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, 2003
[_] 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
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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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities and Exchange Act of 1934).
Yes [_] No [X]
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock as of July 30, 2003:
Common Stock, $.01 par value, 9,565,123 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, 2003 and December 31, 2002...................................1
Consolidated Statements of Operations
Three Months and Six Months Ended June 30, 2003 and 2002.................2
Consolidated Statements of Comprehensive Income
Three Months and Six Months Ended June 30, 2003 and 2002.................3
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2003 and 2002..................................4
Notes to Consolidated Financial Statements...............................5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...............................12
Item 3. Quantitative and Qualitative Disclosures
Regarding Market Risk ............................................24
Item 4. Controls and Procedures...........................................26
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders...............27
Item 6. Exhibits and Reports on Form 8-K..................................28
Signatures.................................................................29
Certifications.............................................................34
PART I - Item 1
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited)
At June 30, At December
2003 31, 2002
-------------- --------------
Assets
- --------------------------------------------------------
Cash and due from banks $ 34,750,387 $ 39,052,123
Federal funds sold 19,374,035 33,367,011
Interest-bearing deposits 409,242 66,349
Investments in debt and equity securities:
Available for sale, at estimated fair value 57,440,553 66,618,556
Held to maturity, at amortized cost (estimated
fair value of $11,240 at June 30, 2003 and
$12,780 at December 31, 2002) 11,042 12,600
-------------- --------------
Total investments in debt and equity securities 57,451,595 66,631,156
-------------- --------------
Loans held for sale 5,087,901 6,991,421
Loans, less unearned loan fees 735,733,218 679,799,399
Less allowance for loan losses 9,538,999 8,600,001
-------------- --------------
Loans, net 726,194,219 671,199,398
-------------- --------------
Other real estate owned 344,985 125,000
Fixed assets, net 7,051,019 7,685,682
Accrued interest receivable 3,265,711 3,458,596
Goodwill 1,937,537 2,087,537
Assets held for sale -- 36,401,416
Prepaid expenses and other assets 10,417,177 9,720,812
-------------- --------------
Total assets $ 866,283,808 $ 876,786,501
============== ==============
Liabilities and Shareholders' Equity
- --------------------------------------------------------
Deposits:
Demand $ 161,499,276 $ 155,596,970
Interest-bearing transaction accounts 49,764,531 59,058,224
Money market accounts 347,458,697 341,589,829
Savings 4,398,609 3,420,987
Certificates of deposit:
$100,000 and over 138,271,640 105,030,371
Other 46,621,545 51,617,893
-------------- --------------
Total deposits 748,014,298 716,314,274
Guaranteed preferred beneficial interests in
subordinated debentures 15,000,000 15,000,000
Federal Home Loan Bank advances 29,107,802 29,464,044
Notes payable and other borrowings 2,358,550 2,358,753
Accrued interest payable 1,137,479 1,264,600
Liabilities held for sale -- 50,053,023
Accounts payable and accrued expenses 7,544,844 3,521,857
-------------- --------------
Total liabilities 803,162,973 817,976,551
-------------- --------------
Shareholders' equity:
Commonstock, $.01 par value; authorized
20,000,000 shares; issued and outstanding
9,565,123 shares at June 30, 2003 and
9,497,794 shares at December 31, 2002 95,651 94,978
Surplus 39,208,558 38,401,814
Retained earnings 22,025,146 18,673,619
Accumulated other comprehensive income 1,791,480 1,639,539
-------------- --------------
Total shareholders' equity 63,120,835 58,809,950
-------------- --------------
Total liabilities and shareholders' equity $ 866,283,808 $ 876,786,501
============== ==============
See accompanying notes to unaudited consolidated financial statements.
1
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
------------- ------------- ------------- -------------
Interest income:
Interest and fees on loans $ 10,304,683 $ 10,963,836 $ 20,673,687 $ 21,425,740
Interest on debt and equity securities:
Taxable 421,415 373,042 888,776 818,082
Nontaxable 4,366 -- 4,553 917
Interest on federal funds sold 48,091 35,400 86,083 127,226
Interest on interest-bearing deposits 50 5,444 107 22,576
Dividends on equity securities 18,875 14,640 33,561 27,284
------------- ------------- ------------- -------------
Total interest income 10,797,480 11,392,362 21,686,767 22,421,825
------------- ------------- ------------- -------------
Interest expense:
Interest-bearing transaction accounts 48,906 68,817 101,283 137,228
Money market accounts 885,293 1,212,304 1,812,196 2,486,669
Savings 3,380 22,159 17,775 42,879
Certificates of deposit:
$100,000 and over 740,637 789,423 1,408,884 1,618,699
Other 377,379 1,061,615 940,694 2,273,051
Guaranteed preferred beneficial interests in
subordinated debentures 308,830 262,607 617,424 521,107
Federal Home Loan Bank borrowings 312,199 177,736 602,505 361,836
Notes payable and other borrowings 18,188 47,399 28,839 63,140
------------- ------------- ------------- -------------
Total interest expense 2,694,812 3,642,060 5,529,600 7,504,609
------------- ------------- ------------- -------------
Net interest income 8,102,668 7,750,302 16,157,167 14,917,216
Provision for loan losses 1,093,962 530,000 2,093,326 1,120,000
------------- ------------- ------------- -------------
Net interest income after
provision for loan losses 7,008,706 7,220,302 14,063,841 13,797,216
------------- ------------- ------------- -------------
Noninterest income:
Service charges on deposit accounts 406,192 448,747 892,819 860,641
Trust and financial advisory income 669,902 540,077 1,259,457 1,169,133
Other service charges and fee income 90,656 83,351 187,168 173,784
Gain on sale of mortgage loans 586,568 284,906 1,114,430 645,243
Gain on sale of securities -- -- 77,884 --
Gain on sale of branches 2,937,976 -- 2,937,976 --
Recoveries and income from Merchant Banc
investments -- 88,889 -- 88,889
------------- ------------- ------------- -------------
Total noninterest income 4,691,294 1,445,970 6,469,734 2,937,690
------------- ------------- ------------- -------------
Noninterest expense:
Salaries 4,039,882 3,352,464 7,802,776 6,812,546
Payroll taxes and employee benefits 634,805 650,949 1,348,889 1,322,153
Occupancy 498,879 460,250 974,917 917,826
Furniture and equipment 233,014 254,853 454,446 506,843
Data processing 269,843 259,550 512,233 512,594
Other 1,900,596 1,388,840 3,516,550 2,927,631
------------- ------------- ------------- -------------
Total noninterest expense 7,577,019 6,366,906 14,609,811 12,999,593
------------- ------------- ------------- -------------
Income before income tax expense 4,122,981 2,299,366 5,923,764 3,735,313
Income tax expense 1,524,609 850,124 2,190,294 1,414,713
------------- ------------- ------------- -------------
Net income $ 2,598,372 $ 1,449,242 $ 3,733,470 $ 2,320,600
============= ============= ============= =============
Per share amounts
Basic earnings per share $ 0.27 $ 0.15 $ 0.39 $ 0.25
Basic weighted average common shares
outstanding 9,560,529 9,399,560 9,541,552 9,349,433
Diluted earnings per share $ 0.26 $ 0.15 $ 0.38 $ 0.24
Diluted weighted average common shares
outstanding 9,892,558 9,575,650 9,855,507 9,576,225
See accompanying notes to unaudited consolidated financial statements.
2
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (unaudited)
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
------------- ------------- ------------- -------------
Net income $ 2,598,372 $ 1,449,242 $ 3,733,470 $ 2,320,600
Other comprehensive income:
Unrealized gain on investment securities
arising during the period, net of tax 129,647 163,944 73,824 24,758
Less reclassification adjustment for realized
gain on sale of securities included in net
income, net of tax -- -- (51,903) --
Unrealized gain on cash flow type derivative
instruments arising during the period, net of tax 89,100 786,060 130,020 560,340
------------- ------------- ------------- -------------
Total other comprehensive income 218,747 950,004 151,941 585,098
------------- ------------- ------------- -------------
Total comprehensive income $ 2,817,119 $ 2,399,246 $ 3,885,411 $ 2,905,698
============= ============= ============= =============
See accompanying notes to unaudited consolidated financial statements.
