Document


 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
 
FORM 10-Q
 
[X]
 
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2018.
 
 
 
[   ]
 
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, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [X]
 
 
 
Accelerated filer [ ]
Non-accelerated filer [ ]
 
(Do not check if a smaller reporting company)
 
Smaller reporting company [ ]
 
 
 
 
Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Yes [   ]  No [X]
 
As of July 25, 2018, the Registrant had 23,150,738 shares of outstanding common stock, $0.01 par value.
 
This document is also available through our website at http://www.enterprisebank.com.
 






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





PART 1 - ITEM 1 - FINANCIAL STATEMENTS
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
(in thousands, except share and per share data)
June 30, 2018
 
December 31, 2017
Assets
 
 
 
Cash and due from banks
$
91,851

 
$
91,084

Federal funds sold
1,445

 
1,223

Interest-bearing deposits (including $1,295 and $1,365 pledged as collateral, respectively)
83,961

 
61,016

Total cash and cash equivalents
177,257

 
153,323

Interest-bearing deposits greater than 90 days
2,180

 
2,645

Securities available for sale
651,140

 
641,382

Securities held to maturity
68,931

 
73,749

Loans held for sale
1,388

 
3,155

Loans
4,275,761

 
4,097,050

Less: Allowance for loan losses
44,370

 
42,577

Total loans, net
4,231,391

 
4,054,473

Other real estate
454

 
498

Other investments, at cost
36,132

 
26,661

Fixed assets, net
32,814

 
32,618

Accrued interest receivable
17,808

 
14,069

State tax credits held for sale (including $299 and $400 carried at fair value, respectively)
46,481

 
43,468

Goodwill
117,345

 
117,345

Intangible assets, net
9,768

 
11,056

Other assets
116,835

 
114,783

Total assets
$
5,509,924

 
$
5,289,225

 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
Demand deposits
$
1,050,969

 
$
1,123,907

Interest-bearing transaction accounts
754,819

 
915,653

Money market accounts
1,558,923

 
1,342,931

Savings
209,870

 
195,150

Certificates of deposit:
 
 
 
Brokered
224,192

 
115,306

Other
449,139

 
463,467

Total deposits
4,247,912

 
4,156,414

Subordinated debentures and notes (net of debt issuance cost of $1,071 and $1,136, respectively)
118,131

 
118,105

Federal Home Loan Bank advances
361,534

 
172,743

Other borrowings
167,216

 
253,674

Accrued interest payable
1,884

 
1,730

Other liabilities
39,163

 
37,986

Total liabilities
4,935,840

 
4,740,652

 
 
 
 
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; 23,900,669 and 23,781,112 shares issued, respectively
239

 
238

Treasury stock, at cost; 756,588 and 691,673 shares, respectively
(26,326
)
 
(23,268
)
Additional paid in capital
348,471

 
350,061

Retained earnings
264,280

 
225,360

Accumulated other comprehensive loss
(12,580
)
 
(3,818
)
Total shareholders' equity
574,084

 
548,573

Total liabilities and shareholders' equity
$
5,509,924

 
$
5,289,225

See accompanying notes to consolidated financial statements.

1



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands, except per share data)
2018
 
2017
 
2018
 
2017
Interest income:
 
 
 
 
 
 
 
Interest and fees on loans
$
52,948

 
$
47,307

 
$
103,398

 
$
87,233

Interest on debt securities:
 
 
 
 
 
 
 
Taxable
4,228

 
3,585

 
8,215

 
6,815

Nontaxable
271

 
304

 
553

 
690

Interest on interest-bearing deposits
231

 
234

 
471

 
364

Dividends on equity securities
201

 
112

 
406

 
180

Total interest income
57,879

 
51,542


113,043


95,282

Interest expense:
 
 
 
 
 
 
 
Interest-bearing transaction accounts
817

 
523

 
1,623

 
1,198

Money market accounts
4,445

 
1,938

 
7,798

 
3,431

Savings accounts
147

 
125

 
272

 
207

Certificates of deposit
2,338

 
1,373

 
4,237

 
2,588

Subordinated debentures and notes
1,454

 
1,288

 
2,822

 
2,452

Federal Home Loan Bank advances
1,448

 
522

 
2,706

 
852

Notes payable and other borrowings
182

 
140

 
366

 
279

Total interest expense
10,831

 
5,909


19,824


11,007

Net interest income
47,048

 
45,633

 
93,219

 
84,275

Provision for portfolio loan losses
2,385

 
3,623

 
4,256

 
5,156

Provision reversal for purchased credit impaired loan losses
(1,995
)
 
(207
)
 
(1,995
)
 
(355
)
Net interest income after provision for loan losses
46,658

 
42,217


90,958


79,474

Noninterest income:
 
 
 
 
 
 
 
Service charges on deposit accounts
3,007

 
2,816

 
5,858

 
5,326

Wealth management revenue
2,141

 
2,054

 
4,255

 
3,887

Card services revenue
1,650

 
1,392

 
3,166

 
2,429

Gain on sale of other real estate

 
17

 

 
17

Gain on state tax credits, net
64

 
9

 
316

 
255

Gain on sale of investment securities

 

 
9

 

Miscellaneous income
2,831

 
1,646

 
5,631

 
2,996

Total noninterest income
9,693

 
7,934


19,235


14,910

Noninterest expense:
 
 
 
 
 
 
 
Employee compensation and benefits
16,582

 
15,798

 
33,073

 
31,006

Occupancy
2,342

 
2,265

 
4,748

 
4,194

Data processing
1,533

 
1,806

 
3,000

 
3,439

Professional fees
747

 
1,079

 
1,596

 
1,916

FDIC and other insurance
920

 
650

 
1,837

 
1,474

Loan legal and other real estate expense
(23
)
 
613

 
276

 
958

Merger related expenses

 
4,480

 

 
6,147

Other
7,118

 
5,960

 
13,832

 
10,253

Total noninterest expense
29,219

 
32,651


58,362


59,387

 
 
 
 
 
 
 
 
Income before income tax expense
27,132

 
17,500


51,831


34,997

Income tax expense
4,881

 
5,545

 
8,659

 
10,651

Net income
$
22,251

 
$
11,955


$
43,172


$
24,346

 
 
 
 
 
 
 
 
Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.96

 
$
0.51

 
$
1.87

 
$
1.07

Diluted
0.95

 
0.50

 
1.85

 
1.06

See accompanying notes to consolidated financial statements.

2




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

 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Net income
$
22,251

 
$
11,955

 
$
43,172

 
$
24,346

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 $(333) and $921, and for six months of $($2,598) and $1,268, respectively
(1,017
)
 
1,502

 
(7,921
)
 
2,070

Less: Reclassification adjustment for realized gains on sale of securities available for sale included in net income, net of income tax expense for the six months of $2 and $0, respectively

 

 
(7
)
 

Total other comprehensive income (loss)
(1,017
)
 
1,502

 
(7,928
)
 
2,070

Total comprehensive income
$
21,234

 
$
13,457

 
$
35,244

 
$
26,416


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)
Common Stock
 
Treasury Stock
 
Additional paid in capital
 
Retained earnings
 
Accumulated
other
comprehensive income (loss)
 
Total
shareholders' equity
Balance December 31, 2017
$
238

 
$
(23,268
)
 
$
350,061

 
$
225,360

 
$
(3,818
)
 
$
548,573

Net income

 

 

 
43,172

 

 
43,172

Other comprehensive income

 

 

 

 
(7,928
)
 
(7,928
)
Total comprehensive income

 

 

 
43,172

 
(7,928
)
 
35,244

Cash dividends paid on common shares, $0.22 per share

 

 

 
(5,086
)
 

 
(5,086
)
Repurchase of common shares

 
(3,058
)
 

 

 

 
(3,058
)
Issuance under equity compensation plans, 119,557 shares, net
1

 

 
(3,221
)
 

 

 
(3,220
)
Share-based compensation

 

 
1,631

 

 

 
1,631

Reclassification adjustments for change in accounting policies



 

 
834

 
(834
)
 

Balance June 30, 2018
$
239

 
$
(26,326
)
 
$
348,471

 
$
264,280

 
$
(12,580
)
 
$
574,084

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except per share data)
Common Stock
 
Treasury Stock
 
Additional paid in capital
 
Retained earnings
 
Accumulated
other
comprehensive income (loss)
 
Total
shareholders' equity
Balance December 31, 2016
$
203

 
$
(6,632
)
 
$
213,078

 
$
182,190

 
$
(1,741
)
 
$
387,098

Net income

 

 

 
24,346

 

 
24,346

Other comprehensive income

 

 

 

 
2,070

 
2,070

Total comprehensive income

 

 

 
24,346

 
2,070

 
26,416

Cash dividends paid on common shares, $0.22 per share

 

 

 
(5,163
)
 

 
(5,163
)
Issuance under equity compensation plans, 140,531 shares, net
1

 

 
(2,904
)
 

 

 
(2,903
)
Share-based compensation

 

 
1,576

 

 

 
1,576

Shares issued in connection with acquisition of Jefferson County Bancshares, Inc., 3,299,865 shares, net
33

 

 
141,696

 

 

 
141,729

Reclassification for the adoption of share-based payment guidance

 

 
(5,229
)
 
5,229

 

 

Balance June 30, 2017
$
237

 
$
(6,632
)
 
$
348,217

 
$
206,602

 
$
329

 
$
548,753


See accompanying notes to consolidated financial statements.

4



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
Six months ended June 30,
(in thousands, except share data)
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
43,172

 
$
24,346

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation
1,707

 
1,583

Provision for loan losses
2,261

 
4,800

Deferred income taxes
3,156

 
4,166

Net amortization of debt securities
956

 
1,708

Amortization of intangible assets
1,288

 
1,207

Gain on sale of investment securities
(9
)
 

Mortgage loans originated for sale
(25,064
)
 
(80,697
)
Proceeds from mortgage loans sold
27,070

 
86,127

Gain on sale of other real estate

 
(17
)
Gain on state tax credits, net
(316
)
 
(255
)
Share-based compensation
1,631

 
1,576

Net accretion of loan discount
(793
)
 
(3,001
)
Changes in:
 
 
 
Accrued interest receivable
(3,739
)
 
1,988

Accrued interest payable
154

 
(299
)
Other assets
(809
)
 
483

Other liabilities
1,203

 
(51,359
)
Net cash provided by (used in) operating activities
51,868

 
(7,644
)
Cash flows from investing activities:
 
 
 
Proceeds from JCB acquisition, net of cash purchase price

 
4,456

Net increase in loans
(178,386
)
 
(65,592
)
Proceeds from the sale of securities, available for sale
1,451

 
143,554

Proceeds from the paydown or maturity of securities, available for sale
40,743

 
107,603

Proceeds from the paydown or maturity of securities, held to maturity
3,239

 
2,722

Proceeds from the redemption of other investments
22,728

 
23,390

Proceeds from the sale of state tax credits held for sale
1,940

 
4,286

Proceeds from the sale of other real estate

 
2,513

Payments for the purchase/origination of:
 
 
 
Available for sale debt securities
(62,055
)
 
(263,453
)
Other investments
(33,719
)
 
(30,977
)
State tax credits held for sale
(4,636
)
 

Fixed assets, net
(1,915
)
 
(1,140
)
Net cash used in investing activities
(210,610
)
 
(72,638
)
Cash flows from financing activities:
 
 
 
Net decrease in noninterest-bearing deposit accounts
(72,938
)
 
(8,162
)
Net increase (decrease) in interest-bearing deposit accounts
164,436

 
(69,117
)
Proceeds from Federal Home Loan Bank advances
907,500

 
1,141,181

Repayments of Federal Home Loan Bank advances
(718,500
)
 
(940,681
)
Net decrease in other borrowings
(86,458
)
 
(115,911
)
Cash dividends paid on common stock
(5,086
)
 
(5,163
)
Payments for the repurchase of common stock
(3,058
)
 

Payments for the issuance of equity instruments, net
(3,220
)
 
(2,903
)
Net cash provided by (used in) financing activities
182,676

 
(756
)
Net increase (decrease) in cash and cash equivalents
23,934

 
(81,038
)
Cash and cash equivalents, beginning of period
153,323

 
198,802

Cash and cash equivalents, end of period
$
177,257

 
$
117,764

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
19,670

 
$
10,653

Income taxes
780

 
6,386

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

 
$
289

Common shares issued in connection with JCB acquisition

 
141,729


See accompanying notes to consolidated financial statements.

