Document


 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
 
FORM 10-Q
 
[X]
 
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2016.
 
 
 
[   ]
 
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

 
Incorporated in the State of Delaware
I.R.S. Employer Identification # 43-1706259
Address: 150 North Meramec
Clayton, MO 63105
Telephone: (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, and (2) has been subject to such filing requirements for the past 90 days. Yes [X]  No [   ] 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X]  No [   ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ]
Accelerated filer [X]
Non-accelerated filer [ ] (Do not check if a smaller reporting company)
Smaller reporting company [ ]

 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Yes [   ]  No [X]
 
As of July 25, 2016, the Registrant had 20,018,101 shares of outstanding common stock, $0.01 par value.
 
This document is also available through our website at http://www.enterprisebank.com.

 






ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
 
Page
PART I - FINANCIAL INFORMATION
 
 
 
 
Item 1.  Financial Statements
 
 
 
Condensed Consolidated Balance Sheets (Unaudited)
 
 
Condensed Consolidated Statements of Operations (Unaudited)
 
 
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
 
 
Condensed Consolidated Statements of Shareholders' Equity (Unaudited)
 
 
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
 
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 4. Controls and Procedures
 
 
PART II - OTHER INFORMATION
 
 
 
 
Item 1.  Legal Proceedings
 
 
 
Item 1A.  Risk Factors
 
 
 
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 6. Exhibits
 
 
Signatures
 
 
 
 





PART 1 - ITEM 1 - FINANCIAL STATEMENTS
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
(in thousands, except share and per share data)
June 30, 2016
 
December 31, 2015
Assets
 
 
 
Cash and due from banks
$
50,370

 
$
47,935

Federal funds sold
317

 
91

Interest-bearing deposits (including $1,870 and $1,320 pledged as collateral)
59,609

 
46,131

Total cash and cash equivalents
110,296

 
94,157

Interest-bearing deposits greater than 90 days
1,000

 
1,000

Securities available for sale
478,514

 
451,770

Securities held to maturity
42,514

 
43,714

Loans held for sale
9,669

 
6,598

Portfolio loans
2,883,909

 
2,750,737

Less: Allowance for loan losses
35,498

 
33,441

Portfolio loans, net
2,848,411

 
2,717,296

Purchased credit impaired loans, net of the allowance for loan losses ($8,551 and $10,175, respectively)
47,978

 
64,583

Total loans, net
2,896,389

 
2,781,879

Other real estate
4,901

 
8,366

Other investments, at cost
17,403

 
17,455

Fixed assets, net
14,512

 
14,842

Accrued interest receivable
8,123

 
8,399

State tax credits held for sale, including $4,774 and $5,941 carried at fair value, respectively
44,918

 
45,850

Goodwill
30,334

 
30,334

Intangible assets, net
2,589

 
3,075

Other assets
100,503

 
101,044

Total assets
$
3,761,665

 
$
3,608,483

 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
Demand deposits
$
753,173

 
$
717,460

Interest-bearing transaction accounts
628,505

 
564,420

Money market accounts
1,019,304

 
1,053,662

Savings
105,224

 
92,861

Certificates of deposit:
 
 
 
Brokered
166,507

 
39,573

Other
355,523

 
316,615

Total deposits
3,028,236

 
2,784,591

Subordinated debentures
56,807

 
56,807

Federal Home Loan Bank advances
78,000

 
110,000

Other borrowings
200,362

 
270,326

Accrued interest payable
625

 
629

Other liabilities
26,006

 
35,301

Total liabilities
3,390,036

 
3,257,654

 
 
 
 
Shareholders' equity:
 
 
 
Preferred stock, $0.01 par value;
5,000,000 shares authorized; 0 shares issued and outstanding

 

Common stock, $0.01 par value; 30,000,000 shares authorized; 20,234,235 and 20,093,119 shares issued, respectively
202

 
201

Treasury stock, at cost; 255,018 and 76,000 shares, respectively
(6,454
)
 
(1,743
)
Additional paid in capital
211,227

 
210,589

Retained earnings
161,137

 
141,564

Accumulated other comprehensive income
5,517

 
218

Total shareholders' equity
371,629

 
350,829

Total liabilities and shareholders' equity
$
3,761,665

 
$
3,608,483

See accompanying notes to consolidated financial statements.

1



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands, except per share data)
2016
 
2015
 
2016
 
2015
Interest income:
 
 
 
 
 
 
 
Interest and fees on loans
$
34,183

 
$
29,875

 
$
66,791

 
$
59,483

Interest on debt securities:
 
 
 
 
 
 
 
Taxable
2,397

 
2,117

 
4,784

 
4,258

Nontaxable
328

 
285

 
660

 
582

Interest on interest-bearing deposits
58

 
38

 
119

 
85

Dividends on equity securities
67

 
37

 
139

 
95

Total interest income
37,033

 
32,352


72,493


64,503

Interest expense:
 
 
 
 
 
 
 
Interest-bearing transaction accounts
329

 
279

 
635

 
556

Money market accounts
1,013

 
672

 
2,019

 
1,314

Savings accounts
63

 
54

 
123

 
104

Certificates of deposit
1,183

 
1,594

 
2,202

 
3,185

Subordinated debentures
361

 
308

 
709

 
610

Federal Home Loan Bank advances
191

 
24

 
373

 
73

Notes payable and other borrowings
110

 
141

 
221

 
336

Total interest expense
3,250

 
3,072


6,282


6,178

Net interest income
33,783

 
29,280

 
66,211

 
58,325

Provision for portfolio loan losses
716

 
2,150

 
1,549

 
3,730

Provision reversal for purchased credit impaired loan losses
(336
)
 

 
(409
)
 
(3,270
)
Net interest income after provision for loan losses
33,403

 
27,130


65,071


57,865

Noninterest income:
 
 
 
 
 
 
 
Service charges on deposit accounts
2,188

 
1,998

 
4,231

 
3,854

Wealth management revenue
1,644

 
1,778

 
3,306

 
3,518

Other service charges and fee income
952

 
840

 
1,820

 
1,593

Gain on state tax credits, net
153

 
74

 
671

 
748

Gain on sale of other real estate
706

 
9

 
828

 
29

Gain on sale of investment securities

 

 

 
23

Change in FDIC loss share receivable

 
(945
)
 

 
(3,209
)
Miscellaneous income
1,406

 
2,052

 
2,198

 
2,833

Total noninterest income
7,049

 
5,806


13,054


9,389

Noninterest expense:
 
 
 
 
 
 
 
Employee compensation and benefits
12,660

 
11,274

 
25,307

 
22,787

Occupancy
1,609

 
1,621

 
3,292

 
3,315

Data processing
1,187

 
1,127

 
2,291

 
2,157

FDIC and other insurance
738

 
665

 
1,461

 
1,391

Professional fees
719

 
854

 
1,403

 
1,826

Loan legal and other real estate expense
353

 
548

 
710

 
826

FDIC clawback

 
50

 

 
462

Other
4,087

 
3,319

 
7,651

 
6,644

Total noninterest expense
21,353

 
19,458


42,115


39,408

 
 
 
 
 
 
 
 
Income before income tax expense
19,099

 
13,478


36,010


27,846

Income tax expense
6,747

 
4,762

 
12,633

 
9,784

Net income
$
12,352

 
$
8,716


$
23,377


$
18,062

 
 
 
 
 
 
 
 
Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.62

 
$
0.44

 
$
1.17

 
$
0.91

Diluted
0.61

 
0.43

 
1.16

 
0.90

See accompanying notes to consolidated financial statements.

2




ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income (Unaudited)

 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Net income
$
12,352

 
$
8,716

 
$
23,377

 
$
18,062

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Unrealized gains (losses) on investment securities arising during the period, net of income tax expense (benefit) for three months of $986 and $(1,322), and for six months of $3,290 and $(277), respectively
1,588

 
(2,130
)
 
5,299

 
(418
)
Less: Reclassification adjustment for realized gains on sale of securities available for sale included in net income, net of income tax expense for three months of $0 and $0, and for six months of $0 and $9, respectively

 

 

 
(14
)
Total other comprehensive income (loss)
1,588

 
(2,130
)
 
5,299

 
(432
)
Total comprehensive income
$
13,940

 
$
6,586

 
$
28,676

 
$
17,630


See accompanying notes to consolidated financial statements.


3



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Shareholders’ Equity (Unaudited)
(in thousands, except per share data)
 
Preferred Stock
 
Common Stock
 
Treasury Stock
 
Additional paid in capital
 
Retained earnings
 
Accumulated
other
comprehensive income (loss)
 
Total
shareholders' equity
Balance January 1, 2016
 
$

 
$
201

 
$
(1,743
)
 
$
210,589

 
$
141,564

 
$
218

 
$
350,829

Net income
 

 

 

 

 
23,377

 

 
23,377

Other comprehensive income
 

 

 

 

 

 
5,299

 
5,299

Cash dividends paid on common shares, $0.19 per share
 

 

 

 

 
(3,804
)
 


 
(3,804
)
Repurchase of common shares
 

 

 
(4,711
)
 

 

 

 
(4,711
)
Issuance under equity compensation plans, 141,116 shares, net
 

 
1

 

 
(1,812
)
 

 

 
(1,811
)
Share-based compensation
 

 

 

 
1,626

 

 

 
1,626

Excess tax benefit related to equity compensation plans
 

 

 

 
824

 

 

 
824

Balance June 30, 2016
 
$

 
$
202

 
$
(6,454
)
 
$
211,227

 
$
161,137

 
$
5,517

 
$
371,629

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except per share data)
 
Preferred Stock
 
Common Stock
 
Treasury Stock
 
Additional paid in capital
 
Retained earnings
 
Accumulated
other
comprehensive income (loss)
 
Total
shareholders' equity
Balance January 1, 2015
 
$

 
$
199

 
$
(1,743
)
 
$
207,731

 
$
108,373

 
$
1,681

 
$
316,241

Net income
 

 

 

 

 
18,062

 

 
18,062

Other comprehensive loss
 

 

 

 

 

 
(432
)
 
(432
)
Cash dividends paid on common shares, $0.1125 per share
 

 

 

 

 
(2,252
)
 

 
(2,252
)
Issuance under equity compensation plans, 109,500 shares, net
 

 
1

 

 
(1,081
)
 

 

 
(1,080
)
Share-based compensation
 

 

 

 
1,738

 

 

 
1,738

Excess tax benefit related to equity compensation plans
 

 

 

 
153

 

 

 
153

Balance June 30, 2015
 
$

 
$
200

 
$
(1,743
)
 
$
208,541

 
$
124,183

 
$
1,249

 
$
332,430


See accompanying notes to consolidated financial statements.

4



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
Six months ended June 30,
(in thousands)
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
23,377

 
$
18,062

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation
1,070

 
1,009

Provision for loan losses
1,140

 
460

Deferred income taxes
3,509

 
2,803

Net amortization of debt securities
1,513

 
1,661

Amortization of intangible assets
486

 
569

Gain on sale of investment securities

 
(23
)
Mortgage loans originated for sale
(70,018
)
 
(69,434
)
Proceeds from mortgage loans sold
67,278

 
68,252

Gain on sale of other real estate
(828
)
 
(29
)
Gain on state tax credits, net
(671
)
 
(748
)
Excess tax benefit of share-based compensation
(824
)
 
(153
)
Share-based compensation
1,626

 
1,738

Valuation adjustment on other real estate
1

 
82

Net accretion of loan discount and indemnification asset
(5,692
)
 
(3,382
)
Changes in:
 
 
 
Accrued interest receivable
276

 
36

Accrued interest payable
(4
)
 
(23
)
Other assets
(5,284
)
 
(2,601
)
Other liabilities
(9,295
)
 
196

Net cash provided by (used in) operating activities
7,660

 
18,475

Cash flows from investing activities:
 
 
 
Net increase in loans
(112,500
)
 
(99,282
)
Net cash proceeds received from FDIC loss share receivable

 
1,574

Proceeds from the sale of securities, available for sale

 
41,069

Proceeds from the paydown or maturity of securities, available for sale
29,398

 
25,813

Proceeds from the paydown or maturity of securities, held to maturity
1,145

 
1,078

Proceeds from the redemption of other investments
34,314

 
25,746

Proceeds from the sale of state tax credits held for sale
3,952

 
4,489

Proceeds from the sale of other real estate
6,355

 
3,723

Payments for the purchase/origination of:
 
 
 
Available for sale debt and equity securities
(49,012
)
 
(74,069
)
Other investments
(34,263
)
 
(19,641
)
State tax credits held for sale
(2,349
)
 
(3,425
)
Fixed assets
(740
)
 
(983
)
Net cash provided by (used in) investing activities
(123,700
)
 
(93,908
)
Cash flows from financing activities:
 
 
 
Net increase in noninterest-bearing deposit accounts
35,713

 
15,328

Net increase in interest-bearing deposit accounts
207,932

 
184,721

Proceeds from Federal Home Loan Bank advances
981,000

 
531,900

Repayments of Federal Home Loan Bank advances
(1,013,000
)
 
(602,900
)
Repayments of notes payable

 
(600
)
Net decrease in other borrowings
(69,964
)
 
(50,737
)
Cash dividends paid on common stock
(3,804
)
 
(2,252
)
Excess tax benefit of share-based compensation
824

 
153

Payments for the repurchase of common stock
(4,711
)
 

Issuance of common stock, net
(1,811
)
 
(1,080
)
Net cash provided by (used in) financing activities
132,179

 
74,533

Net increase (decrease) in cash and cash equivalents
16,139

 
(900
)
Cash and cash equivalents, beginning of period
94,157

 
100,696

Cash and cash equivalents, end of period
$
110,296

 
$
99,796

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
6,286

 
$
6,201

Income taxes
19,124

 
6,517

Noncash transactions:
 
 
 
Transfer to other real estate owned in settlement of loans
$
2,683

 
$
5,998

Sales of other real estate financed
140

 


See accompanying notes to consolidated financial statements.

5



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies used by Enterprise Financial Services Corp (the "Company" or "Enterprise") in the preparation of the condensed consolidated financial statements are summarized below:

Business and Consolidation

Enterprise is a financial holding company that provides a full range of banking and wealth management services to individuals and corporate customers located in the St. Louis, Kansas City, and Phoenix metropolitan markets through its banking subsidiary, Enterprise Bank & Trust (the "Bank").

Operating results for the three and six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2016. 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, 2015.

Basis of Financial Statement Presentation

The condensed consolidated financial statements of the Company and its subsidiaries have been prepared in accordance with the accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The condensed consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All intercompany accounts and transactions have been eliminated. In 2016, the Company changed its presentation of certificates of deposit on the Condensed Consolidated Balance Sheets to separate brokered deposit sources from other sources.  The corresponding prior period balances were reclassified to conform to the current year presentation. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

6



NOTE 2 - EARNINGS PER SHARE

Basic earnings per common share data is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Common shares outstanding include common stock and restricted stock awards where recipients have satisfied the vesting terms. Diluted earnings per common share gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method.