3
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
Six months ended June 30,
2003 2002
------------ ------------
Cash flows from operating activities:
Net income $ 3,733,470 $ 2,320,600
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 695,498 871,158
Provision for loan losses 2,093,326 1,120,000
Net amortization of debt and equity securities 511,517 388,346
Recovery on Merchant Banc investments -- 88,889
Mortgage loans originated (61,338,117) (29,149,314)
Proceeds from mortgage loans sold 64,356,066 37,203,649
Gain on sale of mortgage loans (1,114,430) (645,243)
Noncash compensation expense attributed to stock
option grants 136,169 103,262
Decrease (increase) in accrued interest receivable 192,885 (637,396)
(Decrease) increase in accrued interest payable (127,121) 265,292
Gain on sale of branches (2,937,976) --
Final settlement due in sale of branches 1,447,450 --
Other, net 658,042 59,883
------------ ------------
Net cash provided by operating activities 8,336,779 11,989,126
------------ ------------
Cash flows from investing activities:
Cash paid in sale of branches (15,241,261) --
Purchases of available for sale debt and equity securities (32,732,760) (16,387,077)
Proceeds from sale of available for sale debt securities 11,115,471 --
Proceeds from maturities and principal paydowns on
available for sale debt and equity securities 30,303,217 21,162,540
Proceeds from maturities and principal paydowns on held to
maturity debt securities 1,558 100,000
Proceeds from redemption of FHLB stock 300 1,000
Net increase in loans (49,448,499) (63,210,415)
Recoveries of loans previously charged off 145,552 39,214
Proceeds from sale of fixed assets -- 15,578
Purchases of fixed assets (124,270) (324,702)
------------ ------------
Net cash used in investing activities (55,980,692) (58,603,862)
------------ ------------
Cash flows from financing activities:
Net increase in non-interest bearing deposit accounts 5,218,562 13,201,141
Net increase (decrease) in interest bearing deposit accounts 24,540,469 (7,923,917)
Maturities and paydowns of Federal Home Loan Bank advances (130,356,242) (3,035,621)
Proceeds from borrowings of Federal Home Loan Bank advances 130,000,000 2,700,000
Paydowns of notes payable (100,000) (2,366,667)
Proceeds from notes payable 100,000 1,000,000
Proceeds from sale of guaranteed preferred beneficial
interest in subordinated debentures -- 4,000,000
Cash dividends paid (381,943) (327,917)
Proceeds from the exercise of common stock options 671,248 587,050
------------ ------------
Net cash provided by financing activities 29,692,094 7,834,069
------------ ------------
Net decrease in cash and cash equivalents (17,951,819) (38,780,667)
Cash and cash equivalents, beginning of period 72,485,483 84,236,186
------------ ------------
Cash and cash equivalents, end of period $ 54,533,664 $ 45,455,519
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 5,656,721 $ 7,239,317
Income taxes 1,566,062 1,079,100
============ ============
Noncash transactions
Transfer to other real estate owned in settlement of loans $ 344,985 $ 35,000
Write off of goodwill associated with sale of branches 150,000 --
See accompanying notes to unaudited consolidated financial statements.
4
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, 2002. 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, 2003 are not necessarily indicative of the results that may be
expected for any other interim period or for the year ending December 31,
2003. The consolidated financial statements include the accounts of
Enterprise Financial Services Corp 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, 2002 have been reclassified to conform to the 2003
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: Enterprise 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 Bank.
The majority of the Company's assets and income result from Enterprise Bank
(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
(which were sold on April 4, 2003). 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.
5
The following are the financial results and balance sheet information for the
Company's operating segments as of June 30, 2003 and December 31, 2002, and for
the three and six month periods ended June 30, 2003 and 2002 (unaudited):
Corporate,
Inter
company, and
Enterprise Enterprise Reclassifi-
Bank Trust cations Total
-------------- ------------ ------------ --------------
Balance Sheet Information:
June 30, 2003
- ---------------------------------------
Loans, less unearned loan fees $ 735,733,218 $ -- $ -- $ 735,733,218
Goodwill 1,937,537 -- -- 1,937,537
Deposits 749,486,794 -- (1,472,496) 748,014,298
Borrowings 31,466,352 -- 15,000,000 46,466,352
Total assets $ 864,431,227 $ -- $ 1,852,581 $ 866,283,808
============== ============ ============ ==============
Corporate,
Inter
company, and
Enterprise Enterprise Reclassifi-
Bank Trust cations Total
-------------- ------------ ------------ --------------
December 31, 2002
- ---------------------------------------
Loans, less unearned loan fees $ 679,799,399 $ -- $ -- $ 679,799,399
Assets held for sale 36,401,416 -- -- 36,401,416
Goodwill 2,087,537 -- -- 2,087,537
Deposits 717,135,113 -- (820,839) 716,314,274
Borrowings 31,822,797 -- 15,000,000 46,822,797
Liabilities held for sale 50,053,023 -- -- 50,053,023
Total assets $ 873,035,220 $ -- $ 3,751,281 $ 876,786,501
============== ============ ============ ==============
6
Corporate,
Inter
company, and
Enterprise Enterprise Reclassifi-
Bank Trust cations Total
-------------- ------------ ------------ --------------
Income Statement Information:
Three months ended June 30, 2003
- ---------------------------------------
Net interest income $ 8,384,465 $ 27,783 $ (309,580) $ 8,102,668
Provision for loan losses 1,093,962 -- -- 1,093,962
Other noninterest income 4,018,588 689,675 (16,969) 4,691,294
Other noninterest expense 6,192,150 798,328 586,541 7,577,019
-------------- ------------ ------------ --------------
Income (loss) before income tax expense 5,116,941 (80,870) (913,090) 4,122,981
Income tax expense (benefit) 1,891,321 (29,922) (336,790) 1,524,609
-------------- ------------ ------------ --------------
Net income (loss) $ 3,225,620 $ (50,948) $ (576,300) $ 2,598,372
============== ============ ============ ==============
Corporate,
Inter
company, and
Enterprise Enterprise Reclassifi-
Bank Trust cations Total
-------------- ------------ ------------ --------------
Three months ended June 30, 2002
- ---------------------------------------
Net interest income $ 8,018,738 $ 13,949 $ (282,385) $ 7,750,302
Provision for loan losses 530,000 -- -- 530,000
Other noninterest income 803,923 553,156 88,891 1,445,970
Other noninterest expense 5,029,340 722,774 614,792 6,366,906
-------------- ------------ ------------ --------------
Income (loss) before income tax expense 3,263,321 (155,669) (808,286) 2,299,366
Income tax expense (benefit) 1,167,871 (67,598) (250,149) 850,124
-------------- ------------ ------------ --------------
Net income (loss) $ 2,095,450 $ (88,071) $ (558,137) $ 1,449,242
============== ============ ============ ==============
Corporate,
Inter
company, and
Enterprise Enterprise Reclassifi-
Bank Trust cations Total
-------------- ------------ ------------ --------------
Six months ended June 30, 2003
- ---------------------------------------
Net interest income $ 16,727,094 $ 47,313 $ (617,240) $ 16,157,167
Provision for loan losses 2,093,326 -- -- 2,093,326
Other noninterest income 5,192,620 1,298,676 (21,562) 6,469,734
Other noninterest expense 11,729,473 1,567,421 1,312,917 14,609,811
-------------- ------------ ------------ --------------
Income (loss) before income tax expense 8,096,915 (221,432) (1,951,719) 5,923,764
Income tax expense (benefit) 2,991,669 (81,930) (719,445) 2,190,294
-------------- ------------ ------------ --------------
Net income (loss) $ 5,105,246 $ (139,502) $ (1,232,274) $ 3,733,470
============== ============ ============ ==============
Corporate,
Inter
company, and
Enterprise Enterprise Reclassifi-
Bank Trust cations Total
-------------- ------------ ------------ --------------
Six months ended June 30, 2002
- ---------------------------------------
Net interest income $ 15,444,986 $ 28,544 $ (556,314) $ 14,917,216
Provision for loan losses 1,120,000 -- -- 1,120,000
Other noninterest income 1,668,052 1,197,943 71,695 2,937,690
Other noninterest expense 10,472,452 1,382,323 1,144,818 12,999,593
-------------- ------------ ------------ --------------
Income (loss) before income tax expense 5,520,586 (155,836) (1,629,437) 3,735,313
Income tax expense (benefit) 2,042,874 (78,880) (549,281) 1,414,713
-------------- ------------ ------------ --------------
Net income (loss) $ 3,477,712 $ (76,956) $ (1,080,156) $ 2,320,600
============== ============ ============ ==============
7
(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, 2003, a net interest differential of $425,795 and $821,679,
respectively, was included in interest income on loans. 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.