5



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

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

Business and Consolidation

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

Operating results for the three and six months ended June 30, 2018 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2018. 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, 2017.

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.

During the first quarter of 2018, the Company adopted Accounting Standards Update ("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. The guidance also provides an alternative to measure equity securities without readily determinable fair values at cost less impairment (if any), plus or minus observable price changes from an identical or similar investment of the same issuer (the “measurement alternative”). The Company elected the measurement alternative for its qualifying equity securities. The adoption of this update resulted in an insignificant increase to retained earnings which was reclassified from accumulated other comprehensive income.

In addition, the Company early adopted ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities" during the first quarter of 2018. The objective of ASU 2017-12 is to improve the financial reporting of hedging relationships by better aligning an entity's risk management activity with the economic objectives in undertaking those activities. The adoption of this update had an insignificant impact on the Company's consolidated financial statements.

The Company also early adopted ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" during the first quarter of 2018. The ASU allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The adoption of this update resulted in an increase to retained earnings of $0.8 million which was reclassified from accumulated other comprehensive income.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.


6



Revenue

The Company adopted the accounting standard regarding revenue recognition in the first quarter of 2018 using the modified retrospective approach. The Company's revenues are primarily composed of interest income on financial instruments, including investment securities, which are excluded from the scope of the new guidance. Certain other noninterest income from loans, investment securities and derivative financial instruments is also excluded from this guidance. Service charges on deposit accounts, wealth management revenue, card services revenue, and gain on sale of other real estate are within the scope of the guidance; however, there were no accounting policy changes as the Company's policies were consistent with the new guidance. Other noninterest income sources of revenue are considered immaterial. Implementation of this guidance did not change current business practices or have any changes to the Company's consolidated financial statements.
Descriptions of our revenue-generating activities within the scope of this guidance, which are presented in our income statement as components of noninterest income are as follows:
Service charges on deposit accounts - represents fees generated from a variety of deposit products and services provided to customers under a day-to-day contract. These fees are recognized on a daily or monthly basis.
Wealth management revenue - represents monthly fees earned from directing, holding, and managing customers’ assets. Revenue is recognized over regular intervals, either monthly or quarterly.
Card services revenue - represents revenue earned from merchant, debit and credit cards as incurred and includes a contra revenue account for rebates.
Gain on sale of other real estate - represents income recognized at delivery of control of a property at the time of a real estate closing.

Income Taxes

The SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Cuts and Jobs Act of 2017 (“Tax Act”). SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act. The Company has recorded amounts based on the information known and reasonable estimates used as of June 30, 2018, but are subject to change based on a number of factors. The Company will complete its analysis of certain tax positions at the time it files its tax returns for the year ended December 31, 2017 and will be able to conclude if any further adjustments to the provisional estimate of the impact recorded is required.


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.


7



The following table presents a summary of per common share data and amounts for the periods indicated.
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands, except per share data)
2018
 
2017
 
2018
 
2017
Net income as reported
$
22,251

 
$
11,955

 
$
43,172

 
$
24,346

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
23,124

 
23,475

 
23,119

 
22,706

Additional dilutive common stock equivalents
194

 
257

 
213

 
314

Weighted average diluted common shares outstanding
23,318

 
23,732

 
23,332

 
23,020

 
 
 
 
 
 
 
 
Basic earnings per common share:
$
0.96

 
$
0.51

 
$
1.87

 
$
1.07

Diluted earnings per common share:
$
0.95

 
$
0.50

 
$
1.85

 
$
1.06


For the three and six months ended June 30, 2018 and 2017, there were no common stock equivalents excluded from the earnings per share calculations because their effect would have been anti-dilutive.

8



NOTE 3 - INVESTMENTS

The following table presents the amortized cost, gross unrealized gains and losses and fair value of securities available for sale and held to maturity:
 
 
June 30, 2018
(in thousands)
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
Available for sale securities:
 
 
 
 
 
 
 
Obligations of U.S. Government-sponsored enterprises
$
99,902

 
$

 
$
(1,858
)
 
$
98,044

Obligations of states and political subdivisions
31,750

 
348

 
(154
)
 
31,944

Agency mortgage-backed securities
525,810

 
369

 
(14,890
)
 
511,289

U.S. Treasury bills
9,957

 

 
(94
)
 
9,863

          Total securities available for sale
$
667,419

 
$
717

 
$
(16,996
)
 
$
651,140

Held to maturity securities:
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
12,537

 
$
7

 
$
(240
)
 
$
12,304

Agency mortgage-backed securities
56,394

 

 
(1,789
)
 
54,605

          Total securities held to maturity
$
68,931

 
$
7


$
(2,029
)

$
66,909


 
December 31, 2017
(in thousands)
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
Available for sale securities:
 
 
 
 
 
 
 
    Obligations of U.S. Government-sponsored enterprises
$
99,878

 
$
6

 
$
(660
)
 
$
99,224

    Obligations of states and political subdivisions
34,181

 
674

 
(213
)
 
34,642

    Agency mortgage-backed securities
513,082

 
727

 
(6,293
)
 
507,516

          Total securities available for sale
$
647,141

 
$
1,407

 
$
(7,166
)
 
$
641,382

Held to maturity securities:
 
 
 
 
 
 
 
   Obligations of states and political subdivisions
$
14,031

 
$
69

 
$
(46
)
 
$
14,054

   Agency mortgage-backed securities
59,718

 
16

 
(330
)
 
59,404

          Total securities held to maturity
$
73,749

 
$
85

 
$
(376
)
 
$
73,458


At June 30, 2018, and December 31, 2017, 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 agencies and sponsored enterprises. Securities having a fair value of $376.0 million and $500.0 million at June 30, 2018, and December 31, 2017, respectively, were pledged as collateral to secure deposits of public institutions and for other purposes as required by law or contract provisions.


9



The amortized cost and estimated fair value of debt securities at June 30, 2018, 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 5 years.
 
 
Available for sale
 
Held to maturity
(in thousands)
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
2,675

 
$
2,690

 
$

 
$

Due after one year through five years
121,187

 
119,369

 
867

 
866

Due after five years through ten years
12,703

 
12,804

 
10,804

 
10,603

Due after ten years
5,044

 
4,988

 
866

 
835

Agency mortgage-backed securities
525,810

 
511,289

 
56,394

 
54,605

 
$
667,419

 
$
651,140


$
68,931


$
66,909



The following table represents a summary of investment securities that had an unrealized loss:
 
 
June 30, 2018
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 U.S. Government-sponsored enterprises
$
98,044

 
$
1,858

 
$

 
$

 
$
98,044

 
$
1,858

Obligations of states and political subdivisions
24,883

 
369

 
364

 
25

 
25,247

 
394

Agency mortgage-backed securities
392,242

 
10,617

 
134,128

 
6,062

 
526,370

 
16,679

U.S. Treasury bills
9,863

 
94

 

 

 
9,863

 
94

 
$
525,032

 
$
12,938


$
134,492


$
6,087


$
659,524


$
19,025

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
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 U.S. Government-sponsored enterprises
$
89,309

 
$
660

 
$

 
$

 
$
89,309

 
$
660

Obligations of states and political subdivisions
13,951

 
259

 

 

 
13,951

 
259

Agency mortgage-backed securities
469,655

 
6,034

 
12,229

 
589

 
481,884

 
6,623

 
$
572,915

 
$
6,953


$
12,229


$
589


$
585,144


$
7,542



The unrealized losses at both June 30, 2018, and December 31, 2017, were primarily attributable to changes in market interest rates since the securities were purchased. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include among other considerations (1) the present value of the cash flows expected to be collected compared to the amortized cost of the security, (2) duration and magnitude of the decline in value, (3) the financial condition of the issuer or issuers, (4) structure of the security, and (5) the intent to sell the security or whether it is more likely than not the Company would be required to sell the security before its anticipated recovery in market value. At June 30, 2018, management performed its quarterly analysis of all securities with an unrealized loss and concluded no individual securities were other-than-temporarily impaired.

10



NOTE 4 - LOANS

The loan portfolio is comprised of loans originated by the Company and loans that were acquired in connection with the Company’s acquisitions. These loans are accounted for using the guidance in the Accounting Standards Codification (ASC) section 310-30 and 310-20. Loans accounted for using ASC 310-30 are sometimes referred to as purchased credit impaired ("PCI") loans.
 
The table below shows the loan portfolio composition including carrying value categorized by loans accounted for at amortized cost, which includes our originated loans, and by loans accounted for as PCI. 

(in thousands)

June 30, 2018
 
December 31, 2017
Loans accounted for at amortized cost
$
4,214,996

 
$
4,022,896

Loans accounted for as PCI
60,765

 
74,154

Total loans
$
4,275,761

 
$
4,097,050


The following tables refer to loans not accounted for as PCI loans.

Below is a summary of loans by category at June 30, 2018 and December 31, 2017:
 
(in thousands)
June 30, 2018
 
December 31, 2017
Commercial and industrial
$
2,038,040

 
$
1,918,720

Real estate:
 
 
 
Commercial - investor owned
819,427

 
769,275

Commercial - owner occupied
593,138

 
554,589

Construction and land development
300,117

 
303,091

Residential
318,055

 
341,312

Total real estate loans
2,030,737

 
1,968,267

Consumer and other
147,304

 
137,234

Loans, before unearned loan fees
4,216,081

 
4,024,221

Unearned loan fees, net
(1,085
)
 
(1,325
)
    Loans, including unearned loan fees
$
4,214,996

 
$
4,022,896


A summary of the activity in the allowance for loan losses and the recorded investment in loans by class and category based on impairment methodology through June 30, 2018, and at December 31, 2017, 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, 2017
$
26,406

 
$
3,890

 
$
3,308

 
$
1,487

 
$
2,237

 
$
838

 
$
38,166

Provision (provision reversal) for loan losses
780

 
648

 
190

 
35

 
259

 
(41
)
 
1,871

Losses charged off
(732
)
 

 

 

 
(254
)
 
(49
)
 
(1,035
)
Recoveries
956

 
8

 
4

 
206

 
73

 
14

 
1,261

Balance at March 31, 2018
$
27,410

 
$
4,546


$
3,502


$
1,728


$
2,315


$
762



$
40,263

Provision (provision reversal) for loan losses
2,852

 
5

 
340

 
(206
)
 
(573
)
 
(33
)
 
2,385

Losses charged off
(956
)
 

 

 

 
(38
)
 
(33
)
 
(1,027
)
Recoveries
118

 
10

 
3

 
168

 
59

 
28

 
386

Balance at June 30, 2018
$
29,424

 
$
4,561


$
3,845


$
1,690


$
1,763


$
724


$
42,007


11



(in thousands)
Commercial and industrial
 
CRE - investor owned
 
CRE -
owner occupied
 
Construction and land development
 
Residential real estate
 
Consumer and other
 
Total
Balance June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses - Ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
3,667

 
$

 
$
219

 
$

 
$

 
$

 
$
3,886

Collectively evaluated for impairment
25,757

 
4,561

 
3,626

 
1,690

 
1,763

 
724

 
38,121

Total
$
29,424

 
$
4,561


$
3,845


$
1,690


$
1,763


$
724


$
42,007

Loans - Ending balance:
 
 
 
 
 
 
 

 
 
 
 
 
 
Individually evaluated for impairment
$
11,226

 
$
410

 
$
2,150

 
$
435

 
$
1,669

 
$
318

 
$
16,208

Collectively evaluated for impairment
2,026,814

 
819,017

 
590,988

 
299,682

 
316,386

 
145,901

 
4,198,788

Total
$
2,038,040

 
$
819,427


$
593,138


$
300,117


$
318,055


$
146,219


$
4,214,996

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses - Ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,508

