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 September 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 October 19, 2016, the Registrant had 20,011,401 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)
September 30, 2016
 
December 31, 2015
Assets
 
 
 
Cash and due from banks
$
56,789

 
$
47,935

Federal funds sold
488

 
91

Interest-bearing deposits (including $1,870 and $1,320 pledged as collateral)
61,222

 
46,131

Total cash and cash equivalents
118,499

 
94,157

Interest-bearing deposits greater than 90 days
1,980

 
1,000

Securities available for sale
479,609

 
451,770

Securities held to maturity
41,031

 
43,714

Loans held for sale
7,663

 
6,598

Portfolio loans
3,037,705

 
2,750,737

Less: Allowance for loan losses
37,498

 
33,441

Portfolio loans, net
3,000,207

 
2,717,296

Purchased credit impaired loans, net of the allowance for loan losses ($6,433 and $10,175, respectively)
41,016

 
64,583

Total loans, net
3,041,223

 
2,781,879

Other real estate
2,959

 
8,366

Other investments, at cost
19,789

 
17,455

Fixed assets, net
14,498

 
14,842

Accrued interest receivable
8,526

 
8,399

State tax credits held for sale, including $4,801 and $5,941 carried at fair value, respectively
44,180

 
45,850

Goodwill
30,334

 
30,334

Intangible assets, net
2,357

 
3,075

Other assets
96,996

 
101,044

Total assets
$
3,909,644

 
$
3,608,483

 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
Demand deposits
$
762,155

 
$
717,460

Interest-bearing transaction accounts
633,100

 
564,420

Money market accounts
1,131,997

 
1,053,662

Savings
109,728

 
92,861

Certificates of deposit:
 
 
 
Brokered
137,592

 
39,573

Other
350,253

 
316,615

Total deposits
3,124,825

 
2,784,591

Subordinated debentures
56,807

 
56,807

Federal Home Loan Bank advances
129,000

 
110,000

Other borrowings
190,022

 
270,326

Accrued interest payable
648

 
629

Other liabilities
27,244

 
35,301

Total liabilities
3,528,546

 
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; 20,249,711 and 20,093,119 shares issued, respectively
203

 
201

Treasury stock, at cost; 261,718 and 76,000 shares, respectively
(6,632
)
 
(1,743
)
Additional paid in capital
212,091

 
210,589

Retained earnings
170,768

 
141,564

Accumulated other comprehensive income
4,668

 
218

Total shareholders' equity
381,098

 
350,829

Total liabilities and shareholders' equity
$
3,909,644

 
$
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 September 30,
 
Nine months ended September 30,
(in thousands, except per share data)
2016
 
2015
 
2016
 
2015
Interest income:
 
 
 
 
 
 
 
Interest and fees on loans
$
34,442

 
$
30,626

 
$
101,233

 
$
90,109

Interest on debt securities:
 
 
 
 
 
 
 
Taxable
2,410

 
2,176

 
7,194

 
6,434

Nontaxable
322

 
298

 
982

 
880

Interest on interest-bearing deposits
67

 
68

 
186

 
153

Dividends on equity securities
52

 
12

 
191

 
107

Total interest income
37,293

 
33,180


109,786


97,683

Interest expense:
 
 
 
 
 
 
 
Interest-bearing transaction accounts
332

 
293

 
967

 
849

Money market accounts
1,143

 
822

 
3,162

 
2,136

Savings accounts
68

 
58

 
191

 
162

Certificates of deposit
1,319

 
1,543

 
3,521

 
4,728

Subordinated debentures
369

 
314

 
1,078

 
924

Federal Home Loan Bank advances
126

 
9

 
499

 
82

Notes payable and other borrowings
106

 
135

 
327

 
471

Total interest expense
3,463

 
3,174


9,745


9,352

Net interest income
33,830

 
30,006

 
100,041

 
88,331

Provision for portfolio loan losses
3,038

 
599

 
4,587

 
4,329

Provision reversal for purchased credit impaired loan losses
(1,194
)
 
(227
)
 
(1,603
)
 
(3,497
)
Net interest income after provision for loan losses
31,986

 
29,634


97,057


87,499

Noninterest income:
 
 
 
 
 
 
 
Service charges on deposit accounts
2,200

 
2,044

 
6,431

 
5,898

Wealth management revenue
1,694

 
1,773

 
5,000

 
5,291

Other service charges and fee income
1,007

 
871

 
2,827

 
2,464

Gain on state tax credits, net
228

 
321

 
899

 
1,069

Gain (loss) on sale of other real estate
(226
)
 
32

 
602

 
61

Gain on sale of investment securities
86

 

 
86

 
23

Change in FDIC loss share receivable

 
(1,241
)
 

 
(4,450
)
Miscellaneous income
1,987

 
929

 
4,185

 
3,762

Total noninterest income
6,976

 
4,729


20,030


14,118

Noninterest expense:
 
 
 
 
 
 
 
Employee compensation and benefits
12,091

 
11,475

 
37,398

 
34,262

Occupancy
1,705

 
1,605

 
4,997

 
4,920

Data processing
1,150

 
1,138

 
3,441

 
3,295

FDIC and other insurance
780

 
654

 
2,241

 
2,045

Professional fees
757

 
800

 
2,160

 
2,626

Loan legal and other real estate expense
416

 
530

 
1,126

 
1,356

FDIC clawback

 
298

 

 
760

Other
3,915

 
3,432

 
11,566

 
10,076

Total noninterest expense
20,814

 
19,932


62,929


59,340

 
 
 
 
 
 
 
 
Income before income tax expense
18,148

 
14,431


54,158


42,277

Income tax expense
6,316

 
4,722

 
18,949

 
14,506

Net income
$
11,832

 
$
9,709


$
35,209


$
27,771

 
 
 
 
 
 
 
 
Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.59

 
$
0.49

 
$
1.76

 
$
1.39

Diluted
0.59

 
0.48

 
1.74

 
1.37

See accompanying notes to consolidated financial statements.

2




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

 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Net income
$
11,832

 
$
9,709

 
$
35,209

 
$
27,771

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 $(494) and $1,070, and for nine months of $2,795 and $793, respectively
(796
)
 
1,724

 
4,503

 
1,306

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 $33 and $0, and for nine months of $33 and $9, respectively
(53
)
 

 
(53
)
 
(14
)
Total other comprehensive income (loss)
(849
)
 
1,724

 
4,450

 
1,292

Total comprehensive income
$
10,983

 
$
11,433

 
$
39,659

 
$
29,063


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

 

 

 

 
35,209

 

 
35,209

Other comprehensive income

 

 

 

 

 
4,450

 
4,450

Cash dividends paid on common shares, $0.30 per share

 

 

 

 
(6,005
)
 

 
(6,005
)
Repurchase of common shares

 

 
(4,889
)
 

 

 

 
(4,889
)
Issuance under equity compensation plans, 156,592 shares, net

 
2

 

 
(1,652
)
 

 

 
(1,650
)
Share-based compensation

 

 

 
2,410

 

 

 
2,410

Excess tax benefit related to equity compensation plans

 

 

 
744

 

 

 
744

Balance September 30, 2016
$

 
$
203

 
$
(6,632
)
 
$
212,091

 
$
170,768

 
$
4,668

 
$
381,098

 
 
 
 
 
 
 
 
 
 
 
 
 
 
(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

 

 

 

 
27,771

 

 
27,771

Other comprehensive income

 

 

 

 

 
1,292

 
1,292

Cash dividends paid on common shares, $0.183 per share

 

 

 

 
(3,654
)
 

 
(3,654
)
Issuance under equity compensation plans, 121,646 shares, net

 
1

 

 
(832
)
 

 

 
(831
)
Share-based compensation

 

 

 
2,588

 

 

 
2,588

Excess tax benefit related to equity compensation plans

 

 

 
156

 

 

 
156

Balance September 30, 2015
$

 
$
200

 
$
(1,743
)
 
$
209,643

 
$
132,490

 
$
2,973

 
$
343,563


See accompanying notes to consolidated financial statements.

