems could increase our operating expenses. It may cost much more to clean a property than the property is worth. We could also be liable for pollution generated by a borrower’s operations if the Company takes a role in managing those operations after a default. The Company may also find it difficult or impossible to sell these properties.
Risks Relating to Our Common Stock
The price of our common stock may be volatile or may decline.
The trading price of our common stock may fluctuate widely as a result of a number of factors, many of which are outside our control. In addition, the stock market is subject to fluctuations in the share prices and trading volumes that affect the market prices of the shares of many companies. These broad market fluctuations could make it more difficult for you to resell your common stock when you want and at prices you find attractive.
Our stock price can fluctuate significantly in response to a variety of factors including, among other things:
• | actual or anticipated quarterly fluctuations in our operating results and financial condition; |
• | changes in revenue or earnings estimates or publication of research reports and recommendations by financial analysts; |
• | failure to meet analysts’ revenue or earnings estimates; |
• | speculation in the press or investment community; |
• | strategic actions by us or our competitors, such as acquisitions or restructurings; |
• | actions by institutional shareholders; |
• | fluctuations in the stock prices and operating results of our competitors; |
• | general market conditions and, in particular, developments related to market conditions for the financial services industry; |
• | proposed or adopted regulatory changes or developments; |
• | anticipated or pending investigations, proceedings or litigation that involve or affect us; and/or |
• | domestic and international economic factors unrelated to our performance. |
The stock market and, in particular, the market for financial institution stocks, has historically experienced significant volatility. As a result, the market price of our common stock may be volatile. In addition, the trading volume in our common stock may fluctuate more than usual and cause significant price variations to occur. The trading price of the shares of our common stock and the value of our other securities will depend on many factors, which may change from time to time, including, without limitation, our financial condition, performance, creditworthiness and prospects, future sales of our equity or equity related securities, and other factors identified in this annual report and other reports by the Company. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength or operating results. A significant decline in our stock price could result in substantial losses for individual shareholders and could lead to costly and disruptive securities litigation.
The trading volume in our common stock is less than that of other larger financial institutions.
Although our common stock is listed for trading on the Nasdaq Global Select Market, its trading volume may be less than that of other, larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time, a factor over which we have no control. During any period of lower trading volume of our
24
common stock, significant sales of shares of our common stock or the expectation of these sales could cause our common stock price to fall.
An investment in our common stock is not insured and you could lose the value of your entire investment.
An investment in our common stock is not a savings account, deposit or other obligation of our bank subsidiary, any non-bank subsidiary or any other bank, and such investment is not insured or guaranteed by the FDIC or any other governmental agency. As a result, if you acquire our common stock, you may lose some or all of your investment.
Our ability to pay dividends is limited by various statutes and regulations and depends primarily on the Bank’s ability to distribute funds to us and is also limited by various statutes and regulations. The Company depends on payments from the Bank, including dividends, management fees and payments under tax sharing agreements, for substantially all of the Company’s liquidity requirements. Federal and state regulations limit the amount of dividends and the amount of payments that the Bank may make to the Company under tax sharing agreements. In certain circumstances, the Missouri Division of Finance, FDIC, or Federal Reserve Board could restrict or prohibit the Bank from distributing dividends or making other payments to us. In the event that the Bank was restricted from paying dividends to the Company or making payments under the tax sharing agreement, the Company may not be able to service its debt, pay its other obligations or pay dividends on its common stock. If we are unable or determine not to pay dividends on our outstanding equity securities, the market price of such securities could be materially adversely affected.
There can be no assurance of any future dividends on our common stock.
Holders of our common stock are entitled to receive dividends only when, as and if declared by the Board of Directors. Although we have historically paid cash dividends on our common stock, we are not required to do so.
There may be future sales or other dilution of our equity, which may adversely affect the market price of our common stock.
We are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities.
In addition, to the extent awards to issue common stock under our employee equity compensation plans are exercised, or shares are issued, holders of our common stock could incur additional dilution. Further, if we sell additional equity or convertible debt securities, such sales could result in increased dilution to our shareholders. The market price of our common stock could decline as a result of sales of a large number of shares of common stock or preferred stock or similar securities in the market after an offering or the perception that such sales could occur.
Our outstanding debt securities, related to our trust preferred securities, restrict our ability to pay dividends on our capital stock.
We have outstanding subordinated debentures issued to statutory trust subsidiaries, which have issued and sold preferred securities in the Trusts to investors.
If we are unable to make payments on any of our subordinated debentures for more than 20 consecutive quarters, we would be in default under the governing agreements for such securities and the amounts due under such agreements would be immediately due and payable. Additionally, if for any interest payment period we do not pay interest in respect of the subordinated debentures (which will be used to make distributions on the trust preferred securities), or if for any interest payment period we do not pay interest in respect of the subordinated debentures, or if any other event of default occurs, then we generally will be prohibited from declaring or paying any dividends or other distributions, or redeeming, purchasing or acquiring, any of our capital securities, including the common stock, during the next succeeding interest payment period applicable to any of the subordinated debentures, or next succeeding interest payment period, as the case may be.
Moreover, any other financing agreements that we enter into in the future may limit our ability to pay cash dividends on our capital stock, including the common stock. In the event that our existing or future financing agreements restrict our ability to pay dividends in cash on the common stock, we may be unable to pay dividends in cash on the common stock unless we can refinance amounts outstanding under those agreements. In addition, if we are unable or determine
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not to pay interest on our subordinated debentures, the market price of our common stock could be materially or adversely affected.
Anti-takeover provisions could negatively impact our shareholders.
Provisions of Delaware law and of our certificate of incorporation, as amended, and bylaws, as well as various provisions of federal and Missouri state law applicable to bank and bank holding companies, could make it more difficult for a third party to acquire control of us or have the effect of discouraging a third party from attempting to acquire control of us. We are subject to Section 203 of the Delaware General Corporation Law, which would make it more difficult for another party to acquire us without the approval of our Board of Directors. Additionally, our certificate of incorporation, as amended, authorizes our Board of Directors to issue preferred stock which could be issued as a defensive measure in response to a takeover proposal. In the event of a proposed merger, tender offer or other attempt to gain control of the Company, our Board of Directors would have the ability to readily issue available shares of preferred stock as a method of discouraging, delaying or preventing a change in control of the Company. Such issuance could occur regardless of whether our shareholders favorably view the merger, tender offer or other attempt to gain control of the Company. These and other provisions could make it more difficult for a third party to acquire us even if an acquisition might be in the best interests of our shareholders. Although we have no present intention to issue any shares of our authorized preferred stock, there can be no assurance that the Company will not do so in the future.
ITEM 1B: UNRESOLVED STAFF COMMENTS
None.
ITEM 2: PROPERTIES
Our executive offices are located at 150 North Meramec Avenue, Clayton, Missouri, 63105. As of December 31, 2019, we had 19 banking locations, and three limited service facilities in the St. Louis metropolitan area, seven banking locations in the Kansas City metropolitan area, two banking locations in the Phoenix metropolitan area, and six banking locations in New Mexico. We own or lease our facilities and believe all of our properties are in good condition to meet our business needs.
ITEM 3: LEGAL PROCEEDINGS
The Company and its subsidiaries are, from time to time, parties to various legal proceedings arising out of their businesses. Management believes that there are no such legal proceedings pending or threatened against the Company or its subsidiaries in the ordinary course of business, directly, indirectly, or in the aggregate that, if determined adversely, would have a material adverse effect on the business, consolidated financial condition, results of operations or cash flows of the Company or any of its subsidiaries.
For more information on our legal proceedings, see “Item 8. Note 14 – Litigation and Other Contingencies” in this report.
ITEM 4: MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5: MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market for Our Common Stock
The Company’s common stock trades on the Nasdaq Global Select Market under the symbol “EFSC.” As of February 19, 2020, the Company had 1,414 registered shareholders of common stock. The number of holders of record does not represent the actual number of beneficial owners of our common stock because securities dealers and others frequently hold shares in “street name” for the benefit of individual owners who have the right to vote shares.
Dividends
The holders of shares of our common stock are entitled to receive dividends when declared by our Board of Directors out of funds legally available for the purpose of paying dividends. Our Board of Directors approved the Company’s quarterly dividend of $0.18 per common share for the first quarter of 2020, an increase from $0.17 for the prior quarter, payable on March 31, 2020 to shareholders of record as of March 16, 2020. We anticipate continuing a regular quarterly cash dividend. However, we have no obligation to pay dividends and we may change our dividend policy at any time without notice to our shareholders.
Our ability to pay dividends is substantially dependent upon the ability of our subsidiaries to pay cash dividends to us. Information on regulatory restrictions on our ability to pay dividends is set forth in “Part I, Item 1. Business - Supervision and Regulation - Financial Holding Company - Dividend Restrictions.” The amount of dividends, if any, that may be declared by the Company also depends on many other factors, including future earnings, bank regulatory capital requirements and business conditions as they affect the Company and its subsidiaries. As a result, no assurance can be given that dividends will be paid in the future with respect to our common stock.
Securities Authorized for Issuance Under Equity Compensation Plans
For more information on our equity compensation plans, see “Item 8. Note 16 – Stockholders’ Equity and Compensation Plans” and “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” in this report, which are incorporated herein by reference.
Recent Sales of Unregistered Securities and Use of Proceeds
None.
Issuer Purchases of Equity Securities
The following table provides information on repurchases by the Company of its common stock in each month of the quarter ended December 31, 2019.
Period | Total number of shares purchased | Weighted-average price paid per share | Total number of shares purchased as part of publicly announced plans or programs (a) | Maximum number of shares that may yet be purchased under the plans or programs (a) | |||||||||
October 1 - 31, 2019 | 93,981 | $ | 39.46 | 93,981 | 552,158 | ||||||||
November 1- 30, 2019 | — | — | — | 552,158 | |||||||||
December 1- 31, 2019 | — | — | — | 552,158 | |||||||||
Total | 93,981 | $ | 39.46 | 93,981 | |||||||||
(a) In May 2015, the Company’s Board of Directors authorized the repurchase of up to two million shares of the Company’s common stock, pursuant to a publicly announced Company share repurchase program. The repurchases may be made in open market or privately negotiated transactions and the repurchase program will remain in effect until fully utilized or until modified, superseded or terminated. The timing and exact amount of common stock repurchases will depend on a number of factors including, among others, market and general economic conditions, economic capital and regulatory capital considerations, alternative uses of capital, the potential impact on our credit ratings, and contractual and regulatory limitations.
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Stock Performance Graph
The following graph* compares the cumulative total shareholder return on the Company’s common stock from December 31, 2014 through December 31, 2019. The graph compares the Company’s common stock with the Nasdaq Composite Index (U.S. companies), and the SNL Bank $5B-$10B Index. The graph assumes an investment of $100.00 in the Company’s common stock and each index at the respective closing price on December 31, 2014 and reinvestment of all quarterly dividends. The investment is measured as of each subsequent fiscal year end. There is no assurance that the Company’s common stock performance will continue in the future with the same or similar results as shown in the graph.
Period Ending December 31, | ||||||||||||||||||
Index | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | ||||||||||||
Enterprise Financial Services Corp | $ | 100.00 | $ | 145.29 | $ | 223.28 | $ | 236.91 | $ | 199.36 | $ | 259.14 | ||||||
Nasdaq Composite Index | 100.00 | 106.96 | 116.45 | 150.96 | 146.67 | 200.49 | ||||||||||||
SNL Bank $5B-$10B Index | 100.00 | 113.92 | 163.20 | 162.59 | 147.15 | 182.34 | ||||||||||||
*Source: S&P Global Market Intelligence. Used with permission. All rights reserved.
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ITEM 6: SELECTED FINANCIAL DATA
The following consolidated selected financial data is derived from the Company’s audited financial statements as of and for each of the five years presented. This information should be read in connection with our audited consolidated financial statements as of December 31, 2019 and 2018, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Consolidated Financial Statements and related Notes contained in “Item 8. Financial Statements and Supplementary Data,” appearing elsewhere in this report. The financial results in the following table have been impacted by the acquisitions of Trinity in 2019 and JCB in 2017.
At or for the year ended December 31, | |||||||||||||||||||
($ in thousands, except per share data) | 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||
EARNINGS SUMMARY: | |||||||||||||||||||
Interest income | $ | 305,134 | $ | 237,802 | $ | 202,539 | $ | 149,224 | $ | 132,779 | |||||||||
Interest expense | 66,417 | 45,897 | 25,235 | 13,729 | 12,369 | ||||||||||||||
Net interest income | 238,717 | 191,905 | 177,304 | 135,495 | 120,410 | ||||||||||||||
Provision for loan losses | 6,372 | 6,644 | 10,130 | 3,605 | 458 | ||||||||||||||
Noninterest income | 49,176 | 38,347 | 34,394 | 29,059 | 20,675 | ||||||||||||||
Noninterest expense | 165,485 | 119,031 | 115,051 | 86,110 | 82,226 | ||||||||||||||
Income before income tax expense | 116,036 | 104,577 | 86,517 | 74,839 | 58,401 | ||||||||||||||
Income tax expense1 | 23,297 | 15,360 | 38,327 | 26,002 | 19,951 | ||||||||||||||
Net income1 | $ | 92,739 | $ | 89,217 | $ | 48,190 | $ | 48,837 | $ | 38,450 | |||||||||
PER SHARE DATA: | |||||||||||||||||||
Basic earnings per common share1 | $ | 3.56 | $ | 3.86 | $ | 2.10 | $ | 2.44 | $ | 1.92 | |||||||||
Diluted earnings per common share1 | 3.55 | 3.83 | 2.07 | 2.41 | 1.89 | ||||||||||||||
Cash dividends paid on common shares | 0.62 | 0.47 | 0.44 | 0.41 | 0.26 | ||||||||||||||
Dividend payout ratio | 17.87 | % | 12.16 | % | 21.27 | % | 16.81 | % | 13.68 | % | |||||||||
Book value per common share | $ | 32.67 | $ | 26.47 | $ | 23.76 | $ | 19.31 | $ | 17.53 | |||||||||
Tangible book value per common share2 | 23.76 | 20.95 | 18.20 | 17.69 | 15.86 | ||||||||||||||
BALANCE SHEET DATA: | |||||||||||||||||||
Ending balances: | |||||||||||||||||||
Total loans | $ | 5,314,337 | $ | 4,350,001 | $ | 4,097,050 | $ | 3,158,161 | $ | 2,825,495 | |||||||||
Allowance for loan losses | 43,288 | 43,476 | 42,577 | 43,409 | 43,616 | ||||||||||||||
Goodwill | 210,344 | 117,345 | 117,345 | 30,334 | 30,334 | ||||||||||||||
Other intangible assets, net | 26,076 | 8,553 | 11,056 | 2,151 | 3,075 | ||||||||||||||
Total assets | 7,333,791 | 5,645,662 | 5,289,225 | 4,081,328 | 3,608,483 | ||||||||||||||
Deposits | 5,771,023 | 4,587,985 | 4,156,414 | 3,233,361 | 2,784,591 | ||||||||||||||
Subordinated debentures and notes | 141,258 | 118,156 | 118,105 | 105,540 | 56,807 | ||||||||||||||
FHLB advances | 222,406 | 70,000 | 172,743 | — | 110,000 | ||||||||||||||
Other borrowings | 230,886 | 221,450 | 253,674 | 276,980 | 270,326 | ||||||||||||||
Shareholders' equity | 867,185 | 603,804 | 548,573 | 387,098 | 350,829 | ||||||||||||||
Tangible common equity2 | 630,765 | 477,906 | 420,172 | 354,613 | 317,420 | ||||||||||||||
Average balances: | |||||||||||||||||||
Total loans | $ | 5,018,568 | $ | 4,222,359 | $ | 3,850,879 | $ | 2,978,534 | $ | 2,613,656 | |||||||||
Earning assets | 6,322,075 | 5,041,395 | 4,611,670 | 3,570,186 | 3,163,339 | ||||||||||||||
Total assets | 6,894,291 | 5,436,963 | 4,980,229 | 3,796,478 | 3,381,831 | ||||||||||||||
Interest-bearing liabilities | 4,809,374 | 3,736,523 | 3,396,382 | 2,634,700 | 2,344,861 | ||||||||||||||
Shareholders' equity | 795,477 | 576,960 | 532,306 | 371,587 | 335,095 | ||||||||||||||
Tangible common equity2 | 576,716 | 449,852 | 414,458 | 338,662 | 301,165 | ||||||||||||||
1Includes $12.1 million ($0.52 per share) deferred tax asset revaluation charge for 2017 due to U.S. corporate income tax reform. | |||||||||||||||||||
2Non-GAAP measures. A reconciliation has been included in this MD&A section under the caption “Use of Non-GAAP Financial Measures.” | |||||||||||||||||||
29
At or for the year ended December 31, | ||||||||||||||
2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||
SELECTED RATIOS: | ||||||||||||||
Return on average common equity | 11.66 | % | 15.46 | % | 9.05 | % | 13.14 | % | 11.47 | % | ||||
Return on average tangible common equity2 | 16.08 | 19.83 | 11.63 | 14.42 | 12.77 | |||||||||
Return on average assets | 1.35 | 1.64 | 0.97 | 1.29 | 1.14 | |||||||||
Efficiency ratio | 57.48 | 51.70 | 54.35 | 52.33 | 58.28 | |||||||||
Tax equivalent loan yield | 5.38 | 5.16 | 4.84 | 4.66 | 4.72 | |||||||||
Cost of interest-bearing liabilities | 1.38 | 1.23 | 0.74 | 0.52 | 0.53 | |||||||||
Net interest spread1 | 3.47 | 3.50 | 3.69 | 3.71 | 3.72 | |||||||||
Net interest margin1 | 3.80 | 3.82 | 3.88 | 3.84 | 3.86 | |||||||||
Nonperforming loans to total loans | 0.50 | 0.38 | 0.38 | 0.47 | 0.32 | |||||||||
Nonperforming assets to total assets | 0.45 | 0.30 | 0.31 | 0.39 | 0.48 | |||||||||
Net charge-offs to average loans | 0.13 | 0.13 | 0.26 | 0.05 | 0.06 | |||||||||
Allowance for loan losses to total loans | 0.81 | 1.00 | 1.04 | 1.37 | 1.54 | |||||||||
1Tax equivalent basis. | ||||||||||||||
2Non-GAAP measures. A reconciliation has been included in this MD&A section under the caption “Use of Non-GAAP Financial Measures.” | ||||||||||||||
30
ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Introduction
The objective of this section is to provide an overview of the results of operations and financial condition of the Company for the three-year period ended December 31, 2019. It should be read in conjunction with the Consolidated Financial Statements and related Notes contained in “Item 8. Financial Statements and Supplementary Data,” and other financial data presented elsewhere in this report, particularly the information regarding the Company’s business operations described in Item 1.
Executive Summary
Our Company offers a broad range of business and personal banking services including wealth management services. Lending services include commercial and industrial, commercial real estate, real estate construction and development, residential real estate, and consumer and other loans. A wide variety of deposit products and a complete suite of treasury management and international trade services complement our lending capabilities. Tax-credit brokerage activities consist of the acquisition of Federal and State tax credits and the sale of these tax credits to clients. Enterprise Trust, a division of the Bank, provides financial planning, estate planning, investment management, and trust services to businesses, individuals, institutions, retirement plans, and non-profit organizations. The Company’s results of operations are also affected by prevailing economic conditions, competition, government policies and other actions of regulatory agencies.
The Company closed its acquisition of Trinity and its wholly-owned subsidiary, LANB, on March 8, 2019. Trinity operated six full-service retail and commercial banking offices in Los Alamos, Santa Fe, and Albuquerque, New Mexico. The results of operations of Trinity are included in our consolidated results from this date forward and are excluded from preceding periods. See “Item 8. Note 2 – Acquisitions” for more information.
The following table summarizes the significant components of the transaction as of March 8, 2019:
($ in thousands) | |||
Securities | $ | 428,096 | |
Loans | 684,314 | ||
Total assets acquired | 1,232,539 | ||
Deposits | 1,081,187 | ||
Total liabilities assumed | 1,116,377 | ||
Consideration paid: | |||
Cash | $ | 37,275 | |
Common stock | 171,885 | ||
Total consideration paid | $ | 209,160 | |
31
Financial Performance Highlights
Below are highlights of our financial performance for the years ended December 31, 2019, 2018 and 2017.
($ in thousands, except per share data) | Year ended December 31, | ||||||||||
2019 | 2018 | 2017 | |||||||||
EARNINGS | |||||||||||
Total interest income | $ | 305,134 | $ | 237,802 | $ | 202,539 | |||||
Total interest expense | 66,417 | 45,897 | 25,235 | ||||||||
Net interest income | 238,717 | 191,905 | 177,304 | ||||||||
Provision for loan losses | 6,372 | 6,644 | 10,130 | ||||||||
Net interest income after provision for loan losses | 232,345 | 185,261 | 167,174 | ||||||||
Total noninterest income | 49,176 | 38,347 | 34,394 | ||||||||
Total noninterest expense | 165,485 | 119,031 | 115,051 | ||||||||
Income before income tax expense | 116,036 | 104,577 | 86,517 | ||||||||
Income tax expense | 23,297 | 15,360 | 38,327 | ||||||||
Net income | $ | 92,739 | $ | 89,217 | $ | 48,190 | |||||
Basic earnings per share | $ | 3.56 | $ | 3.86 | $ | 2.10 | |||||
Diluted earnings per share | 3.55 | 3.83 | 2.07 | ||||||||
Return on average assets | 1.35 | % | 1.64 | % | 0.97 | % | |||||
Return on average common equity | 11.66 | 15.46 | 9.05 | ||||||||
Return on average tangible common equity1 | 16.08 | 19.83 | 11.63 | ||||||||
Net interest margin (fully tax equivalent) | 3.80 | 3.82 | 3.88 | ||||||||
Core net interest margin1 | 3.73 | 3.75 | 3.72 | ||||||||
Efficiency ratio | 57.48 | 51.70 | 54.35 | ||||||||
Core efficiency ratio1 | 52.36 | 52.04 | 52.93 | ||||||||
At or for the year ended December 31, | |||||||||||
2019 | 2018 | 2017 | |||||||||
ASSET QUALITY | |||||||||||
Net charge-offs | $ | 6,409 | $ | 5,683 | $ | 10,163 | |||||
Nonperforming loans | 26,425 | 16,745 | 15,687 | ||||||||
Classified assets | 85,897 | 70,126 | 73,239 | ||||||||
Nonperforming loans to total loans | 0.50 | % | 0.38 | % | 0.38 | % | |||||
Nonperforming assets to total assets | 0.45 | 0.30 | 0.31 | ||||||||
Allowance for loan losses to total loans | 0.81 | 1.00 | 1.04 | ||||||||
Net charge-offs to average loans | 0.13 | 0.13 | 0.26 | ||||||||
1Non-GAAP measures. A reconciliation has been included in this MD&A section under the caption “Use of Non-GAAP Financial Measures.”
The Company noted the following trends during 2019:
• | The Company reported net income of $92.7 million, or $3.55 per diluted share for 2019, compared to $89.2 million, or $3.83 per diluted share for 2018. Merger-related expenses from the Trinity acquisition reduced income by $18.0 million pretax ($14.0 million after tax), or $0.53 per diluted share. |
• | Net interest income for 2019 totaled $238.7 million, an increase of $46.8 million, or 24%, compared to $191.9 million for 2018. The increase in net interest income was primarily due to the Trinity acquisition and organic growth. |
32
• | Net interest margin decreased two basis points to 3.80% during 2019, compared to 3.82% in 2018. Similarly, core net interest margin1 decreased two basis points to 3.73% during 2019. The decrease was primarily due to a shift in earning assets and a reduction in interest rates during 2019 that reduced the net interest spread between interest-earning assets and interest-bearing liabilities. While average asset yields increased in 2019, the average rate on liabilities increased at a higher amount. The one-month and three-month LIBOR rates were 1.76% and 1.91% at December 31, 2019, compared to 2.50% and 2.81% at December 31, 2018, respectively. |
• | Noninterest income increased $10.8 million, or 28%, to $49.2 million in 2019 compared to $38.3 million in 2018. This improvement was primarily due to the following: |
◦ | deposit service charges increased $1.1 million, or 9%, |
◦ | wealth management revenue increased $1.7 million, or 21%, |
◦ | card services income increased $2.5 million, or 37%, |
◦ | tax credit income increased $2.6 million, or 91%, and |
◦ | other income increased $2.7 million, or 31%, due to swap fees, sublease income and BOLI income. |
These increases in noninterest income are inclusive of $7.9 million attributed to the acquisition of Trinity.
• | Noninterest expenses totaled $165.5 million for 2019, an increase of $46.5 million, or 39%, compared to 2018. The acquisition of Trinity contributed $24.5 million of the current year increase. In addition, merger-related expenses incurred for the Trinity acquisition were $18.0 million in 2019. The Company’s efficiency ratio was 57.5% in 2019, compared to 51.7% for the prior year. The increase in 2019 was primarily due to the merger-related expenses. The Company’s core efficiency ratio1 was 52.4% in 2019, compared to 52.0% for the prior year. |
• | The Company’s effective tax rate was 20.1% for the year ended December 31, 2019 compared to 14.7% in 2018. The lower rate in 2018 resulted from a non-recurring reduction of income tax expense of $2.7 million from a tax planning election related to the Tax Cuts and Jobs Act. |
1Non-GAAP measures. A reconciliation has been included in this MD&A section under the caption “Use of Non-GAAP Financial Measures.”
Recent Developments
• | The Company’s Board of Directors approved an increase in the Company’s quarterly cash dividend to $0.18 per common share for the first quarter of 2020, payable on March 31, 2020 to shareholders of record as of March 16, 2020. |
2019 Significant Transactions
During 2019, we announced the following significant transactions:
• | On March 8, 2019, the Company announced the completion of its acquisition of Trinity which was merged with and into the Company, and LANB, Trinity’s wholly-owned subsidiary, merged with and into the Bank. Aggregate consideration at closing was 4.0 million shares of Company common stock and $37.3 million cash paid to Trinity shareholders. The overall transaction had a value of $209.2 million. |
• | The Company repurchased 396,737 of its common shares at a weighted-average share price of $39.13, pursuant to its publicly announced share repurchase program. The Board of Directors authorized the repurchase plan in May of 2015, which allows the Company to repurchase up to two million common shares, representing approximately 10% of the Company’s then currently outstanding shares. Shares may be bought back in open market or privately negotiated transactions over an indeterminate time period based on market and business conditions. At December 31, 2019, there were 552,158 shares remaining to be purchased under this share repurchase plan. |
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• | Dividends paid in 2019 of $0.62 per share increased $0.15 per share, or 32%, compared to $0.47 per share in 2018. |
2018 Significant Transactions
During 2018, we announced the following significant transactions:
• | On November 1, 2018, the Company entered into a definitive merger agreement to acquire Trinity and its wholly-owned bank subsidiary, LANB, headquartered in Los Alamos, New Mexico. The Company completed its acquisition of Trinity and LANB on March 8, 2019, as discussed above. |
• | The Company repurchased 435,432 of its common shares at a weighted-average share price of $44.52, pursuant to its publicly announced share repurchase program. |
• | The Company’s Board approved two consecutive increases in the Company’s quarterly cash dividend to $0.13 per common share for the fourth quarter of 2018, up from $0.11 for the second quarter of 2018, expanding cash dividends paid for the year by 6%. |
A detailed discussion comparing 2018 and 2017 results is incorporated herein by reference to the MD&A section of the Company’s 2018 Annual Report on Form 10-K filed on February 22, 2019.
34
RESULTS OF OPERATIONS
Net Interest Income
Average Balance Sheet
Non-core acquired loans were those acquired from the FDIC and were previously covered by shared-loss agreements. These loans are accounted for as purchased credit impaired loans. The following table presents, for the periods indicated, certain information related to our average interest-earning assets and interest-bearing liabilities, as well as, the corresponding interest rates earned and paid, all on a tax equivalent basis.
Year ended December 31, | ||||||||||||||||||||||||||||||||
2019 | 2018 | 2017 | ||||||||||||||||||||||||||||||
($ in thousands) | Average Balance | Interest Income/Expense | Average Yield/ Rate | Average Balance | Interest Income/Expense | Average Yield/ Rate | Average Balance | Interest Income/Expense | Average Yield/ Rate | |||||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||||||||||
Taxable loans1 | $ | 4,977,274 | $ | 261,987 | 5.26 | % | $ | 4,164,377 | $ | 210,402 | 5.05 | % | $ | 3,774,484 | $ | 173,824 | 4.61 | % | ||||||||||||||
Tax-exempt loans2 | 29,583 | 1,852 | 6.26 | 34,371 | 1,889 | 5.50 | 40,634 | 2,652 | 6.53 | |||||||||||||||||||||||
Non-core acquired loans - contractual | 11,711 | 1,242 | 10.61 | 23,611 | 1,689 | 7.15 | 35,761 | 2,273 | 6.36 | |||||||||||||||||||||||
Non-core acquired loans - incremental | 4,783 | 40.85 | 3,700 | 15.67 | 7,718 | 21.58 | ||||||||||||||||||||||||||
Total loans | 5,018,568 | 269,864 | 5.38 | 4,222,359 | 217,680 | 5.16 | 3,850,879 | 186,467 | 4.84 | |||||||||||||||||||||||
Taxable investments in debt and equity securities | 1,064,913 | 30,085 | 2.83 | 712,227 | 18,375 | 2.58 | 634,195 | 15,000 | 2.37 | |||||||||||||||||||||||
Non-taxable investments in debt and equity securities (2) | 131,161 | 4,668 | 3.56 | 40,038 | 1,426 | 3.56 | 47,219 | 2,078 | 4.40 | |||||||||||||||||||||||
Short-term investments | 107,433 | 2,128 | 1.98 | 66,771 | 1,141 | 1.71 | 79,377 | 804 | 1.01 | |||||||||||||||||||||||
Total securities and short-term investments | 1,303,507 | 36,881 | 2.83 | 819,036 | 20,942 | 2.56 | 760,791 | 17,882 | 2.35 | |||||||||||||||||||||||
Total interest-earning assets | 6,322,075 | 306,745 | 4.85 | 5,041,395 | 238,622 | 4.73 | 4,611,670 | 204,349 | 4.43 | |||||||||||||||||||||||
Noninterest-earning assets | 572,216 | 395,568 | 368,559 | |||||||||||||||||||||||||||||
Total assets | $ | 6,894,291 | $ | 5,436,963 | $ | 4,980,229 | ||||||||||||||||||||||||||
Liabilities and Shareholders' Equity | ||||||||||||||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||
Interest-bearing transaction accounts | $ | 1,286,641 | $ | 7,592 | 0.59 | % | $ | 827,155 | $ | 3,643 | 0.44 | % | $ | 802,993 | $ | 2,195 | 0.27 | % | ||||||||||||||
Money market accounts | 1,608,349 | 26,267 | 1.63 | 1,488,238 | 19,361 | 1.30 | 1,286,796 | 8,708 | 0.68 | |||||||||||||||||||||||
Savings | 489,310 | 841 | 0.17 | 206,286 | 597 | 0.29 | 189,516 | 459 | 0.24 | |||||||||||||||||||||||
Certificates of deposit | 799,079 | 15,156 | 1.90 | 653,486 | 10,168 | 1.56 | 586,115 | 5,838 | 1.00 | |||||||||||||||||||||||
Total interest-bearing deposits | 4,183,379 | 49,856 | 1.19 | 3,175,165 | 33,769 | 1.06 | 2,865,420 | 17,200 | 0.60 | |||||||||||||||||||||||
Subordinated debentures and notes | 136,950 | 7,507 | 5.48 | 118,129 | 5,798 | 4.91 | 116,707 | 5,095 | 4.37 | |||||||||||||||||||||||
FHLB advances | 287,474 | 6,668 | 2.32 | 271,493 | 5,556 | 2.05 | 192,489 | 2,356 | 1.22 | |||||||||||||||||||||||
Securities sold under agreements to repurchase | 169,179 | 1,246 | 0.74 | 170,963 | 755 | 0.44 | 220,807 | 493 | 0.22 | |||||||||||||||||||||||
Other borrowings | 32,392 | 1,140 | 3.52 | 773 | 19 | 2.46 | 959 | 91 | 9.49 | |||||||||||||||||||||||
Total interest-bearing liabilities | 4,809,374 | 66,417 | 1.38 | 3,736,523 | 45,897 | 1.23 | 3,396,382 | 25,235 | 0.74 | |||||||||||||||||||||||
Noninterest bearing liabilities: | ||||||||||||||||||||||||||||||||
Demand deposits | 1,228,832 | 1,086,863 | 1,017,660 | |||||||||||||||||||||||||||||
Other liabilities | 60,608 | 36,617 | 33,881 | |||||||||||||||||||||||||||||
Total liabilities | 6,098,814 | 4,860,003 | 4,447,923 | |||||||||||||||||||||||||||||
Shareholders' equity | 795,477 | 576,960 | 532,306 | |||||||||||||||||||||||||||||
Total liabilities & shareholders' equity | $ | 6,894,291 | $ | 5,436,963 | $ | 4,980,229 | ||||||||||||||||||||||||||
Net interest income | $ | 240,328 | $ | 192,725 | $ | 179,114 | ||||||||||||||||||||||||||
Net interest spread | 3.47 | % | 3.50 | % | 3.69 | % | ||||||||||||||||||||||||||
Net interest margin (tax equivalent) | 3.80 | 3.82 | 3.88 | |||||||||||||||||||||||||||||
Core net interest margin3 | 3.73 | 3.75 | 3.72 | |||||||||||||||||||||||||||||
1Average balances include non-accrual loans. Loan fees, net of amortization of deferred loan origination fees and costs, included in interest income are approximately $4.5 million, $4.0 million, and $3.4 million for the years ended December 31, 2019, 2018, and 2017 respectively.