The Bank entered into three interest rate swaps in order to limit exposure from
falling interest rates. The first swap was executed in January 2002 and 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 executed in January 2002 and was a "receive
fixed" interest rate of 6.97% and paid an adjustable rate equivalent to the
prime rate, had a notional amount of $20 million and a term of three years. The
third interest rate swap, executed in March 2003, was a "receive fixed" interest
rate of 5.3425% and paid an adjustable rate equivalent to the prime rate, had a
notional amount of $30 million and a term of three years. The swaps pay interest
on a quarterly basis and the net cash flow paid or received is included in
interest income on loans. The swaps qualify as "cash flow hedges" under SFAS No.
133, so changes in the fair value of the swaps are recognized as part of other
comprehensive income. On June 30, 2003, the Bank had $2.4 million in cash
collateral from the counter party on the interest rate swap agreements, which is
included on the balance sheet as notes payable and other borrowings. The cash
collateral is interest bearing at an interest rate that floats with the six
month London Inter Bank Offered Rate ("LIBOR").
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 Bank entered into two interest rate swaps to limit the risk of a change in
the fair value of the fixed interest rate brokered CDs obtained simultaneously.
In May 2002, the Bank executed a swap with a $20 million notional amount, a term
of two years and obligated the Bank to pay an adjustable rate equivalent to the
three-month LIBOR plus 19 basis points and receive a fixed rate of 3.55%. The
terms allow for semiannual payments for both sides of the swap. In April 2003,
the Bank executed a swap with a $10 million notional amount, a term of three
years and obligated the Bank to pay an adjustable rate equivalent to the
three-month LIBOR plus 11.3 basis points and receive a fixed rate of 2.45%. The
terms allow for semiannual payments on both sides. The swaps qualify for the
"shortcut method" under SFAS No. 133. As a result, changes in the fair value of
the swaps directly offset changes in the fair value of the hedged item (i.e.,
brokered CDs). The impact of the swaps on the Company's statement of operations
is that it converts the fixed interest rate on the brokered CDs to a variable
interest rate. 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, 2003, a net interest differential of $132,933 and
$231,045, respectively, decreased interest expense on certificates of deposit.
For the three and six months ended June 30, 2002, a net interest differential of
$39,726 decreased interest expense on certificates of deposit.
8
The maturity dates, notional amounts, interest rates paid and received and fair
value of our interest rate swap agreements as of June 30, 2003 were as follows:
Interest
Maturity Notional Interest Rate Fair
Hedge Date Amount Rate Paid Received Value
- ---------- --------- ------------ --------- --------- ------------
Cash flow 1/29/2005 $ 20,000,000 4.00% 6.97% $ 978,542
Cash flow 1/29/2004 40,000,000 4.00 6.26 679,001
Fair Value 5/10/2004 20,000,000 1.47 3.55 434,229
Cash flow 3/21/2006 30,000,000 4.00 5.34 557,593
Fair Value 4/17/2006 10,000,000 1.41 2.45 153,838
The notional amounts of derivative financial instruments do not represent
amounts exchanged by the parties and, therefore, are not a measure of the Banks'
credit exposure through its use of these instruments. The credit exposure
represents the accounting loss the Bank would incur in the event the counter
parties failed completely to perform according to the terms of the derivative
financial instruments and the collateral held to support the credit exposure was
of no value. On June 30, 2003 the Bank had credit exposure of $1,148,780.
(4) New Accounting Standards
In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS No.
146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No.
146 addresses financial accounting and reporting for costs associated with exit
or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue
94-3, Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity. The provisions of this Statement are effective for
exit or disposal activities that are initiated after December 31, 2002, with
early application encouraged. The adoption of SFAS No. 146 on January 1, 2003
did not have a material effect on the Company's consolidated financial
statements.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107
and a rescission of FASB Interpretation No. 34. This Interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the Interpretation are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements are effective for financial
statements of interim and annual periods ending after December 15, 2002. We have
implemented the requirements of FASB Interpretation No. 45 and determined they
did not have a material effect on our consolidated financial statements other
than the additional disclosure requirements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123. This Statement amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement No. 123 to require prominent disclosures in both annual and interim
financial statements. Certain of the disclosures modifications are required for
fiscal years ending after December 15, 2002 and are included in note 6 to these
consolidated financial statements.
In April 2003, the FASB issued SFAS No.149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. This Statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under
Statement 133. This Statement is effective for contracts entered into or
modified after June 30, 2003, and for hedging relationships designated after
June 30, 2003. The provisions of this Statement are applied prospectively. We
are currently evaluating the requirements of SFAS No. 149 and believe such
requirements will not have a material effect on our consolidated financial
statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement
establishes standards for how an issuer clarifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). Many of those instruments were
previously classified as equity. This statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. We are currently evaluating the requirements of SFAS No. 150 and believe
such requirements will not have a material effect on our consolidated financial
statements.
9
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.
This Interpretation established accounting guidance for consolidation of
variable interest entities (VIE) that function to support the activities of the
primary beneficiary. The primary beneficiary of a VIE entity is the entity that
absorbs a majority of the VIE's expected losses, receives a majority of the
VIE's expected residual returns, or both, as a result of ownership, controlling
interest contractual relationship or other business relationship with a VIE.
Prior to the implementation of FIN 46, VIEs were generally consolidated by an
enterprise when the enterprise had a controlling financial interest through
ownership of a majority of voting interest in the entity. The provisions of FIN
46 were effective immediately for all arrangements entered into after January
31, 2003, and are otherwise effective at the beginning of the first interim
period beginning after June 15, 2003. The Company has two statutory trusts that
were formed, prior to January 31, 2003, for the purpose of issuing Trust
Preferred Securities (see note 11 to the annual consolidated financial
statements). These statutory trusts will be subjected to FIN 46 in the third
quarter of 2003. We currently believe the continued consolidation of these
trusts is appropriate under FIN 46. However, the application of FIN 46 to this
type of trust is an emerging issue and a possible unintended consequence of FIN
46 is the deconsolidation of these trusts. The deconsolidation of these
statutory trusts would not have a material effect on our consolidated balance
sheet or our consolidated statement of operations. In July 2003, the Board of
Governors of the Federal Reserve System issued a supervisory letter instructing
bank holding companies to continue to include the trust preferred securities in
their Tier I capital for regulatory capital purposes until notice is given to
the contrary. The Federal Reserve intends to review the regulatory implications
of any accounting treatment changes and, if necessary or warranted, provide
further appropriate guidance. There can be no assurance that the Federal Reserve
will continue to allow institutions to include trust preferred securities in
Tier I capital for regulatory capital purposes.
(5) Sale of Southeast Kansas Branches
On April 4, 2003, the Company transferred loans of $27.2 million, fixed assets
of $1.1 million, and deposits of $48.2 when it sold its Humboldt, Chanute and
Iola, Kansas branches ("Southeast Kansas branches") to Emprise Financial
Corporation based in Wichita, Kansas. Assets of $36.4 million and deposits of
$50.1 million associated with these branches are shown as "held for sale" on the
Company's balance sheet at December 31, 2002. The Company received a 2.5%
premium on loans and a 4.75% premium on deposits, which generated a $3.1 million
pretax gain less a $150,000 write-off of related goodwill associated with these
branches. All other items were sold at book value. There were approximately
$343,000 in expenses incurred related to the sale. The sale was subject to the
satisfaction of customary conditions, including regulatory approvals. The
Southeast Kansas branches were included in the Enterprise Banking segment.
(6) Stock Option Plans
As allowed by SFAS No. 148, the Company has elected to apply the
intrinsic-value-based method of accounting prescribed by Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations including FASB Interpretation No. 44, Accounting for
Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25, issued in March 2000, to account for its fixed-plan stock
options. Under this method, compensation expense is recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. SFAS No. 123, Accounting for Stock-Based Compensation,
established accounting and disclosure requirements using a fair-value-based
method of accounting for stock-based employee compensation plans. As allowed by
SFAS No. 123, the Company has elected to continue to apply the
intrinsic-value-based method of accounting described above, and has adopted only
the disclosure requirements of SFAS No. 148. The following table illustrates the
effect on net income if the fair-value-based method had been applied to all
outstanding and unvested awards in each period.
