Enterprise Financial Services (EFSC) 10-Q 2005 Q1 Quarterly report

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended March 31, 2005
o	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:  000-24131

ENTERPRISE FINANCIAL SERVICES CORP

(Exact Name of Registrant as Specified in its Charter)

Delaware	43-1706259
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)
150 North Meramec, Clayton, MO	63105
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s telephone number, including area code:  314-725-5500

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  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities and Exchange Act of 1934).

Yes  x No  o

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of May 4, 2005:

          Common Stock, $.01 par value---- 10,043,202 shares outstanding

ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
TABLE OF CONTENTS

	Page
PART I - FINANCIAL INFORMATION
Item 1.  Financial Statements (unaudited):
Consolidated Balance Sheets At March 31, 2005 and December 31, 2004	1
Consolidated Statements of Operations Three Months Ended March 31, 2005 and 2004	2
Consolidated Statements of Comprehensive Income Three Months Ended March 31, 2005 and 2004	3
Consolidated Statements of Cash Flows Three Months Ended March 31, 2005 and 2004	4
Notes to Consolidated Financial Statements	5
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3. Quantitative and Qualitative Disclosures About Market Risk	22
Item 4. Disclosure Control and Procedures	22
PART II - OTHER INFORMATION
Item 1 Legal Proceedings	23
Item 2 Unregistered Sale of Equity Securities and Use of Proceeds	23
Item 3 Defaults Upon Senior Securities	23
Item 4 Submission of Matters to a Vote of Securities Holders	23
Item 5 Other Information	23
Item 6. Exhibits	23
Signatures	24
Certifications	27

PART I
Item 1 – Financial Statements

ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share and per share data)

		(Unaudited)			(Audited)
	At March 31, 2005			At December 31, 2004
Assets
Cash and due from banks	$	32,085		$	28,324
Interest-bearing deposits		141			156
Investments in debt and equity securities:
Available for sale, at estimated fair value		92,572			121,630
Held to maturity, at amortized cost (estimated fair value of $8 at December 31, 2004)		—			8
Total investments in debt and equity securities		92,572			121,638
Loans held for sale		4,180			2,376
Loans, less unearned loan fees		972,802			898,505
Less: Allowance for loan losses		12,639			11,665
Loans, net		960,163			886,840
Other real estate owned		123			123
Fixed assets, net		8,413			8,044
Accrued interest receivable		4,678			4,238
Goodwill		1,938			1,938
Prepaid expenses and other assets		6,289			6,273
Total assets	$	1,110,582		$	1,059,950
Liabilities and Shareholders' Equity
Deposits:
Demand	$	190,667		$	197,283
Interest-bearing transaction accounts		91,512			85,523
Money market accounts		424,749			432,340
Savings		4,352			3,919
Certificates of deposit:
$100 and over		183,979			178,851
Other		41,534			41,712
Total deposits		936,793			939,628
Subordinated debentures		20,620			20,620
Federal Home Loan Bank advances		68,879			10,299
Other borrowings		2,303			9,616
Notes payable		—			250
Accrued interest payable		1,367			1,665
Accounts payable and accrued expenses		3,896			5,146
Total liabilities		1,033,858			987,224
Shareholders' equity:
Common stock, $.01 par value; authorized 20,000,000 shares; issued and outstanding 10,032,252 shares at March 31, 2005 and 9,778,357 at December 31, 2004.		100			98
Additional paid in capital		46,107			41,326
Unearned compensation		(1,993	)		—
Retained earnings		34,172			32,075
Accumulated other comprehensive loss		(1,662	)		(773	)
Total shareholders' equity		76,724			72,726
Total liabilities and shareholders' equity	$	1,110,582		$	1,059,950

See accompanying notes to consolidated financial statements.

1

ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
(In thousands, except share and per share data)

	Three months ended March 31,
	2005		2004
Interest income:
Interest and fees on loans	$	13,887	$	10,457
Interest on debt and equity securities:
Taxable		716		409
Nontaxable		10		10
Interest on federal funds sold		11		48
Dividends on equity securities		29		20
Total interest income		14,653		10,944
Interest expense:
Interest-bearing transaction accounts		151		39
Money market accounts		1,779		859
Savings		5		3
Certificates of deposit:
$100 and over		1,255		861
Other		274		264
Subordinated debentures		260		317
Federal Home Loan Bank borrowings		377		185
Notes payable and other borrowings		30		26
Total interest expense		4,131		2,554
Net interest income		10,522		8,390
Provision for loan losses		786		597
Net interest income after provision for loan losses		9,736		7,793
Noninterest income:
Service charges on deposit accounts		483		457
Wealth Management income		1,223		856
Other service charges and fee income		109		97
Gain on sale of mortgage loans		22		68
Gain on sale of securities		—		1
Total noninterest income		1,837		1,479
Noninterest expense:
Employee compensation and benefits		5,198		4,689
Occupancy		530		496
Furniture and equipment		172		182
Data processing		224		185
Other		1,593		1,318
Total noninterest expense		7,717		6,870
Income before income tax expense		3,856		2,402
Income tax expense		1,409		875
Net income	$	2,447	$	1,527
Per share amounts:
Basic earnings per share	$	0.25	$	0.16
Basic weighted average common shares outstanding		9,921,762		9,640,145
Diluted earnings per share	$	0.23	$	0.15
Diluted weighted average common shares outstanding		10,520,844		9,942,143

See accompanying notes to consolidated financial statements.

2

ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (unaudited)
(In thousands)

	Three months ended March 31,
	2005			2004
Net income	$	2,447		$	1,527
Other comprehensive (loss) income:
Unrealized (loss) gain on investment securities arising during the period, net of tax		(663	)		60
Less reclassification adjustment for realized gain on sale of securities included in net income, net of tax		—			(1	)
Unrealized (loss) gain on cash flow type derivative instruments arising during the period, net of tax		(226	)		31
Total other comprehensive (loss) income		(889	)		90
Total comprehensive income	$	1,558		$	1,617

See accompanying notes to consolidated financial statements.