4



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
Nine months ended September 30,
(in thousands)
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
35,209

 
$
27,771

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation
1,628

 
1,510

Provision for loan losses
2,984

 
832

Deferred income taxes
3,881

 
1,937

Net amortization of debt securities
2,350

 
2,473

Amortization of intangible assets
718

 
842

Gain on sale of investment securities
(86
)
 
(23
)
Mortgage loans originated for sale
(117,975
)
 
(95,744
)
Proceeds from mortgage loans sold
117,639

 
95,814

Gain on sale of other real estate
(602
)
 
(61
)
Gain on state tax credits, net
(899
)
 
(1,069
)
Excess tax benefit of share-based compensation
(744
)
 
(156
)
Share-based compensation
2,410

 
2,588

Valuation adjustment on other real estate
1

 
82

Net accretion of loan discount and indemnification asset
(8,165
)
 
(4,894
)
Changes in:
 
 
 
Accrued interest receivable
(127
)
 
(703
)
Accrued interest payable
19

 
(63
)
Other assets
(2,101
)
 
4,851

Other liabilities
(8,057
)
 
4,024

Net cash provided by operating activities
28,083

 
40,011

Cash flows from investing activities:
 
 
 
Net increase in loans
(256,706
)
 
(152,970
)
Net cash proceeds received from FDIC loss share receivable

 
1,725

Proceeds from the sale of securities, available for sale
2,493

 
41,069

Proceeds from the paydown or maturity of securities, available for sale
46,017

 
40,230

Proceeds from the paydown or maturity of securities, held to maturity
2,592

 
1,848

Proceeds from the redemption of other investments
44,968

 
29,362

Proceeds from the sale of state tax credits held for sale
4,918

 
5,353

Proceeds from the sale of other real estate
8,072

 
5,662

Payments for the purchase/origination of:
 
 
 
Available for sale debt and equity securities
(71,309
)
 
(150,934
)
Other investments
(48,283
)
 
(23,931
)
State tax credits held for sale
(2,349
)
 
(14,004
)
Fixed assets
(1,284
)
 
(1,152
)
Net cash used in investing activities
(270,871
)
 
(217,742
)
Cash flows from financing activities:
 
 
 
Net increase in noninterest-bearing deposit accounts
44,695

 
48,828

Net increase in interest-bearing deposit accounts
295,539

 
273,625

Proceeds from Federal Home Loan Bank advances
1,309,000

 
635,900

Repayments of Federal Home Loan Bank advances
(1,290,000
)
 
(704,900
)
Repayments of notes payable

 
(900
)
Net decrease in other borrowings
(80,304
)
 
(44,299
)
Cash dividends paid on common stock
(6,005
)
 
(3,654
)
Excess tax benefit of share-based compensation
744

 
156

Payments for the repurchase of common stock
(4,889
)
 

Issuance of common stock, net
(1,650
)
 
(831
)
Net cash provided by financing activities
267,130

 
203,925

Net increase in cash and cash equivalents
24,342

 
26,194

Cash and cash equivalents, beginning of period
94,157

 
100,696

Cash and cash equivalents, end of period
$
118,499

 
$
126,890

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
9,726

 
$
9,415

Income taxes
19,868

 
8,763

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

 
$
6,604

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 nine months ended September 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 September 30,
 
Nine months ended September 30,
(in thousands, except per share data)
2016
 
2015
 
2016
 
2015
Net income as reported
$
11,832

 
$
9,709

 
$
35,209

 
$
27,771

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
19,997

 
19,995

 
20,002

 
19,970

Additional dilutive common stock equivalents
227

 
266

 
229

 
266

Weighted average diluted common shares outstanding
20,224

 
20,261

 
20,231

 
20,236

 
 
 
 
 
 
 
 
Basic earnings per common share:
$
0.59

 
$
0.49

 
$
1.76

 
$
1.39

Diluted earnings per common share:
$
0.59

 
$
0.48

 
$
1.74

 
$
1.37


For the three and nine months ended September 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 0.1 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:
 
 
September 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
$
97,745

 
$
1,313

 
$

 
$
99,058

    Obligations of states and political subdivisions
37,132

 
1,511

 
(307
)
 
38,336

    Agency mortgage-backed securities
336,693

 
5,826

 
(304
)
 
342,215

          Total securities available for sale
$
471,570

 
$
8,650

 
$
(611
)
 
$
479,609

Held to maturity securities:
 
 
 
 
 
 
 
    Obligations of states and political subdivisions
$
14,777

 
$
359

 
$
(2
)
 
$
15,134

    Agency mortgage-backed securities
26,254

 
830

 

 
27,084

          Total securities held to maturity
$
41,031

 
$
1,189


$
(2
)

$
42,218


 
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 September 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 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 $321.5 million and $334.4 million at September 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 September 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
$
52,384

 
$
52,637

 
$

 
$

Due after one year through five years
70,128

 
72,153

 
8,189

 
8,356

Due after five years through ten years
8,836

 
9,328

 
6,588

 
6,778

Due after ten years
3,529

 
3,276

 

 

Agency mortgage-backed securities
336,693

 
342,215

 
26,254

 
27,084

 
$
471,570

 
$
479,609


$
41,031


$
42,218



The following table represents a summary of investment securities that had an unrealized loss:
 
 
September 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
$

 
$

 
$
3,566

 
$
309

 
$
3,566

 
$
309

Agency mortgage-backed securities
6,654

 
11

 
13,379

 
293

 
20,033

 
304

 
$
6,654

 
$
11


$
16,945


$
602


$
23,599


$
613

 
 
 
 
 
 
 
 
 
 
 
 
 
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 September 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 September 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 September 30,
 
Nine months ended September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Gross gains realized
$
86

 
$

 
$
86

 
$
63

Gross losses realized

 

 

 
(40
)
Proceeds from sales
2,493

 

 
2,493

 
41,069



9



NOTE 4 - PORTFOLIO LOANS

Below is a summary of Portfolio loans by category at September 30, 2016 and December 31, 2015:
 
(in thousands)
September 30, 2016
 
December 31, 2015
Commercial and industrial
$
1,598,815

 
$
1,484,327

Real estate:
 
 
 
    Commercial - investor owned
515,055

 
428,064

    Commercial - owner occupied
340,916

 
342,959

    Construction and land development
188,856

 
161,061

    Residential
233,960

 
196,498

Total real estate loans
1,278,787

 
1,128,582

Consumer and other
160,535

 
137,537

Portfolio loans
3,038,137

 
2,750,446

Unearned loan fees, net
(432
)
 
291

    Portfolio loans, including unearned loan fees
$
3,037,705

 
$
2,750,737


A summary of the activity in the allowance for loan losses and the recorded investment in Portfolio loans by class and category based on impairment method through September 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) for loan losses
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) for loan losses
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

Provision (provision reversal) for loan losses
3,575

 
10

 
94

 
(730
)
 
168

 
(79
)
 
3,038

Losses charged off
(2,044
)
 

 

 

 
(25
)
 
(4
)
 
(2,073
)
Recoveries
69

 
8

 
17

 
913

 
26

 
2

 
1,035

Balance at September 30, 2016
$
25,408

 
$
3,374


$
2,702


$
1,402


$
1,966


$
2,646


$
37,498


10



(in thousands)
Commercial and industrial
 
CRE - investor owned
 
CRE -
owner occupied
 
Construction and land development
 
Residential real estate
 
Consumer and other
 
Total
Balance September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses - Ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
3,785

 
$

 
$

 
$
158

 
$
3

 
$
1,855

 
$
5,801

Collectively evaluated for impairment
21,623

 
3,374

 
2,702

 
1,244

 
1,963

 
791

 
31,697

Total
$
25,408

 
$
3,374


$
2,702


$
1,402


$
1,966


$
2,646


$
37,498

Loans - Ending balance:
 
 
 
 
 
 
 

 
 
 
 
 
 
Individually evaluated for impairment
$
13,414

 
$
252

 
$
1,666

 
$
1,907

 
$
124

 
$
4,499

 
$
21,862

Collectively evaluated for impairment
1,585,401

 
514,803

 
339,250

 
186,949

 
233,836

 
155,604

 
3,015,843

Total
$
1,598,815

 
$
515,055


$
340,916


$
188,856


$
233,960


$
160,103


$
3,037,705

 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 September 30, 2016 and December 31, 2015, is as follows:

 
September 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
$
14,895

 
$
136

 
$
13,134

 
$
13,270

 
$
3,785

 
$
15,666

Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
    Commercial - investor owned
252

 
253

 

 
253

 

 
250

    Commercial - owner occupied

 

 

 

 

 

    Construction and land development
1,907

 
1,920

 
358

 
2,278

 
158

 
2,403

    Residential
149

 
65

 
64

 
129

 
3

 
652

Consumer and other
4,499

 

 
4,508

 
4,508

 
1,855

 
4,598

Total
$
21,702

 
$
2,374


$
18,064


$
20,438


$
5,801


$
23,569


 
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




11



The following table presents details for past due and impaired loans:
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Total interest income that would have been recognized under original terms
$
226

 
$
369

 
$
703

 
$
913

Total cash received and recognized as interest income on non-accrual loans
203

 
81

 
253

 
206

Total interest income recognized on impaired loans
32

 
4

 
63

 
31


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

The recorded investment in impaired Portfolio loans by category at September 30, 2016 and December 31, 2015, is as follows: 
 
September 30, 2016
(in thousands)
Non-accrual
 
Restructured
 
Loans over 90 days past due and still accruing interest
 
Total
Commercial and industrial
$
10,959

 
$
2,311

 
$

 
$
13,270

Real estate:
 
 
 
 
 
 
 
    Commercial - investor owned
253

 

 

 
253

    Commercial - owner occupied

 

 

 

    Construction and land development
2,258

 
20

 

 
2,278

    Residential
129

 

 

 
129

Consumer and other
4,508

 

 

 
4,508

       Total
$
18,107

 
$
2,331


$


$
20,438


 
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 nine months ended September 30, 2016 and 2015, is as follows:


12



 
Three months ended September 30, 2016
 
Three months ended September 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

 
$

 
$

 

 
$

 
$

Real estate:
 
 
 
 
 
 
 
 
 
 
 
Commercial - investor owned

 

 

 

 

 

Commercial - owner occupied

 

 

 

 

 

Construction and land development

 

 

 

 

 

Residential

 

 

 

 

 

Consumer and other

 

 

 

 

 

Total

 
$

 
$

 

 
$

 
$


 
Nine months ended September 30, 2016
 
Nine months ended September 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 September 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 three and nine months ended September 30, 2016 or 2015.