10
Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net income, as reported $ 2,598,372 $ 1,449,242 $ 3,733,470 $ 2,320,600
Deduct total stock-based employee compensation
expense determined under fair-value-based
method for all rewards, net of tax (298,187) (133,792) (519,650) (277,615)
------------ ------------ ------------ ------------
Pro forma net income $ 2,300,185 $ 1,315,450 $ 3,213,820 $ 2,042,985
============ ============ ============ ============
Earnings per share:
Basic:
As reported $ 0.27 $ 0.15 $ 0.39 $ 0.25
Pro forma 0.24 0.14 0.34 0.22
Diluted:
As reported $ 0.26 $ 0.15 $ 0.38 $ 0.24
Pro forma 0.23 0.14 0.33 0.21
(7) Disclosures about Financial Instruments
The Bank issues financial instruments with off balance sheet risk in the normal
course of the business of meeting the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. These instruments may involve, to varying degrees, elements of credit
and interest-rate risk in excess of the amounts recognized in the consolidated
balance sheets.
The Company's extent of involvement and maximum potential exposure to credit
loss in the event of nonperformance by the other party to the financial
instrument for commitments to extend and standby letters of credit is
represented by the contractual amount of these instruments. The Bank uses the
same credit policies in making commitments and conditional obligations as it
does for financial instruments included on its consolidated balance sheets. At
June 30, 2003 and December 31, 2002, no amounts have been accrued for any
estimated losses for these financial instruments.
The contractual amount of off-balance-sheet financial instruments as of June 30,
2003 and December 31, 2002 is as follows:
June 30, December 31,
2003 2002
-------------- --------------
Commitments to extend credit $ 212,545,104 $ 183,070,617
Standby letters of credit 20,985,636 17,755,979
============== ==============
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Of the total commitments to extend credit at June 30,
2003, $7,736,501 represents fixed rate loan commitments. Of the total
commitments to extend credit at December 31, 2002, $6,070,659 represents fixed
rate loan commitments. Since certain of the commitments may expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Bank evaluates each customer's credit worthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Bank upon extension of credit, is based on management's credit evaluation of
the borrower. Collateral held varies, but may include accounts receivable,
inventory, premises and equipment, and real estate.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. These standby letters
of credit are primarily issued to support contractual obligations of the Bank's
customers. The credit risk involved in issuing letters of credit is essentially
the same as the risk involved in extending loans to customers. The approximate
remaining terms of standby letters of credit range from 1 month to 9 years at
June 30, 2003.
11
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
the Company's actual results could differ materially from those contained in the
forward-looking statements due to a number of factors, including burdens imposed
by federal and state regulation of banks, credit risk, 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 the Company'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, 2003 compared to the
three and six month periods ended June 30, 2002 and the year ended December 31,
2002. 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, 2002.
Financial Condition
Total assets at June 30, 2003 were $866 million, a decrease of $11 million, or
1%, from total assets of $877 million at December 31, 2002. The decrease in
total assets is the result of the transfer of $36.4 million in assets and $50.1
million in deposits at the closing of the sale of the Southeast Kansas branches
on April 4, 2003. Loans and leases, net of unearned loan fees, were $736
million, an increase of $56 million, or 8%, over total loans and leases of $680
million at December 31, 2002. Federal funds sold, interest-bearing deposits and
investment securities were $77 million and $100 million at June 30, 2003 and
December 31, 2002, respectively. The reduction in these balances since December
31, 2002 supplemented the shortfall in deposit growth to fund new loan volume.
Total deposits at June 30, 2003 were $748 million, an increase of $32 million,
or 4%, over total deposits of $716 million at December 31, 2002. Certificates of
deposits were $185 million, an increase of $28 million, or 18%, over
certificates of deposits at December 31, 2002. The Bank executed three $10
million brokered certificates of deposit during the six months ended June 30,
2003.
Total shareholders' equity at June 30, 2003 was $63.1 million, an increase of
$4.3 million, or 7%, over total shareholders' equity of $58.8 million at
December 31, 2002. The increase in equity is due to net income of $3.7 million
for the six months ended June 30, 2003, the exercise of incentive stock options
by employees, and an increase in accumulated other comprehensive income, offset
by dividends paid to shareholders.
Results of Operations
Net income was $2,598,372 for the three month period ended June 30, 2003, an
increase of 79% compared to the net income of $1,449,242 for the same period in
2002. Net income was $3,733,470 for the six month period ended June 30, 2003, an
increase of 61% compared to net income of $2,320,600 for the same period in
2002. The increase in net income for the three and six months ended June 30,
2003 is attributable to an increase in net interest income and an increase in
noninterest income including a $2,937,976 gain on the sale of branches partially
offset by an increase in noninterest expense and provision for loan losses.
Basic earnings per share for the three month periods ended June 30, 2003 and
2002 were $0.27 and $0.15, respectively. Fully diluted earnings per share for
the three month periods ended June 30, 2003 and 2002 were $0.26 and $0.15,
respectively. Basic earnings per share for the six month periods ended
12
June 30, 2003 and 2002 were $0.39 and $0.25, respectively. Fully
diluted earnings per share for the six month periods ended June 30, 2003 and
2002 were $0.38 and $0.24, respectively.
Net Interest Income
Net interest income (on a tax equivalent basis) was $8.2 million, or 4.05%, of
average interest-earning assets, for the three months ended June 30, 2003,
compared to $7.8 million, or 4.16%, of average interest-earning assets, for the
same period in 2002. The $392,000 increase in net interest income for the three
months ended June 30, 2003 as compared to the same period in 2002 was the result
of an increase in average interest-earning assets and a decrease in the interest
rates on average interest-bearing liabilities partially 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, 2003 were $812 million, a $60 million, or 8%, increase
over $752 million, during the same period in 2002. 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 5.38% for the three month period ended June 30, 2003 compared to
6.11% for the six month period ended June 30, 2002. The decrease in asset yield
was primarily due to a 50 basis point decrease in the prime rate since June 30,
2002 and a general decrease in the average yield on new fixed rate loans and
investment securities. Average interest-bearing liabilities increased to $640
million for the three months ended June 30, 2003 from $606 million for the same
period in 2002. The cost of interest-bearing liabilities decreased to 1.69% for
the three months ended June 30, 2003 compared to 2.41% for the same period in
2002. This decrease is attributed mainly to declines in market interest rates
for all sources of funding and a change in the mix of liabilities. Average
demand deposits increased $17 million, or 13%, to $144 million for the three
months ended June 30, 2003 from $127 million for the same period in 2002.
Average interest bearing liabilities as a percent of average assets decreased to
74.89% for the three months ended June 30, 2003 from 76.51% for the same period
in 2002. The increase in demand deposit accounts, money market accounts and
savings accounts is attributed to continued calling efforts of the Company's
relationship officers. Average certificate of deposit accounts decreased to $179
million for the three months ended June 30, 2003 from $192 million during the
same period in 2002. This decrease in certificate of deposit accounts is a
result of their relative unattractiveness to customers as compared to money
market and other more liquid products in the current rate environment. The
decrease in certificate of deposit accounts was offset by increased Federal Home
Loan Bank borrowings. The Company also issued $4 million in floating rate Trust
Preferred Securities in June 2002. The increase in average balances are net of
the decrease in balances from the sale of the Southeast Kansas branches. The
Company transferred $27.2 million in loans, $1.1 million in fixed assets, and
$48.2 million in deposits on April 4, 2003 when it sold its Southeast Kansas
branches. The Southeast Kansas branches are included in the average balances for
the three months ended June 30, 2002.