 
$

 
$
71

 
$

 
$

 
$

 
$
2,579

Collectively evaluated for impairment
23,898

 
3,890

 
3,237

 
1,487

 
2,237

 
838

 
35,587

Total
$
26,406

 
$
3,890


$
3,308


$
1,487


$
2,237


$
838


$
38,166

Loans - Ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
12,665

 
$
422

 
$
1,975

 
$
136

 
$
1,602

 
$
375

 
$
17,175

Collectively evaluated for impairment
1,906,055

 
768,853

 
552,614

 
302,955

 
339,710

 
135,534

 
4,005,721

Total
$
1,918,720

 
$
769,275


$
554,589


$
303,091


$
341,312


$
135,909


$
4,022,896


A summary of nonperforming loans individually evaluated for impairment by category at June 30, 2018 and December 31, 2017, and the income recognized on impaired loans is as follows:

 
June 30, 2018
(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
$
20,915

 
$
1,900

 
$
9,326

 
$
11,226

 
$
3,667

 
$
12,591

Real estate:
 
 
 
 
 
 
 
 
 
 
 
    Commercial - investor owned
557

 
410

 

 
410

 

 
415

    Commercial - owner occupied
751

 
259

 
484

 
743

 
219

 
750

    Construction and land development
444

 
435

 

 
435

 

 
494

    Residential
1,835

 
1,669

 

 
1,669

 

 
1,688

Consumer and other
332

 
318

 

 
318

 

 
333

Total
$
24,834

 
$
4,991


$
9,810


$
14,801


$
3,886


$
16,271


 
December 31, 2017
(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
$
20,750

 
$
2,321

 
$
10,344

 
$
12,665

 
$
2,508

 
$
16,270

Real estate:
 
 
 
 
 
 
 
 
 
 
 
    Commercial - investor owned
560

 
422

 

 
422

 

 
521

    Commercial - owner occupied
487

 

 
487

 
487

 
71

 
490

    Construction and land development
441

 
136

 

 
136

 

 
331

    Residential
1,730

 
1,602

 

 
1,602

 

 
1,735

Consumer and other
375

 
375

 

 
375

 

 
375

Total
$
24,343

 
$
4,856


$
10,831


$
15,687


$
2,579


$
19,722



12



 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Total interest income that would have been recognized under original terms
$
467

 
$
340

 
$
1,001

 
$
655

Total cash received and recognized as interest income on non-accrual loans
78

 
16

 
89

 
39

Total interest income recognized on accruing, impaired loans
13

 
14

 
23

 
47


The recorded investment in nonperforming loans by category at June 30, 2018 and December 31, 2017, is as follows: 
 
June 30, 2018
(in thousands)
Non-accrual
 
Restructured, not on non-accrual
 
Total
Commercial and industrial
$
10,593

 
$
633

 
$
11,226

Real estate:
 
 
 
 
 
    Commercial - investor owned
410

 

 
410

    Commercial - owner occupied
743

 

 
743

    Construction and land development
435

 

 
435

    Residential
1,669

 

 
1,669

Consumer and other
318

 

 
318

       Total
$
14,168

 
$
633


$
14,801


 
December 31, 2017
(in thousands)
Non-accrual
 
Restructured, not on non-accrual
 
Total
Commercial and industrial
$
11,946

 
$
719

 
$
12,665

Real estate:
 
 
 
 
 
    Commercial - investor owned
422

 

 
422

    Commercial - owner occupied
487

 

 
487

    Construction and land development
136

 

 
136

    Residential
1,602

 

 
1,602

Consumer and other
375

 

 
375

       Total
$
14,968

 
$
719

 
$
15,687


At June 30, 2018, performing loans over 90 days past due and still accruing interest totaled $4.1 million. There were no loans over 90 days past due and still accruing interest at December 31, 2017.

There were no portfolio loans restructured during the three and six months ended June 30, 2018 and 2017.

As of June 30, 2018, the Company had $2.0 million in specific reserves allocated to $7.9 million of loans that have been restructured. During the three and six months ended June 30, 2018 and 2017, there were no portfolio loans that subsequently defaulted.


13



The aging of the recorded investment in past due loans by portfolio class and category at June 30, 2018 and December 31, 2017 is shown below.

 
June 30, 2018
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
Commercial and industrial
$
2,180

 
$
8,070

 
$
10,250

 
$
2,027,790

 
$
2,038,040

Real estate:
 
 
 
 
 
 
 
 
 
Commercial - investor owned
1,141

 

 
1,141

 
818,286

 
819,427

Commercial - owner occupied
958

 
484

 
1,442

 
591,696

 
593,138

Construction and land development

 

 

 
300,117

 
300,117

Residential
895

 
1,031

 
1,926

 
316,129

 
318,055

Consumer and other

 

 

 
146,219

 
146,219

Total
$
5,174

 
$
9,585


$
14,759


$
4,200,237


$
4,214,996


 
December 31, 2017
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
Commercial and industrial
$
7,882

 
$
1,770

 
$
9,652

 
$
1,909,068

 
$
1,918,720

Real estate:
 
 
 
 
 
 
 
 
 
Commercial - investor owned
934

 

 
934

 
768,341

 
769,275

Commercial - owner occupied

 

 

 
554,589

 
554,589

Construction and land development
76

 

 
76

 
303,015

 
303,091

Residential
1,529

 
945

 
2,474

 
338,838

 
341,312

Consumer and other
407

 

 
407

 
135,502

 
135,909

Total
$
10,828

 
$
2,715


$
13,543


$
4,009,353


$
4,022,896


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.

14



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 loans by portfolio class and category at June 30, 2018, which is based upon the most recent analysis performed, and December 31, 2017 is as follows:

 
June 30, 2018
(in thousands)
Pass (1-6)
 
Watch (7)
 
Substandard (8)
 
Total
Commercial and industrial
$
1,853,440

 
$
128,087

 
$
56,513

 
$
2,038,040

Real estate:
 
 
 
 
 
 
 
Commercial - investor owned
785,920

 
28,442

 
5,065

 
819,427

Commercial - owner occupied
537,740

 
49,926

 
5,472

 
593,138

Construction and land development
289,263

 
10,301

 
553

 
300,117

Residential
307,727

 
2,859

 
7,469

 
318,055

Consumer and other
145,289

 
612

 
318

 
146,219

Total
$
3,919,379

 
$
220,227

 
$
75,390

 
$
4,214,996


 
December 31, 2017
(in thousands)
Pass (1-6)
 
Watch (7)
 
Substandard (8)
 
Total
Commercial and industrial
$
1,769,102

 
$
94,002

 
$
55,616

 
$
1,918,720

Real estate:
 
 
 
 
 
 
 
Commercial - investor owned
754,010

 
10,840

 
4,425

 
769,275

Commercial - owner occupied
514,616

 
34,440

 
5,533

 
554,589

Construction and land development
292,766

 
9,983

 
342

 
303,091

Residential
329,742

 
3,648

 
7,922

 
341,312

Consumer and other
134,704

 
10

 
1,195

 
135,909

Total
$
3,794,940

 
$
152,923


$
75,033


$
4,022,896



15



Below is a summary of PCI loans by category at June 30, 2018 and December 31, 2017:
 
 
June 30, 2018
 
December 31, 2017
(in thousands)
Weighted-
Average
Risk Rating1
Recorded
Investment
PCI Loans
 
Weighted-
Average
Risk Rating1
Recorded
Investment
PCI Loans
Commercial and industrial
6.47
$
2,711

 
6.38
$
3,212

Real estate:
 
 
 
 
 
Commercial - investor owned
7.37
30,539

 
7.36
42,887

Commercial - owner occupied
7.02
13,269

 
6.48
11,332

Construction and land development
6.02
5,121

 
5.99
5,883

Residential
6.05
9,102

 
5.99
10,781

Consumer and other
5.20
23

 
2.84
59

Total
 
$
60,765

 
 
$
74,154

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

The aging of the recorded investment in past due PCI loans by portfolio class and category at June 30, 2018 and December 31, 2017 is shown below:

 
June 30, 2018
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
Commercial and industrial
$

 
$

 
$

 
$
2,711

 
$
2,711

Real estate:
 
 
 
 
 
 
 
 
 
Commercial - investor owned
685

 

 
685

 
29,854

 
30,539

Commercial - owner occupied
735

 
728

 
1,463

 
11,806

 
13,269

Construction and land development
149

 

 
149

 
4,972

 
5,121

Residential
37

 
275

 
312

 
8,790

 
9,102

Consumer and other
1

 

 
1

 
22

 
23

Total
$
1,607

 
$
1,003


$
2,610


$
58,155


$
60,765


 
December 31, 2017
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
Commercial and industrial
$

 
$

 
$

 
$
3,212

 
$
3,212

Real estate:
 
 
 
 
 
 
 
 
 
Commercial - investor owned

 
3,034

 
3,034

 
39,853

 
42,887

Commercial - owner occupied

 
673

 
673

 
10,659

 
11,332

Construction and land development

 

 

 
5,883

 
5,883

Residential
328

 
255

 
583

 
10,198

 
10,781

Consumer and other

 

 

 
59

 
59

Total
$
328

 
$
3,962


$
4,290


$
69,864


$
74,154



16



The following table is a roll forward of PCI loans, net of the allowance for loan losses, for the six months ended June 30, 2018 and 2017.

(in thousands)
Contractual Cashflows
 
Non-accretable Difference
 
Accretable Yield
 
Carrying Amount
Balance December 31, 2017
$
112,710

 
$
29,005

 
$
13,964

 
$
69,741

Principal reductions and interest payments
(22,667
)
 

 

 
(22,667
)
Accretion of loan discount

 

 
(3,400
)
 
3,400

Changes in contractual and expected cash flows due to remeasurement
3,281

 
(8,771
)
 
4,124

 
7,928

Balance June 30, 2018
$
93,324

 
$
20,234


$
14,688


$
58,402

 
 
 
 
 
 
 
 
Balance December 31, 2016
$
66,003

 
$
18,902

 
$
13,176

 
$
33,925

Acquisitions
68,763

 
14,296

 
5,312

 
49,155

Principal reductions and interest payments
(10,781
)
 

 

 
(10,781
)
Accretion of loan discount

 

 
(3,534
)
 
3,534

Changes in contractual and expected cash flows due to remeasurement
5,641

 
(1,383
)
 
1,328

 
5,696

Reductions due to disposals
(5,070
)
 
(1,317
)
 
(1,398
)
 
(2,355
)
Balance June 30, 2017
$
124,556

 
$
30,498


$
14,884


$
79,174


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 $81.1 million and $94.9 million as of June 30, 2018, and December 31, 2017, respectively.


NOTE 5 - COMMITMENTS AND CONTINGENCIES

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

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

The Company uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets. At June 30, 2018, the amount of unadvanced commitments on impaired loans was insignificant.

The contractual amounts of off-balance-sheet financial instruments as of June 30, 2018, and December 31, 2017, are as follows:
 
(in thousands)
June 30, 2018
 
December 31, 2017
Commitments to extend credit
$
1,272,570

 
$
1,298,423

Letters of credit
54,647

 
73,790


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

17



significant usage restrictions, and may require payment of a fee. Of the total commitments to extend credit at June 30, 2018, and December 31, 2017, approximately $103.4 million and $112.0 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 includes $0.4 million for estimated losses attributable to the unadvanced commitments at June 30, 2018, and December 31, 2017.

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. As of June 30, 2018, the approximate remaining terms of standby letters of credit range from 1 month to 3 years and 6 months.

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.

NOTE 6 - 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.

Hedging Instruments. At June 30, 2018, the Company has no outstanding derivative contracts used to manage risk.

Client-Related Derivative Instruments. The Company enters into interest rate swaps to allow customers to hedge changes in fair value of certain loans while maintaining a variable rate loan on its own books. The Company also enters into foreign exchange forward contracts with clients, and enters into offsetting foreign exchange forward contracts with established financial institution counterparties. The table below summarizes the notional amounts and fair values of the client-related derivative instruments:

 
 
Asset Derivatives
(Other Assets)
 
Liability Derivatives
(Other Liabilities)
 
Notional Amount
 
Fair Value
 
Fair Value
(in thousands)
June 30,
2018
 
December 31,
2017
 
June 30,
2018
 
December 31,
2017
 
June 30,
2018
 
December 31,
2017
Non-designated hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
$
404,643

 
$
394,852

 
$
4,016

 
$
2,061

 
$
4,016

 
$
2,061

Foreign exchange forward contracts
1,342

 
1,528

 
1,342

 
1,528

 
1,342

 
1,528


Changes in the fair value of client-related derivative instruments are recognized currently in operations. For the three and six months ended June 30, 2018 and 2017, the gains and losses offset each other due to the Company's hedging of the client swaps and foreign exchange contracts with other bank counterparties.