3

ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
(In thousands)

	Three months ended March 31
	2005			2004
Cash flows from operating activities:
Net income	$	2,447		$	1,527
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		258			251
Provision for loan losses		786			597
Net amortization of debt and equity securities		129			67
Gain on sale of available for sale investment securities		—			(1	)
Mortgage loans originated		(12,765	)		(13,194	)
Proceeds from mortgage loans sold		10,983			13,466
Gain on sale of mortgage loans		(22	)		(68	)
Noncash compensation for stock option grants and restricted share units		191			50
Tax benefit for nonqualified stock options		249			—
(Increase) decrease in accrued interest receivable		(440	)		459
Decrease in accrued interest payable		(298	)		(130	)
Decrease in accrued salaries payable		(1,840	)		(1,756	)
Other, net		719			418
Net cash provided by operating activities		397			1,686
Cash flows from investing activities:
Net increase in loans		(74,300	)		(48,258	)
Purchases of available for sale debt and equity securities		(3,637	)		(10,601	)
Proceeds from sales of available for sale debt securities		9,995			37,753
Proceeds from redemption of equity securities		106			620
Proceeds from maturities and principal paydowns on available for sale debt and equity securities		21,437			4,798
Recoveries of loans previously charged off		191			34
Purchases of fixed assets		(626	)		(158	)
Net cash used in investing activities		(46,834	)		(15,814	)
Cash flows from financing activities:
Net (decrease) increase in non-interest bearing deposit accounts		(6,616	)		6,224
Net increase in interest bearing deposit accounts		3,780			58,017
Proceeds from Federal Home Loan Bank advances		146,300			15,000
Repayments of Federal Home Loan Bank advances		(87,720	)		(15,031	)
Decrease in federal funds purchased		(6,333	)		(8,381	)
Decrease in customer repurchase agreements		(979	)		—
Decrease in other borrowings		—			(279	)
Paydowns of notes payable		(250	)		—
Cash dividends paid		(350	)		(242	)
Proceeds from the exercise of common stock options		2,351			342
Net cash provided by financing activities		50,183			55,650
Net increase in cash and cash equivalents		3,746			41,522
Cash and cash equivalents, beginning of period		28,480			26,488
Cash and cash equivalents, end of period	$	32,226		$	68,010
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	4,429		$	2,684
Income taxes		161			—
Noncash transactions:
Transfer to other real estate owned in settlement of loans		—			653

See accompanying notes to consolidated financial statements.

4

ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements

NOTE 1 –  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Financial Statement Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  They do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements.  The accompanying consolidated financial statements of Enterprise Financial Services Corp and subsidiaries (the “Company”) are unaudited and should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.  Enterprise Financial Services Corp (the “Company”) is a financial holding company that provides a full range of banking services to individual and corporate customers located in the St. Louis and Kansas City metropolitan markets through its subsidiary, Enterprise Bank & Trust (the “Bank”).  In the opinion of management, all adjustments consisting of normal recurring accruals considered necessary for a fair presentation of the results of operations for the interim periods presented herein have been included.  Operating results for the three months ended March 31, 2005 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2005.  The consolidated financial statements include the accounts of the Company.  All significant intercompany accounts and transactions have been eliminated.

Certain amounts in the consolidated financial statements for the year ended December 31, 2004 and the three months ended March 31, 2004 have been reclassified to conform to the 2005 presentation.  Such reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.

5

Stock Options Plans

The Company applies the intrinsic-value-based method of accounting proscribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25,  issued in March 2000, to account for its fixed-plan stock options.  Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price.  SFAS No. 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans.  As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of FASB Statement No. 123.  The following table illustrates the effect on net income if the fair-value-based method had been applied to all outstanding and unvested awards in each period.

	Three months ended March 31,
(In thousands, except per share data)	2005			2004
Net income, as reported	$	2,447		$	1,527
Add total stock-based employee compensation expense included in reported net income, net of tax		117			—
Deduct total stock-based employee compensation expense determined under fair-value-based method for all awards, net of tax		(118	)		(346	)
Pro forma net income	$	2,446		$	1,181
Earnings per share:
Basic:
As reported	$	0.25		$	0.16
Pro forma		0.25			0.12
Diluted:
As reported	$	0.23		$	0.15
Pro forma		0.23			0.12

New Accounting Standards

On March 1, 2005, the Board of Governors of the Federal Reserve System, or Board, adopted a final rule, Risk-Based Capital Standards: Trust Preferred Securities and the Definition of Capital, that allows for the continued limited inclusion of trust preferred securities in Tier 1 capital.  The Board’s final rule limits restricted core capital elements to 25% of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability.  Amounts of restricted core capital elements in excess of these limits may generally be included in Tier 2 capital.  Amounts of qualifying trust preferred securities and cumulative perpetual preferred stock in excess of the 25% limit may be included in Tier 2 capital, but limited, together with subordinated debt and limited-life preferred stock, to 50% of Tier 1 capital.  In addition, the final rule provides that in the last five years before the maturity of the underlying subordinated note, the outstanding amount of the associated trust preferred securities is excluded from Tier 1 capital and included in Tier 2 capital, subject to one-fifth amortization per year.  The final rule provides for a five-year transition period, ending March 31, 2009, for the application of the quantitative limits.  Until March 31, 2009, the aggregate amount of qualifying cumulative perpetual preferred stock and qualifying trust preferred securities that may be included in Tier 1 capital is limited to 25% of the sum of the following core capital elements: qualifying common stockholders’ equity, qualifying noncumulative and cumulative perpetual preferred stock, qualifying minority interest in the equity accounts of consolidated subsidiaries and qualifying trust preferred securities.  The Company has evaluated the impact of the final rule on the Company’s financial condition and results of operations, and determined the implementation of the Board’s final rule, as adopted, will not have a material impact on the Company’s regulatory capital ratios.

6

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), Share-Based Payment (“SFAS No. 123(R)”).  SFAS No. 123(R) replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees.  SFAS No. 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award. 

The accounting provisions of SFAS 123(R) are effective for annual reporting periods beginning after June 15, 2005, therefore, the Company will be required to adopt SFAS 123R in the first quarter of fiscal 2006. The pro forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. See Note 1 in our Notes to Consolidated Financial Statements for the pro forma net income and net income per share amounts, for the quarters ended March 31, 2005, and March 31, 2004, as if we had used a fair-value-based method similar to the methods required under SFAS 123R to measure compensation expense for employee stock incentive awards.  The Company expects the implementation of SFAS 123R will have no material effect on the Company’s consolidated financial position or results of operations.

In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on criteria to evaluate whether to record a loss and disclose additional information about unrealized losses relating to debt and equity securities under EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The consensus applies to investments in debt and marketable equity securities that are accounted under SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, and SFAS 124, Accounting for Certain Investments Held by Not-for-Profit Organizations. The Consensus divides the procedures into three sequential steps. The Company first determines whether the investment is impaired. If so, the next step is to determine whether the impairment is other-than-temporary. If it is other-than-temporary, the third step is to recognize the impairment loss in earnings. An investment is impaired if its fair value is less than its carrying value, and an impairment is other-than-temporary if the investor does not have the “ability and intent” to hold the investment until a forecasted recovery of its carrying amount. The loss recognized from an other-than-temporary impairment should equal the difference between the investment’s carrying value and its quoted market price. This establishes a new cost basis for the investment. The EITF has proposed a delay in the effective date of the requirement to record impairment losses caused by the effect of increases in interest rates on investments. The EITF is also determining how to assess the severity of the impairment as well as the effect of selling investments on the Company’s ability and intent to hold other securities until a forecasted recovery of fair value. Consequently, we are currently awaiting additional guidance from the EITF on EITF Issue No. 03-1 and are presently unable to determine its overall impact on our consolidated financial statements or results of operations.

