10-Q 1 ef71681.htm FORM 10-Q

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 September 30, 2005

 

 

o

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

 

 

For the transition period from                         to                         

 

 

 

Commission file number:  001-15373

 

 



ENTERPRISE FINANCIAL SERVICES CORP

(Exact Name of Registrant as Specified in its Charter)


Delaware

 

43-1706259

(State or Other Jurisdiction of
Incorporation or Organization)

 

(I.R.S. Employer
Identification Number)

 

 

 

150 North Meramec, Clayton, MO

 

63105

(Address of Principal Executive Offices)

 

(Zip Code)

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


Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes    x   No    o

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

Yes    x   No    o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes    o   No    x

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of November 1, 2005:

          Common Stock, $.01 par value---- 10,156,802 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 September 30, 2005 and December 31, 2004

2

 

 

 

 

 

 

Consolidated Statements of Operations Three Months and Nine Months Ended September 30, 2005 and 2004

3

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income Three Months and Nine Months Ended September 30, 2005 and 2004

4

 

 

 

 

 

 

Consolidated Statements of Cash Flows Nine Months Ended September 30, 2005 and 2004

5

 

 

 

 

 

 

Notes to Consolidated Financial Statements

6

 

 

 

 

 

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

12

 

 

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

24

 

 

 

 

 

Item 4. Disclosure Control and Procedures

25

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

 

 

Item 1. Legal Proceedings

26

 

 

 

 

 

Item 2. Unregistered Sale of Equity Securities and Use of Proceeds

26

 

 

 

 

 

Item 3. Defaults Upon Senior Securities

26

 

 

 

 

 

Item 4. Submission of Matters to a Vote of Security Holders

26

 

 

 

 

 

Item 5. Other Information

26

 

 

 

 

 

Item 6. Exhibits

27

 

 

 

 

 

Signatures

28

 

 

 

 

 

Certifications

32


PART I
Item 1 – Financial Statements
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share and per share data)

 

 

At September 30,
2005

 

At December 31,
2004

 

 

 



 



 

 

 

(Unaudited)

 

(Audited)

 

Assets

 

 

 

 

 

 

 

Cash and due from banks

 

$

38,542

 

$

28,324

 

Federal funds sold

 

 

45,281

 

 

—  

 

Interest-bearing deposits

 

 

101

 

 

156

 

 

 



 



 

Total cash and cash equivalents

 

 

83,924

 

 

28,480

 

 

 



 



 

Investments in debt and equity securities:

 

 

 

 

 

 

 

Available for sale, at estimated fair value

 

 

96,684

 

 

121,630

 

Held to maturity, at amortized cost (estimated fair value of $8 at December 31, 2004)

 

 

—  

 

 

8

 

 

 



 



 

Total investments in debt and equity securities

 

 

96,684

 

 

121,638

 

 

 



 



 

Loans held for sale

 

 

2,273

 

 

2,376

 

Loans, less unearned loan fees

 

 

976,804

 

 

898,505

 

Less: Allowance for loan losses

 

 

13,168

 

 

11,665

 

 

 



 



 

Loans, net

 

 

963,636

 

 

886,840

 

 

 



 



 

Other real estate owned

 

 

—  

 

 

123

 

Fixed assets, net

 

 

10,098

 

 

8,044

 

Accrued interest receivable

 

 

5,115

 

 

4,238

 

Goodwill

 

 

1,938

 

 

1,938

 

Prepaid expenses and other assets

 

 

6,174

 

 

6,273

 

 

 



 



 

Total assets

 

$

1,169,842

 

$

1,059,950

 

 

 



 



 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

Demand

 

$

206,724

 

$

197,283

 

Interest-bearing transaction accounts

 

 

85,824

 

 

85,523

 

Money market accounts

 

 

445,545

 

 

432,340

 

Savings

 

 

4,562

 

 

3,919

 

Certificates of deposit:

 

 

 

 

 

 

 

$100 and over

 

 

216,370

 

 

178,851

 

Other

 

 

63,940

 

 

41,712

 

 

 



 



 

Total deposits

 

 

1,022,965

 

 

939,628

 

Subordinated debentures

 

 

20,620

 

 

20,620

 

Federal Home Loan Bank advances

 

 

28,749

 

 

10,299

 

Other borrowings

 

 

6,975

 

 

9,616

 

Notes payable

 

 

—  

 

 

250

 

Accrued interest payable

 

 

2,081

 

 

1,665

 

Accounts payable and accrued expenses

 

 

4,955

 

 

5,146

 

 

 



 



 

Total liabilities

 

 

1,086,345

 

 

987,224

 

 

 



 



 

Shareholders’ equity:

 

 

 

 

 

 

 

Common stock, $.01 par value; authorized 20,000,000 shares; issued and outstanding 10,111,302 shares at September 30, 2005 and 9,778,357 at December 31, 2004.

 

 

101

 

 

98

 

Additional paid in capital

 

 

46,955

 

 

41,326

 

Unearned compensation

 

 

(1,745

)

 

—  

 

Retained earnings

 

 

39,485

 

 

32,075

 

Accumulated other comprehensive loss

 

 

(1,299

)

 

(773

)

 

 



 



 

Total shareholders’ equity

 

 

83,497

 

 

72,726

 

 

 



 



 

Total liabilities and shareholders’ equity

 

$

1,169,842

 

$

1,059,950

 

 

 



 



 

See accompanying notes to consolidated financial statements.

2


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

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 


 


 

 

 

2005

 

2004

 

2005

 

2004

 

 

 



 



 



 



 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

16,461

 

$

11,788

 

$

45,772

 

$

33,304

 

Interest on debt and equity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

692

 

 

584

 

 

2,072

 

 

1,561

 

Nontaxable

 

 

10

 

 

10

 

 

30

 

 

31

 

Interest on federal funds sold

 

 

419

 

 

138

 

 

506

 

 

224

 

Interest on interest-bearing deposits

 

 

5

 

 

1

 

 

6

 

 

2

 

Dividends on equity securities

 

 

24

 

 

29

 

 

111

 

 

73

 

 

 



 



 



 



 

Total interest income

 

 

17,611

 

 

12,550

 

 

48,497

 

 

35,195

 

 

 



 



 



 



 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing transaction accounts

 

 

281

 

 

97

 

 

652

 

 

194

 

Money market accounts

 

 

2,942

 

 

1,192

 

 

7,031

 

 

2,955

 

Savings

 

 

8

 

 

3

 

 

23

 

 

9

 

Certificates of deposit:

 

 

 

 

 

 

 

 

 

 

 

 

 

$100 and over

 

 

2,013

 

 

1,057

 

 

4,799

 

 

2,892

 

Other

 

 

511

 

 

260

 

 

1,105

 

 

780

 

Subordinated debentures

 

 

317

 

 

374

 

 

866

 

 

1,036

 

Federal Home Loan Bank borrowings

 

 

343

 

 

173

 

 

1,241

 

 

593

 

Notes payable and other borrowings

 

 

37

 

 

—  

 

 

96

 

 

30

 

 

 



 



 



 



 

Total interest expense

 

 

6,452

 

 

3,156

 

 

15,813

 

 

8,489

 

 

 



 



 



 



 

Net interest income

 

 

11,159

 

 

9,394

 

 

32,684

 

 

26,706

 

Provision for loan losses

 

 

408

 

 

100

 

 

1,420

 

 

1,437

 

Net interest income after provision for loan losses

 

 

10,751

 

 

9,294

 

 

31,264

 

 

25,269

 

 

 



 



 



 



 

Noninterest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

 

533

 

 

532

 

 

1,553

 

 

1,529

 

Wealth Management income

 

 

1,474

 

 

1,119

 

 

4,184

 

 

3,023

 

Other service charges and fee income

 

 

119

 

 

92

 

 

348

 

 

278

 

Gain on sale of mortgage loans

 

 

145

 

 

9

 

 

247

 

 

219

 

Gain on sale of other real estate

 

 

91

 

 

—  

 

 

91

 

 

—  

 

(Loss) gain on sale of securities

 

 

(85

)

 

125

 

 

(85

)

 

126

 

 

 



 



 



 



 

Total noninterest income

 

 

2,277

 

 

1,877

 

 

6,338

 

 

5,175

 

 

 



 



 



 



 

Noninterest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

Employee compensation and benefits

 

 

5,503

 

 

4,574

 

 

16,103

 

 

13,848

 

Occupancy

 

 

568

 

 

523

 

 

1,652

 

 

1,540

 

Furniture and equipment

 

 

212

 

 

176

 

 

572

 

 

534

 

Data processing

 

 

264

 

 

208

 

 

737

 

 

586

 

Other

 

 

1,978

 

 

1,575

 

 

5,349

 

 

4,547

 

 

 



 



 



 



 

Total noninterest expense

 

 

8,525

 

 

7,056

 

 

24,413

 

 

21,055

 

 

 



 



 



 



 

Income before income tax expense

 

 

4,503

 

 

4,115

 

 

13,189

 

 

9,389

 

Income tax expense

 

 

1,625

 

 

1,261

 

 

4,723

 

 

3,022

 

 

 



 



 



 



 

Net income

 

$

2,878

 

$

2,854

 

$

8,466

 

$

6,367

 

 

 



 



 



 



 

Per share amounts:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.29

 

$

0.29

 

$

0.85

 

$

0.66

 

Basic weighted average common shares outstanding

 

 

10,082,730

 

 

9,723,695

 

 

10,017,354

 

 

9,681,437

 

Diluted earnings per share

 

$

0.27

 

$

0.28

 

$

0.80

 

$

0.63

 

Diluted weighted average common shares outstanding

 

 

10,781,971

 

 

10,074,329

 

 

10,667,539

 

 

10,005,663

 

See accompanying notes to consolidated financial statements.

