For the nine months ended September 30, 2009, noninterest income increased $2.0 million, or 12%, from the same period in 2008. The 2008 results include a $3.4 million pre-tax gain on the sale of branches. Excluding this amount, and the pre-tax gain from the extinguishment of debt, noninterest income increased $115,000 or 1% in 2009.
Extinguishment of debt –For the quarter ended September 30, 2009 we recorded a $5.3 million pre-tax gain from the extinguishment of debt resulting from the foreclosure of one of our participated loans. See Note 1 –Summary of Significant Accounting Policies for more information on the accounting treatment of the loan participations.
Noninterest Expense
Noninterest expense decreased $5.2 million or 27%, for the three months ended September 30, 2009 compared to the same period in 2008. The decrease is primarily due to a $5.9 million goodwill impairment charge associated with Millennium in the third quarter of 2008. Excluding the goodwill impairment charge, noninterest expenses increased $746,000, or 6%, compared to third quarter of 2008. The increase is primarily due to a $927,000 increase from Loan legal and other real estate expenses related to nonperforming assets. This increase was offset by a $375,000 decrease in salaries and benefits due to staff reductions and lower producer compensation in Millennium.
For the nine months ended September 30, 2009, noninterest expense increased $43.1 million or 94% from prior year. The increase is due to $45.4 million and $5.9 million of impairment charges related to the banking segment and Millennium, respectively.
Excluding the goodwill impairment charges, noninterest expenses were $43.4 million during the nine months ended September 30, 2009, an increase of $3.6 million, or 9%, from the same period in 2008. The year-over-year increase includes additional FDIC premiums of $2.2 million due to the FDIC special assessment and newly implemented rate structure and $2.9 million of legal and other real estate expenses related to nonperforming assets. These increases are offset by a $1.9 million decrease in salaries and benefits due to staff reductions and reduced incentive compensation.
For the three and nine months ended September 30, 2009, increases in Occupancy expenses were primarily due to expenses related to a new Wealth Management location which was occupied in the fourth quarter of 2008.
For the nine months ended September 30, 2009, Amortization of intangibles decreased $288,000 due to a lower carrying value on the customer related intangible that resulted from the Millennium impairment charge in the fourth quarter of 2008.
The Company’s efficiency ratio in the third quarter of 2009 was 51% compared to 79% in the third quarter of 2008. Absent the gain on extinguishment of debt in the third quarter of 2009 and the branch sale gain and impairment charges in the third quarter of 2008, the efficiency ratio was 64% and 62%, respectively. For the nine months ended September 30, 2009 and 2008, the efficiency ratio is 124% and 68%, respectively. Absent the gain on extinguishment of debt in 2009 and the branch sale gains and impairment charges in 2008, the year-to-date efficiency ratio was 66% and 72%, respectively.
On September 29, 2009, the FDIC announced that at on December 29, 2009, insured institutions will be required to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. We expect the prepayment amount will be approximately $11.0 million. To account for the prepayments, the entire amount of the prepaid FDIC assessment will be recorded as an asset (prepaid expense) on December 29, 2009 and expensed over the subsequent three years.
Income Taxes
Generally, the provision for income taxes is determined by applying an estimated annual effective income tax rate to income before income taxes. The rate is based on the most recent annualized forecast of pretax income, permanent book versus tax differences and tax credits. However, when a reliable estimate of the annual effective tax rate cannot be made, the actual effective tax rate for the year-to-date period may be used. In the third quarter of 2009, the Company concluded that minor changes in the Company’s 2009 estimated pre-tax results and projected permanent items produced significant variability in the estimated annual effective tax rate, and thus, the estimated rate may not be reliable. Accordingly, the Company has determined that the actual effective tax rate for the year-to-date period is the best estimate of the effective tax rate. We re-evaluate the combined federal and state income tax rates each quarter. Therefore, the current projected effective tax rate for the entire year may change.
For the three months ended September 30, 2009, the Company’s income tax expense, which includes both federal and state taxes, was $2.2 million compared to $882,000 for the same period in 2008. For the nine months ended September 30, 2009, the income tax benefit was $2.3 million compared to an income tax expense of $4.1 million for the same period in 2008. The combined federal and state effective income tax rates for the three and nine months ended September 30, 2009 were 31.8% and 4.7%, respectively, compared to 42.3% and 36.1% for the same periods in 2008. Our income tax provision in the first nine months of 2009 reflects the impact of the $45.4 million goodwill impairment charge, which is not tax deductible. The change in the effective tax rate year over year is primarily the result of the nondeductible goodwill impairment charge and other permanent differences related to tax exempt interest and federal tax credits.