18



NOTE 7 - FAIR VALUE MEASUREMENTS

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

The following table summarizes financial instruments measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
 
 
June 30, 2018
(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
$

 
$
98,044

 
$

 
$
98,044

Obligations of states and political subdivisions

 
31,944

 

 
31,944

Residential mortgage-backed securities

 
511,289

 

 
511,289

U.S. Treasury bills

 
9,863

 

 
9,863

Total securities available for sale
$

 
$
651,140


$


$
651,140

Other investments
179

 

 

 
179

State tax credits held for sale

 

 
299

 
299

Derivative financial instruments

 
5,358

 

 
5,358

Total assets
$
179

 
$
656,498


$
299


$
656,976

 
 
 
 
 
 
 
 
Liabilities
 

 
 

 
 

 
 

Derivative financial instruments
$

 
$
5,358

 
$

 
$
5,358

Total liabilities
$

 
$
5,358


$


$
5,358


 
December 31, 2017
(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
$

 
$
99,224

 
$

 
$
99,224

Obligations of states and political subdivisions

 
34,642

 

 
34,642

Residential mortgage-backed securities

 
507,516

 

 
507,516

Total securities available for sale
$

 
$
641,382


$


$
641,382

State tax credits held for sale

 

 
400

 
400

Derivative financial instruments

 
3,589

 

 
3,589

Total assets
$

 
$
644,971


$
400


$
645,371

 
 
 
 
 
 
 
 
Liabilities
 

 
 
 
 

 
 
Derivative financial instruments
$

 
$
3,589

 
$

 
$
3,589

Total liabilities
$

 
$
3,589


$


$
3,589


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.

19



Treasury yield curve, trade execution data, market consensus prepayment speeds, credit information and the bond's terms and conditions at the security level.
Other investments. At June 30, 2018, of the $36.1 million of other investments on the condensed consolidated balance sheet, approximately $0.2 million were carried at fair value. The remaining $35.9 million of other investments were accounted for at cost. Other investments reported at fair value represent equity securities with quoted market prices (Level 1).
State tax credits held for sale. At June 30, 2018, of the $46.5 million of state tax credits held for sale on the condensed consolidated balance sheet, approximately $0.3 million were carried at fair value. The remaining $46.2 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 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 remaining state tax credits carried at fair value are expected to be sold within the next several quarters. 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. 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.
There were no transfers between Level 1 and Level 2 during the three and six months ended June 30, 2018 and 2017.

Level 3 financial instruments

The following table presents the changes in Level 3 financial instruments measured at fair value on a recurring basis as of June 30, 2018 and 2017.
Purchases, sales, issuances and settlements. There were no Level 3 purchases during the quarters ended June 30, 2018 or 2017.
Transfers in and/or out of Level 3. There were no Level 3 transfers during the quarter ended June 30, 2018. There was $3.1 million in Level 3 transfers to Level 2 during the quarter ended June 30, 2017.
 
Securities available for sale, at fair value
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Beginning balance
$

 
$
3,093

 
$

 
$
3,089

   Total gains:
 
 
 
 
 
 
 
Included in other comprehensive income

 

 

 
4

   Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
Purchases

 

 

 

Transfer in and/or out of Level 3

 
(3,093
)
 

 
(3,093
)
Ending balance
$

 
$

 
$

 
$

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

 
$

 
$

 
$




20



 
State tax credits held for sale
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Beginning balance
$
350

 
$
1,458

 
$
400

 
$
3,585

   Total gains:
 
 
 
 
 
 
 
Included in earnings
3

 
9

 
6

 
49

   Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
Sales
(54
)
 
(193
)
 
(107
)
 
(2,360
)
Ending balance
$
299

 
$
1,274

 
$
299

 
$
1,274

 
 
 
 
 
 
 
 
Change in unrealized gains (losses) relating to assets still held at the reporting date
$
(13
)
 
$
(49
)
 
$
(26
)
 
$
(655
)

From time to time, the Company measures certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or fair value that were recognized at fair value below cost at the end of the period. The following table presents financial instruments and non-financial assets measured at fair value on a non-recurring basis as of June 30, 2018.
 
 
(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 June 30, 2018
 
Total losses for the six
months ended June 30, 2018
Impaired loans
$
1,486

 
$

 
$

 
$
1,486

 
$
900

 
$
1,609

Other real estate
454

 

 

 
454

 
1

 
44

Total
$
1,940

 
$


$


$
1,940


$
901

 
$
1,653


(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. At June 30, 2018, impaired loans measured on a non-recurring basis had a principal balance of $2.4 million, with a valuation allowance of $0.9 million.

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.


21



Following is a summary of the carrying amounts and fair values of the Company’s financial instruments on the consolidated balance sheets at June 30, 2018 and December 31, 2017. Fair values that are not estimable are listed at the carrying value.

 
June 30, 2018
 
December 31, 2017
(in thousands)
Carrying Amount
 
Estimated fair value
 
Carrying Amount
 
Estimated fair value
Balance sheet assets
 
 
 
 
 
 
 
Cash and due from banks
$
91,851

 
$
91,851

 
$
91,084

 
$
91,084

Federal funds sold
1,445

 
1,445

 
1,223

 
1,223

Interest-bearing deposits
86,141

 
86,141

 
63,661

 
63,661

Securities available for sale
651,140

 
651,140

 
641,382

 
641,382

Securities held to maturity
68,931

 
66,909

 
73,749

 
73,458

Other investments, at cost
36,132

 
36,132

 
26,661

 
26,661

Loans held for sale
1,388

 
1,388

 
3,155

 
3,155

Derivative financial instruments
5,358

 
5,358

 
3,589

 
3,589

Portfolio loans, net
4,231,391

 
4,252,679

 
4,054,473

 
4,096,741

State tax credits, held for sale
46,481

 
45,069

 
43,468

 
44,271

Accrued interest receivable
17,808

 
17,808

 
14,069

 
14,069

 
 
 
 
 
 
 
 
Balance sheet liabilities
 
 
 
 
 
 
 
Deposits
4,247,912

 
4,242,061

 
4,156,414

 
4,153,323

Subordinated debentures and notes
118,131

 
105,889

 
118,105

 
105,031

Federal Home Loan Bank advances
361,534

 
361,531

 
172,743

 
172,893

Other borrowings
167,216

 
167,086

 
253,674

 
253,530

Derivative financial instruments
5,358

 
5,358

 
3,589

 
3,589

Accrued interest payable
1,884

 
1,884

 
1,730

 
1,730


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 18Fair Value Measurements in the Company's Annual Report on Form 10-K for the year ended December 31, 2017.


22



The following table presents the level in the fair value hierarchy for the estimated fair values of only the Company’s financial instruments that are not already presented on the condensed consolidated balance sheets at fair value at June 30, 2018, and December 31, 2017.
 
 
Estimated Fair Value Measurement at Reporting Date Using
 
Balance at June 30, 2018
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Financial Assets:
 
 
 
 
 
 
 
Securities held to maturity
$

 
$
66,909

 
$

 
$
66,909

Portfolio loans, net

 

 
4,252,679

 
4,252,679

State tax credits, held for sale

 

 
44,770

 
44,770

Financial Liabilities:
 
 
 
 
 
 
 
Deposits
3,574,581

 

 
667,480

 
4,242,061

Subordinated debentures and notes

 
105,889

 

 
105,889

Federal Home Loan Bank advances

 
361,531

 

 
361,531

Other borrowings

 
167,086

 

 
167,086

 
 
Estimated Fair Value Measurement at Reporting Date Using
 
Balance at December 31, 2017
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Financial Assets:
 
 
 
 
 
 
 
Securities held to maturity
$

 
$
73,458

 
$

 
$
73,458

Portfolio loans, net

 

 
4,096,741

 
4,096,741

State tax credits, held for sale

 

 
43,871

 
43,871

Financial Liabilities:
 
 
 
 
 
 
 
Deposits
3,577,641

 

 
575,682

 
4,153,323

Subordinated debentures and notes

 
105,031

 

 
105,031

Federal Home Loan Bank advances

 
172,893

 

 
172,893

Other borrowings

 
253,530

 

 
253,530



NOTE 8 - NEW AUTHORITATIVE ACCOUNTING GUIDANCE

Financial Accounting Standards Board (the "FASB") ASU 2017-08 "Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities" In March 2017, the FASB issued ASU 2017-08, "Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20)" which shortens the amortization period of certain callable debt securities held at a premium to the earliest call date. The amendments are effective for public business entities for annual periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption being permitted. The Company has evaluated the new guidance and does not expect it to have a material impact on the Company's consolidated financial statements. At June 30, 2018, the book value of callable bonds that were purchased at a premium totaled $22.0 million, and the amount of unamortized premium remaining on these securities was $0.8 million.

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 has formed an implementation team that includes members of accounting, credit, and loan operations to review the requirements of ASU 2016-13, and has contracted with a

23



software provider to aid in implementation. The Company 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, including interim periods therein. Early adoption will be permitted. The Company has formed a lease implementation team that includes members of accounting, facilities and operations to review lease contracts and the requirements of ASU 2016-02. The Company expects the adoption of this standard will increase total assets on the Company's consolidated balance sheet and utilize capital.







24



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 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 six months of 2018 compared to the financial condition as of December 31, 2017. In addition, this discussion summarizes the significant factors affecting the results of operations, liquidity and cash flows of the Company for the three and six months ended June 30, 2018, compared to the same periods in 2017. 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, 2017.


 

25



Executive Summary

Below are highlights of our financial performance for the three and six months ended June 30, 2018, as compared to the linked quarter ended March 31, 2018, and prior year period. The Company closed its acquisition of Jefferson County Bancshares, Inc. ("JCB") on February 10, 2017. The results of operations of JCB are included in our consolidated results since this date and, therefore, were not included for the full six months prior year period.

(in thousands, except per share data)
For the Three Months ended/At
 
For the Six Months ended
June 30,
2018
 
March 31,
2018
 
June 30,
2017
 
June 30,
2018
 
June 30,
2017
EARNINGS
 
 
 
 
 
 
 
 
 
Total interest income
$
57,879

 
$
55,164

 
$
51,542

 
$
113,043

 
$
95,282

Total interest expense
10,831

 
8,993

 
5,909

 
19,824

 
11,007

Net interest income
47,048

 
46,171

 
45,633

 
93,219

 
84,275

Provision for portfolio loans
2,385

 
1,871

 
3,623

 
4,256

 
5,156

Provision reversal for PCI loans
(1,995
)
 

 
(207
)
 
(1,995
)
 
(355
)
Net interest income after provision for loan losses
46,658

 
44,300

 
42,217

 
90,958

 
79,474

Total noninterest income
9,693

 
9,542

 
7,934

 
19,235

 
14,910

Total noninterest expense
29,219

 
29,143

 
32,651

 
58,362

 
59,387

Income before income tax expense
27,132

 
24,699


17,500

 
51,831

 
34,997

Income tax expense
4,881

 
3,778

 
5,545

 
8,659

 
10,651

Net income
$
22,251

 
$
20,921

 
$
11,955

 
$
43,172

 
$
24,346

 
 
 
 
 
 
 
 
 
 
Basic earnings per share
$
0.96

 
$
0.91

 
$
0.51

 
$
1.87

 
$
1.07

Diluted earnings per share
0.95

 
0.90

 
0.50

 
1.85

 
1.06

 
 
 
 
 
 
 
 
 
 
Return on average assets
1.65
%
 
1.59
 %
 
0.96
%
 
1.62
%
 
1.02
%
Return on average common equity
15.70
%
 
15.31
 %
 
8.78
%
 
15.51
%
 
9.64
%
Return on average tangible common equity
20.23
%
 
19.92
 %
 
11.49
%
 
20.08
%
 
12.20
%
Net interest margin (fully tax equivalent)
3.77
%
 
3.80
 %
 
3.98
%
 
3.79
%
 
3.86
%
Efficiency ratio
51.50
%
 
52.31
 %
 
60.95
%
 
51.90
%
 
59.87
%
Tangible book value per common share
$
19.32

 
$
18.49

 
$
17.89

 
 
 
 
 
 
 
 
 
 
 
 
 
 
ASSET QUALITY (1)
 
 
 
 
 
 
 
 
 
Net charge-offs (recoveries)
$
641

 
$
(226
)
 
$
6,104

 
$
415

 
$
6,048

Nonperforming loans
14,801

 
15,582

 
13,081

 
 
 
 
Classified assets
74,001

 
77,195

 
93,795

 
 
 
 
Nonperforming loans to portfolio loans
0.35
%
 
0.38
 %
 
0.34
%
 
 
 
 
Nonperforming assets to total assets (1)
0.28
%
 
0.30
 %
 
0.27
%
 
 
 
 
Allowance for loan losses to portfolio loans
1.00
%
 
0.98
 %
 
0.96
%
 
 
 
 
Net charge-offs to average loans (annualized)
0.06
%
 
(0.02
)%
 
0.64
%
 
0.01
%
 
0.33
%
 
 
 
 
 
 
 
 
 
 
(1) Excludes purchased credit impaired loans and related assets, except for their inclusion in total assets.