13
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 net interest rate margin
for the three month periods ended June 30, 2003 and 2002:
Three months ended June 30,
2003 2002
------------------------------------------- ------------------------------------------
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) $ 726,420 85.00% $ 10,398 5.74% $ 699,697 88.39% $ 11,020 6.32%
Taxable investments in debt and
equity securities 66,826 7.82 440 2.64 41,946 5.30 388 3.71
Non-taxable investments in debt and
equity securities(2) 509 0.06 7 5.52 -- -- -- --
Federal funds sold 18,652 2.18 48 1.03 9,312 1.18 35 1.51
Interest-bearing deposits 80 0.01 0 0.25 817 0.10 5 2.45
---------- --------- ---------- ---------- -------- ----------
Total interest-earning assets 812,487 95.07 10,893 5.38 751,772 94.97 11,448 6.11
Non-interest-earning assets:
Cash and due from banks 29,095 3.40 25,912 3.27
Fixed assets, net 7,441 0.87 9,688 1.22
Prepaid expenses and other assets 15,179 1.78 12,262 1.55
Allowance for loan losses (9,552) (1.12) (8,062) (1.01)
-- -- --
---------- --------- ---------- --------
Total assets $ 854,650 100.00% $ 791,572 100.00%
========== ========= ========== ========
Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest-bearing transaction accounts $ 54,099 6.33% $ 49 0.36% $ 59,578 7.53% $ 69 0.46%
Money market accounts 347,255 40.63 885 1.02 312,387 39.46 1,212 1.56
Savings 4,081 0.48 3 0.29 8,809 1.11 22 1.00
Certificates of deposit 178,745 20.91 1,118 2.51 192,115 24.27 1,851 3.86
Guaranteed preferred beneficial
interests in subordinated
debentures 15,000 1.76 309 8.26 11,132 1.41 263 9.48
Borrowed funds 40,839 4.78 331 3.25 21,641 2.73 225 4.17
---------- --------- ---------- ---------- -------- ----------
Total interest-bearing liabilities 640,019 74.89 2,695 1.69 605,662 76.51 3,642 2.41
Noninterest-bearing liabilities:
Demand deposits 144,077 16.86 127,281 16.08
Other liabilities 8,401 0.98 4,720 0.60
---------- --------- ---------- --------
Total liabilities 792,497 92.73 737,663 93.19
Shareholders' equity 62,153 7.27 53,909 6.81
---------- --------- ---------- --------
Total liabilities & shareholders'
equity $ 854,650 100.00% $ 791,572 100.00%
========== ========= ========== ========
Net interest income $ 8,198 $ 7,806
========== ==========
Net interest spread 3.69% 3.70%
Net interest margin(3) 4.05% 4.16%
======== ========
<FN>
<F1>
(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 $299,000, and $394,000 for 2003 and
2002, respectively.
<F2>
(2) Non-taxable income is presented on a fully tax-equivalent basis assuming a
tax rate of 34%.
<F3>
(3) Net interest income divided by average total interest earning assets.
</FN>
14
Net interest income (on a tax equivalent basis) was $16.3 million, or 4.07%, of
average interest-earning assets, for the six months ended June 30, 2003,
compared to $15.0 million, or 4.04%, of average interest-earning assets, for the
same period in 2002. The $1,350,000 increase in net interest income for the six
months ended June 30, 2003 as compared to the same period in 2002 was the result
of an increase in average interest-earning assets and a decrease in the interest
rates on average interest-bearing liabilities partially 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 six months
ended June 30, 2003 were $811 million, a $63 million, or 8%, increase over $748
million, during the same period in 2002. 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 5.44% for the six month period ended June 30, 2003 compared to
6.07% for the six month period ended June 30, 2002. The decrease in asset yield
was primarily due to a 50 basis point decrease in the prime rate since June 30,
2002 and a general decrease in the average yield on new fixed rate loans and
investment securities. Average interest-bearing liabilities increased to $644
million for the six months ended June 30, 2003 from $607 million for the same
period in 2002. The cost of interest-bearing liabilities decreased to 1.73% for
the six months ended June 30, 2003 compared to 2.49% for the same period in
2002. This decrease is attributed mainly to declines in market interest rates
for all sources of funding and a change in the mix of liabilities. Average
demand deposits increased $23 million, or 19%, to $144 million for the six
months ended June 30, 2003 from $122 million for the same period in 2002.
Average interest bearing liabilities as a percent of average assets decreased to
75.19% for the six months ended June 30, 2003 from 77.23% for the same period in
2002. The increase in demand deposit accounts, money market accounts and savings
accounts is attributed to continued calling efforts of the Company's
relationship officers. Average certificate of deposit accounts decreased to $180
million at June 30, 2003 from $191 million at June 30, 2002. This decrease in
certificate of deposit accounts is a result of their relative unattractiveness
to customers as compared to money market and other more liquid products in the
current rate environment. The decrease in certificate of deposit accounts was
offset by Federal Home Loan Bank borrowings. The Company issued $4 million in
floating rate Trust Preferred Securities in June 2002. The increase in average
balances are net of the decrease in balances from the sale of the Southeast
Kansas branches. The Company transferred $27.2 million in loans, $1.1 million in
fixed assets, and $48.2 million in deposits on April 4, 2003 when it sold its
Southeast Kansas branches. The Southeast Kansas branches are included in the
average balances for the six months ended June 30, 2002.
15
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 net interest rate margin
for the six month periods ended June 30, 2003 and 2002:
Six months ended June 30,
2003 2002
------------------------------------------- --------------------------------------------
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) $ 727,402 84.99% $ 20,862 5.78% $ 684,183 87.00% $ 21,507 6.34%
Taxable investments in debt and
equity securities 66,235 7.74 922 2.81 44,919 5.71 845 3.79
Non-taxable investments in debt
and equity securities(2) 269 0.03 7 5.25 37 0.00 1 5.45
Federal funds sold 16,798 1.96 86 1.03 16,649 2.12 127 1.54
Interest-bearing deposits 80 0.01 0 0.14 2,252 0.29 23 2.06
---------- -------- --------- ---------- -------- ----------
Total interest-earning assets 810,784 94.73 21,877 5.44 748,040 95.12 22,503 6.07
Non-interest-earning assets:
Cash and due from banks 30,991 3.62 25,114 3.19
Fixed assets, net 8,060 0.94 9,820 1.25
Prepaid expenses and other assets 15,325 1.80 11,267 1.43
Allowance for loan losses (9,338) (1.09) (7,817) (0.99)
---------- -------- ---------- --------
Total assets $ 855,822 100.00% $ 786,424 100.00%
========== ======== ========== ========
Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest-bearing transaction
accounts $ 58,951 6.89% $ 101 0.35% $ 62,919 8.00% $ 137 0.44%
Money market accounts 345,784 40.40 1.812 1.06 314,871 40.04 2,487 1.59
Savings 6,477 0.75 18 0.56 8,570 1.09 43 1.01
Certificates of deposit 179,800 21.01 2,350 2.64 191,428 24.34 3,892 4.10
Guaranteed preferred beneficial
interests in subordinated
debentures 15,000 1.75 617 8.29 11,066 1.41 521 9.49
Borrowed funds 37,588 4.39 631 3.39 18,497 2.35 425 4.63
---------- -------- --------- ---------- -------- ----------
Total interest-bearing liabilities 643,570 75.19 5,529 1.73 607,351 77.23 7,505 2.49
Noninterest-bearing liabilities:
Demand deposits 144,438 16.88 121,542 15.46
Other liabilities 6,253 0.73 4,099 0.52
---------- -------- ---------- --------
Total liabilities 794,261 92.81 732,992 93.21
Shareholders' equity 61,561 7.19 53,432 6.79
---------- -------- ---------- --------
Total liabilities & shareholders'
equity $ 855,822 100.00% $ 786,424 100.00%
========== ======== ========== ========
Net interest income $ 16,348 $ 14,998
========= ==========
Net interest spread 3.71% 3.58%
Net interest margin(3) 4.07% 4.04%
======= =======
<FN>
<F1>
(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 $680,000 and $731,000 for the
six months ended June 30, 2003 and 2002, respectively.
<F2>
(2) Non-taxable income is presented on a fully tax-equivalent basis assuming a
tax rate of 34%.
<F3>
(3) Net interest income divided by average total interest earning assets.
</FN>
16
During the three months ended June 30, 2003, an increase in the average volume
of interest-earning assets resulted in an increase in interest income of
$629,000. Interest income decreased $1,184,000 due to a decrease in rates on
average interest-earning assets. Increases in the average volume of money market
accounts, guaranteed preferred beneficial interests in subordinated debentures,
and borrowed funds offset by decreases in the average volume of interest-bearing
transaction, savings and time deposits resulted in an increase in interest
expense of $241,000. Changes in interest rates on the average volume of
interest-bearing liabilities resulted in a decrease in interest expense of
$1,188,000. The net effect of the volume and rate changes associated with all
categories of interest-earning assets during the six months ended June 30, 2003
as compared to the same period in 2002 was a decrease in interest income of
$555,000, 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 $947,000.
