Earnings Call Transcript - EFSC Q4 2020

Operator, Operator

Good day. And welcome to the EFSC Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Jim Lally, President and CEO. Please go ahead.

Jim Lally, President and CEO

Well, thank you, Shelby, and good morning. And welcome to our Fourth Quarter Earnings Call. I appreciate all of you taking time to listen in. Joining me this morning is Keene Turner, our company’s Chief Financial Officer and Chief Operating Officer; Scott Goodman, President of Enterprises Bank & Trust; and Doug Bauche, Chief Credit Officer.

Scott Goodman, President of Enterprises Bank & Trust

Thank you, Jim. Good morning, everybody. Loans at year end are highlighted on slide number five and totaled $7.2 billion, representing a 36% increase from the prior year. Growth of $1.1 billion in the quarter is most heavily impacted by the addition of the Seacoast book, combined with a reduction of $206 million in PPP balances and organic growth of $81 million.

Doug Bauche, Chief Credit Officer

Yeah. Thanks, Scott. I’m pleased to review Q4 and fiscal year end 2020 asset quality, as we finished the year with some very strong credit results. Net recoveries of $612,000 in the fourth quarter resulted in total net charge-offs just 3 basis points or $1.9 million for the fiscal year 2020. Total classified increased by $39 million from the prior quarter to $124 million, largely due to the downgrade of two hospitality loans in the legacy Enterprise portfolio and the addition of $29 million in classified loans acquired via Seacoast. As a percentage of capital, however, classified loan levels remained relatively stable at approximately 10% for both the current and prior quarter. Non-performing assets declined to 0.45% of total assets from 0.53% the prior quarter and 30-day delinquencies were well-managed at $12.5 million or 17 basis points of total loans. Turning your attention to slide 11, loan deferral activity has continued to decline as anticipated. Loans remaining in deferral status at year end declined to $63 million or 1% of total loans, excluding PPP, compared to $139 million or 3% the prior quarter. 86% of the remaining deferrals are scheduled to expire by the end of Q1 ‘21. You’ll see on slide 12 the allowance coverage for the broader portfolios of C&I, CRE, construction and residential real estate. While credit metrics remain favorable, our total allowance for credit losses increased 11% from the prior quarter to $137 million at year end. The reserve now provides a 355% coverage of non-performing loans, 2.31% of total loans excluding PPP and SBA 7(a) guaranteed portions and 1.89% of all loan exposure. Provisioning of $9.4 million in the fourth quarter was largely related to the day one CECL reserve on the acquired Seacoast non-PCD portfolio. And with that, I’ll turn it over to Keene Turner.

Keene Turner, Chief Financial Officer and COO

Thanks, Doug, and good morning. My comments begin on slide 13 and we’ll address the full year 2020. We reported net income of $74.4 million or $2.76 per share. Our successful execution on PPP and our diversified fee income sources were differentiators that helped us to offset low interest rates, as well as the income trends from COVID-related restrictions and behaviors. We increased our pre-provision net revenue by 15% in 2020 to $162 million or 1.96% of average assets. We ended the year on a high note closing the acquisition of Seacoast, while also increasing net income during each quarter of 2020.

Operator, Operator

Thank you. We’ll take our first question from Michael Schiavone with KBW.

Michael Schiavone, Analyst

Hi. Good morning.

Jim Lally, President and CEO

Good morning, Michael.

Michael Schiavone, Analyst

So, my first question, you guys saw some pretty good organic commercial growth in the quarter. Can you just talk about the state of those pipelines in the overall loan growth expectations for 2021?

Scott Goodman, President of Enterprises Bank & Trust

Yeah. Hi, Michael. This is Scott. I can kind of handle that. I think, to reinforce what I said, I’ve focused a lot on gross production, particularly over the last few quarters, because I think a lot of the headwinds are external, and obviously, there’s a lot of that, that looks like there’s light at the end of the tunnel there. So, the specialty businesses have been pretty steady producers throughout the year. Life insurance had its typical four quarter uptick. We saw volumes elevated with sponsor finance, which we didn’t necessarily see last fourth quarter, but now see it. And then in the markets, I think, the production is steadily ramping up. We’re seeing things like M&A activity recapitalizations. I think we had two of our long-term clients do ESOPs in the quarter, which is becoming a more popular form of succession and then steady investor CRE volumes. So I feel good about continuing the level of production that we’ve seen looking forward and pipelines are pretty consistent with that right now.