26



Below are highlights of the Company's Core performance measures, which we believe are important measures of financial performance, but are non-GAAP measures. For additional information, refer to the reconciliation of Core performance measures included in this MD&A section under the caption "Use of Non-GAAP Financial Measures".

 
For the Three Months ended
 
For the Six Months ended
(in thousands)
June 30,
2018
 
March 31,
2018
 
June 30,
2017
 
June 30,
2018
 
June 30,
2017
CORE PERFORMANCE MEASURES (1)
 
 
 
 
 
 
 
 
Net interest income
$
46,757

 
$
45,405

 
$
43,049

 
$
92,162

 
$
80,616

Provision for portfolio loans
2,385

 
1,871

 
3,623

 
4,256

 
5,156

Noninterest income
9,026

 
8,520

 
7,934

 
17,546

 
14,910

Noninterest expense
29,209

 
29,129

 
27,798

 
58,338

 
52,744

Income before income tax expense
24,189

 
22,925

 
19,562

 
47,114

 
37,626

Income tax expense
4,145

 
3,340

 
6,329

 
7,485

 
11,245

Net income
$
20,044

 
$
19,585

 
$
13,233

 
$
39,629

 
$
26,381

 
 
 
 
 
 
 
 
 
 
Earnings per share
$
0.86

 
$
0.84

 
$
0.56

 
$
1.70

 
$
1.15

Return on average assets
1.48
%
 
1.49
%
 
1.06
%
 
1.49
%
 
1.11
%
Return on average common equity
14.14
%
 
14.34
%
 
9.72
%
 
14.24
%
 
10.44
%
Return on average tangible common equity
18.22
%
 
18.64
%
 
12.72
%
 
18.43
%
 
13.22
%
Net interest margin (fully tax equivalent)
3.75
%
 
3.74
%
 
3.76
%
 
3.74
%
 
3.70
%
Efficiency ratio
52.36
%
 
54.02
%
 
54.52
%
 
53.18
%
 
55.21
%
 
 
 
 
 
 
 
 
 
 
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

For the six months ended June 30, 2018 compared to the six months ended June 30, 2017, the Company noted the following trends:

The Company reported net income of $43.2 million, or $1.85 per diluted share, for the six months ended June 30, 2018, compared to $24.3 million, or $1.06 per diluted share, for the same period in 2017. The $0.79 increase in earnings per share primarily increased from growth in the balance sheet resulting from organic loan and deposit growth, fee income growth, and corporate tax reform.

On a core basis1, net income grew 50% to $39.6 million, or $1.70 per diluted share, for the six months ended June 30, 2018, compared to $26.4 million, or $1.15 per diluted share, in the prior year period. The diluted core earnings per share1 increase of $0.55 continues to be driven by revenue growth, which expanded $14.2 million, or 15%.

Net interest income for the first six months of 2018 increased $8.9 million or 11%, from the prior year period due to strong portfolio loan growth and a higher average yield partially offset by an increase in cost of funds and a reduction in incremental accretion on non-core acquired loans.

Net interest margin for the first six months of 2018 decreased seven basis points to 3.79% when compared to the prior year period of 3.86%. Core net interest margin1, which excludes incremental accretion on non-core acquired loans, increased four basis points to 3.74% for the first six months of 2018 from the prior year period primarily due to the impact of interest rate increases on portfolio loans out-pacing the increase in deposit and borrowing costs.


27



Noninterest income for the first six months of 2018 increased $4.3 million or 29%, compared to the prior year period primarily due to $2.0 million of nonrecurring revenue along with higher income from deposit service charges and card services from growth in the client base.

Noninterest expenses were $58.4 million for the six months ended June 30, 2018, compared to $59.4 million for the comparable period in 2017. Noninterest expenses for the 2017 period included $6.1 million of merger related expenses. Core noninterest expenses1 were $58.3 million for the six months ended June 30, 2018, compared to $52.7 million for the prior year period primarily due to increases in compensation and benefit expense from investments in revenue producing personnel, tax credit amortization of $1.6 million, and other operating expenses from the acquisition of JCB.

Balance sheet highlights:

Loans – Portfolio loans increased to $4.3 billion at June 30, 2018, increasing $186 million when compared to December 31, 2017 primarily in the commercial and industrial, and commercial real estate categories.
Deposits – Total deposits at June 30, 2018 were $4.2 billion, an increase of $91 million, or 2% from December 31, 2017. Core deposits, defined as total deposits excluding time deposits, were $3.6 billion at June 30, 2018, a decrease of $58 million, or 1.61% from the linked quarter, but an increase of $246 million, or 7.40%, when compared to the prior year period.
Asset quality – Nonperforming loans were $14.8 million at June 30, 2018, compared to $14.9 million at December 31, 2017. Nonperforming loans represented 0.35% and 0.38% of portfolio loans at June 30, 2018 and December 31, 2017, respectively.
Provision for portfolio loan losses was $4.3 million for the six months ended June 30, 2018, compared to $5.2 million for the six months ended June 30, 2017. See Item 1, Note 5 – Portfolio Loans, and Provision and Allowance for Loan Losses in this section for more information.































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

28



RESULTS OF OPERATIONS
Net Interest Income
Average Balance Sheet
Non-core acquired loans were those acquired from the FDIC and were previously covered by shared-loss agreements. These loans continue to be accounted for as purchased credit impaired loans. Approximately $37 million of loans acquired from JCB's portfolio are also accounted for as purchased credit impaired loans. However, all loans acquired from JCB are included in portfolio loans. The following table presents, for the periods indicated, certain information related to our average interest-earning assets and interest-bearing liabilities, as well as, the corresponding interest rates earned and paid, all on a tax equivalent basis.
 
Three months ended June 30,
 
2018
 
2017
(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)
$
4,162,720

 
$
51,783

 
4.99
%
 
$
3,802,103

 
$
43,678

 
4.61
%
Tax-exempt portfolio loans (2)
35,117

 
474

 
5.41

 
42,157

 
712

 
6.77

Non-core acquired loans - contractual
26,179

 
517

 
7.92

 
36,767

 
605

 
6.60

Non-core acquired loans - incremental accretion
 
 
291

 
4.46

 
 
 
2,584

 
28.19

Total loans
4,224,016

 
53,065

 
5.04

 
3,881,027


47,579

 
4.92

Taxable investments in debt and equity securities
703,185

 
4,429

 
2.53

 
623,305

 
3,697

 
2.38

Non-taxable investments in debt and equity securities (2)
40,349

 
360

 
3.58

 
44,476

 
489

 
4.41

Short-term investments
56,057

 
231

 
1.65

 
92,390

 
234

 
1.02

Total securities and short-term investments
799,591

 
5,020

 
2.52

 
760,171


4,420

 
2.33

Total interest-earning assets
5,023,607

 
58,085

 
4.64

 
4,641,198

 
51,999

 
4.49

Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
88,731

 
 
 
 
 
76,355

 
 
 
 
Other assets
348,223

 
 
 
 
 
345,167

 
 
 
 
Allowance for loan losses
(45,410
)
 
 
 
 
 
(45,507
)
 
 
 
 
 Total assets
$
5,415,151

 
 
 
 
 
$
5,017,213

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
823,650

 
$
817

 
0.40
%
 
$
789,922

 
$
523

 
0.27
%
Money market accounts
1,494,194

 
4,445

 
1.19

 
1,309,864

 
1,938

 
0.59

Savings
208,662

 
147

 
0.28

 
200,405

 
125

 
0.25

Certificates of deposit
633,897

 
2,338

 
1.48

 
600,709

 
1,373

 
0.92

Total interest-bearing deposits
3,160,403

 
7,747

 
0.98

 
2,900,900


3,959

 
0.55

Subordinated debentures
118,124

 
1,454

 
4.94

 
118,072

 
1,288

 
4.37

FHLB advances
294,643

 
1,448

 
1.97

 
182,472

 
522

 
1.14

Other borrowed funds
167,661

 
182

 
0.44

 
233,401

 
140

 
0.24

Total interest-bearing liabilities
3,740,831

 
10,831

 
1.16

 
3,434,845


5,909

 
0.69

Noninterest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
1,069,888

 
 
 
 
 
1,008,700

 
 
 
 
Other liabilities
35,877

 
 
 
 
 
27,386

 
 
 
 
Total liabilities
4,846,596

 
 
 
 
 
4,470,931

 
 
 
 
Shareholders' equity
568,555

 
 
 
 
 
546,282

 
 
 
 
Total liabilities & shareholders' equity
$
5,415,151

 
 
 
 
 
$
5,017,213

 
 
 
 
Net interest income
 
 
$
47,254

 
 
 
 
 
$
46,090

 
 
Net interest spread
 
 
 
 
3.48
%
 
 
 
 
 
3.80
%
Net interest margin
 
 
 
 
3.77
%
 
 
 
 
 
3.98
%
Core net interest margin (3)
 
 
 
 
3.75
%
 
 
 
 
 
3.76
%
(1)
Average balances include non-accrual loans. The income on such loans is included in interest but is recognized only upon receipt. Loan fees, net of amortization of deferred loan origination fees and costs, included in interest income are approximately $1.0 million and $0.8 million for the three months ended June 30, 2018 and 2017 respectively.
(2)
Non-taxable income is presented on a fully tax-equivalent basis using a 24.7% and 38.0% tax rate in 2018 and 2017, respectively. The tax-equivalent adjustments were $0.2 million and $0.5 million for the three months ended June 30, 2018 and 2017, respectively.
(3)
A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial measures."