3


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

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 


 


 

 

 

2005

 

2004

 

2005

 

2004

 

 

 



 



 



 



 

Net income

 

$

2,878

 

$

2,854

 

$

8,466

 

$

6,367

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized (loss) gain on investment securities arising during the period, net of tax

 

 

(283

)

 

681

 

 

(502

)

 

(135

)

Less reclassification adjustment for realized loss (gain) on sale of securities included in net income, net of tax

 

 

54

 

 

(83

)

 

54

 

 

(83

)

Unrealized gain (loss) on cash flow type derivative instruments arising during the period, net of tax

 

 

28

 

 

117

 

 

(78

)

 

(576

)

 

 



 



 



 



 

Total other comprehensive (loss) income

 

 

(201

)

 

715

 

 

(526

)

 

(794

)

 

 



 



 



 



 

Total comprehensive income

 

$

2,677

 

$

3,569

 

$

7,940

 

$

5,573

 

 

 



 



 



 



 

See accompanying notes to consolidated financial statements.

4


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

 

 

Nine months ended September 30,

 

 

 


 

 

 

2005

 

2004

 

 

 



 



 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

8,466

 

$

6,367

 

Adjustments to reconcile net income to net cash from operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

807

 

 

747

 

Provision for loan losses

 

 

1,420

 

 

1,437

 

Net amortization of debt and equity securities

 

 

427

 

 

386

 

Loss (gain) on sale of available for sale investment securities

 

 

85

 

 

(126

)

Mortgage loans originated

 

 

(48,834

)

 

(47,915

)

Proceeds from mortgage loans sold

 

 

49,184

 

 

49,383

 

Gain on sale of mortgage loans

 

 

(247

)

 

(219

)

Gain on sale of other real estate

 

 

(91

)

 

—  

 

Noncash compensation for stock option grants and restricted share units

 

 

440

 

 

77

 

Tax benefit for nonqualified stock options

 

 

336

 

 

—  

 

Increase in accrued interest receivable

 

 

(877

)

 

(636

)

Increase in accrued interest payable

 

 

416

 

 

181

 

Decrease in accrued salaries payable

 

 

(120

)

 

(577

)

Other, net

 

 

180

 

 

419

 

 

 



 



 

Net cash provided by operating activities

 

 

11,592

 

 

9,524

 

 

 



 



 

Cash flows from investing activities:

 

 

 

 

 

 

 

Net increase in loans

 

 

(78,626

)

 

(91,222

)

Purchases of available for sale debt and equity securities

 

 

(25,611

)

 

(127,381

)

Proceeds from sales of available for sale debt securities

 

 

19,274

 

 

62,640

 

Proceeds from redemption of equity securities

 

 

4,665

 

 

2,484

 

Proceeds from maturities and principal paydowns on available for sale debt and equity securities

 

 

25,423

 

 

52,597

 

Proceeds from sales of other real estate

 

 

229

 

 

—  

 

Recoveries of loans previously charged off

 

 

409

 

 

148

 

Purchases of fixed assets

 

 

(2,863

)

 

(502

)

 

 



 



 

Net cash used in investing activities

 

 

(57,100

)

 

(101,236

)

 

 



 



 

Cash flows from financing activities:

 

 

 

 

 

 

 

Net increase in non-interest bearing deposit accounts

 

 

9,441

 

 

19,474

 

Net increase in interest bearing deposit accounts

 

 

73,896

 

 

121,061

 

Proceeds from issuance of subordinated debentures

 

 

—  

 

 

5,155

 

Proceeds from Federal Home Loan Bank advances

 

 

301,200

 

 

55,000

 

Repayments of Federal Home Loan Bank advances

 

 

(282,750

)

 

(58,087

)

Decrease in federal funds purchased

 

 

(6,333

)

 

(8,147

)

Increase in customer repurchase agreements

 

 

3,693

 

 

—  

 

Decrease in other borrowings

 

 

—  

 

 

(1,070

)

Paydowns on notes payable

 

 

(250

)

 

—  

 

Cash dividends paid

 

 

(1,056

)

 

(727

)

Proceeds from the exercise of common stock options

 

 

3,111

 

 

735

 

 

 



 



 

Net cash provided by financing activities

 

 

100,952

 

 

133,394

 

 

 



 



 

Net increase in cash and cash equivalents

 

 

55,444

 

 

41,682

 

Cash and cash equivalents, beginning of period

 

 

28,480

 

 

26,488

 

 

 



 



 

Cash and cash equivalents, end of period

 

$

83,924

 

$

68,170

 

 

 



 



 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

 

Interest

 

$

15,397

 

$

8,308

 

Income taxes

 

 

4,736

 

 

1,845

 

 

 



 



 

Noncash transactions:

 

 

 

 

 

 

 

Transfer to other real estate owned in settlement of loans

 

 

—  

 

 

273

 

See accompanying notes to consolidated financial statements.

5


ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Financial Statement Presentation

The accompanying consolidated financial statements are unaudited and contain the accounts of Enterprise Financial Services Corp (the “Company”) and its wholly-owned subsidiary, Enterprise Bank & Trust (the “Bank”.)   All significant intercompany accounts and transactions have been eliminated in consolidation.

The 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 financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three and nine month periods ended September 30, 2005 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2005.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.  Certain reclassifications have been made to prior balances to conform to the current year presentation. Such reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.

Stock Option Plans

The Company accounts for its fixed-plan stock options using the intrinsic-value-based method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations.   As allowed by SFAS No. 123, Accounting for Stock-Based Compensation, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of FASB Statement No. 123.  The following table illustrates the effect on net income if the fair-value-based method had been applied to all outstanding and unvested awards in each period.

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 


 


 

(In thousands, except per share data)

 

2005

 

2004

 

2005

 

2004

 


 



 



 



 



 

Net income, as reported

 

$

2,878

 

$

2,854

 

$

8,466

 

$

6,367

 

Add total stock-based employee compensation expense included in reported net income, net of tax

 

 

80

 

 

—  

 

 

265

 

 

—  

 

Deduct total stock-based employee compensation expense determined under fair-value-based method for all awards, net of tax

 

 

(82

)

 

(298

)

 

(269

)

 

(984

)

 

 



 



 



 



 

Pro forma net income

 

$

2,876

 

$

2,556

 

$

8,462

 

$

5,383

 

 

 



 



 



 



 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

 

 

 

 

As reported

 

$

0.29

 

$

0.29

 

$

0.85

 

$

0.66

 

Pro forma

 

 

0.29

 

 

0.26

 

 

0.84

 

 

0.56

 

Diluted:

 

 

 

 

 

 

 

 

 

 

 

 

 

As reported

 

$

0.27

 

$

0.28

 

$

0.80

 

$

0.63

 

Pro forma

 

 

0.27

 

 

0.25

 

 

0.80

 

 

0.54

 

6


New Accounting Standards

On May 5, 2005, the Financial Accounting Standards Board (“FASB”) issued FAS No. 154, Statement Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3.  FAS 154 changes the requirements for the accounting for and reporting of a voluntary change in accounting principle.  Essentially, the statement requires retrospectively adjusting prior periods’ financial statements for the direct effect of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The statement provides guidance for situations when it is impracticable to determine the period-specific effects or the cumulative effect and also defines various terms such as retrospective application and restatements.   The Statement carries forward without change previous guidance for reporting the correction of an error in previously issued financial statements and changes in accounting estimates. The Statement also carries forward previous guidance requiring justification of a change in accounting principle on the basis of preferability.  The statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company expects the implementation of FAS 154 will have no material effect on the Company’s consolidated financial position or results of operations.

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

The accounting provisions of FAS 123(R) are effective for annual reporting periods beginning after June 15, 2005, therefore, the Company will be required to adopt FAS 123R in the first quarter of fiscal 2006. The pro forma disclosures previously permitted under FAS 123 will no longer be an alternative to financial statement recognition. See Note 1 in our Notes to Consolidated Financial Statements for the pro forma net income and net income per share amounts, for the three and nine months ended September 30, 2005, and September 30, 2004, as if we had used a fair-value-based method similar to the methods required under FAS 123R to measure compensation expense for employee stock incentive awards.  The Company expects the implementation of FAS 123R will have no material effect on the Company’s consolidated financial position or results of operations.

In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on criteria to evaluate whether to record a loss and disclose additional information about unrealized losses relating to debt and equity securities under EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The consensus applies to investments in debt and marketable equity securities that are accounted under FAS 115, Accounting for Certain Investments in Debt and Equity Securities.  After many organizations, including banks, which could be impacted by this guidance, asked for clarification on the meaning of other-than-temporary impairment and its application to certain investments, the FASB postponed the implementation.  In July 2005, the FASB decided not to provide additional guidance on the meaning of other-than-temporary impairment, but instead issued FASB staff position (“FSP”) EITF 03-1-a, Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1, as final.  The final position supersedes several previously issued EITF topics and replaces guidance set forth in several others.  The final position, titled FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, codifies guidance set forth in EITF Topic D-44, Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value, and clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made.  The effective date of the FSP will be reporting periods beginning after December 15, 2005.  The Company has evaluated the impact of the final rule and expects the implementation of FAS 115-1 will not have a material effect on the Company’s consolidated financial position or results of operations.