Michael Schiavone, Analyst

Great. Thanks. And can you guys also just talk about what you’re expecting for fee growth in 2021 and where do you think the biggest opportunities are here especially as it relates to cross-selling to Seacoast and PPP clients?

Keene Turner, Chief Financial Officer and COO

Yeah. Maybe we’ll team up on.

Scott Goodman, President of Enterprises Bank & Trust

I can talk to.

Keene Turner, Chief Financial Officer and COO

Go ahead on cross-sell Scott and then I can provide a little bit of higher level guidance if you’d like.

Scott Goodman, President of Enterprises Bank & Trust

We have been focusing on PPP as a chance to create new relationships, with over 700 new businesses. Additionally, we are working to cross-sell to our existing clients by walking them through the PPP and forgiveness process. We have a strong sales force monitoring our sales activities. There are opportunities in areas like treasury management, which we are continuing to invest in as it shows potential for growth. We are also examining how businesses use cards for payment services, which align well with some of our treasury management offerings. Furthermore, we aim to sell to the families and business owners of our clients, making private banking and wealth management another key area of focus for us.

Keene Turner, Chief Financial Officer and COO

Yeah. And Michael, this is Keene. I would say we normally expect the banking related service charges to basically be mid-single-digit growers, kind of that’s the, I would say, that’s across the board. Expectation, I think, the wild card that you have is, what are the headwinds that relate to potential or additional shutdowns or measures in market and some of these are just behavior driven, the credit card business, for example. We’re starting to see some positive improvement there. But we have some muted volumes, because businesses aren’t traveling and spending as much. So those are difficult to predict, but I think we expect some more resumption, particularly in the back half of 2021. And then, I think, for our drivers of those line items, I think, it’s more of the same. I think we expect basically tax credit to be another 10% grower. And I think there are some opportunities throughout 2021 to have some more success with our CDE, similar to what you saw in the fourth quarter. But that’s a little bit of a tough one to predict. We think it’s coming, but the timing of that could be a little bit uncertain. But to me, I think those are the places where you can see some outsize strength will say in terms of driving the fee income line item.

Michael Schiavone, Analyst

Great. Thanks for taking my questions.

Keene Turner, Chief Financial Officer and COO

Thank you.

Operator, Operator

We’ll take our next question from Jeff Rulis with D.A. Davidson.

Jeff Rulis, Analyst

Thanks. Good morning.

Jim Lally, President and CEO

Good morning, Jeff.

Jeff Rulis, Analyst

I have a question for Doug regarding the deal, specifically about credit migration and the legacy portfolio, and what might be coming in or out. Additionally, could you provide details on what has been added from Seacoast concerning non-accrual? Thank you.

Doug Bauche, Chief Credit Officer

Yeah. Jeff, good morning. I think maybe just in reverse order, what we brought on from Seacoast in terms of non-accrual, non-performing loans was about $6 million. It’s only about $1 million or $1.5 million of that in unguaranteed portions. Seacoast has very little if any loans in deferrals; largely SBA lending their borrowers have benefited from the stimulus payments that the government’s making on all SBA loans. And certainly, there is another round here will further benefit from those payment activities. In the legacy portfolio, it’s remained really quite stable in terms of classified assets. We saw very little change. We’ve successfully worked through a number of credits. We did downgrade Jeff, any remaining lodging or hospitality loans that received a second deferral, we downgraded in the fourth quarter. And we continued kind of to allocate reserves to that COVID impacted portfolio. But as we sit today, I think, we feel that our reserves are well positioned and strong. So, hopefully, that provided color to your question.

Jeff Rulis, Analyst

No. I appreciate it. Thanks Doug. And then just a fine-tuning on Seacoast impact on a couple fronts, the margin, can you appreciate the number you called out on contribution or improvement and then the guidance. But more interested in just how Seacoast changes the sensitivity of the combined franchise, understanding there’s still some kind of liquidity that maybe move around, but just in general, maybe day one, how did that affect sensitivity?