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The Company recognizes deferred tax assets only to the extent that they are expected to be used to reduce amounts that have been paid or will be paid to tax authorities. Management has determined, based on all positive and negative evidence, that the Company’s deferred tax asset at September 30, 2009 is more likely-than-not-to be realized, and accordingly, no valuation allowance has been recorded.
Liquidity and Capital Resources
Liquidity management
Increasing our liquidity position is a key initiative for us during 2009. 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 FHLB, the ability to acquire 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, volatile liabilities as a percentage of long-term earning assets, and liquid assets plus availability on secured lines as a percentage of certain liabilities. 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 repayments 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.
Parent Company liquidity
The parent 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 parent company’s primary funding sources to meet its liquidity requirements are dividends and other payments from subsidiaries and proceeds from the issuance of equity (i.e. stock option exercises).
In December 2008, the Company was approved by the U.S. Treasury for a $62.0 million Capital Purchase Program investment. At the same time, the Company had the opportunity to privately place a Convertible Trust Preferred Security offering. As a result, the Company decided to take advantage of both the private and public capital sources.
On December 12, 2008, we completed a private placement of $25.0 million in Convertible Trust Preferred Securities that qualify as Tier II regulatory capital until they would convert to EFSC common stock. We also received $35.0 million from the U.S. Treasury under the Capital Purchase Program on December 19, 2008.
As of December 31, 2008, $20.0 million of the capital funds were used to pay off the Company’s line of credit and term loan. Our line of credit with a major bank was closed during the first quarter of 2009. In December 2008, we also injected $18.0 million into Enterprise to support continued loan growth and bolster its capital ratios.
As of September 30, 2009, the Company had $82.6 million of outstanding subordinated debentures as part of nine Trust Preferred Securities Pools. These securities are classified as debt but are included in regulatory capital and the related interest expense is tax-deductible, which makes them a very attractive source of funding. Management believes our current level of cash at the holding company of approximately $17.0 million will be sufficient to meet all projected cash needs in 2009.
On June 17, 2009, the Company filed a Shelf Registration statement on Form S-3 for up to $35 million of certain types of our securities. Proceeds from an offering would be used for capital expenditures, repayment or refinancing of indebtedness or other securities from time to time, working capital, to make acquisitions, or for general corporate purposes. The Registration became effective on July 1, 2009. We are sensitive to the dilution a stock offering may have on our shareholders and therefore, are carefully monitoring the equity markets.
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Enterprise liquidity
Enterprise is subject to State and FDIC regulations, which among other things may limit 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.
During the third quarter of 2009, we continued to strengthen our liquidity position. Core deposit balances increased $122.8 million, including $94.9 million in certificates of deposit, both from the CDARS program and our own CDs. Loan balances declined $21.0 million as loan clients continued using their cash to paydown outstanding loans. The increase in core deposits along with the reduced loan funding requirements enabled us to reduce brokered time deposits by $28.5 million and short-term borrowings by $22.2 million. In addition, we increased our investment portfolio by $42.0 million and increased cash reserves by $48.0 million.
Enterprise has a variety of funding sources available to increase financial flexibility. In addition to amounts currently borrowed, at September 30, 2009, Enterprise could borrow an additional $121.7 million from the FHLB of Des Moines under blanket loan pledges and an additional $290.6 million from the Federal Reserve Bank under a pledged loan agreement. Enterprise has unsecured federal funds lines with three correspondent banks totaling $30.0 million at September 30, 2009.
As of September 30, 2009, of the $197.5 million of the securities available for sale, $64.1 million was pledged as collateral for public deposits, treasury, tax and loan notes, and other requirements. The remaining $133.4 million could be pledged or sold to enhance liquidity, if necessary.
In July 2008, Enterprise joined the Certificate of Deposit Account Registry Service, or CDARS, which allows us to provide our customers with access to additional levels of FDIC insurance coverage. The Company considers the reciprocal deposits placed through the CDARS program as core funding and does not report the balances as brokered sources in its internal or external financial reports. As of September 30, 2009, the Bank had $133.0 million of reciprocal CDARS deposits outstanding. In addition to the reciprocal deposits available through CDARS, we also have access to the “one-way buy” program, which allows us to bid on the excess deposits of other CDARS member banks. The Company will report any outstanding “one-way buy” funds as brokered funds in its internal and external financial reports. At September 30, 2009, we had no outstanding “one-way buy” deposits.
