================================================================================ 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 June 30, 2002 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to --------- --------- Commission file number: 001-15373 ---------- ENTERPRISE FINANCIAL SERVICES CORP (Exact Name of Registrant as Specified in its Charter) Delaware 43-1706259 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) 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 [ ] Indicate the number of shares outstanding of each of the Registrant's classes of common stock as of July 1, 2002: Common Stock, $.01 par value---- 9,437,551 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 June 30, 2002 and December 31, 2001.......................................1 Consolidated Statements of Operations Three Months and Six Months Ended June 30, 2002 and 2001.....................2 Consolidated Statements of Comprehensive Income Three Months and Six Months Ended June 30, 2002 and 2001.....................4 Consolidated Statements of Cash Flows Six Months Ended June 30, 2002 and 2001......................................5 Notes to Consolidated Financial Statements...................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..............................................11 Item 3. Quantitative and Qualitative Disclosures Regarding Market Risk ........23 PART II - OTHER INFORMATION Item 4. Submissions of Matters to a Vote of Security Holders.................II-1 Item 6. Exhibits and Reports on Form 8-K.....................................II-2 Signatures...................................................................II-3 PART I - Item 1 ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Consolidated Balance Sheets (unaudited) At June 30, At December 31, 2002 2001 ------------ --------------- Assets Cash and due from banks $ 35,490,098 $ 32,178,155 Federal funds sold 9,166,870 48,624,680 Interest-bearing deposits 798,551 3,433,351 Investments in debt and equity securities: Available for sale, at estimated fair value 40,826,823 45,952,142 Held to maturity, at amortized cost (estimated fair value of $14,489 at June 30, 2002 and $116,633 at December 31, 2001) 14,236 116,214 ------------ ------------ Total investments in debt and equity securities 40,841,059 46,068,356 ------------ ------------ Loans held for sale 1,526,950 8,936,042 Loans, less unearned loan fees 704,999,997 642,053,483 Less allowance for loan losses 8,226,229 7,295,916 ------------ ------------ Loans, net 696,773,768 634,757,567 ------------ ------------ Other real estate owned 125,000 138,000 Fixed assets, net 9,433,397 9,999,432 Accrued interest receivable 3,778,308 3,140,912 Goodwill 2,087,537 2,087,537 Prepaid expenses and other assets 8,052,818 5,885,531 ------------ ------------ Total assets $808,074,356 $795,249,563 ============ ============ Liabilities and Shareholders' Equity Deposits: Demand $139,849,189 $126,648,048 Interest-bearing transaction accounts 57,954,682 71,574,686 Money market accounts 317,984,957 309,355,326 Savings 8,699,472 7,761,917 Certificates of deposit: $100,000 and over 100,707,337 89,323,516 Other 94,434,752 109,689,672 ------------ ------------ Total deposits 719,630,389 714,353,165 Guaranteed preferred beneficial interests in subordinated debentures 15,000,000 11,000,000 Federal Home Loan Bank advances 13,696,764 14,032,385 Notes payable -- 1,366,667 Accrued interest payable 1,473,841 1,208,549 Accounts payable and accrued expenses 3,108,666 1,392,194 ------------ ------------ Total liabilities 752,909,660 743,352,960 ------------ ------------ Shareholders' equity: Common stock, $.01 par value; authorized 20,000,000 shares; issued and outstanding 9,437,551 shares at June 30, 2002 and 9,270,667 shares at December 31, 2001 94,376 92,707 Surplus 37,977,368 37,288,725 Retained earnings 16,323,467 14,330,784 Accumulated other comprehensive income 769,485 184,387 ------------ ------------ Total shareholders' equity 55,164,696 51,896,603 ------------ ------------ Total liabilities and shareholders' equity $808,074,356 $795,249,563 ============ ============ See accompanying notes to consolidated financial statements. 1 ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Consolidated Statements of Operations (unaudited) Three months ended Six months ended June 30, June 30, ------------------------- ------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Interest income: Interest and fees on loans $10,963,836 $12,656,331 $21,425,740 $25,563,707 Interest on debt securities: Taxable 373,042 467,297 818,082 1,251,412 Nontaxable -- 4,708 917 10,465 Interest on federal funds sold 35,400 289,963 127,226 790,935 Interest on interest-bearing deposits 5,444 6,613 22,576 8,417 Dividends on equity securities 14,640 30,813 27,284 74,666 ----------- ----------- ----------- ----------- Total interest income 11,392,362 13,455,725 22,421,825 27,699,602 ----------- ----------- ----------- ----------- Interest expense: Interest-bearing transaction accounts 68,817 139,028 137,228 317,968 Money market accounts 1,212,304 2,577,273 2,486,669 5,684,595 Savings 22,159 45,494 42,879 91,432 Certificates of deposit: $100,000 and over 789,423 1,353,268 1,618,699 2,741,001 Other 1,061,615 1,701,913 2,273,051 3,323,608 Federal funds purchased 27,620 77,621 27,933 140,846 Federal Home Loan Bank borrowings 177,736 124,427 361,836 207,864 Notes payable 19,779 -- 35,207 -- Guaranteed preferred beneficial interests in subordinated debentures 262,607 261,372 521,107 513,951 ----------- ----------- ----------- ----------- Total interest expense 3,642,060 6,280,396 7,504,609 13,021,265 ----------- ----------- ----------- ----------- Net interest income 7,750,302 7,175,329 14,917,216 14,678,337 Provision for loan losses 530,000 330,000 1,120,000 595,000 ----------- ----------- ----------- ----------- Net interest income after provision for loan losses 7,220,302 6,845,329 13,797,216 14,083,337 ----------- ----------- ----------- ----------- Noninterest income: Service charges on deposit accounts 448,747 313,814 860,641 613,375 Trust and financial advisory income 540,077 316,755 1,169,133 569,101 Other service charges and fee income 83,351 80,688 173,784 196,457 Gains on sale of mortgage loans 284,906 332,786 645,243 512,809 Gains on sale of securities -- 52,559 -- 82,246 Recoveries and income (loss) from Merchant Banc investments 88,889 15,723 88,889 (22,906) ----------- ----------- ----------- ----------- Total noninterest income 1,445,970 1,112,325 2,937,690 1,951,082 ----------- ----------- ----------- ----------- Noninterest expense: Salaries 3,352,464 3,248,456 6,812,546 6,477,351 Payroll taxes and employee benefits 690,283 719,926 1,379,929 1,351,730 Occupancy 460,250 401,019 917,826 798,006 Furniture and equipment 254,853 244,281 506,843 461,770 Data processing 259,550 242,689 512,594 538,903 Amortization of goodwill -- 47,641 -- 95,283 Other 1,349,506 1,183,000 2,869,855 2,565,383 ----------- ----------- ----------- ----------- Total noninterest expense 6,366,906 6,087,012 12,999,593 12,288,426 ----------- ----------- ----------- ----------- Income before income tax expense 2,299,366 1,870,642 3,735,313 3,745,993 Income tax expense 850,124 735,405 1,414,713 1,450,704 ----------- ----------- ----------- ----------- Net income $ 1,449,242 $ 1,135,237 $ 2,320,600 $ 2,295,289 =========== =========== =========== =========== See accompanying notes to unaudited consolidated financial statements 2 ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Consolidated Statements of Operations (unaudited) continued Three months ended Six months ended June 30, June 30, ----------------------- ----------------------- 2002 2001 2002 2001 ---------- ---------- ---------- ---------- Per share amounts: Basic earnings per share $ 0.15 $ 0.12 $ 0.25 $ 0.25 Basic weighted average common shares outstanding 9,399,560 9,178,233 9,349,433 9,147,928 Diluted earnings per share $ 0.15 $ 0.12 $ 0.24 $ 0.24 Diluted weighted average common shares outstanding 9,575,650 9,611,136 9,576,225 9,630,369 - ---------- See accompanying notes to unaudited consolidated financial statements 3 ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (unaudited) Three months ended June 30, Six months ended June 30, --------------------------- ------------------------- 2002 2001 2002 2001 ------------ ------------ ----------- ----------- Net income $1,449,242 $1,135,237 $2,320,600 $2,295,289 