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

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

 
$
364

 
$
364

 
$
1,598,451

 
$
1,598,815

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned
136

 

 
136

 
514,919

 
515,055

       Commercial - owner occupied
225

 

 
225

 
340,691

 
340,916

       Construction and land development

 
1,529

 
1,529

 
187,327

 
188,856

       Residential
73

 
60

 
133

 
233,827

 
233,960

    Consumer and other

 

 

 
160,103

 
160,103

          Total
$
434

 
$
1,953


$
2,387


$
3,035,318


$
3,037,705



13



 
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


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 September 30, 2016, which is based upon the most recent analysis performed, and December 31, 2015 is as follows:


14



 
September 30, 2016
(in thousands)
Pass (1-6)
 
Watch (7)
 
Substandard (8)
 
Doubtful (9)
 
Total
    Commercial and industrial
$
1,457,729

 
$
63,572

 
$
77,514

 
$

 
$
1,598,815

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned
501,228

 
9,549

 
4,278

 

 
515,055

       Commercial - owner occupied
311,427

 
25,369

 
4,120

 

 
340,916

       Construction and land development
179,515

 
6,050

 
3,291

 

 
188,856

       Residential
226,287

 
4,224

 
3,449

 

 
233,960

    Consumer and other
153,458

 
711

 
5,934

 

 
160,103

          Total
$
2,829,644

 
$
109,475

 
$
98,586

 
$

 
$
3,037,705


 
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



15



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

Below is a summary of PCI loans by category at September 30, 2016 and December 31, 2015:
 
 
September 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
5.84
$
3,282

 
6.70
$
3,863

Real estate:
 
 
 
 
 
    Commercial - investor owned
6.94
14,595

 
6.98
25,272

    Commercial - owner occupied
6.34
12,417

 
6.30
19,414

    Construction and land development
5.67
4,919

 
6.28
6,838

    Residential
5.66
12,173

 
5.44
19,287

Total real estate loans
 
44,104

 
 
70,811

Consumer and other
1.54
63

 
1.89
84

    Purchased credit impaired loans
 
$
47,449

 
 
$
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 September 30, 2016 and December 31, 2015 is shown below:

 
September 30, 2016
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
    Commercial and industrial
$
805

 
$

 
$
805

 
$
2,477

 
$
3,282

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned

 

 

 
14,595

 
14,595

       Commercial - owner occupied
229

 

 
229

 
12,188

 
12,417

       Construction and land development

 

 

 
4,919

 
4,919

       Residential
84

 
55

 
139

 
12,034

 
12,173

    Consumer and other

 

 

 
63

 
63

          Total
$
1,118

 
$
55


$
1,173


$
46,276


$
47,449


 
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



16



The following table is a rollforward of PCI loans, net of the allowance for loan losses, for the nine months ended September 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
(20,417
)
 

 

 
(20,417
)
Accretion of loan discount

 

 
(4,984
)
 
4,984

Changes in contractual and expected cash flows due to remeasurement
9,194

 
975

 
(1,043
)
 
9,262

Reductions due to disposals
(27,888
)
 
(6,779
)
 
(3,713
)
 
(17,396
)
Balance September 30, 2016
$
77,578

 
$
20,961


$
15,601


$
41,016

 
 
 
 
 
 
 
 
Balance January 1, 2015
$
178,145

 
$
65,719

 
$
28,733

 
$
83,693

Principal reductions and interest payments
(19,315
)
 

 

 
(19,315
)
Accretion of loan discount

 

 
(8,604
)
 
8,604

Changes in contractual and expected cash flows due to remeasurement
(5,731
)
 
(26,797
)
 
9,233

 
11,833

Reductions due to disposals
(19,734
)
 
(4,183
)
 
(3,133
)
 
(12,418
)
Balance September 30, 2015
$
133,365

 
$
34,739


$
26,229


$
72,397


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 $64.6 million and $98.6 million as of September 30, 2016, and December 31, 2015, respectively.



17



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 September 30, 2016, there were $0.5 million unadvanced commitments on impaired loans.

The contractual amounts of off-balance-sheet financial instruments as of September 30, 2016, and December 31, 2015, are as follows:
 
(in thousands)
September 30, 2016
 
December 31, 2015
Commitments to extend credit
$
1,086,372

 
$
1,140,028

Standby letters of credit
64,360

 
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 September 30, 2016, and December 31, 2015, approximately $108 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 September 30, 2016 and December 31, 2015.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance or payment 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 5 years at September 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.


18



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 September 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)
September 30,
2016
 
December 31,
2015
 
September 30,
2016
 
December 31,
2015
 
September 30,
2016
 
December 31,
2015
Non-designated hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
$
171,792

 
$
153,630

 
$
2,099

 
$
1,155

 
$
2,099

 
$
1,155


Changes in the fair value of client-related derivative instruments are recognized currently in operations. For the three and nine months ended September 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 September 30, 2016 and December 31, 2015, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
 

19



 
September 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
$

 
$
99,058

 
$

 
$
99,058

Obligations of states and political subdivisions

 
35,242

 
3,094

 
38,336

Residential mortgage-backed securities

 
342,215

 

 
342,215

Total securities available for sale
$

 
$
476,515


$
3,094


$
479,609

State tax credits held for sale

 

 
4,801

 
4,801

Derivative financial instruments

 
2,099

 

 
2,099

Total assets
$

 
$
478,614


$
7,895


$
486,509

 
 
 
 
 
 
 
 
Liabilities
 

 
 
 
 

 
 
Derivative financial instruments
$

 
$
2,099

 
$

 
$
2,099

Total liabilities
$

 
$
2,099


$


$
2,099


 
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 September 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 September 30, 2016, of the $44.2 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 $39.4 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

20



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 September 30, 2016 and 2015.
Purchases, sales, issuances and settlements. There were no Level 3 purchases during the quarter ended September 30, 2016 or 2015.
Transfers in and/or out of Level 3. There were no Level 3 transfers during the quarter ended September 30, 2016 and 2015.
 
Securities available for sale, at fair value
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Beginning balance
$
3,093

 
$
3,070

 
$
3,077

 
$
3,059

   Total gains:
 
 
 
 
 
 
 
Included in other comprehensive income
1

 
7

 
17

 
18

   Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
Purchases

 

 

 

Ending balance
$
3,094

 
$
3,077

 
$
3,094

 
$
3,077

 
 
 
 
 
 
 
 
Change in unrealized gains relating to assets still held at the reporting date
$
1

 
$
7

 
$
17

 
$
18




21



 
State tax credits held for sale
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Beginning balance
$
4,774

 
$
9,965

 
$
5,941

 
$
11,689

   Total gains:
 
 
 
 
 
 
 
Included in earnings
27

 
124

 
144

 
318

   Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
Sales

 

 
(1,284
)
 
(1,918
)
Ending balance
$
4,801

 
$
10,089

 
$
4,801

 
$
10,089

 
 
 
 
 
 
 
 
Change in unrealized gains (losses) relating to assets still held at the reporting date
$
27

 
$
124

 
$
(237
)
 
$
(186
)

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 September 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 losses for the three
months ended
September 30, 2016
 
Total losses for the nine
months ended
September 30, 2016
Impaired loans
$
357

 
$

 
$

 
$
357

 
$
2,073

 
$
2,309

Other real estate

 

 

 

 

 
1

Total
$
357

 
$


$


$
357


$
2,073

 
$
2,310


(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 September 30, 2016 and December 31, 2015.


22



 
September 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
$
56,789

 
$
56,789

 
$
47,935

 
$
47,935

Federal funds sold
488

 
488

 
91

 
91

Interest-bearing deposits
63,202

 
63,202

 
47,131

 
47,131

Securities available for sale
479,609

 
479,609

 
451,770

 
451,770

Securities held to maturity
41,031

 
42,218

 
43,714

 
43,441

Other investments, at cost
19,789

 
19,789

 
17,455

 
17,455

Loans held for sale
7,663

 
7,663

 
6,598

 
6,598

Derivative financial instruments
2,099

 
2,099

 
1,155

 
1,155

Portfolio loans, net
3,041,223

 
3,045,230

 
2,781,879

 
2,782,704

State tax credits, held for sale
44,180

 
48,959

 
45,850

 
49,588

Accrued interest receivable
8,526

 
8,526

 
8,399

 
8,399

 
 
 
 
 
 
 
 
Balance sheet liabilities
 
 
 
 
 
 
 
Deposits
3,124,825

 
3,126,534

 
2,784,591

 
2,784,654

Subordinated debentures
56,807

 
36,275

 
56,807

 
35,432

Federal Home Loan Bank advances
129,000

 
128,996

 
110,000

 
109,994

Other borrowings
190,022

 
189,996

 
270,326

 
270,286

Derivative financial instruments
2,099

 
2,099

 
1,155

 
1,155

Accrued interest payable
648

 
648

 
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 September 30, 2016, and December 31, 2015.
 

23



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

 
$
42,218

 
$

 
$
42,218

Portfolio loans, net

 

 
3,045,230

 
3,045,230

State tax credits, held for sale

 

 
44,158

 
44,158

Financial Liabilities:
 
 
 
 
 
 
 
Deposits
2,636,980

 

 
489,554

 
3,126,534

Subordinated debentures

 
36,275

 

 
36,275

Federal Home Loan Bank advances

 
128,996

 

 
128,996

Other borrowings

 
189,996

 

 
189,996

 
 
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 2016-15 "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments" In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230)" which addresses changes to reduce the presentation diversity of certain cash receipts and cash payments in the statement of cash flows, including debt prepayment or extinguishment costs, settlement of certain debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, and distributions received from equity method investees. The guidance becomes effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. An entity that elects early adoption must adopt all of the amendments in the same period. The new standard will be applied retrospectively, but may be applied prospectively if retrospective application would be impracticable. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its consolidated statement of cash flows.