During the six months ended June 30, 2003, an increase in the average volume of
interest-earning assets resulted in an increase in interest income of
$1,642,000. Interest income decreased $2,268,000 due to a decrease in rates on
average interest-earning assets. Increases in the average volume of money market
accounts, guaranteed preferred beneficial interests in subordinated debentures,
and borrowed funds offset by decreases in the average volume of interest-bearing
transaction, savings and time deposits resulted in an increase in interest
expense of $215,000. Changes in interest rates on the average volume of
interest-bearing liabilities resulted in a decrease in interest expense of
$2,191,000. The net effect of the volume and rate changes associated with all
categories of interest-earning assets during the six months ended June 30, 2003
as compared to the same period in 2002 was a decrease in interest income of
$626,000, 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 $1,976,000.
The increase in average balances are net of the decrease in balances from the
sale of the Southeast Kansas branches. The Company transferred $27.2 million in
loans, $1.1 million in fixed assets, and $48.2 million in deposits on April 4,
2003 when it sold its Southeast Kansas branches. The Southeast Kansas branches
are included in the average balances for the three and six month periods ended
June 30, 2002.
The following table sets forth on a tax equivalent basis, for the three and six
months ended June 30, 2003 compared to the same periods ended June 30, 2002, a
summary of the changes in interest income and interest expense resulting from
changes in yield/rates and volume:
2003 Compared to 2002
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) $ 418 $ (1,040) $ (622) $ 1,315 $ (1,960) $ (645)
Taxable investments in debt
and equity securities 187 (135) 52 332 (255) 77
Nontaxable investments in debt
and equity securities(3) -- 7 7 6 (0) 6
Federal funds sold 27 (14) 13 1 (42) (41)
Interest-earning deposits (3) (2) (5) (12) (11) (23)
------------ ------------ ------------ ------------ ------------ ------------
Total interest-earning assets $ 629 $ (1,184) $ (555) $ 1,642 $ (2,268) $ (626)
------------ ------------ ------------ ------------ ------------ ------------
Interest paid on:
Interest-bearing transaction
accounts $ (6) $ (14) $ (20) $ (8) $ (28) $ (36)
Money market accounts 128 (455) (327) 223 (898) (675)
Savings (8) (11) (19) (9) (16) (25)
Certificates of deposit (122) (611) (733) (225) (1,317) (1,542)
Guaranteed preferred beneficial
interests in subordinated
debentures 84 (38) 46 149 (53) 96
Borrowed funds 165 (59) 106 85 121 206
------------ ------------ ------------ ------------ ------------ ------------
Total interest-bearing
liabilities 241 (1,188) (947) 215 (2,191) (1,976)
------------ ------------ ------------ ------------ ------------ ------------
Net interest income (loss) $ 388 $ 4 $ 392 $ 1,427 $ (77) $ 1,350
============ ============ ============ ============ ============ ============
<FN>
<F1>
(1) Change in volume multiplied by yield/rate of prior period.
<F2>
(2) Change in yield/rate multiplied by volume of prior period.
<F3>
(3) Nontaxable investment income is presented on a fully tax-equivalent basis
assuming a tax rate of 34%.
</FN>
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.
17
Provision for Loan Losses
The provision for loan losses was $1,094,000 and $2,093,000 for the three and
six month periods ended June 30, 2003, respectively, compared to $530,000 and
$1,120,000 for the same periods in 2002. The increase in provision for loan
losses during the first six months of 2003 as compared to the same period in
2002 is considered prudent by management in view of strong loan growth in a
still-weakened economy, increased concern for credit quality and the company's
recent charge-offs. The company experienced $1,154,000 in net charge-offs for
the six months ended June 30, 2003 compared to net charge-offs of $190,000
during the same period ended June 30, 2002. Gross charge-offs in the first half
of 2003 totaled $1,300,000. This amount is largely associated with one problem
loan relationship consisting of several loans which came to Enterprise as part
of the acquisition of First Commercial Bank in 2000.
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:
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
(Dollars in thousands) (Dollars in thousands)
Allowance at beginning of period $ 9,175 $ 7,856 $ 8,600 $ 7,296
Loans charged off:
Commercial and industrial 805 107 1,299 138
Real estate:
Commercial -- -- -- 14
Construction -- -- --
Residential -- -- --
Consumer and other 1 68 1 77
------------ ------------ ------------ ------------
Total loans charged off 806 175 1,300 229
------------ ------------ ------------ ------------
Recoveries of loans previously charged off:
Commercial and industrial -- 10 3 20
Real estate:
Commercial 66 3 66 8
Construction -- -- -- --
Residential 10 -- 28 --
Consumer and other -- 2 49 11
------------ ------------ ------------ ------------
Total recoveries of loans previously
charged off 76 15 146 39
------------ ------------ ------------ ------------
Net loans charged off 730 160 1,154 190
------------ ------------ ------------ ------------
Provision for loan losses 1,094 530 2,093 1,120
------------ ------------ ------------ ------------
Allowance at end of period $ 9,539 $ 8,226 $ 9,539 $ 8,226
============ ============ ============ ============
Average loans $ 726,420 $ 699,697 $ 727,402 $ 684,183
Total loans 735,733 669,465 735,733 669,465
Nonperforming loans 2,808 2,913 2,808 2,913
Net charge-offs to average loans (annualized) 0.40% 0.09% 0.32% 0.06%
Allowance for loan losses to total loans 1.30 1.23 1.30 1.23
Allowance for loan losses to nonperforming loans 339.71 282.39 339.71 282.39
The Company's credit management policies and procedures focus on identifying,
measuring, and controlling credit exposure. These procedures employ a
lender-initiated system of rating credits, which is ratified in the loan
approval process and subsequently tested in internal loan reviews and regulatory
bank examinations. The system requires rating all loans at the time they are
made.
18
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. 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 Senior Lending Officer and the Executive Loan
Committee. Downgrades of loan risk ratings may be initiated by the responsible
loan officer, internal loan review, or credit analyst department at any time.
However, upgrades of risk ratings may only be made with the concurrence of the
Executive Loan Committee or 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 10-K Annual Report. 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.
19
The Bank had no loans 90 days past due still accruing interest at June 30, 2003
or December 31, 2002. The following table sets forth information concerning the
Company's non-performing assets as of the dates indicated:
June 30, December 31,
2003 2002
------------ ------------
(Dollars in Thousands)
Non-accrual loans $ 2,808 $ 2,212
Restructured loans -- 1,676
------------ ------------
Total nonperforming loans 2,808 3,888
Foreclosed property 345 125
------------ ------------
Total non performing assets $ 3,153 $ 4,013
============ ============
Total assets $ 866,284 $ 876,787
Total loans, less unearned loan fees 735,733 679,799
Total loans plus foreclosed property 736,078 679,924
Nonperforming loans to loans 0.38% 0.57%
Nonperforming assets to loans plus
foreclosed property 0.43 0.59
Nonperforming assets to total assets 0.36 0.46
Noninterest Income
Noninterest income was $4,691,294 and $6,469,734 for the three and six month
periods ended June 30, 2003, respectively, compared to $1,445,970 and $2,937,690
for the same periods in 2002. The increases are primarily attributed to a
$3,087,976 gain on the sale of the Southeast Kansas branches, less a $150,000
write-off of related goodwill, increases in service charges on deposit accounts,
an increase in the gain on the sale of mortgage loans, increases in trust and
financial advisory income, and a $77,884 gain on the sale of securities. Service
charges on deposit accounts were $406,192 and $892,819 for the three and six
month periods ended June 30, 2003, as compared to $448,747 and $860,641 for the
same periods in 2002. The decrease in service charges on deposit accounts for
the three month period ended June 30, 2003 as compared to the same period in
2002, is the result of reduced retail banking activity at the Southeast Kansas
Branches which were sold on April 4, 2003. The Southeast Kansas branch activity
is included in the three and six month periods ended June 30, 2002. The increase
in service charges on deposit accounts for the six months ended June 30, 2003,
as compared to the six months ended June 30, 2002 is a result of a decrease in
the earnings credit rate on business accounts and an increase in the number of
accounts, account activity and services provided offset by decreases related to
the sale of the Southeast Kansas branches. Gains on the sale of mortgage loans
were $586,568 and $1,114,430 for the three and six month periods ended June 30,
2003, as compared to $284,906 and $645,243 for the same periods in 2002. The
increase in these gains is a result of continued high volumes of new
originations and refinancings as a result of low mortgage interest rates. These
loans are sold into the secondary market with release of the servicing rights.