On July 14, 2005, the Financial Accounting Standards Board (“FASB”) issued an exposure draft for Accounting for Uncertain Tax Positions, an Interpretation of FAS No. 109, Accounting for Income Taxes.  The proposed interpretation would clarify the accounting for uncertain tax positions in accordance with FAS 109.  An enterprise would be required to recognize, in its financial statements, the best estimate of the impact of a tax position only if that position is probable of being sustained on audit based solely on the technical merits of the position. In evaluating whether the probable

7


recognition threshold has been met, this proposed Interpretation would require the presumption that the tax position will be evaluated during an audit by taxing authorities. The term probable is used in this proposed Interpretation consistent with its use in FASB Statement No. 5, Accounting for Contingencies, to mean “the future event or events are likely to occur.” Individual tax positions that fail to meet the probable recognition threshold will generally result in either (a) a reduction in the deferred tax asset or an increase in a deferred tax liability or (b) an increase in a liability for income taxes payable or the reduction of an income tax refund receivable. The impact may also include both (a) and (b). This proposed Interpretation also would provide guidance on disclosure, accrual of interest and penalties, accounting in interim periods, and transition.  If approved, the Interpretation would be effective as of the end of the first fiscal year ending after December 15, 2005.   The FASB comment period ended on September 12, 2005.   We are waiting on the final decision related to this Interpretation by FASB and are presently unable to determine its overall impact on our consolidated financial statements or results of operations.

NOTE 2 – SEGMENT DISCLOSURE

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

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

Wealth Management provides fee-based personal and corporate financial consulting and trust services.  Personal financial consulting includes estate planning, investment management, and retirement planning.  Corporate consulting services are focused in the areas of retirement plans, management compensation and strategic planning issues.  The Wealth Management segment also provides life, annuity, disability income, and long-term care products and mutual funds.

Corporate and intercompany includes the holding company and subordinated debentures.  The Company incurs general corporate expenses and owns the Bank.

8


Following are the balance sheet information and financial results for the Company’s operating segments as of September 30, 2005 and December 31, 2004, and for the three and nine months ended September 30, 2005 and 2004 (in thousands) (unaudited):

Balance Sheet Information:

 

Banking

 

Wealth
Management

 

Corporate and
Intercompany

 

Total

 


 



 



 



 



 

September 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, less unearned loan fees

 

$

976,804

 

$

—  

 

$

—  

 

$

976,804

 

Goodwill

 

 

1,938

 

 

—  

 

 

—  

 

 

1,938

 

Deposits

 

 

1,023,117

 

 

—  

 

 

(152

)

 

1,022,965

 

Borrowings

 

 

35,724

 

 

—  

 

 

20,620

 

 

56,344

 

Total assets

 

$

1,167,930

 

$

436

 

$

1,476

 

$

1,169,842

 

 

 



 



 



 



 

December 31, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, less unearned loan fees

 

$

898,505

 

$

—  

 

$

—  

 

$

898,505

 

Goodwill

 

 

1,938

 

 

—  

 

 

—  

 

 

1,938

 

Deposits

 

 

939,784

 

 

—  

 

 

(156

)

 

939,628

 

Borrowings

 

 

19,914

 

 

—  

 

 

20,871

 

 

40,785

 

Total assets

 

$

1,058,124

 

$

414

 

$

1,412

 

$

1,059,950

 

 

 



 



 



 



 


Income Statement Information:

 

Banking

 

Wealth
Management

 

Corporate and
Intercompany

 

Total

 


 



 



 



 



 

Three months ended September 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

11,448

 

$

18

 

$

(307

)

$

11,159

 

Provision for loan losses

 

 

408

 

 

—  

 

 

—  

 

 

408

 

Noninterest income

 

 

791

 

 

1,474

 

 

12

 

 

2,277

 

Noninterest expense

 

 

6,305

 

 

1,318

 

 

902

 

 

8,525

 

 

 



 



 



 



 

Income (loss) before income tax expense

 

 

5,526

 

 

174

 

 

(1,197

)

 

4,503

 

Income tax expense (benefit)

 

 

2,004

 

 

63

 

 

(441

)

 

1,625

 

 

 



 



 



 



 

Net income (loss)

 

$

3,522

 

$

111

 

$

(756

)

$

2,878

 

 

 



 



 



 



 

Three months ended September 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

9,740

 

$

20

 

$

(366

)

$

9,394

 

Provision for loan losses

 

 

100

 

 

—  

 

 

—  

 

 

100

 

Noninterest income

 

 

758

 

 

1,119

 

 

—  

 

 

1,877

 

Noninterest expense

 

 

5,474

 

 

890

 

 

692

 

 

7,056

 

 

 



 



 



 



 

Income (loss) before income tax expense

 

 

4,924

 

 

249

 

 

(1,058

)

 

4,115

 

Income tax expense (benefit)

 

 

1,799

 

 

85

 

 

(623

)

 

1,261

 

 

 



 



 



 



 

Net income (loss)

 

$

3,125

 

$

164

 

$

(435

)

$

2,854

 

 

 



 



 



 



 

Nine months ended September 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

33,472

 

$

53

 

$

(841

)

 

32,684

 

Provision for loan losses

 

 

1,420

 

 

—  

 

 

—  

 

 

1,420

 

Noninterest income

 

 

2,121

 

 

4,184

 

 

33

 

 

6,338

 

Noninterest expense

 

 

18,205

 

 

3,612

 

 

2,596

 

 

24,413

 

 

 



 



 



 



 

Income (loss) before income tax expense

 

 

15,968

 

 

625

 

 

(3,404

)

 

13,189

 

Income tax expense (benefit)

 

 

5,731

 

 

225

 

 

(1,233

)

 

4,723

 

 

 



 



 



 



 

Net income (loss)

 

$

10,237

 

$

400

 

$

(2,171

)

$

8,466

 

 

 



 



 



 



 

Nine months ended September 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

27,655

 

$

58

 

$

(1,007

)

$

26,706

 

Provision for loan losses

 

 

1,437

 

 

—  

 

 

—  

 

 

1,437

 

Noninterest income

 

 

2,148

 

 

3,023

 

 

4

 

 

5,175

 

Noninterest expense

 

 

16,245

 

 

2,729

 

 

2,081

 

 

21,055

 

 

 



 



 



 



 

Income (loss) before income tax expense

 

 

12,121

 

 

352

 

 

(3,084

)

 

9,389

 

Income tax expense (benefit)

 

 

4,259

 

 

120

 

 

(1,357

)

 

3,022

 

 

 



 



 



 



 

Net income (loss)

 

$

7,862

 

$

232

 

$

(1,727

)

$

6,367

 

 

 



 



 



 



 

9


NOTE 3 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

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

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

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

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

Cash Flow Hedges – The Bank enters into interest rate swap agreements to convert floating-rate loan assets to fixed rates. The swap agreements provide for the Bank to pay a variable rate of interest equivalent to the prime rate and to receive a fixed rate of interest.  Under the swap agreements the Bank is to pay or receive interest quarterly.  Amounts to be paid or received under these swap agreements are accounted for on an accrual basis and recognized as interest income of the related loan asset.  The net cash flows related to cash flow hedges decreased interest income on loans by $185,000 and $257,000 for the three and nine months ended September 30, 2005, respectively.  The net cash flows related to cash flow hedges increased interest income on loans by $307,000 and $979,000 for the three and nine months ended September 30, 2004, respectively.

Cash flow hedges are accounted for at fair value.  The effective portion of the change in the cash flow hedge’s gain or loss is reported as a component of other comprehensive income net of taxes.  The ineffective portion of the change in the cash flow hedge’s gain or loss is recorded in earnings on each quarterly measurement date.  At September 30, 2005 and December 31, 2004, $425,000 and $347,000, respectively, in deferred losses, net of tax, were recorded in accumulated other comprehensive income.  All cash flow hedges were effective; therefore, no gain or loss was recorded in earnings for the periods presented.  The maximum term over which the Bank is hedging its exposure to the variability of future cash flows is less than 1 year.

Fair Value Hedges - The Bank enters into interest rate swap agreements with the objective of converting the fixed interest rate on brokered CDs to a variable interest rate.  The swap agreements require the Bank to pay a variable rate of interest based on a spread to the three-month London Interbank Offered Rate (LIBOR) and to receive a fixed rate of interest equal to that of the brokered CD (hedged instrument.) Under the swap agreements the Bank is to pay or receive interest semiannually.  Amounts to be paid or received under these swap agreements are accounted for on an accrual basis and recognized as interest expense of the related liability.  The net cash flows related to fair value hedges increased interest expense on certificates of deposit by $116,000 and $226,000 for the three and nine months ended September 30, 2005, respectively.  The net cash flows related to fair value hedges decreased interest expense on certificates of deposit by $45,000 and $361,000 for the three and six months ended September 30, 2004, respectively.