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.

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

24



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 2016-02 "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 2016-01 "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 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 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 of adoption.

25



NOTE 10 - SUBSEQUENT EVENTS

On October 10, 2016, the Company entered into a definitive merger agreement to acquire Jefferson County Bancshares, Inc. (“JCB”). JCB and its wholly-owned subsidiary, Eagle Bank and Trust Company of Missouri, have approximately $935 million in assets, $670 million in loans, and $763 million in deposits as of June 30, 2016. JCB operates 13 full service retail and commercial banking offices in metropolitan St. Louis and Perry County, Missouri.

JCB shareholders will receive, based on their election, cash consideration in an amount of $85.39 per share of JCB common stock or 2.75 shares of EFSC common stock per share of JCB common stock. Aggregate consideration at the closing will be 3.3 million shares of EFSC common stock and approximately $26.6 million in cash, subject to adjustment for any JCB stock option exercises. Based on EFSC’s 15-day volume weighted average closing stock price of $31.52 as of October 10, 2016, the overall transaction has an estimated value of $130.6 million, including JCB’s common stock and stock options.

The transaction is anticipated to close in early 2017, and is subject to normal and customary closing conditions, including but not limited to, regulatory approval and approval by JCB shareholders.

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 may be expressed differently. Forward-looking statements also include, but are not limited to, statements regarding plans, objectives, expectations or consequences of announced transactions (including the Company's announced pending merger with Jefferson County Bancshares, Inc.), and statements about the future performance, operations products and services of the Company and its subsidiaries. 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: our ability to efficiently integrate acquisitions into our operations, retain the customers of these businesses and grow the acquired operations: 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 or 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 nine 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 nine months ended September 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 September 30, 2016, as compared to the linked quarter ended June 30, 2016, and prior year quarter ended September 30, 2015.

(in thousands, except per share data)
For the Three Months ended and At
 
For the Nine Months ended
September 30,
2016
 
June 30,
2016
 
September 30,
2015
 
September 30,
2016
 
September 30,
2015
EARNINGS
 
 
 
 
 
 
 
 
 
Total interest income
$
37,293

 
$
37,033

 
$
33,180

 
$
109,786

 
$
97,683

Total interest expense
3,463

 
3,250

 
3,174

 
9,745

 
9,352

Net interest income
33,830

 
33,783

 
30,006

 
100,041

 
88,331

Provision for portfolio loans
3,038

 
716

 
599

 
4,587

 
4,329

Provision reversal for PCI loans
(1,194
)
 
(336
)
 
(227
)
 
(1,603
)
 
(3,497
)
Net interest income after provision for loan losses
31,986

 
33,403

 
29,634

 
97,057

 
87,499

Total noninterest income
6,976

 
7,049

 
4,729

 
20,030

 
14,118

Total noninterest expense
20,814

 
21,353

 
19,932

 
62,929

 
59,340

Income before income tax expense
18,148

 
19,099


14,431

 
54,158

 
42,277

Income tax expense
6,316

 
6,747

 
4,722

 
18,949

 
14,506

Net income
$
11,832

 
$
12,352

 
$
9,709

 
$
35,209

 
$
27,771

 
 
 
 
 
 
 
 
 
 
Basic earnings per share
$
0.59

 
$
0.62

 
$
0.49

 
$
1.76

 
$
1.39

Diluted earnings per share
0.59

 
0.61

 
0.48

 
1.74

 
1.37

 
 
 
 
 
 
 
 
 
 
Return on average assets
1.23
%
 
1.33
 %
 
1.13
%
 
1.26
%
 
1.11
%
Return on average common equity
12.46
%
 
13.57
 %
 
11.38
%
 
12.83
%
 
11.24
%
Return on average tangible common equity
13.64
%
 
14.91
 %
 
12.65
%
 
14.10
%
 
12.53
%
Net interest margin (fully tax equivalent)
3.80
%
 
3.93
 %
 
3.77
%
 
3.87
%
 
3.84
%
Efficiency ratio
51.01
%
 
52.29
 %
 
57.38
%
 
52.41
%
 
57.92
%
 
 
 
 
 
 
 
 
 
 
ASSET QUALITY (1)
 
 
 
 
 
 
 
 
 
Net charge-offs (recoveries)
$
1,038

 
$
(409
)
 
$
113

 
$
530

 
$
2,263

Nonperforming loans
19,942

 
12,813

 
9,123

 
 
 
 
Classified assets
101,545

 
87,532

 
62,679

 
 
 
 
Nonperforming loans to portfolio loans
0.66
%
 
0.44
 %
 
0.35
%
 
 
 
 
Nonperforming assets to total assets (1)(2)
0.59
%
 
0.47
 %
 
0.30
%
 
 
 
 
Allowance for loan losses to portfolio loans
1.23
%
 
1.23
 %
 
1.24
%
 
 
 
 
Net charge-offs (recoveries) to average loans (annualized)
0.14
%
 
(0.06
)%
 
0.02
%
 
0.02
%
 
0.12
%
 
 
 
 
 
 
 
 
 
 
(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

28



on the 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, merger related expenses, 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. A reconciliation of 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 Nine Months ended
(in thousands)
September 30,
2016
 
June 30,
2016
 
September 30,
2015
 
September 30,
2016
 
September 30,
2015
CORE PERFORMANCE MEASURES (1)
 
 
 
 
 
 
 
 
Net interest income
$
31,534

 
$
30,212

 
$
27,087

 
$
91,340

 
$
78,951

Provision for portfolio loans
3,038

 
716

 
599

 
4,587

 
4,329

Noninterest income
6,828

 
6,105

 
5,939

 
18,938

 
18,519

Noninterest expense
20,242

 
20,446

 
19,347

 
61,123

 
57,445

Income before income tax expense
15,082

 
15,155

 
13,080

 
44,568

 
35,696

Income tax expense
5,142

 
5,237

 
4,204

 
15,276

 
11,985

Net income
$
9,940

 
$
9,918

 
$
8,876

 
$
29,292

 
$
23,711

 
 
 
 
 
 
 
 
 
 
Earnings per share
$
0.49

 
$
0.49

 
$
0.44

 
$
1.45

 
$
1.17

Return on average assets
1.04
%
 
1.07
%
 
1.03
%
 
1.05
%
 
0.95
%
Return on average common equity
10.47
%
 
10.89
%
 
10.41
%
 
10.67
%
 
9.59
%
Return on average tangible common equity
11.46
%
 
11.98
%
 
11.56
%
 
11.73
%
 
10.70
%
Net interest margin (fully tax equivalent)
3.54
%
 
3.52
%
 
3.41
%
 
3.53
%
 
3.44
%
Efficiency ratio
52.77
%
 
56.30
%
 
58.58
%
 
55.43
%
 
58.94
%
 
 
 
 
 
 
 
 
 
 
(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 nine months ended September 30, 2016, the Company noted the following trends:

The Company reported net income of $35.2 million, or $1.74 per share, for the nine months ended September 30, 2016, compared to $27.8 million, or $1.37 per share, for the same period in 2015. The 27% increase in net income was primarily due to an increase in core net income from growing net interest income and an increase in noninterest income, as well as a more substantial contribution from PCI assets due to the termination of FDIC loss share.

On a core basis1, net income was $29.3 million, or $1.45 per share, for the nine months ended September 30, 2016, compared to $23.7 million, or $1.17 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.

Net interest income for the first nine months of 2016 increased $11.7 million or 13%, from the prior year period due to strong portfolio loan growth.

Net interest margin for the first nine months of 2016 expanded three basis points to 3.87% when compared to the prior year period. Core net interest margin1, for the first nine 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 nine 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.


29



Noninterest income for the first nine months of 2016 increased $5.9 million, or 42%, 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 increased $0.4 million, or 2%, from the prior year period primarily due to higher fee income from service charges on deposits and card products, and an increase in the gain on sale of mortgages.

Noninterest expense increased $3.6 million, or 6%, from the prior year period, due to an increase in Employee compensation and benefits, while the Company's efficiency ratio improved to 52.4% for the nine months ended September 30, 2016, from 57.9% in the prior year. Core noninterest expense1 also increased 6% when compared to the prior year. However, the Core efficiency ratio1 also improved to 55.4% from 58.9% when compared to the prior year period due to revenue growth resulting from investments in customer facing associates driving continued revenue growth.

Other highlights:

On October 10, 2016, the Company entered into a definitive merger agreement to acquire Jefferson County Bancshares, Inc. ("JCB") headquartered in Jefferson County, Missouri. JCB is the parent holding company of Eagle Bank and Trust Company of Missouri. The transaction is anticipated to close in early 2017, and is subject to normal and customary closing conditions, including but not limited to, regulatory approval and approval by JCB shareholders. The merger with JCB is expected to accelerate the Company's St. Louis market expansion and add valuable scale and operating leverage to this market. The Company believes that JCB's commercial and retail customer bases are complementary to EFSC's existing product sets.