In December 2003, the Accounting Standards Executive Committee, (“AcSEC”) issued SOP 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer, effective for loans acquired in fiscal years beginning after December 15, 2004.  The scope of SOP 03-3 applies to “problem” loans that have been acquired, either individually in a portfolio, or in an acquisition.  These loans must have evidence of credit deterioration and the purchaser must not expect to collect contractual cash flows. SOP 03-3 updates Practice Bulletin (PB) No. 6, Amortization of Discounts on Certain Acquired Loans, for more recently issued literature, including FASB Statements No. 114, Accounting by Creditors for Impairment of a Loan; No. 115, Accounting for Certain Investments in Debt and Equity Securities; and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinquishments of Liabilities.  Additionally, it addresses FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, which requires that discounts be recognized as an adjustment of yield over a loan’s life.

SOP 03-3 states that an institution may no longer display discounts on purchased loans within the scope of SOP 03-3 on the balance sheet and may not carry over the allowance for loan losses.  For those loans within the scope of SOP 03-3, this statement clarifies that a buyer cannot carry over the seller’s allowance for loan losses for the acquisition of loans with credit deterioration.  Loans acquired with evidence of deterioration in credit quality since origination will need to be accounted for under a new method using an income recognition model. This prohibition also applies to purchases of problem loans not included in a purchase business combination, which would include syndicated loans purchased in the secondary market and loans acquired in portfolio sales.  This guidance did not have a material effect on the Company’s consolidated financial position or results of operations.

7

NOTE 2 – EARNINGS PER SHARE

The following table shows the components of basic and diluted earnings per share (in thousands, except share and per share data) for the three months ended March 31, 2005 and 2004.

	Three months ended March 31,
	2005		2004
Basic
Net income	$	2,447	$	1,527
Weighted average common shares outstanding		9,921,762		9,640,145
Basic earnings per share	$	0.25	$	0.16
Diluted
Net income	$	2,447	$	1,527
Weighted average common shares outstanding		9,921,762		9,640,145
Effect of dilutive stock options and restricted share units (1)		599,082		301,998
Diluted weighted average common shares outstanding		10,520,844		9,942,143
Diluted earnings per share	$	0.23	$	0.15

(1) Represents average shares outstanding which would have resulted from the exercise of dilutive stock options and issuance of restricted share units.

8

NOTE 3 - SEGMENT DISCLOSURE

Following are the financial results and balance sheet information for the Company’s operating segments as of March 31, 2005 and December 31, 2004, and for the three months ended March 31, 2005 and 2004 (in thousands) (unaudited):

Balance Sheet Information:	Banking		Wealth Management		Corporate, Intercompany, and Reclassifications			Total
March 31, 2005
Loans, less unearned loan fees	$	972,802	$	—	$	—		$	972,802
Goodwill		1,938		—		—			1,938
Deposits		937,616		—		(823	)		936,793
Borrowings		71,182		—		20,620			91,802
Total assets	$	1,109,144	$	—	$	1,438		$	1,110,582
December 31, 2004
Loans, less unearned loan fees	$	898,505	$	—	$	—		$	898,505
Goodwill		1,938		—		—			1,938
Deposits		939,784		—		(156	)		939,628
Borrowings		19,914		—		20,870			40,784
Total assets	$	1,058,538	$	—	$	1,412		$	1,059,950

Income Statement Information:	Banking		Wealth Management		Corporate, Intercompany, and Reclassifications			Total
Three months ended March 31, 2005
Net interest income	$	10,757	$	19	$	(254	)	$	10,522
Provision for loan losses		786		—		—			786
Noninterest income		606		1,223		8			1,837
Noninterest expense		5,819		1,111		787			7,717
Income (loss) before income tax expense		4,758		131		(1,033	)		3,856
Income tax expense (benefit)		1,734		48		(373	)		1,409
Net income (loss)	$	3,024	$	83	$	(660	)	$	2,447
Three months ended March 31, 2004
Net interest income	$	8,678	$	19	$	(307	)	$	8,390
Provision for loan losses		597		—		—			597
Noninterest income		615		856		8			1,479
Noninterest expense		5,411		873		586			6,870
Income (loss) before income tax expense		3,285		2		(885	)		2,402
Income tax expense (benefit)		1,197		1		(323	)		875
Net income (loss)	$	2,088	$	1	$	(562	)	$	1,527

Management segregates the Company into three distinct businesses for evaluation purposes.  The three segments are Banking, Wealth Management and Corporate.  The segments are evaluated separately on their individual performance, as well as, their contribution to the Company as a whole. 

The majority of the Company’s assets and income result from the Banking segment.  The Bank consists of three banking branches and an operations center in the St. Louis County area and two banking branches in the Kansas City region.  The products and services offered by the banking branches include a broad range of commercial and personal banking services, including certificates of deposit, individual retirement and other time deposit accounts, checking and other demand deposit accounts, interest checking accounts, savings accounts and money market accounts.  Loans include commercial, financial, real estate construction and development, commercial and residential real estate, consumer and installment loans.  Other financial services include mortgage banking, debit and credit cards, automatic teller machines, internet account access, safe deposit boxes, and treasury management services. 

9

Wealth Management provides fee-based personal and corporate financial consulting and trust services.  Personal financial consulting includes estate planning, investment management, and retirement planning.  Corporate consulting services are focused in the areas of retirement plans, management compensation and strategic planning issues.

The Corporate, Intercompany, and Reclassifications segment includes the holding company, merchant banking investments, and subordinated debentures.  The Company incurs general corporate expenses and owns the Bank.

NOTE 4 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The Company utilizes interest rate swap derivatives as one method to manage some of its interest rate risks from recorded financial assets and liabilities. These derivatives are utilized when they can be demonstrated to effectively hedge a designated asset or liability and such asset or liability exposes the Bank to interest rate risk. 

The Bank accounts for its derivatives under Statement of Financial Accounting Standards (SFAS) No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities and SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities.  These Standards require recognition of all derivatives as either assets or liabilities in the balance sheet and require measurement of those instruments at fair value through adjustments to either the other comprehensive income, current earnings, or both, as appropriate.