Trust and financial advisory income was $669,902 and $1,259,457 for the three
and six month periods ended June 30, 2003 as compared to $540,077 and $1,169,133
for the periods in 2002. The increases in trust and financial advisory income is
the result of an increase in the number of accounts and an increase in assets
under management to over $1 billion at June 30, 2003, as compared to $879
million at June 30, 2002. Noninterest income was $1,753,318 and $3,531,758 for
the three and six months ended June 30, 2003 after adjusting out the $2,937,976
gain on the sale of the Southeast Kansas branches. This is a $307,348, or 21%,
and $594,068, or 20%, increase over the three and six month periods ended June
30, 2002.
20
Noninterest Expense
Total noninterest expense was $7,577,019 and $14,609,811 for the three and six
months ended June 30, 2003, representing a $1,210,113, or 17% and $1,610,218 or
12% increase from the same periods in 2002. Expenses related to the sale of the
Southeast Kansas branches totaling $343,000 increased performance-based employee
compensation, occupancy costs, and director expenses offset by declines in
various discretionary expense categories and equipment costs.
Employee compensation and benefits increased $671,274 and $1,016,966 for the
three and six months ended June 30, 2003, respectively, as compared to the same
periods in 2002. Approximately $356,000 and $534,000 of these increases were due
to increased accruals under the Company's incentive bonus and 401K match program
as the Company exceeded budgeted performance for the quarter and first half of
the year. The Company paid employees $177,000 in retention and severance bonuses
related to the sale of the Southeast Kansas branches during April 2003. Another
$86,000 and $150,000 of this increase was related to higher commission payouts
in the mortgage department of the Bank for the three and six month periods ended
June 30, 2003 as compared to the same periods in 2002. The remaining variance in
this category was attributable to annual merit increases for personnel and
higher compensation associated with new middle and senior management hired
during 2002. Offsetting some of these costs was an overall reduction in staffing
levels required, as there were 39 fewer full-time equivalent employees at June
30, 2003 versus June 30, 2002.
Occupancy expense increased $38,629 and $57,091 for the three and six month
periods ended June 30, 2003 as compared to the same periods in 2002. Most of the
increase in occupancy expenses was due to scheduled rent increases on various
Company facilities offset by a decrease in building depreciation expense related
to the sale of the buildings with the Southeast Kansas branches.
Other noninterest expense was $1,900,596 and $3,516,550 for the three and six
month periods ended June 30, 2003 as compared to the $1,388,840 and $2,927,631
for the three and six month periods ended June 30, 2002. The increase in other
noninterest expense for the six months ended June 30, 2003 as compared to the
same period in 2002 is the result of $83,000 in expenses related to the sale of
the Southeast Kansas branches, an increase in director expenses, $380,000 in
expenses related to noncompete agreements with two former key employees, and the
recognition of a $50,000 legal settlement related to a loan dispute with another
bank, offset by a decrease in meals and entertainment expenses and fraud and
trading losses. Director expenses were $49,000 and $162,000 for the three and
six month periods ended June 30, 2003, respectively, as compared to $24,000 and
$48,000 for the same periods in 2002. The Company increased its compensation
paid to certain directors whose appointed duties require additional time
commitments. In addition, several Board members chose to forfeit their stock
appreciation rights and receive cash payments for meeting attendance. The stock
appreciation rights still outstanding are marked to the Company's stock market
price on a quarterly basis. The $1.30 increase in the stock price from December
31, 2002 to March 31, 2003 resulted in a $66,000 mark to market expense, which
is included in the $162,000 of directors expenses mentioned above. There was no
expense for marking the stock appreciation rights to market for the three months
ended June 30, 2003; the stock price was $13.45 on June 30, 2003, slightly less
than the stock price on March 31, 2003. In January 2003, the Company recognized
$160,000 in amortization related to a noncompete agreement with a former key
employee who resigned on September 30, 2002. During May 2003, the Company
recognized $220,000 in expense related to a noncompete agreement with another
former key employee.
Declines in certain expense categories like 1) meals and entertainment, 2)
stationary and office supplies, and 3) fraud and trading losses were due to a
concerted effort by management during the six month periods ended June 30, 2003.
The $52,758 decrease in furniture, equipment and data processing expenses along
with decreases in communications expense was the result of savings from
communications upgrades and the discontinuation of depreciation on Southeast
Kansas assets sold in April 2003.
The ratio of noninterest expense to average assets for the three and six month
periods ended June 30, 2003 was 3.56% and 3.44%, respectively, versus 3.23% and
3.33% and for the same periods in 2002. The efficiency ratio, which is total
noninterest expenses as a percent of total revenues, was 59.22% and 64.57% for
the three and six month periods ended June 30, 2003 as compared to 69.23% and
72.81% for the same periods in 2002. After adjusting for the gain and expenses
related to the sale of the Southeast Kansas branches and the non compete
expenses, the efficiency ratio was
21
71.17% and 70.53% and the ratio of noninterest expense to average assets was
3.29% and 3.27%, for the three and six month periods ended June 30, 2003,
respectively. Management is focused on improving these ratios in future years
through employee productivity and expense controls.
The following table presents a breakdown of the gain and expenses related to the
sale of the Southeast Kansas branches. The table also presents noninterest
income, noninterest expense and the related ratios adjusted for the gain and
expenses related to the sale of the Southeast Kansas branches and noncompete
expenses.
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
------------- ------------- -------------- --------------
Net interest income $ 8,102,668 $ 7,750,302 $ 16,157,167 $ 14,917,216
============= ============= ============== ==============
Total noninterest income $ 4,691,294 $ 1,445,970 $ 6,469,734 $ 2,937,690
Gain on the sale of Southeast
Kansas branches 3,087,976 -- 3,087,976 --
Less writeoff of related goodwill 150,000 -- 150,00 --
============= ============= ============== ==============
Adjusted noninterest income $ 1,753,318 $ 1,445,970 $ 3,531,758 $ 2,937,690
============= ============= ============== ==============
Total noninterest expense $ 7,577,019 $ 6,366,906 $ 14,609,811 $ 12,999,593
Severance and retention bonuses 177,161 -- 177,161 --
Occupancy 27,544 -- 27,544 --
Furniture and equipment 17,626 -- 17,626 --
Data Processing 37,475 -- 37,475 --
Other 82,897 -- 82,897 --
Noncompete expenses 220,000 -- 380,000 --
------------- ------------- -------------- --------------
Adjusted noninterest expense $ 7,014,316 $ 6,366,906 $ 13,887,108 $ 12,999,593
============= ============= ============== ==============
Efficiency ratio 59.22% 69.23% 64.57% 72.81%
Adjusted efficiency ratio 71.17% 69.23% 70.53% 72.81%
Noninterest expense to average assets 3.56% 3.23% 3.44% 3.33%
Adjusted noninterest expense
to average assets 3.29% 3.23% 3.27% 3.33%
Liquidity
Liquidity is provided by the Bank'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, 2003, the loan to deposit ratio was 98%,
as compared to 95% at December 31, 2002. Federal funds sold, interest bearing
deposits and investment securities were $77 million and $100 million at June 30,
2003 and December 31, 2002, respectively. During the six months ended June 30,
2003, the Bank funded net new loans of $56 million, while deposits increased a
net $32 million. During 2003, the Bank obtained three $10 million brokered
certificates of deposit, which supplemented its core deposit activities. The
Bank has a total of $50 million in brokered certificates of deposit or 7% of its
total deposits at June 30, 2003. In April 2003, the Bank absorbed about $15
million in lost liquidity when it closed on the sale of the Southeast Kansas
Branches, as they were a net provider of funds.
