Enterprise Financial Services Corporation

Good day and welcome to the Enterprise Financial Services Corporation third quarter 2022 earnings conference call. Please note today's conference call is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star followed by the number one again. Thank you. At this time, I would like to turn the conference over to Jim Lally, President and CEO. Sir, you may begin your conference.

Well, thank you, Erica, and good morning. I welcome everyone to our third quarter earnings call. I appreciate all of you taking time to listen in. Joining me this morning is King Turner, our company's Chief Financial Officer and Chief Operating Officer, and Scott Goodman, President of Enterprise Bank & Trust. Before we begin, I would like to remind everyone on the call that a copy of the release and accompanying presentation can be found on our website. Presentation and earnings release were furnished on SEC form 8K yesterday. Please refer to slide two of the presentation titled forward-looking statements and our most recent 10K and 10Q for reasons why actual results may vary from any forward-looking statements that we make this morning. Please turn to slide three for our financial highlights of the third quarter. We're very pleased with our third quarter results as they reflect the cadence of consistency that we established since the beginning of the fourth quarter of 2021. These earnings are a product of the diversified franchise that we are building with a laser focus on establishing long-term relationships with privately held businesses while building a culture of operational excellence. For the quarter, we earned $1.32 for diluted share, which compared favorably to the $1.19 that we earned in the second quarter. Our patience with respect to our loan and investment portfolios, coupled with our low-cost deposit base, allowed us to take advantage of the rising interest rate environment. For the quarter, our net interest income increased to $124 million. This represented a 13% increase over the linked quarter and was bolstered by our net interest margin of 4.10%. Our return profile improved as well. Pre-provision return on average assets was 1.96% versus 1.73% in the second quarter and 1.81% a year ago. Return on tangible common equity also improved, increasing to 19% compared to 17% at 6-30-22. Scott will provide much more detail on how our markets and specialty businesses fared during the quarter. At a very high level, loans increased 5% annually, net of PPP, and deposits remained north of $11 billion, decreasing modestly by $35 million. At the end of the quarter, our loan-to-deposit ratio stood at 85%, with DDA representing 42% of our total deposits. Dean will spend much more time on capital, but I just wanted to comment that our TCE to total assets was stable at 7.86% despite AOCI pressure and CET1 was 11%. Keeping with the pattern that we established several quarters ago, we did increase our dividend per common share from the fourth quarter to $0.24 from $0.23. Our asset quality remained very solid at quarter ends. While our portfolio statistics remain pristine, we do understand what the impact of rising interest rates and a prolonged recession could have on our loan portfolio. With that in mind, we have conducted segmented internal loan exams and have stress tested larger floating rate portfolios and potentially higher loss portfolios and feel very confident about the resiliency. This segmented testing will continue for the foreseeable future. It goes without saying, but we are looking for the proverbial cracks in the portfolio, but we have yet to see any. I would like to provide some color on the themes I'm hearing from our clients. In my most recent meetings with several of our C&I clients, I'm hearing that orders are strong, balance sheets are good, but labor and supply chains still remain a bit challenging. That being the case, for the most part, they feel confident about their performance to plan for fiscal 2022. their ability to continue to perform at this level into 2023 and into early 2024. Most are preparing for a mild recession in early 2024 but think this will be short-lived and things will rebound by the end of that year. When speaking with our key sponsors related to our sponsored finance business, they too are confident about their portfolios and feel really good about near-term performance and the resiliency of their balance sheets of their portfolio companies should a recession last longer than anticipated. Finally, I will say that some of our larger developer clients are being cautious about new projects that are still on the drawing board. With the recent rise in interest rates, these projects have difficulty penciling, so this will obviously have an impact on new development projects that would have likely closed in mid to late 2023. Our formula for success for the remainder of the year is relatively simple. Slide four lists a sampling of our focus. We need to continue our strong momentum in both organic loan and deposit growth, and doing this with a relationship focus while keeping discipline on both pricing and credit quality. Credit and capital is always a focus for us, but given the current climate, we'll remain especially vigilant in both of these areas. And finally, times of change and uncertainty are typically ideal for us to add good talent everywhere in our organization. As we always do, we will do this with an accretive mindset. We especially think that there are very good opportunities in newer markets like Southern California and Dallas-Fort Worth. With that, I would like to turn the call over to Scott Goodman, President of Enterprise Bank and Trust.