The decision to enter into an interest rate swap is made after considering the asset/liability mix of the Bank, the desired asset/liability sensitivity and by interest rate levels.  Prior to entering into a hedge transaction, the Bank formally documents the relationship between hedging instruments and hedged items, as well as the risk management objective for undertaking the various hedge transactions.

The following is a summary of the Company’s accounting policies for derivative instruments and its activities under SFAS No. 149 and SFAS No. 133.

Cash Flow Hedges – The Bank enters into interest rate swap agreements to convert floating-rate loan assets to fixed rates. The swap agreements provide for the Bank to pay a variable rate of interest equivalent to the prime rate and to receive a fixed rate of interest.  Under the swap agreements the Bank is to pay or receive interest quarterly.  Amounts to be paid or received under these swap agreements are accounted for on an accrual basis and recognized as interest income of the related asset.  The net cash flows related to cash flow hedges increased interest income on loans by $12,000 and $321,000 during the three months ended March 31, 2005 and 2004, respectively.   Increasing prime rates cause interest income from these interest rate swaps to decrease.  In addition, a $20 million swap under which the Bank received a fixed rate of 6.97% matured in late January 2005.

Cash flow hedges are accounted for at fair value.   The effective portion of the change in the cash flow hedge’s gain or loss is reported as a component of other comprehensive income net of taxes.  The ineffective portion of the change in the cash flow hedge’s gain or loss is recorded in earnings on each quarterly measurement date.  At March 31, 2005 and December 31, 2004, $573,000 and $347,000, respectively, in deferred losses, net of tax, related to cash flow hedges were recorded in accumulated other comprehensive income.  All cash flow hedges were effective; therefore, no gain or loss was recorded in earnings.  The maximum term over which the Bank is hedging its exposure to the variability of future cash flows is approximately 1 year. 

Fair Value Hedges - The Bank enters into interest rate swap agreements with the objective of converting the fixed interest rate on brokered CDs to a variable interest rate.  The swap agreements provide for the Bank to pay a variable rate of interest based on a spread to the three-month London Interbank Offered Rate (LIBOR) and to receive a fixed rate of interest equal to that of the brokered CD (hedged instrument.) Under the swap agreements the Bank is to pay or receive interest semiannually.  Amounts to be paid or received under these swap agreements are accounted for on an accrual basis and recognized as interest income or expense of the related liability.   The net cash flows related to fair value hedges increased interest expense on certificates of deposit by $56,000 during the three months ended March 31, 2005.  For the same period in 2004, the net cash flows related to fair value hedges decreased interest expense on certificates of deposit by $177,000. 

10

Fair value hedges are accounted for at fair value.   The swaps qualify for the “shortcut method” under SFAS No. 133.   Based on this shortcut method, no ineffectiveness is assumed.  As a result, changes in the fair value of the swaps directly offset changes in the fair value of the underlying hedged item (i.e., brokered CDs).  All changes in fair value are measured on a quarterly basis.  

The maturity dates, notional amounts, interest rates paid and received and fair value of our interest rate swap agreements as of March 31, 2005 and December 31, 2004 were as follows:

Cash Flow Hedges	March 31, 2005			December 31, 2004
	(Dollars in thousands)
Notional amount	$	70,000		$	90,000
Weighted average pay rate		5.75	%		5.25	%
Weighted average receive rate		5.39	%		5.74	%
Weighted average maturity in months		13			12
Unrealized loss related to interest rate swaps	$	(879	)	$	(511	)

Fair Value Hedges	March 31, 2005			December 31, 2004
	(Dollars in thousands)
Notional amount	$	30,000		$	40,000
Weighted average pay rate		2.90	%		2.60	%
Weighted average receive rate		2.55	%		2.34	%
Weighted average maturity in months		16			14
Unrealized loss related to interest rate swaps	$	(575	)	$	(415	)

NOTE 5 - DISCLOSURES ABOUT FINANCIAL INSTRUMENTS

The Bank issues financial instruments with off balance sheet risk 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 Bank’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 represented by the contractual amount of these instruments.  The Bank uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets.  At March 31, 2005 and December 31, 2004, no amounts have been accrued for any estimated losses for these financial instruments.

The contractual amount (in thousands) of off-balance-sheet financial instruments as of March 31, 2005 and December 31, 2004 is as follows:

	March 31, 2005		December 31, 2004
Commitments to extend credit	$	299,034	$	296,561
Standby letters of credit		21,018		20,263

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 generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since certain of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Bank evaluates each customer’s credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Bank 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.

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Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.  These standby letters of credit are primarily issued to support contractual obligations of the Bank’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 terms of standby letters of credit range from 1 month to 5 years at March 31, 2005.

Item 2 – Management’s Discussion and Analysis of
Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, including the audited financial statements contained therein, filed with the Securities and Exchange Commission.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

Readers should note that in addition to the historical information contained herein, some of the information in this report contains forward-looking statements within the meaning of the federal securities laws.  Forward-looking statements typically are identified with use of terms such as “may,” “will,” “expect,” “anticipate,” “estimate” and similar words, although some forward-looking statements are expressed differently.  You should be aware that the Company’s actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including burdens imposed by federal and state regulation of banks, credit risk, availability of capital to fund the expansion of the Company’s business, exposure to local economic conditions, risks associated with rapid increase or decrease in prevailing interest rates, critical accounting policies and competition from banks and other financial institutions, all of which could cause the Company’s actual results to differ from those set forth in the forward-looking statements.  The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

Overview

This discussion describes significant changes in the financial condition of the Company that have occurred during the first quarter of 2005 compared to December 31, 2004.  In addition, this discussion summarizes the significant factors affecting the consolidated results of operations, liquidity and cash flows of the Company for the three months ended March 31, 2005 compared to the three months ended March 31, 2004.  This discussion should be read in conjunction with the unaudited financial statements and accompanying notes presented in Part I, Item 1 of this report. 

The first quarter of 2005 reflected continued growth in both the Banking and Wealth Management segments.   The increasing interest rate environment had a favorable effect on the Company’s net interest income as rates on interest-bearing assets rose.  In addition, the Company experienced significant loan growth as a result of continued efforts of the relationship officers in obtaining new and expanding existing relationships.  However, rising rates also caused the costs of funds to increase on most of the Company’s deposit products. 

The Company continued to develop and expand fee income opportunities.  Wealth Management income increased 43% from $856,000 in the first quarter of 2004 to $1.2 million in the first quarter of 2005.   