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

10


The maturity dates, notional amounts, interest rates paid and received and fair value of our interest rate swap agreements as of September 30, 2005 were as follows:

Cash Flow Hedges

 

September 30,
2005

 

December 31,
2004

 


 



 



 

 

 

(Dollars in thousands)

 

Notional amount

 

$

70,000

 

$

90,000

 

Weighted average pay rate

 

 

6.75

%

 

5.25

%

Weighted average receive rate

 

 

5.39

%

 

5.74

%

Weighted average maturity in months

 

 

6

 

 

12

 

Unrealized loss related to interest rate swaps

 

$

(647

)

$

(511

)


Fair Value Hedges

 

September 30,
2005

 

December 31,
2004

 


 



 



 

 

 

(Dollars in thousands)

 

Notional amount

 

$

30,000

 

$

40,000

 

Weighted average pay rate

 

 

4.10

%

 

2.60

%

Weighted average receive rate

 

 

2.55

%

 

2.34

%

Weighted average maturity in months

 

 

9

 

 

14

 

Unrealized loss related to interest rate swaps

 

$

(423

)

$

(415

)


NOTE 4 – DISCLOSURES ABOUT FINANCIAL INSTRUMENTS

The Bank issues financial instruments with off balance sheet risk in the normal course of the business of meeting the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  These instruments may involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized in the consolidated balance sheets.

The Bank’s extent of involvement and maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments.  The Bank uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets.  At September 30, 2005 and December 31, 2004, no amounts have been accrued for any estimated losses for these financial instruments.

The contractual amount (in thousands) of off-balance-sheet financial instruments as of September 30, 2005 and December 31, 2004 is as follows:

 

 

September 30,
2005

 

December 31,
2004

 

 

 



 



 

Commitments to extend credit

 

$

337,388

 

$

296,561

 

Standby letters of credit

 

 

27,526

 

 

20,263

 

 

 



 



 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee.  Since certain of these 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.

11


Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.  These standby letters of credit are primarily issued to support contractual obligations of the Bank’s customers.  The credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers.  The approximate remaining terms of standby letters of credit range from 1 month to 5 years at September 30, 2005.

NOTE 5 – SUBSEQUENT EVENTS

On October 11, 2005, EFSC Capital Trust IV (“EFSC Trust IV”), a newly-formed Delaware business trust and subsidiary of the Company, issued 10,000 floating rate Trust Preferred Securities IV (“Preferred Securities IV”) at $1,000 per share to a Trust Preferred Securities Pool.  The rate is fixed at 6.14% for five years.  Following the five-year period, the floating rate will be equal to three month LIBOR rate plus 1.44%, and will reprice quarterly. The Preferred Securities IV are fully, irrevocably and unconditionally guaranteed on a subordinated basis by the Company.  The proceeds of the Preferred Securities IV were invested in junior subordinated debentures of the Company.  The net proceeds to the Company from the sale of the junior subordinated debentures were approximately $10 million.  Distributions on the Preferred Securities IV will be payable quarterly on March 15, June 15, September 15 and December 15 of each year that the Preferred Securities IV are outstanding, commencing December 15, 2005.  The Preferred Securities IV mature on December 15, 2035.  The mandatory date may be shortened to a date not earlier than December 15, 2010 if certain conditions are met.  The Preferred Securities IV are classified as subordinated debentures and the distributions are recorded as interest expense in the Company’s consolidated financial statements.  The proceeds from the offering were used to partially fund the purchase of Millennium Brokerage Group, LLC (“Millennium”).

On October 13, 2005, the Company through its new wholly-owned subsidiary, Millenium Holding Company Inc. executed a Membership Interest Purchase Agreement providing for the acquisition of Millennium.   Millennium is headquartered in Nashville, Tennessee and operates life insurance advisory and brokerage operations from thirteen offices serving life agents, banks, CPA firms, property & casualty groups, and financial advisors in 49 states.  The transaction is structured as a step acquisition with an initial payout of $15 million, 65% cash and 35% company stock, for 60% of Millennium’s shares with two subsequent payouts in years 2008 and 2010 for the remaining interests. The consideration mix between stock and cash for subsequent payouts are at the Company’s discretion with a maximum of 70% stock.   Future payouts are conditioned upon certain pre-tax income performance targets up to a maximum of $36 million, inclusive of the initial $15 million payout. EFSC is contractually entitled to a priority return on its investment of 23.1% (pre-tax) before additional distributions to the Millennium principals.  Please refer to the Form 8-K filed by the Company on October 13, 2005 for more information.  The transaction closed on October 21, 2005.

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

The following discussion describes significant changes in the financial condition of the Company that have occurred during the first nine months of 2005 compared to December 31, 2004.  In addition, this discussion summarizes the significant factors affecting the consolidated results of operations, liquidity and cash flows of the Company for the three and nine months ended September 30, 2005 compared to the three and nine months ended September 30, 2004.  This discussion should be read in conjunction with our consolidated financial statements and notes thereto included in this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2004. 

Results of Operations

Net income for the nine months ended September 30, 2005 was $8.5 million, an increase of 33% compared to $6.4 million for the same period in 2004.  Fully diluted earnings per share for the nine months ended September 30, 2005 were $0.80, an increase of 27%, compared to $0.63 for the same period in 2004.   For the three months ended September 30, 2005, net income was $2.9 million, even with the same period in 2004.  Fully diluted earnings per share for the three months ended September 30, 2005 and 2004 were $0.27 and $0.28, respectively. 

12


On October 13, 2005, the Company announced the agreement to acquire Millennium Brokerage Group, a life insurance advisory and brokerage operation headquartered in Nashville, Tennessee.  This operation will be included in the Wealth Management segment.  Please refer to the Form 8-K filed by the Company on October 13, 2005 for more information.  In addition, please refer to Note 6 - Subsequent Events included in this filing.

Financial Condition

Total assets increased $110 million, or 10.4%, from $1.06 billion at December 31, 2004 to $1.17 billion at September 30, 2005. 

For the nine months ended September 30, 2005, loans, net of unearned loan fees, increased $78 million to $977 million, or 12% annualized since December 31, 2004.  This is an increase of $103 million from September 30, 2004.  Loans, net of unearned loan fees, increased $18 million during the third quarter of 2005.  While new loan originations were strong in the third quarter the Bank experienced a higher than normal level of refinance activity as clients took advantage of the relatively flat yield curve to refinance floating rate debt to the fixed rate permanent markets.  Management does not currently believe that it is in the Company’s long term best interest to compete aggressively for longer term fixed rate loans and expects to experience somewhat lower net loan growth in order to maintain net interest rate margins.

The growth in loans was funded by increases in deposits and advances from the Federal Home Loan Bank (“FHLB”).  Total deposits at September 30, 2005 were $1.02 billion, an increase of $83 million, or 12% annualized, over total deposits of $940 million at December 31, 2004.   During the third quarter of 2005, deposits grew $27 million.  This was comprised of an $8 million increase in demand deposits and a $30 million increase in time deposits, excluding brokered CDs.   Offsetting these increases were broker CDs of $10 million, which matured and were not replaced.   The growth in time deposits was primarily due to time deposit promotions at selected branches and clients choosing more favorable  time deposit rates relative to money market rates, given the current interest rate environment, and competition.  

At September 30, 2005, FHLB advances were $29 million, an $18 million increase over December 31, 2004.  There were no short-term FHLB advances outstanding at September 30, 2005.   The new advances were used to lock in spreads on some anticipated fixed rate lending, which have not yet been realized.

At September 30, 2005, federal funds sold were $45 million compared to $6 million of federal funds purchased at December 31, 2004.   The stronger deposit growth relative to loan growth has resulted in higher liquidity levels.  Given our outlook for the fourth quarter, we expect to utilize some of this liquidity by increasing the size of the investment portfolio as a percentage of total assets.

Total shareholders’ equity was $84 million at September 30, 2005 compared to $73 million at December 31, 2004.  The $11 million increase in equity is due to net income of $8.5 million for the nine months ended September 30, 2005 and the exercise of incentive stock options by employees offset by dividends paid to shareholders and changes in accumulated other comprehensive income.

Net Interest Income

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

13


Net interest income (on a tax-equivalent basis) was $11.3 million for the three months ended September 30, 2005, compared to $9.5 million for the same period of 2004, an increase of 19%.  Average interest-earning assets for the three months ended September 30, 2005 were $1.115 billion, an increase of $131 million, or 13% over $983 million, for the same period in 2004. For the three months ended September 30, 2005, average interest-bearing liabilities were $869 million, an increase of $107 million, or 14% over $762 million for the same period in 2004. 

Net interest rate margin (on a tax-equivalent basis) was 4.03% for the third quarter of 2005, up from 3.85% in the same quarter of 2004.   The increase in net interest rate margin reflects a 121 basis point increase in yields on average interest-earning assets and an increasing benefit from non-interest bearing deposits and equity, offset by a 129 basis point increase in the cost of average interest-bearing liabilities.  The increase in average interest-earning asset yields was the result of prime rate increases in the latter half of 2004 and first nine months of 2005.  Slightly less than two-thirds of the Company’s loan portfolio floats with the prime rate.  The increase in cost of funds was primarily due to increases in money market and certificate of deposit rates given competitor pricing and the increasing interest rate environment.