Thank you, Jim, and good morning, everybody. As you heard from Jim, and as shown on slide six, we posted solid loan growth of $122 million for the third quarter, resulting in a trailing 12-month growth rate of 8% net of PPP changes. Despite Q3 typically being a somewhat seasonally soft period for a number of our specialty business lines, in general, we're very pleased with the overall growth in the portfolio, seeing successful conversion of our regional CNI and CRE pipelines, and continuing steady execution of new opportunities within the specialty businesses. Loan details by segment are outlined on slides number seven and eight. And year over year, growth is being contributed by nearly all segments of the business. Reduction in the residential real estate portfolio mainly reflects the addition of these loan types through the first choice acquisition and our subsequent intentional shift away from short-term bridge or fix and flip lending in the California market. Most of this reduction occurred in prior quarters. For the third quarter, The largest contributors to growth were within our regional commercial banking units in general C&I and commercial real estate categories. We have been able to successfully win a number of new larger C&I relationships during Q3 across most of our geographic markets, reflecting a steady and consistent sales process. Overall, C&I originations increased nearly 14% from the prior quarter and are up nearly 65% from the same quarter last year. We also continue to see good activity in our real estate pipeline, particularly with our existing investor clients and within the western geographies. New development loans have slowed somewhat, as developers consider elevated project costs and some shifting economic factors, but our existing construction portfolio continues to fund and perform well. A number of these projects are moving to a stabilized status, and remaining within our portfolio, which is partially contributing to the reduction that you see in construction development category and the increase in CRE investor-owned balances. The change in tax credit balances also reflect some shift in categorization this quarter as projects that have aged past their qualification periods move into a more permanent category. Moving to slide number nine. Please note that we have consolidated our metro markets into geographic regions as outlined in the footnote. The specialized lending units continue to perform well and have shown some level of immunity to the shifting economic conditions, growing in Q3 by $46 million. Life insurance premium finance grew by $30 million in a seasonally softer time of the year, due mainly to elevated activity from newer referral partners. The California market has presented an opportunity to more fully introduce our expertise in this niche to COIs within this targeted segment, and we are getting introductions to new COIs from our existing insurance partners as well. Practice Finance, which is a new team for us in 2022, has hit the ground running and continues to perform well, contributing $25 million to growth this quarter and $73 million for the year. Sponsor Finance. which was essentially flat for the quarter, which is not uncommon for this time of year. Deal flow and pipeline have begun to regenerate following a mid-year pause and look solid heading into QCOR, which tends to be a more active quarter leading up to year-end closings. In the SBA business, we did experience some decline in originations for new 7 loans this quarter due to lower demand. as well as competition from conventional bank lenders. We were able to offset much of this impact on the portfolio through efforts to proactively retain and extend existing SBA loans, with payoffs and paydowns diminishing to roughly 65% of levels experienced in the prior quarter. We have also recently bolstered our traditional owner-occupied floating rate product with fixed options as well as extending RSBA capabilities to target other business purposes in an effort to elevate production. Within the Midwestern region, St. Louis and Kansas City both had good growth quarters, resulting from landing a balanced mix of new middle market C&I relationships and commercial real estate opportunities. In the Southwest, growth was modest this quarter. We did onboard a number of new CNI relationships in Arizona, Las Vegas, and New Mexico, as well as some momentum of fundings from CRE and construction commitments flowed throughout the year. Net growth was lowered somewhat due to payoffs related to the sale of a large Arizona CNI business to private equity and the sale of investor-owned properties in Arizona and New Mexico. In the West region, the portfolio declined slightly by $10 million. due to mainly to lower advances on existing lines of credit. On a positive note, we are seeing good activity from new talent brought into this market over the last year, and our California pipeline is building heading into Q4. Payoffs there continue to moderate relating to our decision to move away from the aforementioned residential fix and flip business, with total payoffs at roughly half the level experienced last quarter. Moving to deposits, covered on slides 10 and 11, as the market has placed more emphasis recently on deposits and competition increases, our focus continues to be on retaining our existing low-cost and relationship-based funding, while leveraging specialty channels and new commercial relationships to attract additional balances. Year over year, deposit balances have risen 230 million, or roughly 2%, primarily driven by an increase in new non-interest-bearing accounts from the specialty deposit lines and new commercial relationships. For the quarter, overall balances were relatively steady compared to the prior quarter, down just $35 million. Areas of decline were primarily in interest-sensitive consumer and time deposits, while commercial, business banking, and specialty deposit channels remained strong. Average DDA balances per account continue to move down as businesses spend through stimulus dollars and excess liquidity. We've been able to offset the impact of this trend, though, through sourcing new relationships and expanding existing ones, with the current annualized growth rate of deposit accounts just under 9% in the quarter. On a regional level, which is displayed on slide number 12, we saw growth in all areas with the exception of the Midwest. This was primarily due to the movement of balances from one large commercial client in Kansas City, which was acquired in the quarter. Specialty deposits, profile on slide 13, grew by $19 million in the quarter, with the largest contributions coming from the community association and property management segments. These continue to be an efficient and low-cost source of funding, now representing 22% of total deposits. Across our markets, we had positive, net new accounts in the quarter with higher average balances than in our closed accounts and at attractive rates as our average open interest rate for the quarter was well below our peer average in general we're pleased with our ability to hold relationship balances to originate new accounts and to maintain an attractive blended deposit costs now i'd like to turn the call over to king turner for his comments on the quarter king