Results of Operations

Net income for the three months ended March 31, 2005 was $2.4 million, up 60% compared to the three months ended March 31 2004 of $1.5 million.  Earnings per fully diluted share increased 53% to $0.23 per fully diluted share for the first quarter 2005 compared to $0.15 per fully diluted share in the first quarter 2004.   Basic earnings per share for the first quarter 2005 were $0.25 compared to $0.16 for the same period in 2004. 

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Financial Condition

Total assets increased $51 million, or 5% from $1.06 billion at December 31, 2005 to $1.11 billion at March 31, 2005.  Since December 31, 2004, loans and leases, net of unearned loan fees, have increased $74 million, or 8% from $899 million to $973 million.  The growth in loans was funded by $29 million of short-term discount notes that matured and were not replaced and short-term advances from the Federal Home Loan Bank (“FHLB”).

Total deposits at March 31, 2005 were $937 million, a decrease of $3 million over total deposits of $940 million at December 31, 2004.  Historically, deposits decline in the first quarter due to seasonal cash demands of our deposit client base.  In the first quarter of 2004, a new client relationship deposited $30 million, which offset most of the seasonal reduction of deposits.  During first quarter 2005, the Bank executed $30 million of brokered certificates of deposits, a net increase of $10 million from year-end. 

FHLB advances were $69 million at March 31, 2005.  This is a $51 million increase over December 31, 2004.  The new advances have less than one-month maturities and were used to temporarily fund loan growth until replaced with core deposits.  Management considers these advances from the FHLB an attractive alternative to higher-priced certificates of deposit or term fed funds.

Total shareholders’ equity was $77 million at March 31, 2005 compared to $73 million at December 31, 2004.  The $4 million increase in equity is due to net income of $2.4 million for the three months ended March 31, 2005 and the exercise of incentive stock options by employees offset by dividends paid to shareholders and changes in accumulated other comprehensive income.

Net Interest Income

Net interest income, the most significant component of the Company’s earnings, is the difference between interest income earned on loans, investment securities and other interest-earning assets less interest expense on deposit accounts and other interest-bearing liabilities.  The level of net interest income is determined by the mix and volume of interest-earning assets, interest-bearing deposits and borrowed funds, and by changes in interest rates.  Business volumes are influenced by overall economic factors including inflation, market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.  Net interest rate margin represents net interest income on a tax equivalent basis as a percentage of average interest-earning assets during the period.  Net interest rate margin is affected by the spread between average yields earned on interest-earning assets and the average rates paid on interest-bearing deposits and borrowings.  The level of non-interest bearing funds, primarily consisting of demand deposits and stockholders’ equity, also affects the net interest rate margin.

Net interest income (on a tax-equivalent basis) was $10.7 million for the three months ended March 31, 2005, compared to $8.5 million for the same period of 2004, an increase of 25%.  Average interest-earning assets increased $153 million, or 17% to $1.035 billion at March 31, 2005 compared to $882 million at March 31, 2004.  Average interest-bearing liabilities increased $118 million, or 17% to $804 million at March 31, 2005 compared to $685 million at March 31, 2004.

Net interest rate margin (on a tax-equivalent basis) was 4.18% for the first quarter of 2005, up from 3.88% in the first quarter of 2004.   The increase in net interest rate margin reflects a 75 basis point increase in yields on average interest-earning assets and a 58 basis point increase in the costs of average interest-bearing liabilities.  The increase in average interest-earning asset yields was the result of prime rate increases in the latter half of 2004 and first quarter of 2005.  Approximately two-thirds of the Company’s loan portfolio floats with the prime rate.  The increase in cost of funds was primarily due to increases in money market and certificate of deposit rates.

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The following table sets forth, on a tax-equivalent basis, information relating to the Company’s average balance sheet and reflects the average yield earned on interest-earning assets, the average cost of interest-bearing liabilities and the resulting net interest spread and net interest rate margin for the three months ended March 31, 2005 and 2004.

	Three months ended March 31,
	2005											2004
(Dollars in thousands)	Average Balance			Percent of Total Assets			Interest Income/ Expense		Average Yield/ Rate			Average Balance			Percent of Total Assets			Interest Income/ Expense		Average Yield/ Rate
Assets
Interest-earning assets:
Taxable loans (1)	$	916,978			85.25	%	$	13,645		6.03	%	$	786,373			85.45	%	$	10,241		5.24	%
Tax-exempt loans(2)		17,655			1.64			377		8.66			17,156			1.86			327		7.67
Total loans		934,633			86.89			14,022		6.08			803,529			87.31			10,568		5.29
Taxable investments in debt and equity securities		96,132			8.94			746		3.15			54,632			5.94			429		3.16
Non-taxable investments in debt and equity securities(2)		1,585			0.15			16		4.09			1,653			0.18			15		3.65
Short-term investments		2,176			0.20			11		2.05			21,715			2.36			49		0.91
Total securities and short-term investments		99,893			9.29			773		3.14			78,000			8.48			493		2.54
Total interest-earning assets		1,034,526			96.18			14,795		5.80			881,529			95.79			11,061		5.05
Non-interest-earning assets:
Cash and due from banks		33,263			3.09								28,089			3.05
Other assets		20,030			1.86								21,519			2.34
Allowance for loan losses		(12,144	)		(1.13	)							(10,823	)		(1.18	)
Total assets	$	1,075,675			100.00	%						$	920,314			100.00	%
Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest-bearing transaction accounts	$	85,071			7.91	%	$	151		0.72	%	$	55,605			6.04	%	$	39		0.28	%
Money market accounts		414,926			38.57			1,779		1.74			373,028			40.53			859		0.93
Savings		4,198			0.39			5		0.48			4,235			0.46			3		0.28
Certificates of deposit		224,690			20.89			1,529		2.76			212,828			23.13			1,126		2.13
Total interest-bearing deposits		728,885			67.76			3,464		1.93			645,696			70.16			2,027		1.26
Subordinated debentures		20,620			1.92			260		5.11			15,464			1.68			316		8.22
Borrowed funds		54,191			5.04			407		3.05			24,250			2.63			211		3.50
Total interest-bearing liabilities		803,696			74.72			4,131		2.08			685,410			74.38			2,554		1.50
Noninterest-bearing liabilities:
Demand deposits		191,024			17.76								163,103			17.72
Other liabilities		5,916			0.55								5,719			0.72
Total liabilities		1,000,636			93.03								854,232			92.82
Shareholders' equity		75,039			6.98								66,082			7.18
Total liabilities & shareholders' equity	$	1,075,675			100.00	%						$	920,314			100.00	%
Net interest income							$	10,664										$	8,507
Net interest spread										3.72	%										3.55	%
Net interest rate margin(3)										4.18	%										3.88	%

(1)	Average balances include non-accrual loans.  The income on such loans is included in interest but is recognized only upon receipt. Loan fees included in interest income are approximately $189,000 and $133,000 for the quarters ended March 31, 2005 and 2004, respectively.
(2)	Non-taxable income is presented on a fully tax-equivalent basis assuming a tax rate of 36% for 2005 and 34% for 2004.  The approximate tax-equivalent adjustments were $141,000 and $116,000 for the quarters ended March, 2005 and 2004, respectively.
(3)	Net interest income divided by average total interest-earning assets.