Other comprehensive income (loss), before tax Unrealized gain on investment securities arising during the period, net of tax 163,944 19,062 24,758 83,910 Less: reclassification adjustment for realized gains included in net income, net of tax -- 34,689 -- 54,282 Unrealized gain on cash flow type derivative instruments arising during 786,060 -- 560,340 -- the period, net of tax ---------- ---------- ---------- ---------- Total other comprehensive income (loss), net of tax 950,004 (15,627) 585,098 29,628 ---------- ---------- ---------- ---------- Total comprehensive income $2,399,246 $1,119,610 $2,905,698 $2,324,917 ========== ========== ========== ========== - ---------- See accompanying notes to unaudited consolidated financial statements 4 ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Consolidated Statements of Cash Flows (unaudited) Six months ended June 30, --------------------------- 2002 2001 ------------ ------------ Cash flows from operating activities: Net income $ 2,320,600 $ 2,295,289 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 871,158 768,449 Provision for loan losses 1,120,000 595,000 Net amortization (accretion) of debt and equity securities 388,346 (55,336) Gain on sale of available for sale investment securities -- (82,246) (Recovery on) loss from Merchant Banc investments (88,889) 22,906 Mortgage loans originated (29,149,314) (46,341,528) Proceeds from mortgage loans sold 37,203,649 40,452,278 Gain on sale of mortgage loans (645,243) (512,809) Noncash compensation expense attributed to stock option grants 103,262 99,205 (Increase) decrease in accrued interest receivable (637,396) 824,126 Increase (decrease) in accrued interest payable 265,292 (77,410) Other, net 237,661 (802,362) ------------ ------------ Net cash provided (used in) by operating activities 11,989,126 (2,814,438) ------------ ------------ Cash flows from investing activities: Purchases of available for sale debt and equity securities (16,387,077) (10,143,108) Purchases of held to maturity debt securities -- (101,195) Proceeds from sale of available for sale debt securities -- 2,517,209 Proceeds from maturities and principal paydowns on available for sale debt and equity securities 21,162,540 31,505,215 Proceeds from maturities and principal paydowns on held to maturity debt securities 100,000 300,000 Proceeds from redemption of FHLB stock 1,000 -- Net increase in loans (63,210,415) (60,156,694) Recoveries of loans previously charged off 39,214 44,736 Proceeds from sale of fixed assets 15,578 15,300 Purchases of fixed assets (324,702) (1,392,482) Investment in Enterprise Merchant Banc LLC -- (35,000) ------------ ------------ Net cash used in investing activities (58,603,862) (37,446,019) ------------ ------------ Cash flows from financing activities: Net increase (decrease) in non-interest bearing deposit accounts 13,201,141 (2,211,595) Net (decrease) increase in interest bearing deposit accounts (7,923,917) 17,855,816 Decrease in federal funds purchased -- (1,225,000) Maturities and paydowns of Federal Home Loan Bank advances (3,035,621) (41,420) Paydowns of notes payable (2,366,667) -- Proceeds from borrowings of Federal Home Loan Bank advances 2,700,000 8,000,000 Proceeds from borrowings of notes payable 1,000,000 -- Proceeds from sale of guaranteed preferred beneficial interest in subordinated debentures 4,000,000 -- Cash dividends paid (327,917) (275,456) Proceeds from the exercise of common stock options 587,050 1,054,036 ------------ ------------ Net cash provided by financing activities 7,834,069 23,156,381 ------------ ------------ Net decrease in cash and cash equivalents (38,780,667) (17,104,076) Cash and cash equivalents, beginning of period 84,236,186 84,276,370 ------------ ------------ Cash and cash equivalents, end of period $ 45,455,519 $ 67,172,294 ============ ============ Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 7,239,317 $ 13,098,675 Income taxes 1,079,100 3,389,300 ============ ============ Noncash transactions: Transfers to other real estate owned in settlement of loans 35,000 -- Loans made to facilitate sale of other real estate owned -- 28,680 ============ ============ See accompanying notes to unaudited consolidated financial statements. 5 ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) Basis of 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" or "Enterprise Financial") 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, 2001. 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 and six month periods ended June 30, 2002 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2002. The consolidated financial statements include the accounts of Enterprise Financial Services Corp (which changed its name from Enterbank Holdings, Inc. on April 29, 2002) and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain amounts in the consolidated financial statements for the year ended December 31, 2001 have been reclassified to conform to the 2002 presentation. Such reclassifications had no effect on previously reported consolidated net income or shareholders' equity. (2) Segment Disclosure Management segregates the Company into three distinct businesses for evaluation purposes. The three segments are the Bank, Enterprise Trust and Corporate, Intercompany and Reclassifications. The segments are evaluated separately on their individual performance, as well as, their contribution to the Company as a whole. The Corporate, Intercompany, and Reclassifications segment includes the holding company and trust preferred securities activities. The Company incurs general corporate expenses and owns Enterprise Banking. The majority of the Company's assets and income result from Enterprise Banking (the "Bank"). The Bank consists of three banking branches and an operations center in the St. Louis County area, two banking branches in the Kansas City region and three banking branches in the Southeast Kansas 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 and agricultural, 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. Enterprise Trust, which is a division of the Bank, 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 management succession issues. The following are the financial results and balance sheet information for the Company's operating segments as of and for 6 the three and six month periods ended June 30, 2002 and 2001 (unaudited): Corporate, Intercompany, Enterprise Enterprise and Balance sheet information: Banking Trust Reclassifications Total ------------ ---------- ----------------- ------------ June 30, 2002 - ------------- Loans, less unearned loan fees 704,999,997 -- -- 704,999,997 Deposits 721,894,666 -- (2,264,277) 719,630,389 Borrowings 13,696,764 -- 15,000,000 28,696,764 Total assets $805,925,276 $-- $ 2,149,080 $808,074,356 ============ === =========== ============ June 30, 2001 - ------------- Loans, less unearned loan fees 616,098,416 -- -- 616,098,416 Deposits 648,970,190 -- (888,532) 648,081,658 Borrowings 11,855,887 -- 17,068,592 28,924,479 Total assets $731,451,512 $-- $ 5,447,473 $736,898,985 ============ === =========== ============ 7 Corporate, Intercompany, Enterprise Enterprise and Income statement information: Banking Trust Reclassifications Total ----------- ---------- ----------------- ----------- Three months ended June 30, 2002 - -------------------------------- Net interest income $ 8,032,687 $ -- $ (282,385) $ 7,750,302 Provision for loan losses 530,000 -- -- 530,000 Noninterest income 817,002 540,077 88,891 1,445,970 Noninterest expense $ 5,029,340 722,774 614,792 6,366,906 ----------- ---------- ----------- ----------- Income (loss) before income tax expense 3,290,349 (182,697) (808,286) 2,299,366 Income tax expense (benefit) 1,167,871 (67,598) (250,149) 850,124 ----------- ---------- ----------- ----------- Net income (loss) $ 2,122,478 $ (115,099) $ (558,137) $ 1,449,242 =========== ========== =========== =========== Three months ended June 30, 2001 - -------------------------------- Net interest income $ 7,436,700 $ -- $ (261,371) $ 7,175,329 Provision for loan losses 330,000 -- -- 330,000 Noninterest income 819,847 316,755 (24,277) 1,112,325 Noninterest expense 5,205,696 634,589 246,727 6,087,012 ----------- ---------- ----------- ----------- Income (loss) before income tax expense 2,720,851 (317,834) (532,375) 1,870,642 Income tax expense (benefit) 1,082,432 (126,810) (220,217) 735,405 ----------- ---------- ----------- ----------- Net