The following table presents a summary of per common share data and amounts for the periods indicated.

 
Three months ended June 30,
 
Six months ended June 30,
(in thousands, except per share data)
2016
 
2015
 
2016
 
2015
Net income as reported
$
12,352

 
$
8,716

 
$
23,377

 
$
18,062

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
20,003

 
19,978

 
20,002

 
19,958

Additional dilutive common stock equivalents
213

 
190

 
224

 
211

Weighted average diluted common shares outstanding
20,216

 
20,168

 
20,226

 
20,169

 
 
 
 
 
 
 
 
Basic earnings per common share:
$
0.62

 
$
0.44

 
$
1.17

 
$
0.91

Diluted earnings per common share:
$
0.61

 
$
0.43

 
$
1.16

 
$
0.90


For the three and six months ended June 30, 2016 and 2015, the amount of common stock equivalents excluded from the earnings per share calculations because their effect was anti-dilutive was zero, and 0.2 million common stock equivalents, respectively.

7



NOTE 3 - INVESTMENTS

The following table presents the amortized cost, gross unrealized gains and losses and fair value of securities available for sale and held to maturity:
 
 
June 30, 2016
(in thousands)
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
Available for sale securities:
 
 
 
 
 
 
 
    Obligations of U.S. Government-sponsored enterprises
$
98,064

 
$
1,622

 
$

 
$
99,686

    Obligations of states and political subdivisions
37,468

 
1,804

 
(307
)
 
38,965

    Agency mortgage-backed securities
333,549

 
6,587

 
(273
)
 
339,863

          Total securities available for sale
$
469,081

 
$
10,013

 
$
(580
)
 
$
478,514

Held to maturity securities:
 
 
 
 
 
 
 
    Obligations of states and political subdivisions
$
14,795

 
$
471

 
$
(3
)
 
$
15,263

    Agency mortgage-backed securities
27,719

 
855

 

 
28,574

          Total securities held to maturity
$
42,514

 
$
1,326


$
(3
)

$
43,837


 
December 31, 2015
(in thousands)
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
Available for sale securities:
 
 
 
 
 
 
 
    Obligations of U.S. Government-sponsored enterprises
$
98,699

 
$
309

 
$

 
$
99,008

    Obligations of states and political subdivisions
40,700

 
1,343

 
(342
)
 
41,701

    Agency mortgage-backed securities
311,516

 
2,046

 
(2,501
)
 
311,061

          Total securities available for sale
$
450,915

 
$
3,698

 
$
(2,843
)
 
$
451,770

Held to maturity securities:
 
 
 
 
 
 
 
   Obligations of states and political subdivisions
$
14,831

 
$
63

 
$
(50
)
 
$
14,844

   Agency mortgage-backed securities
28,883

 

 
(286
)
 
28,597

          Total securities held to maturity
$
43,714

 
$
63

 
$
(336
)
 
$
43,441


At June 30, 2016, and December 31, 2015, there were no holdings of securities of any one issuer in an amount greater than 10% of shareholders’ equity, other than the U.S. Government agencies and sponsored enterprises. The agency mortgage-backed securities are all issued by U.S. Government-sponsored enterprises. Available for sale securities having a fair value of $336.8 million and $334.4 million at June 30, 2016, and December 31, 2015, respectively, were pledged as collateral to secure deposits of public institutions and for other purposes as required by law or contract provisions.

The amortized cost and estimated fair value of debt securities at June 30, 2016, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The weighted average life of the mortgage-backed securities is approximately 4 years.
 

8



 
Available for sale
 
Held to maturity
(in thousands)
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
52,681

 
$
53,030

 
$

 
$

Due after one year through five years
70,311

 
72,722

 
7,365

 
7,569

Due after five years through ten years
9,009

 
9,607

 
7,430

 
7,694

Due after ten years
3,531

 
3,292

 

 

Agency mortgage-backed securities
333,549

 
339,863

 
27,719

 
28,574

 
$
469,081

 
$
478,514


$
42,514


$
43,837



The following table represents a summary of investment securities that had an unrealized loss:
 
 
June 30, 2016
Less than 12 months
 
12 months or more
 
Total
(in thousands)
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
Obligations of states and political subdivisions
$

 
$

 
$
3,141

 
$
310

 
$
3,141

 
$
310

Agency mortgage-backed securities
904

 
5

 
19,910

 
268

 
20,814

 
273

 
$
904

 
$
5


$
23,051


$
578


$
23,955


$
583

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
Less than 12 months
 
12 months or more
 
Total
(in thousands)
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
Obligations of states and political subdivisions
$
2,199

 
$
12

 
$
9,395

 
$
380

 
$
11,594

 
$
392

Agency mortgage-backed securities
189,229

 
2,050

 
21,020

 
737

 
210,249

 
2,787

 
$
191,428

 
$
2,062


$
30,415


$
1,117


$
221,843


$
3,179



The unrealized losses at both June 30, 2016, and December 31, 2015, were primarily attributable to changes in market interest rates since the securities were purchased. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include among other considerations (1) the present value of the cash flows expected to be collected compared to the amortized cost of the security, (2) duration and magnitude of the decline in value, (3) the financial condition of the issuer or issuers, (4) structure of the security, and (5) the intent to sell the security or whether it is more likely than not the Company would be required to sell the security before its anticipated recovery in market value. At June 30, 2016, management performed its quarterly analysis of all securities with an unrealized loss and concluded no individual securities were other-than-temporarily impaired.

 The gross gains and gross losses realized from sales of available for sale investment securities were as follows:
 
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Gross gains realized
$

 
$

 
$

 
$
63

Gross losses realized

 

 

 
(40
)
Proceeds from sales

 

 

 
41,069




9



NOTE 4 - PORTFOLIO LOANS

Below is a summary of Portfolio loans by category at June 30, 2016 and December 31, 2015:
 
(in thousands)
June 30, 2016
 
December 31, 2015
Commercial and industrial
$
1,540,457

 
$
1,484,327

Real estate:
 
 
 
    Commercial - investor owned
466,713

 
428,064

    Commercial - owner occupied
332,639

 
342,959

    Construction and land development
171,778

 
161,061

    Residential
211,155

 
196,498

Total real estate loans
1,182,285

 
1,128,582

Consumer and other
161,417

 
137,537

Portfolio loans
2,884,159

 
2,750,446

Unearned loan fees, net
(250
)
 
291

    Portfolio loans, including unearned loan fees
$
2,883,909

 
$
2,750,737




10



A summary of the year-to-date activity in the allowance for loan losses and the recorded investment in Portfolio loans by class and category based on impairment method through June 30, 2016, and at December 31, 2015, is as follows:

(in thousands)
Commercial and industrial
 
CRE - investor owned
 
CRE -
owner occupied
 
Construction and land development
 
Residential real estate
 
Consumer and other
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
$
22,056

 
$
3,484

 
$
2,969

 
$
1,704

 
$
1,796

 
$
1,432

 
$
33,441

Provision (provision reversal) charged to expense
1,120

 
(116
)
 
80

 
(65
)
 
11

 
(197
)
 
833

Losses charged off
(68
)
 

 

 

 

 
(5
)
 
(73
)
Recoveries
53

 
7

 
68

 
6

 
34

 
4

 
172

Balance at March 31, 2016
$
23,161

 
$
3,375


$
3,117


$
1,645


$
1,841


$
1,234


$
34,373

Provision (provision reversal) charged to expense
302

 
(27
)
 
(541
)
 
(434
)
 
(80
)
 
1,496

 
716

Losses charged off
(157
)
 

 

 

 

 
(6
)
 
(163
)
Recoveries
502

 
8

 
15

 
8

 
36

 
3

 
572

Balance at June 30, 2016
$
23,808

 
$
3,356


$
2,591


$
1,219


$
1,797


$
2,727


$
35,498


(in thousands)
Commercial and industrial
 
CRE - investor owned
 
CRE -
owner occupied
 
Construction and land development
 
Residential real estate
 
Consumer and other
 
Total
Balance June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses - Ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,716

 
$

 
$

 
$
31

 
$
3

 
$
1,927

 
$
4,677

Collectively evaluated for impairment
21,092

 
3,356

 
2,591

 
1,188

 
1,794

 
800

 
30,821

Total
$
23,808

 
$
3,356


$
2,591


$
1,219


$
1,797


$
2,727


$
35,498

Loans - Ending balance:
 
 
 
 
 
 
 

 
 
 
 
 
 
Individually evaluated for impairment
$
5,019

 
$
248

 
$
1,704

 
$
2,576

 
$
670

 
$
4,571

 
$
14,788

Collectively evaluated for impairment
1,535,438

 
466,465

 
330,935

 
169,202

 
210,485

 
156,596

 
2,869,121

Total
$
1,540,457

 
$
466,713


$
332,639


$
171,778


$
211,155


$
161,167


$
2,883,909

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for Loan Losses - Ending Balance:
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
1,953

 
$

 
$
6

 
$
369

 
$
7

 
$

 
$
2,335

Collectively evaluated for impairment
20,103

 
3,484

 
2,963

 
1,335

 
1,789

 
1,432

 
31,106

Total
$
22,056

 
$
3,484


$
2,969


$
1,704


$
1,796


$
1,432


$
33,441

Loans - Ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
4,514

 
$
921

 
$
1,962

 
$
2,800

 
$
681

 
$

 
$
10,878

Collectively evaluated for impairment
1,479,813

 
427,143

 
340,997

 
158,261

 
195,817

 
137,828

 
2,739,859

Total
$
1,484,327

 
$
428,064


$
342,959


$
161,061


$
196,498


$
137,828


$
2,750,737


A summary of Portfolio loans individually evaluated for impairment by category at June 30, 2016 and December 31, 2015, is as follows:


11



 
June 30, 2016
(in thousands)
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance
 
Recorded
Investment
With
Allowance
 
Total
Recorded Investment
 
Related Allowance
 
Average
Recorded Investment
Commercial and industrial
$
4,840

 
$
134

 
$
4,700

 
$
4,834

 
$
2,716

 
$
4,873

Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
    Commercial - investor owned

 
249

 

 
249

 

 
250

    Commercial - owner occupied

 

 

 

 

 

    Construction and land development
3,481

 
2,970

 
367

 
3,337

 
31

 
2,646

    Residential
670

 
642

 
65

 
707

 
3

 
679

Consumer and other
4,571

 

 
4,580

 
4,580

 
1,927

 
4,628

Total
$
13,562

 
$
3,995


$
9,712


$
13,707


$
4,677


$
13,076


 
December 31, 2015
(in thousands)
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance
 
Recorded
Investment
With
Allowance
 
Total
Recorded Investment
 
Related Allowance
 
Average
Recorded Investment
Commercial and industrial
$
5,554

 
$
509

 
$
4,204

 
$
4,713

 
$
1,953

 
$
6,970

Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
    Commercial - investor owned
927

 
927

 

 
927

 

 
970

    Commercial - owner occupied
329

 
85

 
113

 
198

 
6

 
301

    Construction and land development
4,349

 
2,914

 
530

 
3,444

 
369

 
3,001

    Residential
705

 
637

 
68

 
705

 
7

 
682

Consumer and other

 

 

 

 

 

Total
$
11,864

 
$
5,072


$
4,915


$
9,987


$
2,335


$
11,924


The following table presents details for past due and impaired loans:
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Total interest income that would have been recognized under original terms
$
329

 
$
229

 
$
477

 
$
544

Total cash received and recognized as interest income on non-accrual loans
44

 
98

 
50

 
125

Total interest income recognized on impaired loans
25

 
14

 
31

 
27


There were no loans over 90 days past due and still accruing interest at June 30, 2016 or December 31, 2015.

The recorded investment in impaired Portfolio loans by category at June 30, 2016 and December 31, 2015, is as follows:
 

12



 
June 30, 2016
(in thousands)
Non-accrual
 
Restructured
 
Loans over 90 days past due and still accruing interest
 
Total
Commercial and industrial
$
2,524

 
$
2,310

 
$

 
$
4,834

Real estate:
 
 
 
 
 
 
 
    Commercial - investor owned
249

 

 

 
249

    Commercial - owner occupied

 

 

 

    Construction and land development
3,317

 
20

 

 
3,337

    Residential
707

 

 

 
707

Consumer and other
4,580

 

 

 
4,580

       Total
$
11,377

 
$
2,330


$


$
13,707


 
December 31, 2015
(in thousands)
Non-accrual
 
Restructured
 
Loans over 90 days past due and still accruing interest
 
Total
Commercial and industrial
$
4,406

 
$
307

 
$

 
$
4,713

Real estate:
 
 
 
 
 
 
 
    Commercial - investor owned
927

 

 

 
927

    Commercial - owner occupied
198

 

 

 
198

    Construction and land development
3,444

 

 

 
3,444

    Residential
705

 

 

 
705

Consumer and other

 

 

 

       Total
$
9,680

 
$
307

 
$

 
$
9,987


The recorded investment by category for the Portfolio loans that have been restructured during the three and six months ended June 30, 2016 and 2015, is as follows:

 
Three months ended June 30, 2016
 
Three months ended June 30, 2015
(in thousands, except for number of loans)
Number of Loans
 
Pre-Modification Outstanding Recorded Balance
 
Post-Modification Outstanding Recorded Balance
 
Number of Loans
 
Pre-Modification Outstanding Recorded Balance
 
Post-Modification Outstanding Recorded Balance
Commercial and industrial
1

 
$
2,300

 
$
2,300

 

 
$

 
$

Real estate:
 
 
 
 
 
 
 
 
 
 
 
Commercial - investor owned

 

 

 

 

 

Commercial - owner occupied

 

 

 

 

 

Construction and land development
1

 
20

 
20

 

 

 

Residential

 

 

 

 

 

Consumer and other

 

 

 

 

 

Total
2

 
$
2,320

 
$
2,320

 

 
$

 
$



13



 
Six months ended June 30, 2016
 
Six months ended June 30, 2015
(in thousands, except for number of loans)
Number of Loans
 
Pre-Modification Outstanding Recorded Balance
 
Post-Modification Outstanding Recorded Balance
 
Number of Loans
 
Pre-Modification Outstanding Recorded Balance
 
Post-Modification Outstanding Recorded Balance
Commercial and industrial
2

 
$
2,341

 
$
2,341

 

 
$

 
$

Real estate:
 
 
 
 
 
 
 
 
 
 
 
Commercial - investor owned
1

 
248

 
248

 

 

 

Commercial - owner occupied

 

 

 

 

 

Construction and land development
1

 
20

 
20

 

 

 

Residential

 

 

 

 

 

Consumer and other

 

 

 

 

 

Total
4

 
$
2,609

 
$
2,609

 

 
$

 
$


The restructured loans resulted from deferral of principal and extending the term to maturity. As of June 30, 2016, the Company had $1.2 million specific reserves allocated to loans that have been restructured. There were no Portfolio loans restructured that subsequently defaulted during the six months ended June 30, 2016 or 2015.