2Non-taxable income is presented on a fully tax-equivalent basis using a 24.7% tax rate in 2019 and 2018, respectively and a 38.0% rate in 2017. The tax-equivalent adjustments were $1.6 million for the year ended December 31, 2019, $0.8 million for the year ended December 31, 2018, and $1.8 million for the year ended December 31, 2017.
3A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption “Use of Non-GAAP Financial Measures.”
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Rate/Volume
The following table sets forth, on a tax-equivalent basis for the periods indicated, a summary of the changes in interest income and interest expense resulting from changes in yield/rates and volume.
2019 compared to 2018 | 2018 compared to 2017 | ||||||||||||||||||||||
Increase (decrease) due to | Increase (decrease) due to | ||||||||||||||||||||||
($ in thousands) | Volume1 | Rate2 | Net | Volume1 | Rate2 | Net | |||||||||||||||||
Interest earned on: | |||||||||||||||||||||||
Taxable loans | $ | 42,485 | $ | 9,100 | $ | 51,585 | $ | 18,854 | $ | 17,724 | $ | 36,578 | |||||||||||
Tax-exempt loans3 | (282 | ) | 245 | (37 | ) | (377 | ) | (386 | ) | (763 | ) | ||||||||||||
Non-core acquired loans | (3,692 | ) | 4,328 | 636 | (2,991 | ) | (1,611 | ) | (4,602 | ) | |||||||||||||
Taxable investments in debt and equity securities | 9,825 | 1,885 | 11,710 | 1,942 | 1,433 | 3,375 | |||||||||||||||||
Non-taxable investments in debt and equity securities3 | 3,243 | (1 | ) | 3,242 | (289 | ) | (363 | ) | (652 | ) | |||||||||||||
Short-term investments | 782 | 205 | 987 | (144 | ) | 481 | 337 | ||||||||||||||||
Total interest-earning assets | 52,361 | 15,762 | 68,123 | 16,995 | 17,278 | 34,273 | |||||||||||||||||
Interest paid on: | |||||||||||||||||||||||
Interest-bearing transaction accounts | $ | 2,450 | $ | 1,499 | $ | 3,949 | $ | 68 | $ | 1,380 | $ | 1,448 | |||||||||||
Money market accounts | 1,659 | 5,247 | 6,906 | 1,546 | 9,107 | 10,653 | |||||||||||||||||
Savings | 562 | (318 | ) | 244 | 44 | 94 | 138 | ||||||||||||||||
Certificates of deposit | 2,515 | 2,473 | 4,988 | 735 | 3,595 | 4,330 | |||||||||||||||||
Subordinated debentures and notes | 986 | 723 | 1,709 | 63 | 640 | 703 | |||||||||||||||||
FHLB advances | 340 | 772 | 1,112 | 1,213 | 1,987 | 3,200 | |||||||||||||||||
Securities sold under agreements to repurchase | (8 | ) | 499 | 491 | (139 | ) | 401 | 262 | |||||||||||||||
Other borrowed funds | 1,110 | 11 | 1,121 | (15 | ) | (57 | ) | (72 | ) | ||||||||||||||
Total interest-bearing liabilities | 9,614 | 10,906 | 20,520 | 3,515 | 17,147 | 20,662 | |||||||||||||||||
Net interest income | $ | 42,747 | $ | 4,856 | $ | 47,603 | $ | 13,480 | $ | 131 | $ | 13,611 | |||||||||||
1Change in volume multiplied by yield/rate of prior period. | |||||||||||||||||||||||
2Change in yield/rate multiplied by volume of prior period. | |||||||||||||||||||||||
3Nontaxable income is presented on a fully tax equivalent basis using a 24.7% for 2019 and 2018, respectively | |||||||||||||||||||||||
NOTE: The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each. | |||||||||||||||||||||||
Comparison of 2019 and 2018
Net interest income (on a tax equivalent basis) was $240.3 million for 2019, compared to $192.7 million for 2018, an increase of $47.6 million, or 25%. Total interest income increased $68.1 million and total interest expense increased $20.5 million. The increase in net interest income in 2019 was primarily due to higher loan and investment volumes, which benefited from the Trinity acquisition and organic growth in the loan portfolio. Higher average interest rates in 2019 compared to 2018 also positively impacted net interest income.
The tax-equivalent net interest margin was 3.80% for 2019, compared to 3.82% for 2018. Core net interest margin1 also declined two basis points to 3.73% during 2019. While an increase in the investment portfolio in 2019 over 2018 contributed to growth in net interest income, the shift in earning assets between loans and investments also reduced the net interest margin. Total investments were 21% of average interest earning assets for 2019 compared to 16% in the prior year. Partially offsetting the increase from earning assets was the cost of total interest-bearing liabilities that increased 15 basis points in 2019 compared to the prior year. The increase in the interest rate paid on deposits reflects market interest rate trends, as the Company continues to defend existing and attract new core deposit relationships.
36
Average interest-earning assets increased $1.3 billion, or 25%, to $6.3 billion for the year ended December 31, 2019. The increase was due to growth in average total loans of $796.2 million, or 19%, primarily due to the Trinity acquisition and organic loan growth. Additionally, average securities and short-term investments increased $484.5 million, or 59%. Due to the growth in the balance sheet, interest income on earning assets increased $52.4 million. Interest income on interest-earnings assets increased by $15.8 million primarily due to higher average interest rates in 2019 compared to 2018.
For the year ended December 31, 2019, average interest-bearing liabilities increased $1.1 billion, or 29%. The increase in average interest-bearing liabilities resulted from $1.0 billion of growth in interest-bearing deposits primarily due to the Trinity acquisition. The growth in deposits and other borrowing sources utilized to fund asset growth increased interest expense for 2019 by $9.6 million. Additionally, for the year ended December 31, 2019, interest expense on interest-bearing liabilities increased $10.9 million due to higher rates from market and competitive conditions.
The Company manages its balance sheet in part to defend against pressures on core net interest margin, which could be negatively impacted by continued competition for deposits, current interest rate conditions, and downward movement in short-term rates.
1Non-GAAP measures. A reconciliation has been included in this MD&A section under the caption “Use of Non-GAAP Financial Measures.”
Noninterest Income
The following table presents a comparative summary of the major components of noninterest income for each of the years in the three-year period ended December 31, 2019:
Year ended December 31, | Change from | ||||||||||||||||||
($ in thousands) | 2019 | 2018 | 2017 | 2019 vs. 2018 | 2018 vs. 2017 | ||||||||||||||
Service charges on deposit accounts | $ | 12,801 | $ | 11,749 | $ | 11,043 | $ | 1,052 | $ | 706 | |||||||||
Wealth management revenue | 9,932 | 8,241 | 8,102 | 1,691 | 139 | ||||||||||||||
Card services revenue | 9,154 | 6,686 | 5,433 | 2,468 | 1,253 | ||||||||||||||
Tax credit income | 5,393 | 2,820 | 2,581 | 2,573 | 239 | ||||||||||||||
Gain on sale of securities | 243 | 9 | 22 | 234 | (13 | ) | |||||||||||||
Miscellaneous income | 11,653 | 8,842 | 7,213 | 2,811 | 1,629 | ||||||||||||||
Total noninterest income | $ | 49,176 | $ | 38,347 | $ | 34,394 | $ | 10,829 | $ | 3,953 | |||||||||
Noninterest income increased $10.8 million, or 28%, in 2019 compared to 2018. This improvement was primarily due to higher income from card services, wealth management services, and service charges on deposit accounts from the Trinity acquisition along with increases in tax credit income, and other miscellaneous income including swap fees, sublease income and BOLI income.
37
Noninterest Expense
The following table presents a comparative summary of the components of noninterest expense:
Year ended December 31, | Change from | ||||||||||||||||||
($ in thousands) | 2019 | 2018 | 2017 | 2019 vs. 2018 | 2018 vs. 2017 | ||||||||||||||
Employee compensation and benefits | $ | 81,295 | $ | 66,039 | $ | 61,388 | $ | 15,256 | $ | 4,651 | |||||||||
Occupancy | 12,465 | 9,550 | 9,057 | 2,915 | 493 | ||||||||||||||
Data processing | 8,242 | 6,321 | 6,272 | 1,921 | 49 | ||||||||||||||
Professional fees | 3,683 | 3,134 | 3,813 | 549 | (679 | ) | |||||||||||||
Merger related expenses | 17,969 | 1,271 | 6,462 | 16,698 | (5,191 | ) | |||||||||||||
Other expenses | 41,831 | 32,716 | 28,059 | 9,115 | 4,657 | ||||||||||||||
Total noninterest expense | $ | 165,485 | $ | 119,031 | $ | 115,051 | $ | 46,454 | $ | 3,980 | |||||||||
Efficiency ratio | 57.48 | % | 51.70 | % | 54.35 | % | 5.78 | % | (2.65 | )% | |||||||||
Core efficiency ratio1 | 52.36 | 52.04 | 52.93 | 0.32 | (0.89 | ) | |||||||||||||
1 A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption “Use of Non-GAAP Financial Measures.” | |||||||||||||||||||
Noninterest expense increased $46.5 million, or 39%, in 2019 compared to 2018. Increased operating expenses following the Trinity acquisition and merger-related expenses primarily contributed to the increase.
The Company expects to continue to invest in revenue producing associates and other infrastructure that supports additional growth.
Income Taxes
The Company’s blended federal and state tax rate is approximately 24.7%. Permanent differences between pre-tax income and taxable income along with tax planning initiatives reduced the effective income tax rate in 2019 to 20.1%.
In 2018, the Company recorded income tax expense of $15.4 million on pre-tax income of $104.6 million, resulting in an effective income tax rate of 14.7%. The following items impacted the 2018 effective tax rate:
• | A subsidiary dividend timing election resulting in a reduction of income tax expense of $2.7 million, partially offset by $0.7 million of excise tax included as a component of noninterest expenses; and |
• | excess tax benefits on stock awards of $1.6 million. |
FINANCIAL CONDITION
Summary Balance Sheet
($ in thousands) | December 31, | % Increase (Decrease) | |||||||||||||||
2019 | 2018 | 2017 | 2019 vs. 2018 | 2018 vs. 2017 | |||||||||||||
Total cash and cash equivalents | $ | 167,256 | $ | 196,552 | $ | 153,323 | (14.90 | )% | 28.19 | % | |||||||
Securities | 1,316,483 | 787,048 | 715,131 | 67.27 | % | 10.06 | % | ||||||||||
Total loans | 5,314,337 | 4,350,001 | 4,097,050 | 22.17 | % | 6.17 | % | ||||||||||
Total assets | 7,333,791 | 5,645,662 | 5,289,225 | 29.90 | % | 6.74 | % | ||||||||||
Deposits | 5,771,023 | 4,587,985 | 4,156,414 | 25.79 | % | 10.38 | % | ||||||||||
Total liabilities | 6,466,606 | 5,041,858 | 4,740,652 | 28.26 | % | 6.35 | % | ||||||||||
Total shareholders’ equity | 867,185 | 603,804 | 548,573 | 43.62 | % | 10.07 | % | ||||||||||
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Assets
Loans by Type
The Company has a diversified loan portfolio, with no particular concentration of credit in any one economic sector; however, a substantial portion of the portfolio, including the C&I category, is secured by real estate. The ability of the Company’s borrowers to honor their contractual obligations is partially dependent upon the local economy and its effect on the real estate market.
The following table sets forth the composition of the Company’s loan portfolio by type of loans at the dates indicated:
December 31, | |||||||||||||||||||
($ in thousands) | 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||
Commercial and industrial | $ | 2,361,157 | $ | 2,123,167 | $ | 1,921,676 | $ | 1,636,238 | $ | 1,488,190 | |||||||||
Commercial real estate - investor owned | 1,299,884 | 867,667 | 812,162 | 552,969 | 453,336 | ||||||||||||||
Commercial real estate - owner occupied | 697,437 | 614,167 | 565,803 | 362,011 | 362,373 | ||||||||||||||
Construction and land development | 457,273 | 334,645 | 308,974 | 198,907 | 167,899 | ||||||||||||||
Residential real estate | 366,261 | 305,026 | 352,093 | 252,552 | 215,785 | ||||||||||||||
Consumer and other | 132,325 | 105,329 | 136,342 | 155,484 | 137,912 | ||||||||||||||
Total loans | $ | 5,314,337 | $ | 4,350,001 | $ | 4,097,050 | $ | 3,158,161 | $ | 2,825,495 | |||||||||
December 31, | |||||||||||||||||||
2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
Commercial and industrial | 44.4 | % | 48.8 | % | 46.9 | % | 51.8 | % | 52.7 | % | |||||||||
Commercial real estate - investor owned | 24.5 | 19.9 | 19.8 | 17.4 | 16.1 | ||||||||||||||
Commercial real estate - owner occupied | 13.1 | 14.1 | 13.8 | 11.6 | 12.8 | ||||||||||||||
Construction and land development | 8.6 | 7.7 | 7.5 | 6.3 | 5.9 | ||||||||||||||
Residential real estate | 6.9 | 7.0 | 8.6 | 8.0 | 7.6 | ||||||||||||||
Consumer and other | 2.5 | 2.5 | 3.4 | 4.9 | 4.9 | ||||||||||||||
Total loans | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | |||||||||
The following table illustrates loan growth, including selected specialized lending detail, at December 31, 2019 and 2018:
December 31, | Trinity Acquired Loans | |||||||||||||||||
($ in thousands) | 2019 | 2018 | Change | % Change | at 3/31/19 | |||||||||||||
C&I - general | $ | 1,186,667 | $ | 995,491 | $ | 191,176 | 19.2 | % | $ | 65,122 | ||||||||
CRE investor owned - general | 1,290,258 | 862,423 | 427,835 | 49.6 | 304,615 | |||||||||||||
CRE owner occupied - general | 582,579 | 496,835 | 85,744 | 17.3 | 91,758 | |||||||||||||
Enterprise value lendinga | 428,896 | 465,992 | (37,096 | ) | (8.0 | ) | — | |||||||||||
Life insurance premium financinga | 472,822 | 417,950 | 54,872 | 13.1 | — | |||||||||||||
Residential real estate - general | 366,261 | 304,671 | 61,590 | 20.2 | 137,487 | |||||||||||||
Construction and land development - general | 428,681 | 310,832 | 117,849 | 37.9 | 70,251 | |||||||||||||
Tax creditsa | 294,210 | 262,735 | 31,475 | 12.0 | — | |||||||||||||
Agriculture | 139,873 | 136,188 | 3,685 | 2.7 | — | |||||||||||||
Consumer and other - general | 124,090 | 96,884 | 27,206 | 28.1 | 12,835 | |||||||||||||
Total Loans | $ | 5,314,337 | $ | 4,350,001 | $ | 964,336 | 22.2 | % | $ | 682,068 | ||||||||
Certain prior period amounts have been reclassified among the categories to conform to the current period presentation.
aSpecialized categories may include a mix of C&I, CRE, Construction and land development, or Consumer and other loans.
As noted in the table above, the acquisition of Trinity added $682 million of loans in 2019.
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The following table presents a breakdown of total loans by geographic region at December 31, 2019 and 2018:
($ in thousands) | December 31, 2019 | December 31, 2018 | |||||
St. Louis | $ | 2,462,723 | 2,312,171 | ||||
Kansas City | 816,507 | 719,434 | |||||
Arizona | 391,535 | 353,718 | |||||
New Mexico | 640,249 | — | |||||
Specialized Lending | 1,003,323 | 964,678 | |||||
Total | $ | 5,314,337 | $ | 4,350,001 | |||
C&I loans are made based on the borrower’s ability to generate cash flows for repayment from income sources, general credit strength, experience, and character, even though such loans may also be secured by real estate or other assets. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations.
The Company continues to focus on originating high-quality C&I relationships as they typically have variable interest rates and allow for cross selling opportunities involving other banking products. For the period ending December 31, 2019, C&I loans increased $238 million, or 11% from 2018. C&I loan growth also supports our efforts to maintain the Company’s asset sensitive interest rate risk position. Additionally, our specialized products, especially Enterprise value lending, Life insurance premium financing, and Tax credit financing/lending, consist of primarily C&I loans, and have contributed significantly to the Company’s C&I loan growth. These loans are sourced through relationships developed with wealth and estate planning firms and private equity funds and are not bound geographically by our markets. As a result, these specialized loan products offer opportunities to expand and diversify our overall geographic concentration by entering into new markets.
The commercial and industrial category represents $2.4 billion, or 44%, of portfolio loans. This category includes $828 million in loans secured by general business assets, such as accounts receivable, inventory and equipment. Additionally, $426 million is from the Enterprise value lending portfolio, and $473 million is from the Life insurance premium finance portfolio. Loans secured by general business assets consist of approximately 1,360 relationships with an average outstanding balance of $2 million. The largest loans within this category are a $28 million term loan secured by accounts receivable and inventory and a $24 million term loan secured by the cash surrender value of a life insurance policy.
The Enterprise value lending portfolio comprised 18% of the C&I category as of December 31, 2019. Loans in the manufacturing, and wholesale trade sectors comprise the largest categories within this portfolio. As of December 31, 2019, the average outstanding balance of loan relationships in this category was $5 million. The largest relationships within this category are an $18 million relationship in the securities and investments sector and an $18 million relationship in the fitness and recreational sports centers sector.
Real estate loans place an emphasis on the estimated cash flows from the operation of the property and/or the underlying collateral value.
• | Our commercial real estate loans, including investor-owned and owner-occupied categories, primarily represent multifamily and other commercial property loans on which the primary source of repayment is income from the property. At December 31, 2019, these loans totaled $1.6 billion, or 81% of the category. These loans are principally located within our St. Louis, Kansas City, and Phoenix markets, and they are underwritten based on the cash flow coverage of the property, the Company’s loan to value guidelines, and generally require either the limited or full guaranty of principal sponsors of the credit. Commercial real estate loans also represent owner-occupied C&I loans for which the primary source of repayment is dependent on sources other than the underlying collateral. |
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• | Construction and land development loans relating primarily to residential and commercial properties, represent financing secured by real estate under development for eventual sale or undeveloped ground. $150.0 million of these loans include the use of interest reserves and follow standard underwriting guidelines. Construction projects are monitored by the loan officer and a centralized independent loan disbursement function is employed. |
• | Residential real estate loans include residential mortgages, which are loans that, due to size or other attributes, do not qualify for conventional home mortgages available-for-sale in the secondary market, second mortgages and home equity lines. Residential mortgage loans are usually limited to a maximum of 80% of collateral value at origination. |
Consumer and other loans represent loans to individuals, loans to state and political subdivisions, loans to nondepository financial institutions, and loans to purchase or are fully secured by investment securities. Credit risk is managed by thoroughly reviewing the creditworthiness of the borrowers prior to origination and thereafter.
The following table presents a breakdown of loan categories at December 31, 2019 and 2018:
% of portfolio | |||||
December 31, 2019 | December 31, 2018 | ||||
Non-real estate: | |||||
Commercial and industrial | 44 | % | 49 | % | |
Consumer and other | 3 | 2 | |||
Total non-real estate | 47 | % | 51 | % | |
Real estate: | |||||
Commercial - investor owned | |||||
Retail | 7 | % | 6 | % | |
Commercial office | 8 | 6 | |||
Multi-family housing | 2 | 2 | |||
Industrial/ Warehouse | 5 | 3 | |||
Other | 2 | 3 | |||
Total commercial real estate - investor owned | 24 | % | 20 | % | |
Commercial - owner occupied | |||||
Commercial and industrial | 6 | % | 8 | % | |
Other | 7 | 6 | |||
Total commercial real estate - owner occupied | 13 | % | 14 | % | |
Construction and land development | 9 | % | 8 | % | |
Residential | |||||
Investor owned | 2 | % | 2 | % | |
Owner occupied | 5 | 5 | |||
Total residential real estate | 7 | % | 7 | % | |
Total real estate | 53 | % | 49 | % | |
Total | 100 | % | 100 | % | |
Within the investor-owned commercial real estate portfolio, the largest loans are commercial and retail office permanent loans. The Company had $410 million of investor-owned permanent loans secured by commercial office properties at December 31, 2019. There are approximately 230 loan relationships with an average outstanding loan balance of $2 million. The largest loans within this category are a $29 million loan secured by an office park in the St. Louis area,
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a $19 million loan secured by a multi-tenant office building in St. Louis, and a $16 million loan secured by a multi-tenant office condominium complex in Phoenix. The Company had $377 million of investor-owned permanent loans secured by retail properties at December 31, 2019. There are approximately 140 loan relationships in this category with an average outstanding loan balance of $3 million. The largest loans within this category are a $14 million loan secured by a multi-tenant retail center in Kansas City, a $14 million loan secured by a hotel in Illinois, and a $13 million loan secured by a multi-tenant retail center in Phoenix.
Within the owner-occupied commercial real estate portfolio, the largest loans are commercial and industrial loans. The Company had $348 million of owner-occupied loans secured by commercial and industrial properties at December 31, 2019. There are approximately 440 loan relationships in this category with an average outstanding loan balance of $1 million. The largest loans within this category are an $18 million loan secured by a single-tenant office building in the St. Louis region, a $17 million loan secured by a dealership in Kansas, and an $8 million loan secured by a multi-tenant office building in Arizona.
Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to numerous borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2019, no significant concentrations exceeding 10% of total loans existed in the Company’s loan portfolio, except as described above.
The following table presents the maturity distribution of loans at December 31, 2019 categorized by fixed or variable interest rates, net of unearned loan fees:
($ in thousands) | Due in One Year or Less | After One Through Five Years | After Five Years | Total | Percent of Total Loans | |||||||||||||
Fixed Rate Loans | ||||||||||||||||||
Commercial and industrial | $ | 85,677 | $ | 290,319 | $ | 81,795 | $ | 457,791 | 9 | % | ||||||||
Real estate: | ||||||||||||||||||
Commercial | 178,804 | 915,895 | 263,589 | 1,358,288 | 26 | |||||||||||||
Construction and land development | 54,960 | 113,146 | 6,252 | 174,358 | 3 | |||||||||||||
Residential | 19,502 | 58,087 | 54,485 | 132,074 | 2 | |||||||||||||
Consumer and other | 5,748 | 13,592 | 21,646 | 40,986 | 1 | |||||||||||||
Total | $ | 344,691 | $ | 1,391,039 | $ | 427,767 | $ | 2,163,497 | 41 | % | ||||||||
Variable Rate Loans | ||||||||||||||||||
Commercial and industrial | $ | 1,842,858 | $ | 51,157 | $ | 9,351 | $ | 1,903,366 | 36 | % | ||||||||
Real estate: | ||||||||||||||||||
Commercial | 531,646 | 105,668 | 1,719 | 639,033 | 12 | |||||||||||||
Construction and land development | 276,527 | 6,388 | — | 282,915 | 5 | |||||||||||||
Residential | 161,904 | 60,423 | 11,860 | 234,187 | 4 | |||||||||||||
Consumer and other | 86,970 | 4,369 | — | 91,339 | 2 | |||||||||||||
Total | $ | 2,899,905 | $ | 228,005 | $ | 22,930 | $ | 3,150,840 | 59 | % | ||||||||
Loans | ||||||||||||||||||
Commercial and industrial | $ | 1,928,535 | $ | 341,476 | $ | 91,146 | $ | 2,361,157 | 45 | % | ||||||||
Real estate: | ||||||||||||||||||
Commercial | 710,450 | 1,021,563 | 265,308 | 1,997,321 | 38 | |||||||||||||
Construction and land development | 331,487 | 119,534 | 6,252 | 457,273 | 8 | |||||||||||||
Residential | 181,406 | 118,510 | 66,345 | 366,261 | 6 | |||||||||||||
Consumer and other | 92,718 | 17,961 | 21,646 | 132,325 | 3 | |||||||||||||
Total | $ | 3,244,596 | $ | 1,619,044 | $ | 450,697 | $ | 5,314,337 | 100 | % | ||||||||
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Fixed rate loans comprise 41% of the total loan portfolio at December 31, 2019, and 59% of the Company’s loans are variable-rate loans, most of which are based on the prime rate or LIBOR. In 2019, the Federal Reserve lowered the targeted Fed Funds rate 25 basis points on three separate occasions. These decreases resulted in a Fed Funds Target rate of 1.50% to 1.75% and a prime rate of 4.75% at December 31, 2019. Most loan originations have one to three year maturities. Management monitors this mix as part of its interest rate risk management. See “Interest Rate Risk” of this MD&A section.
Of the $710 million of commercial real estate loans maturing in one year or less, $469 million, or 66%, represent loans secured by non-owner occupied commercial properties.
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Provision and Allowance for Loan Losses
The following table summarizes changes in the allowance for loan losses by loan category.
December 31, | |||||||||||||||||||
($ in thousands) | 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||
Allowance for portfolio loan losses, at beginning of period | $ | 42,295 | $ | 38,166 | $ | 37,565 | $ | 33,441 | $ | 30,185 | |||||||||
Charge-offs: | |||||||||||||||||||
Commercial and industrial | (6,882 | ) | (6,894 | ) | (9,872 | ) | (2,303 | ) | (3,699 | ) | |||||||||
Real estate: | |||||||||||||||||||
Commercial | (609 | ) | (313 | ) | (207 | ) | (95 | ) | (702 | ) | |||||||||
Construction and land development | (54 | ) | (56 | ) | (254 | ) | — | (350 | ) | ||||||||||
Residential | (667 | ) | (546 | ) | (973 | ) | (25 | ) | (1,313 | ) | |||||||||
Consumer and other | (382 | ) | (167 | ) | (201 | ) | (1,912 | ) | (27 | ) | |||||||||
Total charge-offs | (8,594 | ) | (7,976 | ) | (11,507 | ) | (4,335 | ) | (6,091 | ) | |||||||||
Recoveries: | |||||||||||||||||||
Commercial and industrial | 338 | 1,133 | 545 | 674 | 1,796 | ||||||||||||||
Real estate: | |||||||||||||||||||
Commercial | 114 | 112 | 235 | 1,165 | 1,567 | ||||||||||||||
Construction and land development | 776 | 459 | 101 | 934 | 674 | ||||||||||||||
Residential | 661 | 508 | 390 | 123 | 337 | ||||||||||||||
Consumer and other | 295 | 80 | 73 | 12 | 101 | ||||||||||||||
Total recoveries | 2,184 | 2,292 | 1,344 | 2,908 | 4,475 | ||||||||||||||
Net charge-offs | (6,410 | ) | (5,684 | ) | (10,163 | ) | (1,427 | ) | (1,616 | ) | |||||||||
Provision for loan losses | 6,682 | 9,813 | 10,764 | 5,551 | 4,872 | ||||||||||||||
Allowance for portfolio loan losses, at end of period | $ | 42,567 | $ | 42,295 | $ | 38,166 | $ | 37,565 | $ | 33,441 | |||||||||
Allowance for PCI loan losses, at beginning of period | $ | 1,181 | $ | 4,411 | $ | 5,844 | $ | 10,175 | $ | 15,410 | |||||||||
Charge-offs | (150 | ) | (61 | ) | (799 | ) | (2,385 | ) | (821 | ) | |||||||||
Net charge-offs | (150 | ) | (61 | ) | (799 | ) | (2,385 | ) | (821 | ) | |||||||||
Provision reversal for loan losses | (310 | ) | (3,169 | ) | (634 | ) | (1,946 | ) | (4,414 | ) | |||||||||
Allowance for PCI loan losses, at end of period | $ | 721 | $ | 1,181 | $ | 4,411 | $ | 5,844 | $ | 10,175 | |||||||||
Total allowance for loan losses, at end of period | $ | 43,288 | $ | 43,476 | $ | 42,577 | $ | 43,409 | $ | 43,616 | |||||||||
Total loans, average | $ | 5,018,568 | $ | 4,222,359 | $ | 3,850,879 | $ | 2,978,534 | $ | 2,613,656 | |||||||||
Total loans, ending | 5,314,337 | 4,350,001 | 4,097,050 | 3,158,161 | 2,825,495 | ||||||||||||||
Net charge-offs to average loans | 0.13 | % | 0.13 | % | 0.26 | % | 0.05 | % | 0.06 | % | |||||||||
Allowance for loan losses to total loans | 0.81 | 1.00 | 1.04 | 1.37 | 1.54 | ||||||||||||||
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The following table is a summary of the allocation of the allowance for loan losses for the five-year period ended December 31, 2019:
December 31, | |||||||||||||||||||||||||||||
2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||||||||||||
($ in thousands) | Allowance | Percent by Category to Total Loans | Allowance | Percent by Category to Total Loans | Allowance | Percent by Category to Total Loans | Allowance | Percent by Category to Total Loans | Allowance | Percent by Category to Total Loans | |||||||||||||||||||
Commercial and industrial | $ | 27,455 | 44.4 | % | $ | 29,286 | 48.8 | % | $ | 26,706 | 46.9 | % | $ | 27,615 | 51.8 | % | $ | 22,556 | 52.7 | % | |||||||||
Real estate: | |||||||||||||||||||||||||||||
Commercial | 10,808 | 37.6 | 8,924 | 34.1 | 8,553 | 33.6 | 8,220 | 29.0 | 11,682 | 28.9 | |||||||||||||||||||
Construction and land development | 2,611 | 8.6 | 2,344 | 7.7 | 2,251 | 7.5 | 2,127 | 6.3 | 2,863 | 5.9 | |||||||||||||||||||
Residential | 1,703 | 6.9 | 2,191 | 7.0 | 4,217 | 8.6 | 4,500 | 8.0 | 5,068 | 7.6 | |||||||||||||||||||
Consumer and other | 711 | 2.5 | 731 | 2.4 | 850 | 3.4 | 947 | 4.9 | 1,447 | 4.9 | |||||||||||||||||||
Total allowance | $ | 43,288 | 100.0 | % | $ | 43,476 | 100.0 | % | $ | 42,577 | 100.0 | % | $ | 43,409 | 100.0 | % | $ | 43,616 | 100.0 | % | |||||||||
The provision for loan losses on portfolio loans for the year ended December 31, 2019 was $6.7 million, compared to $9.8 million, and $10.8 million for the comparable 2018 and 2017 periods, respectively. The provision for loan losses for the years ended December 31, 2019 and 2018 was primarily to provide for reserves and charge-offs incurred on impaired loans, as well as organic loan growth in the portfolio. The allowance on PCI loans is established for expected decreases in cash flows subsequent to acquisition. The provision reversal on PCI loans for the years ended December 31, 2019, 2018 and 2017 was $0.3 million, $3.2 million and $0.6 million, respectively, due to increased expectations of future cash flows.
For PCI loans, the Company remeasures contractual and expected cash flows periodically. When the re-measurement process results in a decrease in expected cash flows, typically due to an increase in expected credit losses, impairment is recorded through provision for loan losses. Similarly, when expected credit losses decrease in the re-measurement process, prior recorded impairment is reversed before the yield is increased prospectively.