income (loss) $ 1,638,419 $ (191,024) $ (312,158) $ 1,135,237 =========== ========== =========== =========== Six months ended June 30, 2002 - ------------------------------ Net interest income $15,473,530 $ -- $ (556,314) $14,917,216 Provision for loan losses 1,120,000 -- -- 1,120,000 Noninterest income 1,696,862 1,169,133 71,695 2,937,690 Noninterest expense 10,472,452 1,382,323 1,144,818 12,999,593 ----------- ---------- ----------- ----------- Income (loss) before income tax expense 5,577,940 (213,190) (1,629,437) 3,735,313 Income tax expense (benefit) 2,042,874 (78,880) (549,281) 1,414,713 ----------- ---------- ----------- ----------- Net income (loss) $3,535,066 $ (134,310) $(1,080,156) $ 2,320,600 =========== ========== =========== =========== Six months ended June 30, 2001 - ------------------------------ Net interest income $15,191,011 $ -- $ (512,674) $ 4,678,337 Provision for loan losses 595,000 -- -- 595,000 Noninterest income 1,404,887 569,101 (22,906) 1,951,082 Noninterest expense 10,397,872 1,234,305 656,249 12,288,426 ----------- ---------- ----------- ----------- Income (loss) before income tax expense 5,603,026 (665,204) (1,191,829) 3,745,993 Income tax expense (benefit) 2,176,034 (253,952) (471,378) 1,450,704 ----------- ---------- ----------- ----------- Net income (loss) $ 3,426,992 $ (411,252) $ (720,451) $ 2,295,289 =========== ========== =========== =========== 8 (3) Derivative Instruments and Hedging Activities The Company began utilizing derivative instruments to assist in the management of interest rate sensitivity and to modify the repricing, maturity and option characteristics of certain assets and liabilities in the first quarter of 2002. The Company uses such derivative instruments solely to reduce its interest rate exposure. The following is a summary of the Company's accounting policies for derivative instruments and hedging activities under Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. Interest Rate Swap Agreements - Cash Flow Hedges. Interest rate swap agreements designated as 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 initially reported as a component of other comprehensive income net of taxes and subsequently reclassified into noninterest income when the underlying transaction affects earnings. The ineffective portion of the change in the cash flow hedge's gain or loss is recorded in earnings on each quarterly measurement date. The swap agreements are accounted for on an accrual basis with the net interest differential being recognized as an adjustment to interest income or interest expense of the related asset or liability. For the three and six months ended June 30, 2002, a net interest differential of $255,689 and $435,834, respectively was included in interest income on loans. Interest Rate Swap Agreements - Fair Value Hedges. Interest rate swap agreements designated as fair value hedges are accounted for at fair value. Changes in the fair value of the swap agreements are recognized currently in noninterest income. The change in the fair value on the underlying hedged item attributable to the hedged risk adjusts the carrying amount of the underlying hedged item and is also recognized currently in noninterest income. All changes in fair value are measured on a quarterly basis. The swap agreement is accounted for on an accrual basis with the net interest differential being recognized as an adjustment to interest income or interest expense of the related asset or liability. For the three and six months ended June 30, 2002, a net interest differential of $39,726 decreased interest expense on certificates of deposit. (4) New Accounting Standards In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Account Standards (SFAS) No. 142 - Goodwill and other Intangible Assets. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144 - Accounting for the Impairment or Disposal of Long-Lived Assets as discussed below. The amortization of goodwill ceased upon adoption of SFAS No. 142, which for the calendar year-end companies was January 1, 2002. On January 1, 2002, the Company adopted SFAS No. 142. At the date of adoption, the company had unamortized goodwill of $2,087,537, which was subject to the transition provisions of SFAS No. 142. Under SFAS No. 142, goodwill will no longer be amortized, but instead will be tested annually for impairment following existing methods of measuring and recording impairment losses. The Company recently completed the testing for the goodwill and found no impairment. Amortization expense related to goodwill was $0 and $47,641 for the three months ended June 30, 2002 and 2001 respectively, $0 and $95,283 for the six months ended June 30, 2002 and 2001 respectively, and $190,567 for the year ended December 31, 2001. The goodwill intangible asset is reflected in the Enterprise Banking segment. The adoption of SFAS No. 142 had no impact on the basic or diluted earnings per share reported for the Company for the three and six months ended June 30, 2002 and 2001. 9 In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, it retains many of the fundamental provisions of that statement. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transaction, for the disposal of a segment of a business. However, it retains the requirement in Opinion No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and interim financial periods within those fiscal years. The adoption of this statement did not have a material effect on the Company's consolidated financial statements. (5) Trust Preferred Securities On June 28, 2002, EFSC Capital Trust I ("EFSC Trust"), a newly-formed Delaware business trust and subsidiary of the Company issued 4,000 floating rate Trust Preferred Securities ("Preferred Securities") at $1,000 per share to a Trust Preferred Securities Pool. The floating rate is equal to the three month LIBOR rate plus 3.65%, and reprices quarterly. The Preferred Securities are fully irrevocably and unconditionally guaranteed on a subordinated basis by the Company. The proceeds of the Preferred Securities were invested in junior subordinated debentures of the Company. The net proceeds to the Company from the sale of the junior subordinated debentures, after deducting underwriting commissions and estimated offering expenses, were approximately $3.92 million. Distributions on the Preferred Securities will be payable quarterly on March 30, June 30, September 30 and December 30 of each year that the Preferred Securities are outstanding, commencing September 30, 2002. The Preferred Securities will be classified as long term debt, while the distributions will be recorded as interest expense in the Company's consolidated financial statements. A portion of the proceeds from the offering were used to repay the $2.3 million of outstanding indebtedness with the remaining available for cash operating expenses at the holding company level. The Company currently has $7 million available under its revolving credit facility and uses it for general corporate purposes, including investments from time to time in the Bank in the form of additional capital. (6) Management Change Effective July 1, 2002, Kevin C. Eichner, the Vice Chairman of the Board of Directors since inception of the Company, was named President and Chief Executive Officer. Fred Eller, the former President and Chief Executive Officer, will remain with the Company during a transition period until September 30, 2002, after which the Company expects Mr. Eller to continue serving as a Director. 