Jim Lally, President and CEO

Yeah. Jeff, I would say, we didn’t see a big movement in the asset sensitivity. I think up 100 basis points, we’re still 2% asset sensitive. I think to the extent that rates rise more dramatically than that, I think, that’s where the assets sensitivity maybe pop maybe 1.5% to 2% in those plus 2 and plus 3 scenarios. Unfortunately, I don’t think those are likely and so we’ll just kind of continue to monitor the balance sheet and see what’s there. But also to your point, that asset sensitivity is going to be reflective of $0.5 billion of cash on the end of the balance sheet at the end of the year as well, so both of those are factual. But I think, number one, lower more stable cost of funds on a combined basis and I think when you look at what we’ve done with now Trinity, Seacoast, the funding base is, I think, materially different than it was four years or five years ago, and then I think we feel like the Seacoast SBA engine, particularly now during more challenging economic times will provide a nice addition for some predictable growth for 2021 and beyond. So we’re excited about that.

Jeff Rulis, Analyst

Got it. And then the other Seacoast related, was on the expenses, you talked about $52 million in the first quarter run rate and then the step down? The conversion for Seacoast I forget when that was set?

Jim Lally, President and CEO

Yeah. We’re converting core, call it, core banking systems mid-first quarter, but there’ll be some other conversions that have already taken place and some that are following. So I think of most conversion being completed as of the end of the first quarter. So I’m not sure if you’re going to get a fully clean second quarter, but certainly by the third quarter, we expect the synergies to be out of it and the 25% cost save assumption to be there.

Jeff Rulis, Analyst

Okay. So that was the $2 million step down depending on the timing of…

Jim Lally, President and CEO

Yeah.

Jeff Rulis, Analyst

...it’s fully clean in the second quarter?

Jim Lally, President and CEO

Yeah. It is really $3 million of synergies and then, as you know, I think, our first quarter is usually a little bit heavy with payroll taxes. We expect that to kind of level out in the second quarter and then you get some normal additions will say for growth and adds the staff and continued lending. So my $52 sort of blended a little bit of investment in the business in there. But I think of kind of core Enterprise’s of $40 million, $41 million and then the Seacoast is 12 pre-synergies and nine post-synergy.

Jeff Rulis, Analyst

Very clear. Thank you.

Operator, Operator

We’ll take our next question from Andrew Liesch with Piper Sandler.

Andrew Liesch, Analyst

Hi, everyone. Good morning. Just want to question on loan yields. References are that they are holding up well here, I guess, 3 basis point decline one quarter, like you said. The improvement in the yield curve helps at all or do you just expect any improvement that could occur just basically be competed away, just given the liquidity in the system?

Keene Turner, Chief Financial Officer and COO

I don't think we're anticipating positive news regarding the investment portfolio or loan yields. We are making efforts to maintain our current position. Trends have been stable for several quarters, and we're optimistic that with some net production and by continuing our relationship-based pricing, we should be able to maintain our yields. However, I don't foresee any improvement in the yield curve impacting the margin guidance I shared.

Andrew Liesch, Analyst

Got it. And just hearing some optimism around loan growth, which may be core loan growth, which maybe you didn’t really have a couple of quarters ago, you referenced, maybe around mid-single digits. When do you think we could see and maybe it’s too premature to discuss it now, but an improvement just in the earning asset mix and just see margin expansion that way? I recognize that you’re focusing on NII dollars rather than margin, but just trying to figure out the trajectory here?

Scott Goodman, President of Enterprises Bank & Trust

Yeah. Look, I think, the big question comes down from my perspective, how much more does another round of PPP pressure line of credit usage and things like that? I mean, I think, we’re down on the slide that we have, line usage is down 8 percentage points from a year ago. And so, normally, we’re sweating over a couple basis points of line usage that could mute or to make a quarter look robust from a growth perspective. So I think it’s a tough question. But I think what you heard from Scott, is that, he is focused on gross production and I think that bodes well. And I think that we’re optimistic that at least in some combination of bringing Seacoast on a little bit of momentum in the base Enterprise pipeline and business development that’s not completely washed away by line usage and things like that pay down that we’ll get a little bit of that in 2021. But it’s hard for me to say, you’re going to see that in the second quarter or the third quarter. I think a lot depends on what happens over the next few months in the economy and getting people kind of back and operating in a more normal fashion.