The allowance for loan losses was 0.81% of total loans at December 31, 2019, compared to 1.00%, and 1.04%, at December 31, 2018 and 2017, respectively. The decrease in the ratio of allowance for loan losses to total loans in 2019 compared to 2018 was primarily due to the acquisition of Trinity loans that were recorded at fair value and do not have a material corresponding allowance for loan losses.
See “Critical Accounting Policies” of this MD&A section for more information on the allowance for loan losses methodology.
Nonperforming assets
See “Item 8. Note 1 – Summary of Significant Accounting Policies” for more policy information on impaired loans and other real estate.
45
The following table presents the categories of nonperforming assets as of the dates indicated:
December 31, | |||||||||||||||||||
($ in thousands) | 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||
Non-accrual loans | $ | 26,096 | $ | 16,520 | $ | 14,968 | $ | 12,585 | $ | 8,797 | |||||||||
Loans past due 90 days or more and still accruing interest | 250 | — | — | — | — | ||||||||||||||
Restructured loans | 79 | 225 | 719 | 2,320 | 303 | ||||||||||||||
Total nonperforming loans | 26,425 | 16,745 | 15,687 | 14,905 | 9,100 | ||||||||||||||
Other real estate | 6,344 | 469 | 498 | 980 | 8,366 | ||||||||||||||
Total nonperforming assets | $ | 32,769 | $ | 17,214 | $ | 16,185 | $ | 15,885 | $ | 17,466 | |||||||||
Total assets | $ | 7,333,791 | $ | 5,645,662 | $ | 5,289,225 | $ | 4,081,328 | $ | 3,608,483 | |||||||||
Total loans | 5,314,337 | 4,350,001 | 4,097,050 | 3,158,161 | 2,825,495 | ||||||||||||||
Nonperforming loans to total loans | 0.50 | % | 0.38 | % | 0.38 | % | 0.47 | % | 0.32 | % | |||||||||
Nonperforming assets to total assets | 0.45 | 0.30 | 0.31 | 0.39 | 0.48 | ||||||||||||||
Allowance for loan losses to nonperforming loans | 164 | 260 | 271 | 291 | 479 | ||||||||||||||
Nonperforming loans
Nonperforming loans exclude PCI loans that are accounted for on a pool basis, as the pools are considered to be performing. See “Item 8. Note 5 – Loans” for more information on these loans, delinquent loans and relevant risk ratings.
Nonperforming loans based on loan type were as follows:
($ in thousands) | December 31, 2019 | Number of loans | December 31, 2018 | Number of loans | |||||||||||||||
Commercial and industrial | $ | 22,578 | 85 | % | 14 | $ | 12,950 | 77 | % | 13 | |||||||||
Commercial real estate | 2,516 | 10 | 7 | 1,206 | 7 | 6 | |||||||||||||
Residential real estate | 1,330 | 5 | 10 | 2,277 | 14 | 5 | |||||||||||||
Consumer and other | 1 | — | 1 | 312 | 2 | 1 | |||||||||||||
Total | $ | 26,425 | 100 | % | 32 | $ | 16,745 | 100 | % | 25 | |||||||||
The following table summarizes the changes in nonperforming loans:
Year ended December 31, | |||||||
($ in thousands) | 2019 | 2018 | |||||
Nonperforming loans, beginning of period | $ | 16,745 | $ | 15,687 | |||
Additions to nonaccrual loans | 32,214 | 15,911 | |||||
Additions to restructured loans | — | 354 | |||||
Charge-offs | (8,173 | ) | (7,823 | ) | |||
Principal reductions | (12,205 | ) | (6,164 | ) | |||
Moved to other real estate | (1,732 | ) | (669 | ) | |||
Moved to performing | (674 | ) | (551 | ) | |||
Nonperforming loans, end of period | $ | 26,425 | $ | 16,745 | |||
Nonperforming loans at December 31, 2019 increased $9.7 million, or 58%, when compared to December 31, 2018. The increase in nonaccrual additions during 2019 was primarily from a $13 million nonaccrual C&I loan in the fourth
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quarter of 2019. The Company has a specific reserve of approximately 10% on this loan to cover the potential collateral shortfall.
At December 31, 2019, nonperforming loans were comprised of 22 relationships. The largest relationship was the aforementioned $13 million C&I relationship, which was related to the Company’s specialized lending products and represented 49% of nonperforming loans. Of the remaining nonperforming loans, approximately 57% were located in the St. Louis market, 35% were related to the Company’s specialized lending products, 5% were located in the New Mexico market, and the remaining 3% were in the Kansas City and Phoenix markets.
At December 31, 2018, nonperforming loans were comprised of 19 relationships with the largest being a $3 million C&I relationship, which represented 18% of nonperforming loans. Approximately 56% of nonperforming loans were related to the Company’s specialized lending products, 21% was located in the St. Louis market and 22% in the Kansas City market.
Potential problem loans
Potential problem loans are unimpaired loans with a risk rating of 8-Substandard still accruing interest. See “Item 8. Note 5 – Loans” for the definitions of risk ratings. Potential problem loans, which are not included in nonperforming loans, were $56 million, or 1%, of loans outstanding at December 31, 2019, compared to $53 million, or 1%, of loans outstanding at December 31, 2018. For these loans, payment of principal and interest is current and the loans are performing; however, some doubts exist as to the borrower’s ability to continue to comply with repayment terms. Potential problem loans include loans to companies characterized by significant losses or where downward trends in financial performance have been identified, or are in an industry experiencing significant difficulty.
Other real estate
Other real estate at December 31, 2019 and December 31, 2018 was $6.3 million and $0.5 million, respectively.
At December 31, 2019, other real estate was comprised of two commercial properties located in the St. Louis region primarily resulting from a $4.6 million purchased credit impaired loan and nine properties in New Mexico consisting of a mix of commercial, construction, and residential. Included in additions to other real estate in the table below is $3.2 million from the acquisition of Trinity.
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The following table summarizes the changes in other real estate:
Year ended December 31, | |||||||
($ in thousands) | 2019 | 2018 | |||||
Other real estate, beginning of period | $ | 469 | $ | 498 | |||
Additions and expenses capitalized to prepare property for sale | 8,148 | 877 | |||||
Additions from acquisition | 3,225 | — | |||||
Writedowns in value | (812 | ) | (44 | ) | |||
Sales | (4,686 | ) | (862 | ) | |||
Other real estate, end of period | $ | 6,344 | $ | 469 | |||
The writedowns in fair value were recorded in loan, legal, and other real estate expense. For the year ended December 31, 2019, the Company realized a net gain of $0.1 million on the sale of other real estate that was recorded in noninterest income.
Investments
At December 31, 2019, our portfolio of investment securities was $1.3 billion, or 18%, of total assets. The portfolio is comprised of both available-for-sale and held-to-maturity securities. The Company added $428.1 million from the Trinity acquisition.
Other investments primarily consist of the FHLB capital stock, common stock investments related to our trust preferred securities, and other investments in private equity funds, primarily SBICs.
The table below sets forth the carrying value of investment securities held by the Company at the dates indicated:
December 31, | ||||||||||||||||||||
2019 | 2018 | 2017 | ||||||||||||||||||
($ in thousands) | Amount | % | Amount | % | Amount | % | ||||||||||||||
Obligations of U.S. Government sponsored enterprises | $ | 10,046 | 0.7 | % | $ | 98,498 | 12.1 | % | $ | 99,224 | 13.4 | % | ||||||||
Obligations of states and political subdivisions | 224,728 | 16.6 | 39,316 | 4.8 | 48,674 | 6.6 | ||||||||||||||
Agency mortgage-backed securities | 948,367 | 70.0 | 639,309 | 78.6 | 567,233 | 76.4 | ||||||||||||||
U.S. Treasury Bills | 10,226 | 0.8 | 9,925 | 1.2 | — | — | ||||||||||||||
Corporate debt securities | 123,116 | 9.1 | — | — | — | — | ||||||||||||||
FHLB capital stock | 15,673 | 1.2 | 9,158 | 1.1 | 12,924 | 1.7 | ||||||||||||||
Other investments | 22,371 | 1.6 | 17,496 | 2.2 | 13,737 | 1.9 | ||||||||||||||
Total | $ | 1,354,527 | 100.0 | % | $ | 813,702 | 100.0 | % | $ | 741,792 | 100.0 | % | ||||||||
The Company had no debt securities classified as trading at December 31, 2019, 2018, or 2017.
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The following table summarizes expected maturity and tax-equivalent yield information on the investment portfolio at December 31, 2019:
Within 1 year | 1 to 5 years | 5 to 10 years | Over 10 years | No Stated Maturity | Total | ||||||||||||||||||||||||||||||
($ in thousands) | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||||||||
Obligations of U.S. Government-sponsored enterprises | $ | — | — | % | $ | 10,046 | 2.12 | % | $ | — | — | % | $ | — | — | % | $ | — | — | % | $ | 10,046 | 2.12 | % | |||||||||||
Obligations of states and political subdivisions | 978 | 4.78 | 11,250 | 3.80 | 20,422 | 3.28 | 192,078 | 3.47 | — | — | 224,728 | 3.48 | |||||||||||||||||||||||
Agency mortgage-backed securities | 18,777 | 2.90 | 684,176 | 3.04 | 239,068 | 3.13 | 6,346 | 3.50 | — | — | 948,367 | 3.07 | |||||||||||||||||||||||
U.S. Treasury Bills | — | — | 10,226 | 2.47 | — | — | — | — | — | — | 10,226 | 2.47 | |||||||||||||||||||||||
Corporate debt securities | — | — | — | — | 123,116 | 3.22 | — | — | — | — | 123,116 | 3.22 | |||||||||||||||||||||||
FHLB capital stock | — | — | — | — | — | — | — | — | 15,673 | 4.92 | 15,673 | 4.92 | |||||||||||||||||||||||
Other investments | — | — | — | — | — | — | — | — | 22,371 | 0.73 | 22,371 | 0.73 | |||||||||||||||||||||||
Total | $ | 19,755 | 2.99 | % | $ | 715,698 | 3.03 | % | $ | 382,606 | 3.17 | % | $ | 198,424 | 3.47 | % | $ | 38,044 | 2.44 | % | $ | 1,354,527 | 3.12 | % | |||||||||||
Yields on tax-exempt securities are computed on a taxable equivalent basis using a tax rate of 24.7%. Expected maturities will differ from contractual maturities, as borrowers may have the right to call or repay obligations with or without prepayment penalties.
Deposits
The following table shows the breakdown of the Company’s deposits by type for the periods indicated:
Years ended December 31, | % Increase (decrease) | ||||||||||||||||
($ in thousands) | 2019 | 2018 | 2017 | 2019 vs. 2018 | 2018 vs. 2017 | ||||||||||||
Noninterest-bearing deposit accounts | $ | 1,327,348 | $ | 1,100,718 | $ | 1,123,907 | 20.6 | % | (2.1 | )% | |||||||
Interest-bearing transaction accounts | 1,367,444 | 1,037,684 | 915,653 | 31.8 | 13.3 | ||||||||||||
Money market accounts | 1,713,615 | 1,565,729 | 1,342,931 | 9.4 | 16.6 | ||||||||||||
Savings accounts | 536,169 | 199,425 | 195,150 | 168.9 | 2.2 | ||||||||||||
Total core deposits | 4,944,576 | 3,903,556 | 3,577,641 | ||||||||||||||
Certificates of deposit: | |||||||||||||||||
Brokered | 215,758 | 198,981 | 115,306 | 8.4 | 72.6 | ||||||||||||
Other | 610,689 | 485,448 | 463,467 | 25.8 | 4.7 | ||||||||||||
Total deposits | $5,771,023 | $4,587,985 | $4,156,414 | 25.8 | % | 10.4 | % | ||||||||||
Non-Certificates of deposit / Total deposits | 86 | % | 85 | % | 86 | % | |||||||||||
Noninterest-bearing deposits / Total deposits | 23 | 24 | 27 | ||||||||||||||
An increase in deposits from 2018 to 2019 occurred in all categories. Core deposits, defined as total deposits excluding certificates of deposits, were $4.9 billion at December 31, 2019, an increase of $1.0 billion, or 27%, from December 31, 2018. The increase in 2019 was largely due to the Trinity acquisition in 2019. The Trinity acquisition in 2019 and the JCB acquisition in 2017 added a stable, low cost consumer deposit base. The Company continues to strengthen and diversify the funding base across all regions and within commercial, consumer, and business categories.
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The following table sets forth the maturities of certificates of deposit of $100,000 or more as of December 31, 2019:
($ in thousands) | Total | ||
Three months or less | $ | 88,858 | |
Over three through six months | 61,169 | ||
Over six through twelve months | 159,194 | ||
Over twelve months | 84,158 | ||
Total | $ | 393,379 | |
Shareholders’ equity
Shareholders’ equity totaled $867.2 million at December 31, 2019, an increase of $263.4 million, or 44%, from December 31, 2018.
Significant activity during the year ended December 31, 2019 included the following:
• | issuance of approximately 4.0 million shares of common stock for the Trinity acquisition reflecting approximately $171.9 million of consideration; |
• | net income of $92.7 million; |
• | net increase in fair value of available-for-sale securities and cash flow hedges of $27.0 million; |
• | dividends paid on common stock of $16.6 million; and |
• | repurchase of 396,737 shares of common stock at an average price of $39.13, or $15.5 million, pursuant to the Company’s publicly-announced stock repurchase program. |
Liquidity and Capital Resources
Liquidity
The objective of liquidity management is to ensure we have the ability to generate sufficient cash or cash equivalents in a timely and cost-effective manner to meet our commitments as they become due. Typical demands on liquidity are changes in deposit levels, maturing time deposits which are not renewed, and fundings under credit commitments to customers. Funds are available from a number of sources, such as the core deposit base and loans and securities repayments and maturities.
Additionally, liquidity is provided from lines of credit with the FHLB, the Federal Reserve, and correspondent banks; the ability to acquire large and brokered deposits, sales of the securities portfolio, and the ability to sell loan participations to other banks. These alternatives are an important part of our liquidity plan and provide flexibility and efficient execution of the asset-liability management strategy.
The Bank’s Asset-Liability Management Committee oversees our liquidity position, the parameters of which are approved by the Bank’s Board of Directors. Our liquidity position is monitored daily by producing a liquidity report, which measures the amount of liquid versus non-liquid assets and liabilities. Our liquidity management framework includes measurement of several key elements, such as the loan to deposit ratio, a liquidity ratio, and a dependency ratio. The Company’s liquidity framework also incorporates contingency planning to assess the nature and volatility of funding sources and to determine alternatives to these sources. While core deposits and loan and investment repayments are principal sources of liquidity, funding diversification is another key element of liquidity management and is achieved by strategically varying depositor types, terms, funding markets, and instruments.
Net cash provided by operations for the years ended December 31, 2019 and 2018 was $92 million and $109 million, respectively. Continued profitability of the Company provides liquidity. For the year ended December 31, 2019, net cash used in investing activities was $379 million, compared to net cash used of $332 million in 2018. The investing activities in 2019 primarily represents our normal business activity of making loans and investing in securities. Net cash provided by financing activities was $257 million in 2019, compared to $266 million in 2018. The decrease in cash provided by financing activities was primarily due to a reduction in deposit growth, partially offset by an increase in borrowings.
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Strong capital ratios, credit quality and core earnings are essential to retaining cost-effective access to the wholesale funding markets. Deterioration in any of these factors could have a negative impact on the Company’s ability to access these funding sources and, as a result, these factors are monitored on an ongoing basis as part of the liquidity management process. The Bank is subject to regulations and, among other things, may be limited in its ability to pay dividends or transfer funds to the parent company. Accordingly, consolidated cash flows as presented in the consolidated statements of cash flows may not represent cash immediately available for the payment of cash dividends to the Company’s shareholders or for other cash needs.
Company liquidity
The Company’s liquidity is managed to provide the funds necessary to pay dividends to shareholders, service debt, invest in subsidiaries as necessary, and satisfy other operating requirements. The Company’s primary funding sources to meet its liquidity requirements are dividends and payments from the Bank and proceeds from the issuance of equity (i.e. stock option exercises, stock offerings). Another source of funding for the Company includes the issuance of subordinated debentures and other debt instruments.
The Company has an effective shelf registration statement on Form S-3 registering up to $100 million of common stock, preferred stock, debt securities, and various other securities, including combinations of such securities. The Company’s ability to offer securities pursuant to the registration statement depends on market conditions and the Company’s continuing eligibility to use the Form S-3 under rules of the SEC.
On November 1, 2016, the Company issued $50 million aggregate principal amount of 4.75% fixed-to-floating rate subordinated notes with a maturity date of November 1, 2026, which initially bear an annual interest rate of 4.75%, with interest payable semiannually. Beginning November 1, 2021, the interest rate resets quarterly to the three-month LIBOR rate plus a spread of 338.7 basis points, payable quarterly.
The Company has a senior unsecured revolving credit agreement (the “Revolving Agreement”) with another bank allowing for borrowings up to $25 million which is renewed through February 2021. The proceeds can be used for general corporate purposes. The Revolving Agreement is subject to ongoing compliance with a number of customary affirmative and negative covenants as well as specified financial covenants. As of December 31, 2019, there was no outstanding balance under the Revolving Agreement.
The Company entered into an unsecured term loan agreement (the “Term Loan”) with another bank allowing for borrowings up to $40 million which matures in 2024. The interest rate on the Term Loan is the one-month LIBOR rate plus 125 basis points. The proceeds were principally used to fund the Company’s acquisition of Trinity. The Term Loan is subject to ongoing compliance with a number of customary affirmative and negative covenants, as well as specified financial covenants. As of December 31, 2019, the outstanding balance was approximately $34.3 million.
The Bank has historically provided a dividend to supplement the parent company’s liquidity at the discretion of the Bank’s board of directors. The Bank paid dividends of $60 million, $30 million, and $20 million in 2019, 2018, and 2017, respectively. The parent company’s cash balance was $19 million as of December 31, 2019. Management believes the projected level of cash at the holding company will be sufficient to meet all projected cash needs for at least the next year.
As of December 31, 2019, the Company had $92 million of outstanding subordinated debentures with a weighted average rate of 4.75% as part of 13 Trust Preferred Securities Pools. In January 2019, the Company completed five interest rate swap transactions with a total notional amount of $62 millionto hedge its exposure to variability in cash flows on a portion of the Company’s floating-rate debt. The transactions convert the floating 90-day LIBOR rates to a weighted average fixed rate of 2.62% with original terms of five or seven years. The subordinated debentures are classified as debt but are included in regulatory capital and the related interest expense is tax-deductible, which makes them an attractive source of funding. Regulations issued by the Federal Reserve under the Basel III regulatory capital reforms allow our currently outstanding trust preferred securities to retain tier 1 capital status.
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Bank liquidity
The Bank has a variety of funding sources available to increase financial flexibility. In addition to amounts currently borrowed, at December 31, 2019, the Bank could borrow an additional $742 million from the FHLB of Des Moines under blanket loan pledges and has an additional $1.1 billion available from the Federal Reserve Bank under a pledged loan agreement. The Bank has unsecured federal funds lines with six correspondent banks totaling $90 million.
Investment securities are another important tool to the Bank’s liquidity objectives. Securities totaled $1.3 billion at December 31, 2019, and included $485 million pledged as collateral for deposits of public institutions, treasury, loan notes, and other requirements. The remaining $832 million could be pledged or sold to enhance liquidity, if necessary.
In the normal course of business, the Bank enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Bank’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company’s liquidity. The Bank has $2 billion in unused commitments as of December 31, 2019. While this commitment level would exhaust the majority the Company’s current liquidity resources, the nature of these commitments is such that the likelihood of funding them in the aggregate at any one time is low.
Capital Resources
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and its bank affiliate must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The banking affiliate’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets. To be categorized as “well-capitalized”, banks must maintain minimum total risk-based (10%), tier 1 risk-based (8%), common equity tier 1 risk-based (6.5%), and tier 1 leverage ratios (5%). As of December 31, 2019, and December 31, 2018, the Company and the Bank met all capital adequacy requirements to which they are subject.
The Bank met the definition of “well-capitalized” at each of December 31, 2019, 2018, and 2017. Refer to “Item 8. Note 15 – Regulatory Matters” for a summary of our risk-based capital and leverage ratios.
The following table summarizes the Company’s various capital ratios at the dates indicated:
($ in thousands) | December 31, | ||||||||||
2019 | 2018 | 2017 | |||||||||
Total capital to risk weighted assets | 12.90 | % | 13.02 | % | 12.21 | % | |||||
Tier 1 capital to risk weighted assets | 11.40 | % | 11.14 | % | 10.29 | % | |||||
Common equity tier 1 capital to risk weighted assets | 9.90 | % | 9.79 | % | 8.88 | % | |||||
Leverage ratio (Tier 1 capital to average assets) | 10.05 | % | 10.29 | % | 9.72 | % | |||||
Tangible common equity to tangible assets1 | 8.89 | % | 8.66 | % | 8.14 | % | |||||
Total risk-based capital | $ | 804,273 | $ | 650,859 | $ | 589,047 | |||||
Tier 1 capital | 710,480 | 556,958 | 496,045 | ||||||||
Common equity tier 1 capital | 616,825 | 489,301 | 428,397 | ||||||||
1 Not a required regulatory capital ratio | |||||||||||
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The following table summarizes the Bank’s various capital ratios at the dates indicated:
($ in thousands) | December 31, | Well-Capitalized | |||||||||||
2019 | 2018 | 2017 | Minimum % | ||||||||||
Total capital to risk weighted assets | 12.40 | % | 12.26 | % | 11.36 | % | 10.00% | ||||||
Tier 1 capital to risk weighted assets | 11.70 | % | 11.38 | % | 10.46 | % | 8.00% | ||||||
Tier 1 common equity to risk weighted assets | 11.69 | % | 11.37 | % | 10.46 | % | 6.50% | ||||||
Leverage ratio (Tier 1 capital to average assets) | 10.31 | % | 10.52 | % | 9.68 | % | 5.00% | ||||||
Total risk-based capital | $ | 769,254 | $ | 611,197 | $ | 546,314 | |||||||
Tier 1 capital | 725,461 | 567,296 | 503,312 | ||||||||||
Common equity tier 1 capital | 725,406 | 567,239 | 503,264 | ||||||||||
The Company believes the tangible common equity and regulatory capital ratios are important measures of capital strength even though they are considered to be non-GAAP measures. The tables further within MD&A reconcile these ratios to U.S. GAAP.
Risk Management
Market risk arises from exposure to changes in interest rates and other relevant market rate or price risk. The Company faces market risk in the form of interest rate risk through transactions other than trading activities. Market risk from these activities, in the form of interest rate risk, is measured and managed through a number of methods. The Company uses financial modeling techniques to measure interest rate risk. These techniques measure the sensitivity of future earnings due to changing interest rate environments. Guidelines established by the Bank’s Asset/Liability Management Committee and approved by the Bank’s Board of Directors are used to monitor exposure of earnings at risk. General interest rate movements are used to develop sensitivity as management believes it has no primary exposure to a specific point on the yield curve. These limits are based on the Company’s exposure to immediate and sustained parallel rate movements, either upward or downward. The Company does not have any direct market risk from commodity exposures.
Interest Rate Risk
Our interest rate risk management practices are aimed at optimizing net interest income, while guarding against deterioration that could be caused by certain interest rate scenarios. Interest rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. We attempt to maintain interest-earning assets, comprised primarily of both loans and investments, and interest-bearing liabilities, comprised primarily of deposits, maturing or repricing in similar time horizons in order to manage any impact from market interest rate changes according to our risk tolerance. The Company uses an earnings simulation model to measure earnings sensitivity to changing rates.
The Company determines the sensitivity of its short-term future earnings to a hypothetical plus or minus 100 to 300 basis point parallel rate shock through the use of simulation modeling. The simulation of earnings includes the modeling of the balance sheet as an ongoing entity. Future business assumptions involving administered rate products, prepayments for future rate-sensitive balances, and the reinvestment of maturing assets and liabilities are included. These items are then modeled to project net interest income based on a hypothetical change in interest rates. The resulting net interest income for the next 12-month period is compared to the net interest income amount calculated using flat rates. This difference represents the Company’s earnings sensitivity to a positive or negative 100 basis points parallel rate shock.
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The following table summarizes the projected impact of interest rate shocks on net interest income at December 31, 2019 (due to the current level of interest rates, the 300-basis point downward shock scenario is not shown):
Rate Shock | Annual % change in net interest income |
+ 300 bp | 6.4% |
+ 200 bp | 4.4% |
+ 100 bp | 2.3% |
- 100 bp | (3.6)% |
- 200 bp | (7.1)% |
In addition to the rate shocks shown in the table above, the Company models net interest income under various dynamic interest rate scenarios. In general, changes in interest rates are positively correlated with changes in net interest income.
The Company occasionally uses interest rate derivative instruments as an asset/liability management tool to hedge mismatches in interest rate exposure indicated by the net interest income simulation described above. They are used to modify the Company’s exposures to interest rate fluctuations and provide more stable spreads between loan yields and the rate on their funding sources. At December 31, 2019, the Company had $62.0 million in derivative contracts used to manage interest rate risk. Derivative financial instruments are also discussed in “Item 8. Note 7 – Derivative Financial Instruments.”
The United Kingdom’s Financial Conduct Authority (“FCA”) announced in 2017 that market participants should not rely on LIBOR after 2021. LIBOR is the most liquid and common interest rate index in the world and is commonly referenced in financial instruments. While the Ice Benchmark Administration Ltd., who administers LIBOR, has said that it intends to continue to produce LIBOR after 2021, there can be no guarantee that it will continue without the FCA compelling or persuading LIBOR panel banks to submit quotes. The Federal Reserve’s Alternative Reference Rates Committee (“ARRC”) has proposed that the Secured Overnight Funding Rate (“SOFR”) replace LIBOR. However, at this time, the Company has not identified a replacement index for LIBOR.
We have exposure to LIBOR in various financial contracts. Instruments that may be impacted include loans, securities, debt instruments and derivatives, among other financial contracts indexed to LIBOR and that mature after December 31, 2021. We have an internal working group composed of members from legal, credit, finance, operations, risk and audit to monitor developments, develop policies and procedures, assess the impact to the Company, consider relevant options and to determine an appropriate replacement index for affected contracts that expire after the expected discontinuation of LIBOR on December 31, 2021. We are actively working to amend and address impacted contracts to allow for a replacement index. However, amending certain contracts indexed to LIBOR may require consent from the counterparties which could be difficult and costly to obtain in certain limited circumstances. As of December 31, 2019, the Company’s financial contracts indexed to LIBOR included $2.6 billion in loans, $166.3 million in deposits and borrowings, and $811.8 million (notional) in derivatives.
In addition, LIBOR is used in the Company’s analysis of the fair value of tax credits and may be referenced in other financial contracts not included in the discussion above.
The Company has $3.2 billion in variable rate loans as of December 31, 2019. Of these loans, $1.0 billion, or 32.6%, have a floor. $2.6 billion in variable rate loans are indexed to LIBOR, $369 million are indexed to the prime rate, and $222 million are indexed to other rates.
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Contractual Obligations, Off-Balance Sheet Risk, and Contingent Liabilities
Through the normal course of operations, the Company has entered into certain contractual obligations and other commitments. Such obligations relate to funding of operations through deposits or debt issuances, as well as leases for premises and equipment. As a financial services provider, the Company routinely enters into commitments to extend credit. While contractual obligations represent future cash requirements of the Company, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans made by the Company.
The recorded contractual obligations and other commitments, excluding any contractual interest1, at December 31, 2019, were as follows:
Payments due by Period | |||||||||||||||||||
($ in thousands) | Total | Less Than 1 Year | Over 1 Year Less than 3 Years | Over 3 Years Less than 5 Years | Over 5 Years | ||||||||||||||
Operating leases | $ | 16,761 | $ | 3,054 | $ | 5,831 | $ | 4,673 | $ | 3,203 | |||||||||
Certificates of deposit | 826,447 | 636,625 | 121,815 | 62,228 | 5,779 | ||||||||||||||
Subordinated debentures and notes | 146,500 | — | — | — | 146,500 | ||||||||||||||
FHLB advances | 222,300 | 170,000 | 52,300 | — | — | ||||||||||||||
Notes payable | 34,286 | 5,714 | 11,429 | 17,143 | — | ||||||||||||||
Solar tax credits | 2,866 | 2,866 | — | — | — | ||||||||||||||
(1) Interest charges on related contractual obligations were excluded from reported amounts as the potential cash outflows would have corresponding cash inflows from interest-earning assets. | |||||||||||||||||||
The contractual commitments of off-balance sheet financial instruments at December 31, 2019, were as follows:
` | Payments due by Period | ||||||||||||||||||
($ in thousands) | Total | Less Than 1 Year | Over 1 Year Less than 3 Years | Over 3 Years Less than 5 Years | Over 5 Years | ||||||||||||||
Commitments to extend credit | $ | 1,469,413 | $ | 761,386 | $ | 411,868 | $ | 80,958 | $ | 215,201 | |||||||||
Letters of credit | 47,969 | 39,187 | 8,663 | 119 | — | ||||||||||||||
State tax credits | 28,035 | 13,279 | 14,756 | — | — | ||||||||||||||
Low-income housing tax credits | 704 | 704 | — | — | — | ||||||||||||||
SBICs (1) | 20,829 | 4,166 | 16,663 | — | — | ||||||||||||||
(1) Represents the estimated timing of various capital raises for SBICs and other private equity investments. | |||||||||||||||||||
See “Item 8. Note 18 – Commitments” for narrative disclosure regarding off-balance sheet arrangements. | |||||||||||||||||||
As of December 31, 2019, we had liabilities associated with uncertain tax positions of $1.1 million. The table above does not include these liabilities due to the high degree of uncertainty regarding the future cash flows associated with these amounts.
The Company also enters into derivative contracts under which the Company either receives cash from or pays cash to counterparties depending on changes in interest rates. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. The fair value of these contracts changes daily as market interest rates change.
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CRITICAL ACCOUNTING POLICIES
The following accounting policies are considered most critical to the understanding of the Company’s financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experience. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to our critical accounting policies on our business operations are discussed throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see “Item 8. Note 1 – Summary of Significant Accounting Policies.”
The Company has prepared all of the consolidated financial information in this report in accordance with GAAP. The Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Such estimates include the valuation of loans, goodwill, intangible assets, and other long-lived assets, along with assumptions used in the calculation of income taxes, among others. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using loss experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. We adjust such estimates and assumptions when facts and circumstances dictate. Decreased real estate values, volatile credit markets, and persistent high unemployment have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statement in future periods. There can be no assurances that actual results will not differ from those estimates.
Acquisitions
Acquisitions and Business Combinations are accounted for using the acquisition method of accounting. The assets and liabilities of the acquired entities have been recorded at their estimated fair values at the date of acquisition. Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including the amount assigned to identifiable intangible assets.
The purchase price allocation process requires an estimation of the fair values of the assets acquired and the liabilities assumed. When a business combination agreement provides for an adjustment to the cost of the combination contingent on future events, the Company includes an estimate of the acquisition-date fair value as part of the cost of the combination. To determine the fair values, the Company relies on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. The results of operations of the acquired business are included in the Company’s consolidated financial statements from the respective date of acquisition. Merger-related costs are costs the Company incurs to effect a business combination. Merger-related expenses include costs directly related to merger or acquisition activity and include legal and professional fees, system consolidation and conversion costs, and compensation costs such as severance and retention incentives for employees impacted by acquisition activity. The Company accounts for merger-related costs as expenses in the periods in which the costs are incurred and the services are received.
Allowance for Loan Losses
The Company maintains an allowance for loan losses (“the allowance”), which is management’s estimate of probable, inherent losses in the outstanding loan portfolio. The allowance is based on management’s continuous review and evaluation of the loan portfolio. The review and evaluation combines several factors including: consideration of loan loss experience; trends in past due and nonperforming loans; changes in lending policies and procedures; existing business and economic conditions; the fair value of underlying collateral; changes in the nature and volume of the Company’s loan portfolio; changes in the lending department of the Company; volume and severity of past due loans; the quality of the loan review system; concentrations of credit and other qualitative and other factors which affect
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probable credit losses. Because current economic conditions can change and are difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly.