Finally, because the bank is “well-capitalized”, it has the ability to sell certificates of deposit through various national or regional brokerage firms, if needed. At September 30, 2009, we had $207.6 million of brokered certificates of deposit outstanding compared to $336.0 million outstanding at December 31, 2008, a decrease of $128.4 million.
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 $468.0 million in unused loan commitments as of September 30, 2009. While this commitment level would be difficult to fund given the Company’s current liquidity resources, the nature of these commitments is such that the likelihood of funding them is low.
Regulatory capital
The Company and its bank affiliate 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 its banking affiliate 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 (6%) and Tier 1 leverage ratios (5%). Management believes, as of September 30, 2009 and December 31, 2008, that the Company and its banking affiliates meet all capital adequacy requirements to which they are subject.
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The following table summarizes the Company’s risk-based capital and leverage ratios at the dates indicated:
| At Sept 30 | | At December 31 |
| (Dollars in thousands) | 2009 | | 2008 |
| Tier I capital to risk weighted assets | | 7.54 | % | | | 8.89 | % |
| Total capital to risk weighted assets | | 11.87 | % | | | 12.81 | % |
| Leverage ratio (Tier I capital to average assets) | | 6.97 | % | | | 8.67 | % |
| Tangible common equity to tangible assets | | 5.14 | % | | | 6.07 | % |
| Tier I capital | $ | 171,481 | | | $ | 190,254 | |
| Total risk-based capital | $ | 269,926 | | | $ | 273,977 | |
Critical Accounting Policies
The impact and any associated risks related to the Company’s critical accounting policies on 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.
The Company’s consolidated financial position reflects material amounts of assets and liabilities that are measured at fair value. Securities available for sale and state tax credits held for sale are carried at fair value. The fair value of securities available for sale is based upon measurements from an independent pricing service, including dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data and other information. Fair value of state tax credits held for sale is determined using an internal valuation model with observable market data inputs. Considerable judgment may be required in determining the assumptions used in certain pricing models, including interest rate, credit risk and liquidity risk assumptions. Changes in these assumptions may have a significant effect on values.
New Accounting Standards
In June 2009, the FASB issued Accounting Standards Codification (“ASC”) 860 “Transfers and Servicing” (formerly FASB No. 166,Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140) which requires additional information regarding transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. This standard eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures. It is effective for fiscal years beginning after November 15, 2009. We are currently evaluating the impact that the adoption of this standard will have on our financial position, results of operations, cash flows or disclosures.
In June 2009, the FASB issued FASB No. 167,Amendments to FASB Interpretation No. 46(R) (“FASB 167”) which has not yet been codified in the ASC. FASB 167 amends Interpretation No. 46(R) to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. Additionally, FASB 167 requires enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in variable interest entities. FASB 167 is effective for fiscal years beginning after November 15, 2009. We are currently evaluating the impact that the adoption of FASB 167 will have on our financial position, results of operations, cash flows or disclosures.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The disclosures set forth in this item are qualified by the section captioned “Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995” included in Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations of this report and other cautionary statements set forth elsewhere in this report.
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 Asset/Liability Management Committees and approved by the Company’s Board of Directors are used to monitor 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.
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Interest rate simulations for September 30, 2009 demonstrate that a rising rate environment will initially have a negative impact on net interest income because the Enterprise prime rate is set higher than the market prime rate and will not increase with the cost of our deposits and other interest-bearing liabilities.