The aging of the recorded investment in past due Portfolio loans by portfolio class and category at June 30, 2016 and December 31, 2015 is shown below.

 
June 30, 2016
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
    Commercial and industrial
$
83

 
$
2,407

 
$
2,490

 
$
1,537,967

 
$
1,540,457

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned

 

 

 
466,713

 
466,713

       Commercial - owner occupied

 

 

 
332,639

 
332,639

       Construction and land development
367

 
2,189

 
2,556

 
169,222

 
171,778

       Residential
10

 
605

 
615

 
210,540

 
211,155

    Consumer and other
4

 

 
4

 
161,163

 
161,167

          Total
$
464

 
$
5,201


$
5,665


$
2,878,244


$
2,883,909


 
December 31, 2015
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
    Commercial and industrial
$
505

 
$
888

 
$
1,393

 
$
1,482,934

 
$
1,484,327

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned
464

 

 
464

 
427,600

 
428,064

       Commercial - owner occupied
94

 
184

 
278

 
342,681

 
342,959

       Construction and land development
384

 
2,273

 
2,657

 
158,404

 
161,061

       Residential
70

 
681

 
751

 
195,747

 
196,498

    Consumer and other
20

 

 
20

 
137,808

 
137,828

          Total
$
1,537

 
$
4,026


$
5,563


$
2,745,174


$
2,750,737



14



The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as current financial information, payment experience, credit documentation, and current economic factors among other factors. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:
Grades 1, 2, and 3 Includes loans to borrowers with a continuous record of strong earnings, sound balance sheet condition and capitalization, ample liquidity with solid cash flow, and whose management team has experience and depth within their industry.
Grade 4 Includes loans to borrowers with positive trends in profitability, satisfactory capitalization and balance sheet condition, and sufficient liquidity and cash flow.
Grade 5 Includes loans to borrowers that may display fluctuating trends in sales, profitability, capitalization, liquidity, and cash flow.
Grade 6 Includes loans to borrowers where an adverse change or perceived weakness has occurred, but may be correctable in the near future. Alternatively, this rating category may also include circumstances where the borrower is starting to reverse a negative trend or condition, or has recently been upgraded from a 7, 8, or 9 rating.
Grade 7 – Watch credits are borrowers that have experienced financial setback of a nature that is not determined to be severe or influence ‘ongoing concern’ expectations. Although possible, no loss is anticipated, due to strong collateral and/or guarantor support.
Grade 8Substandard credits will include those borrowers characterized by significant losses and sustained downward trends in balance sheet condition, liquidity, and cash flow. Repayment reliance may have shifted to secondary sources. Collateral exposure may exist and additional reserves may be warranted.
Grade 9Doubtful credits include borrowers that may show deteriorating trends that are unlikely to be corrected. Collateral values may appear insufficient for full recovery, therefore requiring a partial charge-off, or debt renegotiation with the borrower. The borrower may have declared bankruptcy or bankruptcy is likely in the near term. All doubtful rated credits will be on non-accrual.

The recorded investment by risk category of the Portfolio loans by portfolio class and category at June 30, 2016, which is based upon the most recent analysis performed, and December 31, 2015 is as follows:

 
June 30, 2016
(in thousands)
Pass (1-6)
 
Watch (7)
 
Substandard (8)
 
Doubtful (9)
 
Total
    Commercial and industrial
$
1,396,684

 
$
82,775

 
$
60,998

 
$

 
$
1,540,457

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned
448,321

 
13,223

 
5,169

 

 
466,713

       Commercial - owner occupied
302,411

 
27,144

 
3,084

 

 
332,639

       Construction and land development
161,528

 
6,258

 
3,992

 

 
171,778

       Residential
202,880

 
4,840

 
3,435

 

 
211,155

    Consumer and other
154,500

 
714

 
5,953

 

 
161,167

          Total
$
2,666,324

 
$
134,954

 
$
82,631

 
$

 
$
2,883,909



15



 
December 31, 2015
(in thousands)
Pass (1-6)
 
Watch (7)
 
Substandard (8)
 
Doubtful (9)
 
Total
    Commercial and industrial
$
1,356,864

 
$
90,370

 
$
37,093

 
$

 
$
1,484,327

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned
403,820

 
18,868

 
5,376

 

 
428,064

       Commercial - owner occupied
314,791

 
24,727

 
3,441

 

 
342,959

       Construction and land development
146,601

 
10,114

 
4,346

 

 
161,061

       Residential
188,269

 
5,138

 
3,091

 

 
196,498

    Consumer and other
131,060

 
721

 
6,047

 

 
137,828

          Total
$
2,541,405

 
$
149,938


$
59,394


$


$
2,750,737



16



NOTE 5 - PURCHASED CREDIT IMPAIRED ("PCI") LOANS

Below is a summary of PCI loans by category at June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
 
December 31, 2015
(in thousands)
Weighted-
Average
Risk Rating1
Recorded
Investment
PCI Loans
 
Weighted-
Average
Risk Rating1
Recorded
Investment
PCI Loans
Commercial and industrial
6.45
$
3,498

 
6.70
$
3,863

Real estate:
 
 
 
 
 
    Commercial - investor owned
7.14
19,328

 
6.98
25,272

    Commercial - owner occupied
6.35
13,068

 
6.30
19,414

    Construction and land development
5.70
5,523

 
6.28
6,838

    Residential
5.44
15,047

 
5.44
19,287

Total real estate loans
 
52,966

 
 
70,811

Consumer and other
1.60
65

 
1.89
84

    Purchased credit impaired loans
 
$
56,529

 
 
$
74,758

1Risk ratings are based on the borrower's contractual obligation, which is not reflective of the purchase discount.

The aging of the recorded investment in past due PCI loans by portfolio class and category at June 30, 2016 and December 31, 2015 is shown below:

 
June 30, 2016
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
    Commercial and industrial
$
22

 
$

 
$
22

 
$
3,476

 
$
3,498

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned

 

 

 
19,328

 
19,328

       Commercial - owner occupied

 

 

 
13,068

 
13,068

       Construction and land development

 

 

 
5,523

 
5,523

       Residential
372

 
144

 
516

 
14,531

 
15,047

    Consumer and other

 

 

 
65

 
65

          Total
$
394

 
$
144


$
538


$
55,991


$
56,529


 
December 31, 2015
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
    Commercial and industrial
$

 
$

 
$

 
$
3,863

 
$
3,863

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned
2,342

 
3,661

 
6,003

 
19,269

 
25,272

       Commercial - owner occupied
731

 

 
731

 
18,683

 
19,414

       Construction and land development

 

 

 
6,838

 
6,838

       Residential
1,594

 
130

 
1,724

 
17,563

 
19,287

    Consumer and other
4

 

 
4

 
80

 
84

          Total
$
4,671

 
$
3,791


$
8,462


$
66,296


$
74,758



17



The following table is a rollforward of PCI loans, net of the allowance for loan losses, for the six months ended June 30, 2016 and 2015.

(in thousands)
Contractual Cashflows
 
Non-accretable Difference
 
Accretable Yield
 
Carrying Amount
Balance January 1, 2016
$
116,689

 
$
26,765

 
$
25,341

 
$
64,583

Principal reductions and interest payments
(11,768
)
 

 

 
(11,768
)
Accretion of loan discount

 

 
(3,431
)
 
3,431

Changes in contractual and expected cash flows due to remeasurement
6,144

 
1,522

 
(788
)
 
5,410

Reductions due to disposals
(21,663
)
 
(4,912
)
 
(3,073
)
 
(13,678
)
Balance June 30, 2016
$
89,402

 
$
23,375


$
18,049


$
47,978

 
 
 
 
 
 
 
 
Balance January 1, 2015
$
178,145

 
$
65,719

 
$
28,733

 
$
83,693

Principal reductions and interest payments
(13,214
)
 

 

 
(13,214
)
Accretion of loan discount

 

 
(5,989
)
 
5,989

Changes in contractual and expected cash flows due to remeasurement
(12,100
)
 
(26,187
)
 
5,304

 
8,783

Reductions due to disposals
(13,831
)
 
(2,794
)
 
(1,836
)
 
(9,201
)
Balance June 30, 2015
$
139,000

 
$
36,738


$
26,212


$
76,050


The accretable yield is recognized in interest income over the estimated life of the acquired loans using the effective yield method. Outstanding customer balances on PCI loans were $75.1 million and $98.6 million as of June 30, 2016, and December 31, 2015, respectively.



18



NOTE 6 - COMMITMENTS AND CONTINGENCIES

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

The Company’s extent of involvement and maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments.

The Company uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets. At June 30, 2016, there were $0.1 million unadvanced commitments on impaired loans.

The contractual amounts of off-balance-sheet financial instruments as of June 30, 2016, and December 31, 2015, are as follows:
 
(in thousands)
June 30,
2016
 
December 31,
2015
Commitments to extend credit
$
1,067,353

 
$
1,140,028

Standby letters of credit
82,606

 
54,648


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 usually have fixed expiration dates or other termination clauses, may have significant usage restrictions, and may require payment of a fee. Of the total commitments to extend credit at June 30, 2016, and December 31, 2015, approximately $115 million and $94 million, respectively, represent fixed rate loan commitments. Since certain of the commitments may expire without being drawn upon or may be revoked, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company 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. Other liabilities include $0.3 million for estimated losses attributable to the unadvanced commitments at June 30, 2016 and December 31, 2015.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are issued to support contractual obligations of the Company’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 term of standby letters of credit range from 1 month to 2 years 11 months at June 30, 2016.

Contingencies

The Company and its subsidiaries are, from time to time, parties to various legal proceedings arising out of their businesses. Management believes there are no such proceedings pending or threatened against the Company or its subsidiaries which, if determined adversely, would have a material adverse effect on the business, consolidated financial condition, results of operations or cash flows of the Company or any of its subsidiaries.


19



NOTE 7 - DERIVATIVE FINANCIAL INSTRUMENTS

The Company is a party to various derivative financial instruments that are used in the normal course of business to meet the needs of its clients and as part of its risk management activities. These instruments include interest rate swaps and option contracts and foreign exchange forward contracts. The Company does not enter into derivative financial instruments for trading purposes.

Risk Management Instruments. The Company enters into interest rate caps in order to economically hedge changes in fair value of State tax credits held for sale. See Note 8 – Fair Value Measurements for further discussion on the fair value of state tax credits. The notional amount of the derivative instruments used to manage risk was $3.5 million at June 30, 2016 and December 31, 2015, and the fair value was zero in both periods.

Client-Related Derivative Instruments. The Company enters into interest rate swaps to allow customers to hedge changes in fair value of certain loans while maintaining a variable rate loan on its own books. The Company also enters into foreign exchange forward contracts with clients, and enters into offsetting foreign exchange forward contracts with established financial institution counterparties. The table below summarizes the notional amounts and fair values of the client-related derivative instruments:
 
 
Asset Derivatives
(Other Assets)
 
Liability Derivatives
(Other Liabilities)
 
Notional Amount
 
Fair Value
 
Fair Value
(in thousands)
June 30,
2016
 
December 31,
2015
 
June 30,
2016
 
December 31,
2015
 
June 30,
2016
 
December 31,
2015
Non-designated hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
$
161,598

 
$
153,630

 
$
2,264

 
$
1,155

 
$
2,264

 
$
1,155


Changes in the fair value of client-related derivative instruments are recognized currently in operations. For the three and six months ended June 30, 2016 and 2015, the gains and losses offset each other due to the Company's hedging of the client swaps with other bank counterparties.


NOTE 8 - FAIR VALUE MEASUREMENTS

Below is a description of certain assets and liabilities measured at fair value.

The following table summarizes financial instruments measured at fair value on a recurring basis as of June 30, 2016 and December 31, 2015, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
 

20



 
June 30, 2016
(in thousands)
Quoted Prices in
Active Markets
for Identical Assets
(Level 1)
 
Significant
Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Fair
Value
Assets
 
 
 
 
 
 
 
Securities available for sale
 
 
 
 
 
 
 
Obligations of U.S. Government-sponsored enterprises
$

 
$
99,686

 
$

 
$
99,686

Obligations of states and political subdivisions

 
35,872

 
3,093

 
38,965

Residential mortgage-backed securities

 
339,863

 

 
339,863

Total securities available for sale
$

 
$
475,421


$
3,093


$
478,514

State tax credits held for sale

 

 
4,774

 
4,774

Derivative financial instruments

 
2,264

 

 
2,264

Total assets
$

 
$
477,685


$
7,867


$
485,552

 
 
 
 
 
 
 
 
Liabilities
 

 
 
 
 

 
 
Derivative financial instruments
$

 
$
2,264

 
$

 
$
2,264

Total liabilities
$

 
$
2,264


$


$
2,264


 
December 31, 2015
(in thousands)
Quoted Prices in
Active Markets
for Identical Assets
(Level 1)
 
Significant
Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Fair
Value
Assets
 
 
 
 
 
 
 
Securities available for sale
 
 
 
 
 
 
 
Obligations of U.S. Government-sponsored enterprises
$

 
$
99,008

 
$

 
$
99,008

Obligations of states and political subdivisions

 
38,624

 
3,077

 
41,701

Residential mortgage-backed securities

 
311,061

 

 
311,061

Total securities available for sale
$

 
$
448,693


$
3,077


$
451,770

State tax credits held for sale

 

 
5,941

 
5,941

Derivative financial instruments

 
1,155

 

 
1,155

Total assets
$

 
$
449,848


$
9,018


$
458,866

 
 
 
 
 
 
 
 
Liabilities
 

 
 
 
 

 
 
Derivative financial instruments
$

 
$
1,155

 
$

 
$
1,155

Total liabilities
$

 
$
1,155


$


$
1,155


Securities available for sale. Securities classified as available for sale are reported at fair value utilizing Level 2 and Level 3 inputs. Fair values for Level 2 securities are based upon dealer quotes, market spreads, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, credit information and the bond's terms and conditions at the security level. At June 30, 2016, Level 3 securities available for sale consist primarily of three Auction Rate Securities that are valued based on the securities' estimated cash flows, yields of comparable securities, and live trading levels.
State tax credits held for sale. At June 30, 2016, of the $44.9 million of state tax credits held for sale on the condensed consolidated balance sheet, approximately $4.8 million were carried at fair value. The remaining $40.1 million of state tax credits were accounted for at cost.
The Company is not aware of an active market that exists for the 10-year streams of state tax credit financial instruments. However, the Company’s principal market for these tax credits consists of Missouri state residents

21



who buy these credits and local and regional accounting firms who broker them. As such, the Company employed a discounted cash flow analysis (income approach) to determine the fair value.
The fair value measurement is calculated using an internal valuation model with market data including discounted cash flows based upon the terms and conditions of the tax credits. If the underlying project remains in compliance with the various federal and state rules governing the tax credit program, each project will generate about 10 years of tax credits. The inputs to the discounted cash flow calculation include: the amount of tax credits generated each year, the anticipated sale price of the tax credit, the timing of the sale and a discount rate. The discount rate is estimated using the LIBOR swap curve at a point equal to the remaining life in years of credits plus a 205 basis point spread. With the exception of the discount rate, the other inputs to the fair value calculation are observable and readily available. The discount rate is considered a Level 3 input because it is an “unobservable input” and is based on the Company’s assumptions. An increase in the discount rate utilized would generally result in a lower estimated fair value of the tax credits. Alternatively, a decrease in the discount rate utilized would generally result in a higher estimated fair value of the tax credits. Given the significance of this input to the fair value calculation, the state tax credit assets are reported as Level 3 assets.
Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs. The Company obtains counterparty quotations to value its interest rate swaps and caps. In addition, the Company validates the counterparty quotations with third party valuation sources. Derivatives with negative fair values are included in Other liabilities in the consolidated balance sheets. Derivatives with positive fair value are included in Other assets in the consolidated balance sheets.
Level 3 financial instruments

The following table presents the changes in Level 3 financial instruments measured at fair value on a recurring basis as of June 30, 2016 and 2015.
Purchases, sales, issuances and settlements. There were no Level 3 purchases during the quarter ended June 30, 2016 or 2015.
Transfers in and/or out of Level 3. There were no Level 3 transfers during the quarter ended June 30, 2016 and 2015.
 