10 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 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 Enterprise Financial Services Corp'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, exposure to local economic conditions, risks associated with rapid increase or decrease in prevailing interest rates and competition from banks and other financial institutions, all of which could cause Enterprise Financial Services Corp's actual results to differ from those set forth in the forward-looking statements. Introduction This discussion summarizes the significant factors affecting the consolidated financial condition, results of operations, liquidity and cash flows of the Company for the three and six month periods ended June 30, 2002 compared to the three and six month periods ended June 30, 2001 and the year ended December 31, 2001. This discussion 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, 2001. Financial Condition Total assets at June 30, 2002 were $808 million, an increase of $13 million, or 2%, over total assets of $795 million at December 31, 2001. Loans and leases, net of unearned loan fees, were $705 million, an increase of $63 million, or 10%, over total loans and leases of $642 million at December 31, 2001. The increase in loans is attributed, in part, to the success of the efforts of the Company's relationship officers. Federal funds sold, interest-bearing deposits and investment securities were $51 million, a decrease of $47 million, or 48%, from total federal funds sold, interest-bearing deposits and investment securities of $98 million at December 31, 2001. The decrease resulted primarily from the shift in earning assets from short-term investments into loans during the first six months of 2002. Total deposits at June 30, 2002 were $720 million, an increase of $6 million, or 1%, over total deposits of $714 million at December 31, 2001. Total shareholders' equity at June 30, 2002 was $55.2 million, an increase of $3.3 million, or 6%, over total shareholders' equity of $51.9 million at December 31, 2001. The increase in equity is due to net income of $2.3 million for the six months ended June 30, 2002, a $585,000 increase in accumulated other comprehensive income, and the exercise of incentive stock options by employees, less dividends paid to shareholders. Results of Operations Net income was $1,449,242 for the three month period ended June 30, 2002, an increase of 28% compared to net income of $1,135,237 for the same period in 2001. Net income was $2,320,600 for the six month period ended June 30, 2002, an increase of 1.0% over net income of $2,295,289 for the same period in 2001. The increase in net income for the three months ended June 30, 2002 is attributable to an increase in the net interest income and an increase in noninterest 11 income offset by an increase in noninterest expense and provision expense. Basic earnings per share for the three month periods ended June 30, 2002 and 2001 were $0.15 and $0.12, respectively. Diluted earnings per share for the three month periods ended June 30, 2002 and 2001 were $0.15 and $0.12, respectively. Basic earnings per share for the six month periods ended June 30, 2002 and 2001 were $0.25 and $0.25, respectively. Diluted earnings per share for the six month periods ended June 30, 2002 and 2001 were $0.24 and $0.24, respectively. Net Interest Income Net interest income (on a tax equivalent basis) was $7.8 million, or 4.16%, of average interest-earning assets, for the three months ended June 30, 2002, compared to $7.2 million, or 4.30%, of average earning assets, for the same period in 2001. The $609,000 increase in net interest income for the three months ended June 30, 2002 as compared to the same period in 2001 was the result of an increase in average interest-earning assets and a decrease in the interest rates on average interest-bearing liabilities offset by a decrease in interest rates of average interest-earning assets and an increase in average interest-bearing liabilities. Average interest-earning assets for the three months ended June 30, 2002 were $752 million, an $80 million, or 12%, increase over $672 million, during the same period in 2001. The increase in average interest-earning assets is attributable to the continued calling efforts of the Company's relationship officers. The yield on average interest-earning assets decreased to 6.11% for the three month period ended June 30, 2002 compared to 8.05% for the three month period ended June 30, 2001. The decrease in asset yield was primarily due to a 200 basis point decrease in the prime rate since June 30, 2001 and a general decrease in the average yield on new fixed rate loans and investment securities. Average interest-bearing liabilities increased to $606 million for the three months ended June 30, 2002 from $560 million for the same period in 2001. The increase in interest-bearing transaction accounts, money market accounts and certificates of deposit is attributed to continued calling efforts of the Company's relationship officers. The cost of interest-bearing liabilities decreased to 2.41% for the three months ended June 30, 2002 compared to 4.50% for the same period in 2002. This decrease is attributed mainly to declines in market interest rates for all sources of funding. 12 The following table sets forth, on a tax-equivalent basis, certain 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 interest spread and net interest rate margin for the three month periods ended June 30, 2002 and 2001: Three Months Ended June 30, ----------------------------------------------------------------------------------- 2002 2001 ---------------------------------------- ---------------------------------------- Percent Interest Average Percent Interest Average Average of Total Income/ Yield/ Average of Total Income/ Yield/ Balance Assets Expense Rate Balance Assets Expense Rate -------- -------- -------- ------- -------- -------- -------- ------- (Dollars in Thousands) Assets Interest-earning assets: Loans (1)(2) $699,697 88.39% $11,020 6.32% $610,342 85.91% $12,675 8.33% Taxable investments in debt and equity securities 41,946 5.30 388 3.71 32,934 4.64 498 6.07 24 Non-taxable investments in debt and equity securities (2) -- -- -- -- 350 7 8.18 0.05 Federal funds sold 9,312 1.18 35 1.51 27,252 3.84 290 4.27 Interest-bearing deposits 817 0.10 5 2.45 717 0.10 7 3.70 -------- ------ ------- -------- ------ ------- Total interest-earning assets 751,772 94.97 $11,448 6.11% 671,595 94.54 $13,477 8.05% Non interest-earning assets: Cash and due from banks 25,912 3.27 22,934 3.22 Fixed assets, net 9,688 1.22 9,319 1.31 Prepaid expenses and other assets 12,262 1.55 13,871 1.95 Allowance for loan losses (8,062) (1.01) (7,339) (1.02) -------- ------ -------- ------ Total assets $791,572 100.00% $710,380 100.00% ======== ====== ======== ====== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing transaction accounts $ 59,578 7.53% $ 69 0.46% $ 51,009 7.18% $ 139 1.09% Money market accounts 312,387 39.46 1,212 1.56 272,379 38.34 2,577 3.80 Savings 8,809 1.11 22 1.00 7,409 1.04 46 2.46 Certificates of deposit 192,115 24.27 1,851 3.86 202,522 28.51 3,055 6.05 Guaranteed preferred beneficial interest in subordinated debentures 11,132 1.41 263 9.48 11,000 1.55 261 9.53 Borrowed funds 21,641 2.73 225 4.17 15,767 2.22 202 5.14 -------- ------ ------- -------- ------ ------- Total interest-bearing liabilities 605,662 76.51 3,642 2.41 560,086 78.84 6,280 4.50 Noninterest-bearing liabilities: Demand deposits 127,281 16.08 91,500 12.88 Other liabilities 4,720 0.60 2,701 0.38 -------- ------ -------- ------ Total liabilities 737,663 93.19 654,287 92.10 Shareholders' equity 53,909 6.81 56,093 7.90 -------- ------ -------- ------ Total liabilities and shareholders' equity $791,572 100.00% $710,380 100.00% ======== ====== ======== ====== Net interest income $ 7,806 $ 7,197 ======= ======= Net interest spread 3.70 3.55 Net interest rate margin(3) 4.16% 4.30% ==== ==== (1) Average balances include non-accrual loans. The income on such loans is included in interest income but is recognized only upon receipt. The income on such loans is included in interest but is recognized only upon receipt. Loan fees included in interest income are approximately $394,000 and $342,000 for the three months ended June 30, 2002 and 2001, respectively. (2) Non-taxable investment income is presented on a fully tax-equivalent basis assuming a tax rate of 34%. (3) Net interest income divided by average total interest-earning assets. Net interest income, presented on a tax equivalent basis, was $15.0 million, or 4.04% of average interest-earning assets, for the six months ended June 30, 2002, compared to $14.7 million, or 4.49% of average interest-earning assets, for the same period in 2001. The $276,000 increase in net interest income for the six months ended June 30, 2002 as compared to the same period in 2001 was the result of an increase in average interest-earning assets and a decrease in the interest rates on average interest-bearing liabilities offset by a decrease in the interest rates of average interest earning assets and 13 an increase in average interest-bearing liabilities. Average interest-earning assets for the six months ended June 30, 2002 were $748 million, an $87 million, or 13%, increase over $661 million during the same period in 2001. The increase in interest-earning assets is attributable to the continued calling efforts of the Company's relationship officers. The yield on average interest-earning assets decreased to 6.07% for the six month period ended June 30, 2002 compared to 8.46% for the same period ended June 30, 2001. The decrease in asset yield was primarily due to decreases in the prime rate and a general decrease in the average yield on loans and investment securities. Average interest-bearing liabilities increased $55 million, or 10%, to $607 million, for the six months ended June 30, 2002 from $552 million for the same period in 2001. The increase in interest-bearing transaction accounts and money market accounts is attributed to continued calling efforts of the Company's relationship officers. The cost of interest-bearing liabilities decreased to 2.49% for the six months ended June 30, 2002 compared to 4.76% for the same period in 2001. This decrease is attributed mainly to declines in market interest rates for all sources of funding. 