Net interest income (on a tax-equivalent basis) was $33.1 million for the nine months ended September 30, 2005, compared to $27.0 million for the same period of 2004, an increase of 22%.  Average interest-earning assets for the nine months ended September 30, 2005 were $1.073 billion, an increase of $132 million, or 14% over $941 million, for the same period in 2004.  Average interest-bearing liabilities increased $105 million, or 14% to $834 million for the nine months ended September 30, 2005 compared to $729 million for the nine months ended September 30, 2004. 

Net interest rate margin (on a tax-equivalent basis) was 4.13% for the first nine months of 2005, up from 3.84% for the same period in 2004.  The increase in net interest rate margin reflects a 106 basis point increase in yields on average interest-earning assets and an increasing benefit from non-interest bearing deposits and equity, offset by a 97 basis point increase in the costs of average interest-bearing liabilities.    The reasons for increases in yields and cost of funds are the same as those described above.

14


The following tables set 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 and nine months ended September 30, 2005 and 2004.

 

 

Three months ended September 30,

 

 

 


 

 

 

 

2005

 

2004

 

 

 



 


 

(Dollars in thousands)

 

Average
Balance

 

Percent
of Total
Assets

 

Interest
Income/
Expense

 

Average
Yield/
Rate

 

Average
Balance

 

Percent
of Total
Assets

 

Interest
Income/
Expense

 

Average
Yield/
Rate

 


 



 



 



 



 



 



 



 



 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable loans (1)

 

$

953,578

 

 

82.3

%

$

16,176

 

 

6.73

%

$

841,383

 

 

82.2

%

$

11,580

 

 

5.48

%

Tax-exempt loans(2)

 

 

19,359

 

 

1.7

 

 

445

 

 

9.12

 

 

16,407

 

 

1.6

 

 

316

 

 

7.66

 

 

 



 



 



 

 

 

 



 



 



 



 

Total loans

 

 

972,937

 

 

84.0

 

 

16,621

 

 

6.78

 

 

857,790

 

 

83.8

 

 

11,896

 

 

5.52

 

Taxable investments in debt and equity securities

 

 

90,045

 

 

7.8

 

 

717

 

 

3.16

 

 

81,972

 

 

8.0

 

 

612

 

 

2.97

 

Non-taxable investments in debt and equity securities(2)

 

 

1,521

 

 

0.1

 

 

15

 

 

3.91

 

 

1,634

 

 

0.2

 

 

15

 

 

3.65

 

Short-term investments

 

 

50,005

 

 

4.3

 

 

424

 

 

3.36

 

 

41,936

 

 

4.1

 

 

139

 

 

1.32

 

 

 



 



 



 

 

 

 



 



 



 

 

 

 

Total securities and short-term investments

 

 

141,571

 

 

12.2

 

 

1,156

 

 

3.24

 

 

125,542

 

 

12.3

 

 

766

 

 

2.43

 

 

 



 



 



 

 

 

 



 



 



 

 

 

 

Total interest-earning assets

 

 

1,114,508

 

 

96.2

 

 

17,777

 

 

6.33

 

 

983,332

 

 

96.1

 

 

12,662

 

 

5.12

 

Non-interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

 

34,622

 

 

3.0

 

 

 

 

 

 

 

 

30,682

 

 

3.0

 

 

 

 

 

 

 

Other assets

 

 

23,220

 

 

1.9

 

 

 

 

 

 

 

 

20,683

 

 

2.0

 

 

 

 

 

 

 

Allowance for loan losses

 

 

(13,009

)

 

(1.1

)

 

 

 

 

 

 

 

(11,563

)

 

(1.1

)

 

 

 

 

 

 

 

 



 



 

 

 

 

 

 

 



 



 

 

 

 

 

 

 

Total assets

 

$

1,159,341

 

 

100.0

%

 

 

 

 

 

 

$

1,023,134

 

 

100.0

%

 

 

 

 

 

 

 

 



 



 

 

 

 

 

 

 



 



 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing transaction accounts

 

$

84,379

 

 

7.3

%

$

281

 

 

1.32

%

$

78,842

 

 

7.7

%

$

97

 

 

0.49

%

Money market accounts

 

 

437,374

 

 

37.7

 

 

2,942

 

 

2.67

 

 

401,765

 

 

39.3

 

 

1,192

 

 

1.18

 

Savings

 

 

4,533

 

 

0.4

 

 

8

 

 

0.70

 

 

4,278

 

 

0.4

 

 

3

 

 

0.28

 

Certificates of deposit

 

 

285,998

 

 

24.7

 

 

2,524

 

 

3.50

 

 

234,251

 

 

22.9

 

 

1,317

 

 

2.24

 

 

 



 



 



 

 

 

 



 



 



 

 

 

 

Total interest-bearing deposits

 

 

812,284

 

 

70.1

 

 

5,755

 

 

2.81

 

 

719,136

 

 

70.3

 

 

2,609

 

 

1.44

 

Subordinated debentures

 

 

20,620

 

 

1.8

 

 

317

 

 

6.10

 

 

20,619

 

 

2.0

 

 

374

 

 

7.22

 

Borrowed funds

 

 

36,351

 

 

3.1

 

 

380

 

 

4.15

 

 

22,155

 

 

2.2

 

 

173

 

 

3.11

 

 

 



 



 



 

 

 

 



 



 



 

 

 

 

Total interest-bearing liabilities

 

 

869,255

 

 

75.0

 

 

6,452

 

 

2.94

 

 

761,910

 

 

74.5

 

 

3,156

 

 

1.65

 

Noninterest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

 

199,787

 

 

17.2

 

 

 

 

 

 

 

 

185,446

 

 

18.1

 

 

 

 

 

 

 

Other liabilities

 

 

7,804

 

 

0.7

 

 

 

 

 

 

 

 

7,009

 

 

0.7

 

 

 

 

 

 

 

 

 



 



 

 

 

 

 

 

 



 



 

 

 

 

 

 

 

Total liabilities

 

 

1,076,846

 

 

92.9

 

 

 

 

 

 

 

 

954,365

 

 

93.3

 

 

 

 

 

 

 

Shareholders’ equity

 

 

82,495

 

 

7.1

 

 

 

 

 

 

 

 

68,769

 

 

6.7

 

 

 

 

 

 

 

 

 



 



 

 

 

 

 

 

 



 



 

 

 

 

 

 

 

Total liabilities & shareholders’ equity

 

$

1,159,341

 

 

100.0

%

 

 

 

 

 

 

$

1,023,134

 

 

100.0

%

 

 

 

 

 

 

 

 



 



 

 

 

 

 

 

 



 



 

 

 

 

 

 

 

Net interest income

 

 

 

 

 

 

 

$

11,325

 

 

 

 

 

 

 

 

 

 

$

9,506

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 



 

 

 

 

Net interest spread

 

 

 

 

 

 

 

 

 

 

 

3.39

%

 

 

 

 

 

 

 

 

 

 

3.47

%

Net interest rate margin(3)

 

 

 

 

 

 

 

 

 

 

 

4.03

%

 

 

 

 

 

 

 

 

 

 

3.85

%

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 



 



(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 $430,000 and $409,000 for the quarters ended September 30, 2005 and 2004, respectively.

(2)

Non-taxable income is presented on a fully tax-equivalent basis assuming a tax rate of 36% for 2005 and 34% for 2004. The approximate tax-equivalent adjustments were $166,000 and $112,000 for the quarters ended September, 2005 and 2004, respectively.

(3)

Net interest income divided by average total interest-earning assets.

15


 

 

Nine months ended September 30,

 

 

 


 

 

 

2005

 

2004

 

 

 


 


 

(Dollars in thousands)

 

Average
Balance

 

Percent
of Total
Assets

 

Interest
Income/
Expense

 

Average
Yield/
Rate

 

Average
Balance

 

Percent
of Total
Assets

 

Interest
Income/
Expense

 

Average
Yield/
Rate

 


 



 



 



 



 



 



 



 



 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable loans (1)

 

$

940,099

 

 

84.2

%

$

44,999

 

 

6.40

%

$

821,399

 

 

83.8

%

$

32,669

 

 

5.31

%

Tax-exempt loans(2)

 

 

18,145

 

 

1.6

 

 

1,207

 

 

8.89

 

 

16,734

 

 

1.7

 

 

962

 

 

7.68

 

 

 



 



 



 

 

 

 



 



 



 

 

 

 

Total loans

 

 

958,244

 

 

85.8

 

 

46,206

 

 

6.45

 

 

838,133

 

 

85.5

 

 

33,631

 

 

5.36

 

Taxable investments in debt and equity securities

 

 

91,690

 

 

8.2

 

 

2,183

 

 

3.18

 

 

72,835

 

 

7.4

 

 

1,635

 

 

3.00

 

Non-taxable investments in debt and equity securities(2)

 

 

1,545

 

 

0.1

 

 

47

 

 

4.07

 

 

1,644

 

 

0.2

 

 

46

 

 

3.74

 

Short-term investments

 

 

21,881

 

 

2.0

 

 

512

 

 

3.13

 

 

28,336

 

 

2.9

 

 

226

 

 

1.07

 

 

 



 



 



 

 

 

 



 



 



 

 

 

 

Total securities and short-term investments

 

 

115,116

 

 

10.3

 

 

2,742

 

 

3.18

 

 

102,815

 

 

10.5

 

 

1,907

 

 

2.48

 

 

 



 



 



 

 

 

 



 



 



 

 

 

 