Securities available for sale, at fair value
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Beginning balance
$
3,085

 
$
3,071

 
$
3,077

 
$
3,059

   Total gains:
 
 
 
 
 
 
 
Included in other comprehensive income
8

 
(1
)
 
16

 
11

   Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
Purchases

 

 

 

Ending balance
$
3,093

 
$
3,070

 
$
3,093

 
$
3,070

 
 
 
 
 
 
 
 
Change in unrealized gains (losses) relating to assets still held at the reporting date
$
8

 
$
(1
)
 
$
16

 
$
11




22



 
State tax credits held for sale
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Beginning balance
$
4,733

 
$
10,286

 
$
5,941

 
$
11,689

   Total gains:
 
 
 
 
 
 
 
Included in earnings
41

 
66

 
117

 
194

   Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
Sales

 
(387
)
 
(1,284
)
 
(1,918
)
Ending balance
$
4,774

 
$
9,965

 
$
4,774

 
$
9,965

 
 
 
 
 
 
 
 
Change in unrealized gains (losses) relating to assets still held at the reporting date
$
41

 
$
(36
)
 
$
(264
)
 
$
(310
)

From time to time, the Company measures certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or fair value that were recognized at fair value below cost at the end of the period. The following table presents financial instruments and non-financial assets measured at fair value on a non-recurring basis as of June 30, 2016.
 
 
(1)
 
(1)
 
(1)
 
(1)
 
 
 
 
(in thousands)
Total Fair Value
 
Quoted Prices in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total gains (losses) for the three
months ended
June 30, 2016
 
Total gains (losses) for the six
months ended
June 30, 2016
Impaired loans
$

 
$

 
$

 
$

 
$
(163
)
 
$
(236
)
Other real estate

 

 

 

 

 
(1
)
Total
$

 
$


$


$


$
(163
)
 
$
(237
)

(1) The amounts represent only balances measured at fair value during the period and still held as of the reporting date.
 
Impaired loans are reported at the fair value of the underlying collateral for collateral dependent loans. Fair values for impaired loans are obtained from current appraisals by qualified licensed appraisers or independent valuation specialists. Other real estate owned is adjusted to fair value upon foreclosure of the underlying loan. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value less costs to sell. Fair value of other real estate is based upon the current appraised values of the properties as determined by qualified licensed appraisers and the Company’s judgment of other relevant market conditions. Certain state tax credits are reported at cost.

Following is a summary of the carrying amounts and fair values of the Company’s financial instruments on the consolidated balance sheets at June 30, 2016 and December 31, 2015.


23



 
June 30, 2016
 
December 31, 2015
(in thousands)
Carrying Amount
 
Estimated fair value
 
Carrying Amount
 
Estimated fair value
Balance sheet assets
 
 
 
 
 
 
 
Cash and due from banks
$
50,370

 
$
50,370

 
$
47,935

 
$
47,935

Federal funds sold
317

 
317

 
91

 
91

Interest-bearing deposits
60,609

 
60,609

 
47,131

 
47,131

Securities available for sale
478,514

 
478,514

 
451,770

 
451,770

Securities held to maturity
42,514

 
43,837

 
43,714

 
43,441

Other investments, at cost
17,403

 
17,403

 
17,455

 
17,455

Loans held for sale
9,669

 
9,669

 
6,598

 
6,598

Derivative financial instruments
2,264

 
2,264

 
1,155

 
1,155

Portfolio loans, net
2,896,389

 
2,902,083

 
2,781,879

 
2,782,704

State tax credits, held for sale
44,918

 
49,961

 
45,850

 
49,588

Accrued interest receivable
8,123

 
8,123

 
8,399

 
8,399

 
 
 
 
 
 
 
 
Balance sheet liabilities
 
 
 
 
 
 
 
Deposits
3,028,236

 
3,030,334

 
2,784,591

 
2,784,654

Subordinated debentures
56,807

 
35,771

 
56,807

 
35,432

Federal Home Loan Bank advances
78,000

 
78,000

 
110,000

 
109,994

Other borrowings
200,362

 
200,332

 
270,326

 
270,286

Derivative financial instruments
2,264

 
2,264

 
1,155

 
1,155

Accrued interest payable
625

 
625

 
629

 
629


For information regarding the methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practical to estimate such value, refer to Note 19 – Fair Value Measurements in the Company's Annual Report on Form 10-K for the year ended December 31, 2015.

The following table presents the level in the fair value hierarchy for the estimated fair values of only the Company’s financial instruments that are not already presented on the condensed consolidated balance sheets at fair value at June 30, 2016, and December 31, 2015.
 

24



 
Estimated Fair Value Measurement at Reporting Date Using
 
Balance at
June 30, 2016
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Financial Assets:
 
 
 
 
 
 
 
Securities held to maturity
$

 
$
43,837

 
$

 
$
43,837

Portfolio loans, net

 

 
2,902,083

 
2,902,083

State tax credits, held for sale

 

 
45,187

 
45,187

Financial Liabilities:
 
 
 
 
 
 
 
Deposits
2,506,206

 

 
524,128

 
3,030,334

Subordinated debentures

 
35,771

 

 
35,771

Federal Home Loan Bank advances

 
78,000

 

 
78,000

Other borrowings

 
200,332

 

 
200,332

 
 
Estimated Fair Value Measurement at Reporting Date Using
 
Balance at December 31, 2015
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Financial Assets:
 
 
 
 
 
 
 
Securities held to maturity
$

 
$
43,441

 
$

 
$
43,441

Portfolio loans, net

 

 
2,782,704

 
2,782,704

State tax credits, held for sale

 

 
43,647

 
43,647

Financial Liabilities:
 
 
 
 
 
 
 
Deposits
2,428,403

 

 
356,251

 
2,784,654

Subordinated debentures

 
35,432

 

 
35,432

Federal Home Loan Bank advances

 
109,994

 

 
109,994

Other borrowings

 
270,286

 

 
270,286



NOTE 9 - NEW AUTHORITATIVE ACCOUNTING GUIDANCE

FASB ASU 2014-09, "Revenue from Contracts with Customers" In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers”. The objective of ASU 2014-09 is to establish a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most of the existing revenue recognition guidance, including industry-specific guidance. The core principle of ASU 2014-09 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the new guidance, an entity will (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the contract’s performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification. The new guidance was originally effective for annual reporting periods (including interim periods within those periods) beginning after December 15, 2016 for public companies. In August 2015, the FASB issued ASU 2015-14, which defers the effective date of this guidance to annual reporting periods beginning after December 15, 2017 for public companies, and permits early adoption on a limited basis. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its financial statements, nor decided upon the method of adoption. Entities have the option of using either a full retrospective or modified approach to adopt ASU 2014-09.
FASB ASU 2016-01 "Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" In January 2016, the FASB issued ASU 2016-01, "Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." ASU 2016-01 requires equity investments to be measured at fair value through earnings, and eliminates the available-for-sale classification for equity securities with readily determinable fair values. For financial liabilities where the fair value option has been elected, changes in fair value due to instrument-specific credit risk must be recognized in other

25



comprehensive income. When measuring the fair value of financial instruments at amortized cost, the exit price must be used for disclosure purposes. The ASU also requires that financial assets and liabilities be presented separately in the notes to the financial statements. This ASU becomes effective for the Company in the first quarter of 2018. Early adoption is permitted. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its financial statements.

FASB ASU 2016-02 "Leases (Topic 842)" In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)" which requires organizations that lease assets ("lessees") to recognize the assets and liabilities for the rights and obligations created by leases with terms of more than 12 months. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee remains dependent on its classification as a finance or operating lease. The criteria for determining whether a lease is a finance or operating lease has not been significantly changed by this ASU. The ASU also requires additional disclosure of the amount, timing, and uncertainty of cash flows arising from leases, including qualitative and quantitative requirements. The guidance becomes effective for periods beginning after December 15, 2018. Early adoption will be permitted. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its consolidated balance sheets.

FASB ASU 2016-09 "Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" In March 2016, the FASB issued ASU 2016-09, "Compensation-Stock Compensation (Topic 718)" which impacts accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 requires all excess tax benefits and tax deficiencies to be recognized in the income statement as income tax expense (or benefit.) The tax effects of exercised or vested awards must be treated as discrete items in the reporting period in which they occur, regardless of whether the benefit reduces taxes payable in the current period. Excess tax benefits will be classified with other income tax cash flows as an operating activity, and cash paid by an employer when withholding shares for tax liabilities should be classified as a financing activity. The guidance becomes effective for annual periods beginning after December 15, 2017, and interim periods beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its financial statements.

FASB ASU 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" In June 2016, the FASB issued ASU 2016-13, "Financial Instruments (Topic 326)" which changes the methodology for evaluating impairment of most financial instruments. The ASU replaces the currently used incurred loss model with a forward-looking expected loss model, which will generally result in a more timely recognition of losses. The guidance becomes effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its financial statements.
  

26



ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
Some of the information in this report contains “forward-looking statements” within the meaning of and intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements typically are identified with use of terms such as “may,” “might,” “will, “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “could,” “continue” and the negative of these terms and similar words, although some forward-looking statements are expressed differently. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including, but not limited to: credit risk; changes in the appraised valuation of real estate securing impaired loans; outcomes of litigation and other contingencies; exposure to general and local economic conditions; risks associated with rapid increases or decreases in prevailing interest rates; consolidation within the banking industry; competition from banks and other financial institutions; our ability to attract and retain relationship officers and other key personnel; burdens imposed by federal and state regulation; changes in regulatory requirements; changes in accounting regulation or standards applicable to banks; and other risks discussed under the caption “Risk Factors” of our most recently filed Form 10-K and within this Form 10-Q, all of which could cause the Company’s actual results to differ from those set forth in the forward-looking statements.

Readers are cautioned not to place undue reliance on our forward-looking statements, which reflect management’s analysis and expectations only as of the date of such statements. Forward-looking statements speak only as of the date they are made, and the Company does not intend, and undertakes no obligation, to publicly revise or update forward-looking statements after the date of this report, whether as a result of new information, future events or otherwise, except as required by federal securities law. You should understand that it is not possible to predict or identify all risk factors. Readers should carefully review all disclosures we file from time to time with the Securities and Exchange Commission which are available on our website at www.enterprisebank.com under "Investor Relations."

Introduction

The following discussion describes the significant changes to the financial condition of the Company that have occurred during the first six months of 2016 compared to the financial condition as of December 31, 2015. In addition, this discussion summarizes the significant factors affecting the results of operations, liquidity and cash flows of the Company for the three and six months ended June 30, 2016, compared to the same periods in 2015. This discussion should be read in conjunction with the accompanying condensed consolidated financial statements included in this report and our Annual Report on Form 10-K for the year ended December 31, 2015.

 

27



Executive Summary

Below are highlights of our financial performance for the quarter ended June 30, 2016, as compared to the linked quarter ended March 31, 2016, and prior year quarter ended June 30, 2015.

(in thousands, except per share data)
For the Three Months ended and At
 
For the Six Months ended
June 30,
2016
 
March 31,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
EARNINGS
 
 
 
 
 
 
 
 
 
Total interest income
$
37,033

 
$
35,460

 
$
32,352

 
$
72,493

 
$
64,503

Total interest expense
3,250

 
3,032

 
3,072

 
6,282

 
6,178

Net interest income
33,783

 
32,428

 
29,280

 
66,211

 
58,325

Provision for portfolio loans
716

 
833

 
2,150

 
1,549

 
3,730

Provision reversal for PCI loans
(336
)
 
(73
)
 

 
(409
)
 
(3,270
)
Net interest income after provision for loan losses
33,403

 
31,668

 
27,130

 
65,071

 
57,865

Total noninterest income
7,049

 
6,005

 
5,806

 
13,054

 
9,389

Total noninterest expense
21,353

 
20,762

 
19,458

 
42,115

 
39,408

Income before income tax expense
19,099

 
16,911


13,478

 
36,010

 
27,846

Income tax expense
6,747

 
5,886

 
4,762

 
12,633

 
9,784

Net income
$
12,352

 
$
11,025

 
$
8,716

 
$
23,377

 
$
18,062

 
 
 
 
 
 
 
 
 
 
Basic earnings per share
$
0.62

 
$
0.55

 
$
0.44

 
$
1.17

 
$
0.91

Diluted earnings per share
0.61

 
0.54

 
0.43

 
1.16

 
0.90

 
 
 
 
 
 
 
 
 
 
Return on average assets
1.33
 %
 
1.22
 %
 
1.06
%
 
1.27
 %
 
1.11
%
Return on average common equity
13.57
 %
 
12.46
 %
 
10.56
%
 
13.02
 %
 
11.16
%
Return on average tangible common equity
14.91
 %
 
13.74
 %
 
11.77
%
 
14.34
 %
 
12.47
%
Net interest margin (fully tax equivalent)
3.93
 %
 
3.87
 %
 
3.85
%
 
3.90
 %
 
3.88
%
Efficiency ratio
52.29
 %
 
54.02
 %
 
55.46
%
 
53.13
 %
 
58.20
%
 
 
 
 
 
 
 
 
 
 
ASSET QUALITY (1)
 
 
 
 
 
 
 
 
 
Net charge-offs (recoveries)
$
(409
)
 
$
(99
)
 
$
672

 
$
(508
)
 
$
2,150

Nonperforming loans
12,813

 
9,513

 
17,498

 
 
 
 
Classified assets
87,532

 
73,194

 
61,722

 
 
 
 
Nonperforming loans to portfolio loans
0.44
 %
 
0.34
 %
 
0.69
%
 
 
 
 
Nonperforming assets to total assets (2)
0.47
 %
 
0.52
 %
 
0.58
%
 
 
 
 
Allowance for loan losses to portfolio loans
1.23
 %
 
1.21
 %
 
1.25
%
 
 
 
 
Net charge-offs (recoveries) to average loans (annualized)
(0.06
)%
 
(0.01
)%
 
0.11
%
 
(0.04
)%
 
0.19
%
 
 
 
 
 
 
 
 
 
 
(1) Excludes PCI loans and related assets, except for their inclusion in total assets.
(2) Other real estate from PCI loans included in Nonperforming assets beginning with the period ended December 31, 2015 due to termination of FDIC loss share agreements.