Jim Lally, President and CEO

And Andrew, this is Jim. I would add to that, this whole balance between growth and yield is intertwined. We’ve worked hard culturally to avoid having to do the last deal in the market to achieve growth. Wavering from that can lead to challenges. I credit Scott and Doug for the discipline within the teams. Additionally, we’ve built a diverse engine, allowing us not to rely on any single class while maintaining our pricing and still achieving acceptable growth. However, we need to be cautious during these times to avoid taking any opportunity just for growth or holding back and missing out on it. It’s a daily challenge, which is honestly exciting.

Andrew Liesch, Analyst

Understood. Thank you for taking the questions. I’ll step back.

Operator, Operator

We’ll take our next question from David Long with Raymond James.

David Long, Analyst

Good morning, everyone.

Jim Lally, President and CEO

Good morning, David.

David Long, Analyst

As it relates to M&A, just could you talk maybe a little bit about the pipeline now, we’ve seen a few deals in the industry get announced and I think buyers are getting a little bit more comfortable with potential sellers, loan portfolios? Can you maybe talk about the pipeline and then any discussions you’ve had, how has the seller reception been and how have price expectations changed over the last few months?

Jim Lally, President and CEO

This is Jim. I have to say this so, we have a lot of great momentum in the business right now. And so number one, we have to make sure that any target or any discussions only adds to it and doesn’t become a distraction. And we don’t openly discuss our pipeline per se, just know that it’s a consistent process, conversations are ongoing, we don’t fall in love with anything. I think we just look for the right partners with the right business model can accelerate our long-term strategic plan.

David Long, Analyst

Okay. And I don’t know separately from…

Keene Turner, Chief Financial Officer and COO

David, I will add to this….

David Long, Analyst

Go ahead.

Keene Turner, Chief Financial Officer and COO

I want to emphasize that we have maintained a disciplined approach to pricing. While it's important for us to remain steadfast, we are also inviting a new group of shareholders to share in our vision. Our team does an excellent job of ensuring we strike the right balance.

David Long, Analyst

Okay. And absent M&A, what can you do or how are you managing the asset level, so you don’t go over the $10 billion level in an inefficient manner?

Keene Turner, Chief Financial Officer and COO

Yeah. What I would say is, as you saw us make that pivot away from wholesale funding at the end of the year that obviously that $200 million helped to stay, but look and also provides some earnings growth for ‘21 and ‘22, that we wouldn’t have otherwise had just eliminating that expense. But our view is this that, to the extent if there is the cash that’s on the balance sheet is not relationship money. We’re looking at those places. But we’re not going to push out good borrowing relationships for the long-term detriment of the business because we’re worried about tripping over $10 billion a little bit. We’ve got some time if we don’t do it via M&A and so all of the impacts become affected. And I think, Jim indicated, we’re kind of always looking for M&A. So my expectation is that this next round of PPP is going to make it really difficult for us to limbo under $10 billion and I think that’s just sort of an industry issue. And we’re going to do our best just to earn through it to the extent possible.

David Long, Analyst

Got it. I appreciate the color guys. Thank you.

Keene Turner, Chief Financial Officer and COO

Thanks, David.

Operator, Operator

We’ll take our next question from Brian Martin with Janney Montgomery.

Brian Martin, Analyst

Hey. Good morning.

Jim Lally, President and CEO

Good morning, Brian.

Brian Martin, Analyst

Hey, Keene, one follow-up on the last question that impact if you do cross $10 billion, do you have an indication of how much that is what that cost you?

Keene Turner, Chief Financial Officer and COO

On the expense side, it's a couple million dollars, and on the fee side, it's a few million dollars. So the total impact, once it phases in, is about $5 million pretax.

Brian Martin, Analyst

Okay. And then just going back to your comments, can I miss some of what you said on the margin and just kind of the, I think, you talked about some hedges and some cash flow hedges and the impact to margin? Can you just run back through that if you could?

Keene Turner, Chief Financial Officer and COO

Yeah. So, Brian, the easiest way to think about the impact at least in terms of dollars is, the charge that we took in the quarter being $3 million, quick and dirty, that comes back in essentially evenly as avoided interest expense in ‘21 and ‘22, because there were two years remaining on that. So $1.5 million on the total margin, so, you have 2 basis points, 3 basis points.