In determining the allowance and the related provision for loan losses for portfolio loans, three principal elements are considered:
1) | specific allocations based upon probable losses identified during a quarterly review of the loan portfolio, |
2) | allocations based principally on the Company’s risk rating formulas, and |
3) | a qualitative adjustment based on other economic, environmental and portfolio factors. |
The first element reflects management’s estimate of probable losses based upon a systematic review of specific loans considered to be impaired. These estimates are based upon discounted cash flows as estimated and used to assign loss or collateral exposure, if they are collateral dependent for collection.
The second element reflects the application of our loan rating system. Loans are rated and assigned a loss allocation factor for each category based on a loss migration analysis using the Company’s loss experience over the last eight years. The higher the rating assigned to a loan, the greater the loss allocation percentage applied. This element also incorporates an estimate of the loss emergence period, which is an estimate of the time between when a credit event occurs and when the charge-off of a loan occurs. The process is an estimate and is, therefore, imprecise. For example, if our estimate of the loss emergence period would have been increased/decreased by one quarter, it would have resulted in an increase of $2.2 million and a decrease of $3.8 million, respectively, in our allowance at December 31, 2019.
The qualitative adjustment is based on management’s evaluation of conditions that are not directly reflected in the loss migration analysis and/or specific reserve. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they may not be identified with specific problem credits. The conditions evaluated in connection with the qualitative or environmental adjustment include the following:
• | changes in lending policies and procedures; |
• | changes in business and economic conditions; |
• | changes in the nature and volume of our loan portfolio; |
• | changes in our lending department; |
• | changes in volume and/or severity of past due loans; |
• | changes in the quality of our loan review system; |
• | changes in the value of underlying collateral related to loans; |
• | existence and effect of concentrations of credit within our loan portfolio; and |
• | other external factors such as asset quality trends (including trends in nonperforming loans expected to result from existing conditions), and related allowance metrics of our peers. |
Executive management reviews these conditions quarterly based on discussion with our lending staff. Management then assigns a specified number of basis points of allowance to each factor above by loan category. To the extent that any of these conditions are evidenced by a specifically identifiable problem credit or loan category as of the evaluation date, management’s estimate of the effect of such conditions may be reflected as a specific allowance, applicable to such credit or loan category.
The allocation of the allowance for loan losses by loan category is a result of the analysis above. The allocation methodology applied by the Company focuses on changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing economic conditions, and historical losses on each portfolio category.
Management believes the allowance for loan losses is adequate at December 31, 2019.
The Financial Accounting Standards Board has adopted a new accounting standard that will be effective for the Company beginning January 1, 2020. This standard, referred to as CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances
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for loan losses in the period when the loans are booked. CECL will change the current methodology and will require us to increase our allowance for loan losses and increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses.
PCI Loans
PCI loans are acquired in a business combination or transaction that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable. PCI loans are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance. The difference between the undiscounted cash flows expected at acquisition and the investment in the loans, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loans. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” are not recognized as a yield adjustment or as a loss accrual or a valuation allowance. The Company aggregates individual loans with common risk characteristics into pools of loans. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loans over their remaining lives. Decreases in expected cash flows due to an inability to collect contractual cash flows are recognized as impairment through the provision for loan losses account. Any allowance for loan loss on these pools reflect only losses incurred after the acquisition. Disposals of loans, including sales of loans, paydowns, payments in full or foreclosures result in the removal or reduction of the loan from the loan pool.
PCI loans are generally considered accruing and performing, as the loans accrete income over the estimated life of the loan, in circumstances where cash flows are reasonably estimable by management. Accordingly, PCI loans that could be contractually past due could be considered to be accruing and performing. If the timing and amount of future cash flows is not reasonably estimable or is less than the carrying value, the loans may be classified as nonaccrual loans and the purchase price discount on those loans is not recorded as interest income until the timing and amount of future cash flows can be reasonably estimable.
The Company updates its cash flow projections for purchased credit-impaired loans on a periodic basis. Assumptions utilized in this process include projections related to probability of default, loss severity, prepayment, extensions and recovery lag. Projections related to probability of default and prepayment are calculated utilizing a loan migration analysis and management’s assessment of loss exposure including the fair value of underlying collateral. The loan migration analysis is a matrix that specifies the probability of a loan pool transitioning into a particular delinquency or liquidation state given its current performance at the measurement date. Loss severity factors are based upon industry data and historical experience.
Any decreases in expected cash flows after the acquisition date and subsequent measurement periods are recognized by recording an impairment in allowance for loan losses through a provision for loan losses.
Goodwill and Other Intangible Assets
The Company completes a goodwill impairment test in the fourth quarter each year or whenever events or changes in circumstances indicate that the Company may not be able to recover the goodwill, or intangible assets, respective carrying amount. The impairment test involves the use of various estimates and assumptions. Management believes the estimates and assumptions utilized are reasonable. However, the Company may incur impairment charges related to goodwill or intangible assets in the future due to changes in business prospects or other matters that could impact estimates and assumptions.
Goodwill is evaluated for impairment at the reporting unit level. Reporting units are defined as the same level as, or one level below, an operating segment. An operating segment is a component of a business for which separate financial information is available that management regularly evaluates in deciding how to allocate resources and assess performance. At December 31, 2019, the Company had one reporting unit and one operating segment.
Potential impairments to goodwill must first be identified by performing a qualitative assessment which evaluates relevant events or circumstances to determine whether it is more likely than not that the fair value of a reporting unit
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is less than its carrying amount. If this test indicates it is more likely than not that goodwill has been impaired, then a quantitative impairment test is completed. The quantitative impairment test calculates the fair value of the reporting unit and compares it with its carrying amount, including goodwill. If the carrying amount of goodwill exceeds its implied fair market value, an impairment loss is recognized. That loss is equal to the carrying amount of goodwill that is in excess of its implied fair market value.
Intangible assets other than goodwill, such as core deposit intangibles, that are determined to have finite lives are amortized over their estimated remaining useful lives. These assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset.
In 2019, we performed a qualitative assessment to determine if our goodwill was impaired. At December 31, 2019 the Company’s goodwill balance was $210.3 million compared to $117.3 million at December 31, 2018. The 2019 annual impairment evaluation of goodwill and intangible balances did not identify any impairment.
Impact of Inflation and Changing Prices
Our consolidated financial statements and related data presented in this Annual Report on Form 10-K have been prepared in accordance with U.S. GAAP, which requires the measurement of financial position and operating results in terms of historical dollar amounts (except with respect to securities classified as available-for-sale which are carried at market value) without considering the changes in the relative purchasing power of money over time due to inflation. Substantially all of our assets and liabilities are monetary in nature; as a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same magnitude as the price of goods and services.
Effects of New Accounting Pronouncements
See “Item 8. Note 22 – New Authoritative Accounting Guidance” for information on recent accounting pronouncements and their impact, if any, on our consolidated financial statements.
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Use of Non-GAAP Financial Measures
The Company’s accounting and reporting policies conform to U.S. GAAP and the prevailing practices in the banking industry. However, the Company provides other financial measures, such as core net interest income, core net interest margin, core efficiency ratio, tangible common equity, and the tangible common equity ratio, in this filing that are considered “non-GAAP financial measures.” Generally, a non-GAAP financial measure is a numerical measure of a company’s financial performance, financial position, or cash flows that exclude (or include) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP.
The Company considers its core net interest income, core net interest margin, core efficiency ratio, tangible common equity, and the tangible common equity ratio, collectively “core performance measures” presented in this Annual Report on Form 10-K, as relevant measures of financial performance, even though they are non-GAAP measures, as they provide supplemental information by which to evaluate the impact of non-core acquired loans and related income and expenses, the impact of certain non-comparable items, and the Company’s operating performance on an ongoing basis. Core performance measures include contractual interest on non-core acquired loans, but exclude incremental accretion on these loans. Core performance measures also exclude the following:
• | expenses directly related to non-core acquired loans and other assets formerly covered under FDIC loss share agreements, and |
• | certain other income and expense items the Company believes to be not indicative of or useful to measure the Company’s operating performance on an ongoing basis, such as: |
◦ | merger-related expenses, |
◦ | facilities charges, and |
◦ | the gain or loss on sale of investment securities. |
The Company believes the tangible common equity ratio provides useful information to investors about the Company’s capital strength, even though it is considered to be a non-GAAP financial measure, and is not part of the regulatory capital requirements to which the Company is subject.
The Company believes these non-GAAP measures and ratios, when taken together with the corresponding GAAP measures and ratios, provide meaningful supplemental information regarding the Company’s performance and capital strength. The Company’s management uses, and believes investors benefit from referring to, these non-GAAP measures and ratios in assessing the Company’s operating results and related trends and when forecasting future periods. However, these non-GAAP measures and ratios should be considered in addition to, and not as a substitute for or preferable to, ratios prepared in accordance with GAAP. The Company has provided a reconciliation of, where applicable, the most comparable GAAP financial measures and ratios to the non-GAAP financial measures and ratios, or a reconciliation of the non-GAAP calculation of the financial measure for the periods indicated.
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Reconciliations of Non-GAAP Financial Measures
Core Efficiency Ratio
For the Years ended | |||||||||||
($ in thousands) | December 31, 2019 | December 31, 2018 | December 31, 2017 | ||||||||
Net interest income | $ | 238,717 | $ | 191,905 | $ | 177,304 | |||||
Less: Incremental accretion income | 4,783 | 3,701 | 7,718 | ||||||||
Core net interest income | 233,934 | 188,204 | 169,586 | ||||||||
Total noninterest income | 49,176 | 38,347 | 34,394 | ||||||||
Less: Other income from non-core acquired assets | 1,372 | 1,048 | (6 | ) | |||||||
Less: Gain on sale of investment securities | 243 | 9 | 22 | ||||||||
Less: Other non-core income | 266 | 675 | — | ||||||||
Core noninterest income | 47,295 | 36,615 | 34,378 | ||||||||
Total core revenue | $ | 281,229 | $ | 224,819 | $ | 203,964 | |||||
Total noninterest expense | $ | 165,485 | $ | 119,031 | $ | 115,051 | |||||
Less: Merger related expenses | 17,969 | 1,271 | 6,462 | ||||||||
Less: Other expenses (credits) related to non-core acquired loans | 257 | (163 | ) | 240 | |||||||
Less: Facilities disposal charge | — | 239 | 389 | ||||||||
Less: Other non-core expenses | — | 682 | — | ||||||||
Core noninterest expense | $ | 147,259 | $ | 117,002 | $ | 107,960 | |||||
Core efficiency ratio | 52.36 | % | 52.04 | % | 52.93 | % | |||||
Net Interest Margin to Core Net Interest Margin (Fully tax equivalent)
($ in thousands) | For the Years ended December 31, | ||||||||||
2019 | 2018 | 2017 | |||||||||
Net interest income | $ | 240,328 | $ | 192,725 | $ | 179,114 | |||||
Less: Incremental accretion income | 4,783 | 3,701 | 7,718 | ||||||||
Core net interest income | $ | 235,545 | $ | 189,024 | $ | 171,396 | |||||
Average earning assets | $ | 6,322,075 | $ | 5,041,395 | $ | 4,611,670 | |||||
Reported net interest margin | 3.80 | % | 3.82 | % | 3.88 | % | |||||
Core net interest margin | 3.73 | 3.75 | 3.72 | ||||||||
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Tangible Common Equity and Tangible Common Equity Ratio
For the Years ended December 31, | |||||||||||
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Total shareholders' equity | $ | 867,185 | $ | 603,804 | $ | 548,573 | |||||
Less: Goodwill | 210,344 | 117,345 | 117,345 | ||||||||
Less: Intangible assets | 26,076 | 8,553 | 11,056 | ||||||||
Tangible common equity | $ | 630,765 | $ | 477,906 | $ | 420,172 | |||||
Total assets | $ | 7,333,791 | $ | 5,645,662 | $ | 5,289,225 | |||||
Less: Goodwill | 210,344 | 117,345 | 117,345 | ||||||||
Less: Intangible assets | 26,076 | 8,553 | 11,056 | ||||||||
Tangible assets | $ | 7,097,371 | $ | 5,519,764 | $ | 5,160,824 | |||||
Tangible common equity to tangible assets | 8.89 | % | 8.66 | % | 8.14 | % | |||||
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Please refer to “Risk Factors” included in Item 1A and “Risk Management” and “Interest Rate Risk” included in Management’s Discussion and Analysis under Item 7.
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ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Enterprise Financial Services Corp and Subsidiaries
Page Number | |
Report of Independent Registered Public Accounting Firm | |
Consolidated Balance Sheets at December 31, 2019 and 2018 | |
Consolidated Statements of Operations for the years ended December 31, 2019, 2018, and 2017 | |
Consolidated Statements of Comprehensive Income for the years ended December 31, 2019, 2018, and 2017 | |
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2019, 2018, and 2017 | |
Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018, and 2017 | |
Notes to Consolidated Financial Statements | |
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and Board of Directors of Enterprise Financial Services Corp
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Enterprise Financial Services Corp and subsidiaries (the “Company”) as of December 31, 2019 and 2018, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows, for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 21, 2020, expressed an unqualified opinion on the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
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Allowance for Loan Losses-Qualitative Adjustment-Refer to Notes 1 and 5 to the consolidated financial statements
Critical Audit Matter Description
The Company maintains an allowance for loan losses, which is management’s estimate of probable, inherent losses in the outstanding loan portfolio. In determining the allowance for loan losses, three principal elements are considered-specific allocations based upon probable losses; allocations based principally on the Company’s risk-rating formulas; and a qualitative adjustment based on other economic, environmental, and portfolio factors. The qualitative adjustment is based on management’s evaluation of conditions that are not directly reflected in the loss migration analysis and/or specific reserve. The conditions evaluated in connection with the qualitative or environmental adjustment primarily include existing business and economic conditions, concentrations of credit, and other qualitative factors.
Given the significant amount of judgment used by management to develop the qualitative adjustment in the allowance for loan losses, performing audit procedures to evaluate the reasonableness of the qualitative adjustment required a high degree of auditor judgment and an increased extent of effort.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management’s allowance for loan losses attributable to the qualitative adjustment included the following, among others:
• | We tested the effectiveness of controls over the Company’s determination of the qualitative adjustment in the allowance for loan losses, including management’s review of the relevant factors considered. |
• | We evaluated the appropriateness and consistency of the methods and assumptions used by management to develop the qualitative adjustment, including comparing actual losses incurred to management’s historical estimates, evaluating external economic and industry trends, benchmarking against peers, and evaluating the overall composition of the loan portfolios and period-over-period changes in concentration. |
• | We tested the accuracy and completeness of quantitative data used by management to develop the qualitative adjustment in the allowance for loan losses. |
Acquisition of Trinity Capital Corporation-Valuation of Loans-Refer to Note 2 to the consolidated financial statements
Critical Audit Matter Description
The Company closed its acquisition of Trinity Capital Corporation (“Trinity”) on March 8, 2019, for a purchase price of $209.2 million. The acquisition of Trinity has been accounted for as a business combination using the acquisition method of accounting which requires assets acquired and liabilities assumed to be recognized at fair value as of the acquisition date. Assets acquired included loans with a total fair value of approximately $684.3 million, which includes fair value adjustments based on the Company’s evaluation of the acquired loan portfolio, write-off of net deferred loan costs, and elimination of the allowance for loan losses recorded by Trinity. Management utilized a third-party specialist to assist in the calculation of the fair value of loans based on a discounted cash flow approach. The fair value adjustments required management to make significant estimates and assumptions, including the probability of default (i.e., credit risk) related to the valuation of acquired loans.
Given that the fair value determination of these loans required management to make significant estimates and assumptions related to the associated credit risk, performing audit procedures to evaluate the reasonableness of these estimates and assumptions required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management’s determination of the credit risk associated with these loans included the following, among others:
• | We tested the design and operating effectiveness of controls over the valuation of the acquired loans, including management’s controls over the determination of credit risk. |
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• | With the assistance of our fair value specialists, we evaluated the reasonableness of the (1) the discounted cash flow valuation methodology and (2) credit risk assumption utilized in the calculations by: |
• | Testing the source information underlying the determination of the credit risk assumptions and testing the mathematical accuracy of the calculation. |
• | Developing independent estimates and comparing those to the credit risk assumptions selected by management. |
Disclosure of ASU No. 2016-13 Adoption-Refer to Note 22 to the consolidated financial statements
Critical Audit Matter Description
On January 1, 2020, the Company adopted Accounting Standards Update (ASU) No. 2016-13, Financial Instruments-Credit Losses, which introduces a forward-looking “expected loss” model (the “Current Expected Credit Losses (CECL)” model) to estimate credit losses over the remaining expected life of the Company’s loan portfolio upon adoption, rather than the incurred loss model under current accounting principles generally accepted in the United States of America. Estimates of expected credit losses under the CECL model are based on relevant information about past events, current conditions, and reasonable and supportable forward-looking forecasts regarding the collectability of the loan portfolio.
In order to estimate the expected credit losses, existing credit loss estimation models were updated and, in certain cases, new models implemented to align with the CECL model. Assumptions used to estimate expected credit losses under the CECL model included the length of the reasonable and supportable forecast period and the qualitative adjustment. The Company disclosed that the impact of adoption on January 1, 2020, will result in an expected increase to its allowances for credit losses by 50%-65%.
Given the estimation of credit losses significantly changes under the CECL model, including the application of new accounting policies, the use of new subjective judgments, and changes made to the loss estimation models, performing audit procedures to evaluate the disclosure of ASU No. 2016-13 adoption involved a high degree of auditor judgment and required significant effort, including the need to involve our credit specialists.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the disclosure of ASU No. 2016-13 included the following, among others:
• | We tested the design and operating effectiveness of management’s controls covering the key assumptions and judgments, CECL estimation models, selection and application of new accounting policies, and disclosure of the impact of adoption discussed in Note 22 to the financial statements. |
• | We evaluated the completeness of the Company’s disclosure related to the adoption of ASU No. 2016-13. |
• | We evaluated the appropriateness of the Company’s accounting policies, methodologies, and elections involved in the adoption of the CECL model. |
• | We involved credit specialists, to assist us in evaluating the reasonableness and conceptual soundness of the methodology as applied in the CECL estimation models and the length of the reasonable and supportable forecast period. |
• | We evaluated the appropriateness of the methods and assumptions used by management to develop the qualitative adjustment, including comparing actual losses incurred to management’s historical estimates, evaluating external economic and industry trends, and evaluating the overall composition of the loan portfolios and period-over-period changes in concentration. |
/s/ Deloitte & Touche LLP
St. Louis, Missouri
February 21, 2020
We have served as the Company’s auditor since 2010.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and Board of Directors of Enterprise Financial Services Corp
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of Enterprise Financial Services Corp and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on the criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2019, of the Company and our report dated February 21, 2020 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Assessment on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Deloitte & Touche LLP
St. Louis, Missouri
February 21, 2020
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ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Balance Sheets
As of December 31, 2019 and 2018
($ in thousands, except per share data) | December 31, 2019 | December 31, 2018 | |||||
Assets | |||||||
Cash and due from banks | $ | 74,769 | $ | 91,511 | |||
Federal funds sold | 3,060 | 1,714 | |||||
Interest-earning deposits (including $15,285 and $1,305 pledged as collateral, respectively) | 89,427 | 103,327 | |||||
Total cash and cash equivalents | 167,256 | 196,552 | |||||
Interest-earning deposits greater than 90 days | 3,730 | 3,185 | |||||
Securities available-for-sale | 1,135,317 | 721,369 | |||||
Securities held-to-maturity | 181,166 | 65,679 | |||||
Loans held-for-sale | 5,570 | 392 | |||||
Loans | 5,314,337 | 4,350,001 | |||||
Less: Allowance for loan losses | 43,288 | 43,476 | |||||
Total loans, net | 5,271,049 | 4,306,525 | |||||
Other investments | 38,044 | 26,654 | |||||
Fixed assets, net | 60,013 | 32,109 | |||||
Goodwill | 210,344 | 117,345 | |||||
Intangible assets, net | 26,076 | 8,553 | |||||
Other assets | 235,226 | 167,299 | |||||
Total assets | $ | 7,333,791 | $ | 5,645,662 | |||
Liabilities and Shareholders' equity | |||||||
Noninterest-bearing deposit accounts | $ | 1,327,348 | $ | 1,100,718 | |||
Interest-bearing transaction accounts | 1,367,444 | 1,037,684 | |||||
Money market accounts | 1,713,615 | 1,565,729 | |||||
Savings accounts | 536,169 | 199,425 | |||||
Certificates of deposit: | |||||||
Brokered | 215,758 | 198,981 | |||||
Other | 610,689 | 485,448 | |||||
Total deposits | 5,771,023 | 4,587,985 | |||||
Subordinated debentures and notes | 141,258 | 118,156 | |||||
FHLB advances | 222,406 | 70,000 | |||||
Other borrowings | 230,886 | 221,450 | |||||
Notes payable | 34,286 | 2,000 | |||||
Other liabilities | 66,747 | 42,267 | |||||
Total liabilities | 6,466,606 | 5,041,858 | |||||
Commitments and contingent liabilities | |||||||
Shareholders' equity: | |||||||
Preferred stock, $0.01 par value; 5,000,000 shares authorized; 0 shares issued and outstanding | — | — | |||||
Common stock, $0.01 par value; 45,000,000 shares authorized; 28,067,087 and 23,938,994 shares issued, respectively | 281 | 239 | |||||
Treasury stock, at cost; 1,523,842 and 1,127,105 shares, respectively | (58,181 | ) | (42,655 | ) | |||
Additional paid in capital | 526,599 | 350,936 | |||||
Retained earnings | 380,737 | 304,566 | |||||
Accumulated other comprehensive income (loss) | 17,749 | (9,282 | ) | ||||
Total shareholders' equity | 867,185 | 603,804 | |||||
Total liabilities and shareholders' equity | $ | 7,333,791 | $ | 5,645,662 | |||
See accompanying notes to consolidated financial statements.
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ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 2019, 2018, and 2017
Year ended December 31, | |||||||||||
($ in thousands, except per share data) | 2019 | 2018 | 2017 | ||||||||
Interest income: | |||||||||||
Interest and fees on loans | $ | 269,406 | $ | 217,212 | $ | 185,452 | |||||
Interest on debt securities: | |||||||||||
Taxable | 29,030 | 17,469 | 14,551 | ||||||||
Nontaxable | 3,515 | 1,074 | 1,283 | ||||||||
Interest on interest-earning deposits | 2,128 | 1,141 | 804 | ||||||||
Dividends on equity securities | 1,055 | 906 | 449 | ||||||||
Total interest income | 305,134 | 237,802 | 202,539 | ||||||||
Interest expense: | |||||||||||
Interest-bearing transaction accounts | 7,592 | 3,643 | 2,195 | ||||||||
Money market accounts | 26,267 | 19,361 | 8,708 | ||||||||
Savings accounts | 841 | 597 | 459 | ||||||||
Certificates of deposit | 15,156 | 10,168 | 5,838 | ||||||||
Subordinated debentures and notes | 7,507 | 5,798 | 5,095 | ||||||||
FHLB advances | 6,668 | 5,556 | 2,356 | ||||||||
Notes payable and other borrowings | 2,386 | 774 | 584 | ||||||||
Total interest expense | 66,417 | 45,897 | 25,235 | ||||||||
Net interest income | 238,717 | 191,905 | 177,304 | ||||||||
Provision for loan losses | 6,372 | 6,644 | 10,130 | ||||||||
Net interest income after provision for loan losses | 232,345 | 185,261 | 167,174 | ||||||||
Noninterest income: | |||||||||||
Service charges on deposit accounts | 12,801 | 11,749 | 11,043 | ||||||||
Wealth management revenue | 9,932 | 8,241 | 8,102 | ||||||||
Card services revenue | 9,154 | 6,686 | 5,433 | ||||||||
Tax credit income | 5,393 | 2,820 | 2,581 | ||||||||
Gain on sale of investment securities | 243 | 9 | 22 | ||||||||
Miscellaneous income | 11,653 | 8,842 | 7,213 | ||||||||
Total noninterest income | 49,176 | 38,347 | 34,394 | ||||||||
Noninterest expense: | |||||||||||
Employee compensation and benefits | 81,295 | 66,039 | 61,388 | ||||||||
Occupancy | 12,465 | 9,550 | 9,057 | ||||||||
Data processing | 8,242 | 6,321 | 6,272 | ||||||||
Professional fees | 3,683 | 3,134 | 3,813 | ||||||||
Merger-related expenses | 17,969 | 1,271 | 6,462 | ||||||||
Other | 41,831 | 32,716 | 28,059 | ||||||||
Total noninterest expense | 165,485 | 119,031 | 115,051 | ||||||||
Income before income tax expense | 116,036 | 104,577 | 86,517 | ||||||||
Income tax expense | 23,297 | 15,360 | 38,327 | ||||||||
Net income | $ | 92,739 | $ | 89,217 | $ | 48,190 | |||||
Earnings per common share | |||||||||||
Basic | $ | 3.56 | $ | 3.86 | $ | 2.10 | |||||
Diluted | 3.55 | 3.83 | 2.07 | ||||||||
See accompanying notes to consolidated financial statements.
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ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Years ended December 31, 2019, 2018, and 2017
Year ended December 31, | |||||||||||
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Net income | $ | 92,739 | $ | 89,217 | $ | 48,190 | |||||
Other comprehensive income (loss), net of tax: | |||||||||||
Change in unrealized gain (loss) on available-for-sale debt securities, net of tax effect of $9,575, $(1,518), and $(1,272), respectively | 29,189 | (4,626 | ) | (2,076 | ) | ||||||
Reclassification adjustment for realized (gain) loss on the sale of available-for-sale debt securities, net of tax effect of $(12), $2, and $9, respectively | 37 | (7 | ) | (13 | ) | ||||||
Reclassification of (gain) loss on held-to-maturity securities, net of tax effect of $(11), $1, and $7, respectively | (33 | ) | 3 | 12 | |||||||
Change in unrealized loss on cash flow hedges arising during the period, net of tax effect of $742 | (2,262 | ) | — | — | |||||||
Reclassification of loss on cash flow hedges, net of tax effect of $(33) | 100 | — | — | ||||||||
Other comprehensive income (loss), net | 27,031 | (4,630 | ) | (2,077 | ) | ||||||
Total comprehensive income | $ | 119,770 | $ | 84,587 | $ | 46,113 | |||||
See accompanying notes to consolidated financial statements.
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ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Statements of Shareholders’ Equity
Years ended December 31, 2019, 2018, and 2017
($ in thousands, except per share data) | Common Stock | Treasury Stock | Additional paid in capital | Retained earnings | Accumulated other comprehensive income (loss) | Total shareholders’ equity | |||||||||||||||||
Balance December 31, 2016 | $ | 203 | $ | (6,632 | ) | $ | 213,078 | $ | 182,190 | $ | (1,741 | ) | $ | 387,098 | |||||||||
Net income | $ | — | $ | — | $ | — | $ | 48,190 | $ | — | $ | 48,190 | |||||||||||
Other comprehensive loss, net | — | — | — | — | (2,077 | ) | (2,077 | ) | |||||||||||||||
Cash dividends paid on common shares, $0.44 per share | — | — | — | (10,249 | ) | — | (10,249 | ) | |||||||||||||||
Repurchase of common shares, 429,955 shares | — | (16,636 | ) | — | — | — | (16,636 | ) | |||||||||||||||
Issuance under equity compensation plans, 174,895 shares, net | 2 | — | (2,911 | ) | — | — | (2,909 | ) | |||||||||||||||
Shares issued in connection with acquisition of Jefferson County Bancshares, Inc., 3,299,865 shares, net | 33 | — | 141,696 | — | — | 141,729 | |||||||||||||||||
Share-based compensation | — | — | 3,427 | — | — | 3,427 | |||||||||||||||||
Reclassification for the adoption of share-based payment guidance | — | — | (5,229 | ) | 5,229 | — | — | ||||||||||||||||
Balance December 31, 2017 | $ | 238 | $ | (23,268 | ) | $ | 350,061 | $ | 225,360 | $ | (3,818 | ) | $ | 548,573 | |||||||||
Net income | $ | — | $ | — | $ | — | $ | 89,217 | $ | — | $ | 89,217 | |||||||||||
Other comprehensive loss, net | — | — | — | — | (4,630 | ) | (4,630 | ) | |||||||||||||||
Cash dividends paid on common shares, $0.47 per share | — | — | — | (10,845 | ) | — | (10,845 | ) | |||||||||||||||
Repurchase of common shares, 435,435 shares | — | (19,387 | ) | — | — | — | (19,387 | ) | |||||||||||||||
Issuance under equity compensation plans, 157,882 shares, net | 1 | — | (2,577 | ) | — | — | (2,576 | ) | |||||||||||||||
Share-based compensation | — | — | 3,452 | — | — | 3,452 | |||||||||||||||||
Reclassification adjustments for change in accounting policies | — | — | — | 834 | (834 | ) | — | ||||||||||||||||
Balance December 31, 2018 | $ | 239 | $ | (42,655 | ) | $ | 350,936 | $ | 304,566 | $ | (9,282 | ) | $ | 603,804 | |||||||||
Net income | $ | — | $ | — | $ | — | $ | 92,739 | $ | — | $ | 92,739 | |||||||||||
Other comprehensive income, net | — | — | — | — | 27,031 | 27,031 | |||||||||||||||||
Cash dividends paid on common shares, $0.62 per share | — | — | — | (16,568 | ) | — | (16,568 | ) | |||||||||||||||
Repurchase of common shares, 396,737 shares | — | (15,526 | ) | — | — | — | (15,526 | ) | |||||||||||||||
Issuance under equity compensation plans, 137,271 shares, net | 2 | — | (214 | ) | — | — | (212 | ) | |||||||||||||||
Shares issued in connection with acquisition of Trinity Capital Corporation, 3,990,822 shares, net | 40 | — | 171,845 | — | — | 171,885 | |||||||||||||||||
Share-based compensation | — | — | 4,032 | — | — | 4,032 | |||||||||||||||||
Balance December 31, 2019 | $ | 281 | $ | (58,181 | ) | $ | 526,599 | $ | 380,737 | $ | 17,749 | $ | 867,185 | ||||||||||
See accompanying notes to consolidated financial statements.