The Company repurchased 6,700 shares at $26.50 per share pursuant to its publicly announced program during the quarter ended September 30, 2016, 18,918 shares at $26.46 per share 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 $3.1 billion at September 30, 2016, including $47.4 million of PCI loans. Portfolio loans increased $287.0 million, or 10%, from December 31, 2015. Commercial and industrial loans increased $114.5 million, or 8%, Consumer and other loans increased $22.3 million, or 16%, Construction loans and Residential real estate loans increased $65.3 million, or 18%, and Commercial real estate increased $84.9 million, or 11%. See Item 1, Note 4 – Portfolio Loans for more information.
Deposits – Total deposits at September 30, 2016 were $3.1 billion, an increase of $340.2 million, or 12%, from December 31, 2015. Deposits increased from both core deposit gathering efforts and brokered sources to supplement and fund loan growth.
Asset quality – Nonperforming loans were $19.9 million at September 30, 2016, compared to $9.1 million at December 31, 2015. Nonperforming loans represented 0.66% of portfolio loans at September 30, 2016 versus 0.33% at December 31, 2015. There were no portfolio loans that were over 90 days delinquent and still accruing at September 30, 2016 or December 31, 2015.
Provision for portfolio loan losses was $4.6 million for the nine months ended September 30, 2016, compared to $4.3 million for the nine months ended September 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 September 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)
$
2,916,678

 
$
30,980

 
4.23
%
 
$
2,505,985

 
$
26,061

 
4.13
%
Tax-exempt portfolio loans (2)
41,495

 
611

 
5.86

 
39,218

 
644

 
6.51

Purchased credit impaired loans
53,198

 
3,085

 
23.07

 
85,155

 
4,167

 
19.41

Total loans
3,011,371

 
34,676

 
4.58

 
2,630,358


30,872

 
4.66

Taxable investments in debt and equity securities
479,755

 
2,462

 
2.04

 
431,313

 
2,188

 
2.01

Non-taxable investments in debt and equity securities (2)
47,761

 
521

 
4.34

 
43,867

 
483

 
4.37

Short-term investments
50,193

 
67

 
0.53

 
95,642

 
68

 
0.28

Total securities and short-term investments
577,709

 
3,050

 
2.10

 
570,822


2,739

 
1.90

Total interest-earning assets
3,589,080

 
37,726

 
4.18

 
3,201,180

 
33,611

 
4.17

Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
58,178

 
 
 
 
 
49,057

 
 
 
 
Other assets
213,352

 
 
 
 
 
210,109

 
 
 
 
Allowance for loan losses
(45,692
)
 
 
 
 
 
(43,630
)
 
 
 
 
 Total assets
$
3,814,918

 
 
 
 
 
$
3,416,716

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
600,707

 
$
332

 
0.22
%
 
$
518,260

 
$
293

 
0.22
%
Money market accounts
1,075,747

 
1,143

 
0.42

 
1,023,062

 
822

 
0.32

Savings
108,075

 
68

 
0.25

 
92,596

 
58

 
0.25

Certificates of deposit
516,159

 
1,319

 
1.02

 
500,877

 
1,543

 
1.22

Total interest-bearing deposits
2,300,688

 
2,862

 
0.49

 
2,134,795


2,716

 
0.50

Subordinated debentures
56,807

 
369

 
2.59

 
56,807

 
314

 
2.19

Other borrowed funds
286,896

 
232

 
0.32

 
203,133

 
144

 
0.28

Total interest-bearing liabilities
2,644,391

 
3,463

 
0.52

 
2,394,735


3,174

 
0.53

Noninterest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
768,468

 
 
 
 
 
653,450

 
 
 
 
Other liabilities
24,198

 
 
 
 
 
30,163

 
 
 
 
Total liabilities
3,437,057

 
 
 
 
 
3,078,348

 
 
 
 
Shareholders' equity
377,861

 
 
 
 
 
338,368

 
 
 
 
Total liabilities & shareholders' equity
$
3,814,918

 
 
 
 
 
$
3,416,716

 
 
 
 
Net interest income
 
 
$
34,263

 
 
 
 
 
$
30,437

 
 
Net interest spread
 
 
 
 
3.66
%
 
 
 
 
 
3.64
%
Net interest margin
 
 
 
 
3.80
%
 
 
 
 
 
3.77
%

(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 $0.6 million for the three months ended September 30, 2016 and 2015 respectively.
(2)
Non-taxable income is presented on a fully tax-equivalent basis using a 38.3% tax rate in 2016 and 2015. The tax-equivalent adjustments were $0.4 million and $0.4 million for the three months ended September 30, 2016 and 2015.

31



 
Nine months ended September 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)
$
2,830,365

 
$
88,667

 
4.18
%
 
$
2,449,606

 
$
75,560

 
4.12
%
Tax-exempt portfolio loans (2)
41,526

 
1,899

 
6.11

 
38,691

 
1,896

 
6.55

Purchased credit impaired loans
60,420

 
11,394

 
25.19

 
91,464

 
13,376

 
19.55

Total loans
2,932,311

 
101,960

 
4.64

 
2,579,761

 
90,832

 
4.71

Taxable investments in debt and equity securities
474,981

 
7,385

 
2.08

 
424,058

 
6,541

 
2.06

Non-taxable investments in debt and equity securities (2)
48,475

 
1,591

 
4.38

 
42,913

 
1,421

 
4.43

Short-term investments
47,771

 
186

 
0.52

 
68,926

 
153

 
0.30

Total securities and short-term investments
571,227

 
9,162

 
2.14

 
535,897

 
8,115

 
2.02

Total interest-earning assets
3,503,538

 
111,122

 
4.24

 
3,115,658

 
98,947

 
4.25

Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
56,618

 
 
 
 
 
48,633

 
 
 
 
Other assets
214,860

 
 
 
 
 
212,419

 
 
 
 
Allowance for loan losses
(44,567
)
 
 
 
 
 
(44,280
)
 
 
 
 
 Total assets
$
3,730,449

 
 
 
 
 
$
3,332,430

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
578,373

 
$
967

 
0.22
%
 
$
503,142

 
$
849

 
0.23
%
Money market accounts
1,056,565

 
3,162

 
0.40

 
915,989

 
2,136

 
0.31

Savings
102,589

 
191

 
0.25

 
86,996

 
162

 
0.25

Certificates of deposit
460,667

 
3,521

 
1.02

 
522,157

 
4,728

 
1.21

Total interest-bearing deposits
2,198,194

 
7,841

 
0.48

 
2,028,284

 
7,875

 
0.52

Subordinated debentures
56,807

 
1,078

 
2.53

 
56,807

 
924

 
2.18

Other borrowed funds
339,849

 
826

 
0.32

 
235,622

 
553

 
0.31

Total interest-bearing liabilities
2,594,850

 
9,745

 
0.50

 
2,320,713

 
9,352

 
0.54

Noninterest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
739,705

 
 
 
 
 
654,721

 
 
 
 
Other liabilities
29,196

 
 
 
 
 
26,556

 
 
 
 
Total liabilities
3,363,751

 
 
 
 
 
3,001,990

 
 
 
 
Shareholders' equity
366,698

 
 
 
 
 
330,440

 
 
 
 
Total liabilities & shareholders' equity
$
3,730,449

 
 
 
 
 
$
3,332,430

 
 
 
 
Net interest income
 
 
$
101,377

 
 
 
 
 
$
89,595

 
 
Net interest spread
 
 
 
 
3.74
%
 
 
 
 
 
3.71
%
Net interest margin
 
 
 
 
3.87
%
 
 
 
 
 
3.84
%

(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 $1.6 million and $1.5 million for the nine months ended September 30, 2016 and 2015 respectively.
(2)
Non-taxable income is presented on a fully tax-equivalent basis using a 38.3% tax rate in 2016 and 2015. The tax-equivalent adjustments were $1.3 million and $1.3 million for the nine months ended September 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 September 30,
 
Nine months ended September 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
$
4,287

 
$
632

 
$
4,919

 
$
11,977

 
$
1,130

 
$
13,107

Tax-exempt portfolio loans (3)
35

 
(68
)
 
(33
)
 
135

 
(132
)
 
3

Purchased credit impaired loans
(1,763
)
 
681

 
(1,082
)
 
(5,246
)
 
3,264

 
(1,982
)
Taxable investments in debt and equity securities
243

 
31

 
274

 
797

 
47

 
844

Non-taxable investments in debt and equity securities (3)
41

 
(3
)
 
38

 
184

 
(14
)
 
170

Short-term investments
(42
)
 
41

 
(1
)
 
(57
)
 
90

 
33

Total interest-earning assets
$
2,801

 
$
1,314

 
$
4,115

 
$
7,790

 
$
4,385

 
$
12,175

 
 
 
 
 
 
 
 
 
 
 
 
Interest paid on:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
45

 
$
(6
)
 
$
39

 
$
127

 
$
(9
)
 
$
118

Money market accounts
44

 
277

 
321

 
361

 
665

 
1,026

Savings
10

 

 
10

 
29

 

 
29

Certificates of deposit
45

 
(269
)
 
(224
)
 
(518
)
 
(689
)
 
(1,207
)
Subordinated debentures

 
55

 
55

 

 
154

 
154

Borrowed funds
65

 
23

 
88

 
253

 
20

 
273

Total interest-bearing liabilities
209

 
80

 
289

 
252

 
141

 
393

Net interest income
$
2,592

 
$
1,234

 
$
3,826

 
$
7,538

 
$
4,244

 
$
11,782

(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 $34.3 million for the three months ended September 30, 2016, compared to $30.4 million for the same period of 2015, an increase of $3.8 million, or 13%. Total interest income increased $4.1 million and total interest expense increased $0.3 million. The tax-equivalent net interest margin was 3.80% for the third quarter of 2016, compared to 3.93% for the second quarter of 2016, and 3.77% in the third quarter of 2015, and combined with portfolio loan growth, supported the $4.1 million increase in interest income. The yield on taxable portfolio loans increased 10 basis points from the prior year period to 4.23% for the three months ended September 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 $1.8 million decrease in interest income due to volume for the three months ended September 30, 2016.