14 The following table sets forth, on a tax-equivalent basis, certain 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 rate margin for the six month periods ended June 30, 2002 and 2001: Six Months Ended June 30, ----------------------------------------------------------------------------------- 2002 2001 ---------------------------------------- ---------------------------------------- Percent Interest Average Percent Interest Average Average of Total Income/ Yield/ Average of Total Income/ Yield/ Balance Assets Expense Rate Balance Assets Expense Rate -------- -------- -------- ------- -------- -------- -------- ------- Assets (Dollars in Thousands) Interest-earning assets: Loans (1)(2) $684,183 87.00% $21,507 6.34% $589,384 84.30% $25,602 8.76% Taxable investments in debt and equity securities 44,919 5.71 845 3.79 38,699 5.53 1,326 6.91 Non-taxable investments in debt and equity securities (2) 37 -- 1 5.45 409 0.06 16 7.82 Federal funds sold 16,649 2.12 127 1.54 32,218 4.61 791 4.95 Interest-earning deposits 2,252 0.29 23 2.06 461 0.07 8 3.68 -------- ------ ------- -------- ------ ------- Total interest-earning assets 748,040 94.12 22,503 6.07% 661,171 94.57 $27,743 8.46 Noninterest-earning assets: Cash and due from banks 25,114 3.19 22,524 3.22 Fixed assets, net 9,820 1.25 9,107 1.30 Prepaid expenses and other assets 11,267 1.43 13,586 1.94 Allowance for possible loan losses (7,817) (0.99) (7,282) (1.03) -------- ------ -------- ------ Total assets $786,424 100.00% $699,106 100.00% ======== ====== ======== ====== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing transaction accounts $ 62,919 8.00% $ 137 0.44% $52,392 7.49% $ 318 $1.22% Money market accounts 314,871 40.04 2,487 1.59 269,885 38.60 5,684 4.25 Savings 8,570 1.09 43 1.01 7,316 1.05 91 2.52 Certificates of deposit 191,428 24.34 3,892 4.10 197,182 28.20 6,065 6.20 Guaranteed preferred beneficial interests in subordinated debentures 11,066 1.41 521 9.49 11,000 1.57 514 9.42 Borrowed funds 18,497 2.35 425 4.63 13,771 1.97 349 5.11 -------- ------ ------- -------- ------ ------- Total interest-bearing liabilities 607,351 77.23 7,505 2.49 551,546 78.88 $13,021 $4.76 Noninterest-bearing liabilities: Demand deposits 121,542 15.46 89,353 12.79 Other liabilities 4,099 0.52 2,784 0.40 -------- ------ -------- ------ Total liabilities 732,992 93.21 643,683 92.07 Shareholders' equity 53,432 6.79 55,423 7.93 -------- ------ -------- ------ Total liabilities and shareholders' equity $786,424 100.00% $699,106 100.00% ======== ====== ======== ====== Net interest income $14,998 $14,722 ======= ======= Net interest spread 3.58 3.70 Net interest rate margin (3) 4.04% 4.49% ==== ===== (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 $731,000 and $690,000 for 2002 and 2001, respectively. (2) Non-taxable investment income is presented on a fully tax-equivalent basis assuming a tax rate of 34%. (3) Net interest income divided by average total interest-earning assets. During the three months ended June 30, 2002, an increase in the average volume of interest-earning assets resulted in an increase in interest income of $1,668,000. Interest income decreased $3,697,000 due to a decrease in rates on average interest-earning assets. Increases in the average volume of interest-bearing transaction accounts, savings and money market accounts, and borrowed funds resulted in an increase in interest expense of $281,000. Changes in interest rates on the average volume of interest-bearing liabilities resulted in a decrease in interest expense of $2,919,000. The net effect of the volume and rate changes associated with all categories of interest-earning assets during the three months 15 ended June 30, 2002 as compared to the same period in 2001 was a decrease in interest income of $2,029,000, while the net effect of the volume and rate changes associated with all categories of interest-bearing liabilities was a decrease in interest expense of $2,638,000. During the six months ended June 30, 2002 as compared to the same period in 2001, an increase in the average volume of interest-earning assets resulted in an increase in interest income of $3,622,000, offset by a decrease of $8,862,000 due to a decrease in interest rates on interest-earning assets. Increases in the average volume of interest-bearing transaction accounts, savings and money market accounts, borrowed funds, and guaranteed preferred beneficial interests in subordinated debentures resulted in an increase in interest expense of $835,000. Changes in interest rates on the average volume of interest-bearing liabilities resulted in a decrease in interest expense of $6,351,000. The net effect of the volume and rate changes associated with all categories of interest-earning assets during the six months ended June 30, 2002 as compared to the same period in 2001, decreased interest income by $5,240,000, while the net effect of the volume and rate changes associated with all categories of interest-bearing liabilities was a decrease in interest expense of $5,516,000. The following table sets forth, on a tax-equivalent basis for the periods indicated, a summary of the changes in interest income and interest expense resulting from changes in yield/rates and volume: 2002 Compared to 2001 ------------------------------------------------------------- 3 months ended June 30 6 months ended June 30 Increase (Decrease) Due to Increase (Decrease) Due to ----------------------------- ----------------------------- Volume(1) Rate(2) Net Volume(1) Rate(2) Net --------- ------- ------- --------- ------- ------- (Dollars in Thousands) Interest earned on: Loans (3) $1,685 $(3,340) $(1,655) $3,699 $(7,794) $(4,095) Taxable investments in debt and equity securities 115 (225) (110) 188 (669) (481) Nontaxable investments in debt and equity securities (3) (4) (3) (7) (11) (4) (15) Federal funds sold (129) (126) (255) (274) (390) (664) Interest-earning deposits 1 (3) (2) 20 (5) 15 ------ ------- ------- ------ ------- ------- Total interest-earning assets $1,668 $(3,697) $(2,029) $3,622 $(8,862) $(5,240 ------ ------- ------- ------ ------- ------- Interest paid on: Interest-bearing transaction accounts $ 20 $ (90) $ (70) $ 54 $ (235) $ (181) Money market accounts 335 (1,700) (1,365) 825 (4,022) (3,197) Savings 7 (31) (24) 14 (62) (48) Certificates of deposit (150) (1,054) (1,204) (172) (2,001) (2,173) Borrowed funds 66 (43) 23 111 (35) 76 Guaranteed preferred beneficial interests in subordinated debentures 3 (1) 2 3 4 7 ------ ------- ------- ------ ------- ------- Total interest-bearing liabilities 281 (2,919) (2,638) 835 (6,351) (5,516) ------ ------- ------- ------ ------- ------- Net interest income (loss) $1,387 $ (778) $ 609 $2,787 $(2,511) $ 276 ====== ======= ======= ====== ======= ======= (1) Change in volume multiplied by yield/rate of prior period (2) Change in yield/rate multiplie d by volume of prior period (3) Nontaxable investment income is presented on a fully tax-equivalent basis assuming a tax rate of 34%. 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. 