Below are highlights of the Company's Core performance measures, which we believe are important measures of financial performance, but are non-GAAP measures. Core performance measures include contractual interest on PCI loans, but exclude incremental accretion on these loans, and exclude the Change in the FDIC receivable, gain or loss on the sale of other real estate from PCI loans, and certain other income and expense items the Company believes are not indicative of or useful to measure the Company's operating performance on an ongoing basis. A reconciliation of

28



Core performance measures has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures".

 
For the Three Months ended
 
For the Six Months ended
(in thousands)
June 30,
2016
 
March 31,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
CORE PERFORMANCE MEASURES (1)
 
 
 
 
Net interest income
$
30,212

 
$
29,594

 
$
26,277

 
$
59,806

 
$
51,864

Provision for portfolio loans
716

 
833

 
2,150

 
1,549

 
3,730

Noninterest income
6,105

 
6,005

 
6,741

 
12,110

 
12,580

Noninterest expense
20,446

 
20,435

 
19,030

 
40,881

 
38,098

Income before income tax expense
15,155

 
14,331

 
11,838

 
29,486

 
22,616

Income tax expense
5,237

 
4,897

 
4,134

 
10,134

 
7,781

Net income
$
9,918

 
$
9,434

 
$
7,704

 
$
19,352

 
$
14,835

 
 
 
 
 
 
 
 
 
 
Earnings per share
$
0.49

 
$
0.47

 
$
0.38

 
$
0.96

 
$
0.74

Return on average assets
1.07
%
 
1.04
%
 
0.93
%
 
1.06
%
 
0.91
%
Return on average common equity
10.89
%
 
10.66
%
 
9.34
%
 
10.78
%
 
9.17
%
Return on average tangible common equity
11.98
%
 
11.76
%
 
10.41
%
 
11.87
%
 
10.24
%
Net interest margin (fully tax equivalent)
3.52
%
 
3.54
%
 
3.46
%
 
3.53
%
 
3.46
%
Efficiency ratio
56.30
%
 
57.40
%
 
57.64
%
 
56.85
%
 
59.12
%
 
 
 
 
 
 
 
 
 
 
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

During the six months ended June 30, 2016, the Company noted the following trends:

The Company reported net income of $23.4 million, or $1.16 per share, for the six months ended June 30, 2016, compared to $18.1 million, or $0.90 per share, for the same period in 2015. The increase in net income was primarily due to an increase in net interest income and an increase in noninterest income.

On a core basis1, net income was $19.4 million, or $0.96 per share, for the six months ended June 30, 2016, compared to $14.8 million, or $0.74 per share, in the prior year period. The increase from the prior year was primarily due to increases in earning asset balances, driving growth in core net interest income. Additionally, a decrease in provision for losses on portfolio loans contributed to the increase, and was offset by a modest increase in noninterest expense.

Net interest income for the first six months of 2016 increased $7.9 million or 14%, from the prior year period due to strong portfolio loan growth.

Net interest margin for the first six months of 2016 increased two basis points to 3.90% when compared to the prior year period. Core net interest margin1, for the first six months of 2016, defined as Net interest margin (fully tax equivalent), including contractual interest on PCI loans, but excluding the incremental accretion on these loans, increased seven basis points from the prior year period primarily due to managed reductions in funding costs combined with an improved earning asset mix, and an increase in the yield on portfolio loans.

Noninterest income for the first six months of 2016 increased $3.7 million, or 39%, compared to the prior year period largely due to a decrease in the Change in FDIC receivable from termination of the Company's loss share agreements in the fourth quarter of 2015. Core noninterest income1 declined $0.5 million, or 4%, from the prior year period primarily due to higher allocation fees from tax credit projects and higher fees earned from recoveries received during the first six months of 2015.

29




Noninterest expense increased $2.7 million, or 7%, from the prior year period, and the Company's efficiency ratio improved to 53.1% from 58.2% when compared to the prior year. The increase was largely due to an increase in Employee compensation and benefits, including $0.3 million of executive severance. Core noninterest expense1 also increased 7% when compared to the prior year. However, the Core efficiency ratio1 also improved to 56.9% from 59.1% when compared to the prior year period due to revenue growth resulting from investments in customer facing associates driving continued revenue growth.

Other highlights:

The Company's Board approved a sixth consecutive increase in the Company’s quarterly cash dividend to $0.11 per common share for the third quarter of 2016 from $0.10, payable on September 30, 2016 to shareholders of record as of the close of business on September 15, 2016.

The Company repurchased 18,918 shares at $26.46 per share pursuant to its publicly announced program during the quarter ended June 30, 2016, and 160,100 shares at $26.30 per share during the quarter ended March 31, 2016. The Company's Board authorized the repurchase plan in May of 2015, which allows the Company to repurchase up to two million common shares, representing approximately 10% of the Company’s currently outstanding shares. Shares may be bought back in open market or privately negotiated transactions over an indeterminate time period based on market and business conditions.

Balance sheet highlights:

Loans – Loans totaled $2.9 billion at June 30, 2016, including $56.5 million of PCI loans. Portfolio loans increased $133.2 million, or 5%, from December 31, 2015. Commercial and industrial loans increased $56.1 million, or 4%, Consumer and other loans increased $23.9 million, or 17%, Construction loans and Residential real estate loans increased $25.4 million, or 7%, and Commercial real estate increased $28.3 million, or 4%. See Item 1, Note 4 – Portfolio Loans for more information.
Deposits – Total deposits at June 30, 2016 were $3.0 billion, an increase of $243.6 million, or 9%, from December 31, 2015. Deposits increased from both core deposit gathering efforts and brokered sources to supplement and fund our loan growth.
Asset quality – Nonperforming loans were $12.8 million at June 30, 2016, compared to $9.1 million at December 31, 2015. Nonperforming loans represented 0.44% of portfolio loans at June 30, 2016 versus 0.33% at December 31, 2015. There were no portfolio loans that were over 90 days delinquent and still accruing at June 30, 2016 or December 31, 2015.
Provision for portfolio loan losses was $1.5 million for the six months ended June 30, 2016, compared to $3.7 million for the six months ended June 30, 2015. See Item 1, Note 4 – Portfolio Loans, and Provision and Allowance for Loan Losses in this section for more information.




30



RESULTS OF OPERATIONS
Net Interest Income
Average Balance Sheet
The following table presents, for the periods indicated, certain information related to our average interest-earning assets and interest-bearing liabilities, as well as, the corresponding interest rates earned and paid, all on a tax equivalent basis.
 
Three months ended June 30,
 
2016
 
2015
(in thousands)
Average Balance
 
Interest
Income/Expense
 
Average
Yield/
Rate
 
Average Balance
 
Interest
Income/Expense
 
Average
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Taxable portfolio loans (1)
$
2,832,279

 
$
29,377

 
4.17
%
 
$
2,450,453

 
$
25,273

 
4.14
%
Tax-exempt portfolio loans (2)
42,253

 
628

 
5.98

 
38,443

 
627

 
6.54

Purchased credit impaired loans
59,110

 
4,419

 
30.07

 
92,168

 
4,212

 
18.33

Total loans
2,933,642

 
34,424

 
4.72

 
2,581,064


30,112

 
4.68

Taxable investments in debt and equity securities
479,844

 
2,464

 
2.07

 
421,912

 
2,154

 
2.05

Non-taxable investments in debt and equity securities (2)
48,276

 
531

 
4.42

 
41,895

 
459

 
4.39

Short-term investments
45,039

 
58

 
0.52

 
51,423

 
38

 
0.30

Total securities and short-term investments
573,159

 
3,053

 
2.14

 
515,230


2,651

 
2.06

Total interest-earning assets
3,506,801

 
37,477

 
4.30

 
3,096,294

 
32,763

 
4.24

Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
56,662

 
 
 
 
 
48,599

 
 
 
 
Other assets
214,880

 
 
 
 
 
208,897

 
 
 
 
Allowance for loan losses
(44,151
)
 
 
 
 
 
(43,212
)
 
 
 
 
 Total assets
$
3,734,192

 
 
 
 
 
$
3,310,578

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
582,482

 
$
329

 
0.23
%
 
$
506,073

 
$
279

 
0.22
%
Money market accounts
1,029,122

 
1,013

 
0.40

 
879,685

 
672

 
0.31

Savings
103,564

 
63

 
0.24

 
86,860

 
54

 
0.25

Certificates of deposit
481,140

 
1,183

 
0.99

 
539,387

 
1,594

 
1.19

Total interest-bearing deposits
2,196,308

 
2,588

 
0.47

 
2,012,005


2,599

 
0.52

Subordinated debentures
56,807

 
361

 
2.56

 
56,807

 
308

 
2.18

Other borrowed funds
350,783

 
301

 
0.35

 
230,492

 
165

 
0.29

Total interest-bearing liabilities
2,603,898

 
3,250

 
0.50

 
2,299,304


3,072

 
0.54

Noninterest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
735,580

 
 
 
 
 
655,635

 
 
 
 
Other liabilities
28,582

 
 
 
 
 
24,640

 
 
 
 
Total liabilities
3,368,060

 
 
 
 
 
2,979,579

 
 
 
 
Shareholders' equity
366,132

 
 
 
 
 
330,999

 
 
 
 
Total liabilities & shareholders' equity
$
3,734,192

 
 
 
 
 
$
3,310,578

 
 
 
 
Net interest income
 
 
$
34,227

 
 
 
 
 
$
29,691

 
 
Net interest spread
 
 
 
 
3.80
%
 
 
 
 
 
3.70
%
Net interest margin
 
 
 
 
3.93
%
 
 
 
 
 
3.85
%

(1)
Average balances include non-accrual loans. Loan fees, net of amortization of deferred loan origination fees and costs, included in interest income are approximately $0.4 million and $0.5 million for the three months ended June 30, 2016 and 2015 respectively.
(2)
Non-taxable income is presented on a fully tax-equivalent basis using a 38% tax rate in 2016 and 2015. The tax-equivalent adjustments were $0.4 million and $0.4 million for the three months ended June 30, 2016 and 2015.

31



 
Six months ended June 30,
 
2016
 
2015
(in thousands)
Average Balance
 
Interest
Income/Expense
 
Average
Yield/
Rate
 
Average Balance
 
Interest
Income/Expense
 
Average
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Taxable portfolio loans (1)
$
2,786,733

 
$
57,687

 
4.16
%
 
$
2,420,949

 
$
49,498

 
4.12
%
Tax-exempt portfolio loans (2)
41,542

 
1,288

 
6.24

 
38,424

 
1,252

 
6.57

Purchased credit impaired loans
64,071

 
8,310

 
26.08

 
94,670

 
9,209

 
19.62

Total loans
2,892,346

 
67,285

 
4.68

 
2,554,043

 
59,959

 
4.73

Taxable investments in debt and equity securities
472,567

 
4,923

 
2.09

 
420,371

 
4,353

 
2.09

Non-taxable investments in debt and equity securities (2)
48,836

 
1,069

 
4.40

 
42,429

 
939

 
4.46

Short-term investments
46,547

 
119

 
0.51

 
55,345

 
85

 
0.31

Total securities and short-term investments
567,950

 
6,111

 
2.16

 
518,145

 
5,377

 
2.09

Total interest-earning assets
3,460,296

 
73,396

 
4.27

 
3,072,188

 
65,336

 
4.29

Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
55,829

 
 
 
 
 
48,417

 
 
 
 
Other assets
215,623

 
 
 
 
 
213,596

 
 
 
 
Allowance for loan losses
(43,998
)
 
 
 
 
 
(44,611
)
 
 
 
 
 Total assets
$
3,687,750

 
 
 
 
 
$
3,289,590

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
567,083

 
$
635

 
0.23
%
 
$
495,457

 
$
556

 
0.23
%
Money market accounts
1,046,869

 
2,019

 
0.39

 
861,565

 
1,314

 
0.31

Savings
99,815

 
123

 
0.25

 
84,149

 
104

 
0.25

Certificates of deposit
432,616

 
2,202

 
1.02

 
532,974

 
3,185

 
1.21

Total interest-bearing deposits
2,146,383

 
4,979

 
0.47

 
1,974,145

 
5,159

 
0.53

Subordinated debentures
56,807

 
709

 
2.51

 
56,807

 
610

 
2.17

Other borrowed funds
366,616

 
594

 
0.33

 
252,137

 
409

 
0.33

Total interest-bearing liabilities
2,569,806

 
6,282

 
0.49

 
2,283,089

 
6,178

 
0.55

Noninterest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
725,165

 
 
 
 
 
655,367

 
 
 
 
Other liabilities
31,723

 
 
 
 
 
24,723

 
 
 
 
Total liabilities
3,326,694

 
 
 
 
 
2,963,179

 
 
 
 
Shareholders' equity
361,056

 
 
 
 
 
326,411

 
 
 
 
Total liabilities & shareholders' equity
$
3,687,750

 
 
 
 
 
$
3,289,590

 
 
 
 
Net interest income
 
 
$
67,114

 
 
 
 
 
$
59,158

 
 
Net interest spread
 
 
 
 
3.78
%
 
 
 
 
 
3.74
%
Net interest margin
 
 
 
 
3.90
%
 
 
 
 
 
3.88
%

(1)
Average balances include non-accrual loans. Loan fees, net of amortization of deferred loan origination fees and costs, included in interest income are approximately $0.8 million and $0.9 million for the three months ended June 30, 2016 and 2015 respectively.
(2)
Non-taxable income is presented on a fully tax-equivalent basis using a 38% tax rate in 2016 and 2015. The tax-equivalent adjustments were $0.9 million and $0.8 million for the six months ended June 30, 2016 and 2015.