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The following table sets forth, on a tax equivalent basis, a summary of the changes in interest income and interest expense resulting from changes in yield/rates and volume for the three months ended March 31, 2005 and 2004.

	2005 Compared to 2004 Increase (decrease) Due to
	Volume(1)			Rate(2)			Net
	(Dollars in thousands)
Interest earned on:
Loans	$	1,777		$	1,627		$	3,404
Nontaxable loans (3)		9			41			50
Taxable investments in debt and equity securities		318			(1	)		317
Nontaxable investments in debt and equity securities (3)		(1	)		2			1
Short-term investments		(67	)		29			(38	)
Total interest-earning assets	$	2,036		$	1,698		$	3,734
Interest paid on:
Interest-bearing transaction accounts	$	28		$	84		$	112
Money market accounts		105			815			920
Savings		—			2			2
Certificates of deposit		63			340			403
Subordinated debentures		84			(140	)		(56	)
Borrowed funds		226			(30	)		196
Total interest-bearing liabilities		506			1,071			1,577
Net interest income	$	1,530		$	627		$	2,157

(1)	Change in volume multiplied by yield/rate of prior period.
(2)	Change in yield/rate multiplied by volume of prior period.
(3)	Nontaxable income is presented on a fully tax-equivalent basis assuming a tax rate of 36% in 2005 and 34% in 2004.
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.

15

Provision for Loan Losses

The provision for loan losses is affected by changes in the loan portfolio, management’s assessment of the collectability of the loan portfolio, loss experience and economic and market factors.  A description of the process used to determine the loan loss provision is below.  The allowance for loan losses as a percentage of total loans was 1.30% at March 31, 2005 compared to 1.30% at December 31, 2004 and 1.29% at March 31, 2004.   At March 31, 2005, three relationships comprised $2.2 million, or 71% of the non-performing loans.  The remaining non-performing loans represented four different relationships.  At March 31, 2004, two relationships comprised $1.1 million, or 77% of the non-performing loans.  One of the relationships was foreclosed and sold in first quarter 2005.  The Company recovered $73,000 on the property.  In March 2005, the Company also recovered $92,000 on a loan previously charged off. 

The following table summarizes changes in the allowance for loan losses for the three months ended March 31, 2005 and 2004.

	Three months ended March 31,
	2005			2004
	(Dollars in thousands)
Allowance at beginning of period	$	11,665		$	10,590
Loans charged off:
Commercial and industrial		3			—
Real estate:
Commercial		—			427
Construction		—			—
Residential		—			100
Consumer and other		—			8
Total loans charged off		3			535
Recoveries of loans previously charged off:
Commercial and industrial		20			9
Real estate:
Commercial		73			—
Construction		—			—
Residential		94			16
Consumer and other		4			9
Total recoveries of loans previously charged off:		191			34
Net loans (recovered) charged off		(188	)		501
Provision for loan losses		786			597
Allowance at end of period	$	12,639		$	10,686
Average loans	$	934,633		$	803,529
Total loans		972,802			830,948
Non-performing loans		3,134			1,480
Net (recoveries) charge-offs to average loans (annualized)		(0.08	)%		0.25	%
Allowance for loan losses to loans		1.30			1.29
Allowance for loan losses to non-performing loans		403			722

The Company’s credit management policies and procedures focus on identifying, measuring, and controlling credit exposure.  These procedures employ a lender-initiated system of rating credits, which is ratified in the loan approval process and subsequently tested in internal loan reviews and regulatory bank examinations. The system requires rating all loans at the time they are made, and at each renewal date.

Adversely rated credits, including loans requiring close monitoring, which would normally not be considered criticized credits by regulators, are included on a monthly loan watch list. Other loans are added whenever any adverse circumstances are detected which might affect the borrower’s ability to meet the terms of the loan.  This could be initiated by any of the following:

1)	delinquency of a scheduled loan payment;
2)	deterioration in the borrower’s financial condition identified in a review of periodic financial statements;
3)	decrease in the value of collateral securing the loan; or
4)	change in the economic environment in which the borrower operates.

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Loans on the watch list require detailed loan status reports, including recommended corrective actions, prepared by the responsible loan officer every three months.  These reports are then discussed in formal meetings with the Chief Credit Officer and Chief Executive Officer of the Bank.

Downgrades of loan risk ratings may be initiated by the responsible loan officer, internal loan review, or the credit analyst department at any time.  Upgrades of risk ratings may only be made with the concurrence of the Chief Credit Officer and Loan Review.

In determining the allowance and the related provision for loan losses, three principal elements are considered:

• specific allocations based upon probable losses identified during a monthly review of the loan portfolio;

• allocations based principally on the Company’s risk rating formulas; and

• an unallocated allowance based on subjective 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 collateral exposure, if they are collateral dependent for collection.  Otherwise, discounted cash flows are estimated and used to assign loss.

The second element reflects the application of the Company’s loan rating system.  This rating system is similar to those employed by state and federal banking regulators.  Loans are rated and assigned a loss allocation factor for each category that is consistent with our historical losses, adjusted for environmental factors.  The higher the rating assigned to a loan, the greater the allocation percentage that is applied.

The unallocated allowance is based on management’s evaluation of conditions that are not directly reflected in the determination of the formula and specific allowances.  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 or portfolio segments.  The conditions evaluated in connection with the unallocated allowance include the following:

• general economic and business conditions affecting our key lending areas;

• credit quality trends (including trends in nonperforming loans expected to result from existing conditions);

• collateral values;

• loan volumes and concentrations;

• competitive factors resulting in shifts in underwriting criteria;

• specific industry conditions within portfolio segments;

• recent loss experience in particular segments of the portfolio;

• bank regulatory examination results; and

• findings of our internal loan review department.

Executive management reviews these conditions quarterly in discussion with the entire lending staff.  To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment 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 portfolio segment.  Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the probable loss related to such condition is reflected in the unallocated allowance.

Based on this quantitative and qualitative analysis, provisions are made to the allowance for loan losses.  Such provisions are reflected in the Company’s consolidated statements of income.