16 Provision for Loan Losses The provision for loan losses was $530,000 and $1,120,000 for the three month and six month periods ended June 30, 2002, respectively, compared to $330,000 and $595,000 for the same periods in 2001. The Company had net chargeoffs of $190,000 for the six months ended June 30, 2002 compared to net charge offs of $574,000 during the same period ended June 30, 2001. Loan growth remained strong during the first six months of 2002. The Company increased its allowance for loan losses for the six months ended June 30, 2002 by charging $1,120,000 to the provision for loan losses. The increase in provision for loan losses during the first six months of 2002 as compared to the same period in 2001 was due to a $407,000 increase in non-accrual loans, a higher level of internally criticized credits as a percentage of bank capital plus loan loss reserves, and the continued increase in loans outstanding. One relationship comprises $1.7 million, or 57%, of the nonaccrual loans at June 30, 2002 . The following table summarizes changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off, by loan category, and additions to the allowance that have been charged to the provision: Six Months Ended June 30, ------------------------- 2002 2001 --------- --------- (Dollars in Thousands) Allowance at beginning of year $ 7,296 $ 7,097 Loans charged off: Commercial and industrial 138 162 Real estate: Commercial 14 270 Construction -- -- Residential -- 165 Consumer and other 77 22 -------- -------- Total loans charged off 229 619 -------- -------- Recoveries of loans previously charged off: Commercial and industrial 20 11 Real estate: Commercial 8 25 Construction -- -- Residential -- 6 Consumer and other 11 3 -------- -------- Total recoveries of loans previously charged off 39 45 -------- -------- Net loans charged off 190 574 -------- -------- Provision charged to operations 1,120 595 -------- -------- Allowance at end of period $ 8,226 $ 7,118 ======== ======== Average loans $684,183 $589,384 Ending total loans, less unearned loan fees $705,000 $616,098 Ending nonperforming loans $ 2,913 $ 2,692 Net charge offs to average loans (annualized) 0.06% 0.19% Allowance for loan losses to total loans 1.17% 1.16% 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 regulatory bank examinations. The system requires rating all loans at the time they are made. 17 Adversely rated credits, including loans requiring close monitoring, which would not normally be considered criticized credits by regulators, are included on a monthly loan watch list. Loans may be added to the watch list for reasons which are temporary and correctable, such as the absence of current financial statements of the borrower or a deficiency in loan documentation. Other loans are added whenever any adverse circumstance is detected which might affect the borrower's ability to meet the terms of the loan. This could be initiated by the delinquency of a scheduled loan payment, a deterioration in the borrower's financial condition identified in a review of periodic financial statements, a decrease in the value of the collateral securing the loan, or a change in the economic environment in which the borrower operates. Loans on the watch list require detailed loan status reports prepared by the responsible officer every three months, which are then discussed in formal meetings with the Asset Quality/Risk Management Area and the Executive Loan Committee. Downgrades of loan risk ratings may be initiated by the responsible loan officer at any time. However, upgrades of risk ratings may only be made with the concurrence of the Executive Loan Committee generally at the time of the formal quarterly watch list review meetings. Each month, management prepares a detailed list of loans on the watch list and summaries of the entire loan portfolio categorized by risk rating. These are coupled with an analysis of changes in the risk profiles of the portfolios, changes in past due and non-performing loans and changes in watch list and classified loans over time. In this manner, the overall increases or decreases in the levels of risk in the portfolios are monitored continually. Factors are applied to the loan portfolios for each category of loan risk to determine acceptable levels of allowance for loan losses. These factors are derived primarily from the actual loss experience. The calculated allowance for loan losses required for the portfolios are then compared to the actual allowance balances to determine the provision necessary to maintain the allowance for loan losses at an appropriate level. In addition, management exercises judgment in its analysis of determining the overall level of the allowance for loan losses. In its analysis, management considers the change in the portfolio, including growth and composition, and the economic conditions of the region in which the Company operates. Based on this quantitative and qualitative analysis, the allowance for loan losses is adjusted. Such adjustments are reflected in the consolidated statements of operations. The Company does not engage in foreign lending. Additionally, the Company does not have any concentrations of loans exceeding 10% of total loans which are not otherwise disclosed in the loan portfolio composition table provided in the most recent form 10-K. The Company does not have a material amount of interest-bearing assets which would have been included in non-accrual, past due or restructured loans if such assets were loans. Management believes the allowance for loan losses is adequate to absorb probable losses in the loan portfolio. While management uses available information to recognize loan losses, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require the Company to increase the allowance for loan losses based on their judgments and interpretations about information available to them at the time of their examinations. 18 The following table sets forth information concerning the Company's non-performing assets as of the dates indicated: June 30, December 31, 2002 2001 -------- ------------ (Dollars in Thousands) Non-accrual loans $ 2,913 $ 2,506 Restructured loans -- 1,243 -------- -------- Total nonperforming loans 2,913 3,749 Foreclosed property 125 138 -------- -------- Total non-performing assets $ 3,038 $ 3,887 ======== ======== Total assets $808,074 $795,250 Total loans, less unearned loan fees $705,000 $642,053 Total loans plus foreclosed property $705,125 $642,191 Nonperforming loans to loans 0.41% 0.58% Nonperforming assets to loans plus foreclosed property 0.43% 0.61% Nonperforming assets to total assets 0.38% 0.49% Noninterest Income Noninterest income was $1,445,970 and $2,937,690 for the three month and six month periods ended June 30, 2002, respectively, compared to $1,112,325 and $1,951,082 for the same periods in 2001. The increases are primarily attributed to increases in trust and financial advisory income, increases in service charges on deposit accounts, recoveries and income (loss) on previously written off Merchant Banc investments and an increase in the gains on the sale of mortgage loans. Trust and financial advisory income was $540,077 and $1,169,133 for the three month and six month periods ended June 30, 2002, respectively, as compared to $316,755 and $569,101 for the same periods in 2001. The increases in fees were the result of increased assets under management in Enterprise Trust and commissions on insurance sales activity in the financial advisory area. Service charges on deposit accounts were $448,747 and $860,641 for the three month and six month periods ended June 30, 2002, respectively, as compared to $313,814 and $613,375 for the same periods in 2001. The increase in service charges on deposit accounts is a result of a decrease in the earnings credit rate on business accounts and an increase in deposit balances outstanding. Recoveries and income (loss) on Merchant Banc investments were $88,889 for the three month and six month periods ended June 30, 2002, respectively, as compared to $15,723 and ($22,906) for the same periods in 2001. The increase is a result of a $88,889 reimbursement from a participant guarantor for a line of credit guaranteed by the Company for a Merchant Banc investment, which the Company had previously written off in full. The Company wrote off its assets related to Merchant Banc investments during December 2001 and is pursuing recoveries on those investment losses. The gains on the sale of mortgage loans were $284,906 and $645,243 for the three month and six month periods ended June 30, 2002, respectively, as compared to $332,786 and $512,809 for the same periods in 2001. The year to date increase in these gains was due to continued demand for refinancing and purchase