Net interest income was $101.4 million for the nine months ended September 30, 2016, compared to $89.6 million for the same period of 2015, an increase of $11.8 million, or 13%. Total interest income increased $12.2 million and total interest expense increased $0.4 million. The tax-equivalent net interest margin was 3.87% for the nine months ended September 30, 2016, compared to 3.84% for the same period of 2015. The yield on taxable portfolio loans increased six basis points from the prior year period to 4.18% for the nine months ended September 30, 2016.

Core net interest margin1 was 3.53% for the nine months ended September 30, 2016, compared to 3.44% for the prior year period, an increase of nine basis points primarily due to loan growth improving the earning asset mix, lower funding costs, and the aforementioned increase in the yield on portfolio loans. These factors have been partially offset

33



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 Nine Months ended
(in thousands)
September 30, 2016
 
September 30, 2015
 
September 30, 2016
 
September 30, 2015
Accelerated cash flows and other incremental accretion
$
2,296

 
$
2,919

 
$
8,701

 
$
9,380

Provision reversal for PCI loan losses
1,194

 
227

 
1,603

 
3,497

Gain (loss) on sale of other real estate
(225
)
 
31

 
480

 
26

Other income from other real estate
287

 

 
526

 

Change in FDIC loss share receivable

 
(1,241
)
 

 
(4,450
)
Change in FDIC clawback liability

 
(298
)
 

 
(760
)
Other expenses
(270
)
 
(287
)
 
(922
)
 
(1,136
)
PCI assets income before income tax expense
$
3,282

 
$
1,351

 
$
10,388

 
$
6,557


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 September 30, 2016, the remaining accretable yield on the portfolio was estimated to be $16 million and the non-accretable difference was approximately $21 million. Accelerated cash flows and other incremental accretion from PCI loans was $8.7 million for the nine months ended September 30, 2016, and $9.4 million for the same period in 2015. The Company estimates 2016 income from accelerated cash flows and other incremental accretion to be between $10 million and $12 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 September 30,
(in thousands)
2016
 
2015
 
Increase (decrease)
Service charges on deposit accounts
$
2,200

 
$
2,044

 
$
156

 
8
 %
Wealth management revenue
1,694

 
1,773

 
(79
)
 
(4
)%
Other service charges and fee income
1,007

 
871

 
136

 
16
 %
Gain on state tax credits, net
228

 
321

 
(93
)
 
(29
)%
Gain on sale of other real estate - core

 
1

 
(1
)
 
(100
)%
Miscellaneous income - core
1,699

 
929

 
770

 
83
 %
Core noninterest income (1)
6,828

 
5,939

 
889

 
15
 %
Change in FDIC loss share receivable

 
(1,241
)
 
1,241

 
(100
)%
Gain (loss) on sale of other real estate from PCI loans
(225
)
 
31

 
(256
)
 
(826
)%
Gain on sale of investment securities
86

 

 
86

 
 %
Other income from PCI assets
287

 

 
287

 
 %
Total noninterest income
$
6,976

 
$
4,729

 
$
2,247

 
48
 %
 
 
 
 
 
 
 
 
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

 
Nine months ended September 30,
(in thousands)
2016
 
2015
 
Increase (decrease)
Service charges on deposit accounts
$
6,431

 
$
5,898

 
$
533

 
9
 %
Wealth management revenue
5,000

 
5,291

 
(291
)
 
(5
)%
Other service charges and fee income
2,827

 
2,464

 
363

 
15
 %
Gain on state tax credits, net
899

 
1,069

 
(170
)
 
(16
)%
Gain on sale of other real estate - core
122

 
35

 
87

 
249
 %
Miscellaneous income - core
3,659

 
3,762

 
(103
)
 
(3
)%
Core noninterest income (1)
18,938

 
18,519

 
419

 
2
 %
Change in FDIC loss share receivable

 
(4,450
)
 
4,450

 
(100
)%
Gain on sale of other real estate from PCI loans
480

 
26

 
454

 
1,746
 %
Gain on sale of investment securities
86

 
23

 
63

 
274
 %
Other income from PCI assets
526

 

 
526

 
 %
Total noninterest income
$
20,030

 
$
14,118

 
$
5,912

 
42
 %
 
 
 
 
 
 
 
 
(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 $5.9 million, or 42% in the first nine months of 2016 compared to the first nine months of 2015, largely from the impact of the Company's termination of FDIC loss share agreements in the fourth quarter of 2015. Core noninterest income1 grew 2% in the first nine months of 2016 due to an increase in service charges on deposit accounts, gain on sale of mortgages, and fee income from card products, when compared to the first nine 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 September 30,
(in thousands)
2016
 
2015
 
Increase (decrease)
Core expenses (1):
 
 
 
 
 
 
 
 Employee compensation and benefits - core
$
11,910

 
$
11,237

 
$
673

 
6
 %
 Occupancy - core
1,679

 
1,580

 
99

 
6
 %
 Data processing - core
1,135

 
1,107

 
28

 
3
 %
 FDIC and other insurance
780

 
654

 
126

 
19
 %
 Professional fees - core
540

 
772

 
(232
)
 
(30
)%
 Loan, legal and other real estate expense - core
310

 
567

 
(257
)
 
(45
)%
 Other - core
3,888

 
3,430

 
458

 
13
 %
Core noninterest expense (1)
20,242

 
19,347

 
895

 
5
 %
FDIC clawback

 
298

 
(298
)
 
(100
)%
Merger related expenses
302

 

 
302

 
 %
Other expenses related to PCI loans
270

 
287

 
(17
)
 
(6
)%
Total noninterest expense
$
20,814

 
$
19,932

 
$
882

 
4
 %
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

 
Nine months ended September 30,
(in thousands)
2016
 
2015
 
Increase (decrease)
Core expenses (1):
 
 
 
 
 
 
 
 Employee compensation and benefits - core
$
36,560

 
$
33,517

 
$
3,043

 
9
 %
 Occupancy - core
4,920

 
4,845

 
75

 
2
 %
 Data processing - core
3,396

 
3,205

 
191

 
6
 %
 FDIC and other insurance
2,241

 
2,045

 
196

 
10
 %
 Professional fees - core
1,942

 
2,582

 
(640
)
 
(25
)%
 Loan, legal and other real estate expense - core
782

 
1,188

 
(406
)
 
(34
)%
 Other - core
11,282

 
10,063

 
1,219

 
12
 %
Core noninterest expense (1)
61,123

 
57,445

 
3,678

 
6
 %
FDIC clawback

 
760

 
(760
)
 
(100
)%
Executive severance
332

 

 
332

 
 %
Merger related expenses
302

 

 
302

 
 %
Other non-core expenses
250

 

 
250

 
 %
Other expenses related to PCI loans
922

 
1,135

 
(213
)
 
(19
)%
Total noninterest expense
$
62,929

 
$
59,340

 
$
3,589

 
6
 %
(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 $62.9 million for the nine months ended September 30, 2016, compared to $59.3 million for the nine months ended September 30, 2015. The increase was primarily due to an increase in Employee compensation and benefits from investments in revenue producing personnel. Core noninterest expenses1 increased $3.7 million to $61.1 million for the nine months ended September 30, 2016, from $57.4 million for the prior year

36



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 declined to 55.4% for the nine months ended September 30, 2016 from 58.9% 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 for the fourth quarter of 2016.

Income Taxes

The Company's income tax expense for the three and nine months ended September 30, 2016, which includes both federal and state taxes, was $6.3 million and $18.9 million, respectively, compared to $4.7 million and $14.5 million, respectively, for the same periods of 2015. The combined federal and state effective income tax rate for the nine months ended September 30, 2016 was 35.0%, and was 34.3% for the same period in 2015. The increase in the effective tax rate over the prior year period was caused by higher pre-tax income lessening the impact of permanent differences, and a state tax benefit from refunds received for prior years.