Rate/Volume
The following table sets forth, on a tax-equivalent basis for the periods indicated, a summary of the changes in interest income and interest expense resulting from changes in yield/rates and volume.
  

32



 
2016 compared to 2015
 
Three months ended June 30,
 
Six months ended June 30,
 
Increase (decrease) due to
 
Increase (decrease) due to
(in thousands)
Volume(1)
 
Rate(2)
 
Net
 
Volume(1)
 
Rate(2)
 
Net
Interest earned on:
 
 
 
 
 
 
 
 
 
 
 
Taxable portfolio loans
$
3,893

 
$
211

 
$
4,104

 
$
7,696

 
$
493

 
$
8,189

Tax-exempt portfolio loans (3)
58

 
(57
)
 
1

 
101

 
(65
)
 
36

Purchased credit impaired loans
(1,857
)
 
2,064

 
207

 
(3,459
)
 
2,560

 
(899
)
Taxable investments in debt and equity securities
292

 
18

 
310

 
556

 
14

 
570

Non-taxable investments in debt and equity securities (3)
69

 
3

 
72

 
143

 
(13
)
 
130

Short-term investments
(5
)
 
25

 
20

 
(16
)
 
50

 
34

Total interest-earning assets
$
2,450

 
$
2,264

 
$
4,714

 
$
5,021

 
$
3,039

 
$
8,060

 
 
 
 
 
 
 
 
 
 
 
 
Interest paid on:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
42

 
$
8

 
$
50

 
$
82

 
$
(3
)
 
$
79

Money market accounts
125

 
216

 
341

 
318

 
387

 
705

Savings
10

 
(1
)
 
9

 
20

 
(1
)
 
19

Certificates of deposit
(163
)
 
(248
)
 
(411
)
 
(546
)
 
(437
)
 
(983
)
Subordinated debentures

 
53

 
53

 

 
99

 
99

Borrowed funds
98

 
38

 
136

 
187

 
(2
)
 
185

Total interest-bearing liabilities
112

 
66

 
178

 
61

 
43

 
104

Net interest income
$
2,338

 
$
2,198

 
$
4,536

 
$
4,960

 
$
2,996

 
$
7,956

(1) Change in volume multiplied by yield/rate of prior period.
(2) Change in yield/rate multiplied by volume of prior period.
(3) Nontaxable income is presented on a fully-tax equivalent basis using the combined statutory federal and state income tax rate in effect for each tax year.
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.

Net interest income (on a tax equivalent basis) was $34.2 million for the three months ended June 30, 2016, compared to $29.7 million for the same period of 2015, an increase of $4.5 million, or 15%. Total interest income increased $4.7 million and total interest expense increased $0.2 million. The tax-equivalent net interest margin was 3.93% for the second quarter of 2016, compared to 3.87% for the first quarter of 2016, and 3.85% in the second quarter of 2015, and combined with portfolio loan growth, supported the $4.7 million increase in net interest income. The yield on taxable portfolio loans increased three basis points from the prior year period to 4.17% for the three months ended June 30, 2016. The increase was due to an increase in yields on variable rate loans, aided by the Federal Reserve's raise in the targeted Fed Funds rate of 25 basis points, to a range of 0.25% to 0.50%, in December 2015. The run-off of higher yielding PCI loans continues to negatively impact net interest margin leading to a $1.9 million decrease in interest income due to volume for the three months ended June 30, 2016.

Net interest income was $67.1 million for the six months ended June 30, 2016, compared to $59.2 million for the same period of 2015, an increase of $8.0 million, or 13%. Total interest income increased $8.1 million and total interest expense increased $0.1 million. The tax-equivalent net interest margin was 3.90% for the six months ended June 30, 2016, compared to 3.88% for the same period of 2015. The yield on taxable portfolio loans increased four basis points from the prior year period to 4.16% for the six months ended June 30, 2016.

Core net interest margin1 was 3.53% for the six months ended June 30, 2016, compared to 3.46% for the prior year period.  Core net interest margin1 increased seven basis points from the prior year quarter primarily due to loan growth improving the earning asset mix, lower funding costs, and the aforementioned increase in the yield on portfolio loans.

33



These factors have been partially offset by reductions in PCI loan balances and the higher contractual rates associated with these loans. The Company continues to manage its balance sheet to grow core net interest income and expects to maintain core net interest margin over the coming quarters; however, pressure on funding costs and continued reductions in PCI loan balances could negate the expected trends in core net interest margin.

Purchased Credit Impaired "PCI" Contribution
The following table illustrates the non-core contribution of PCI loans and related assets for the periods indicated.

 
For the Three Months ended
 
For the Six Months ended
(in thousands)
June 30, 2016
 
June 30, 2015
 
June 30, 2016
 
June 30, 2015
Accelerated cash flows and other incremental accretion
$
3,571

 
$
3,003

 
$
6,405

 
$
6,461

Provision reversal for PCI loan losses
336

 

 
409

 
3,270

Gain (loss) on sale of other real estate
705

 
10

 
705

 
(5
)
Other income from other real estate
239

 

 
239

 

Change in FDIC loss share receivable

 
(945
)
 

 
(3,209
)
Change in FDIC clawback liability

 
(50
)
 

 
(462
)
Other expenses
(325
)
 
(378
)
 
(652
)
 
(849
)
PCI assets income before income tax expense
$
4,526

 
$
1,640

 
$
7,106

 
$
5,206


Accelerated cash flows and other incremental accretion consists of the interest income on PCI loans in excess of contractual interest on the loans. The contractual amount of interest is included in the Company's core results. At June 30, 2016, the remaining accretable yield on the portfolio was estimated to be $18 million and the non-accretable difference was approximately $23 million. Absent cash flow accelerations or pool impairment, the Company currently estimates average PCI loan balances for 2016 to be approximately $60 million, and income from accelerated cash flows and other incremental accretion to be between $9 million and $11 million.

34



Noninterest Income

The following table presents a comparative summary of the major components of noninterest income for the periods indicated.

 
Three months ended June 30,
(in thousands)
2016
 
2015
 
Increase (decrease)
Service charges on deposit accounts
$
2,188

 
$
1,998

 
$
190

 
10
 %
Wealth management revenue
1,644

 
1,778

 
(134
)
 
(8
)%
Other service charges and fee income
952

 
840

 
112

 
13
 %
Gain on state tax credits, net
153

 
74

 
79

 
107
 %
Miscellaneous income - core
1,168

 
2,051

 
(883
)
 
(43
)%
Core noninterest income (1)
6,105

 
6,741

 
(636
)
 
(9
)%
Gain on sale of other real estate from PCI loans
705

 
10

 
695

 
6,950
 %
Change in FDIC loss share receivable

 
(945
)
 
945

 
(100
)%
Other income from PCI assets
239

 

 
239

 
 %
Total noninterest income
$
7,049

 
$
5,806

 
$
1,243

 
21
 %
 
 
 
 
 
 
 
 
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

 
Six months ended June 30,
(in thousands)
2016
 
2015
 
Increase (decrease)
Service charges on deposit accounts
$
4,231

 
$
3,854

 
$
377

 
10
 %
Wealth management revenue
3,306

 
3,518

 
(212
)
 
(6
)%
Other service charges and fee income
1,820

 
1,593

 
227

 
14
 %
Gain on state tax credits, net
671

 
748

 
(77
)
 
(10
)%
Gain on sale of other real estate - core
123

 
34

 
89

 
262
 %
Miscellaneous income - core
1,959

 
2,833

 
(874
)
 
(31
)%
Core noninterest income (1)
12,110

 
12,580

 
(470
)
 
(4
)%
Gain (loss) on sale of other real estate from PCI loans
705

 
(5
)
 
710

 
(14,200
)%
Gain on sale of investment securities

 
23

 
(23
)
 
(100
)%
Change in FDIC loss share receivable

 
(3,209
)
 
3,209

 
(100
)%
Other income from PCI assets
239

 

 
239

 
 %
Total noninterest income
$
13,054

 
$
9,389

 
$
3,665

 
39
 %
 
 
 
 
 
 
 
 
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

Noninterest income increased $3.7 million, or 39% in the first six months of 2016 compared to the first six months of 2015, primarily from the impact of the Company's termination of FDIC loss share agreements in the fourth quarter of 2015. Core noninterest income1 declined 4% in the first six months of 2016 due to higher allocation fees from tax credit projects and higher fees earned from recoveries received during the first six months of 2015.


35



Noninterest Expense

The following table presents a comparative summary of the major components of noninterest expense for the periods indicated.

 
Three months ended June 30,
(in thousands)
2016
 
2015
 
Increase (decrease)
Core expenses (1):
 
 
 
 
 
 
 
 Employee compensation and benefits - core
$
12,185

 
$
11,030

 
$
1,155

 
10
 %
 Occupancy - core
1,584

 
1,598

 
(14
)
 
(1
)%
 Data processing - core
1,172

 
1,097

 
75

 
7
 %
 FDIC and other insurance
738

 
665

 
73

 
11
 %
 Professional fees - core
718

 
837

 
(119
)
 
(14
)%
 Loan, legal and other real estate expense - core
218

 
490

 
(272
)
 
(56
)%
 Other - core
3,831

 
3,313

 
518

 
16
 %
Core noninterest expense (1)
20,446

 
19,030

 
1,416

 
7
 %
FDIC clawback

 
50

 
(50
)
 
(100
)%
Executive severance
332

 

 
332

 
 %
Other non-core
250

 

 
250

 
 %
Other expenses related to PCI loans
325

 
378

 
(53
)
 
(14
)%
Total noninterest expense
$
21,353

 
$
19,458

 
$
1,895

 
10
 %
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

 
Six months ended June 30,
(in thousands)
2016
 
2015
 
Increase (decrease)
Core expenses (1):
 
 
 
 
 
 
 
 Employee compensation and benefits - core
$
24,650

 
$
22,280

 
$
2,370

 
11
 %
 Occupancy - core
3,241

 
3,265

 
(24
)
 
(1
)%
 Data processing - core
2,261

 
2,097

 
164

 
8
 %
 FDIC and other insurance
1,461

 
1,391

 
70

 
5
 %
 Professional fees - core
1,402

 
1,809

 
(407
)
 
(22
)%
 Loan, legal and other real estate expense - core
472

 
621

 
(149
)
 
(24
)%
 Other - core
7,394

 
6,635

 
759

 
11
 %
Core noninterest expense (1)
40,881

 
38,098

 
2,783

 
7
 %
FDIC clawback

 
462

 
(462
)
 
(100
)%
Executive severance
332

 

 
332

 
 %
Other non-core
250

 

 
250

 
 %
Other expenses related to PCI loans
652

 
848

 
(196
)
 
(23
)%
Total noninterest expense
$
42,115

 
$
39,408

 
$
2,707

 
7
 %
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."


Noninterest expenses were $42.1 million for the six months ended June 30, 2016, compared to $39.4 million for the six months ended June 30, 2015. The increase was partly due to an increase in Employee compensation and benefits from investments in revenue producers. Core noninterest expenses1, which exclude $0.3 million of executive severance, $0.3 million of other non-core expense and expenses directly related to PCI loans and related assets, increased $2.8

36



million to $40.9 million for the six months ended June 30, 2016, from $38.1 million for the prior year period. The increase was largely due to an increase in Employee compensation and benefits from the addition of client service personnel to facilitate growth.

The Company's Core efficiency ratio1 was 56.9% for the six months ended June 30, 2016, compared to 59.1% for the prior year, and reflects overall expense management and revenue growth trends. Core efficiency ratio is a non-GAAP measure. A reconciliation of Core efficiency ratio has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures".

The Company anticipates total noninterest expenses to be between $19.5 million and $21.5 million per quarter for 2016.

Income Taxes

The Company's income tax expense for the three and six months ended June 30, 2016, which includes both federal and state taxes, was $6.7 million and $12.6 million, respectively, compared to $4.8 million and $9.8 million, respectively, for the same periods of 2015. The combined federal and state effective income tax rate for the six months ended June 30, 2016 and 2015 was 35.1%.




37



Summary Balance Sheet

(in thousands)
June 30, 2016
 
December 31, 2015
 
Increase (decrease)
Total cash and cash equivalents
$
110,296

 
$
94,157

 
16,139

17.1
 %
Securities
521,028

 
495,484

 
25,544

5.2
 %
Portfolio loans
2,883,909

 
2,750,737

 
133,172

4.8
 %
Purchased credit impaired loans
56,529

 
74,758

 
(18,229
)
(24.4
)%
Total assets
3,761,665

 
3,608,483

 
153,182

4.2
 %
Deposits
3,028,236

 
2,784,591

 
243,645

8.7
 %
Total liabilities
3,390,036

 
3,257,654

 
132,382

4.1
 %
Total shareholders' equity
371,629

 
350,829

 
20,800

5.9
 %

Assets

Loans by Type

The Company has a diversified loan portfolio, with no particular concentration of credit in any one economic sector; however, a substantial portion of the portfolio is secured by real estate, including loans classified as C&I loans. The ability of the Company's borrowers to honor their contractual obligations is partially dependent upon the local economy and its effect on the real estate market. The following table summarizes the composition of the Company's loan portfolio:

(in thousands)
June 30, 2016
 
December 31, 2015
 
Increase (decrease)
Commercial and industrial
$
1,540,457

 
$
1,484,327

 
$
56,130

3.8
 %
Commercial real estate - investor owned
466,713

 
428,064

 
38,649

9.0
 %
Commercial real estate - owner occupied
332,639

 
342,959

 
(10,320
)
(3.0
)%
Construction and land development
171,778

 
161,061

 
10,717

6.7
 %
Residential real estate
211,155

 
196,498

 
14,657

7.5
 %
Consumer and other
161,167

 
137,828

 
23,339

16.9
 %
   Portfolio loans
2,883,909

 
2,750,737

 
133,172

4.8
 %
Purchased credit impaired loans
56,529

 
74,758

 
(18,229
)
(24.4
)%
   Total loans
$
2,940,438

 
$
2,825,495

 
$
114,943

4.1
 %

Portfolio loans grew by $133.2 million, to $2.9 billion at June 30, 2016, when compared to December 31, 2015. PCI loans totaled $56.5 million at June 30, 2016, a decrease of $18.2 million, or 24%, from December 31, 2015, primarily as a result of principal paydowns and accelerated loan payoffs.