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, designed to assess the adequacy of the allowance for loan losses, 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,

17

and historical losses on each portfolio category.  Because each of the criteria used is subject to change, the allocation of the allowance for loan losses is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category.  The total allowance is available to absorb losses from any segment of the portfolio.  Management continues to target and maintain the allowance for loan losses equal to the allocation methodology plus an unallocated portion, as determined by economic conditions and other qualitative and quantitative factors affecting the Company’s borrowers, as described above.

Prior to 2004, the methods of calculating the allowance requirements had not changed significantly over time. The reallocations among different categories of loans that appear between periods were the result of the redistribution of the individual loans that comprise the aggregate portfolio due to the factors listed above.  However, the perception of risk with respect to particular loans within the portfolio will change over time as a result of the characteristics and performance of those loans, overall economic and market trends, and the actual and expected trends in nonperforming loans.  Consequently, while there are no specific allocations of the allowance resulting from economic or market conditions or actual or expected trends in nonperforming loans, these factors are considered in the initial assignment of risk ratings to loans, subsequent changes to those risk ratings and to a lesser extent in the size of the unallocated reserve amount.

The Bank had no loans 90 days past due still accruing interest at March 31, 2005 or December 31, 2004. The following table sets forth information concerning the Company’s non-performing assets as of the dates indicated:

	March 31, 2005			December 31, 2004
	(Dollars in thousands)
Non-accrual loans	$	3,134		$	1,827
Total non-performing loans		3,134			1,827
Foreclosed real estate		123			123
Total non-performing assets	$	3,257		$	1,950
Total assets	$	1,110,582		$	1,059,950
Total loans		972,802			898,505
Total loans plus foreclosed property		972,925			898,628
Non-performing loans to loans		0.32	%		0.20	%
Non-performing assets to loans plus foreclosed property		0.33			0.22
Non-performing assets to total assets		0.29			0.18

The increase in nonperforming loans during the first quarter of 2005 consists of a $1.1 million credit that is secured by a first mortgage on a residential property and a $480,000 credit to a manufacturer.  The increase was partially offset by a motel property that was foreclosed and sold during the first quarter of 2005.  Five other borrowers represent the remainder.

Noninterest Income
Noninterest income primarily consists of fees and service charges on deposit accounts, Wealth Management fee income and to a lesser extent, gains on sales of mortgage loans.  Noninterest income was $1.8 million for the three months ended March 31, 2005, compared to $1.5 million for the same period in 2004.  Wealth Management income was $1.2 million for the three months ended March 31, 2005, compared to $856,000 for the same period in 2004.  This increase was the result of both increased assets under administration and a more favorable mix of managed versus custodial assets.  Assets under administration in Enterprise Trust were $1.4 billion at March 31, 2005 versus $1.2 billion at March 31, 2004.  Gains on the sale of mortgage loans were $22,000 for the three months ended March 31, 2005, compared to $68,000 for the same period in 2004.  The decrease in mortgage gains in 2005 was due to higher demand for refinancing and purchase activities in the first three months of 2004.

Noninterest Expense
Total noninterest expense was $7.7 million for the three months ended March 31, 2005, representing a $847,000, or 12% increase over the same period in 2004.  Most of the increase was comprised of a $509,000 increase in employee compensation and benefits and a $275,000 increase in other expenses.

18

The increase in employee compensation and benefits was related to several factors.  Payouts under the Company’s incentive bonus programs, which are tied to performance targets, increased $210,000.  As a result of the higher compensation, payroll taxes increased $37,000.  During the fourth quarter 2004, the Board of Directors accelerated the vesting on the Company’s outstanding stock options.  Additional compensation expense of $45,000 related to the acceleration was incurred during the first quarter of 2005.  Growth in the Wealth Management business increased commissions by $30,000.  Effective January 1, 2005, the Board of Directors awarded restricted share units (“RSUs”) to selected personnel during the first quarter of 2005.  RSUs will be expensed annually as they vest over five years.  Compensation expense related to the RSUs was $112,000 in the first of quarter 2005.  The remaining increase was attributable to annual merit increases for personnel, recruiting bonuses for new employees and increases in temporary help.

The increase in other expenses was the result of legal and professional and director expenses. Legal and professional expenses increased $135,000 for the first three months of 2005 compared to the same period in 2004.  This increase was primarily due to additional expenses related to Sarbanes-Oxley 404 compliance.  Director expenses increased $132,000 for the first three months of 2005 compared to the first three months of 2004.  $29,000 of this increase was related to director stock appreciation rights which are marked to market on a quarterly basis based upon the Company’s stock price. The remaining increase in director expenses was due to increases in compensation to more competitive levels.   

Income Taxes

The provision for income taxes was $1.4 million for the three months ended March 31, 2005 compared to $875,000 for the three months ended March 31, 2004.  The effective tax rates for the first quarter of 2005 and 2004 were 36.5% and 36.4%, respectively.

Liquidity

The objective of liquidity management is to ensure the Company has the ability to generate sufficient cash or cash equivalents in a timely and cost-effective manner to meet its commitments as they become due.  Funds are available from a number of sources, such as from the core deposit base and from loans and securities repayments and maturities.  Additionally, liquidity is provided from sales of the securities portfolio, lines of credit with major banks, the Federal Reserve and the Federal Home Loan Bank, the ability to acquire large and brokered deposits and the ability to sell loan participations to other banks.

The Company’s liquidity management framework includes measurement of several key elements, such as the loan to deposit ratio, wholesale deposits as a percentage of total deposits, and various dependency ratios used by regulators.  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. 

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 an 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.

While core deposits and loan and investment repayment are principal sources of liquidity, funding diversification is another key element of liquidity management.  Diversity is achieved by strategically varying depositor types, terms, funding markets, and instruments.

Investment securities are an important part of the Company’s liquidity objective.  As of March 31, 2005, all of the investment portfolio was available for sale.  Of the $92.6 million available for sale investment portfolio, $12.6 million was pledged as collateral for public deposits, treasury, tax and loan notes, and other requirements.  The remaining securities could be pledged or sold to enhance liquidity if necessary.

19

The Bank has a variety of funding sources (in addition to key liquidity sources, such as core deposits, loan repayments, loan participations sold, and investment portfolio sales) available to increase financial flexibility.  During the first quarter 2005, the Bank increased its reliance on FHLB borrowings as a funding source.  At March 31, 2005, the Bank had $69 million of outstanding FHLB borrowings.  Of the outstanding borrowings, $15.1 million were overnight funds and $45.0 million were short-term advances with one month or less maturities.  At March 31, 2005, the Bank had an additional $84.5 million available for borrowing from the Federal Home Loan Bank of Des Moines under a blanket loan pledge, absent the Bank being in default of its credit agreement, and $26.6 million available from the Federal Reserve Bank under a pledged loan agreement.  The Bank also has access to over $70.0 million in overnight federal funds purchased lines from various banking institutions.  Finally, since the Bank is a “well-capitalized” institution, it has the ability to sell certificates of deposit through various national or regional brokerage firms, if needed.