Summary Balance Sheet

(in thousands)
September 30, 2016
 
December 31, 2015
 
Increase (decrease)
Total cash and cash equivalents
$
118,499

 
$
94,157

 
24,342

25.9
 %
Securities
520,640

 
495,484

 
25,156

5.1
 %
Portfolio loans
3,037,705

 
2,750,737

 
286,968

10.4
 %
Purchased credit impaired loans
47,449

 
74,758

 
(27,309
)
(36.5
)%
Total assets
3,909,644

 
3,608,483

 
301,161

8.3
 %
Deposits
3,124,825

 
2,784,591

 
340,234

12.2
 %
Total liabilities
3,528,546

 
3,257,654

 
270,892

8.3
 %
Total shareholders' equity
381,098

 
350,829

 
30,269

8.6
 %

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:


37



(in thousands)
September 30, 2016
 
December 31, 2015
 
Increase (decrease)
Commercial and industrial
$
1,598,815

 
$
1,484,327

 
$
114,488

7.7
 %
Commercial real estate - investor owned
515,055

 
428,064

 
86,991

20.3
 %
Commercial real estate - owner occupied
340,916

 
342,959

 
(2,043
)
(0.6
)%
Construction and land development
188,856

 
161,061

 
27,795

17.3
 %
Residential real estate
233,960

 
196,498

 
37,462

19.1
 %
Consumer and other
160,103

 
137,828

 
22,275

16.2
 %
   Portfolio loans
3,037,705

 
2,750,737

 
286,968

10.4
 %
Purchased credit impaired loans
47,449

 
74,758

 
(27,309
)
(36.5
)%
   Total loans
$
3,085,154

 
$
2,825,495

 
$
259,659

9.2
 %

Portfolio loans grew by $287.0 million, to $3.0 billion at September 30, 2016, when compared to December 31, 2015. PCI loans totaled $47.4 million at September 30, 2016, a decrease of $27.3 million, or 37%, from December 31, 2015, primarily as a result of principal paydowns and accelerated loan payoffs.

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

(in thousands)
September 30, 2016
 
December 31, 2015
 
Increase (decrease)
Enterprise value lending
$
394,923

 
$
350,266

 
$
44,657

12.7
%
C&I - general
755,829

 
732,186

 
23,643

3.2
%
Life insurance premium financing
298,845

 
265,184

 
33,661

12.7
%
Tax credits
149,218

 
136,691

 
12,527

9.2
%
CRE, Construction, and land development
1,044,827

 
932,084

 
112,743

12.1
%
Residential
233,960

 
196,498

 
37,462

19.1
%
Other
160,103

 
137,828

 
22,275

16.2
%
Portfolio loans
$
3,037,705

 
$
2,750,737

 
$
286,968

10.4
%

Specialized lending products, especially Enterprise value lending, Life insurance premium financing, and Tax credits, consist 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 expects continued loan growth in the fourth quarter of 2016, and loan growth, excluding the acquisition of JCB, at or above 10% for 2017.



38



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 September 30,
 
Nine months ended September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Allowance at beginning of period, for portfolio loans
$
35,498

 
$
31,765

 
$
33,441

 
$
30,185

Loans charged off:
 
 
 
 
 
 
 
Commercial and industrial
(2,044
)
 
(572
)
 
(2,269
)
 
(3,634
)
Real estate:
 
 
 
 
 
 
 
Commercial

 

 

 
(664
)
Construction and land development

 

 

 
(350
)
Residential
(25
)
 
(240
)
 
(25
)
 
(1,313
)
Consumer and other
(4
)
 
(9
)
 
(15
)
 
(24
)
Total loans charged off
(2,073
)
 
(821
)

(2,309
)

(5,985
)
Recoveries of loans previously charged off:
 
 
 
 
 
 
 
Commercial and industrial
69

 
389

 
624

 
1,578

Real estate:
 
 
 
 
 
 
 
Commercial
25

 
84

 
123

 
1,540

Construction and land development
913

 
125

 
927

 
300

Residential
26

 
108

 
96

 
221

Consumer and other
2

 
2

 
9

 
83

Total recoveries of loans
1,035

 
708


1,779


3,722

Net loan charge-offs
(1,038
)
 
(113
)

(530
)

(2,263
)
Provision for portfolio loan losses
3,038

 
599

 
4,587

 
4,329

Allowance at end of period, for portfolio loans
$
37,498

 
$
32,251


$
37,498


$
32,251

 
 
 
 
 
 
 
 
Allowance at beginning of period, for purchased credit impaired loans
$
8,551

 
$
11,594

 
$
10,175

 
$
15,410

   Loans charged off
(312
)
 
(10
)
 
(1,295
)
 
(12
)
Other
(612
)
 
(18
)
 
(844
)
 
(562
)
Net loan charge-offs
(924
)
 
(28
)

(2,139
)

(574
)
Provision reversal for PCI loan losses
(1,194
)
 
(227
)
 
(1,603
)
 
(3,497
)
Allowance at end of period, for purchased credit impaired loans
$
6,433

 
$
11,339


$
6,433


$
11,339

 
 
 
 
 
 
 
 
Total allowance at end of period
$
43,931

 
$
43,590

 
$
43,931

 
$
43,590

 
 
 
 
 
 
 
 
Portfolio loans, average
$
2,947,949

 
$
2,540,948

 
$
2,864,916

 
$
2,483,488

Portfolio loans, ending
3,037,705

 
2,602,156

 
3,037,705

 
2,602,156

Net charge-offs to average portfolio loans
0.14
%
 
0.02
%
 
0.02
%
 
0.12
%
Allowance for portfolio loan losses to loans
1.23
%
 
1.24
%
 
1.23
%
 
1.24
%

The provision for loan losses on portfolio loans for the nine months ended September 30, 2016 was $4.6 million, compared to $4.3 million for the comparable 2015 period. The provision for loan losses for the nine month period ended September 30, 2016 is reflective of growth in the portfolio as well as reflecting additional reserves on loans evaluated individually for impairment. 


39



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 $1.6 million of provision reversal for loan losses on PCI loans for the nine months ended September 30, 2016, compared to provision reversal of $3.5 million for the comparable 2015 period.

The allowance for loan losses on portfolio loans was 1.23% of portfolio loans at September 30, 2016 compared to 1.24% at September 30, 2015. Management believes the allowance for loan losses is adequate to absorb inherent losses in the loan portfolio. The reduction in the ratio of allowance for loan losses to total loans over the prior year period is due to continued strong credit performance, and the low level of charge-off activity during the year, which also results in 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)
September 30,
2016
 
December 31,
2015
 
September 30,
2015
Non-accrual loans
$
17,622

 
$
8,797

 
$
9,123

Restructured loans
2,320

 
303

 

Total nonperforming loans (1)
19,942

 
9,100

 
9,123

Other real estate from originated loans
2,719

 
3,218

 
1,575

Other real estate from acquired loans
240

 
5,148

 

Total nonperforming assets (1) (2)
$
22,901

 
$
17,466

 
$
10,698

 
 
 
 
 
 
Total assets
$
3,909,644

 
$
3,608,483

 
$
3,516,541

Portfolio loans
3,037,705

 
2,750,737

 
2,602,156

Portfolio loans plus other real estate
3,040,664

 
2,759,103

 
2,603,731

Nonperforming loans to portfolio loans (1)
0.66
%
 
0.33
%
 
0.35
%
Nonperforming assets to total loans plus other real estate (1) (2)
0.75

 
0.63

 
0.41

Nonperforming assets to total assets (1) (2)
0.59

 
0.48

 
0.30

Allowance for portfolio loans to nonperforming loans (1)
188
%
 
367
%
 
354
%
 
 
 
 
 
 
(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.


40



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)
September 30, 2016
 
December 31, 2015
 
September 30, 2015
Commercial and industrial
$
13,160

 
$
4,514

 
$
2,975

Commercial real estate
252

 
1,105

 
2,611

Construction and land development
1,907

 
2,800

 
2,823

Residential real estate
124

 
681

 
714

Consumer and other
4,499

 

 

Total
$
19,942

 
$
9,100


$
9,123


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

 
$
22,244

Additions to nonaccrual loans
18,354

 
18,854

Additions to restructured loans
2,320

 

Charge-offs
(2,104
)
 
(6,109
)
Other principal reductions
(6,058
)
 
(24,840
)
Moved to other real estate
(283
)
 
(450
)
Moved to performing
(1,387
)
 
(576
)
Loans past due 90 days or more and still accruing interest

 

Nonperforming loans end of period
$
19,942

 
$
9,123


Nonperforming loans at September 30, 2016 increased by $10.8 million, or 119%, when compared to September 30, 2015 and December 31, 2015, primarily due to the addition of one $10.8 million relationship in the C&I portfolio.

Other real estate
Other real estate at September 30, 2016, was $3.0 million, compared to $8.4 million at September 30, 2015.

The following table summarizes the changes in Other real estate:
 
Nine months ended September 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

 
6,604

Writedowns in value

 
(299
)
Sales
(7,610
)
 
(5,775
)
Other real estate end of period
$
2,959

 
$
8,370


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 nine months ended September 30, 2016, the Company realized a net gain of $0.6 million from the sales of other real estate, primarily from the sale of properties related to PCI loans, and recorded these gains as part of Noninterest income.


41



Liabilities

Liabilities totaled $3.5 billion at September 30, 2016, compared to $3.3 billion at December 31, 2015. The increase in liabilities was largely due to a $340 million increase in total deposits, offset by a decrease of $80 million in other borrowings.