29



 
Six months ended June 30,
 
2018
 
2017
(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)
$
4,117,928

 
$
100,675

 
4.93
%
 
$
3,635,296

 
$
81,505

 
4.52
%
Tax-exempt portfolio loans (2)
36,156

 
963

 
5.37

 
43,482

 
1,405

 
6.52

Non-core acquired loans - contractual
27,644

 
942

 
6.87

 
38,020

 
1,200

 
6.36

Non-core acquired loans - incremental accretion
 
 
1,057

 
7.71

 
 
 
3,659

 
19.41

Total loans
4,181,728

 
103,637

 
5.00

 
3,716,798

 
87,769

 
4.76

Taxable investments in debt and equity securities
700,835

 
8,621

 
2.48

 
602,070

 
6,995

 
2.34

Non-taxable investments in debt and equity securities (2)
41,233

 
735

 
3.59

 
50,518

 
1,111

 
4.43

Short-term investments
62,651

 
471

 
1.52

 
81,867

 
364

 
0.90

Total securities and short-term investments
804,719

 
9,827

 
2.46

 
734,455

 
8,470

 
2.33

Total interest-earning assets
4,986,447

 
113,464

 
4.59

 
4,451,253

 
96,239

 
4.36

Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
88,681

 
 
 
 
 
75,794

 
 
 
 
Other assets
347,305

 
 
 
 
 
314,478

 
 
 
 
Allowance for loan losses
(44,594
)
 
 
 
 
 
(44,899
)
 
 
 
 
 Total assets
$
5,377,839

 
 
 
 
 
$
4,796,626

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
843,172

 
$
1,623

 
0.39
%
 
$
777,731

 
$
1,198

 
0.31
%
Money market accounts
1,442,910

 
7,798

 
1.09

 
1,251,929

 
3,431

 
0.55

Savings
205,276

 
272

 
0.27

 
177,504

 
207

 
0.24

Certificates of deposit
618,900

 
4,237

 
1.38

 
574,850

 
2,588

 
0.91

Total interest-bearing deposits
3,110,258

 
13,930

 
0.90

 
2,782,014

 
7,424

 
0.54

Subordinated debentures
118,117

 
2,822

 
4.82

 
115,300

 
2,452

 
4.29

FHLB advances
298,573

 
2,706

 
1.83

 
163,791

 
852

 
1.05

Other borrowed funds
187,442

 
366

 
0.39

 
239,687

 
279

 
0.23

Total interest-bearing liabilities
3,714,390

 
19,824

 
1.08

 
3,300,792

 
11,007

 
0.67

Noninterest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
1,067,343

 
 
 
 
 
958,107

 
 
 
 
Other liabilities
34,755

 
 
 
 
 
28,343

 
 
 
 
Total liabilities
4,816,488

 
 
 
 
 
4,287,242

 
 
 
 
Shareholders' equity
561,351

 
 
 
 
 
509,384

 
 
 
 
Total liabilities & shareholders' equity
$
5,377,839

 
 
 
 
 
$
4,796,626

 
 
 
 
Net interest income
 
 
$
93,640

 
 
 
 
 
$
85,232

 
 
Net interest spread
 
 
 
 
3.51
%
 
 
 
 
 
3.69
%
Net interest margin
 
 
 
 
3.79
%
 
 
 
 
 
3.86
%
Core net interest margin (3)
 
 
 
 
3.74
%
 
 
 
 
 
3.70
%
(1)
Average balances include non-accrual loans. The income on such loans is included in interest but is recognized only upon receipt. Loan fees, net of amortization of deferred loan origination fees and costs, included in interest income are approximately $1.9 million and $1.6 million for the six months ended June 30, 2018 and 2017 respectively.
(2)
Non-taxable income is presented on a fully tax-equivalent basis using a 24.7% and 38.0% tax rate in 2018 and 2017, respectively. The tax-equivalent adjustments were $0.4 million and $1.0 million for the six months ended June 30, 2018 and 2017, respectively.
(3)
A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial measures."

30



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.
  
 
2018 compared to 2017
 
Three months ended June 30,
 
Six months ended June 30,
 
Increase (decrease) due to
 
Increase (decrease) due to
(in thousands)
Volume(1)
 
Rate(2)
 
Net
 
Volume(1)
 
Rate(2)
 
Net
Interest earned on:
 
 
 
 
 
 
 
 
 
 
 
Taxable portfolio loans
$
4,337

 
$
3,768

 
$
8,105

 
$
11,403

 
$
7,767

 
$
19,170

Tax-exempt portfolio loans (3)
(108
)
 
(130
)
 
(238
)
 
(216
)
 
(226
)
 
(442
)
Non-core acquired loans
(735
)
 
(1,646
)
 
(2,381
)
 
(1,104
)
 
(1,756
)
 
(2,860
)
Taxable investments in debt and equity securities
491

 
241

 
732

 
1,197

 
429

 
1,626

Non-taxable investments in debt and equity securities (3)
(42
)
 
(87
)
 
(129
)
 
(185
)
 
(191
)
 
(376
)
Short-term investments
(114
)
 
111

 
(3
)
 
(100
)
 
207

 
107

Total interest-earning assets
$
3,829

 
$
2,257

 
$
6,086

 
$
10,995

 
$
6,230

 
$
17,225

 
 
 
 
 
 
 
 
 
 
 
 
Interest paid on:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
24

 
$
270

 
$
294

 
$
107

 
$
318

 
$
425

Money market accounts
305

 
2,202

 
2,507

 
592

 
3,775

 
4,367

Savings
6

 
16

 
22

 
35

 
30

 
65

Certificates of deposit
80

 
885

 
965

 
211

 
1,438

 
1,649

Subordinated debentures
1

 
165

 
166

 
61

 
309

 
370

FHLB advances
424

 
502

 
926

 
975

 
879

 
1,854

Borrowed funds
(48
)
 
90

 
42

 
(71
)
 
158

 
87

Total interest-bearing liabilities
792

 
4,130

 
4,922

 
1,910

 
6,907

 
8,817

Net interest income
$
3,037

 
$
(1,873
)
 
$
1,164

 
$
9,085

 
$
(677
)
 
$
8,408

(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 $47.3 million for the three months ended June 30, 2018, compared to $46.1 million for the same period of 2017, an increase of $1.2 million, or 3%. The tax-equivalent net interest margin was 3.77% for the second quarter of 2018, compared to 3.98% in the second quarter of 2017. Portfolio loan growth and higher rates supported the $6.1 million increase in interest income over the prior year period. The yield on taxable portfolio loans increased 38 basis points from the prior year period to 4.99% for the three months ended June 30, 2018, due to increasing interest rates on the existing variable-rate loan portfolio and higher rates on newly originated loans. The run-off of higher yielding non-core acquired loans continues to negatively impact net interest margin and resulted in a $2.4 million decrease in interest income for the three months ended June 30, 2018 compared to the prior year period.

Net interest income (on a tax equivalent basis) was $93.6 million for the six months ended June 30, 2018, compared to $85.2 million for the same period of 2017, an increase of $8.4 million, or 10%. The tax-equivalent net interest margin was 3.74% for the six months ended June 30, 2018, compared to 3.86% for the prior year period. The decrease in net interest margin was primarily due to a decline in contributions from non-core acquired assets. The

31



increase in net interest income was primarily due to increasing interest rates on the existing variable-rate loan portfolio and higher rates on newly originated loans.

Core net interest margin1 expanded four basis points from the prior year to 3.74% for the six months ended June 30, 2018, primarily due to loan growth improving the earning asset mix, combined with increased yield on portfolio loans out-pacing the increase to borrowing costs. The increase in the interest rate paid on deposits reflects market interest rate trends, as the Company continues to defend and attract new core deposit relationships. 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 as growth in loan yields balance rising deposit prices. However, pressure on funding costs could hinder the expected trends in core net interest margin.

Non-Core Acquired Assets Contribution
The following table illustrates the non-core contribution of non-core acquired loans and related assets for the periods indicated.

 
For the Three Months ended
 
For the Six Months ended
(in thousands)
June 30,
2018
 
June 30,
2017
 
June 30,
2018
 
June 30,
2017
Accelerated cash flows and other incremental accretion
$
291

 
$
2,584

 
$
1,057

 
$
3,659

Provision reversal for non-core acquired loan losses
1,995

 
207

 
1,995

 
355

Other income
18

 

 
1,031

 

Less: Other expenses (credits)
(229
)
 
(16
)
 
(215
)
 
107

Non-core acquired assets income before income tax expense
$
2,533

 
$
2,807

 
$
4,298

 
$
3,907


Accelerated cash flows and other incremental accretion consists of the interest income on non-core acquired loans in excess of contractual interest on the loans. The contractual amount of interest is included in the Company's core results. At June 30, 2018, the remaining accretable yield on the remaining non-core acquired portfolio was estimated to be $11 million and the non-accretable difference was approximately $10 million. Accelerated cash flows and other incremental accretion from these loans was $1.1 million for the six months ended June 30, 2018, and $3.7 million for the same period in 2017. The Company estimates income from accelerated cash flows and other incremental accretion to be between $2 million and $3 million in total for 2018.

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


32



Noninterest Income

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

 
Three months ended June 30,
(in thousands)
2018
 
2017
 
Increase (decrease)
Service charges on deposit accounts
$
3,007

 
$
2,816

 
$
191

 
7
%
Wealth management revenue
2,141

 
2,054

 
87

 
4
%
Card services revenue
1,650

 
1,392

 
258

 
19
%
Gain on state tax credits, net
64

 
9

 
55

 
611
%
Miscellaneous income - core
2,164

 
1,646

 
518

 
31
%
Core noninterest income (1)
9,026

 
7,934

 
1,092

 
14
%
Gain on sale of investment securities

 

 

 
NM

Other income from non-core acquired assets
18

 

 
18

 
NM

Other
649

 

 
649

 
NM

Total noninterest income
$
9,693

 
$
7,934

 
$
1,110

 
14
%
 
 
 
 
 
 
 
 
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."


 
Six months ended June 30,
(in thousands)
2018
 
2017
 
Increase (decrease)
Service charges on deposit accounts
$
5,858

 
$
5,326

 
$
532

 
10
 %
Wealth management revenue
4,255

 
3,887

 
368

 
9
 %
Card services revenue
3,166

 
2,429

 
737

 
30
 %
Gain on state tax credits, net
316

 
255

 
61

 
24
 %
Gain on sale of other real estate

 
17

 
(17
)
 
(100
)%
Miscellaneous income - core
3,951

 
2,996

 
955

 
32
 %
Core noninterest income (1)
17,546

 
14,910

 
2,636

 
18
 %
Gain on sale of investment securities
9

 

 
9

 
NM

Other income from non-core acquired assets
1,031

 

 
1,031

 
NM

Other
649

 

 
649

 
NM

Total noninterest income
$
19,235

 
$
14,910

 
$
4,325

 
29
 %
 
 
 
 
 
 
 
 
(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 $4.3 million, or 29% in the first six months of 2018 compared to the first six months of 2017. During the six months ended June 30, 2018, the Company received a gain of $0.6 million from the sale of an equity partnership, and a $1.0 million gain from non-core acquired assets. Core noninterest income1 grew 18% in the first six months of 2018. The improvement over the prior year period was primarily due to increases on deposit service charges and card services along with death benefit proceeds on an insurance policy.

The Company expects continued growth in fee income of 5% - 7% for 2018 compared to 2017.


33



Noninterest Expense

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

 
Three months ended June 30,
(in thousands)
2018
 
2017
 
Increase (decrease)
Core expenses (1):
 
 
 
 
 
 
 
 Employee compensation and benefits
$
16,582

 
$
15,798

 
$
784

 
5
 %
 Occupancy
2,342

 
2,265

 
77

 
3
 %
 Data processing
1,533

 
1,806

 
(273
)
 
(15
)%
 FDIC and other insurance
920

 
650

 
270

 
42
 %
 Professional fees
747

 
1,079

 
(332
)
 
(31
)%
 Loan, legal and other real estate expense
206

 
629

 
(423
)
 
(67
)%
 Other
6,879

 
5,571

 
1,308

 
23
 %
Core noninterest expense (1)
29,209

 
27,798

 
1,411

 
5
 %
Merger related expenses

 
4,480

 
(4,480
)
 
(100
)%
Other non-core
239

 
389

 
(150
)
 
(39
)%
Other expenses related to non-core acquired loans
(229
)
 
(16
)
 
(213
)
 
1,331
 %
Total noninterest expense
$
29,219

 
$
32,651

 
$
(3,432
)
 
(11
)%
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."


 
Six months ended June 30,
(in thousands)
2018
 
2017
 
Increase (decrease)
Core expenses (1):
 
 
 
 
 
 
 
 Employee compensation and benefits
$
33,073

 
$
31,006

 
$
2,067

 
7
 %
 Occupancy
4,748

 
4,194

 
554

 
13
 %
 Data processing
3,000

 
3,439

 
(439
)
 
(13
)%
 FDIC and other insurance
1,837

 
1,474

 
363

 
25
 %
 Professional fees
1,596

 
1,916

 
(320
)
 
(17
)%
 Loan, legal and other real estate expense
491

 
851

 
(360
)
 
(42
)%
 Other
13,593

 
9,864

 
3,729

 
38
 %
Core noninterest expense (1)
58,338

 
52,744

 
5,594

 
11
 %
Merger related expenses

 
6,147

 
(6,147
)
 
(100
)%
Other non-core
239

 
389

 
(150
)
 
(39
)%
Other expenses related to non-core acquired loans
(215
)
 
107

 
(322
)
 
(301
)%
Total noninterest expense
$
58,362

 
$
59,387

 
$
(1,025
)
 
(2
)%
(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 $58.4 million for the six months ended June 30, 2018, compared to $59.4 million for the six months ended June 30, 2017. Noninterest expenses for the 2017 period included $6.1 million of merger related expenses. Core noninterest expenses1 increased $5.6 million to $58.3 million for the six months ended June 30, 2018, from $52.7 million for the prior year period. Core expenses1 increased over the prior year period due to increases in employee compensation and benefits from investments in revenue producing personnel and $1.6 million of tax credit amortization.