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ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2019, 2018, and 2017
Year ended December 31, | |||||||||||
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Cash flows from operating activities: | |||||||||||
Net income | $ | 92,739 | $ | 89,217 | $ | 48,190 | |||||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
Depreciation | 5,719 | 3,532 | 3,281 | ||||||||
Provision for loan losses | 6,372 | 6,644 | 10,130 | ||||||||
Deferred income taxes | 5,800 | 3,307 | 21,105 | ||||||||
Net amortization of debt securities | 2,973 | 1,691 | 2,415 | ||||||||
Amortization of intangible assets | 5,543 | 2,503 | 2,609 | ||||||||
Mortgage loans originated-for-sale | (81,941 | ) | (36,229 | ) | (138,949 | ) | |||||
Proceeds from mortgage loans sold | 77,302 | 39,310 | 145,836 | ||||||||
Loss (gain) on: | |||||||||||
Sale of investment securities | 49 | (9 | ) | (22 | ) | ||||||
Valuation adjustments and sale of other real estate | (113 | ) | (13 | ) | (93 | ) | |||||
Sale of state tax credits | (2,549 | ) | (2,820 | ) | (2,581 | ) | |||||
Share-based compensation | 4,032 | 3,452 | 3,427 | ||||||||
Net accretion of loan discount | (10,494 | ) | (1,700 | ) | (5,609 | ) | |||||
Changes in other assets and liabilities, net | (12,975 | ) | (77 | ) | (43,948 | ) | |||||
Net cash provided by operating activities | 92,457 | 108,808 | 45,791 | ||||||||
Cash flows from investing activities: | |||||||||||
Proceeds from acquisition (acquisition price paid), net | (23,377 | ) | — | 4,456 | |||||||
Net increase in loans | (284,235 | ) | (257,872 | ) | (270,090 | ) | |||||
Proceeds received from: | |||||||||||
Sale of debt securities, available-for-sale | 357,976 | 1,451 | 144,076 | ||||||||
Paydown or maturity of debt securities, available-for-sale | 146,132 | 84,189 | 143,949 | ||||||||
Paydown or maturity of debt securities, held-to-maturity | 7,447 | 6,397 | 6,510 | ||||||||
Redemption of other investments | 61,917 | 50,274 | 43,207 | ||||||||
Sale of state tax credits held for sale | 14,689 | 14,718 | 15,314 | ||||||||
Sale of other real estate | 4,798 | 875 | 2,779 | ||||||||
Settlement of bank-owned life insurance policies | — | 1,256 | — | ||||||||
Payments for the purchase of: | |||||||||||
Available for sale debt securities | (577,211 | ) | (172,026 | ) | (325,393 | ) | |||||
Other investments | (68,963 | ) | (51,828 | ) | (56,412 | ) | |||||
State tax credits held for sale | (11,356 | ) | (6,017 | ) | (18,294 | ) | |||||
Fixed assets | (6,337 | ) | (3,035 | ) | (2,546 | ) | |||||
Net cash used in investing activities | (378,520 | ) | (331,618 | ) | (312,444 | ) | |||||
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Year ended December 31, | |||||||||||
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Cash flows from financing activities: | |||||||||||
Net increase (decrease) in noninterest-bearing deposit accounts | 57,551 | (23,189 | ) | 96,681 | |||||||
Net increase in interest-bearing deposit accounts | 44,300 | 454,760 | 61,204 | ||||||||
Proceeds (repayments) from short-term FHLB advances, net | 95,500 | (102,500 | ) | 172,500 | |||||||
Proceeds from long-term FHLB advances | 50,000 | — | — | ||||||||
Proceeds from notes payable | 41,000 | 2,000 | 10,000 | ||||||||
Repayments of notes payable | (8,714 | ) | — | (10,000 | ) | ||||||
Net increase (decrease) in other borrowings | 9,436 | (32,224 | ) | (79,417 | ) | ||||||
Cash dividends paid on common stock | (16,568 | ) | (10,845 | ) | (10,249 | ) | |||||
Repurchase of common stock | (15,526 | ) | (19,387 | ) | (16,636 | ) | |||||
Payments for the issuance of equity instruments, net | (212 | ) | (2,576 | ) | (2,909 | ) | |||||
Net cash provided by financing activities | 256,767 | 266,039 | 221,174 | ||||||||
Net (decrease) increase in cash and cash equivalents | (29,296 | ) | 43,229 | (45,479 | ) | ||||||
Cash and cash equivalents, beginning of period | 196,552 | 153,323 | 198,802 | ||||||||
Cash and cash equivalents, end of period | $ | 167,256 | $ | 196,552 | $ | 153,323 | |||||
Supplemental disclosures of cash flow information: | |||||||||||
Cash paid during the period for: | |||||||||||
Interest | $ | 65,667 | $ | 45,650 | $ | 24,610 | |||||
Income taxes | 13,582 | 10,136 | 12,449 | ||||||||
Noncash transactions: | |||||||||||
Transfer to other real estate owned in settlement of loans | $ | 8,148 | $ | 876 | $ | 564 | |||||
Sales of other real estate financed | 621 | — | — | ||||||||
Transfer of securities from available-for-sale to held-to-maturity | 116,303 | — | — | ||||||||
Right-of-use assets obtained in exchange for lease obligations | 5,208 | — | — | ||||||||
Common shares issued in connection with acquisitions | 171,885 | — | 141,729 | ||||||||
See accompanying notes to consolidated financial statements.
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ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies used by the Company in the preparation of the consolidated financial statements are summarized below.
Business and Consolidation
Enterprise is a financial holding company that provides a full range of banking and wealth management services to individuals and corporate customers primarily located in the Arizona, Kansas, Missouri, and New Mexico markets through its banking subsidiary, Enterprise Bank & Trust. All intercompany accounts and transactions have been eliminated.
The Company and its banking subsidiary are subject to the regulations of certain federal and state agencies and undergo periodic examinations by those regulatory agencies. The Company has one operating segment.
Use of Estimates
The consolidated financial statements of the Company have been prepared in conformity with GAAP. In preparing the consolidated financial statements, management is required to make estimates and assumptions, which significantly affect the reported amounts in the consolidated financial statements. Such estimates include the valuation of loans, goodwill, intangible assets, and other long-lived assets, along with assumptions used in the calculation of income taxes, among others. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. Management adjusts such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.
Cash Flow Information
For purposes of reporting cash flows, the Company considers cash and due from banks, interest-bearing deposits and federal funds sold that mature within 90 days of the balance sheet date to be cash and cash equivalents. At December 31, 2019 and 2018, approximately $9.7 million, and $15.1 million, respectively, of cash and due from banks represented required reserves on deposits maintained by the Company in accordance with Federal Reserve requirements.
Recently Adopted Accounting Pronouncements
During the first quarter of 2019, the Company adopted the FASB ASU 2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities.” ASU 2017-08 shortens the amortization period of certain callable debt securities held at a premium to the earliest call date. The adoption of this update did not have a material effect on the Company’s consolidated financial statements.
The Company adopted the FASB ASU 2016-02 “Leases (Topic 842)” using the optional transition method effective on January 1, 2019. ASU 2016-02 requires organizations that lease assets to recognize the assets and liabilities for the rights and obligations created by leases. The Company recorded $15.5 million for right-to-use assets and $16.2 million for lease liabilities related to operating leases. The Company elected the practical expedients package which eliminates (1) the need to reassess whether any expired or existing contracts are or contain a lease, (2) the need to reassess the lease classification, and (3) the need to reassess initial direct costs for any existing leases. The Company also elected an accounting policy to not recognize assets and liabilities on leases 12 months or less, and an accounting policy for equipment and real estate leases to not separate nonlease components because the impact was immaterial.
Investments
The Company has classified all investments in debt securities as available-for-sale or held-to-maturity.
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Securities classified as available-for-sale are carried at fair value. Unrealized holding gains and losses for available-for-sale securities are excluded from earnings and reported as a net amount in a separate component of shareholders’ equity until realized. All previous fair value adjustments included in the separate component of shareholders’ equity are reversed upon sale.
Securities classified as held-to-maturity are carried at amortized cost and adjusted for amortization of premiums and accretion of discounts.
Declines in the fair value of securities below their cost deemed to be other-than-temporary are reflected in operations as realized losses. In estimating other-than-temporary impairment losses, management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) the present value of the cash flows expected to be collected compared to the amortized cost of the security, (2) duration and magnitude of the decline in value, (3) the financial condition of the issuer or issuers, (4) structure of the security, and (5) the intent to sell the security or whether it’s more likely than not the Company would be required to sell the security before its anticipated recovery in market value.
Premiums and discounts are amortized or accreted over the expected lives of the respective securities as an adjustment to yield using the interest method. Dividend and interest income is recognized when earned. Realized gains and losses are included in earnings and are derived using the specific identification method for determining the cost of securities sold.
Loans Held for Sale
The Company provides long-term financing of one-to-four-family residential real estate by originating fixed and variable rate loans. Long-term fixed and variable rate loans are sold into the secondary market with limited recourse. Upon receipt of an application for a real estate loan, the Company determines whether the loan will be sold into the secondary market or retained in the Company’s loan portfolio. The interest rates on the loans sold are locked with the buyer and the Company bears no interest rate risk related to these loans. Mortgage loans held for sale are carried at the lower of cost or fair value, which is determined on a specific identification method. The Company does not retain servicing on any loans sold, nor does the Company have any capitalized mortgage servicing rights at December 31, 2019 or 2018. Gains on the sale of loans held for sale are reported net of direct origination fees and costs in the Company’s Consolidated Statements of Operations.
Loans
Loans are reported at the principal balance outstanding, net of unearned fees, costs, and premiums or discounts on acquired loans. Loan origination fees, direct origination costs, and premiums or discounts resulting from acquired loans are deferred and recognized over the lives of the related loans as a yield adjustment using the interest method.
Interest on loans is accrued to income based on the principal balance outstanding. The recognition of interest income is discontinued when a loan becomes 90 days past due or a significant deterioration in the borrower’s credit has occurred which, in management’s judgment, negatively impacts the collectibility of the loan. Unpaid interest on such loans is reversed at the time the loan becomes uncollectible and subsequent interest payments received are generally applied to principal if any doubt exists as to the collectibility of such principal. Loans that have not been restructured are returned to accrual status when management believes full collectibility of principal and interest is expected. Non-accrual loans that have been restructured will remain in a non-accrual status until the borrower has made at least six months of consecutive contractual payments.
PCI Loans
PCI loans are acquired in a business combination or transaction, that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable. PCI loans are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance. The difference between the undiscounted cash flows expected at acquisition and the investment in the loans, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loans. Contractually required payments for interest and principal that exceed the
75
undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” are not recognized as a yield adjustment or as a loss accrual or a valuation allowance. The Company aggregates individual loans with common risk characteristics into pools of loans. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loans over their remaining lives. Decreases in expected cash flows due to an inability to collect contractual cash flows are recognized as impairment through the provision for loan losses account. Any allowance for loan loss on these pools reflect only losses incurred after the acquisition. Disposals of loans, including sales of loans, paydowns, payments in full or foreclosures result in the removal or reduction of the loan from the loan pool.
PCI loans are generally considered accruing and performing, as the loans accrete income over the estimated life of the loan, in circumstances where cash flows are reasonably estimable by management. Accordingly, PCI loans that could be contractually past due could be considered to be accruing and performing. If the timing and amount of future cash flows is not reasonably estimable or is less than the carrying value, the loans may be classified as nonaccrual loans and the purchase price discount on those loans is not recorded as interest income until the timing and amount of future cash flows can be reasonably estimable.
Impaired Loans
Loans are considered “impaired” when it becomes probable that the Company will be unable to collect all amounts due according to the loan’s contractual terms. Non-accrual loans, loans past due greater than 90 days and still accruing, unless adequately secured and in the process of collection, and restructured loans qualify as “impaired loans.” Restructured loans involve the granting of a concession on the terms of a loan to a borrower experiencing financial difficulty. Concessions may be granted in various forms, including changes in payment schedule or interest rate.
When measuring impairment, the expected future cash flows of an impaired loan are discounted at the loan’s effective interest rate at origination. Alternatively, impairment can be measured by reference to an observable market price, if one exists, or the fair value of the collateral for a collateral-dependent loan. Loans and leases, which are deemed uncollectible, are charged off to the allowance for loan losses, while recoveries of amounts previously charged off are credited to the allowance for loan losses.
Impaired loans exclude PCI loans, as described above. Although, if the timing and amount of future cash flows is not reasonably estimable, the loans may be classified as nonaccrual loans and the purchase price discount on those loans is not recorded as interest income until the timing and amount of future cash flows can be reasonably estimated. See “Note 5 – Loans” for more information on these loans.
Loans are generally placed on non-accrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on non-accrual status immediately, rather than delaying such action until the loans become 90 days past due. Previously accrued and uncollected interest on such loans is reversed. Income is recorded only to the extent that a determination has been made that the principal balance of the loan is collectible and the interest payments are subsequently received in cash, or for a restructured loan, the borrower has made six consecutive contractual payments. If collectibility of the principal is in doubt, payments received are applied to loan principal.
Loans past due 90 days or more but still accruing interest are also generally included in nonperforming loans. Loans past due 90 days or more but still accruing are classified as such where the underlying loans are both well secured (the collateral value covers principal and accrued interest) and in the process of collection.
Loan Charge-Offs
Loans are charged-off when the primary and secondary sources of repayment (cash flow, collateral, guarantors, etc.) are less than their carrying value.
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Allowance for Loan Losses
The allowance for loan losses is increased by a provision for loan losses charged to expense and is available to absorb charge-offs, net of recoveries. Management utilizes a systematic, documented approach in determining the appropriate level of the allowance for loan losses. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; and probable losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a degree of subjectivity and requires that the Company make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses.
Management believes the allowance for loan losses is adequate to absorb inherent losses in the loan portfolio. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of the examination process, periodically review the Bank’s loan portfolio. Such agencies may require additions to the allowance for loan losses based on their judgments and interpretations of information available to them at the time of their examinations.
Allowance for Loan Losses on PCI Loans
The Company updates its cash flow projections for PCI loans on a periodic basis. Assumptions utilized in this process include projections related to probability of default, loss severity, prepayment, extensions and recovery lag. Projections related to probability of default and prepayment are calculated utilizing a loan migration analysis and management’s assessment of loss exposure including the fair value of underlying collateral. The loan migration analysis is a matrix that specifies the probability of a loan pool transitioning into a particular delinquency or liquidation state given its current performance at the measurement date. Loss severity factors are based upon industry data and historical experience.
Any decreases in expected cash flows after the acquisition date and subsequent measurement periods are recognized by recording an impairment in allowance for loan losses.
Other Real Estate
Other real estate represents property acquired through foreclosure or deeded to the Company in lieu of foreclosure on loans on which the borrowers have defaulted on the payment of principal or interest. Other real estate is recorded on an individual asset basis at the lower of cost or fair value less estimated costs to sell. The fair value of other real estate is based upon estimates of future cash flows, market value of similar assets, if available, or independent appraisals. These estimates involve significant uncertainties and judgments. As a result, fair value estimates may not be realizable in a current sale or settlement of the other real estate. Subsequent reductions in fair value are expensed within noninterest expense.
Gains and losses resulting from the sale of other real estate are credited or charged to current period earnings. Costs of maintaining and operating other real estate are expensed as incurred, and expenditures to complete or improve other real estate properties are capitalized if the expenditures are expected to be recovered upon ultimate sale of the property.
Fixed Assets
Buildings, leasehold improvements, furniture, fixtures, equipment, and capitalized software are stated at cost less accumulated depreciation. All categories are computed using the straight-line method over their respective estimated useful lives. Furniture, fixtures and equipment is depreciated over three to ten years, buildings and leasehold improvements over ten to forty years, and capitalized software over three years based upon estimated lives or lease obligation periods.
State Tax Credits
The Company has purchased the rights to receive 10-year streams of state tax credits at agreed upon discount rates and sells such tax credits to its clients and others. State tax credits are accounted for at cost. The Company is also a
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minority partner in a joint venture, accounted for as an equity method investment, that purchases state income tax credits for resale to customers. Income from both the sale of state tax credits and earnings from the joint venture are reported as tax credit income in the Consolidated Statements of Operations.
Cash Surrender Value of Life Insurance
The Company has purchased bank-owned life insurance policies on certain bank officers. Bank-owned life insurance is recorded at its cash surrender value. Changes in the cash surrender values, including death benefits in excess of the carrying amount, are included in noninterest income.
Federal Home Loan Bank Stock
The Bank, as a member of the FHLB, is required to maintain an investment in the capital stock of the FHLB. The stock is redeemable at par by the FHLB, and is, therefore, carried at cost and periodically evaluated for impairment. The Company records FHLB dividends in interest income.
Goodwill and Other Intangible Assets
The Company tests goodwill for impairment on an annual basis and whenever events or changes in circumstances indicate that the Company may not be able to recover the respective asset’s carrying amount. The Company’s annual test for impairment was performed in the fourth quarter of December 31, 2019. Such tests involve the use of estimates and assumptions. Core deposit intangibles are amortized using an accelerated method over an estimated useful life of approximately 10 years.
Potential impairments to goodwill must first be identified by performing a qualitative assessment which evaluates relevant events or circumstances to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If this test indicates it is more likely than not that goodwill has been impaired, then a quantitative impairment test is completed. The quantitative impairment test calculates the fair value of the reporting unit and compares it with its carrying amount, including goodwill. If the carrying amount of goodwill exceeds its implied fair market value, an impairment loss is recognized. That loss is equal to the carrying amount of goodwill that is in excess of its implied fair market value.
Impairment of Long-Lived Assets
Long-lived assets, such as fixed assets and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet.
Derivative Financial Instruments and Hedging Activities
The Company uses derivative financial instruments to assist in the management of interest rate sensitivity and to modify the repricing, maturity and option characteristics of certain assets and liabilities. In addition, the Company also offers an interest rate hedge program that includes interest rate swaps to assist its customers in managing their interest rate risk profile. In order to eliminate the interest rate risk associated with offering these products, the Company enters into derivative contracts with third parties to offset the customer contracts.
Derivative instruments are required to be measured at fair value and recognized as either assets or liabilities in the consolidated financial statements. Fair value represents the payment the Company would receive or pay if the item were sold or bought in a current transaction. The accounting for changes in fair value (gains or losses) of a hedged item is dependent on whether the related derivative is designated and qualifies for “hedge accounting.” The Company assigns derivatives to one of these categories at the purchase date: cash flow hedge, fair value hedge, or non-designated derivatives. An assessment of the expected and ongoing hedge effectiveness of any derivative designated a fair value hedge or cash flow hedge is performed as required by the accounting standards. Derivatives are included in other assets
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and other liabilities in the consolidated balance sheets. Generally, the only derivative instruments used by the Company have been interest rate swaps, forward currency contracts, and interest rate caps.
Certain derivative financial instruments are not designated as cash flow or as fair value hedges for accounting purposes. These non-designated derivatives are intended to provide interest rate protection on net interest income or noninterest income but do not meet hedge accounting treatment. Customer accommodation interest rate swap contracts are not designated as hedging instruments. Changes in the fair value of these instruments are recorded in interest income or noninterest income in the consolidated statements of income depending on the underlying hedged item.
Revenue
The Company adopted the accounting standard regarding revenue recognition in the first quarter of 2018 using the modified retrospective approach. The Company’s revenues are primarily composed of interest income on financial instruments, including investment securities, which are excluded from the scope of the new guidance. Certain other noninterest income from loans, investment securities and derivative financial instruments is also excluded from this guidance. Service charges on deposit accounts, wealth management revenue, card services revenue, and gain on sale of other real estate are within the scope of the guidance; however, there were no accounting policy changes as the Company’s policies were consistent with the new guidance. Other noninterest income sources of revenue are considered immaterial. Implementation of this guidance did not change current business practices or have any changes to the Company’s consolidated financial statements.
Descriptions of our revenue-generating activities within the scope of this guidance, which are presented in our income statement as components of noninterest income are as follows:
• | Service charges on deposit accounts - represents fees generated from a variety of deposit products and services provided to customers under a day-to-day contract. These fees are recognized on a daily or monthly basis. |
• | Wealth management revenue - represents monthly fees earned from directing, holding, and managing customers’ assets. Revenue is recognized over regular intervals, either monthly or quarterly. Incentive fees are only recognized when incurred. |
• | Card services revenue - represents revenue earned from merchant, debit and credit cards as incurred and includes a contra revenue account for rebates. |
• | Gain on sale of other real estate - represents income recognized at delivery of control of a property at the time of a real estate closing. |
Income Taxes
The Company and its subsidiaries file a consolidated federal income tax return. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. We evaluate the need for deferred tax asset valuation allowances based on a more-likely-than-not standard. The ability to realize deferred tax assets depends on the ability to generate sufficient positive taxable income within the carryback or carryforward periods provided for in the laws for each applicable taxing jurisdiction. We consider the following possible sources of taxable income: future reversal patterns of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences, taxable income in prior carryback years and the availability of qualified tax planning strategies. The assessment regarding whether a valuation allowance is required or should be adjusted depends on all available positive and negative factors including, but not limited to, nature, frequency, and severity of recent losses, duration of available carryforward periods, experience with tax attributes expiring unused and near and medium term financial outlook. Because of the complexity of tax laws and regulations, interpretation can be difficult and subject to legal judgment given specific facts and circumstances. It is possible that others, given the same information, may at any point in time reach different reasonable conclusions regarding the estimated amounts of accrued taxes.
Stock-Based Compensation
Stock-based compensation is recognized as an expense for stock options, restricted stock awards, performance stock units, and restricted stock units granted to employees, directors, and advisors in return for service. Equity classified
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awards are measured at the grant date fair value using either an observable market value or a valuation methodology, and recognized over the requisite service period on a straight-line basis. Forfeitures are recorded as they occur. A description of the Company’s stock-based employee compensation plan is described in “Note 16 - Stockholders’ Equity and Compensation Plans.”
Acquisitions and Divestitures
Acquisitions and business combinations are accounted for using the acquisition method of accounting. The assets and liabilities of the acquired entities have been recorded at their estimated fair values at the date of acquisition. Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including the amount assigned to identifiable intangible assets.
The purchase price allocation process requires an estimation of the fair values of the assets acquired and the liabilities assumed. When a business combination agreement provides for an adjustment to the cost of the combination contingent on future events, the Company includes an estimate of the acquisition-date fair value as part of the cost of the combination. To determine the fair values, the Company relies on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. The results of operations of the acquired business are included in the Company’s consolidated financial statements from the date of acquisition. Merger-related expenses include costs directly related to merger or acquisition activity and include legal and professional fees, system consolidation and conversion costs, and compensation costs such as severance and retention incentives for employees impacted by acquisition activity. The Company accounts for merger-related expenses in the periods in which the costs are incurred and the services are received.
For divestitures, the Company measures an asset (disposal group) classified as held for sale at the lower of its carrying value at the date the asset is initially classified as held for sale or its fair value less costs to sell. The Company reports the results of operations of an entity or group of components that either has been disposed of or held for sale as discontinued operations only if the disposal of that component represents a strategic shift that has or will have a major effect on an entity’s operations and financial results.
Any incremental direct costs incurred to transact the sale are allocated against the gain or loss on the sale. These costs would include items like legal fees, title transfer fees, broker fees, etc. Any goodwill and intangible assets associated with the portion of the reporting unit to be disposed of is included in the carrying amount of the business in determining the gain or loss on the sale.
Basic and Diluted Earnings Per Common Share
Basic earnings per common share data is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Common shares outstanding include common stock and restricted stock awards where recipients have satisfied the vesting terms. Diluted earnings per common share gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method.
Consolidated Statement of Comprehensive Income
The Consolidated Statement of Comprehensive Income includes the amount and the related tax impact that have been reclassified from accumulated other comprehensive income to net income. The classification adjustment for unrealized loss/gain on sale of securities included in net income has been recorded through the gain on sale of investment securities line item, within noninterest income, in the Company’s Consolidated Statements of Operations.
Reclassifications
Certain amounts reported in prior periods have been reclassified to conform to the current presentation. The reclassifications had no effect on net income or shareholders’ equity.
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NOTE 2 - ACQUISITIONS & DIVESTITURES
Acquisition of Trinity Capital Corporation.
On March 8, 2019, the Company closed its acquisition of 100% of Trinity and its wholly-owned subsidiary, LANB. Trinity operated six full-service retail and commercial banking offices in Los Alamos, Santa Fe, and Albuquerque, New Mexico.
Trinity shareholders received cash consideration of $1.84 per share of Trinity common stock and 0.1972 shares of EFSC common stock per share of Trinity common stock with cash in lieu of fractional shares. Aggregate consideration at closing was approximately 4.0 million shares of EFSC common stock and $37.3 million cash paid to Trinity shareholders. Based on EFSC’s closing stock price of $43.07 on March 7, 2019, the overall transaction had a value of $209.2 million. The Company recognized $18.0 million and $1.3 million of merger-related costs recorded in noninterest expense in the statement of operations for the years ended December 31, 2019 and 2018, respectively.
The acquisition of Trinity has been accounted for as a business combination using the acquisition method of accounting which requires assets acquired and liabilities assumed to be recognized at fair value as of the acquisition date. Goodwill of $93.0 million arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of Trinity into Enterprise. None of the goodwill recognized is expected to be deductible for income tax purposes.
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The following table presents the assets acquired and liabilities assumed of Trinity as of March 8, 2019. Additional adjustments may be recorded during the measurement period specified in ASC 805, Business Combinations, as additional information becomes known.
($ in thousands) | As Recorded by Trinity | Adjustments | As Recorded by EFSC | ||||||||
Assets acquired: | |||||||||||
Cash and cash equivalents | $ | 13,899 | $ | — | $ | 13,899 | |||||
Interest-earning deposits greater than 90 days | 100 | — | 100 | ||||||||
Securities | 428,715 | (619 | ) | (a) | 428,096 | ||||||
Loans | 705,057 | (20,743 | ) | (b) | 684,314 | ||||||
Other real estate | 5,284 | (2,059 | ) | (c) | 3,225 | ||||||
Other investments | 6,673 | — | 6,673 | ||||||||
Fixed assets | 27,586 | (300 | ) | (d) | 27,286 | ||||||
Accrued interest receivable | 3,997 | — | 3,997 | ||||||||
Intangible assets | — | 23,066 | (e) | 23,066 | |||||||
Deferred tax assets | 10,708 | (2,386 | ) | (f) | 8,322 | ||||||
Other assets | 35,045 | (1,484 | ) | (g) | 33,561 | ||||||
Total assets acquired | $ | 1,237,064 | $ | (4,525 | ) | $ | 1,232,539 | ||||
Liabilities assumed: | |||||||||||
Deposits | $ | 1,081,151 | $ | 36 | (h) | $ | 1,081,187 | ||||
Subordinated debentures | 26,806 | (3,972 | ) | (i) | 22,834 | ||||||
FHLB advances | 6,800 | 171 | (j) | 6,971 | |||||||
Accrued interest payable | 370 | — | 370 | ||||||||
Other liabilities | 5,842 | (827 | ) | (k) | 5,015 | ||||||
Total liabilities assumed | $ | 1,120,969 | $ | (4,592 | ) | $ | 1,116,377 | ||||
Net assets acquired | $ | 116,095 | $ | 67 | $ | 116,162 | |||||
Consideration paid: | |||||||||||
Cash | $ | 37,275 | |||||||||
Common stock | 171,885 | ||||||||||
Total consideration paid | $ | 209,160 | |||||||||
Goodwill | $ | 92,998 | |||||||||
(a)Fair value adjustments of the securities portfolio.
(b) | Fair value adjustments based on the Company’s evaluation of the acquired loan portfolio, write-off of net deferred loan costs and elimination of the allowance for loan losses recorded by Trinity. |
(c) | Fair value adjustment based on the Company’s evaluation of the acquired other real estate portfolio. |
(d) | Fair value adjustments based on the Company’s evaluation of the acquired premises and equipment. |
(e) | Record the core deposit intangible asset on the acquired core deposit accounts. Amount to be amortized using a sum of years digits method over a useful life of 10 years. |
(f) | Adjustment for deferred taxes. |
(g) | Fair value adjustment of other assets. |
(h) | Fair value adjustment to time deposits. |
(i) | Fair value adjustment to the trust preferred securities. |
(j) | Fair value adjustment to the FHLB borrowings. |
(k) | Fair value adjustment of other liabilities. |
The following table provides the unaudited pro forma information for the results of operations for the twelve months ended December 31, 2019 and 2018, as if the acquisition had occurred on January 1, 2018. The pro forma results combine the historical results of Trinity with the Company’s Consolidated Statements of Income, adjusted for the impact of the application of the acquisition method of accounting including loan discount accretion, intangible assets
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amortization, and deposit and trust preferred securities premium accretion, net of taxes. The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisition actually occurred on January 1, 2018. No assumptions have been applied to the pro forma results of operations regarding possible revenue enhancements, expense efficiencies or asset dispositions. Only the acquisition-related expenses that have been incurred as of December 31, 2019 are included in net income in the table below.
Pro Forma | |||||||
Twelve months ended December 31, | |||||||
($ in thousands, except per share data) | 2019 | 2018 | |||||
Total revenues (net interest income plus noninterest income) | $ | 296,677 | $ | 286,076 | |||
Net income | 107,626 | 85,579 | |||||
Diluted earnings per common share | 4.11 | 3.14 | |||||
Acquisition of Jefferson County Bancshares, Inc.
On February 10, 2017, the Company closed its acquisition of 100% of JCB and its wholly-owned subsidiary, Eagle Bank and Trust Company of Missouri. JCB operated 13 full service retail and commercial banking offices in the metropolitan St. Louis area and one in Perry County, Missouri.
JCB shareholders received, based on their election, cash consideration in an amount of $85.39 per share of JCB common stock or 2.75 shares of EFSC common stock per share of JCB common stock, subject to allocation and proration procedures. Aggregate consideration at closing was 3.3 million shares of EFSC common stock and $29.3 million cash paid to JCB shareholders and holders of JCB stock options. Based on EFSC’s closing stock price of $42.95 on February 10, 2017, the overall transaction had a value of $171.0 million, including JCB’s common stock and stock options. The Company also recognized $6.5 million of merger-related costs that were recorded in noninterest expense in the statement of operations for the year ended December 31, 2017.
NOTE 3 - EARNINGS PER SHARE
The following table presents a summary of earnings per common share data and amounts for the periods indicated.
Year ended December 31, | |||||||||||
($ in thousands, except per share data) | 2019 | 2018 | 2017 | ||||||||
Net income as reported | $ | 92,739 | $ | 89,217 | $ | 48,190 | |||||
Weighted average common shares outstanding | 26,045 | 23,100 | 22,953 | ||||||||
Additional dilutive common stock equivalents | 114 | 189 | 296 | ||||||||
Weighted average diluted common shares outstanding | 26,159 | 23,289 | 23,249 | ||||||||
Basic earnings per common share: | $ | 3.56 | $ | 3.86 | $ | 2.10 | |||||
Diluted earnings per common share: | $ | 3.55 | $ | 3.83 | $ | 2.07 | |||||
For 2019, common stock equivalents of approximately 21,000 were excluded from the earnings per share calculation because their effect would have been anti-dilutive. For 2018 and 2017, the amounts were immaterial.
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NOTE 4 - INVESTMENTS
The following table presents the amortized cost, gross unrealized gains and losses and fair value of securities available-for-sale and held-to-maturity:
December 31, 2019 | |||||||||||||||
($ in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||
Available-for-sale securities: | |||||||||||||||
Obligations of U.S. Government-sponsored enterprises | $ | 9,954 | $ | 92 | $ | — | $ | 10,046 | |||||||
Obligations of states and political subdivisions | 207,269 | 6,118 | (363 | ) | 213,024 | ||||||||||
Agency mortgage-backed securities | 888,129 | 15,083 | (1,191 | ) | 902,021 | ||||||||||
U.S. Treasury Bills | 9,971 | 255 | — | 10,226 | |||||||||||
Total securities available-for-sale | $ | 1,115,323 | $ | 21,548 | $ | (1,554 | ) | $ | 1,135,317 | ||||||
Held-to-maturity securities: | |||||||||||||||
Obligations of states and political subdivisions | $ | 11,704 | $ | 170 | $ | — | $ | 11,874 | |||||||
Agency mortgage-backed securities | 46,346 | 675 | — | 47,021 | |||||||||||
Corporate debt securities | 123,116 | 128 | (200 | ) | 123,044 | ||||||||||
Total securities held-to-maturity | $ | 181,166 | $ | 973 | $ | (200 | ) | $ | 181,939 | ||||||
December 31, 2018 | |||||||||||||||
($ in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||
Available-for-sale securities: | |||||||||||||||
Obligations of U.S. Government-sponsored enterprises | $ | 99,926 | $ | — | $ | (1,428 | ) | $ | 98,498 | ||||||
Obligations of states and political subdivisions | 26,566 | 327 | (83 | ) | 26,810 | ||||||||||
Agency mortgage-backed securities | 596,825 | 1,160 | (11,849 | ) | 586,136 | ||||||||||
U.S. Treasury Bills | 9,962 | — | (37 | ) | 9,925 | ||||||||||
Total securities available-for-sale | $ | 733,279 | $ | 1,487 | $ | (13,397 | ) | $ | 721,369 | ||||||
Held-to-maturity securities: | |||||||||||||||
Obligations of states and political subdivisions | $ | 12,506 | $ | 16 | $ | (114 | ) | $ | 12,408 | ||||||
Agency mortgage-backed securities | 53,173 | — | (1,647 | ) | 51,526 | ||||||||||
Total securities held-to-maturity | $ | 65,679 | $ | 16 | $ | (1,761 | ) | $ | 63,934 | ||||||
During the fourth quarter of 2019, the Company transferred corporate debt securities with a book value of $116.3 million and fair value of $123.2 million from available to sale to held-to-maturity. The Company believes the held-to-maturity category is more consistent with the Company’s intent for these securities. The transfer of securities was made at fair value at the time of transfer. The unamortized portion of the $6.9 million unrealized holding gain at the time of transfer is retained in accumulated other comprehensive income and in the carrying value of held-to-maturity securities. Accordingly, the balance of held-to-maturity securities in the “Amortized cost” column in the table above includes a net unamortized unrealized gain of $6.8 million at December 31, 2019. Such amounts are amortized over the remaining life of the securities.