Deposits
(in thousands)
September 30, 2016
 
December 31, 2015
 
Increase (decrease)
Demand deposits
$
762,155

 
$
717,460

 
44,695

 
6.2
%
Interest-bearing transaction accounts
633,100

 
564,420

 
68,680

 
12.2
%
Money market accounts
1,131,997

 
1,053,662

 
78,335

 
7.4
%
Savings
109,728

 
92,861

 
16,867

 
18.2
%
Certificates of deposit:
 
 
 
 
 
 
 
Brokered
137,592

 
39,573

 
98,019

 
247.7
%
Other
350,253

 
316,615

 
33,638

 
10.6
%
Total deposits
$
3,124,825

 
$
2,784,591

 
340,234

 
12.2
%
 
 
 
 
 
 
 
 
Non-time deposits / total deposits
84
%
 
87
%
 
 
 
 
Demand deposits / total deposits
24
%
 
26
%
 
 
 
 

Total deposits at September 30, 2016 were $3.1 billion, an increase of $340 million, or 12%, from December 31, 2015. Growth in core deposits, defined as total deposits excluding time deposits, was strong at $208.6 million, or 9%, supporting robust loan growth and was augmented by an increase in brokered certificates of deposit. The composition of our noninterest bearing deposits remained relatively stable at 24% of total deposits at September 30, 2016 compared to December 31, 2015. Lower rates on time deposit balances and a change in composition improved deposit costs by three basis points during the first nine months of 2016 to 0.36%, as compared to 0.39% for the same period in 2015.

Shareholders' Equity

Shareholders' equity totaled $381 million at September 30, 2016, an increase of $30.3 million from December 31, 2015. Significant activity during the nine months ended September 30, 2016 was as follows:

Net income of $35.2 million,
Other comprehensive income of $4.5 million from the change in unrealized gains on investment securities,
Repurchase of 185,718 common shares for $4.9 million,
Dividends paid on common shares of $6.0 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 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.

42




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 September 30, 2016, there are no outstanding balances under the Revolving Agreement. Additionally, the Company received three 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 $6.2 million, together with the Company's other available funding sources, will be sufficient to meet projected cash needs for at least the next year.

As of September 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 September 30, 2016 the Bank has borrowing capacity of $293.8 million from the FHLB of Des Moines under blanket loan pledges, and has an additional $878.2 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 $479.6 million of the securities available for sale at September 30, 2016, $321.5 million was pledged as collateral for deposits of public institutions, treasury, loan notes, and other requirements. The remaining $158.1 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 $1.2 billion in unused commitments as of September 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.

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

43



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 September 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 September 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)
September 30,
2016
 
December 31, 2015
Well Capitalized Minimum %
Total capital to risk-weighted assets
12.01
%
 
11.85
%
10.00
%
Tier 1 capital to risk-weighted assets
10.82
%
 
10.61
%
8.00
%
Common equity tier 1 capital to risk-weighted assets
9.33
%
 
9.05
%
6.50
%
Leverage ratio (Tier 1 capital to average assets)
10.58
%
 
10.71
%
5.00
%
Tangible common equity to tangible assets1
8.99
%
 
8.88
%
N/A

Tier 1 capital
$
400,382

 
$
374,676

 
Total risk-based capital
444,388

 
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.

44



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, merger related expenses, 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.

45



Core Performance Measures
 
For the Three Months ended
 
For the Nine Months ended
(in thousands)
September 30,
2016
 
June 30,
2016
 
September 30,
2015
 
September 30,
2016
 
September 30,
2015
Net interest income
$
33,830

 
$
33,783

 
$
30,006

 
$
100,041

 
$
88,331

Less: Incremental accretion income
2,296

 
3,571

 
2,919

 
8,701

 
9,380

Core net interest income
31,534

 
30,212

 
27,087

 
91,340

 
78,951

 
 
 
 
 
 
 
 
 
 
Total noninterest income
6,976

 
7,049

 
4,729

 
20,030

 
14,118

Less: Change in FDIC loss share receivable

 

 
(1,241
)
 

 
(4,450
)
Less: Gain (loss) on sale of other real estate from PCI loans
(225
)
 
705

 
31

 
480

 
26

Less: Gain on sale of investment securities
86

 

 

 
86

 
23

Less: Other income from PCI assets
287

 
239

 

 
526

 

Core noninterest income
6,828

 
6,105

 
5,939

 
18,938

 
18,519

 
 
 
 
 
 
 
 
 
 
Total core revenue
38,362

 
36,317

 
33,026

 
110,278

 
97,470

 
 
 
 
 
 
 
 
 
 
Provision for portfolio loans
3,038

 
716

 
599

 
4,587

 
4,329

 
 
 
 
 
 
 
 
 
 
Total noninterest expense
20,814

 
21,353

 
19,932

 
62,929

 
59,340

Less: FDIC clawback

 

 
298

 

 
760

Less: Other expenses related to PCI loans
270

 
325

 
287

 
922

 
1,135

Less: Executive severance

 
332

 

 
332

 

Less: Merger related expenses
302

 

 

 
302

 

Less: Other non-core expenses

 
250

 

 
250

 

Core noninterest expense
20,242

 
20,446

 
19,347

 
61,123

 
57,445

 
 
 
 
 
 
 
 
 
 
Core income before income tax expense
15,082

 
15,155

 
13,080

 
44,568

 
35,696

 
 
 
 
 
 
 
 
 
 
Total income tax expense
6,316

 
6,747

 
4,722

 
18,949

 
14,506

Less: Non-core income tax expense1
1,174

 
1,510

 
518

 
3,673

 
2,521

Core income tax expense
5,142

 
5,237

 
4,204

 
15,276

 
11,985

Core net income
$
9,940

 
$
9,918

 
$
8,876

 
$
29,292

 
$
23,711

 
 
 
 
 
 
 
 
 
 
Core diluted earnings per share
$
0.49

 
$
0.49

 
$
0.44

 
$
1.45

 
$
1.17

Core return on average assets
1.04
%
 
1.07
%
 
1.03
%
 
1.05
%
 
0.95
%
Core return on average common equity
10.47
%
 
10.89
%
 
10.41
%
 
10.67
%
 
9.59
%
Core return on average tangible common equity
11.46
%
 
11.98
%
 
11.56
%
 
11.73
%
 
10.70
%
Core efficiency ratio
52.77
%
 
56.30
%
 
58.58
%
 
55.43
%
 
58.94
%
 
 
 
 
 
 
 
 
 
 
1Non-core income tax expense calculated at 38.3% of non-core pretax income.


46




Net Interest Margin to Core Net Interest Margin (fully tax equivalent)
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Net interest income
$
34,263

 
$
30,437

 
$
101,377

 
$
89,595

Less: Incremental accretion income
2,296

 
2,919

 
8,701

 
9,380

Core net interest income
$
31,967

 
$
27,518

 
$
92,676

 
$
80,215

 
 
 
 
 
 
 
 
Average earning assets
$
3,589,080

 
$
3,201,181

 
$
3,503,538

 
$
3,115,658

Reported net interest margin
3.80
%
 
3.77
%
 
3.87
%
 
3.84
%
Core net interest margin
3.54
%
 
3.41
%
 
3.53
%
 
3.44
%


Tangible common equity ratio
(in thousands)
September 30, 2016
 
December 31, 2015
Total shareholders' equity
$
381,098

 
$
350,829

Less: Goodwill
30,334

 
30,334

Less: Intangible assets
2,357

 
3,075

Tangible common equity
$
348,407

 
$
317,420

 
 
 
 
Total assets
$
3,909,644

 
$
3,608,483

Less: Goodwill
30,334

 
30,334

Less: Intangible assets
2,357

 
3,075

Tangible assets
$
3,876,953

 
$
3,575,074

 
 
 
 
Tangible common equity to tangible assets
8.99
%
 
8.88
%

47



Regulatory Capital to Risk-Weighted Assets

(in thousands)
September 30, 2016
 
December 31, 2015
Total shareholders' equity
$
381,098

 
$
350,829

Less: Goodwill
30,334

 
30,334

Less: Intangible assets, net of deferred tax liabilities
873

 
759

Less: Unrealized gains
4,668

 
218

Plus: Other
24

 
35

Common equity tier 1 capital
345,247

 
319,553

Plus: Qualifying trust preferred securities
55,100

 
55,100

Plus: Other
35

 
23

Tier 1 capital
400,382

 
374,676

Plus: Tier 2 capital
44,006

 
43,691

Total risk-based capital
444,388

 
418,367

 
 
 
 
Total risk-weighted assets determined in accordance with prescribed regulatory requirements
$
3,699,757

 
$
3,530,521

 
 
 
 
Common equity tier 1 to risk-weighted assets
9.33
%
 
9.05
%
Tier 1 capital to risk-weighted assets
10.82
%
 
10.61
%
Total risk-based capital to risk-weighted assets
12.01
%
 
11.85
%

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.

48



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
7.8%
+ 200 bp
5.5%
+ 100 bp
3.0%
 - 100 bp
-5.0%

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 September 30, 2016, the Company had $3.5 million in notional amount of outstanding interest rate caps, to help manage interest rate risk.

49



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 September 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 September 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.


50



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 September 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
July 1, 2016 through July 31, 2016
 
6,700

 
$
26.50

 
6,700

 
1,814,282

August 1, 2016 through August 31, 2016
 

 

 

 
1,814,282

September 1, 2016 through September 30, 2016
 

 

 

 
1,814,282

Total
 
6,700

 
$
26.50

 
6,700

 
 


(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.

*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 September 30, 2016, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheet at September 30, 2016 and December 31, 2015; (ii) Consolidated Statement of Income for the three and nine months ended September 30, 2016 and 2015; (iii) Consolidated Statement of Comprehensive Income for the three and nine months ended September 30, 2016 and 2015; (iv) Consolidated Statement of Changes in Equity for the nine months ended September 30, 2016 and 2015; (v) Consolidated Statement of Cash Flows for the nine months ended September 30, 2016 and 2015; and (vi) Notes to Financial Statements.

* 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.



51



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 October 25, 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
 



52