Total interest-earning assets

 

 

1,073,360

 

 

96.1

 

 

48,948

 

 

6.10

 

 

940,948

 

 

96.0

 

 

35,538

 

 

5.04

 

Non-interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

 

33,867

 

 

3.0

 

 

 

 

 

 

 

 

28,597

 

 

2.9

 

 

 

 

 

 

 

Other assets

 

 

21,767

 

 

2.0

 

 

 

 

 

 

 

 

21,310

 

 

2.2

 

 

 

 

 

 

 

Allowance for loan losses

 

 

(12,641

)

 

(1.1

)

 

 

 

 

 

 

 

(11,123

)

 

(1.1

)

 

 

 

 

 

 

 

 



 



 

 

 

 

 

 

 



 



 

 

 

 

 

 

 

Total assets

 

$

1,116,353

 

 

100.0

%

 

 

 

 

 

 

$

979,732

 

 

100.0

%

 

 

 

 

 

 

 

 



 



 

 

 

 

 

 

 



 



 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing transaction accounts

 

$

84,882

 

 

7.6

%

$

652

 

 

1.03

%

$

67,148

 

 

6.9

%

$

194

 

 

0.39

%

Money market accounts

 

 

422,026

 

 

37.8

 

 

7,031

 

 

2.23

 

 

385,297

 

 

39.3

 

 

2,955

 

 

1.02

 

Savings

 

 

4,464

 

 

0.4

 

 

23

 

 

0.69

 

 

4,235

 

 

0.4

 

 

9

 

 

0.28

 

Certificates of deposit

 

 

250,275

 

 

22.4

 

 

5,904

 

 

3.15

 

 

225,626

 

 

23.0

 

 

3,672

 

 

2.17

 

 

 



 



 



 

 

 

 



 



 



 

 

 

 

Total interest-bearing deposits

 

 

761,647

 

 

68.2

 

 

13,610

 

 

2.39

 

 

682,306

 

 

69.6

 

 

6,830

 

 

1.34

 

Subordinated debentures

 

 

20,620

 

 

1.9

 

 

866

 

 

5.62

 

 

18,155

 

 

1.9

 

 

1,036

 

 

7.62

 

Borrowed funds

 

 

51,808

 

 

4.6

 

 

1,337

 

 

3.45

 

 

28,448

 

 

2.9

 

 

623

 

 

2.93

 

 

 



 



 



 

 

 

 



 



 



 

 

 

 

Total interest-bearing liabilities

 

 

834,075

 

 

74.7

 

 

15,813

 

 

2.53

 

 

728,909

 

 

74.4

 

 

8,489

 

 

1.56

 

Noninterest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

 

196,839

 

 

17.6

 

 

 

 

 

 

 

 

176,799

 

 

18.1

 

 

 

 

 

 

 

Other liabilities

 

 

6,667

 

 

0.6

 

 

 

 

 

 

 

 

6,342

 

 

0.6

 

 

 

 

 

 

 

 

 



 



 

 

 

 

 

 

 



 



 

 

 

 

 

 

 

Total liabilities

 

 

1,037,581

 

 

92.9

 

 

 

 

 

 

 

 

912,050

 

 

93.1

 

 

 

 

 

 

 

Shareholders’ equity

 

 

78,772

 

 

7.1

 

 

 

 

 

 

 

 

67,682

 

 

6.9

 

 

 

 

 

 

 

 

 



 



 

 

 

 

 

 

 



 



 

 

 

 

 

 

 

Total liabilities & shareholders’ equity

 

$

1,116,353

 

 

100.0

%

 

 

 

 

 

 

$

979,732

 

 

100.0

%

 

 

 

 

 

 

 

 



 



 

 

 

 

 

 

 



 



 

 

 

 

 

 

 

Net interest income

 

 

 

 

 

 

 

$

33,135

 

 

 

 

 

 

 

 

 

 

$

27,049

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 



 

 

 

 

Net interest spread

 

 

 

 

 

 

 

 

 

 

 

3.57

%

 

 

 

 

 

 

 

 

 

 

3.48

%

Net interest rate margin(3)

 

 

 

 

 

 

 

 

 

 

 

4.13

%

 

 

 

 

 

 

 

 

 

 

3.84

%

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 



 



(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 $1,355,000 and $1,144,000 for the nine months ended September 30, 2005 and 2004, respectively.

(2)

Non-taxable income is presented on a fully tax-equivalent basis assuming a tax rate of 36% for 2005 and 34% for 2004. The approximate tax-equivalent adjustments were $451,000 and $343,000 for the nine months ended September, 2005 and 2004, respectively.

(3)

Net interest income divided by average total interest-earning assets.

16


The following table sets forth, on a tax equivalent basis, a summary of the changes in interest income and interest expense resulting from changes in yield/rates and volume for the three and nine months ended September 30, 2005 and 2004.

 

 

2005 Compared to 2004

 

   
 

 

 

3 month

 

9 month

 

 

 

Increase (decrease) Due to

 

Increase (decrease) Due to

 

 

 


 


 

 

 

Volume(1)

 

Rate(2)

 

Net

 

Volume(1)

 

Rate(2)

 

Net

 

 

 


 


 


 


 


 


 

 

 

(Dollars in thousands)

 

(Dollars in thousands)

 

Interest earned on:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

1,690

 

$

2,906

 

$

4,596

 

$

5,104

 

$

7,226

 

$

12,330

 

Nontaxable loans (3)

 

 

63

 

 

66

 

 

129

 

 

85

 

 

160

 

 

245

 

Taxable investments in debt and equity securities

 

 

64

 

 

41

 

 

105

 

 

442

 

 

106

 

 

548

 

Nontaxable investments in debt and equity securities (3)

 

 

(1

)

 

1

 

 

—  

 

 

(3

)

 

4

 

 

1

 

Short-term investments

 

 

32

 

 

253

 

 

285

 

 

(61

)

 

347

 

 

286

 

 

 



 



 



 



 



 



 

Total interest-earning assets

 

$

1,848

 

$

3,267

 

$

5,115

 

$

5,567

 

$

7,843

 

$

13,410

 

 

 



 



 



 



 



 



 

Interest paid on:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing transaction accounts

 

$

7

 

$

177

 

$

184

 

$

63

 

$

395

 

$

458

 

Money market accounts

 

 

115

 

 

1,635

 

 

1,750

 

 

306

 

 

3,770

 

 

4,076

 

Savings

 

 

—  

 

 

5

 

 

5

 

 

—  

 

 

14

 

 

14

 

Certificates of deposit

 

 

339

 

 

868

 

 

1,207

 

 

436

 

 

1,796

 

 

2,232

 

Subordinated debentures

 

 

—  

 

 

(57

)

 

(57

)

 

128

 

 

(298

)

 

(170

)

Borrowed funds

 

 

136

 

 

71

 

 

207

 

 

586

 

 

128

 

 

714

 

 

 



 



 



 



 



 



 

Total interest-bearing liabilities

 

 

597

 

 

2,699

 

 

3,296

 

 

1,519

 

 

5,805

 

 

7,324

 

 

 



 



 



 



 



 



 

Net interest income

 

$

1,251

 

$

568

 

$

1,819

 

$

4,048

 

$

2,038

 

$

6,086

 

 

 



 



 



 



 



 



 



(1)

Change in volume multiplied by yield/rate of prior period.

(2)

Change in yield/rate multiplied by volume of prior period.

(3)

Non taxable income is presented on a fully tax-equivalent basis assuming a tax rate of 36% in 2005 and 34% in 2004.

NOTE: The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.

17


Provision for Loan Losses

The provision for loan losses is affected by changes in the loan portfolio, management’s assessment of the collectability of the loan portfolio, loss experience and economic and market factors.  A description of the process used to determine the  provision for loan losses is below.  The provision for loan losses was $408,000 for the third quarter 2005 compared to $100,000 for the same period in 2004 due to higher loan growth in the quarter.  The allowance for loan losses as a percentage of total loans was 1.35% at September 30, 2005 compared to 1.30% at December 31, 2004 and 1.31% at September 30, 2004. 

Asset quality remains strong.  Nonperforming loans were $1.8 million or 18 basis points of total loans at September 30, 2005 versus 20 basis points at both September 30 and December 31, 2004.  At September 30, 2005, four relationships comprised $1.4 million, or 78% of the non-performing loans.  The remaining non-performing loans represented four different relationships.  At September 30, 2004, three relationships comprised $1.5 million, or 85% of the non-performing loans.  One of the relationships was foreclosed and sold in first quarter 2005.  The Company recovered $73,000 on the property. 

The following table summarizes changes in the allowance for loan losses for the three and nine months ended September 30, 2005 and 2004.