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At December 31, 2019, and 2018, there were no holdings of securities of any one issuer in an amount greater than 10% of shareholders’ equity, other than the U.S. Government agencies and sponsored enterprises. The agency mortgage-backed securities are all issued by U.S. Government-sponsored enterprises. Securities having a fair value of $484.8 million and $433.7 million at December 31, 2019, and December 31, 2018, respectively, were pledged as collateral to secure deposits of public institutions and for other purposes as required by law or contract provisions.
The amortized cost and estimated fair value of debt securities at December 31, 2019, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The weighted average life of the agency mortgage-backed securities is approximately 4 years.
Available-for-sale | Held-to-maturity | ||||||||||||||
($ in thousands) | Amortized Cost | Estimated Fair Value | Amortized Cost | Estimated Fair Value | |||||||||||
Due in one year or less | $ | 959 | $ | 978 | $ | — | $ | — | |||||||
Due after one year through five years | 26,825 | 27,355 | 4,167 | 4,234 | |||||||||||
Due after five years through ten years | 8,646 | 8,945 | 130,653 | 130,684 | |||||||||||
Due after ten years | 190,764 | 196,018 | — | — | |||||||||||
Agency mortgage-backed securities | 888,129 | 902,021 | 46,346 | 47,021 | |||||||||||
$ | 1,115,323 | $ | 1,135,317 | $ | 181,166 | $ | 181,939 | ||||||||
The Company owned 73 and 131 securities that were in a loss position as of December 31, 2019 and December 31, 2018, respectively. The following table represents a summary of investment securities that had an unrealized loss:
December 31, 2019 | |||||||||||||||||||||||
Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
($ in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||
Obligations of states and political subdivisions | $ | 56,327 | $ | 363 | $ | — | $ | — | $ | 56,327 | $ | 363 | |||||||||||
Agency mortgage-backed securities | 131,693 | 756 | 41,491 | 435 | 173,184 | 1,191 | |||||||||||||||||
Corporate debt securities | 67,964 | 200 | — | — | 67,964 | 200 | |||||||||||||||||
$ | 255,984 | $ | 1,319 | $ | 41,491 | $ | 435 | $ | 297,475 | $ | 1,754 | ||||||||||||
December 31, 2018 | |||||||||||||||||||||||
Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
($ in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||
Obligations of U.S. Government-sponsored enterprises | $ | 19,622 | $ | 322 | $ | 78,876 | $ | 1,106 | $ | 98,498 | $ | 1,428 | |||||||||||
Obligations of states and political subdivisions | 3,102 | 15 | 14,156 | 182 | 17,258 | 197 | |||||||||||||||||
Agency mortgage-backed securities | 87,357 | 2,211 | 389,770 | 11,285 | 477,127 | 13,496 | |||||||||||||||||
U.S. Treasury Bills | — | — | 9,925 | 37 | 9,925 | 37 | |||||||||||||||||
$ | 110,081 | $ | 2,548 | $ | 492,727 | $ | 12,610 | $ | 602,808 | $ | 15,158 | ||||||||||||
The unrealized losses at both December 31, 2019, and 2018, were primarily attributable to changes in market interest rates since the securities were purchased. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include among other considerations (1) the present value of the cash flows expected to be collected compared to the amortized cost of the security, (2) duration and magnitude of the decline in value, (3) the financial condition of the issuer or issuers, (4) structure of the security, and (5) the intent to sell the security or whether it is more likely than
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not that the Company would be required to sell the security before its anticipated recovery in market value. At December 31, 2019 and 2018, management performed its quarterly analysis of all securities with an unrealized loss and concluded no individual securities were other-than-temporarily impaired.
The gross gains and losses realized from sales of available-for-sale investment securities were as follows:
December 31, | |||||||||||
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Gross gains realized | $ | 400 | $ | 9 | $ | 22 | |||||
Gross losses realized | (449 | ) | — | — | |||||||
Proceeds from sales | 357,976 | 1,451 | 144,076 | ||||||||
Other Investments
At both December 31, 2019, and 2018, other investments totaled $38.0 million. As a member of the FHLB system administered by the Federal Housing Finance Agency, the Bank is required to maintain a minimum investment in capital stock with the FHLB Des Moines and the FHLB Dallas consisting of membership stock and activity-based stock. The FHLB capital stock of $15.7 million, and $9.2 million at December 31, 2019, and 2018, respectively, is recorded at cost, which represents redemption value, and is included in other investments in the consolidated balance sheets. The remaining amounts in other investments primarily include various investments in SBICs and the Company’s investment in unconsolidated trusts used to issue preferred securities to third parties, see “Note 11 – Subordinated Debentures.”
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NOTE 5 - LOANS
The loan portfolio is comprised of loans originated by the Company and loans that were acquired in connection with the Company’s acquisitions. Loans are accounted for using the guidance in the ASC sections 310-30 and 310-20. Loans accounted for using ASC 310-30 are sometimes referred to as purchased credit impaired, or PCI, loans.
The table below shows the loan portfolio composition including carrying value by segment of loans accounted for at amortized cost, which includes originated loans, and loans accounted for as PCI.
($ in thousands) | December 31, 2019 | December 31, 2018 | |||||
Loans accounted for at amortized cost | $ | 5,224,048 | $ | 4,303,600 | |||
Loans accounted for as PCI | 90,289 | 46,401 | |||||
Total loans | $ | 5,314,337 | $ | 4,350,001 | |||
The following tables refer to loans accounted for at amortized cost.
Below is a summary of loans by category at December 31, 2019 and 2018:
($ in thousands) | December 31, 2019 | December 31, 2018 | |||||
Commercial and industrial | $ | 2,345,823 | $ | 2,121,008 | |||
Real estate loans: | |||||||
Commercial - investor owned | 1,262,981 | 843,728 | |||||
Commercial - owner occupied | 678,522 | 604,498 | |||||
Construction and land development | 449,380 | 330,097 | |||||
Residential | 355,192 | 298,944 | |||||
Total real estate loans | 2,746,075 | 2,077,267 | |||||
Consumer and other | 134,766 | 107,351 | |||||
Loans, before unearned loan fees | 5,226,664 | 4,305,626 | |||||
Unearned loan fees, net | (2,616 | ) | (2,026 | ) | |||
Loans, including unearned loan fees | $ | 5,224,048 | $ | 4,303,600 | |||
Following is a summary of activity for the years ended December 31, 2019, 2018, and 2017 of loans to executive officers and directors, or to entities in which such individuals had beneficial interests as a shareholder, officer, or director. Such loans were made in the normal course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other customers and did not involve more than the normal risk of collectibility.
($ in thousands) | December 31, 2019 | December 31, 2018 | December 31, 2017 | ||||||||
Balance at beginning of year | $ | 17,169 | $ | 5,349 | $ | 15,406 | |||||
New loans and advances | 1,376 | 13,995 | 1,353 | ||||||||
Payments and other reductions | (13,070 | ) | (2,175 | ) | (11,410 | ) | |||||
Balance at end of year | $ | 5,475 | $ | 17,169 | $ | 5,349 | |||||
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A summary of activity in the allowance for loan losses and the recorded investment in loans by class and category based on impairment method for the years ended indicated below is as follows:
($ in thousands) | Commercial and industrial | CRE - investor owned | CRE - owner occupied | Construction and land development | Residential real estate | Consumer and other | Total | ||||||||||||||||||||
Balance at December 31, 2019 | |||||||||||||||||||||||||||
Allowance for loan losses: | |||||||||||||||||||||||||||
Balance, beginning of year | $ | 29,039 | $ | 4,683 | $ | 4,239 | $ | 1,987 | $ | 1,616 | $ | 731 | $ | 42,295 | |||||||||||||
Provision for loan losses | 4,801 | 1,708 | 673 | (237 | ) | (330 | ) | 67 | 6,682 | ||||||||||||||||||
Charge-offs | (6,882 | ) | (551 | ) | (58 | ) | (54 | ) | (667 | ) | (382 | ) | (8,594 | ) | |||||||||||||
Recoveries | 338 | 95 | 19 | 776 | 661 | 295 | 2,184 | ||||||||||||||||||||
Balance, end of year | $ | 27,296 | $ | 5,935 | $ | 4,873 | $ | 2,472 | $ | 1,280 | $ | 711 | $ | 42,567 | |||||||||||||
Balance at December 31, 2018 | |||||||||||||||||||||||||||
Allowance for loan losses: | |||||||||||||||||||||||||||
Balance, beginning of year | $ | 26,406 | $ | 3,890 | $ | 3,308 | $ | 1,487 | $ | 2,237 | $ | 838 | $ | 38,166 | |||||||||||||
Provision for loan losses | 8,394 | 709 | 1,216 | 97 | (583 | ) | (20 | ) | 9,813 | ||||||||||||||||||
Charge-offs | (6,894 | ) | — | (313 | ) | (56 | ) | (546 | ) | (167 | ) | (7,976 | ) | ||||||||||||||
Recoveries | 1,133 | 84 | 28 | 459 | 508 | 80 | 2,292 | ||||||||||||||||||||
Balance, end of year | $ | 29,039 | $ | 4,683 | $ | 4,239 | $ | 1,987 | $ | 1,616 | $ | 731 | $ | 42,295 | |||||||||||||
Balance at December 31, 2017 | |||||||||||||||||||||||||||
Allowance for loan losses: | |||||||||||||||||||||||||||
Balance, beginning of year | $ | 26,996 | $ | 3,420 | $ | 2,890 | $ | 1,304 | $ | 2,023 | $ | 932 | $ | 37,565 | |||||||||||||
Provision for loan losses | 8,737 | 456 | 404 | 336 | 797 | 34 | 10,764 | ||||||||||||||||||||
Charge-offs | (9,872 | ) | (117 | ) | (90 | ) | (254 | ) | (973 | ) | (201 | ) | (11,507 | ) | |||||||||||||
Recoveries | 545 | 131 | 104 | 101 | 390 | 73 | 1,344 | ||||||||||||||||||||
Balance, end of year | $ | 26,406 | $ | 3,890 | $ | 3,308 | $ | 1,487 | $ | 2,237 | $ | 838 | $ | 38,166 | |||||||||||||
($ in thousands) | Commercial and industrial | CRE - investor owned | CRE - owner occupied | Construction and land development | Residential real estate | Consumer and other | Total | ||||||||||||||||||||
Balance December 31, 2019 | |||||||||||||||||||||||||||
Allowance for loan losses - Ending balance: | |||||||||||||||||||||||||||
Individually evaluated for impairment | $ | 2,286 | $ | 247 | $ | — | $ | — | $ | 33 | $ | 1 | $ | 2,567 | |||||||||||||
Collectively evaluated for impairment | 25,010 | 5,688 | 4,873 | 2,472 | 1,247 | 710 | 40,000 | ||||||||||||||||||||
Total | $ | 27,296 | $ | 5,935 | $ | 4,873 | $ | 2,472 | $ | 1,280 | $ | 711 | $ | 42,567 | |||||||||||||
Loans - Ending balance: | |||||||||||||||||||||||||||
Individually evaluated for impairment | $ | 22,578 | $ | 2,303 | $ | 1,373 | $ | — | $ | 1,330 | $ | 1 | $ | 27,585 | |||||||||||||
Collectively evaluated for impairment | 2,323,245 | 1,260,678 | 677,149 | 449,380 | 353,862 | 132,149 | 5,196,463 | ||||||||||||||||||||
Total | $ | 2,345,823 | $ | 1,262,981 | $ | 678,522 | $ | 449,380 | $ | 355,192 | $ | 132,150 | $ | 5,224,048 | |||||||||||||
Balance December 31, 2018 | |||||||||||||||||||||||||||
Allowance for loan losses - Ending balance: | |||||||||||||||||||||||||||
Individually evaluated for impairment | $ | 4,266 | $ | — | $ | 109 | $ | — | $ | 52 | $ | 26 | $ | 4,453 | |||||||||||||
Collectively evaluated for impairment | 24,773 | 4,683 | 4,130 | 1,987 | 1,564 | 705 | 37,842 | ||||||||||||||||||||
Total | $ | 29,039 | $ | 4,683 | $ | 4,239 | $ | 1,987 | $ | 1,616 | $ | 731 | $ | 42,295 | |||||||||||||
Loans - Ending balance: | |||||||||||||||||||||||||||
Individually evaluated for impairment | $ | 12,950 | $ | 398 | $ | 2,135 | $ | — | $ | 2,277 | $ | 311 | $ | 18,071 | |||||||||||||
Collectively evaluated for impairment | 2,108,058 | 843,330 | 602,363 | 330,097 | 296,667 | 105,014 | 4,285,529 | ||||||||||||||||||||
Total | $ | 2,121,008 | $ | 843,728 | $ | 604,498 | $ | 330,097 | $ | 298,944 | $ | 105,325 | $ | 4,303,600 | |||||||||||||
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A summary of nonperforming loans individually evaluated for impairment by category at December 31, 2019 and 2018, and the income recognized on impaired loans is as follows:
December 31, 2019 | |||||||||||||||||||||||
($ in thousands) | Unpaid Contractual Principal Balance | Recorded Investment With No Allowance | Recorded Investment With Allowance | Total Recorded Investment | Related Allowance | Average Recorded Investment | |||||||||||||||||
Commercial and industrial | $ | 36,223 | $ | 7,654 | $ | 14,924 | $ | 22,578 | $ | 2,286 | $ | 25,423 | |||||||||||
Real estate: | |||||||||||||||||||||||
Commercial - investor owned | 2,988 | 811 | 1,492 | 2,303 | 247 | 2,457 | |||||||||||||||||
Commercial - owner occupied | 237 | 213 | — | 213 | — | 231 | |||||||||||||||||
Residential | 1,464 | 1,120 | 210 | 1,330 | 33 | 1,428 | |||||||||||||||||
Consumer and other | 1 | — | 1 | 1 | 1 | 1 | |||||||||||||||||
Total | $ | 40,913 | $ | 9,798 | $ | 16,627 | $ | 26,425 | $ | 2,567 | $ | 29,540 | |||||||||||
December 31, 2018 | |||||||||||||||||||||||
($ in thousands) | Unpaid Contractual Principal Balance | Recorded Investment With No Allowance | Recorded Investment With Allowance | Total Recorded Investment | Related Allowance | Average Recorded Investment | |||||||||||||||||
Commercial and industrial | $ | 21,893 | $ | 3,294 | $ | 9,656 | $ | 12,950 | $ | 4,266 | $ | 13,827 | |||||||||||
Real estate: | |||||||||||||||||||||||
Commercial - investor owned | 553 | 398 | — | 398 | — | 277 | |||||||||||||||||
Commercial - owner occupied | 847 | 472 | 336 | 808 | 109 | 691 | |||||||||||||||||
Residential | 2,425 | 1,659 | 618 | 2,277 | 52 | 778 | |||||||||||||||||
Consumer and other | 329 | — | 312 | 312 | 26 | — | |||||||||||||||||
Total | $ | 26,047 | $ | 5,823 | $ | 10,922 | $ | 16,745 | $ | 4,453 | $ | 15,573 | |||||||||||
December 31, | |||||||||||
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Total interest income that would have been recognized under original terms on impaired loans | $ | 1,137 | $ | 2,153 | $ | 1,324 | |||||
Total cash received and recognized as interest income on impaired loans | 307 | 284 | 643 | ||||||||
Total interest income recognized on impaired loans still accruing | 116 | 149 | 63 | ||||||||
Average balance of impaired loans | 29,540 | 15,573 | 19,722 | ||||||||
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The recorded investment in nonperforming loans by category at December 31, 2019 and 2018 is as follows:
December 31, 2019 | |||||||||||||||
($ in thousands) | Non-accrual | Restructured, not on non-accrual | Loans over 90 days past due and still accruing interest | Total | |||||||||||
Commercial and industrial | $ | 22,328 | $ | — | $ | 250 | $ | 22,578 | |||||||
Real estate: | |||||||||||||||
Commercial - investor owned | 2,303 | — | — | 2,303 | |||||||||||
Commercial - owner occupied | 213 | — | — | 213 | |||||||||||
Residential | 1,251 | 79 | — | 1,330 | |||||||||||
Consumer and other | 1 | — | — | 1 | |||||||||||
Total | $ | 26,096 | $ | 79 | $ | 250 | $ | 26,425 | |||||||
December 31, 2018 | |||||||||||
($ in thousands) | Non-accrual | Restructured, not on non-accrual | Total | ||||||||
Commercial and industrial | $ | 12,805 | $ | 145 | $ | 12,950 | |||||
Real estate: | |||||||||||
Commercial - investor owned | 398 | — | 398 | ||||||||
Commercial - owner occupied | 808 | — | 808 | ||||||||
Residential | 2,197 | 80 | 2,277 | ||||||||
Consumer and other | 312 | — | 312 | ||||||||
Total | $ | 16,520 | $ | 225 | $ | 16,745 | |||||
The recorded investment by category for loans restructured during the years ended December 31, 2019 and 2018 is as follows:
Year ended December 31, 2019 | Year ended December 31, 2018 | ||||||||||||||||||||
($ in thousands, except for number of loans) | Number of Loans | Pre-Modification Outstanding Recorded Balance | Post-Modification Outstanding Recorded Balance | Number of Loans | Pre-Modification Outstanding Recorded Balance | Post-Modification Outstanding Recorded Balance | |||||||||||||||
Commercial and industrial | — | $ | — | $ | — | 1 | $ | 187 | $ | 187 | |||||||||||
Real estate: | |||||||||||||||||||||
Commercial - owner occupied | 1 | 188 | 188 | — | — | — | |||||||||||||||
Residential | 2 | 332 | 332 | 1 | 80 | 80 | |||||||||||||||
Total | 3 | $ | 520 | $ | 520 | 2 | $ | 267 | $ | 267 | |||||||||||
Restructured loans primarily resulted from interest rate concessions. As of December 31, 2019, the Company allocated an immaterial amount in specific reserves to loans that have been restructured.
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Loans restructured that subsequently defaulted during the year ended December 31, 2019, and 2018 are as follows:
Year ended December 31, 2019 | Year ended December 31, 2018 | ||||||||||||
($ in thousands, except for number of loans) | Number of Loans | Recorded Balance | Number of Loans | Recorded Balance | |||||||||
Commercial and industrial | 2 | $ | 352 | — | $ | — | |||||||
Total | 2 | $ | 352 | — | $ | — | |||||||
The aging of the recorded investment in past due loans by class and category at December 31, 2019 and 2018 is shown below:
December 31, 2019 | |||||||||||||||||||
($ in thousands) | 30-89 Days Past Due | 90 or More Days Past Due | Total Past Due | Current | Total | ||||||||||||||
Commercial and industrial | $ | 5,679 | $ | 8,212 | $ | 13,891 | $ | 2,331,932 | $ | 2,345,823 | |||||||||
Real estate: | |||||||||||||||||||
Commercial - investor owned | 321 | 1,492 | 1,813 | 1,261,168 | 1,262,981 | ||||||||||||||
Commercial - owner occupied | 562 | 213 | 775 | 677,747 | 678,522 | ||||||||||||||
Construction and land development | 308 | — | 308 | 449,072 | 449,380 | ||||||||||||||
Residential | 4,689 | 595 | 5,284 | 349,908 | 355,192 | ||||||||||||||
Consumer and other | 81 | — | 81 | 132,069 | 132,150 | ||||||||||||||
Total | $ | 11,640 | $ | 10,512 | $ | 22,152 | $ | 5,201,896 | $ | 5,224,048 | |||||||||
December 31, 2018 | |||||||||||||||||||
($ in thousands) | 30-89 Days Past Due | 90 or More Days Past Due | Total Past Due | Current | Total | ||||||||||||||
Commercial and industrial | $ | 66 | $ | 10,257 | $ | 10,323 | $ | 2,110,685 | $ | 2,121,008 | |||||||||
Real estate: | |||||||||||||||||||
Commercial - investor owned | 529 | 127 | 656 | 843,072 | 843,728 | ||||||||||||||
Commercial - owner occupied | 292 | 565 | 857 | 603,641 | 604,498 | ||||||||||||||
Construction and land development | 6 | — | 6 | 330,091 | 330,097 | ||||||||||||||
Residential | 709 | 897 | 1,606 | 297,338 | 298,944 | ||||||||||||||
Consumer and other | — | 312 | 312 | 105,013 | 105,325 | ||||||||||||||
Total | $ | 1,602 | $ | 12,158 | $ | 13,760 | $ | 4,289,840 | $ | 4,303,600 | |||||||||
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, and current economic factors among other factors. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:
• | Grades 1, 2, and 3 – Includes loans to borrowers with a continuous record of strong earnings, sound balance sheet condition and capitalization, ample liquidity with solid cash flow, and whose management team has experience and depth within their industry. |
• | Grade 4 – Includes loans to borrowers with positive trends in profitability, satisfactory capitalization and balance sheet condition, and sufficient liquidity and cash flow. |
• | Grade 5 – Includes loans to borrowers that may display fluctuating trends in sales, profitability, capitalization, liquidity, and cash flow. |
• | Grade 6 – Includes loans to borrowers where an adverse change or perceived weakness has occurred, but may be correctable in the near future. Alternatively, this rating category may also include circumstances where the borrower is starting to reverse a negative trend or condition, or has recently been upgraded from a 7, 8, or 9 rating. |
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• | Grade 7 – Watch credits are borrowers that have experienced financial setback of a nature that is not determined to be severe or influence ‘ongoing concern’ expectations. Although possible, no loss is anticipated, due to strong collateral and/or guarantor support. |
• | Grade 8 – Substandard credits will include those borrowers characterized by significant losses and sustained downward trends in balance sheet condition, liquidity, and cash flow. Repayment reliance may have shifted to secondary sources. Collateral exposure may exist and additional reserves may be warranted. |
• | Grade 9 – Doubtful credits include borrowers that may show deteriorating trends that are unlikely to be corrected. Collateral values may appear insufficient for full recovery, therefore requiring a partial charge-off, or debt renegotiation with the borrower. The borrower may have declared bankruptcy or bankruptcy is likely in the near term. All doubtful rated credits will be on non-accrual. |
The recorded investment by risk category of the loans by class and category at December 31, 2019 and December 31, 2018 is as follows:
December 31, 2019 | |||||||||||||||
($ in thousands) | Pass (1-6) | Watch (7) | Classified (8 & 9) | Total | |||||||||||
Commercial and industrial | $ | 2,151,084 | $ | 124,718 | $ | 70,021 | $ | 2,345,823 | |||||||
Real estate: | |||||||||||||||
Commercial - investor owned | 1,242,569 | 17,572 | 2,840 | 1,262,981 | |||||||||||
Commercial - owner occupied | 643,276 | 28,773 | 6,473 | 678,522 | |||||||||||
Construction and land development | 437,134 | 12,140 | 106 | 449,380 | |||||||||||
Residential | 348,246 | 4,450 | 2,496 | 355,192 | |||||||||||
Consumer and other | 132,096 | 3 | 51 | 132,150 | |||||||||||
Total | $ | 4,954,405 | $ | 187,656 | $ | 81,987 | $ | 5,224,048 | |||||||
December 31, 2018 | |||||||||||||||
($ in thousands) | Pass (1-6) | Watch (7) | Classified (8 & 9) | Total | |||||||||||
Commercial and industrial | $ | 1,927,782 | $ | 146,033 | $ | 47,193 | $ | 2,121,008 | |||||||
Real estate: | |||||||||||||||
Commercial - investor owned | 823,128 | 15,083 | 5,517 | 843,728 | |||||||||||
Commercial - owner occupied | 563,003 | 31,834 | 9,661 | 604,498 | |||||||||||
Construction and land development | 318,451 | 11,580 | 66 | 330,097 | |||||||||||
Residential | 287,802 | 4,232 | 6,910 | 298,944 | |||||||||||
Consumer and other | 105,007 | 6 | 312 | 105,325 | |||||||||||
Total | $ | 4,025,173 | $ | 208,768 | $ | 69,659 | $ | 4,303,600 | |||||||
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Below is a summary of PCI loans by category at December 31, 2019 and 2018:
December 31, 2019 | December 31, 2018 | ||||||||
($ in thousands) | Weighted- Average Risk Rating1 | Recorded Investment PCI Loans | Weighted- Average Risk Rating1 | Recorded Investment PCI Loans | |||||
Commercial and industrial | 5.65 | $ | 15,334 | 6.09 | $ | 2,159 | |||
Real estate loans: | |||||||||
Commercial - investor owned | 7.02 | 36,903 | 7.19 | 23,939 | |||||
Commercial - owner occupied | 6.54 | 18,915 | 7.39 | 9,669 | |||||
Construction and land development | 5.82 | 7,893 | 6.03 | 4,548 | |||||
Residential | 6.34 | 11,069 | 6.40 | 6,082 | |||||
Total real estate loans | 74,780 | 44,238 | |||||||
Consumer and other | 5.10 | 175 | 2.18 | 4 | |||||
Purchased credit impaired loans | $ | 90,289 | $ | 46,401 | |||||
(1) Risk ratings are based on the borrower’s contractual obligation, which is not reflective of the purchase discount. | |||||||||
The aging of the recorded investment in past due PCI loans by portfolio class and category at December 31, 2019 and 2018 is shown below:
December 31, 2019 | |||||||||||||||||||
($ in thousands) | 30-89 Days Past Due | 90 or More Days Past Due | Total Past Due | Current | Total | ||||||||||||||
Commercial and industrial | $ | — | $ | 356 | $ | 356 | $ | 14,978 | $ | 15,334 | |||||||||
Real estate: | |||||||||||||||||||
Commercial - investor owned | 1,250 | 1,340 | 2,590 | 34,313 | 36,903 | ||||||||||||||
Commercial - owner occupied | — | 434 | 434 | 18,481 | 18,915 | ||||||||||||||
Construction and land development | — | 217 | 217 | 7,676 | 7,893 | ||||||||||||||
Residential | 791 | 992 | 1,783 | 9,286 | 11,069 | ||||||||||||||
Consumer and other | — | — | — | 175 | 175 | ||||||||||||||
Total | $ | 2,041 | $ | 3,339 | $ | 5,380 | $ | 84,909 | $ | 90,289 | |||||||||
December 31, 2018 | |||||||||||||||||||
($ in thousands) | 30-89 Days Past Due | 90 or More Days Past Due | Total Past Due | Current | Total | ||||||||||||||
Commercial and industrial | $ | — | $ | — | $ | — | $ | 2,159 | $ | 2,159 | |||||||||
Real estate: | |||||||||||||||||||
Commercial - investor owned | 416 | 88 | 504 | 23,435 | 23,939 | ||||||||||||||
Commercial - owner occupied | 591 | 6,279 | 6,870 | 2,799 | 9,669 | ||||||||||||||
Construction and land development | — | — | — | 4,548 | 4,548 | ||||||||||||||
Residential | 146 | 37 | 183 | 5,899 | 6,082 | ||||||||||||||
Consumer and other | — | — | — | 4 | 4 | ||||||||||||||
Total | $ | 1,153 | $ | 6,404 | $ | 7,557 | $ | 38,844 | $ | 46,401 | |||||||||
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The following table is a rollforward of PCI loans, net of the allowance for loan losses, for the years ended December 31, 2019 and 2018.
($ in thousands) | Contractual Cashflows | Non-accretable Difference | Accretable Yield | Carrying Amount | |||||||||||
Balance January 1, 2019 | $ | 73,157 | $ | 15,299 | $ | 12,638 | $ | 45,220 | |||||||
Acquisitions | 111,963 | 13,541 | 30,238 | 68,184 | |||||||||||
Principal reductions and interest payments | (42,862 | ) | — | — | (42,862 | ) | |||||||||
Accretion of loan discount | — | — | (10,345 | ) | 10,345 | ||||||||||
Changes in contractual and expected cash flows due to remeasurement | 13,247 | 357 | (1,711 | ) | 14,601 | ||||||||||
Reductions due to disposals | (9,626 | ) | (3,668 | ) | (38 | ) | (5,920 | ) | |||||||
Balance December 31, 2019 | $ | 145,879 | $ | 25,529 | $ | 30,782 | $ | 89,568 | |||||||
Balance January 1, 2018 | $ | 112,711 | $ | 29,006 | $ | 13,962 | $ | 69,743 | |||||||
Principal reductions and interest payments | (45,668 | ) | — | — | (45,668 | ) | |||||||||
Accretion of loan discount | — | — | (6,654 | ) | 6,654 | ||||||||||
Changes in contractual and expected cash flows due to remeasurement | 6,114 | (13,707 | ) | 5,330 | 14,491 | ||||||||||
Balance December 31, 2018 | $ | 73,157 | $ | 15,299 | $ | 12,638 | $ | 45,220 | |||||||
The accretable yield is recognized in interest income over the estimated life of the acquired loans using the effective
yield method.
Outstanding customer balances on PCI loans were $114.9 million and $64.7 million as of December 31, 2019, and December 31, 2018, respectively. The allowance for loan losses on PCI loans totaled $0.7 million and $1.2 million as of December 31, 2019, and December 31, 2018, respectively.
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NOTE 6 - LEASES
The Company has banking and limited-service facilities, datacenters, and certain equipment leased under agreements. Most of the leases expire between 2020 and 2024 and include one or more renewal options of up to 5 years. One lease expires in 2031. All leases are classified as operating leases.
For the twelve months ended | |||
($ in thousands) | December 31, 2019 | ||
Operating lease cost | $ | 3,301 | |
Short-term lease cost | 288 | ||
Total lease cost | $ | 3,589 | |
Payments on operating leases included in the measurement of lease liabilities during the twelve months ended December 31, 2019 totaled $3.3 million. Right-of-use assets obtained in exchange for lease obligations totaled $5.2 million during the twelve months ended December 31, 2019.
Supplemental balance sheet information related to leases was as follows:
As of | |||
($ in thousands) | December 31, 2019 | ||
Operating lease right-of-use assets, included in other assets | $ | 14,843 | |
Operating lease liabilities, included in other liabilities | 15,461 | ||
Operating leases | |||
Weighted average remaining lease term | 6 years | ||
Weighted average discount rate | 2.7 | % | |
Maturities of operating lease liabilities were as follows:
($ in thousands) | |||
Year | Amount | ||
2020 | $ | 3,054 | |
2021 | 3,097 | ||
2022 | 2,734 | ||
2023 | 2,527 | ||
2024 | 2,146 | ||
Thereafter | 3,203 | ||
Total operating lease liabilities, payments | 16,761 | ||
Less: present value adjustment | 1,300 | ||
Operating lease liabilities | $ | 15,461 | |
As of December 31, 2019, the Company has an operating lease renewal for an existing facility that has not yet commenced. This renewal is expected to commence in the first quarter of 2020 with a lease term of 3 years.
Lessor income was $0.9 million during the twelve months ended December 31, 2019.
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NOTE 7 - DERIVATIVE FINANCIAL INSTRUMENTS
Risk Management Objective of Using Derivatives
The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s borrowings. The Company does not enter into derivative financial instruments for trading purposes.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. During 2019, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. These cash flow hedges swap variable 90 day LIBOR to a fixed rate of 2.62% on average for an original average term of 6 years.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive income and subsequently reclassified into interest expense in the same period(s) during which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are paid on the Company’s variable-rate debt. During the next twelve months, the Company estimates that an additional $0.6 million will be reclassified as an increase to interest expense.
Non-designated Hedges
Derivatives not designated as hedges are not considered speculative and result from a service the Company provides to certain customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings as a component of other noninterest income.
96
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Balance Sheet as of December 31, 2019 and December 31, 2018.