The following table illustrates loan growth with selected specialized lending detail:


38



(in thousands)
June 30, 2016
 
December 31, 2015
 
Increase (decrease)
Enterprise value lending
$
353,915

 
$
350,266

 
$
3,649

1.0
%
C&I - general
737,904

 
732,186

 
5,718

0.8
%
Life insurance premium financing
295,643

 
265,184

 
30,459

11.5
%
Tax credits
152,995

 
136,691

 
16,304

11.9
%
CRE, Construction, and land development
971,130

 
932,084

 
39,046

4.2
%
Residential
211,155

 
196,498

 
14,657

7.5
%
Other
161,167

 
137,828

 
23,339

16.9
%
Portfolio loans
$
2,883,909

 
$
2,750,737

 
$
133,172

4.8
%

Specialty lending products, especially Enterprise value lending, Life insurance premium financing, and Tax credits, consists of primarily C&I loans, and have contributed significantly to the Company's loan growth. These loans are sourced through relationships developed with estate planning firms and private equity funds, and are not bound geographically by our traditional three markets. These specialized loan products offer opportunities to expand and diversify geographically by entering into new markets. The Company continues to focus on originating high-quality C&I relationships as they typically have variable interest rates and allow for cross selling opportunities involving other banking products. C&I loan growth also supports our efforts to maintain the Company's asset sensitive interest rate risk position. The Company continues to expect loan growth at or above 10% for 2016.



39



Provision and Allowance for Loan Losses
The following table summarizes changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off, by loan category, and additions to the allowance charged to expense.
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Allowance at beginning of period, for portfolio loans
$
34,373

 
$
30,288

 
$
33,441

 
$
30,185

Loans charged off:
 
 
 
 
 
 
 
Commercial and industrial
(157
)
 
(1,578
)
 
(225
)
 
(3,062
)
Real estate:
 
 
 
 
 
 
 
Commercial

 
(664
)
 

 
(664
)
Construction and land development

 
(350
)
 

 
(350
)
Residential

 

 

 
(1,073
)
Consumer and other
(6
)
 
(4
)
 
(11
)
 
(15
)
Total loans charged off
(163
)
 
(2,596
)

(236
)

(5,164
)
Recoveries of loans previously charged off:
 
 
 
 
 
 
 
Commercial and industrial
502

 
420

 
555

 
1,189

Real estate:
 
 
 
 
 
 
 
Commercial
23

 
1,300

 
98

 
1,456

Construction and land development
8

 
115

 
14

 
175

Residential
36

 
87

 
70

 
113

Consumer and other
3

 
1

 
7

 
81

Total recoveries of loans
572

 
1,923


744


3,014

Net loan recoveries (chargeoffs)
409

 
(673
)

508


(2,150
)
Provision for portfolio loan losses
716

 
2,150

 
1,549

 
3,730

Allowance at end of period, for portfolio loans
$
35,498

 
$
31,765


$
35,498


$
31,765

 
 
 
 
 
 
 
 
Allowance at beginning of period, for purchased credit impaired loans
$
9,569

 
$
11,625

 
$
10,175

 
$
15,410

   Loans charged off
(495
)
 
(5
)
 
(983
)
 
(2
)
Other
(187
)
 
(26
)
 
(232
)
 
(544
)
Net loan chargeoffs
(682
)
 
(31
)

(1,215
)

(546
)
Provision reversal for PCI loan losses
(336
)
 

 
(409
)
 
(3,270
)
Allowance at end of period, for purchased credit impaired loans
$
8,551

 
$
11,594


$
8,551


$
11,594

 
 
 
 
 
 
 
 
Total allowance at end of period
$
44,049

 
$
43,359

 
$
44,049

 
$
43,359

 
 
 
 
 
 
 
 
Portfolio loans, average
$
2,874,532

 
$
2,482,291

 
$
2,483,488

 
$
2,255,180

Portfolio loans, ending
2,883,909

 
2,542,555

 
2,883,909

 
2,542,555

Net chargeoffs to average portfolio loans
(0.06
)%
 
0.11
%
 
(0.04
)%
 
0.19
%
Allowance for portfolio loan losses to loans
1.23

 
1.25

 
1.23

 
1.25


The provision for loan losses on portfolio loans for the six months ended June 30, 2016 was $1.5 million, compared to $3.7 million for the comparable 2015 period. The provision for loan losses for the six month period ended June 30, 2016 was primarily to provide for loan growth.


40



For PCI loans, the Company remeasures contractual and expected cash flows periodically. When the remeasurement process results in a decrease in expected cash flows, typically due to an increase in expected credit losses, impairment is recorded through provision for loan losses. Similarly, when expected credit losses decrease in the remeasurement process, prior recorded impairment is reversed before the yield is increased prospectively. There was $0.4 million of provision reversal for loan losses on PCI loans for the six months ended June 30, 2016, compared to provision reversal of $3.3 million for the comparable 2015 period.

The allowance for loan losses on portfolio loans was 1.23% of portfolio loans at June 30, 2016 compared to 1.25% at June 30, 2015. Management believes the allowance for loan losses is adequate to absorb inherent losses in the loan portfolio and coverage trends reflect relatively steady improvements in credit quality measures and classified loan levels. The reduction in the ratio of allowance for loan losses to total loans over the prior year period is due to lower levels of nonperforming loans, as well as continued improvement in loss migration results.


Nonperforming assets

The following table presents the categories of nonperforming assets and other ratios as of the dates indicated.
 
(in thousands)
June 30,
2016
 
December 31,
2015
 
June 30,
2015
Non-accrual loans
$
10,493

 
$
8,797

 
$
16,751

Restructured loans
2,320

 
303

 
747

Total nonperforming loans (1)
12,813

 
9,100

 
17,498

Other real estate from originated loans
2,741

 
3,218

 
1,933

Other real estate from acquired loans
2,160

 
5,148

 

Total nonperforming assets (1) (2)
$
17,714

 
$
17,466

 
$
19,431

 
 
 
 
 
 
Total assets
$
3,761,665

 
$
3,608,483

 
$
3,371,078

Portfolio loans
2,883,909

 
2,750,737

 
2,542,555

Portfolio loans plus other real estate
2,888,810

 
2,759,103

 
2,544,488

Nonperforming loans to portfolio loans (1)
0.44
%
 
0.33
%
 
0.69
%
Nonperforming assets to total loans plus other real estate (1) (2)
0.61

 
0.63

 
0.76

Nonperforming assets to total assets (1) (2)
0.47

 
0.48

 
0.58

Allowance for portfolio loans to nonperforming loans (1)
277
%
 
367
%
 
182
%
 
 
 
 
 
 
(1) Excludes PCI loans, except for their inclusion in total assets.
(2) Other real estate from PCI loans included in Nonperforming assets beginning with the year ended December 31, 2015 due to termination of all existing FDIC loss share agreements.


41



Nonperforming loans 
Nonperforming loans exclude PCI loans that are accounted for on a pool basis, as the pools are considered to be performing. See Item 1, Note 5 – Purchased Credit Impaired Loans for more information on these loans.
 
Nonperforming loans based on loan type were as follows:
 
(in thousands)
June 30, 2016
 
December 31, 2015
 
June 30, 2015
Commercial and industrial
$
4,748

 
$
4,514

 
$
5,998

Commercial real estate
248

 
1,105

 
3,026

Construction and land development
2,576

 
2,800

 
5,968

Residential real estate
670

 
681

 
2,506

Consumer and other
4,571

 

 

Total
$
12,813

 
$
9,100


$
17,498


The increase in Nonperforming loans was primarily due to the increase in the Consumer and other loans category which consists of one tax credit relationship for a multifamily property.

The following table summarizes the changes in nonperforming loans:
 
 
Six months ended June 30,
(in thousands)
2016
 
2015
Nonperforming loans beginning of period
$
9,100

 
$
22,244

Additions to nonaccrual loans
7,555

 
16,100

Additions to restructured loans
2,320

 

Chargeoffs
(35
)
 
(5,297
)
Other principal reductions
(4,932
)
 
(14,523
)
Moved to other real estate
(283
)
 
(450
)
Moved to performing
(912
)
 
(576
)
Loans past due 90 days or more and still accruing interest

 

Nonperforming loans end of period
$
12,813

 
$
17,498


Nonperforming loans at June 30, 2016 increased by $3.7 million, or 41%, when compared to December 31, 2015, and decreased by $4.7 million, or 27%, when compared to June 30, 2015.

Other real estate
Other real estate at June 30, 2016, was $4.9 million, compared to $9.8 million at June 30, 2015.

The following table summarizes the changes in Other real estate:

 
Six months ended June 30,
(in thousands)
2016
 
2015
Other real estate beginning of period
$
8,366

 
$
7,840

Additions and expenses capitalized to prepare property for sale
2,203

 
5,998

Writedowns in value

 
(295
)
Sales
(5,668
)
 
(3,701
)
Other real estate end of period
$
4,901

 
$
9,842



42



Writedowns in fair value are recorded in Loan legal and other real estate expense based on current market activity shown in the appraisals. In the six months ended June 30, 2016, the Company realized a net gain of $0.8 million from the sales of other real estate, primarily from the sale of a property related to PCI loans, and recorded these gains as part of Noninterest income.

Liabilities

Liabilities totaled $3.4 billion at June 30, 2016, compared to $3.3 billion at December 31, 2015. The increase in liabilities was largely due to a $244 million increase in total deposits, offset by a decrease of $32 million in Federal Home Loan Bank advances and a decrease of $70 million in other borrowings.

Deposits
(in thousands)
June 30, 2016
 
December 31, 2015
 
Increase (decrease)
Demand deposits
$
753,173

 
$
717,460

 
35,713

 
5.0
 %
Interest-bearing transaction accounts
628,505

 
564,420

 
64,085

 
11.4
 %
Money market accounts
1,019,304

 
1,053,662

 
(34,358
)
 
(3.3
)%
Savings
105,224

 
92,861

 
12,363

 
13.3
 %
Certificates of deposit:
 
 
 
 
 
 
 
Brokered
166,507

 
39,573

 
126,934

 
320.8
 %
Other
355,523

 
316,615

 
38,908

 
12.3
 %
Total deposits
$
3,028,236

 
$
2,784,591

 
243,645

 
8.7
 %
 
 
 
 
 
 
 
 
Non-time deposits / total deposits
83
%
 
87
%
 
 
 
 
Demand deposits / total deposits
25
%
 
26
%
 
 
 
 

Total deposits at June 30, 2016 were $3.0 billion, an increase of $244 million, or 9%, from December 31, 2015. The increase in deposits within our brokered certificates of deposit was to provide for loan growth in the year. The composition of our noninterest bearing deposits remained relatively stable at 25% of total deposits at June 30, 2016 compared to December 31, 2015. Lower rates on time deposit balances and a change in composition modestly improved deposit costs during the first six months of 2016 to 0.35%, as compared to 0.40% for the same period in 2015.

Core deposits, defined as total deposits excluding time deposits, were $2.5 billion at June 30, 2016, an increase of $78 million, or 3%, from December 31, 2015.

Shareholders' Equity

Shareholders' equity totaled $372 million at June 30, 2016, an increase of $20.8 million from December 31, 2015. Significant activity during the six months ended June 30, 2016 was as follows:

Net income of $23.4 million,
Other comprehensive income of $5.3 million from the change in unrealized gains on investment securities,
Repurchase of 179,018 common shares for $4.7 million,
Dividends paid on common shares of $3.8 million.

Liquidity and Capital Resources

Liquidity

The objective of liquidity management is to ensure we have the ability to generate sufficient cash or cash equivalents in a timely and cost-effective manner to meet our commitments as they become due. Typical demands on liquidity are run-off from demand deposits, maturing time deposits which are not renewed, and fundings under credit

43



commitments to customers. 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, fed fund lines with correspondent banks, borrowings from the Federal Reserve and the FHLB, the ability to acquire large and brokered deposits, and the ability to sell loan participations to other banks. These alternatives are an important part of our liquidity plan and provide flexibility and efficient execution of the asset-liability management strategy.

The Bank's Asset-Liability Management Committee oversees our liquidity position, the parameters of which are approved by the Bank's Board of Directors. Our liquidity position is monitored monthly by producing a liquidity report, which measures the amount of liquid versus non-liquid assets and liabilities. Our liquidity management framework includes measurement of several key elements, such as the loan to deposit ratio, a liquidity ratio, and a dependency ratio. 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. While core deposits and loan and investment repayments are principal sources of liquidity, funding diversification is another key element of liquidity management and is achieved by strategically varying depositor types, terms, funding markets, and instruments.

Parent Company liquidity
The parent company's liquidity is managed to provide the funds necessary to pay dividends to shareholders, service debt, invest in subsidiaries as necessary, and satisfy other operating requirements. The parent company's primary funding sources to meet its liquidity requirements are dividends and payments from the Bank and proceeds from the issuance of equity (i.e. stock option exercises, stock offerings). Another source of funding for the parent company includes the issuance of subordinated debentures and other debt instruments.

The parent company currently has a senior unsecured revolving credit agreement ("Revolving Agreement") with another bank allowing for borrowings up to $20 million. As of June 30, 2016, there are no outstanding balances under the Revolving Agreement. Additionally, the Company received two quarterly dividends from the Bank of $2.5 million each as part of the Company's ongoing capital management.  Management believes the current level of cash at the holding company of $7.0 million will be sufficient to meet projected cash needs for at least the next year.

As of June 30, 2016, the Company had $56.8 million of outstanding subordinated debentures as part of eight Trust Preferred Securities Pools. These securities are classified as debt but are included in regulatory capital and the related interest expense is tax-deductible, which makes them an attractive source of funding.

Bank liquidity
The Bank has a variety of funding sources available to increase financial flexibility. In addition to amounts currently borrowed, at June 30, 2016 the Bank has borrowing capacity of $310.7 million from the FHLB of Des Moines under blanket loan pledges, and has an additional $889.9 million available from the Federal Reserve Bank under a pledged loan agreement. The Bank has unsecured federal funds lines with five correspondent banks totaling $60.0 million.

Investment securities are another important tool to the Bank's liquidity objectives. Of the $478.5 million of the securities available for sale at June 30, 2016, $336.8 million was pledged as collateral for deposits of public institutions, treasury, loan notes, and other requirements. The remaining $141.7 million could be pledged or sold to enhance liquidity, if necessary.

In the normal course of business, the Bank enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Bank'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 Bank has $1.1 billion in unused commitments as of June 30, 2016. While this commitment level would exhaust the majority the Company's current liquidity resources, the nature of these commitments is such that the likelihood of funding them in the aggregate at any one time is low.

44




Capital Resources

The Company and the Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and its bank affiliate must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The banking affiliate’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
 
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total, Tier 1, and Common equity tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. To be categorized as “well capitalized”, banks must maintain minimum total risk-based (10%), Tier 1 risk-based (8%), Common equity tier 1 risk-based (6.5%), and Tier 1 leverage ratios (5%). As of June 30, 2016, and December 31, 2015, the Company and the Bank met all capital adequacy requirements to which they are subject.
 