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

   
 
 

 

 

2005

 

2004

 

2005

 

2004

 

 

 


 


 


 


 

 

 

(Dollars in Thousands)

 

(Dollars in Thousands)

 

Allowance at beginning of period

 

$

12,769

 

$

11,448

 

$

11,665

 

$

10,590

 

Loans charged off:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

—  

 

 

200

 

 

67

 

 

200

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

144

 

 

—  

 

 

244

 

 

427

 

Construction

 

 

—  

 

 

—  

 

 

—  

 

 

—  

 

Residential

 

 

—  

 

 

—  

 

 

—  

 

 

100

 

Consumer and other

 

 

1

 

 

—  

 

 

15

 

 

7

 

 

 



 



 



 



 

Total loans charged off

 

 

145

 

 

200

 

 

326

 

 

734

 

 

 



 



 



 



 

Recoveries of loans previously charged off:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

110

 

 

82

 

 

187

 

 

91

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

—  

 

 

—  

 

 

73

 

 

—  

 

Construction

 

 

—  

 

 

—  

 

 

—  

 

 

—  

 

Residential

 

 

16

 

 

7

 

 

130

 

 

39

 

Consumer and other

 

 

10

 

 

4

 

 

19

 

 

18

 

 

 



 



 



 



 

Total recoveries of loans previously charged off:

 

 

136

 

 

93

 

 

409

 

 

148

 

 

 



 



 



 



 

Net loans charged off (recovered)

 

 

9

 

 

107

 

 

(83

)

 

586

 

 

 



 



 



 



 

Provisions for loan losses

 

 

408

 

 

100

 

 

1,420

 

 

1,437

 

 

 



 



 



 



 

Allowance at end of period

 

$

13,168

 

$

11,441

 

$

13,168

 

$

11,441

 

 

 



 



 



 



 

Average loans

 

$

972,937

 

$

857,790

 

$

958,244

 

$

838,133

 

Total loans

 

 

976,804

 

 

874,092

 

 

976,804

 

 

874,092

 

Non-performing loans

 

 

1,777

 

 

1,722

 

 

1,777

 

 

1,722

 

Net charge-offs (recoveries) to average loans

 

 

0.00

%

 

0.05

%

 

(0.01

)%

 

0.09

%

Allowance for loan losses to loans

 

 

1.35

 

 

1.31

 

 

1.35

 

 

1.31

 

Allowance for loan losses to non-performing loans

 

 

741.02

 

 

664.40

 

 

741.02

 

 

664.40

 

18


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

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

 

1)

delinquency of a scheduled loan payment;

 

2)

deterioration in the borrower’s financial condition identified in a review of periodic financial statements;

 

3)

decrease in the value of collateral securing the loan; or

 

4)

change in the economic environment in which the borrower operates.

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

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

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

 

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

 

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

 

an unallocated allowance based on subjective factors.

The first element reflects management’s estimate of probable losses based upon a systematic review of specific loans considered to be impaired.  These estimates are based upon collateral exposure, if they are collateral dependent for collection.  Otherwise, discounted cash flows are estimated and used to assign loss.

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

The unallocated allowance is based on management’s evaluation of conditions that are not directly reflected in the determination of the formula and specific allowances.  The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they may not be identified with specific problem credits or portfolio segments.  The conditions evaluated in connection with the unallocated allowance include the following:

 

general economic and business conditions affecting our key lending areas;

 

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

 

collateral values;

 

loan volumes and concentrations;

 

competitive factors resulting in shifts in underwriting criteria;

 

specific industry conditions within portfolio segments;

 

recent loss experience in particular segments of the portfolio;

 

bank regulatory examination results; and

 

findings of our internal loan review department.

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

19


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

The Bank had no loans 90 days past due still accruing interest at September 30, 2005 or December 31, 2004. The following table sets forth information concerning the Company’s non-performing assets as of the dates indicated:

 

 

September 30,
2005

 

December 31,
2004

 

 

 


 


 

 

 

(Dollars in thousands)

 

Non-accrual loans

 

$

1,777

 

$

1,827

 

 

 



 



 

Total non-performing loans

 

 

1,777

 

 

1,827

 

Foreclosed real estate

 

 

—  

 

 

123

 

 

 



 



 

Total non-performing assets

 

$

1,777

 

$

1,950

 

 

 



 



 

Total assets

 

$

1,169,842

 

$

1,059,950

 

Total loans

 

 

976,804

 

 

898,505

 

Total loans plus foreclosed property

 

 

976,804

 

 

898,628

 

Non-performing loans to loans

 

 

0.18

%

 

0.20

%

Non-performing assets to loans plus foreclosed property

 

 

0.18

 

 

0.22

 

Non-performing assets to total assets

 

 

0.15

 

 

0.18

 

The change in non-performing loans for the first nine months of 2005 includes a $465,000 credit that is secured by a first mortgage on a commercial property, a $300,000 credit to a manufacturer, and a $144,000 credit secured by residential property.  These increases were offset by a motel property that was foreclosed and sold during the first quarter of 2005 along with a commercial property that paid off during the third quarter of 2005.  During third quarter of 2005, the foreclosed real estate property was sold for a gain of $91,000.

Noninterest Income

Noninterest income primarily consists of fees and service charges on deposit accounts, Wealth Management fee income and to a lesser extent, gains on sales of mortgage loans.  Noninterest income was $2.3 million for the three months ended September 30, 2005, compared to $1.9 million for the same period in 2004.  Wealth Management income increased 38%, from $1.1 million for second quarter of 2004 to $1.5 million for the same quarter of 2005.  This increase was the result of both increased assets under administration and a more favorable mix of managed versus custodial assets.  Assets under administration in Enterprise Trust were $1.48 billion at September 30, 2005 versus $1.24 billion at September 30, 2004. 

Service charges on deposit accounts of $533,000 were basically unchanged in the third quarter of 2005 compared to the same quarter in 2004.  This is due to a rising earnings credit rate on commercial accounts, which was offset by increased account activity.  Higher production activity led to an increase in mortgage gains from $9,000 in third quarter of 2004 to $145,000 in third quarter 2005.  The Company sold a foreclosed real estate property during the third quarter of 2005 for a gain of $91,000.  The Company also recorded $85,000 in losses on the sale of securities during the third quarter, versus $125,000 in gains for the same quarter in 2004.  In both cases, the securities were sold to assist in repositioning the balance sheet for the anticipated interest rate environment.

For the nine months ended September 30, 2005, noninterest income was $6.3 million compared to $5.2 million for the same period in 2004.  Wealth management income increased $1.2 million, or 38%, to $4.2 million for the nine month period ended September 30, 2005, compared to $3.0 million for the same period in 2004 as a result of the reasons stated above.   In addition, Wealth Products Group, which was introduced in March 2004, contributed $428,000 of the Wealth Management increase.  Service charges were essentially flat at $1.6 million for the nine month periods ended September 30, 2005 versus the same period in 2004.  

20


Noninterest Expense

Total noninterest expense was $8.5 million for the three months ended September 30, 2005, an increase of $1.5 million over the same period in 2004.  Additional employee compensation and benefits comprised $929,000 of the increase.  Other noninterest expenses increased $403,000. 

The increase in employee compensation and benefits was related to several factors.  Accrued expenses under the Company’s incentive bonus programs, which are tied to performance targets, increased $316,000.  Growth in the Wealth Management revenues  increased commissions by $204,000.  Effective January 1, 2005, the Board of Directors awarded restricted share units (“RSUs”) to selected personnel during the first quarter of 2005.  RSUs are expensed annually as they vest over five years.  Compensation expense related to the RSUs was $104,000 in the third quarter 2005.   The remaining increase was attributable to salaries and benefits of new associates, annual merit increases, along with increases  in medical and disability insurance costs, temporary help and recruiting fees.

The increase in other expenses was due to the following: 1)   $147,000 of legal and professional expenses, including expenses related to Sarbanes-Oxley 404 compliance and compensation committee assistance, 2) $96,000 of marketing and public relations expenses, 3) $46,000 of director expenses due to increases in compensation to more competitive levels, 4) $74,000 of meals, entertainment and travel expenses, 5) $31,000 of additional insurance expenses and 6) $58,000 of expenses related to deferred compensation market value adjustments.   Offsetting these increases was a $121,000 decrease in loan legal fees primarily related to a foreclosed property sold in the first quarter of 2005. 

Total noninterest expense was $24.4 million for the nine months ended September 30, 2005, representing a $3.4 million increase over the same period in 2004.  Employee compensation and benefits and other expenses comprise the increase. Fluctuations in these expense categories for the nine month period are similar to those discussed above.

Income Taxes

The provision for income taxes was $1.6 million and $4.7 million for the three and nine months ended September 30, 2005 compared to $1.3 million and $3.0 for the three and nine months ended September 30, 2004.  The effective tax rates for the three and nine months ended September 30, 2005 were 36.1% and 35.8%, respectively.  The effective tax rates for the three and nine months ended September 30, 2004 were 30.6% and 32.2%, respectively.  The 2004 tax rates are lower due to $163,000 of state income tax refunds related to prior state income tax returns recognized during the second quarter of 2004 and a $241,000 reversal of deferred tax valuation allowance recorded in the third quarter of 2004.

Liquidity

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

The Company’s liquidity management framework includes measurement of several key elements, such as the loan to deposit ratio, wholesale deposits as a percentage of total deposits, and various dependency ratios used by banking regulators.  The Company’s liquidity framework also incorporates contingency planning to assess the nature and volatility of funding sources and to determine alternatives to these sources.

Strong capital ratios, credit quality and core earnings are essential to retaining cost-effective access to the wholesale funding markets.  Deterioration in any of these factors could have an impact on the Company’s ability to access these funding sources and, as a result, these factors are monitored on an ongoing basis as part of the liquidity management process.

21


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

Investment securities are an important part of the Company’s liquidity objective.  As of September 30, 2005, the entire investment portfolio was available for sale.  Of the $97 million investment portfolio, $18 million was pledged as collateral for public deposits, treasury, tax and loan notes, and other requirements.  The remaining securities could be pledged or sold to enhance liquidity, if necessary.