Derivative Assets | Derivative Liabilities | ||||||||||||||||||||||
December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||||||||||
($ in thousands) | Notional Amount | Balance Sheet Location | Fair Value | Notional Amount | Balance Sheet Location | Fair Value | Balance Sheet Location | Fair Value | Balance Sheet Location | Fair Value | |||||||||||||
Derivatives Designated as Hedging Instruments | |||||||||||||||||||||||
Interest rate swap | $ | 61,962 | Other Assets | $ | — | $ | — | Other Assets | $ | — | Other Liabilities | $ | 2,872 | Other Liabilities | $ | — | |||||||
Total | $ | — | $ | — | $ | 2,872 | $ | — | |||||||||||||||
Derivatives not Designated as Hedging Instruments | |||||||||||||||||||||||
Interest rate swap | $ | 749,819 | Other Assets | $ | 11,055 | $ | 494,567 | Other Assets | $ | 2,217 | Other Liabilities | $ | 11,875 | Other Liabilities | $ | 2,217 | |||||||
Foreign exchange forward contracts | — | Other Assets | — | 806 | Other Assets | 806 | Other Liabilities | — | Other Liabilities | 806 | |||||||||||||
Total | $ | 11,055 | $ | 3,023 | $ | 11,875 | $ | 3,023 | |||||||||||||||
The table below presents a gross presentation, the effects of offsetting, and a net presentation of the Company’s financial instruments that are subject to offsetting as of December 31, 2019 and December 31, 2018. The gross amounts of assets or liabilities can be reconciled to the tabular disclosure of fair value. The tabular disclosure of fair value provides the location that financial assets and liabilities are presented on the Balance Sheet.
As of December 31, 2019 | |||||||||||||||||||||||
Gross Amounts Not Offset | |||||||||||||||||||||||
($ in thousands) | Gross Amounts Recognized | Gross Amounts Offset | Net Amounts of Assets Presented | Financial Instruments | Fair Value Collateral Posted | Net Amount | |||||||||||||||||
Assets: | |||||||||||||||||||||||
Interest rate swap | $ | 11,055 | $ | — | $ | 11,055 | $ | 56 | $ | — | $ | 10,999 | |||||||||||
Liabilities: | |||||||||||||||||||||||
Interest rate swap | $ | 14,747 | $ | — | $ | 14,747 | $ | 56 | $ | 14,573 | $ | 118 | |||||||||||
Securities sold under agreements to repurchase | 230,886 | — | 230,886 | — | 230,886 | — | |||||||||||||||||
As of December 31, 2018 | |||||||||||||||||||||||
Gross Amounts Not Offset | |||||||||||||||||||||||
($ in thousands) | Gross Amounts Recognized | Gross Amounts Offset | Net Amounts of Assets Presented | Financial Instruments | Fair Value Collateral Posted | Net Amount | |||||||||||||||||
Assets: | |||||||||||||||||||||||
Interest rate swap | $ | 2,217 | $ | — | $ | 2,217 | $ | — | $ | — | $ | 2,217 | |||||||||||
Liabilities: | |||||||||||||||||||||||
Interest rate swap | $ | 2,217 | $ | — | $ | 2,217 | $ | — | $ | — | $ | 2,217 | |||||||||||
Securities sold under agreements to repurchase | 221,450 | — | 221,450 | — | 221,450 | — | |||||||||||||||||
As of December 31, 2019, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $14.8 million. Further, the Company has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $14.6 million.
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NOTE 8 - FIXED ASSETS
A summary of fixed assets at December 31, 2019 and 2018, is as follows:
December 31, | |||||||
($ in thousands) | 2019 | 2018 | |||||
Land | $ | 14,079 | $ | 8,559 | |||
Buildings and leasehold improvements | 54,838 | 32,456 | |||||
Furniture, fixtures and equipment | 15,178 | 9,850 | |||||
Capitalized software | 1,373 | 1,305 | |||||
85,468 | 52,170 | ||||||
Less accumulated depreciation and amortization | 25,455 | 20,061 | |||||
Total fixed assets | $ | 60,013 | $ | 32,109 | |||
Depreciation and amortization of fixed assets included in noninterest expense amounted to $5.7 million, $3.5 million, and $3.3 million in 2019, 2018, and 2017, respectively.
NOTE 9 - GOODWILL AND INTANGIBLE ASSETS
Goodwill increased to $210.3 million as of December 31, 2019, compared to $117.3 million as of December 31, 2018 due to the acquisition of Trinity. The annual goodwill impairment evaluations in 2019, 2018, and 2017 did not identify any impairment.
The table below presents a summary of intangible assets:
($ in thousands) | Years ended December 31, | ||||||
2019 | 2018 | ||||||
Core deposit intangible, net, beginning of year | $ | 8,553 | $ | 11,056 | |||
Additions from acquisition | 23,066 | — | |||||
Amortization | (5,543 | ) | (2,503 | ) | |||
Core deposit intangible, net, end of year | $ | 26,076 | $ | 8,553 | |||
Amortization expense on the core deposit intangibles was $5.5 million, $2.5 million, and $2.6 million for the years ended December 31, 2019, 2018, and 2017, respectively. The core deposit intangibles are being amortized over a 10-year period.
The following table reflects the amortization schedule for the core deposit intangible at December 31, 2019.
Year | Core Deposit Intangible ($ in thousands) | ||
2020 | $ | 5,608 | |
2021 | 4,814 | ||
2022 | 4,085 | ||
2023 | 3,456 | ||
2024 | 2,828 | ||
After 2024 | 5,285 | ||
$ | 26,076 | ||
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NOTE 10 - DEPOSITS
Following is a summary of certificates of deposit maturities at December 31, 2019:
($ in thousands) | Brokered | Customer | Total | ||||||||
Less than 1 year | $ | 165,549 | $ | 471,076 | $ | 636,625 | |||||
Greater than 1 year and less than 2 years | — | 108,209 | 108,209 | ||||||||
Greater than 2 years and less than 3 years | — | 13,606 | 13,606 | ||||||||
Greater than 3 years and less than 4 years | 25,069 | 8,457 | 33,526 | ||||||||
Greater than 4 years and less than 5 years | 25,140 | 3,562 | 28,702 | ||||||||
Greater than 5 years | — | 5,779 | 5,779 | ||||||||
$ | 215,758 | $ | 610,689 | $ | 826,447 | ||||||
Certificates of deposit balances over the FDIC insurance limit of $250,000 were $202.4 million as of December 31, 2019.
Following is a summary of activity for the year ended December 31, 2019, for deposit accounts of executive officers and directors, or to entities in which such individuals had beneficial interests as a shareholder, officer, or director.
($ in thousands) | December 31, 2019 | |||
Balance at beginning of year | $ | 10,457 | ||
Deposits | 3,031 | |||
Withdrawals | (3,725 | ) | ||
Balance at end of year | $ | 9,763 | ||
The Company is a participant in the Promontory Interfinancial Network, a network that offers deposit placement services such as CDARS and ICS, which offer products that qualify large deposits for FDIC insurance. At December 31, 2019, the Company had $0.2 million of CDARS deposits and $147.9 million of ICS deposits. At December 31, 2019 and 2018, overdraft deposits of $2.1 million and $2.0 million, respectively, were reclassified to loans.
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NOTE 11 - SUBORDINATED DEBENTURES
The amounts and terms of each issuance of the Company’s subordinated debentures at December 31, 2019 and 2018 were as follows:
Amount | Maturity Date | Initial Call Date (1) | Interest Rate | ||||||||||
($ in thousands) | 2019 | 2018 | |||||||||||
EFSC Clayco Statutory Trust I | $ | 3,196 | $ | 3,196 | December 17, 2033 | December 17, 2008 | Floats @ 3MO LIBOR + 2.85% | ||||||
EFSC Capital Trust II | 5,155 | 5,155 | June 17, 2034 | June 17, 2009 | Floats @ 3MO LIBOR + 2.65% | ||||||||
EFSC Statutory Trust III | 11,341 | 11,341 | December 15, 2034 | December 15, 2009 | Floats @ 3MO LIBOR + 1.97% | ||||||||
EFSC Clayco Statutory Trust II | 4,124 | 4,124 | September 15, 2035 | September 15, 2010 | Floats @ 3MO LIBOR + 1.83% | ||||||||
EFSC Statutory Trust IV | 10,310 | 10,310 | December 15, 2035 | December 15, 2010 | Floats @ 3MO LIBOR + 1.44% | ||||||||
EFSC Statutory Trust V | 4,124 | 4,124 | September 15, 2036 | September 15, 2011 | Floats @ 3MO LIBOR + 1.60% | ||||||||
EFSC Capital Trust VI | 14,433 | 14,433 | March 30, 2037 | March 30, 2012 | Floats @ 3MO LIBOR + 1.60% | ||||||||
EFSC Capital Trust VII | 4,124 | 4,124 | December 15, 2037 | December 15, 2012 | Floats @ 3MO LIBOR + 2.25% | ||||||||
JEFFCO Stat Trust I (2) | 7,886 | 8,019 | February 22, 2031 | February 22, 2011 | Fixed @ 10.20% | ||||||||
JEFFCO Stat Trust II (2) | 4,388 | 4,335 | March 17, 2034 | March 17, 2009 | Floats @ 3MO LIBOR + 2.75% | ||||||||
Trinity Capital Trust III (2) | 5,206 | — | September 8, 2034 | September 8, 2009 | Floats @ 3MO LIBOR + 2.70% | ||||||||
Trinity Capital Trust IV (2) | 10,302 | — | November 23, 2035 | August 23, 2010 | Fixed @ 6.88% | ||||||||
Trinity Capital Trust V (2) | 7,543 | — | December 15, 2036 | September 15, 2011 | Floats @ 3MO LIBOR + 1.65% | ||||||||
Total | 92,132 | 69,161 | |||||||||||
Fixed-to-floating rate subordinated notes | 50,000 | 50,000 | November 1, 2026 | November 1, 2021 | Fixed @ 4.75% until November 1, 2021, then floats @ 3MO LIBOR + 3.387% | ||||||||
Debt issuance costs | (874 | ) | (1,005 | ) | |||||||||
Total fixed-to-floating rate subordinated notes | 49,126 | 48,995 | |||||||||||
Total subordinated debentures and notes | $ | 141,258 | $ | 118,156 | |||||||||
(1) Callable each quarter after initial call date. | |||||||||||||
(2) Purchase accounting adjustments are reflected in the balance and also impact the effective interest rate. | |||||||||||||
The Company has 13 unconsolidated statutory business trusts. These trusts issued preferred securities that were sold to third parties. The sole purpose of the trusts was to invest the proceeds in junior subordinated debentures of the Company that have terms identical to the trust preferred securities. The subordinated debentures, which are the sole assets of the trusts, are subordinate and junior in right of payment to all present and future senior and subordinated indebtedness and certain other financial conditions of the Company. The Company fully and unconditionally guarantees each trust’s securities obligations. Under current regulations, the trust preferred securities are included in tier 1 capital for regulatory capital purposes, subject to certain limitations.
The trust preferred securities are redeemable in whole or in part on or after their respective call dates. Mandatory redemption dates may be shortened if certain conditions are met. The securities are classified as subordinated debentures in the Company’s consolidated balance sheets. Interest on the subordinated debentures held by the trusts is recorded as interest expense in the Company’s consolidated statements of operations. The Company’s investment of $2.9 million at December 31, 2019, in these trusts is included in other investments in the consolidated balance sheets. The Company has fixed the interest rate on a portion of its junior subordinated debentures through a series of interest rate swaps. For further discussion of the interest rate swaps and the corresponding terms, see “Note 7 - Derivative Financial Instruments.”
On November 1, 2016, the Company issued $50 million of fixed-to-floating rate subordinated notes. The notes initially bear a fixed annual interest rate of 4.75%, with interest payable semiannually in arrears on May 1 and November 1 of each year, commencing May 1, 2017. Commencing November 1, 2021, the interest rate on the notes resets quarterly
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to the three-month LIBOR rate plus a spread of 338.7 basis points, payable quarterly in arrears. On or after November 1, 2021, the Company will have the option to redeem the notes, in whole or in part, at a redemption price equal to 100% of the principal amount of the subordinated notes to be redeemed plus accrued interest, subject to applicable regulatory approval. The Company’s obligation to make payments of principal and interest on the notes is subordinate and junior in right of payment to all of its senior debt. Current regulatory guidance allows for this subordinated debt to be treated as tier 2 regulatory capital for the first five years of its term, subject to certain limitations, and then phased out of tier 2 capital pro rata over the next five years.
NOTE 12 - FEDERAL HOME LOAN BANK ADVANCES
FHLB advances are collateralized by 1-4 family residential real estate loans, business loans, certain commercial real estate loans, and investment securities. At December 31, 2019 and 2018, the carrying value of the loans pledged to the FHLB of Des Moines was $1.6 billion and $1.2 billion, respectively. The secured line of credit had availability of approximately $742.4 million at December 31, 2019.
The following table summarizes the type, maturity, and rate of the Company’s FHLB advances at December 31:
2019 | 2018 | |||||||||||
($ in thousands) | Term | Outstanding Balance | Weighted Rate | Outstanding Balance | Weighted Rate | |||||||
Non-amortizing fixed advance | Less than 1 year | $ | 170,000 | 1.73 | % | $ | 70,000 | 2.63 | % | |||
Non-amortizing fixed advance | Greater than 1 year | 52,406 | 1.62 | % | — | — | % | |||||
Total FHLB advances | $ | 222,406 | 1.70 | % | $ | 70,000 | 2.63 | % | ||||
In August 2019, the Company entered into agreements totaling $50 million for convertible advances with a weighted average rate of 1.56% that mature in 2024 and are puttable by the FHLB after one year.
At December 31, 2019, the Company used $4.7 million of collateral value to secure confirming letters of credit for public unit deposits and industrial development bonds.
NOTE 13 - OTHER BORROWINGS AND NOTES PAYABLE
Securities Sold Under Agreement to Repurchase
The Company enters into sales of securities under agreements to repurchase. The agreements are transacted with deposit customers and are utilized as an overnight investment product. The amounts received under these agreements represent short-term borrowings and are reflected as a liability in the consolidated balance sheets. The securities underlying these agreements are included in investment securities in the Consolidated Balance Sheets. The Company has no control over the market value of the securities, which fluctuates due to market conditions. However, the Company is obligated to promptly transfer additional securities if the market value of the securities falls below the repurchase agreement price. The Company manages this risk by maintaining an unpledged securities portfolio that it believes is sufficient to cover a decline in the market value of the securities sold under agreements to repurchase.
A summary of securities sold under agreements to repurchase is as follows:
December 31, | |||||||
($ in thousands) | 2019 | 2018 | |||||
Securities sold under agreement to repurchase | $ | 230,886 | $ | 221,450 | |||
Average balance during the year | 169,179 | 170,963 | |||||
Maximum balance outstanding at any month-end | 230,886 | 231,450 | |||||
Average interest rate during the year | 0.69 | % | 0.41 | % | |||
Average interest rate at December 31 | 0.91 | 0.49 | |||||
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Federal Reserve Line
The Bank also has a line with the Federal Reserve Bank of St. Louis which provides additional liquidity to the Company. As of December 31, 2019, $1.1 billion was available under this line. This line is secured by a pledge of certain eligible loans aggregating $1.3 billion. There were no amounts drawn on the Federal Reserve line of credit as of December 31, 2019.
Revolving Credit Line
In February 2016, the Company entered into a senior unsecured revolving credit agreement (the “Revolving Agreement”) with another bank. The Revolving Agreement was amended in February 2020, with a one-year maturity, allowing for borrowings up to $25 million. The interest rate is the one-month LIBOR plus 125 basis points. The proceeds can be used for general corporate purposes. The Revolving Agreement is subject to ongoing compliance with a number of customary affirmative and negative covenants as well as specified financial covenants.
A summary of the amounts drawn on the Revolving Agreement is as follows:
December 31, | |||||||
($ in thousands) | 2019 | 2018 | |||||
Outstanding balance | $ | — | $ | 2,000 | |||
Average balance during the year | 323 | 22 | |||||
Maximum balance outstanding at any month-end | 2,000 | 2,000 | |||||
Weighted average interest rate during the year | 4.61 | % | 4.63 | % | |||
Average interest rate at December 31 | — | 4.63 | |||||
Term Loan
In February 2019, the Company entered into a five year, $40.0 million unsecured term loan agreement (the “Term Loan”) with another bank with the proceeds primarily used to fund the company’s cash portion of the acquisition of Trinity. The interest rate is the one-month LIBOR plus 125 basis points.
A summary of the Term Loan is as follows:
December 31, | |||
($ in thousands) | 2019 | ||
Term Loan | $ | 34,286 | |
Average balance during the year | 30,810 | ||
Maximum balance outstanding at any month-end | 40,000 | ||
Weighted average interest rate during the year | 3.55 | % | |
Average interest rate at December 31 | 3.00 | ||
NOTE 14 - LITIGATION AND OTHER CONTINGENCIES
The Company and its subsidiaries are, from time to time, parties to various legal proceedings arising out of their businesses. Management believes there are no such legal proceedings pending or threatened against the Company or its subsidiaries in the ordinary course of business, directly, indirectly, or in the aggregate that, if determined adversely, would have a material adverse effect on the business, consolidated financial condition, results of operations or cash flows of the Company or any of its subsidiaries.
As previously reported, in connection with its acquisition of Trinity/LANB, the Company, as successor-in-interest to Trinity, was a party to certain consolidated proceedings pending in the First Judicial Circuit Court for the State of New Mexico, styled Trinity Capital Corporation, et al v. Atlantic Specialty Ins. Co., et al. The lawsuit sought declaratory relief, defense costs, and damages related to claims for bad faith breach of insurance contracts and violations of New
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Mexico insurance statutes. In January 2020, the parties settled all pending matters related to the pending claims and lawsuit, and proceeds were received by the Company in connection with this settlement. In addition, the pending proceedings were dismissed on January 31, 2020.
NOTE 15 - REGULATORY CAPITAL
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios (set forth in the following table) of total, tier 1, and common equity tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets. Management believes, as of December 31, 2019 and 2018, that the Company met all capital adequacy requirements to which it is subject.
As of December 31, 2019 and 2018, the Bank was categorized as “well-capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized” the Bank must maintain minimum total risk-based capital, tier 1 risk-based capital, common equity tier 1 risk-based capital, and tier 1 leverage ratios as set forth in the table. In addition, the Company must maintain an additional CCB above the regulatory minimum ratio requirements. The CCB is designed to insulate banks from periods of stress and impose constraints on dividends, share repurchases and discretionary bonus payments when capital levels fall below prescribed levels.
The capital ratios are presented in the table below:
December 31, 2019 | December 31, 2018 | |||||||||||||
EFSC | Bank | EFSC | Bank | To Be Well-Capitalized | Minimum Ratio with CCB | |||||||||
Common Equity Tier 1 Capital to Risk Weighted Assets | 9.90 | % | 11.69 | % | 9.79 | % | 11.37 | % | 6.50 | % | 7.00 | % | ||
Tier 1 Capital to Risk Weighted Assets | 11.40 | 11.70 | 11.14 | 11.38 | 8.00 | 8.50 | ||||||||
Total Capital to Risk Weighted Assets | 12.90 | 12.40 | 13.02 | 12.26 | 10.00 | 10.50 | ||||||||
Leverage Ratio (Tier 1 Capital to Average Assets) | 10.05 | 10.31 | 10.29 | 10.52 | 5.00 | 4.00 | ||||||||
NOTE 16 - STOCKHOLDERS’ EQUITY AND COMPENSATION PLANS
Stockholders’ Equity
Common Stock
At December 31, 2019 and 2018, the Company has reserved the following shares of its authorized but unissued common stock for possible future issuance in connection with the following:
December 31, 2019 | December 31, 2018 | ||||
Outstanding performance units (maximum issuance) | 73,172 | 98,279 | |||
Outstanding RSU’s | 117,369 | 67,027 | |||
Outstanding options and appreciation rights | 28,300 | 40,650 | |||
Future awards under 2018 Stock Incentive Plan | 521,573 | 632,246 | |||
Future awards under Non-Management Director Plan | 96,031 | 7,413 | |||
2018 Employee Stock Purchase Plan | 694,085 | 735,201 | |||
Total | 1,530,530 | 1,580,816 | |||
Common Stock Repurchase Plan
In May 2015, the Company’s board of directors authorized the repurchase of up to two million shares of the Company’s common stock. The repurchases may be made in open market or privately negotiated transactions and the stock
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repurchase program will remain in effect until fully utilized or until modified, superseded or terminated. At December 31, 2019, there were 552,158 shares available for repurchase under the plan.
Preferred Stock
The Company has 5,000,000 shares of authorized preferred stock with a par value of $0.01. The Board of Directors has the right to set for each series of preferred stock, subject to the laws of the State of Delaware, the dividend rate, conversion and redemption terms, voting rights and liquidation preferences, among others. At December 31, 2019 and 2018 there were no shares of preferred stock outstanding.
Dividends
The Company’s ability to pay dividends to its shareholders is generally dependent upon the payment of dividends by the Bank to the parent company. The Bank cannot pay dividends to the extent it would be deemed undercapitalized by the FDIC after making such dividend.
Dividends on the Company’s capital stock are prohibited under the terms of the junior subordinated debenture agreements, see “Note 11 - Subordinated Debentures,” if the Company is in continuous default on its payment obligations to the capital trusts, has elected to defer interest payments on the debentures or extends the interest payment period. At December 31, 2019, the Company was not in default on any of the junior subordinated debenture issuances.
Accumulated Other Comprehensive Income (Loss)
The following table presents the changes in accumulated other comprehensive income (loss) after-tax:
(in thousands) | Net Unrealized Gain (Loss) on Available-for-Sale Debt Securities | Unamortized Gain (Loss) on Held-to-Maturity Securities | Net Unrealized Loss on Cash Flow Hedges | Total | |||||||||||
Balance, December 31, 2016 | $ | (1,533 | ) | $ | (208 | ) | $ | — | $ | (1,741 | ) | ||||
Net change | (2,089 | ) | 12 | — | (2,077 | ) | |||||||||
Balance, December 31, 2017 | (3,622 | ) | (196 | ) | — | (3,818 | ) | ||||||||
Net change | (4,633 | ) | 3 | — | (4,630 | ) | |||||||||
Adjustment for change in accounting policies | (792 | ) | (42 | ) | — | (834 | ) | ||||||||
Balance, December 31, 2018 | (9,047 | ) | (235 | ) | — | (9,282 | ) | ||||||||
Net change | 29,226 | (33 | ) | (2,162 | ) | 27,031 | |||||||||
Transfer from available-for-sale to held-to-maturity | (5,202 | ) | 5,202 | — | — | ||||||||||
Balance, December 31, 2019 | $ | 14,977 | $ | 4,934 | $ | (2,162 | ) | $ | 17,749 | ||||||
Amounts Reclassified from Other Comprehensive Income (Loss) | |||||||||||||
(in thousands) | 2019 | 2018 | 2017 | Affected Line Item in the Statements of Operations | |||||||||
Realized gain (loss) on securities available-for-sale, net | $ | (49 | ) | $ | 9 | $ | 22 | Noninterest income (expense) | |||||
Loss on cash flow hedges | (133 | ) | — | — | Interest income (expense) | ||||||||
Reclassifications before tax | (182 | ) | 9 | 22 | Total before income tax expense | ||||||||
Tax effect | 45 | (2 | ) | (9 | ) | Income tax (expense) benefit | |||||||
Total reclassifications, net of tax | $ | (137 | ) | $ | 7 | $ | 13 | Net income | |||||
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Compensation Plans
The Company has adopted share-based compensation plans to reward and provide long-term incentive for directors and key employees of the Company including its subsidiaries. These plans provide for the granting of stock, stock options, stock-settled stock appreciation rights (“SSARs”), and restricted stock units (“RSUs”), and may contain performance terms as designated by the Company’s Board of Directors upon the recommendation of the Compensation Committee of the Board. The Company uses authorized and unissued shares to satisfy share award exercises.
The total excess income tax benefit for share-based compensation arrangements was $0.5 million, $1.6 million, and $2.1 million for the years ended December 31, 2019, 2018, and 2017, respectively. At December 31, 2019, there was $4.6 million of total unrecognized compensation cost related to unvested share-based compensation awards. The cost is expected to be recognized over a weighted-average period of 2 years.
The following table summarizes share-based compensation expense:
(in thousands) | 2019 | 2018 | 2017 | ||||||||
Performance stock units | $ | 1,699 | $ | 2,067 | $ | 2,451 | |||||
Restricted stock units | 1,969 | 1,211 | 898 | ||||||||
Employee stock issuance - restricted stock | — | — | 78 | ||||||||
Employee stock purchase plan | 364 | 174 | — | ||||||||
Total share-based compensation expense | $ | 4,032 | $ | 3,452 | $ | 3,427 | |||||
Performance Units
The Company has entered into long-term incentive agreements with certain key employees. These awards are conditioned on certain performance criteria and market criteria measured against a group of peer banks over a three-year period for each grant. The awards contain minimum (threshold), target, and maximum (exceptional) performance levels. In the event of a change in control, as defined in the plan, the awards will vest at a minimum of the target level. The amount of the awards is determined at the end of the three year vesting and performance period. In January 2020, the Company awarded 62,649 shares to employees upon completion of the 2017-2019 performance cycle. In January 2019, the Company awarded 99,308 shares to employees upon completion of the 2016-2018 performance cycle. In January 2018, the Company awarded 134,600 shares to employees upon completion of the 2015-2017 performance cycle.
Information related to the outstanding grants at December 31, 2019 is shown below:
($ in thousands) | 2018 - 2020 Cycle | 2019 - 2021 Cycle | |||||
Shares issuable at target | 15,726 | 20,860 | |||||
Maximum shares issuable | 31,452 | 41,720 | |||||
Unrecognized compensation cost | $ | 440 | $ | 705 | |||
Weighted average grant date fair value | 50.19 | 47.46 | |||||
In 2018, stock-based compensation expense for these awards included an additional $0.1 million related to modifications made for retiring executives. The modification allows for portions of outstanding performance awards to continue to vest as though employment had not terminated and will be paid based on actual performance as determined by the compensation committee following completion of the applicable performance period.
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Restricted Stock Units
The Company awards nonvested stock, in the form of RSUs to employees. RSUs generally are subject to continued employment and generally vest ratably over two to five years. Shares issued to the Bank’s directors for compensation are not subject to vesting requirements. Vesting is accelerated upon a change in control or the employee meeting certain retirement criteria. RSUs do not carry voting or dividend rights until vested. Sales of the units are restricted prior to vesting. Various information related to the RSUs is shown below.
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Total fair value at vesting date | $ | 1,067 | $ | 1,544 | $ | 1,471 | |||||
Total unrecognized compensation cost for nonvested stock units | 3,417 | 2,175 | 837 | ||||||||
Expected years to recognize unearned compensation | 1.9 years | 2.0 years | 1.8 years | ||||||||
A summary of the status of the Company’s RSU awards as of December 31, 2019 and changes during the year then ended is presented below
Shares | Weighted Average Grant Date Fair Value | |||||
Outstanding at December 31, 2018 | 67,027 | $ | 46.69 | |||
Granted | 77,227 | 45.00 | ||||
Vested | (23,842 | ) | 45.38 | |||
Forfeited | (3,043 | ) | 46.04 | |||
Outstanding at December 31, 2019 | 117,369 | $ | 45.86 | |||
Employee Stock Options and Stock-settled Stock Appreciation Rights
In determining compensation cost for stock options and SSARs, the Black-Scholes option-pricing model is used to estimate the fair value on date of grant. There were no grants of employee stock options or SSARs during the years ended December 31, 2019, 2018, or 2017.
Stock options have been granted to key employees with exercise prices equal to the market price of the Company’s common stock at the date of grant and 10-year contractual terms. Stock options have a vesting schedule of three to five years. The SSARs are subject to continued employment, have a 10-year contractual term and vest ratably over five years. Neither stock options nor SSARs carry voting or dividend rights until exercised. At December 31, 2019, there was no remaining unrecognized compensation expense related to stock options and SSARs and all outstanding awards are vested. Various information related to the stock options and SSARs is shown below.
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Intrinsic value of option exercises on date of exercise | $ | 407 | $ | 2,469 | $ | 3,156 | |||||
Following is a summary of the employee stock option and SSAR activity for 2019.
($ in thousands, except per share data) | Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | ||||||||
Outstanding at December 31, 2018 | 40,650 | $ | 10.14 | |||||||||
Exercised | (12,350 | ) | 10.14 | |||||||||
Outstanding at December 31, 2019 | 28,300 | $ | 10.14 | 0.6 years | $ | 1,077 | ||||||
Exercisable at December 31, 2019 | 28,300 | $ | 10.14 | 0.6 years | $ | 1,077 | ||||||
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Employee Stock Purchase Plan
The Company adopted an Employee Stock Purchase Plan (“ESPP”) in 2018 to provide its eligible employees with an opportunity to purchase common stock through accumulated contributions. The ESPP provides for shares to be purchased at 85% of the lesser of the stock price at the enrollment date or the exercise date. The maximum number of shares of common stock available for sale under the ESPP is 750,000. In 2019 and 2018, employees purchased 41,116 and 14,799 shares, respectively.
Stock Plan for Non-Management Directors
The Company has adopted a Stock Plan for Non-Management Directors, which provides for issuing up to 200,000 shares of common stock to non-management directors as compensation in lieu of cash. At December 31, 2019, there were 96,031 shares of stock available for grant under the Stock Plan for Non-Management Directors.
Various information related to the Director Plan is shown below.
2019 | 2018 | 2017 | |||||||||
Shares granted | 11,382 | 11,750 | 10,531 | ||||||||
Weighted average fair value | $ | 41.63 | $ | 50.74 | $ | 42.46 | |||||
401(k) Plan
The Company has a 401(k) savings plan which covers substantially all full-time employees over the age of 21. The amount charged to expense for the Company’s contributions to the plan was $3.2 million, $2.8 million and $2.0 million for 2019, 2018, and 2017, respectively.
Deferred Compensation Plan
The Company’s Deferred Compensation Plan permits certain executives to participate and defer up to 25% of their base salary and/or up to 100% of their eligible bonus for a plan year. Participants make an irrevocable election when they elect to participate for a plan year to receive the vested account balance following their retirement date, or at a future date not less than five years after the beginning of the plan year. At December 31, 2019, the Company had assets and liabilities of $3.5 million and $4.9 million, respectively, related to the Deferred Compensation Plan.
NOTE 17 - INCOME TAXES
The components of income tax expense for the years ended December 31 are as follows:
Year ended December 31, | |||||||||||
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Current: | |||||||||||
Federal | $ | 15,470 | $ | 9,621 | $ | 15,845 | |||||
State and local | 2,027 | 2,432 | 1,377 | ||||||||
Total current | 17,497 | 12,053 | 17,222 | ||||||||
Deferred: | |||||||||||
Federal | 4,262 | 2,812 | 20,989 | ||||||||
State and local | 1,538 | 495 | 116 | ||||||||
Total deferred | 5,800 | 3,307 | 21,105 | ||||||||
Total income tax expense | $ | 23,297 | $ | 15,360 | $ | 38,327 | |||||
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A reconciliation of expected income tax expense, computed by applying the statutory federal income tax rate in 2019, 2018, and 2017 to income before income taxes and the amounts reflected in the consolidated statements of operations is as follows:
Year ended December 31, | |||||||||||
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Income tax expense at statutory rate | $ | 24,368 | $ | 21,961 | $ | 30,281 | |||||
Increase (reduction) in income tax resulting from: | |||||||||||
Tax-exempt income, net | (962 | ) | (506 | ) | (961 | ) | |||||
State and local income taxes, net | 2,816 | 2,423 | 1,676 | ||||||||
Bank-owned life insurance, net | (628 | ) | (452 | ) | (715 | ) | |||||
Non-deductible expenses | 749 | 294 | 407 | ||||||||
Change in estimated rate for deferred taxes | — | — | 12,117 | ||||||||
Tax benefits of LIHTC investments, net | (278 | ) | (50 | ) | (257 | ) | |||||
Excess tax benefits | (526 | ) | (1,631 | ) | (2,141 | ) | |||||
Federal tax credits | (913 | ) | (4,627 | ) | (1,701 | ) | |||||
Subsidiary dividend timing election | — | (2,728 | ) | — | |||||||
Non-taxable donation to charitable foundation | (420 | ) | — | — | |||||||
Other, net | (909 | ) | 676 | (379 | ) | ||||||
Total income tax expense | $ | 23,297 | $ | 15,360 | $ | 38,327 | |||||
The net amount recognized as a component of tax expense for tax credits, other tax benefits, and amortization from low-income housing tax credit (“LIHTC”) investments recognized per the table above was $0.3 million for the year ended December 31, 2019. The net amount recognized as a component of income tax expense per the table above was $0.1 million for the year ended December 31, 2018, and $0.3 million for the year ended December 31, 2017. As of December 31, 2019 and 2018, the carrying value of the investments related to low-income housing tax credits was $4.0 million and $1.4 million, respectively. No impairment losses have been recognized from forfeiture or ineligibility of tax credits or other circumstances during the life of any of the investments. As of December 31, 2019, the Company has future capital commitments of $0.7 million related to low-income housing tax credit investments. The capital commitments are expected to be called in 2020.