34



The Company's core efficiency ratio1 improved to 53.2% for the six months ended June 30, 2018, compared to 55.2% for the prior year period, and reflects continuing efforts to leverage its expense base. The Company expects to continue to invest in revenue producing associates and other infrastructure that supports additional growth. These investments are expected to result in expense growth, at a rate of 35% - 45% of projected revenue growth for 2018, resulting in continued improvements to the Company's efficiency ratio.


Income Taxes

The Company's income tax expense for the six months ended June 30, 2018, which includes both federal and state taxes, was $4.9 million compared to $3.8 million for the linked quarter, and $5.5 million for the same period in 2017.
The Company's effective tax rate was 16.7% for the six months ended June 30, 2018 compared to 30.4% for the same period in 2017 due to the combination of federal income tax reform and the Company's tax planning initiatives.

The Company expects its effective tax rate for the remainder of 2018 to be approximately 18% - 20%, which is expected to result in a full year effective tax rate of 17% - 19%.



Summary Balance Sheet

(in thousands)
June 30,
2018
 
December 31,
2017
 
Increase (decrease)
Total cash and cash equivalents
$
177,257

 
$
153,323

 
$
23,934

15.6
 %
Securities
720,071

 
715,131

 
4,940

0.7
 %
Portfolio loans
4,252,336

 
4,066,659

 
185,677

4.6
 %
Non-core acquired loans
23,425

 
30,391

 
(6,966
)
(22.9
)%
Total assets
5,509,924

 
5,289,225

 
220,699

4.2
 %
Deposits
4,247,912

 
4,156,414

 
91,498

2.2
 %
Total liabilities
4,935,840

 
4,740,652

 
195,188

4.1
 %
Total shareholders' equity
574,084

 
548,573

 
25,511

4.7
 %

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, including the C&I category, is secured by real estate. 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.


35



The following table summarizes the composition of the Company's loan portfolio:
(in thousands)
June 30,
2018
 
December 31,
2017
 
Increase (decrease)
Commercial and industrial
$
2,038,400

 
$
1,919,145

 
$
119,255

 
6.2
 %
Commercial real estate - investor owned
844,895

 
769,275

 
75,620

 
9.8
 %
Commercial real estate - owner occupied
601,086

 
554,589

 
46,497

 
8.4
 %
Construction and land development
302,514

 
345,209

 
(42,695
)
 
(12.4
)%
Residential real estate
319,208

 
342,518

 
(23,310
)
 
(6.8
)%
Consumer and other
146,233

 
135,923

 
10,310

 
7.6
 %
   Portfolio loans
4,252,336

 
4,066,659

 
185,677

 
4.6
 %
Non-core acquired loans
23,425

 
30,391

 
(6,966
)
 
(22.9
)%
   Total loans
$
4,275,761

 
$
4,097,050

 
$
178,711

 
4.4
 %

Portfolio loans grew by $185.7 million to $4.3 billion at June 30, 2018, when compared to December 31, 2017. Non-core acquired loans totaled $23.4 million at June 30, 2018, a decrease of $7.0 million, or 23%, from December 31, 2017, primarily as a result of principal paydowns and accelerated loan payoffs.

The following table illustrates portfolio loan growth with selected specialized lending detail:
 
At the quarter ended
(in thousands)
June 30,
2018
 
December 31,
2017
 
Increase (decrease)
C&I - general
$
990,153

 
$
936,588

 
$
53,565

 
5.7
 %
CRE investor owned - general
836,516

 
801,156

 
35,360

 
4.4
 %
CRE owner occupied - general
493,589

 
468,151

 
25,438

 
5.4
 %
Enterprise value lending1
442,877

 
407,644

 
35,233

 
8.6
 %
Life insurance premium financing1
358,787

 
364,876

 
(6,089
)
 
(1.7
)%
Residential real estate - general
318,841

 
342,140

 
(23,299
)
 
(6.8
)%
Construction and land development - general
286,482

 
294,123

 
(7,641
)
 
(2.6
)%
Tax credits1
260,595

 
234,835

 
25,760

 
11.0
 %
Agriculture loans1
127,849

 
91,031

 
36,818

 
40.4
 %
Consumer and other - general
136,647

 
126,115

 
10,532

 
8.4
 %
Portfolio loans
$
4,252,336

 
$
4,066,659

 
$
185,677

 
4.6
 %
 
 
 
 
 
 
 
 
Note: Certain prior period amounts have been reclassified among the categories to conform to the current period presentation.
1Specialized categories may include a mix of C&I, CRE, construction and land development, or consumer and other loans.

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 loans increased $119 million during the first six months of 2018 and represented 48% of the Company's loan portfolio at June 30, 2018. Given performance through June 30, 2018, we expect total 2018 portfolio loan growth to be a high single digit percentage.

36



Provision and Allowance for Loan Losses
The following table summarizes changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off, by loan category, and additions to the allowance charged to expense.
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Allowance at beginning of period, for portfolio loans
$
40,263

 
$
39,148

 
$
38,166

 
$
37,565

Loans charged off:
 
 
 
 
 
 
 
Commercial and industrial
(956
)
 
(6,035
)
 
(1,688
)
 
(6,168
)
Real estate:
 
 
 
 
 
 
 
Commercial

 
(45
)
 

 
(45
)
Construction and land development

 
(5
)
 

 
(5
)
Residential
(38
)
 
(265
)
 
(292
)
 
(274
)
Consumer and other
(33
)
 
(39
)
 
(82
)
 
(68
)
Total loans charged off
(1,027
)
 
(6,389
)

(2,062
)

(6,560
)
Recoveries of loans previously charged off:
 
 
 
 
 
 
 
Commercial and industrial
118

 
57

 
1,074

 
137

Real estate:
 
 
 
 
 
 
 
Commercial
13

 
103

 
25

 
201

Construction and land development
168

 
49

 
374

 
58

Residential
59

 
62

 
132

 
87

Consumer and other
28

 
20

 
42

 
29

Total recoveries of loans
386

 
291


1,647


512

Net loan charge-offs
(641
)
 
(6,098
)

(415
)

(6,048
)
Provision for loan losses
2,385

 
3,623

 
4,256

 
5,156

Allowance at end of period, for portfolio loans (1)
$
42,007

 
$
36,673


$
42,007


$
36,673

 
 
 
 
 
 
 
 
Allowance at beginning of period, for purchased credit impaired loans
$
4,387

 
$
5,477

 
$
4,411

 
$
5,844

   Loans charged off

 
(48
)
 

 
(48
)
   Recoveries of loans

 

 

 

Other
(29
)
 
(96
)
 
(53
)
 
(315
)
Net loan charge-offs
(29
)
 
(144
)

(53
)

(363
)
Provision reversal for purchased credit impaired loan losses
(1,995
)
 
(207
)
 
(1,995
)
 
(355
)
Allowance at end of period, for purchased credit impaired loans
$
2,363

 
$
5,126


$
2,363


$
5,126

 
 
 
 
 
 
 
 
Total allowance at end of period
$
44,370

 
$
41,799

 
$
44,370

 
$
41,799

 
 
 
 
 
 
 
 
Portfolio loans, average
$
4,196,875

 
$
3,839,266

 
$
4,152,882

 
$
3,673,012

Portfolio loans, ending (1)
4,214,996

 
3,810,470

 
4,214,996

 
3,810,470

Net charge-offs to average portfolio loans (1)
0.06
%
 
0.64
%
 
0.01
%
 
0.33
%
Allowance for portfolio loan losses to loans (1)
1.00
%
 
0.96
%
 
1.00
%
 
0.96
%
 
 
 
 
 
 
 
 
(1) Excludes PCI loans.

The provision for loan losses on portfolio loans for the six months ended June 30, 2018 was $4.3 million, compared to $5.2 million for same period in 2017. The provision is reflective of growth in portfolio loan balances, and maintaining a prudent credit risk posture.

37




The allowance for loan losses on portfolio loans was 1.00% of portfolio loans at June 30, 2018 compared to 0.96% at June 30, 2017. Management believes the allowance for loan losses is adequate to absorb inherent losses in the loan portfolio.


Nonperforming assets

The following table presents the categories of nonperforming assets and other ratios as of the dates indicated.
 
(in thousands)
June 30,
2018
 
December 31,
2017
 
June 30,
2017
Non-accrual loans
$
14,168

 
$
14,968

 
$
12,405

Restructured loans
633

 
719

 
676

Total nonperforming loans (1)
14,801

 
15,687

 
13,081

Other real estate
454

 
498

 
529

Total nonperforming assets (1)
$
15,255

 
$
16,185

 
$
13,610

 
 
 
 
 
 
Total assets
$
5,509,924

 
$
5,289,225

 
$
5,038,696

Portfolio loans (1)
4,214,996

 
4,022,896

 
3,810,470

Portfolio loans plus other real estate (1)
4,215,450

 
4,023,394

 
3,810,999

Nonperforming loans to portfolio loans (1)
0.35
%
 
0.39
%
 
0.34
%
Nonperforming assets to total loans plus other real estate (1)
0.36

 
0.40

 
0.36

Nonperforming assets to total assets (1)
0.28

 
0.31

 
0.27

Allowance for loans to nonperforming loans (1)
284
%
 
243
%
 
280
%
 
 
 
 
 
 
(1) Excludes PCI loans, except for their inclusion in total assets.


38



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 4 – Loans for more information on these loans.
 
Nonperforming loans based on loan type were as follows:
 
(in thousands)
June 30, 2018
 
December 31, 2017
 
June 30, 2017
Commercial and industrial
$
11,227

 
$
12,665

 
$
10,003

Commercial real estate
1,153

 
909

 
287

Construction and land development
435

 
136

 
1,489

Residential real estate
1,669

 
1,602

 
1,293

Consumer and other
317

 
375

 
9

Total
$
14,801

 
$
15,687


$
13,081


The following table summarizes the changes in nonperforming loans:
 
Six months ended June 30,
(in thousands)
2018
 
2017
Nonperforming loans beginning of period
$
15,687

 
$
14,905

Additions to nonaccrual loans
2,176

 
6,111

Additions to restructured loans
10

 
676

Charge-offs
(1,997
)
 
(6,508
)
Other principal reductions
(1,075
)
 
(1,820
)
Moved to other real estate

 
(283
)
Nonperforming loans end of period
$
14,801

 
$
13,081


Other real estate
Other real estate was $0.5 million at June 30, 2018 and 2017.

The following table summarizes the changes in other real estate:
 
Six months ended June 30,
(in thousands)
2018
 
2017
Other real estate beginning of period
$
498

 
$
980

Additions and expenses capitalized to prepare property for sale

 
383

Additions from acquisition

 
1,680

Writedowns in value
(44
)
 
(18
)
Other real estate end of period
$
454

 
$
529


Writedowns in fair value are recorded in loan legal and other real estate expense based on current market activity shown in the appraisals.

Liabilities

Liabilities totaled $4.9 billion at June 30, 2018, compared to $4.7 billion at December 31, 2017. The increase in liabilities was due to $91 million of growth in total deposits and a $189 million increase in Federal Home Loan Bank advances, partially offset by a decrease of $86 million in other borrowings.

39




Deposits
(in thousands)
June 30,
2018
 
December 31,
2017
 
Increase (decrease)
Demand deposits
$
1,050,969

 
$
1,123,907

 
$
(72,938
)
 
(6.5
)%
Interest-bearing transaction accounts
754,819

 
915,653

 
(160,834
)
 
(17.6
)%
Money market accounts
1,558,923

 
1,342,931

 
215,992

 
16.1
 %
Savings
209,870

 
195,150

 
14,720

 
7.5
 %
Certificates of deposit:
 
 
 
 
 
 
 
Brokered
224,192

 
115,306

 
108,886

 
94.4
 %
Other
449,139

 
463,467

 
(14,328
)
 
(3.1
)%
Total deposits
$
4,247,912

 
$
4,156,414

 
$
91,498

 
2.2
 %
 
 
 
 
 
 
 
 
Non-time deposits / total deposits
84
%
 
86
%
 
 
 
 
Demand deposits / total deposits
25
%
 
27
%
 
 
 
 

Total deposits at June 30, 2018 were $4.2 billion, an increase of 2%, from December 31, 2017, primarily from increases in money market accounts and brokered certificates of deposit. The composition of our noninterest bearing deposits remained relatively stable at 25% of total deposits at June 30, 2018 compared to 27% at December 31, 2017.