The Bank has a variety of funding sources (in addition to key liquidity sources, such as core deposits, loan repayments, loan participations sold, and investment portfolio sales) available to increase financial flexibility.  At September 30, 2005, we had $29 million of outstanding FHLB long-term advances.  At September 30, 2005, we had an additional $127 million available for borrowing from the Federal Home Loan Bank of Des Moines under a blanket loan pledge, absent the Bank being in default of its credit agreement, and $174 million available from the Federal Reserve Bank under a pledged loan agreement.  We also have access to over $70 million in overnight federal funds purchased lines from various banking institutions.  Finally, since the Bank is a “well-capitalized” institution, it has the ability to sell certificates of deposit through various national or regional brokerage firms, if needed.

Over the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit.  These transactions are managed through the Company’s various risk management processes.  Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company’s liquidity.  The Company has $337 million in unused loan commitments as of September 30, 2005.  The Company believes that the nature of these commitments are such that the likelihood of such a funding demand is very low.

22


Capital Adequacy

The Company and Bank are subject to various regulatory capital requirements administered by the Federal banking agencies.  Failure to meet minimum requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulations to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets.  The Company believes, as of September 30, 2005 and December 31, 2004, that the Company and Bank meet all capital adequacy requirements to which they are subject.

As of September 30, 2005 and December 31, 2004, the Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action.  To be categorized as “well capitalized” the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table.

 

 

Actual

 

For Capital
Adequacy Purposes

 

To Be Well
Capitalized Under
Applicable
Action Provisions

 

   
 
 
 

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

 

 


 


 


 


 


 


 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

As of September 30, 2005:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Capital (to Risk Weighted Assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise Financial Services Corp

 

$

116,069

 

 

11.58

%

$

80,197

 

 

8.00

%

$

—  

 

 

—  

 

Enterprise Bank & Trust

 

 

111,253

 

 

11.10

 

 

80,154

 

 

8.00

 

 

100,192

 

 

10.00

 

Tier I Capital (to Risk Weighted Assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise Financial Services Corp

 

 

103,531

 

 

10.33

 

 

40,099

 

 

4.00

 

 

—  

 

 

—  

 

Enterprise Bank & Trust

 

 

98,721

 

 

9.85

 

 

40,077

 

 

4.00

 

 

60,115

 

 

6.00

 

Tier I Capital (to Average Assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise Financial Services Corp

 

 

103,531

 

 

8.94

 

 

34,752

 

 

3.00

 

 

—  

 

 

—  

 

Enterprise Bank & Trust

 

 

98,721

 

 

8.53

 

 

34,708

 

 

3.00

 

 

57,847

 

 

5.00

 

As of December 31, 2004:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Capital (to Risk Weighted Assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise Financial Services Corp

 

$

103,673

 

 

11.19

 

$

74,086

 

 

8.00

 

$

—  

 

 

—  

 

Enterprise Bank & Trust

 

 

99,545

 

 

10.76

 

 

74,036

 

 

8.00

 

 

92,545

 

 

10.00

 

Tier I Capital (to Risk Weighted Assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise Financial Services Corp

 

 

92,096

 

 

9.94

 

 

37,043

 

 

4.00

 

 

—  

 

 

—  

 

Enterprise Bank & Trust

 

 

87,976

 

 

9.51

 

 

37,018

 

 

4.00

 

 

55,527

 

 

6.00

 

Tier I Capital (to Average Assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise Financial Services Corp

 

 

92,096

 

 

8.44

 

 

32,725

 

 

3.00

 

 

—  

 

 

—  

 

Enterprise Bank & Trust

 

 

87,976

 

 

8.08

 

 

32,659

 

 

3.00

 

 

54,432

 

 

5.00

 

On March 1, 2005, the Board of Governors of the Federal Reserve System, or Board, adopted a final rule, Risk-Based Capital Standards: Trust Preferred Securities and the Definition of Capital, that allows for the continued limited inclusion of trust preferred securities in Tier 1 capital.  The Board’s final rule limits restricted core capital elements to 25% of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability.  Amounts of restricted core capital elements in excess of these limits may generally be included in Tier 2 capital.  Amounts of qualifying trust preferred securities and cumulative perpetual preferred stock in excess of the 25% limit may be included in Tier 2 capital, but limited, together with subordinated debt and limited-life preferred stock, to 50% of Tier 1 capital.  In addition, the final rule provides that in the last five years before the

23


maturity of the underlying subordinated note, the outstanding amount of the associated trust preferred securities is excluded from Tier 1 capital and included in Tier 2 capital, subject to one-fifth amortization per year.  The final rule provides for a five-year transition period, ending March 31, 2009, for the application of the quantitative limits.  Until March 31, 2009, the aggregate amount of qualifying cumulative perpetual preferred stock and qualifying trust preferred securities that may be included in Tier 1 capital is limited to 25% of the sum of the following core capital elements: qualifying common stockholders’ equity, qualifying noncumulative and cumulative perpetual preferred stock, qualifying minority interest in the equity accounts of consolidated subsidiaries and qualifying trust preferred securities.  The Company has evaluated the impact of the final rule on the Company’s financial condition and results of operations, and determined the implementation of the Board’s final rule, as adopted, would not have a material impact on the Company’s regulatory capital ratios.

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

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

Item 3 - Quantitative and Qualitative Disclosures About Market Risk

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

24


The following table (in thousands) presents the scheduled repricing of market risk sensitive instruments at September 30, 2005:

 

 

Year 1

 

Year 2

 

Year 3

 

Year 4

 

Year 5

 

Beyond
5 years
or no stated
maturity

 

Total

 

 

 


 


 


 


 


 


 


 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments in debt and equity securities

 

$

268

 

$

13,024

 

$

54,678

 

$

21,638

 

$

2,791

 

$

4,285

 

$

96,684

 

Interest-bearing deposits

 

 

101

 

 

—  

 

 

—  

 

 

—  

 

 

—  

 

 

—  

 

 

101

 

Loans (1)

 

 

724,686

 

 

63,766

 

 

93,105

 

 

27,660

 

 

52,344

 

 

15,243

 

 

976,804

 

Loans held for sale

 

 

2,273

 

 

—  

 

 

—  

 

 

—  

 

 

—  

 

 

—  

 

 

2,273

 

 

 



 



 



 



 



 



 



 

Total

 

$

727,328

 

$

76,790

 

$

147,783

 

$

49,298

 

$

55,135

 

$

19,528

 

$

1,075,862

 

 

 



 



 



 



 



 



 



 

LIABILITIES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings, NOW, and Money market deposits

 

$

535,931

 

$

—  

 

$

—  

 

$

—  

 

$

—  

 

$

—  

 

$

535,931

 

Certificates of deposit (1)

 

 

193,056

 

 

61,787

 

 

22,246

 

 

2,080

 

 

1,109

 

 

31

 

 

280,310

 

Subordinated debentures

 

 

20,620

 

 

—  

 

 

—  

 

 

—  

 

 

—  

 

 

—  

 

 

20,620

 

Other borrowings

 

 

8,500

 

 

150

 

 

1,250

 

 

650

 

 

1,050

 

 

24,124

 

 

35,724

 

 

 



 



 



 



 



 



 



 

Total

 

$

758,107

 

$

61,937

 

$

23,496

 

$

2,730

 

$

2,159

 

$

24,155

 

$

872,584

 

 

 



 



 



 



 



 



 



 



(1)

Adjusted for the impact of the interest rate swaps.

Item 4 - Disclosure Control and Procedures

As of September 30, 2005, under the supervision and with the participation of the Company’s Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15.  Based on that evaluation, the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2005, to ensure that information required to be disclosed in the Company’s periodic SEC filings is processed, recorded, summarized and reported when required.  There were no significant changes in the Company’s internal controls over financial reporting for the quarter ended September 30, 2005, that have materially affected, or are reasonably likely to affect, those controls.

25


PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

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

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

 

(a)

During the quarter ended September 30, 2005, the Company issued no unregistered shares of its common stock.

     

 

(b)

Not applicable.

     

 

(c)

There were no repurchases of the Company’s common stock during the quarter ended September 30, 2005.

Item 3 – Defaults Upon Senior Securities

None.

Item 4 - Submission of Matters to a Vote of Security Holders

None.

Item 5 – Other Information

Not applicable or required.

26


Item 6 - Exhibits

Exhibit
Number

 

Description


 


*11.1

 

Statement regarding computation of per share earnings

 

 

 

*31.1

 

Chief Executive Officer’s Certification required by Rule 13(a)-14(a).

 

 

 

*31.2

 

Chief Financial Officer’s Certification required by Rule 13(a)-14(a).

 

 

 

*32.1

 

Chief Executive Officer Certification pursuant to 18 U.S.C. § 1350, as adopted pursuant to section § 906 of the Sarbanes-Oxley Act of 2002

 

 

 

*32.2

 

Chief Financial Officer Certification pursuant to 18 U.S.C. § 1350, as adopted pursuant to section § 906 of the Sarbanes-Oxley Act of 2002

 

 

 


*Filed herewith.

27


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Clayton, State of Missouri on the day of November 4, 2005.

 

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

28