Brian Martin, Analyst

Got you. Okay. All right. That’s helpful and the…

Keene Turner, Chief Financial Officer and COO

But that will likely get soaked up by excess liquidity and you’ll never see it.

Brian Martin, Analyst

I was going to mention the overall size of the balance sheet, specifically regarding the excess liquidity. Relating to your last point about managing to the $10 billion, how do you expect the balance sheet to evolve throughout the year in relation to the PPP? What is your anticipated timing, and how much reduction do you expect with the PPP impacting the balance sheet as the year progresses?

Keene Turner, Chief Financial Officer and COO

Currently, we are seeing around $20 million a week in PPP forgiveness. However, this does not lead to a decrease in our balance sheet. Most of this funding remains with our customers, similar to what we experienced in 2020. My expectation is that regardless of our success with PPP—having achieved over $800 million in the first round and nearly $900 million with Seacoast—even if we only secure half or two-thirds of that amount, we will exceed $10 billion significantly. Based on trends from the first round, I do not anticipate that this liquidity will be removed from the balance sheet anytime soon. From my viewpoint, we managed to avoid surpassing the threshold as of December 31, 2020, but I don't see a way to offload that liquidity to stay under the limit, and I don't think it would be viewed positively by our customers. PPP will provide us with a beneficial income boost during another round, and we need to take advantage of that. We are prepared from a systems and personnel standpoint to cross the $10 billion mark, and we must continue executing our strategy, grow our loan portfolio, and potentially pursue another deal to aid our scaling efforts.

Brian Martin, Analyst

Got you. Okay. That’s helpful. And just maybe the last two, which is, when you think about, I appreciate the comments on the outlook for the reserve and whatnot. But as you get beyond, if the economic conditions do improve and the credit quality continues to hold this, it sounds like it could. I mean, can you talk about where the post-COVID reserve level kind of where you think it trends to over time?

Keene Turner, Chief Financial Officer and COO

Regarding CECL adoption, we were previously at approximately 115 to 125 basis points of total loans, and now we’re about 100 basis points higher than that. I believe the lowest point of adoption is likely at this level, but we may experience some additional permanent risk due to unexpected events or a worse economic environment that could arise suddenly. I would say it's probably at the upper end of that range, but it’s not as high as 230 basis points, so there is some potential for relief. Additionally, the ultimate resolution and loss rate for certain asset classes is still to be determined, which we will need to consider as well. However, if there are no losses, I think a lot of what was done in 2020 could be unwound.

Brian Martin, Analyst

Okay. Are you expecting that you might gradually grow into that, or could there actually be releases in a specific quarter?

Keene Turner, Chief Financial Officer and COO

Yeah. Brian, I think, it’s really hard for me right now to envision doing anything quickly. I think…

Brian Martin, Analyst

Yeah.

Keene Turner, Chief Financial Officer and COO

...CECL to me suggests you build quickly, when you see the evidence, we did that. But I just think with how elongated the loss emergence period is, I think it’s difficult to reduce in material chunks. So I think you’re going to end up with some sort of growing into it, so to speak, simply because you’re going to always be worried that maybe you didn’t fully incur losses or there is more impairment in certain asset classes that just is out there. Now, something swiftly or abruptly is done to allay those concerns then clearly we would need to evaluate that in terms of the reserve. But my view is that at least for the foreseeable future that, unless you get evidence one way or another, your actions are going to be less material when you are provisioning than more material.

Brian Martin, Analyst

Yeah. Okay. Well, I appreciate you taking the questions. Thanks, guys.

Keene Turner, Chief Financial Officer and COO

Thank you, Brian.

Operator, Operator

That concludes today’s question-and-answer session. At this time, I will turn the conference back to Jim Lally, President and CEO for any additional closing remarks.

Jim Lally, President and CEO

Thank you, Shelby. And thank you all again for joining us this morning and certainly for your interest in our company. We look forward to speaking with you again following the first quarter. Have a great day.

Operator, Operator

This concludes today’s call. Thank you for your participation. You may now disconnect.