Over the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit.  These transactions are managed through the Company’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 Company has $299 million in unused loan commitments as of March 31, 2005.  The Company believes that the nature of these commitments are such that the likelihood of such a funding demand is very low.

Capital Adequacy

The Company and Bank are subject to various regulatory capital requirements administered by the Federal banking agencies.  Failure to meet minimum requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank 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 Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulations to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets.  The Company believes, as of March 31, 2005 and December 31, 2004, that the Company and Bank meet all Capital Adequacy requirements to which they are subject.

As of March 31, 2005 and December 31, 2004, 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, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table.

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The Company’s and Bank’s actual capital amounts and ratios are also presented in the table.

	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Applicable Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
As of March 31, 2005:
Total Capital (to Risk Weighted Assets)
Enterprise Financial Services Corp	$	109,497		10.98	%	$	79,782		8.00	%	$	—		—	%
Enterprise Bank & Trust		103,584		10.39			79,772		8.00			99,715		10.00
Tier I Capital (to Risk Weighted Assets)
Enterprise Financial Services Corp		97,029		9.73			39,891		4.00			—		—
Enterprise Bank & Trust		91,117		9.14			39,886		4.00			59,829		6.00
Tier I Capital (to Average Assets)
Enterprise Financial Services Corp		97,029		9.03			32,230		3.00			—		—
Enterprise Bank & Trust		91,117		8.49			32,188		3.00			53,646		5.00
As of December 31, 2004:
Total Capital (to Risk Weighted Assets)
Enterprise Financial Services Corp	$	103,673		11.19		$	74,086		8.00		$	—		—
Enterprise Bank & Trust		99,545		10.76			74,036		8.00			92,545		10.00
Tier I Capital (to Risk Weighted Assets)
Enterprise Financial Services Corp		92,096		9.94			37,043		4.00			—		—
Enterprise Bank & Trust		87,976		9.51			37,018		4.00			55,527		6.00
Tier I Capital (to Average Assets)
Enterprise Financial Services Corp		92,096		8.44			32,725		3.00			—		—
Enterprise Bank & Trust		87,976		8.08			32,659		3.00			54,432		5.00

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Item 3 – Quantitative and Qualitative Disclosures About Market Risk

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 other than trading activities.  Market risk from other than trading activities in the form of interest rate risk is measured and managed through a number of methods.  The Company uses financial modeling techniques that measure the sensitivity of future earnings due to changing rate environments to measure interest rate risk.  Policies established by the Company’s Asset/Liability Committee and approved by the Company’s Board of Directors limit exposure of earnings at risk.  General interest rate movements are used to develop sensitivity as the Company feels it has no primary exposure to a specific point on the yield curve.  These limits are based on the Company’s exposure to a 100 basis points and 200 basis points immediate and sustained parallel rate move, either upward or downward.

The following table (in thousands) presents the scheduled repricing of market risk sensitive instruments at March 31, 2005:

	Year 1		Year 2		Year 3		Year 4		Year 5		Beyond 5 years or no stated maturity		Total
ASSETS
Investments in debt and equity securities	$	3,056	$	36,990	$	44,981	$	693	$	8	$	6,844	$	92,572
Interest-bearing deposits		141		—		—		—		—		—		141
Loans (1)		728,197		102,413		57,011		35,684		37,954		11,543		972,802
Loans held for sale		4,180		—		—		—		—		—		4,180
Total	$	735,574	$	139,403	$	101,992	$	36,377	$	37,962	$	18,387	$	1,069,695
LIABILITIES
Savings, NOW, and Money market deposits	$	520,613	$	—	$	—	$	—	$	—	$	—	$	520,613
Certificates of deposit (1)		141,845		58,424		22,580		2,382		281		1		225,513
Subordinated debentures		20,620		—		—		—		—		—		20,620
Other borrowings		64,553		1,525		1,250		1,050		650		2,154		71,182
Total	$	747,631	$	59,949	$	23,830	$	3,432	$	931	$	2,155	$	837,928

(1) Adjusted for the impact of the interest rate swaps.

Item 4 – Disclosure Control and Procedures

As of March 31, 2005, under the supervision and with the participation of the Company’s Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15.  Based on that evaluation, the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2005, to ensure that information required to be disclosed in the Company’s periodic SEC filings is processed, recorded, summarized and reported when required.  There were no significant changes in the Company’s internal controls over financial reporting for the quarter ended March 31, 2005, that have materially affected, or are  reasonably likely to affect, those controls.

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PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

There were no material changes in legal proceedings as described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

(a)	During the quarter ended March 31, 2005, the Company issued 27,722 unregistered shares of its common stock to officers upon exercise of stock options pursuant to the 2002 Stock Incentive Plan (Plan V.)  The aggregate value of unregistered shares issued was $368,375.  The issuances were made in reliance upon the exemptions from registration (to the extent applicable) under Section 4(2) of the Securities Act of 1933.
(b)	Not applicable.
(c)	There were no repurchases of the Company’s common stock during the quarter ended March 31, 2005.

Item 3 – Defaults Upon Senior Securities

None.

Item 4 – Submission of Matters to a Vote of Securities Holders

Not applicable or required.

Item 5 – Other Information

Not applicable or required.

Item 6 – Exhibits

Exhibit Number	Description
*11.1	Statement regarding computation of per share earnings
*31.1	Chief Executive Officer’s Certification required by Rule 13(a)-14(a).
*31.2	Chief Financial Officer’s Certification required by Rule 13(a)-14(a).
*32.1	Chief Executive Officer Certification pursuant to 18 U.S.C. § 1350, as adopted pursuant to section § 906 of the Sarbanes-Oxley Act of 2002
*32.2	Chief Financial Officer Certification pursuant to 18 U.S.C. § 1350, as adopted pursuant to section § 906 of the Sarbanes-Oxley Act of 2002

* Filed herewith

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SIGNATURES

Pursuant to the requirements 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, in the City of Clayton, State of Missouri on the day of May 6, 2005.

ENTERPRISE FINANCIAL SERVICES CORP
By:	/s/ KEVIN C. EICHNER
	Kevin C. Eichner
	Chief Executive Officer
By:	/s/ FRANK H. SANFILIPPO
	Chief Financial Officer
	Frank H. Sanfilippo

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