activities as a result of a very low interest rate environment. These loans are sold into the secondary market with release of the servicing rights. This activity has somewhat slowed down during the three month period ended June 30, 2002 as demonstrated by the $47,880 decrease in gains on the sale of mortgage loans during the three months ended June 30, 2002 as compared to the same period in 2001. These increases were slightly offset by the $52,559 and $82,246 decreases in the gains on sale of securities for the three month and six month periods 19 ended June 30, 2002 respectively as compared to the same periods in 2001. The Company had no sales of investment securities during 2002. Noninterest Expense Noninterest expense was $6.4 million and $13.0 million for the three month and six month periods ended June 30, 2002, respectively, compared to $6.1 million and $12.3 million for the same periods in 2001. The 6% increase for the six month period ended June 30, 2002 in noninterest expense was primarily due to: 1) increased activity and growth in the trust and financial advisory services which resulted in a $148,018 increase in noninterest expense; 2) recent renovation and remodeling at the Clayton location in the fourth quarter of 2001 which increased noninterest expense by $73,372; 3) the opening of a new banking facility in the Kansas City area which increased noninterest expense by $193,824; and 4) a $304,472 increase in various other operating expenses detailed below. These increases were offset by a $47,641 and $95,283 decrease in amortization of goodwill for the three and six months ended June 30, 2002 as compared to the same periods in 2001. Salaries, payroll and employee benefits increased $74,365, or 2%, and $363,394 or 5%, for the three and six month periods ended June 30, 2002 as compared to the same periods in 2001. Most of this increase is related to an increase in commission based income in the Mortgage and Financial Advisory areas and annual merit and promotional increases in salaries. Occupancy expense increased $59,231, or 15%, for the three month period and $119,820 or 15% for the six month period ended June 30, 2002 as compared to the same periods in 2001. The Clayton location acquired additional space for the Holding Company and Trust offices and existing space was remodeled. The Company opened a new banking facility in the Country Club Plaza in Kansas City, Missouri during the fourth quarter of 2001, which also increased occupancy, furniture and equipment expenses. The Company upgraded its telephone and voicemail systems during the fourth quarter of 2001 which increased furniture and equipment expense during 2002. Furniture and equipment expense increased $10,572, or 4%, for the three month period and $45,073, or 10%, for the six month period ended June 30, 2002 as compared to the same period in 2001. Data processing expense increased $16,861, or 7%, for the three month period and decreased $26,309, or 5%, for the six month period ended June 30, 2002 as compared to the same periods in 2001. During the first quarter of 2001, the Bank expanded the computer and data processing infrastructure for the additional Kansas locations. Other operating expenses increased $166,506, or 14%, for the three month period and $304,472, or 12%, for the six month period ended June 30, 2002 over the same periods ended June 30, 2001. In June 2002, the Company donated foreclosed property to a not-for-profit organization. This donation resulted in a $49,000 charitable contribution expense which is expected to be offset with state tax credits. The Company incurred approximately $150,000 in additional professional fees and other expenses during the six month period ended June 30, 2002 related to the Merchant Banc investment recovery efforts. In addition, expected increases in premiums on renewal of various insurance policies along with increases in certain coverages caused those expenses to increase approximately $78,000 from the 2001 year-to-date levels. The Bank recognized $138,000 in fraud losses in March, 2002 that was substantially recovered in April. Liquidity Liquidity is provided by the Company's earning assets, including short-term investments in federal funds sold, maturities in the loan and investment portfolios, and amortization of term loans, along with deposit inflows, and proceeds from borrowings. At June 30, 2002, the loan to deposit ratio was 98%, as compared to 90% at December 31, 2001. Federal funds sold, interest bearing deposits and investment securities were $51 million at June 30, 2002 as compared to $98 million at December 31, 2000. During the six months ended June 30, 2002, the Company funded net new loans of $63 million, while deposits increased a net $6 million. This decrease in the Company's liquidity position resulted in the utilization of federal funds sold balances and investment securities to fund loan growth. In May 2002, the Bank obtained $20 million in brokered CDs with a 2 year maturity to supplement its core deposit activities. 20 This decrease in the Company's liquidity position during the first six months of the year is very typical. The Company's deposits tend to increase at year end and decrease during the first six months of the year. The Company closely monitors its current liquidity position and believes there are sufficient backup sources of liquidity. As of June 30, 2002, the Company has over $110 million available from the Federal Home Loan Bank of Des Moines under a blanket loan pledge and $59 million from the Federal Reserve under a pledged loan agreement. The Company also has access to over $50 million in overnight fed funds lines from various banking institutions. Capital Adequacy The Bank is subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum requirements can initiate certain mandatory and possibly 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 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 Bank to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets, and of Tier I capital to average assets. Management believes the Bank is well capitalized. As of June 30, 2002, the most recent notification from the Company's primary regulator categorized the Bank 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 I risk-based and Tier I leverage ratios as set forth in the following table. 21 At June 30, 2002 and December 31, 2001, Enterprise Financial Services Corp and Enterprise Banking had required and actual capital ratios as follows: To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions(1) -------------------- ------------------- -------------------- Amount Ratio Amount Ratio Amount Ratio ------------ ----- ----------- ----- ----------- ------ At June 30, 2002: Total Capital (to Risk Weighted Assets) Enterprise Financial Services Corp $ 75,533,903 10.85% $55,709,212 8.00% $ -- --% Enterprise Banking 71,936,759 10.37 55,511,683 8.00 69,389,604 10.00 Tier I Capital (to Risk Weighted Assets) Enterprise Financial Services Corp $ 67,307,674 9.67% $27,854,606 4.00% $ -- --% Enterprise Banking 63,710,530 9.18 27,755,842 4.00 41,633,763 6.00 Tier I Capital (to Average Assets) Enterprise Financial Services Corp $ 67,307,674 8.58% $23,529,738 3.00% $ -- --% Enterprise Banking 63,710,530 8.09 23,624,386 3.00 39,373,977 5.00 At December 31, 2001: Total Capital (to Risk Weighted Assets) Enterprise Financial Services Corp $67,920,5958 10.41% $52,203,818 8.00% $ -- --% Enterprise Banking 67,605,690 10.40 52,024,902 8.00 65,031,128 10.00 Tier I Capital (to Risk Weighted Assets) Enterprise Financial Services Corp $ 60,624,679 9.29% $26,101,909 4.00% $ -- --% Enterprise Banking 60,309,774 9.27 26,012,451 4.00 39,018,677 6.00 Tier I Capital (to Average Assets) Enterprise Financial Services Corp $ 60,624,679 8.18% $22,232,250 3.00% $ -- --% Enterprise Banking 60,309,774 8.21 22,040,917 3.00 36,734,862 5.00 (1) There are no regulatory guidelines for the well capitalization of Bank Holding Companies as opposed to Banks. 22 Effect of Inflation Changes in interest rates may have a significant impact on a commercial bank's performance because virtually all assets and liabilities of commercial banks are monetary in nature. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Inflation does have an impact on the growth of total assets in the banking industry, often resulting in a need to increase equity capital at higher than normal rates to maintain an appropriate equity to asset ratio. Item 3: Quantitative and Qualitative Disclosures Regarding Market Risk The Company's exposure to market risk is reviewed on a regular basis by its Asset/Liability Committee. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the interest risk while at the same time maximizing income. Management realizes that certain interest rate risks are inherent in our business and that the goal is to identify and minimize those risks. Tools used by management include the standard repricing or "GAP" report subject to different rate shock scenarios. At June 30, 2002, the rate shock scenario models indicated that annual net interest income would change by less than 5% should rates rise or fall within 100 basis points from their current level over a one year period. The Bank has no market risk sensitive instruments held for trading purposes. In January 2002, the Bank executed two interest rate swaps in order to limit exposure from falling interest rates. The first swap had a $40 million notional amount, a term of two years and obligated the Bank to pay an adjustable rate equivalent to the Prime rate and receive a fixed rate of 6.255%. The second swap was also a "receive fixed" interest rate of 6.97% and pay an adjustable rate equivalent to the Prime rate, but had a notional amount of $20 million and a term of three years. Both swaps pay interest on a quarterly basis. The swaps qualify as "cash flow hedges" under SFAS 133, so changes in the fair value of the swaps are recognized as part of other comprehensive income. In May 2002, the Bank executed an interest rate swap to limit the risk of a change in the fair value of the $20 million in fixed interest rate brokered CDs obtained that month. The swap had a $20 million notional amount, a term of two years and obligated the Bank to pay an adjustable rate equivalent to the three-month London Interbank Offering Rate plus 19 basis points and receive a fixed rate of 3.55%. The terms allow for semiannual payments for both sides of the swap. The swap qualifies under the "shortcut method" under SFAS No. 133. As a result, changes in the fair value of the swap directly offset changes in the fair value of the hedged item (i.e., brokered CDs). The impact of the swap on the Company's income statement is that it converts the fixed interest rate on the brokered CDs to a variable interest rate. The maturity dates, notional amounts, interest rates paid and received and fair value of our interest rate swap agreements as of June 30 2002 were as follows: Maturity Notional Interest Rate Interest Rate Fair Date Amount Paid Received Value - --------- ----------- ------------- ------------- -------- 1/29/2005 $20,000,000 4.75% 6.97% $365,797 1/29/2004 40,000,000 4.75 6.26 483,170 5/10/2004 20,000,000 2.10 3.55 139,154 23 The following tables present the scheduled maturity of market risk sensitive instruments at June 30, 2002: Beyond 5 Years or No Stated Year 1 Year 2 Year 3 Year 4 Year 5 Maturity Total -------- ------- ------- ------- ------- ----------- -------- ASSETS Securities $ 22,858 $10,681 $ 2,306 $ 2,001 $ 1,002 $ 1,993 $ 40,841 Interest-bearing deposits 799 -- -- -- -- -- 799 Federal funds sold 9,167 -- -- -- -- -- 9,167 Loans 564,836 36,789 66,917 13,055 10,494 12,909 705,000 Loans held for sale 1,527 -- -- -- -- -- 1,527 -------- ------- ------- ------- ------- ------- -------- Total $599,187 $47,470 $69,223 $15,056 $11,496 $14,902 $757,334 ======== ======= ======= ======= ======= ======= ======== LIABILITIES Savings, NOW, money market deposits $524,488 $ -- $ -- $ -- $ -- $ -- $524,488 Certificates of deposit 145,775 43,059 3,868 2,020 420 -- 195,142 Guaranteed preferred beneficial interest in subordinated debentures -- -- -- -- -- 15,000 15,000 Borrowed funds 457 6,480 3,800 550 450 1,960 13,697 -------- ------- ------- ------- ------- ------- -------- Total $670,720 $49,539 $ 7,668 $ 2,570 $ 870 $16,960 $748,327 ======== ======= ======= ======= ======= ======= ======== Average Interest Rate for Six Months Ended Carrying June 30, Estimated Value 2001 Fair Value -------- ---------- ---------- ASSETS Securities $ 40,841 3.79% $ 40,841 Interest-earning deposits 799 2.06 799 Federal funds sold 9,167 1.54 9,167 Loans 705,000 6.34 723,990 Loans held for sale 1,527 1,527 -------- -------- Total $757,334 $776,324 ======== ======== LIABILITIES Savings, NOW, money market deposits $524,488 1.39% $524,488 Certificates of deposit 195,142 4.10 196,845 Guaranteed preferred beneficial interest in subordinated debentures 15,000 9.49 15,123 Borrowed funds 13,697 4.63 13,897 -------- -------- Total $748,327 $750,353 ======== ======== 24 PART II - Item 4: Submissions of Matters to a Vote of Security Holders ANNUAL MEETING OF SHAREHOLDERS: The annual meeting of shareholders was held on April 25, 2002. Proxies were solicited pursuant to Regulation 14A of the Securities Exchange Act of 1934. There was no solicitation in opposition to management's nominees for Directors and all nominees were elected. The appointment of KPMG LLP to serve as independent auditor for the Company in 2002 was ratified and shareholders approved changing the name of the Company to Enterprise Financial Services Corp. There were no other matters considered except those stated above. The results of the votes are as follows: PROPOSAL NO. 1: ELECTION OF DIRECTORS Director For Against Abstain - ------------------- --------- ------- ------- Fred H. Eller 6,435,215 0 49,010 Ronald E. Henges 6,192,826 0 291,399 Kevin C. Eichner 6,189,497 0 294,728 Paul R. Cahn 6,467,838 0 16,387 William B. Moskoff 6,474,338 0 9,887 Birch M. Mullins 6,195,897 0 288,328 Robert E. Saur 6,191,997 0 292,288 Paul L. Vogel 6,439,715 0 44,510 James L. Wilhite 6,466,196 0 18,029 James A. Williams 6,474,338 0 9,887 Ted C. Wetterau 6,189,897 0 294,328 Richard S. Masinton 6,197,712 0 286,513 Ted A. Murray 6,199,897 0 284,328 Stephen Oliver 6,473,838 0 10,387 Paul J. McKee, Jr. 6,459,125 0 25,100 Jack L. Sutherland 6,439,215 0 45,010 PROPOSAL NO. 2: INDEPENDENT PUBLIC ACCOUNTANTS Accountants For Against Abstain - ----------- --------- ------- ------- KPMG LLP 6,337,242 14,936 18,586 PROPOSAL NO. 3: NAME CHANGE TO ENTERPRISE FINANCIAL SERVICES CORP For Against Abstain --------- ------- ------- Name Change 6,293,441 51,745 25,578 II-1 Item 6: Exhibits and Reports on Form 8-K (a). Exhibits. Exhibit Number Description - --------- ----------- 4.8.1 Subordinated Indenture dated October 24, 1999 between the Registrant and Wilmington Trust Company relating to 9.40% Junior Subordinated Debentures due December 15, 2029, incorporated by reference to Exhibit 4.6 to Registrant's Registration Statement No. 333-87881 on Form S-3. 4.8.2 Form of 9.40% Junior subordinated Debenture (included as an Exhibit to Exhibit 4.8.1), incorporated by reference to Exhibit 4.6 to Registrant's Registration Statement No. 333-87881 on Form S-3. 4.8.3 Amended and Redated Trust Agreement of EBH Capital Trust I dated October 19, 1999, incorporated by reference to Exhibit 4.4 to Registrant's Registration Statement No. 33-87881 on Form S-3. 4.8.4 Preferred Securities Guarantee Agreement between Registrant and Wilmington Trust Company dated October 25, 1999, incorporated by reference to Exhibit 4.8 to Registrant's Registration Statement No. 333-87881 on Form S-3. 4.9.1 (1) Indenture dated June 27, 2002 between Registrant and Wells Fargo, National Association, relating to Floating Rate Junior Subordinated Deferrable Interest Debentures due June 30, 2032. 4.9.2 (1) Form of Floating Rate Junior Subordinated Deferrable Interest Debenture due June 30, 2032. 4.9.3 (1) Amended and Restated Trust Agreement of EFSC Capital Trust I dated June 27, 2002. 4.9.4 (1) Trust Preferred Securities Guarantee Agreement between Registrant and Wells Fargo, National Association, dated June 27, 2002. 11.1 (1) Statement regarding computation of per share earnings (b). During the three months ended June 30, 2002, the Registrant filed one Current Report on Form 8-K, dated April 29, 2002, in which the Registrant reported the change in the Company's name to Enterprise Financial Services Corp. (1) Filed herewith. II-2 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 1st day of August 2002. ENTERPRISE FINANCIAL SERVICES CORP By: /s/ Kevin C. Eichner ------------------------------ Kevin C. Eichner Chief Executive Officer By: /s/ Frank H. Sanfilippo ------------------------------ Frank H. Sanfilippo Chief Financial Officer II-3