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A net deferred income tax asset of $14.4 million and $20.7 million is included in other assets in the consolidated balance sheets at December 31, 2019 and 2018, respectively. The tax effect of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities is as follows:
Year ended December 31, | |||||||
($ in thousands) | 2019 | 2018 | |||||
Deferred tax assets: | |||||||
Allowance for loan losses | $ | 10,692 | $ | 10,742 | |||
Acquired loans | 9,722 | 3,677 | |||||
Other real estate | 657 | 81 | |||||
Deferred compensation | 2,462 | 2,480 | |||||
Intangible assets | — | 989 | |||||
Accrued compensation | 1,607 | 1,130 | |||||
Unrealized losses on securities | — | 3,019 | |||||
Net operating losses and tax credits | 7,066 | — | |||||
Other deferred tax assets | 791 | 1,786 | |||||
Total deferred tax assets | 32,997 | 23,904 | |||||
Deferred tax liabilities: | |||||||
Unrealized gains on securities | 5,847 | — | |||||
Intangible assets | 7,432 | 2,112 | |||||
Other deferred tax liabilities | 2,407 | 1,068 | |||||
Total deferred tax liabilities | 15,686 | 3,180 | |||||
Net deferred tax asset before valuation allowance | 17,311 | 20,724 | |||||
Less: valuation allowance | 2,932 | — | |||||
Net deferred tax asset | $ | 14,379 | $ | 20,724 | |||
Deferred tax rate | 24.7 | % | 24.7 | % | |||
As part of the Trinity Capital Corporation acquisition in 2019, the company acquired net operating loss, tax credit, and capital loss deferred tax assets. Net operating losses originated in the years 2012, 2014, 2015, 2016, 2017, and 2019 and will expire in the years between 2032-2037. The 2019 net operating loss can be carried forward indefinitely. Tax credit carryforwards originated in years 2010-2015 and will expire in the years between 2030-3035. Capital losses originated in 2015, 2016, & 2018 and will expire in the years between 2020-2023.
A valuation allowance is provided on deferred tax assets when it is more likely than not that some portion of the assets will not be realized. In 2019, as part of the Trinity Capital Corporation acquisition, the company acquired net operating loss, tax credit, and capital loss deferred tax assets. The company determined that it was more likely than not that some of the assets would not be realized. As such, the company recorded a $2.9 million valuation allowance as of December 31, 2019. The company did not record a valuation allowance for any federal or state deferred income tax assets as of December 31, 2018.
The Company and its subsidiaries file income tax returns in the federal jurisdiction and in eleven states. The Company is no longer subject to federal, state or local income tax audits by tax authorities for years before 2016, with the exception of 2015 being an open year by one state taxing authority. Net operating losses generated prior to 2015 that are utilized going forward would still be subject to examination.
As of December 31, 2019, the gross amount of unrecognized tax benefits was $1.5 million and the total amount of net unrecognized tax benefits that would impact the effective tax rate, if recognized, was $1.1 million. As of December 31, 2018 and 2017, the total amount of the net unrecognized tax benefits that would impact the effective tax rate, if recognized, was $0.9 million and $0.8 million, respectively. The Company believes it is reasonably possible that the
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gross amount of unrecognized benefits will be reduced by approximately $0.3 million as a result of a lapse of statute of limitations in the next 12 months.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense and classifies such interest and penalties in the liability for unrecognized tax benefits. The amounts accrued for interest and penalties as of December 31, 2019, 2018, and 2017 were not significant.
The activity in the gross liability for unrecognized tax benefits was as follows:
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Balance at beginning of year | $ | 1,301 | $ | 1,244 | $ | 1,180 | |||||
Additions based on tax positions related to the current year | 401 | 367 | 331 | ||||||||
Additions for tax positions of prior years | 62 | 50 | 41 | ||||||||
Settlements or lapse of statute of limitations | (267 | ) | (360 | ) | (308 | ) | |||||
Balance at end of year | $ | 1,497 | $ | 1,301 | $ | 1,244 | |||||
NOTE 18 - COMMITMENTS
Long-term Lease Commitments
See “Note 6 – Leases” in this report for information regarding the Company’s long-term lease commitments.
Off-balance-Sheet Commitments
The Company issues financial instruments in the normal course of the business of meeting the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.
The Company’s extent of involvement and maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is not more than the contractual amount of these instruments.
The Company uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets.
The contractual amounts of off-balance-sheet financial instruments as of December 31, 2019, and December 31, 2018, are as follows:
(in thousands) | December 31, 2019 | December 31, 2018 | |||||
Commitments to extend credit | $ | 1,469,413 | $ | 1,344,687 | |||
Letters of credit | 47,969 | 44,665 | |||||
State tax credits | 28,035 | 37,473 | |||||
Low-income housing tax credits | 704 | 4,299 | |||||
SBICs | 20,829 | 20,402 | |||||
There was an insignificant amount of unadvanced commitments on impaired loans at December 31, 2019 and December 31, 2018. Other liabilities include approximately $0.4 million for estimated losses attributable to unadvanced commitments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments usually have fixed expiration dates or other termination clauses, may have significant usage restrictions, and may require payment of a fee. Of the total commitments to extend credit at
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December 31, 2019, and December 31, 2018, $144.8 million and $68.5 million, respectively, represent fixed rate loan commitments. Since certain of the commitments may expire without being drawn upon or may be revoked, the total commitment amounts do not necessarily represent future cash obligations. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, premises and equipment, and real estate.
Letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These letters of credit are issued to support contractual obligations of the Company’s customers. The credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers. The approximate remaining term of letters of credit range from 1 month to 5 years, 3 months at December 31, 2019.
The Company also has off-balance sheet commitments for purchases of state tax credits, low-income housing tax credits, and commitments for various capital raises for SBICs.
NOTE 19 - FAIR VALUE MEASUREMENTS
The fair value of an asset or liability is the exchange price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820, Fair Value Measurements and Disclosures, establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
• | Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. |
• | Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means. |
• | Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. |
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Fair value on a recurring basis
The following table summarizes financial instruments measured at fair value on a recurring basis as of December 31, 2019 and 2018, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value.
December 31, 2019 | |||||||||||||||
($ in thousands) | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | |||||||||||
Assets | |||||||||||||||
Securities available-for-sale | |||||||||||||||
Obligations of U.S. Government-sponsored enterprises | $ | — | $ | 10,046 | $ | — | $ | 10,046 | |||||||
Obligations of states and political subdivisions | — | 213,024 | — | 213,024 | |||||||||||
Residential mortgage-backed securities | — | 902,021 | — | 902,021 | |||||||||||
U.S. Treasury Bills | — | 10,226 | — | 10,226 | |||||||||||
Total securities available-for-sale | — | 1,135,317 | — | 1,135,317 | |||||||||||
Derivative financial instruments | — | 11,055 | — | 11,055 | |||||||||||
Total assets | $ | — | $ | 1,146,372 | $ | — | $ | 1,146,372 | |||||||
Liabilities | |||||||||||||||
Derivative financial instruments | $ | — | $ | 14,747 | $ | — | $ | 14,747 | |||||||
Total liabilities | $ | — | $ | 14,747 | $ | — | $ | 14,747 | |||||||
December 31, 2018 | |||||||||||||||
($ in thousands) | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total Fair Value | |||||||||||
Assets | |||||||||||||||
Securities available-for-sale | |||||||||||||||
Obligations of U.S. Government-sponsored enterprises | $ | — | $ | 98,498 | $ | — | $ | 98,498 | |||||||
Obligations of states and political subdivisions | — | 26,810 | — | 26,810 | |||||||||||
Residential mortgage-backed securities | — | 586,136 | — | 586,136 | |||||||||||
U.S. Treasury Bills | — | 9,925 | — | 9,925 | |||||||||||
Total securities available-for-sale | — | 721,369 | — | 721,369 | |||||||||||
Other investments | 121 | — | — | 121 | |||||||||||
Derivative financial instruments | — | 3,023 | — | 3,023 | |||||||||||
Total assets | $ | 121 | $ | 724,392 | $ | — | $ | 724,513 | |||||||
Liabilities | |||||||||||||||
Derivative financial instruments | $ | — | $ | 3,023 | $ | — | $ | 3,023 | |||||||
Total liabilities | $ | — | $ | 3,023 | $ | — | $ | 3,023 | |||||||
• | Securities available-for-sale. Securities classified as available-for-sale are reported at fair value utilizing Level 2 and Level 3 inputs. Fair values for Level 2 securities are based upon dealer quotes, market spreads, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions at the security level. Changes in fair value are recognized through accumulated other comprehensive income. |
• | Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs. The Company obtains counterparty quotations to value its interest rate swaps and caps. In addition, the Company validates the counterparty |
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quotations with third party valuation sources. Derivatives with negative fair values are included in Other liabilities in the consolidated balance sheets. Derivatives with positive fair value are included in Other assets in the consolidated balance sheets. Changes in the fair value of client-related derivative instruments are recognized through net income. For the years ended December 31, 2019 and 2018, the gains and losses offset each other due to the Company’s hedging of the client swaps with other bank counterparties.
Fair value on a non-recurring basis
Certain financial assets and financial liabilities are measured at fair value on a non-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
• | Impaired loans. Impaired loans are included as Portfolio loans on the Company’s consolidated balance sheets with amounts specifically reserved for credit impairment in the Allowance for loan losses. On a quarterly basis, fair value adjustments are recorded on impaired loans to account for (1) partial write-downs that are based on the current appraised or market-quoted value of the underlying collateral or (2) the full charge-off of the loan carrying value. In some cases, the properties for which market quotes or appraised values have been obtained are located in areas where comparable sales data is limited, outdated, or unavailable. In addition, the Company may adjust the valuations based on other relevant market conditions or information. Accordingly, fair value estimates, including those obtained from real estate brokers or other third-party consultants, for collateral-dependent impaired loans are classified in Level 3 of the valuation hierarchy. |
• | Other Real Estate. These assets are reported at the lower of the loan carrying amount at foreclosure or fair value. Fair value is based on third party appraisals of each property and the Company’s judgment of other relevant market conditions. These are considered Level 3 inputs. |
The following table presents financial instruments and non-financial assets measured at fair value on a non-recurring basis as of December 31, 2019 and 2018.
December 31, 2019 | ||||||||||||||||||
(1) | (1) | (1) | (1) | |||||||||||||||
($ in thousands) | Total Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total losses for the year ended December 31, 2019 | |||||||||||||
Impaired loans | $ | 2,506 | $ | — | $ | — | $ | 2,506 | $ | 2,687 | ||||||||
Other real estate | 4,944 | — | — | 4,944 | — | |||||||||||||
Total | $ | 7,450 | $ | — | $ | — | $ | 7,450 | $ | 2,687 | ||||||||
December 31, 2018 | ||||||||||||||||||
(1) | (1) | (1) | (1) | |||||||||||||||
($ in thousands) | Total Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total losses for the year ended December 31, 2018 | |||||||||||||
Impaired loans | $ | 1,958 | $ | — | $ | — | $ | 1,958 | $ | 815 | ||||||||
Total | $ | 1,958 | $ | — | $ | — | $ | 1,958 | $ | 815 | ||||||||
(1) The amounts represent balances measured at fair value during the period and still held as of the reporting date.
Impaired loans are reported at the fair value of the underlying collateral. Fair values for impaired loans are obtained from current appraisals by qualified licensed appraisers or independent valuation specialists. Other real estate owned
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is adjusted to fair value upon foreclosure of the underlying loan. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value less costs to sell. Fair value of other real estate is based upon the current appraised values of the properties as determined by qualified licensed appraisers and the Company’s judgment of other relevant market conditions.
Carrying amount and fair value at December 31, 2019 and 2018
Following is a summary of the carrying amounts and fair values of the Company’s financial instruments on the consolidated balance sheets at December 31, 2019 and 2018. This summary excludes certain financial assets and liabilities for which carrying value approximates fair value and financial instruments that are recorded at fair value on a recurring basis disclosed above. Financial instruments for which carrying values approximate fair value include cash and due from banks, federal funds sold, interest bearing deposits, accrued interest receivable/payable, demand, savings and money market deposits.
December 31, 2019 | December 31, 2018 | ||||||||||||||||||
($ in thousands) | Carrying Amount | Estimated fair value | Level | Carrying Amount | Estimated fair value | Level | |||||||||||||
Balance sheet assets | |||||||||||||||||||
Securities held-to-maturity | $ | 181,166 | $ | 181,939 | Level 2 | $ | 65,679 | $ | 63,934 | Level 2 | |||||||||
Other investments | 38,044 | 38,044 | Level 2 | 26,654 | 26,654 | Level 2 | |||||||||||||
Loans held for sale | 5,570 | 5,570 | Level 2 | 392 | 392 | Level 2 | |||||||||||||
Loans, net | 5,271,049 | 5,205,651 | Level 3 | 4,306,525 | 4,253,239 | Level 3 | |||||||||||||
State tax credits, held for sale | 36,802 | 39,046 | Level 3 | 37,587 | 39,169 | Level 3 | |||||||||||||
Balance sheet liabilities | |||||||||||||||||||
Certificates of deposit | $ | 826,447 | $ | 825,203 | Level 3 | $ | 684,429 | $ | 679,491 | Level 3 | |||||||||
Subordinated debentures and notes | 141,258 | 130,985 | Level 2 | 118,156 | 106,316 | Level 2 | |||||||||||||
FHLB advances | 222,406 | 221,402 | Level 2 | 70,000 | 70,000 | Level 2 | |||||||||||||
Other borrowings | 265,172 | 265,172 | Level 2 | 223,450 | 223,260 | Level 2 | |||||||||||||
Limitations
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and therefore, cannot be determined with precision. Such estimates include the valuation of loans, goodwill, intangible assets, and other long-lived assets, along with assumptions used in the calculation of income taxes, among others. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. We adjust such estimates and assumptions when facts and circumstances dictate. Decreasing real estate values, illiquid credit markets, volatile equity markets, and declines in consumer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statement in future periods. In addition, these estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Fair value estimates are based on existing on-balance and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in many of the estimates.
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NOTE 20 - PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS
Condensed Balance Sheets
December 31, | |||||||
($ in thousands) | 2019 | 2018 | |||||
Assets | |||||||
Cash | $ | 21,955 | $ | 6,369 | |||
Investment in Bank | 977,959 | 681,742 | |||||
Investment in nonbank subsidiaries | 9,795 | 7,312 | |||||
Other assets | 37,905 | 30,287 | |||||
Total assets | $ | 1,047,614 | $ | 725,710 | |||
Liabilities and Shareholders’ Equity | |||||||
Subordinated debentures and notes | $ | 141,258 | $ | 118,156 | |||
Notes payable | 34,286 | 2,000 | |||||
Accounts payable and other liabilities | 4,885 | 1,750 | |||||
Shareholders' equity | 867,185 | 603,804 | |||||
Total liabilities and shareholders' equity | $ | 1,047,614 | $ | 725,710 | |||
Condensed Statements of Operations
Year ended December 31, | |||||||||||
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Income: | |||||||||||
Dividends from Bank | $ | 60,000 | $ | 30,000 | $ | 20,000 | |||||
Dividends from nonbank subsidiaries | 1,500 | 1,200 | — | ||||||||
Other | 663 | 1,784 | 708 | ||||||||
Total income | 62,163 | 32,984 | 20,708 | ||||||||
Expenses: | |||||||||||
Interest expense-subordinated debentures and notes | 7,507 | 5,798 | 5,094 | ||||||||
Interest expense-notes payable | 1,182 | 62 | 89 | ||||||||
Other expenses | 6,936 | 7,087 | 5,486 | ||||||||
Total expenses | 15,625 | 12,947 | 10,669 | ||||||||
Income before taxes and equity in undistributed earnings of subsidiaries | 46,538 | 20,037 | 10,039 | ||||||||
Income tax benefit | 3,478 | 3,482 | 3,098 | ||||||||
Net income before equity in undistributed earnings of subsidiaries | 50,016 | 23,519 | 13,137 | ||||||||
Equity in undistributed earnings of subsidiaries | 42,723 | 65,698 | 35,053 | ||||||||
Net income and comprehensive income | $ | 92,739 | $ | 89,217 | $ | 48,190 | |||||
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Condensed Statements of Cash Flows
Year ended December 31, | |||||||||||
($ in thousands) | 2019 | 2018 | 2017 | ||||||||
Cash flows from operating activities: | |||||||||||
Net income | $ | 92,739 | $ | 89,217 | $ | 48,190 | |||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | |||||||||||
Share-based compensation | 4,032 | 3,452 | 3,427 | ||||||||
Net income of subsidiaries | (104,223 | ) | (94,898 | ) | (55,053 | ) | |||||
Dividends from subsidiaries | 61,500 | 31,200 | 20,000 | ||||||||
Other, net | (1,063 | ) | (953 | ) | (1,806 | ) | |||||
Net cash provided by operating activities | 52,985 | 28,018 | 14,758 | ||||||||
Cash flows from investing activities: | |||||||||||
Cash paid for acquisitions, net of cash acquired | (36,015 | ) | — | (25,187 | ) | ||||||
Purchases of other investments | (2,634 | ) | (2,729 | ) | (3,679 | ) | |||||
Proceeds from distributions on other investments | 1,271 | 1,911 | 1,634 | ||||||||
Net cash used by investing activities | (37,378 | ) | (818 | ) | (27,232 | ) | |||||
Cash flows from financing activities: | |||||||||||
Proceeds from notes payable | 1,000 | 2,000 | 10,000 | ||||||||
Repayments of notes payable | (3,000 | ) | — | (10,000 | ) | ||||||
Proceeds from issuance of long-term debt | 40,000 | — | — | ||||||||
Repayment of long-term debt | (5,714 | ) | — | — | |||||||
Cash dividends paid | (16,569 | ) | (10,845 | ) | (10,249 | ) | |||||
Payments for the repurchase of common stock | (15,526 | ) | (19,387 | ) | (16,636 | ) | |||||
Payments for the issuance of equity instruments, net | (212 | ) | (2,576 | ) | (2,909 | ) | |||||
Net cash used by financing activities | (21 | ) | (30,808 | ) | (29,794 | ) | |||||
Net increase (decrease) in cash and cash equivalents | 15,586 | (3,608 | ) | (42,268 | ) | ||||||
Cash and cash equivalents, beginning of year | 6,369 | 9,977 | 52,245 | ||||||||
Cash and cash equivalents, end of year | $ | 21,955 | $ | 6,369 | $ | 9,977 | |||||
Supplemental disclosures of cash flow information: | |||||||||||
Noncash transactions: | |||||||||||
Common shares issued in connection with acquisitions | $ | 171,885 | $ | — | $ | 141,729 | |||||
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NOTE 21 - QUARTERLY CONDENSED FINANCIAL INFORMATION (Unaudited)
The following table presents unaudited quarterly financial information for the periods indicated:
2019 | |||||||||||||||
($ in thousands, except per share data) | 4th Quarter | 3rd Quarter | 2nd Quarter | 1st Quarter | |||||||||||
Interest income | $ | 77,238 | $ | 81,078 | $ | 79,201 | $ | 67,617 | |||||||
Interest expense | 15,625 | 18,032 | 17,486 | 15,274 | |||||||||||
Net interest income | 61,613 | 63,046 | 61,715 | 52,343 | |||||||||||
Provision for portfolio loan losses | 1,341 | 1,833 | 1,722 | 1,476 | |||||||||||
Net interest income after provision for loan losses | 60,272 | 61,213 | 59,993 | 50,867 | |||||||||||
Noninterest income | 14,418 | 13,564 | 11,964 | 9,230 | |||||||||||
Noninterest expense | 38,354 | 38,239 | 49,054 | 39,838 | |||||||||||
Income before income tax expense | 36,336 | 36,538 | 22,903 | 20,259 | |||||||||||
Income tax expense | 7,246 | 7,469 | 4,479 | 4,103 | |||||||||||
Net income | $ | 29,090 | $ | 29,069 | $ | 18,424 | $ | 16,156 | |||||||
Earnings per common share: | |||||||||||||||
Basic | $ | 1.10 | $ | 1.09 | $ | 0.69 | $ | 0.68 | |||||||
Diluted | 1.09 | 1.08 | 0.68 | 0.67 | |||||||||||
2018 | |||||||||||||||
($ in thousands, except per share data) | 4th Quarter | 3rd Quarter | 2nd Quarter | 1st Quarter | |||||||||||
Interest income | $ | 64,002 | $ | 60,757 | $ | 57,879 | $ | 55,164 | |||||||
Interest expense | 13,409 | 12,664 | 10,831 | 8,993 | |||||||||||
Net interest income | 50,593 | 48,093 | 47,048 | 46,171 | |||||||||||
Provision for portfolio loan losses | 2,120 | 2,263 | 390 | 1,871 | |||||||||||
Net interest income after provision for loan losses | 48,473 | 45,830 | 46,658 | 44,300 | |||||||||||
Noninterest income | 10,702 | 8,410 | 9,693 | 9,542 | |||||||||||
Noninterest expense | 30,747 | 29,922 | 29,219 | 29,143 | |||||||||||
Income before income tax expense | 28,428 | 24,318 | 27,132 | 24,699 | |||||||||||
Income tax expense | 4,899 | 1,802 | 4,881 | 3,778 | |||||||||||
Net income | $ | 23,529 | $ | 22,516 | $ | 22,251 | $ | 20,921 | |||||||
Earnings per common share: | |||||||||||||||
Basic | $ | 1.02 | $ | 0.97 | $ | 0.96 | $ | 0.91 | |||||||
Diluted | 1.02 | 0.97 | 0.95 | 0.90 | |||||||||||
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NOTE 22 - NEW AUTHORITATIVE ACCOUNTING GUIDANCE
FASB ASU 2018-13 “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” In August 2018, the FASB issued ASU 2018-13, which changes the fair value measurement disclosure requirements of ASC 820. The amendments in this ASU are the result of a broader disclosure project called FASB Concepts Statement, Conceptual Framework for Financial Reporting — Chapter 8: Notes to Financial Statements, which the Board finalized on August 28, 2018. The Board used the guidance in the Concepts Statement, including consideration of costs and benefits, to improve the effectiveness of ASC 820’s disclosure requirements. The amendments in this update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted upon issuance of this update. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this update and delay adoption of the additional disclosures until their effective date. The Company has selected the option to adopt the removal or modification of disclosures during the second quarter of 2019. The Company has evaluated the additional disclosures and does not expect them to have a material impact on its consolidated financial statements.
FASB ASU 2016-13 “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” In June 2016, the FASB issued ASU 2016-13, “Financial Instruments (Topic 326)” which changes the methodology for evaluating impairment of most financial instruments. The ASU replaces the currently used incurred loss model with a forward-looking expected loss model, which will generally result in a timelier recognition of losses. Existing PCI assets will be grandfathered and classified as PCD assets at the date of adoption. The PCD assets will be grossed up for the allowance for expected credit losses at the date of adoption and the noncredit discount will continue to be recognized in interest income based on the yield of such assets as of the adoption date. Subsequent changes in expected credit losses on PCD assets will be recorded through the allowance. The guidance becomes effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The modeling aspects of ASU 2016-13 have introduced new concepts to the Company’s modeling process, including; economic loss driver factors; a reasonable and supportable forecast period; a reversion period; and inputs necessary for a discounted cash flow analysis.
The Company expects the January 1, 2020 adoption of ASU 2016-13, on a modified retrospective basis, to increase its allowance for credit losses by 50-65%, excluding an additional $1-3 million increase in the reserve for unfunded commitments. The Company’s recent acquisitions have contributed to the increase in the allowance for credit losses under ASU 2016-13, as PCI loans typically have a fair value discount, but do not have a material reserve under the current accounting model. The Company will also record an immaterial reserve on held-to-maturity securities. As the Company is still completing its review of the model validation, control documentation and process implementation, the actual adoption impact may be different.
In December 2018, the Federal banking regulators issued guidance to address the regulatory capital impact from the adoption of ASU 2016-13. The guidance provides an option to phase in the regulatory capital impact over a three-year period. The Company is planning on adopting the capital transition relief over the permissible three-year period.
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ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A: CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, the “Act”) as of December 31, 2019. Based upon this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that as of December 31, 2019, such disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Act is accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) to allow timely decisions regarding required disclosure, and is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
Management’s Assessment of Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(e) and 15(d)-15(e) under the Act). The Company’s internal control system is a process designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements.
The Company’s internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and provide reasonable assurance regarding prevention or untimely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial reporting. Further, because of changes in conditions, the effectiveness of any system of internal control may vary over time. The design of any internal control system also factors in resource constraints and consideration for the benefit of the control relative to the cost of implementing the control. Because of these inherent limitations in any system of internal control, management cannot provide absolute assurance that all control issues and instances of fraud within the Company have been detected.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019. In making this assessment, management used the criteria set forth by the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management has concluded that the Company maintained an effective system of internal control over financial reporting based on these criteria as of December 31, 2019.
The Company’s independent registered public accounting firm, Deloitte & Touche LLP, who audited the consolidated financial statements, has issued an audit report on the Company’s internal control over financial reporting as of December 31, 2019, and it is included herein.
Changes in Internal Control Over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Act) that occurred during the Company’s quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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ITEM 9B: OTHER INFORMATION
None.
PART III
ITEM 10: DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is incorporated herein by reference to the Board and Committee Information and Executive Officer sections of the Company’s Proxy Statement for its 2020 Annual Meeting of Stockholders, which will be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
Governance:
The Company has adopted a Code of Ethics applicable to all of its directors and employees, including the principal executive officer, principal financial officer and principal accounting officer. A copy of the Code of Ethics is available on the Company’s website at www.enterprisebank.com.
ITEM 11: EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the Executive Compensation section of the Company’s Proxy Statement for its 2020 Annual Meeting of Stockholders, which will be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table provides information regarding the securities authorized for issuance under our equity compensation plans as of December 31, 2019. Additional information regarding these plans is included in “Item 8. Note 16 – Stockholders’ Equity and Compensation Plans” in this report.
EQUITY COMPENSATION PLAN INFORMATION
Plan Category | Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) | Weighted-average exercise price of outstanding options, warrants and rights (b) | Number of securities remaining available for future issuance under equity compensation plans (c) | |||||||
Equity compensation plans approved by security holders | 225,451 | $ | 10.14 | 1,311,689 | ||||||
Equity compensation plans not approved by security holders | — | — | — | |||||||
Total | 225,451 | $ | 10.14 | 1,311,689 | ||||||
(a) Includes the following:
• | 117,369 shares of common stock to be issued upon vesting of outstanding restricted stock units under the 2018 Stock Incentive Plan; |
• | 73,172 shares of common stock to be issued upon vesting of outstanding performance units under the 2018 Stock Incentive Plan; |
• | 28,300 shares of common stock to be issued upon exercise of outstanding stock options under the 2002 Stock Incentive Plan; and |
• | 6,610 shares of common stock to be issued upon deferral release of common stock under the 2018 Stock Incentive Plan and the Non-Management Director Stock Plan. |
(b) The weighted-average exercise price pertains only to the 28,300 shares under the outstanding stock options.
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(c) Includes the following:
• | 521,573 shares of common stock available for issuance under the 2018 Stock Incentive Plan; |
• | 96,031 shares of common stock available for issuance under the Non-Management Director Stock Plan; and |
• | 694,085 shares of common stock available for issuance under the 2018 Employee Stock Purchase Plan. |
Additional information required by this item is incorporated herein by reference to the Information Regarding Beneficial Ownership section of the Company’s Proxy Statement for its 2020 Annual Meeting of Stockholders, which will be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated herein by reference to the Related Person Transactions section of the Company’s Proxy Statement for its 2020 Annual Meeting of Stockholders, which will be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
ITEM 14: PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated by reference to the Fees Paid to Independent Registered Public Accounting Firm section of the Company’s Proxy Statement for its 2020 Annual Meeting of Stockholders, which will be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended.
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PART IV
ITEM 15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements
The consolidated financial statements of Enterprise Financial Services Corp and its subsidiaries and independent auditors’ reports are included in Part II, Item 8, of this Form 10-K.
2. Financial Statement Schedules
All financial statement schedules have been omitted, as they are either inapplicable or included in the Notes to Consolidated Financial Statements.
3. Exhibits
No. Description
2.1 |
2.2 |
3.1 |
3.2 |
3.3 |
3.4 |
3.5 |
3.6 |
3.7 |
3.8 |
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3.9 |
4.1+ |
4.2 | Long-term borrowing instruments are omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K. The Company undertakes to furnish copies of such instruments to the Securities and Exchange Commission upon request. |
10.1.1* |
10.1.3* |
10.1.5* |
10.1.6* |
10.1.7* |
10.1.8* |
10.1.9* |
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10.1.11* |
10.1.12* |
10.1.13* |
10.1.14* |
10.1.15* |
10.1.16* |
10.2 |
21.1+ |
23.1+ |
24.1+ |
31.1+ |
31.2+ |
32.1+ |
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32.2+ |
101+ | Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company’s Annual Report on Form 10-K for the period ended December 31, 2019, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheet at December 31, 2019 and December 31, 2018; (ii) Consolidated Statement of Income for the years ended December 31, 2019, 2018, and 2017; (iii) Consolidated Statement of Comprehensive Income for the years ended December 31, 2019, 2018, and 2017; (iv) Consolidated Statement of Changes in Equity for the years ended December 31, 2019, 2018, and 2017; (v) Consolidated Statement of Cash Flows for the years ended December 31, 2019, 2018, and 2017; and (vi) Notes to Financial Statements. |
104+ | The cover page of Enterprise Financial Services Corp’s Annual Report on Form 10-K for the year ended December 31, 2019, formatted in Inline XBRL (contained in Exhibit 101). |
* Management contract or compensatory plan or arrangement.
+ Filed herewith
Note: In accordance with Item 601(b)(4)(iii) of Regulation S-K, Registrant hereby agrees to furnish to the SEC, upon its request, a copy of any instrument that defines the rights of holders of each issue of long-term debt of Registrant and its consolidated subsidiaries for which consolidated and unconsolidated financial statements are required to be filed and that authorizes a total amount of securities not in excess of ten percent of the total assets of the Registrant on a consolidated basis.
(b) The exhibits not incorporated by reference herein are filed herewith.
(c) The financial statement schedules are either included in the Notes to Consolidated Financial Statements or omitted if inapplicable.
ITEM 16: FORM 10-K SUMMARY
None.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on February 21, 2020.
ENTERPRISE FINANCIAL SERVICES CORP
/s/ James B. Lally |
James B. Lally |
Chief Executive Officer and Director |
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Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on February 21, 2020.
Signatures | Title | |
/s/ James B. Lally | Chief Executive Officer and Director (Principal Executive Officer) | |
James B. Lally | ||
/s/ Keene S. Turner | Executive Vice President and Chief Financial Officer (Principal Financial Officer) | |
Keene S. Turner | ||
/s/ Troy R. Dumlao | Chief Accounting Officer (Principal Accounting Officer) | |
Troy R. Dumlao | ||
/s/ John S. Eulich* | ||
John S. Eulich | Chairman of the Board of Directors | |
/s/ Michael A. DeCola* | ||
Michael A. DeCola | Director | |
/s/ James F. Deutsch* | ||
James F. Deutsch | Director | |
/s/ Robert E. Guest, Jr.* | ||
Robert E. Guest, Jr. | Director | |
/s/ James M. Havel* | ||
James M. Havel | Director | |
/s/ Judith S. Heeter* | ||
Judith S. Heeter | Director | |
/s/ Michael R. Holmes* | ||
Michael R. Holmes | Director | |
/s/ Nevada A. Kent, IV* | ||
Nevada A. Kent, IV | Director | |
/s/ Anthony R. Scavuzzo* | ||
Anthony R. Scavuzzo | Director | |
/s/ Eloise E. Schmitz* | ||
Eloise E. Schmitz | Director | |
/s/ Sandra A. Van Trease* | ||
Sandra A. Van Trease | Director | |
*By: /s/ Keene S. Turner
Keene S. Turner
Attorney-In-Fact
February 21, 2020
127