Shareholders' Equity

Shareholders' equity totaled $574.1 million at June 30, 2018, an increase of $25.5 million from December 31, 2017. Significant activity during the six months ended June 30, 2018 was as follows:

Net income of $43.2 million,
decrease in fair value of securities of $7.9 million,
issuance under equity compensation plans of $3.2 million,
dividends paid on common shares of $5.1 million, and
repurchase of 64,915 shares at an average price of $47.10 per share, or approximately $3.1 million in the aggregate, pursuant to the publicly announced program.

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.

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

40



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). $15 million in dividends was paid to the parent company from the Bank in 2018. Another source of funding for the parent company includes the issuance of subordinated debentures and other debt instruments.

The Company has an effective shelf registration statement on Form S-3 registering up to $100 million of common stock, preferred stock, debt securities, and various other securities, including combinations of such securities. The Company's ability to offer securities pursuant to the registration statement depends on market conditions and the Company's continuing eligibility to use the Form S-3 under rules of the SEC.

On November 1, 2016, the Company issued $50 million aggregate principal amount of 4.75% fixed-to-floating rate subordinated notes with a maturity date of November 1, 2026, which initially bear an annual interest rate of 4.75%, with interest payable semiannually. Beginning November 1, 2021, the interest rate resets quarterly to the three-month LIBOR rate plus a spread of 338.7 basis points, payable quarterly.

The Company has a senior unsecured revolving credit agreement (the "Revolving Agreement") with another bank allowing for borrowings up to $20 million which is renewed through February 2019. The proceeds can be used for general corporate purposes. The Revolving Agreement is subject to ongoing compliance with a number of customary affirmative and negative covenants as well as specified financial covenants. As of June 30, 2018, there were no outstanding balances under the Revolving Agreement.

As of June 30, 2018, the Company had $69.2 million of outstanding subordinated debentures as part of ten 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.

Management believes our current level of cash at the holding company of $13.6 million, along with the Company's other available funding sources, will be sufficient to meet all projected cash needs for the remainder of 2018.

Bank liquidity
The Bank has a variety of funding sources available to increase financial flexibility. In addition to amounts currently borrowed, at June 30, 2018, the Bank had borrowing capacity of $313.0 million from the FHLB of Des Moines under blanket loan pledges, and has an additional $1.0 billion available from the Federal Reserve Bank under a pledged loan agreement. The Bank has unsecured federal funds lines with six correspondent banks totaling $95.0 million, and $79.0 million of unsecured credit through the American Financial Exchange.

Investment securities are another important tool to the Bank's liquidity objectives. Total securities available for sale of $651.1 million at June 30, 2018, included $360.7 million of securities that were pledged as collateral for deposits of public institutions, treasury, loan notes, and other requirements. The remaining $290.4 million could be pledged or sold to enhance liquidity, if necessary. In addition, $51.7 million of unpledged held to maturity securities could also be pledged for liquidity purposes.

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 $1.3 billion in unused commitments as of June 30, 2018. While this commitment

41



level would exhaust the majority of 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 bank affiliate must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The banking affiliate’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
 
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total, Tier 1, and common equity tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. To be categorized as “well capitalized”, banks must maintain minimum total risk-based (10%), Tier 1 risk-based (8%), common equity tier 1 risk-based (6.5%), and Tier 1 leverage ratios (5%). As of June 30, 2018, and December 31, 2017, the Company and the Bank met all capital adequacy requirements to which they are subject.
 
The Bank continues to exceed regulatory standards and met the definition of “well-capitalized” (the highest category) at June 30, 2018. The Company adopted the Regulatory Capital Framework (Basel III) in 2015, and has implemented the necessary processes and procedures to comply.

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

(in thousands)
June 30,
2018
 
December 31, 2017
 
Well Capitalized Minimum %
Total capital to risk-weighted assets
12.60
%
 
12.21
%
 
10.00
%
Tier 1 capital to risk-weighted assets
10.68
%
 
10.29
%
 
8.00
%
Common equity tier 1 capital to risk-weighted assets
9.32
%
 
8.88
%
 
6.50
%
Leverage ratio (Tier 1 capital to average assets)
9.99
%
 
9.72
%
 
5.00
%
Tangible common equity to tangible assets1
8.30
%
 
8.14
%
 
N/A

Tier 1 capital
$
529,624

 
$
496,045

 
 
Total risk-based capital
624,419

 
589,047

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

42



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 non-core acquired 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 non-core acquired loans, but exclude incremental accretion on these loans. Core performance measures also exclude the gain or loss on sale of other real estate from non-core acquired loans, deferred tax asset revaluation due to U.S. corporate income tax reform, and expenses directly related to non-core acquired 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, facilities disposal 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.

43



Core Performance Measures
 
For the Three Months ended
 
For the Six Months ended
(in thousands)
June 30,
2018
 
March 31,
2018
 
June 30,
2017
 
June 30,
2018
 
June 30,
2017
Net interest income
$
47,048

 
$
46,171

 
$
45,633

 
$
93,219

 
$
84,275

Less: Incremental accretion income
291

 
766

 
2,584

 
1,057

 
3,659

Core net interest income
46,757

 
45,405

 
43,049

 
92,162

 
80,616

 
 
 
 
 
 
 
 
 
 
Total noninterest income
9,693

 
9,542

 
7,934

 
19,235

 
14,910

Less: Gain on sale of investment securities

 
9

 

 
9

 

Less: Other income from non-core acquired assets
18

 
1,013

 

 
1,031

 

Less: Other non-core income
649

 

 

 
649

 

Core noninterest income
9,026

 
8,520

 
7,934

 
17,546

 
14,910

 
 
 
 
 
 
 
 
 
 
Total core revenue
55,783

 
53,925

 
50,983

 
109,708

 
95,526

 
 
 
 
 
 
 
 
 
 
Provision for portfolio loans
2,385

 
1,871

 
3,623

 
4,256

 
5,156

 
 
 
 
 
 
 
 
 
 
Total noninterest expense
29,219

 
29,143

 
32,651

 
58,362

 
59,387

Less: Other expenses related to non-core acquired loans
(229
)
 
14

 
(16
)
 
(215
)
 
107

Less: Merger related expenses

 

 
4,480

 

 
6,147

Less: Facilities disposal charge
239

 

 
389

 
239

 
389

Core noninterest expense
29,209

 
29,129

 
27,798

 
58,338

 
52,744

 
 
 
 
 
 
 
 
 
 
Core income before income tax expense
24,189

 
22,925

 
19,562

 
47,114

 
37,626

 
 
 
 
 
 
 
 
 
 
Total income tax expense
4,881

 
3,778

 
5,545

 
8,659

 
10,651

Less: Other non-core income tax expense1
736

 
438

 
(784
)
 
1,174

 
(594
)
Core income tax expense
4,145

 
3,340

 
6,329

 
7,485

 
11,245

Core net income
$
20,044

 
$
19,585

 
$
13,233

 
$
39,629

 
$
26,381

 
 
 
 
 
 
 
 
 
 
Core diluted earnings per share
$
0.86

 
$
0.84

 
$
0.56

 
$
1.70

 
$
1.15

Core return on average assets
1.48
%
 
1.49
%
 
1.06
%
 
1.49
%
 
1.11
%
Core return on average common equity
14.14
%
 
14.34
%
 
9.72
%
 
14.24
%
 
10.44
%
Core return on average tangible common equity
18.22
%
 
18.64
%
 
12.72
%
 
18.43
%
 
13.22
%
Core efficiency ratio
52.36
%
 
54.02
%
 
54.52
%
 
53.18
%
 
55.21
%
 
 
 
 
 
 
 
 
 
 
1Other non-core income tax expense calculated at 24.7% of non-core pretax income for 2018. For 2017, the calculation is 38.0% of non-core pretax income plus an estimate of taxes payable related to non-deductible JCB acquisition costs.

44




Net Interest Margin to Core Net Interest Margin (fully tax equivalent)
 
Three months ended June 30,
 
Six months ended June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Net interest income
$
47,254

 
$
46,096

 
$
93,640

 
$
85,243

Less: Incremental accretion income
291

 
2,584

 
1,057

 
3,659

Core net interest income
$
46,963

 
$
43,512

 
$
92,583

 
$
81,584

 
 
 
 
 
 
 
 
Average earning assets
$
5,023,607

 
$
4,641,198

 
$
4,986,447

 
$
4,451,253

Reported net interest margin
3.77
%
 
3.98
%
 
3.79
%
 
3.86
%
Core net interest margin
3.75
%
 
3.76
%
 
3.74
%
 
3.70
%


Tangible common equity ratio
(in thousands)
June 30, 2018
 
December 31, 2017
Total shareholders' equity
$
574,084

 
$
548,573

Less: Goodwill
117,345

 
117,345

Less: Intangible assets
9,768

 
11,056

Tangible common equity
$
446,971

 
$
420,172

 
 
 
 
Total assets
$
5,509,924

 
$
5,289,225

Less: Goodwill
117,345

 
117,345

Less: Intangible assets
9,768

 
11,056

Tangible assets
$
5,382,811

 
$
5,160,824

 
 
 
 
Tangible common equity to tangible assets
8.30
%
 
8.14
%

45



Regulatory Capital to Risk-Weighted Assets

(in thousands)
June 30, 2018
 
December 31, 2017
Total shareholders' equity
$
574,084

 
$
548,573

Less: Goodwill
117,345

 
117,345

Less: Intangible assets, net of deferred tax liabilities
7,355

 
6,661

Plus: Unrealized gains (losses)
(12,580
)
 
(3,818
)
Plus: Other

 
12

Common equity Tier 1 capital
461,964

 
428,397

Plus: Qualifying trust preferred securities
67,600

 
67,600

Plus: Other
60

 
48

Tier 1 capital
529,624

 
496,045

Plus: Tier 2 capital
94,795

 
93,002

Total risk-based capital
624,419

 
589,047

 
 
 
 
Total risk-weighted assets determined in accordance with prescribed regulatory requirements
$
4,956,820

 
$
4,822,695

 
 
 
 
Common equity tier 1 to risk-weighted assets
9.32
%
 
8.88
%
Tier 1 capital to risk-weighted assets
10.68
%
 
10.29
%
Total risk-based capital to risk-weighted assets
12.60
%
 
12.21
%

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, 2017.


46



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
4.9%
+ 200 bp
3.4%
+ 100 bp
1.7%
 - 100 bp
(3.9)%

In addition to the rate shocks shown in the table above, the Company models net interest income under various dynamic
interest rate scenarios. Therefore, positive changes in rates result in higher levels of net interest income, while scenarios based on declining rates, particularly those involving decreases in long-term rates, result in reduced net interest income.

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.

47



ITEM 4: CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of the Company’s Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15, as of June 30, 2018. Disclosure controls and procedures include without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Based on that evaluation, the CEO and CFO concluded the Company’s disclosure controls and procedures were effective as of June 30, 2018 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, 2017. There have been no material changes to the risk factors described in such Annual Report on Form 10-K.


48



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

Issuer Purchases of Equity Securities

There were no repurchases of common stock by the Company during the quarter ended June 30, 2018.



49



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

14.0

*31.1

*31.2

**32.1

**32.2

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 June 30, 2018, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheet at June 30, 2018 and December 31, 2017; (ii) Consolidated Statement of Income for the three and six months ended June 30, 2018 and 2017; (iii) Consolidated Statement of Comprehensive Income for the three and six months ended June 30, 2018 and 2017; (iv) Consolidated Statement of Changes in Equity for the six months ended June 30, 2018 and 2017; (v) Consolidated Statement of Cash Flows for the six months ended June 30, 2018 and 2017; 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.

50



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Clayton, State of Missouri on the day of July 27, 2018.
 
 
ENTERPRISE FINANCIAL SERVICES CORP
 
 
 
By:
/s/ James B. Lally
 
 
 
James B. Lally
 
 
 
Chief Executive Officer
 
 
 
 
By: 
/s/ Keene S. Turner
 
 
 
Keene S. Turner
 
 
 
Chief Financial Officer
 



51