The Bank closely monitors its current liquidity position and believes there are
sufficient backup sources of liquidity. As of June 30, 2003, the Bank has over
$110 million available from the Federal Home Loan Bank of Des Moines under a
blanket loan pledge, and $45 million from the Federal Reserve under a pledged
loan agreement. The Bank also has access to over $70 million in overnight fed
funds lines from various banking institutions. In addition, the Company has a $5
million credit line, which can be drawn upon for additional capital injections
into the Bank.
22
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 possible additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the 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, 2003, 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.
At June 30, 2003 and December 31, 2002, Enterprise Financial Services Corp and
Enterprise Bank 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, 2003:
Total Capital (to Risk Weighted Assets)
Enterprise Financial Services Corp $ 83,400,434 11.18% $ 59,653,914 8.00% $ -- --%
Enterprise Bank 79,705,939 10.72 59,503,855 8.00 74,379,819 10.00
Tier I Capital (to Risk Weighted Assets)
Enterprise Financial Services Corp $ 74,076,818 9.93% $ 29,826,957 4.00% $ -- --%
Enterprise Bank 70,405,480 9.47 29,751,928 4.00 44,627,891 6.00
Tier I Capital (to Average Assets)
Enterprise Financial Services Corp $ 74,076,818 8.69% $ 25,571,924 3.00% $ -- --%
Enterprise Bank 70,405,480 8.28 25,511,446 3.00 42,519,077 5.00
At December 31, 2002:
Total Capital (to Risk Weighted Assets)
Enterprise Financial Services Corp $ 78,207,875 10.95% $ 57,136,811 8.00% $ -- --%
Enterprise Bank 75,204,737 10.58 56,885,394 8.00 71,106,743 10.00
Tier I Capital (to Risk Weighted Assets)
Enterprise Financial Services Corp $ 69,607,874 9.75% $ 28,568,406 4.00% $ -- --%
Enterprise Bank 66,604,736 9.37 28,442,697 4.00 42,664,046 6.00
Tier I Capital (to Average Assets)
Enterprise Financial Services Corp $ 69,607,874 7.93% $ 26,346,052 3.00% $ -- --%
Enterprise Bank 66,604,736 7.60 26,283,571 3.00 43,805,951 5.00
<FN>
(1) There are no regulatory guidelines for defining "well capitalized" for Bank
Holding Companies as opposed to Banks.
</FN>
23
Effects 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. The Company's operations are not
currently impacted by inflation.
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 rate 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, 2003, the rate shock
scenario models indicated that annual net interest income would increase by less
than 12% should rates rise 100 basis points and decrease by less than 13% should
rates fall 100 basis points from their current level over a one year period. The
Bank has no market risk sensitive instruments held for trading purposes.
24
The following tables (dollars in thousands) present the scheduled maturity of
market risk sensitive instruments at June 30, 2003:
Beyond 5
Years
or No
Stated
Year 1 Year 2 Year 3 Year 4 Year 5 Maturity Total
--------- --------- --------- --------- -------- -------- ---------
ASSETS
Investments in debt and
equity securities $ 21,668 $ 17,864 $ 2,713 $ 3,573 $ 4,068 $ 7,566 $ 57,452
Interest-bearing
deposits 409 -- -- -- -- -- 409
Federal funds sold 19,374 -- -- -- -- -- 19,374
Loans (1) 545,290 60,902 80,342 12,078 19,337 17,784 735,733
Loans held for sale 5,088 -- -- -- -- -- 5,088
--------- --------- --------- --------- -------- -------- ---------
Total $ 591,829 $ 78,766 $ 83,055 $ 15,651 $ 23,405 $ 25,350 $ 818,056
========= ========= ========= ========= ======== ======== =========
LIABILITIES
Savings, NOW, money
market deposits $ 401,622 $ -- $ -- $ -- $ -- $ -- $ 401,622
Certificates of deposit (1) 126,944 47,039 8,597 1,963 350 -- 184,893
Guaranteed preferred
beneficial interest in
subordinated debentures -- -- -- -- -- 15,000 15,000
Borrowed funds 19,208 3,820 1,350 1,425 950 4,713 31,466
--------- --------- --------- --------- -------- -------- ---------
Total $ 547,774 $ 50,589 $ 9,947 $ 3,388 $ 1,300 $ 19,713 $ 632,981
========= ========= ========= ========= ======== ======== =========
Average
Interest
Rate for
Six Months
Ended
Carrying June 30, Estimated
Value 2003 Fair Value
---------- ----------- ----------
ASSETS
Investments in debt
and equity securities $ 57,452 2.82% $ 57,452
Interest-bearing
deposits 409 0.14 409
Federal funds sold 19,374 1.03 19,374
Loans 735,733 5.78 749,113
Loans held for sale 5,088 5,088
---------- ----------
Total $ 818,056 $ 831,436
========== ==========
LIABILITIES
Savings, NOW, money
market deposits $ 401,622 0.95% $ 401,622
Certificates of deposit 184,893 2.64 186,633
Guaranteed preferred
beneficial interest in
subordinated debentures 15,000 8.29 15,122
Borrowed funds 31,466 3.39 31,819
---------- ----------
Total $ 632,981 $ 635,196
========== ==========
(1) Adjusted for the impact of the interest rate swaps.
25
Item 4: Controls and Procedures
As of June 30, 2003, 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. Based on that evaluation, the CEO
and CFO concluded that the Company's disclosure controls and procedures were
effective as of June 30, 2003. There were no changes in internal control over
financial reporting that occurred during the fiscal quarter covered by this
report that have materially affected, or are reasonably likely to affect, the
Company's internal control over financial reporting.
26
PART II - Item 4:
Submission of Matters to a Vote of Security Holders
ANNUAL MEETING OF SHAREHOLDERS: The annual meeting of shareholders was held on
April 23, 2003. 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 2003
was ratified and shareholders approved adoption of the 2002 Incentive Stock
Plan.
The results of the voting on each proposal submitted at the meeting are as
follows:
PROPOSAL NO. 1: ELECTION OF DIRECTORS
-------------------------------------
Director For Against Abstain
- -------------------- --------- ------- -------
Paul J. McKee, Jr. 6,842,645 0 3,813
Kevin C. Eichner 6,840,370 0 3,813
Peter F. Benoist 6,840,370 0 3,813
Paul R. Cahn 6,842,645 0 3,813
William H. Downey 6,842,645 0 3,813
Robert E. Guest, Jr. 6,842,645 0 3,813
Ronald E. Henges 6,572,796 0 252,857
Richard S. Masinton 6,575,071 0 252,857
Jerry McElhatton 6,842,645 0 3,813
William B. Moskoff 6,826,390 0 3,813
Birch M. Mullins 6,826,390 0 3,813
James J. Murphy 6,842,645 0 3,813
Ted A. Murray 6,577,346 0 252,857
Stephen A. Oliver 6,842,645 0 3,813
Robert E. Saur 6,842,645 0 3,813
Jack L. Sutherland 6,842,645 0 3,813
Paul L.Vogel 6,842,645 0 3,813
Henry D. Warshaw 6,842,645 0 3,813
Ted C. Wetterau 6,566,571 0 261,357
James L. Wilhite 6,842,645 0 3,813
James A. Williams 6,842,651 0 3,813
PROPOSAL NO. 2: INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------------
Accountants For Against Abstain
- ----------- --------- ------- -------
KPMG LLP 6,794,761 40,123 6,280
PROPOSAL NO. 3: 2002 STOCK INCENTIVE PLAN
-----------------------------------------
For Against Abstain Delivered N Vote
--------- ------- ------- ----------------
Stock Plan 5,063,636 481,940 103,516 1,192,072
27
Item 6: Exhibits and Reports on Form 8-K
(a). Exhibits.
Exhibit
Number Description
-------- --------------------------------------------------------------
11.1 Statement regarding computation of per share earnings
31.1 Chief Executive Officer's Certification required by Rule
13a-14(a)
31.2 Chief Financial Officer's Certification required by Rule
13a-14(a)
32.1 Chief Executive Officer Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to section Section 906 of
the Sarbanes-Oxley Act of 2002
32.2 Chief Financial Officer Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to section Section 906
of the Sarbanes-Oxley Act of 2002
(b). During the three months ended June 30, 2003, the Registrant filed one
current report on form 8-K, dated April 21, 2003, in which the Registrant
reported the first quarter results.
28
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 14/th/ day of August 2003.
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
29