The following table represents the Company’s estimated interest rate sensitivity and periodic and cumulative gap positions calculated as of September 30, 2009.
| | | | | | | | | | | | | | | | | | | Beyond | | | |
| | | | | | | | | | | | | | | | | | | 5 years | | | |
| | | | | | | | | | | | | | | | | | | or no stated | | | |
| (in thousands) | Year 1 | | Year 2 | | Year 3 | | Year 4 | | Year 5 | | maturity | | Total |
| Interest-Earning Assets | | | | | | | | | | | | | | | | | | | | | | | |
| Securities available for sale | $ | 70,790 | | | $ | 39,308 | | | $ | 24,090 | | $ | 10,520 | | $ | 787 | | | $ | 52,026 | | $ | 197,521 |
| Other investments | | - | | | | - | | | | - | | | - | | | | | | | 13,548 | | | 13,548 |
| Interest-bearing deposits | | 82,651 | | | | - | | | | - | | | - | | | - | | | | - | | | 82,651 |
| Federal funds sold | | 1,771 | | | | - | | | | - | | | - | | | - | | | | - | | | 1,771 |
| Loans (1) | | 1,476,673 | | | | 203,065 | | | | 135,952 | | | 199,357 | | | 5,373 | | | | 92,945 | | | 2,113,365 |
| Loans held for sale | | 2,130 | | | | - | | | | - | | | - | | | - | | | | - | | | 2,130 |
| Total interest-earning assets | $ | 1,634,015 | | | $ | 242,373 | | | $ | 160,042 | | $ | 209,877 | | $ | 6,160 | | | $ | 158,519 | | $ | 2,410,986 |
| |
| Interest-Bearing Liabilities | | | | | | | | | | | | | | | | | | | | | | | |
| Savings, NOW and Money market deposits | $ | 757,542 | | | $ | - | | | $ | - | | $ | - | | $ | - | | | $ | - | | $ | 757,542 |
| Certificates of deposit | | 634,083 | | | | 147,700 | | | | 28,526 | | | 13,760 | | | 96 | | | | 14,023 | | | 838,188 |
| Subordinated debentures | | 32,064 | | | | 10,310 | | | | 14,433 | | | - | | | 28,274 | | | | - | | | 85,081 |
| Other borrowings | | 351,156 | | | | 20,396 | | | | 22,096 | | | 87 | | | 7 | | | | 10,368 | | | 404,110 |
| Total interest-bearing liabilities | $ | 1,774,845 | | | $ | 178,406 | | | $ | 65,055 | | $ | 13,847 | | $ | 28,377 | | | $ | 24,391 | | $ | 2,084,921 |
| |
| Interest-sensitivity GAP | | | | | | | | | | | | | | | | | | | | | | | |
| GAP by period | $ | (140,830 | ) | | $ | 63,967 | | | $ | 94,987 | | $ | 196,030 | | $ | (22,217 | ) | | $ | 134,128 | | $ | 326,065 |
| Cumulative GAP | $ | (140,830 | ) | | $ | (76,863 | ) | | $ | 18,124 | | $ | 214,154 | | $ | 191,937 | | | $ | 326,065 | | $ | 326,065 |
| Ratio of interest-earning assets to | | | | | | | | | | | | | | | | | | | | | | | |
| interest-bearing liabilities | | | | | | | | | | | | | | | | | | | | | | | |
| Periodic | | 0.92 | | | | 1.36 | | | | 2.46 | | | 15.16 | | | 0.22 | | | | 6.50 | | | 1.16 |
| Cumulative GAP as of September 30, 2009 | | 0.92 | | | | 0.96 | | | | 1.01 | | | 1.11 | | | 1.09 | | | | 1.16 | | | 1.16 |
(1) Adjusted for the impact of the interest rate swaps.
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ITEM 4: CONTROLS AND PROCEDURES
As of September 30, 2009, 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 September 30, 2009, 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 changes during the period covered by this Quarterly Report on Form 10-Q in the Company’s internal controls that have materially affected, or are reasonably likely to materially affect, those controls.
PART II – OTHER INFORMATION
ITEM 6: EXHIBITS
| Exhibit | | |
| Number | | | Description | |
| | | Registrant herby agrees to furnish to the Commission, upon request, the instruments defining the rights of holders of each issue of long-term debt of Registrant and its consolidatedsubsidiaries. |
| | |
| *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
** Furnished herewith. Notwithstanding any incorporation of this Quarterly Statement on Form 10-Q in any other filing by the Registrant, Exhibits furnished herewith and designated with two (**) shall not be deemed incorporated by reference to any other filing unless specifically otherwise set forth herein.
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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 November 6, 2009.
| ENTERPRISE FINANCIAL SERVICES CORP |
| | |
| By: | /s/ Peter F. Benoist | |
| | Peter F. Benoist |
| | Chief Executive Officer |
| | |
| | |
| By: | /s/ Frank H. Sanfilippo | |
| | Frank H. Sanfilippo |
| | Chief Financial Officer |
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