The Bank continues to exceed regulatory standards and met the definition of “well-capitalized” (the highest category) at June 30, 2016. The Company adopted the Regulatory Capital Framework (Basel III) in 2015, and has implemented the necessary processes and procedures to comply.

The following table summarizes the Company's various capital ratios at the dates indicated:

(in thousands)
June 30,
2016
 
December 31, 2015
Well Capitalized Minimum %
Total capital to risk-weighted assets
12.16
%
 
11.85
%
10.00
%
Tier 1 capital to risk-weighted assets
10.92
%
 
10.61
%
8.00
%
Common equity tier 1 capital to risk-weighted assets
9.38
%
 
9.05
%
6.50
%
Leverage ratio (Tier 1 capital to average assets)
10.53
%
 
10.71
%
5.00
%
Tangible common equity to tangible assets1
9.08
%
 
8.88
%
N/A

Tier 1 capital
$
389,978

 
$
374,676

 
Total risk-based capital
434,102

 
418,367

 
 
 
 
 
 
1 Not a required regulatory capital ratio
 

The Company believes the tangible common equity ratio and the common equity tier 1 capital ratio are important measures of capital strength even though they are considered to be non-GAAP measures. The tables further within MD&A reconcile these ratios to U.S. GAAP.
 












45



Use of Non-GAAP Financial Measures:

The Company's accounting and reporting policies conform to generally accepted accounting principles in the United States (“GAAP”) and the prevailing practices in the banking industry. However, the Company provides other financial measures, such as Core net income and net interest margin, and other Core performance measures, regulatory capital ratios, and the tangible common equity ratio, in this report that are considered “non-GAAP financial measures.” Generally, a non-GAAP financial measure is a numerical measure of a company's financial performance, financial position, or cash flows that exclude (or include) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP.
The Company considers its Core performance measures presented in this report and the included tables as important measures of financial performance, even though they are non-GAAP measures, as they provide supplemental information by which to evaluate the impact of PCI loans and related income and expenses, the impact of certain non-comparable items, and the Company's operating performance on an ongoing basis. Core performance measures include contractual interest on PCI loans, but exclude incremental accretion on these loans. Core performance measures also exclude the Change in FDIC receivable, Gain or loss on sale of other real estate from PCI loans, and expenses directly related to PCI loans and other assets formerly covered under FDIC loss share agreements. Core performance measures also exclude certain other income and expense items, such as executive separation costs and the gain or loss on sale of investment securities, the Company believes to be not indicative of or useful to measure the Company's operating performance on an ongoing basis. The Company believes that the tangible common equity ratio provides useful information to investors about the Company's capital strength even though it is considered to be a non-GAAP financial measure and is not part of the regulatory capital requirements to which the Company is subject.
The Company believes these non-GAAP measures and ratios, when taken together with the corresponding GAAP measures and ratios, provide meaningful supplemental information regarding the Company's performance and capital strength. The Company's management uses, and believes that investors benefit from referring to, these non-GAAP measures and ratios in assessing the Company's operating results and related trends and when forecasting future periods. However, these non-GAAP measures and ratios should be considered in addition to, and not as a substitute for or preferable to, ratios prepared in accordance with GAAP. In the following tables, the Company has provided a reconciliation of, where applicable, the most comparable GAAP financial measures and ratios to the non-GAAP financial measures and ratios, or a reconciliation of the non-GAAP calculation of the financial measure for the periods indicated.

46



Core Performance Measures
 
For the Three Months ended
 
For the Six Months ended
(in thousands)
June 30,
2016
 
March 31,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
CORE PERFORMANCE MEASURES
 
 
 
 
 
 
 
 
Net interest income
$
33,783

 
$
32,428

 
$
29,280

 
$
66,211

 
$
58,325

Less: Incremental accretion income
3,571

 
2,834

 
3,003

 
6,405

 
6,461

Core net interest income
30,212

 
29,594

 
26,277

 
59,806

 
51,864

 
 
 
 
 
 
 
 
 
 
Total noninterest income
7,049

 
6,005

 
5,806

 
13,054

 
9,389

Less: Change in FDIC loss share receivable

 

 
(945
)
 

 
(3,209
)
Less (plus): Gain (loss) on sale of other real estate from PCI loans
705

 

 
10

 
705

 
(5
)
Less: Gain on sale of investment securities

 

 

 

 
23

Less: Other income from PCI assets
239

 

 

 
239

 

Core noninterest income
6,105

 
6,005

 
6,741

 
12,110

 
12,580

 
 
 
 
 
 
 
 
 
 
Total core revenue
36,317

 
35,599

 
33,018

 
71,916

 
64,444

 
 
 
 
 
 
 
 
 
 
Provision for portfolio loans
716

 
833

 
2,150

 
1,549

 
3,730

 
 
 
 
 
 
 
 
 
 
Total noninterest expense
21,353

 
20,762

 
19,458

 
42,115

 
39,408

Less: FDIC clawback

 

 
50

 

 
462

Less: Other expenses related to PCI loans
325

 
327

 
378

 
652

 
848

Less: Executive severance
332

 

 

 
332

 

Less: Other non-core expense
250

 

 

 
250

 

Core noninterest expense
20,446

 
20,435

 
19,030

 
40,881

 
38,098

 
 
 
 
 
 
 
 
 
 
Core income before income tax expense
15,155

 
14,331

 
11,838

 
29,486

 
22,616

 
 
 
 
 
 
 
 
 
 
Total income tax expense
6,747

 
5,886

 
4,762

 
12,633

 
9,784

Less: Non-core income tax expense
1,510

 
989

 
628

 
2,499

 
2,003

Core income tax expense
5,237

 
4,897

 
4,134

 
10,134

 
7,781

Core net income
$
9,918

 
$
9,434

 
$
7,704

 
$
19,352

 
$
14,835

 
 
 
 
 
 
 
 
 
 
Core earnings per share
$
0.49

 
$
0.47

 
$
0.38

 
$
0.96

 
$
0.74

Core return on average assets
1.07
%
 
1.04
%
 
0.93
%
 
1.06
%
 
0.91
%
Core return on average common equity
10.89
%
 
10.66
%
 
9.34
%
 
10.78
%
 
9.17
%
Core return on average tangible common equity
11.98
%
 
11.76
%
 
10.41
%
 
11.87
%
 
10.24
%
Core efficiency ratio
56.30
%
 
57.40
%
 
57.64
%
 
56.85
%
 
59.12
%


47




Net Interest Margin to Core Net Interest Margin (fully tax equivalent)
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Net interest income
$
34,227

 
$
29,691

 
$
67,114

 
$
59,158

Less: Incremental accretion income
3,571

 
3,003

 
6,405

 
6,461

Core net interest income
$
30,656

 
$
26,688

 
$
60,709

 
$
52,697

 
 
 
 
 
 
 
 
Average earning assets
$
3,506,801

 
$
3,096,294

 
$
3,460,296

 
$
3,072,188

Reported net interest margin
3.93
%
 
3.85
%
 
3.90
%
 
3.88
%
Core net interest margin
3.52
%
 
3.46
%
 
3.53
%
 
3.46
%


Tangible common equity ratio
(in thousands)
June 30, 2016
 
December 31, 2015
Total shareholders' equity
$
371,629

 
$
350,829

Less: Goodwill
30,334

 
30,334

Less: Intangible assets
2,589

 
3,075

Tangible common equity
$
338,706

 
$
317,420

 
 
 
 
Total assets
$
3,761,665

 
$
3,608,483

Less: Goodwill
30,334

 
30,334

Less: Intangible assets
2,589

 
3,075

Tangible assets
$
3,728,742

 
$
3,575,074

 
 
 
 
Tangible common equity to tangible assets
9.08
%
 
8.88
%

48



Common equity tier 1 ratio

(in thousands)
June 30, 2016
 
December 31, 2015
Total shareholders' equity
$
371,629

 
$
350,829

Less: Goodwill
30,334

 
30,334

Less: Intangible assets, net of deferred tax liabilities
958

 
759

Less: Unrealized gains
5,517

 
218

Plus: Qualifying trust preferred securities
55,100

 
55,100

Plus: Other
58

 
58

Total tier 1 capital
389,978

 
374,676

Less: Qualifying trust preferred securities
55,100

 
55,100

Less: Other
35

 
23

Common equity tier 1 capital
$
334,843

 
$
319,553

 
 
 
 
Total risk-weighted assets determined in accordance with prescribed regulatory requirements
$
3,570,437

 
$
3,530,521

 
 
 
 
Common equity tier 1 capital to risk-weighted assets
9.38
%
 
9.05
%

Critical Accounting Policies

The impact and any associated risks related to the Company's critical accounting policies on business operations are described throughout "Management's Discussion and Analysis of Financial Condition and Results of Operations," where such policies affect our reported and expected financial results. For a detailed description on the application of these and other accounting policies, see the Company's Annual Report on Form 10-K for the year ended December 31, 2015.

49



ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The disclosures set forth in this item are qualified by the section captioned “Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995” included in Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations of this report and other cautionary statements set forth elsewhere in this report.

Interest Rate Risk 
Our interest rate risk management practices are aimed at optimizing net interest income, while guarding against deterioration that could be caused by certain interest rate scenarios. Interest rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. We attempt to maintain interest-earning assets, comprised primarily of both loans and investments, and interest-bearing liabilities, comprised primarily of deposits, maturing or repricing in similar time horizons in order to minimize or eliminate any impact from market interest rate changes. In order to measure earnings sensitivity to changing rates, the Company uses an earnings simulation model.

The Company determines the sensitivity of its short-term future earnings to a hypothetical plus or minus 100 to 300 basis point parallel rate shock through the use of simulation modeling. The simulation of earnings includes the modeling of the balance sheet as an ongoing entity. Future business assumptions involving administered rate products, prepayments for future rate-sensitive balances, and the reinvestment of maturing assets and liabilities are included. These items are then modeled to project net interest income based on a hypothetical change in interest rates. The resulting net interest income for the next 12-month period is compared to the net interest income amount calculated using flat rates. This difference represents the Company's earnings sensitivity to a plus or minus 100 basis points parallel rate shock.

The following table summarizes the expected impact of interest rate shocks on net interest income (due to the current level of interest rates, the 200 and 300 basis point downward shock scenarios are not shown):

Rate Shock
 
Annual % change
in net interest income
+ 300 bp
 
8.2%
+ 200 bp
 
5.7%
+ 100 bp
 
3.0%
 - 100 bp
 
-3.4%

The Company occasionally uses interest rate derivative financial instruments as an asset/liability management tool to hedge mismatches in interest rate exposure indicated by the net interest income simulation described above. They are used to modify the Company's exposures to interest rate fluctuations and provide more stable spreads between loan yields and the rate on their funding sources. At June 30, 2016, the Company had $3.5 million in notional amount of outstanding interest rate caps, to help manage interest rate risk.

 





50



ITEM 4: CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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, as of June 30, 2016. Disclosure controls and procedures include without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Based on that evaluation, the CEO and CFO concluded the Company’s disclosure controls and procedures were effective as of June 30, 2016 to provide reasonable assurance of the achievement of the objectives described above.

Changes to Internal Controls

There were no changes during the period covered by this Quarterly Report on Form 10-Q in the Company's internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, those controls.

PART II - OTHER INFORMATION


ITEM 1: LEGAL PROCEEDINGS

The Company and its subsidiaries are, from time to time, parties to various legal proceedings arising out of their businesses. Management believes there are no such proceedings pending or threatened against the Company or its subsidiaries which, if determined adversely, would have a material adverse effect on the business, consolidated financial condition, results of operations or cash flows of the Company or any of its subsidiaries.


ITEM 1A: RISK FACTORS

For information regarding risk factors affecting the Company, please see the cautionary language regarding forward-looking statements in the introduction to Item 2 of Part I of this Report on Form 10-Q, and Part I, Item 1A of our Report on Form 10-K for the fiscal year ended December 31, 2015. There have been no material changes to the risk factors described in such Annual Report on Form 10-K.


51



ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Issuer Purchases of Equity Securities

The following table provides information on repurchases by the Company of its common stock in each month of the quarter ended June 30, 2016.

Period
 
Total number of shares purchased (a)
 
Weighted-average price paid per share
 
Total number of shares purchased as part of publicly announced plans or programs
 
Maximum number of shares that may yet be purchased under the plans or programs
April 1, 2016 through April 30, 2016
 

 
$

 

 
1,839,900

May 1, 2016 through May 31, 2016
 

 

 

 
1,839,900

June 1, 2016 through June 30, 2016
 
18,918

 
26.46

 
18,918

 
1,820,982

Total
 
18,918

 
$
26.46

 
18,918

 
 


(a) In May 2015, the Company’s board of directors authorized the repurchase of up to two million shares of the Company’s common stock. The repurchases may be made in open market or privately negotiated transactions and the repurchase program will remain in effect until fully utilized or until modified, superseded or terminated. The timing and exact amount of common stock repurchases will depend on a number of factors including, among others, market and general economic conditions, economic capital and regulatory capital considerations, alternative uses of capital, the potential impact on our credit ratings, and contractual and regulatory limitations.


ITEM 6: EXHIBITS

Exhibit
No.
 
Description
 
 
Registrant hereby agrees to furnish to the Commission, upon request, the instruments defining the rights of holders of each issue of long-term debt of Registrant and its consolidated subsidiaries.
 
 
 
10.1
 
Employment separation and release agreement dated effective July 23, 2016 by and between Registrant and Frank H. Sanfilippo

 
 
 
*12.1
 
Computation of Ratio of Earnings to Fixed Charges and Preferred Dividends.
 
 
 
*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.
 
 
 
101
 
Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2016, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheet at March 31, 2016 and December 31, 2015; (ii) Consolidated Statement of Income for the three months ended March 31, 2016 and 2015; (iii) Consolidated Statement of Comprehensive Income for the three months ended March 31, 2016 and 2015; (iv) Consolidated Statement of Changes in Equity for the three months ended March 31, 2016 and 2015; (v) Consolidated Statement of Cash Flows for the three months ended March 31, 2016 and 2015; and (vi) Notes to Financial Statements.


52



* Filed herewith
** Furnished herewith. Notwithstanding any incorporation of this Quarterly Statement on Form 10-Q in any other filing by the Registrant, Exhibits furnished herewith and designated with two (**) shall not be deemed incorporated by reference to any other filing unless specifically otherwise set forth herein or therein.

53



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 July 29, 2016.
 
 
ENTERPRISE FINANCIAL SERVICES CORP
 
 
 
By:
/s/ Peter F. Benoist
 
 
 
Peter F. Benoist
 
 
 
Chief Executive Officer
 
 
 
 
By: 
/s/ Keene S. Turner
 
 
 
Keene S. Turner
 
 
 
Chief Financial Officer
 



54