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EX-12.1 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS - ENTERPRISE FINANCIAL SERVICES CORPa2017930-ex121.htm
EX-99.1 - EXHIBIT 99.1 - ENTERPRISE FINANCIAL SERVICES CORPa2017930-ex991.htm
EX-32.2 - CHIEF FINANCIAL OFFICER CERTIFICATION PURSUANT TO 18 U.S.C SECT 1350 - ENTERPRISE FINANCIAL SERVICES CORPa2017930-ex322.htm
EX-32.1 - CHIEF EXECUTIVE OFFICER CERTIFICATION PURSUANT TO 18 U.S.C SECT 1350 - ENTERPRISE FINANCIAL SERVICES CORPa2017930-ex321.htm
EX-31.2 - CHIEF FINANCIAL OFFICER CERTIFICATION REQUIRED BY RULE 13(A)-14(A) - ENTERPRISE FINANCIAL SERVICES CORPa2017930-ex312.htm
EX-31.1 - CHIEF EXECUTIVE OFFICER CERTIFICATION REQUIRED BY RULE 13(A)-14(A) - ENTERPRISE FINANCIAL SERVICES CORPa2017930-ex311.htm


 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
 
FORM 10-Q
 
[X]
 
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2017.
 
 
 
[   ]
 
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ______ to ______
 
 
 
 
 
Commission file number 001-15373
 
ENTERPRISE FINANCIAL SERVICES CORP

 
Incorporated in the State of Delaware
I.R.S. Employer Identification # 43-1706259
Address: 150 North Meramec
Clayton, MO 63105
Telephone: (314) 725-5500
___________________
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes [X]  No [   ] 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X]  No [   ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ]
Accelerated filer [X]
Non-accelerated filer [ ] (Do not check if a smaller reporting company)
Smaller reporting company [ ]

 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Yes [   ]  No [X]
 
As of October 25, 2017, the Registrant had 23,064,850 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 5. Other Information
 
 
 
 
Item 6. Exhibits
 
 
Signatures
 
 
 
 





PART 1 - ITEM 1 - FINANCIAL STATEMENTS
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
(in thousands, except share and per share data)
September 30, 2017
 
December 31, 2016
Assets
 
 
 
Cash and due from banks
$
76,777

 
$
54,288

Federal funds sold
1,155

 
446

Interest-bearing deposits (including $2,949 and $675 pledged as collateral)
105,176

 
144,068

Total cash and cash equivalents
183,108

 
198,802

Interest-bearing deposits greater than 90 days
2,645

 
980

Securities available for sale
603,121

 
460,797

Securities held to maturity
76,168

 
80,463

Loans held for sale
6,411

 
9,562

Loans
4,030,658

 
3,158,161

Less: Allowance for loan losses
43,191

 
43,409

Total loans, net
3,987,467

 
3,114,752

Other real estate
491

 
980

Other investments, at cost
29,436

 
14,840

Fixed assets, net
32,803

 
14,910

Accrued interest receivable
14,213

 
11,117

State tax credits held for sale (including $1,274 and $3,585 carried at fair value)
35,291

 
38,071

Goodwill
117,345

 
30,334

Intangible assets, net
11,745

 
2,151

Other assets
131,244

 
103,569

Total assets
$
5,231,488

 
$
4,081,328

 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
Demand deposits
$
1,047,910

 
$
866,756

Interest-bearing transaction accounts
814,338

 
731,539

Money market accounts
1,375,844

 
1,050,472

Savings
203,923

 
111,435

Certificates of deposit:
 
 
 
Brokered
170,701

 
117,145

Other
446,495

 
356,014

Total deposits
4,059,211

 
3,233,361

Subordinated debentures and notes (net of debt issuance cost of $1,169 and $1,267)
118,093

 
105,540

Federal Home Loan Bank advances
248,868

 

Other borrowings
209,104

 
276,980

Notes payable
10,000

 

Accrued interest payable
2,007

 
1,105

Other liabilities
37,869

 
77,244

Total liabilities
4,685,152

 
3,694,230

 
 
 
 
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; 23,754,814 and 20,306,353 shares issued
237

 
203

Treasury stock, at cost; 691,673 and 261,718 shares, respectively
(23,268
)
 
(6,632
)
Additional paid in capital
349,485

 
213,078

Retained earnings
220,371

 
182,190

Accumulated other comprehensive loss
(489
)
 
(1,741
)
Total shareholders' equity
546,336

 
387,098

Total liabilities and shareholders' equity
$
5,231,488

 
$
4,081,328

See accompanying notes to consolidated financial statements.

1



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands, except per share data)
2017
 
2016
 
2017
 
2016
Interest income:
 
 
 
 
 
 
 
Interest and fees on loans
$
48,020

 
$
34,442

 
$
135,253

 
$
101,233

Interest on debt securities:
 
 
 
 
 
 
 
Taxable
3,855

 
2,410

 
10,670

 
7,194

Nontaxable
294

 
322

 
984

 
982

Interest on interest-bearing deposits
173

 
67

 
537

 
186

Dividends on equity securities
126

 
52

 
306

 
191

Total interest income
52,468

 
37,293


147,750


109,786

Interest expense:
 
 
 
 
 
 
 
Interest-bearing transaction accounts
523

 
332

 
1,721

 
967

Money market accounts
2,410

 
1,143

 
5,841

 
3,162

Savings accounts
125

 
68

 
332

 
191

Certificates of deposit
1,493

 
1,319

 
4,081

 
3,521

Subordinated debentures and notes
1,316

 
369

 
3,768

 
1,078

Federal Home Loan Bank advances
832

 
126

 
1,684

 
499

Notes payable and other borrowings
144

 
106

 
423

 
327

Total interest expense
6,843

 
3,463


17,850


9,745

Net interest income
45,625

 
33,830

 
129,900

 
100,041

Provision for portfolio loan losses
2,422

 
3,038

 
7,578

 
4,587

Provision reversal for purchased credit impaired loan losses

 
(1,194
)
 
(355
)
 
(1,603
)
Net interest income after provision for loan losses
43,203

 
31,986


122,677


97,057

Noninterest income:
 
 
 
 
 
 
 
Service charges on deposit accounts
2,820

 
2,200

 
8,146

 
6,431

Wealth management revenue
2,062

 
1,694

 
5,949

 
5,000

Card services revenue
1,459

 
804

 
3,888

 
2,236

Gain (loss) on sale of other real estate

 
(226
)
 
17

 
602

Gain on state tax credits, net
77

 
228

 
332

 
899

Gain on sale of investment securities
22

 
86

 
22

 
86

Miscellaneous income
1,932

 
2,190

 
4,928

 
4,776

Total noninterest income
8,372

 
6,976


23,282


20,030

Noninterest expense:
 
 
 
 
 
 
 
Employee compensation and benefits
15,090

 
12,091

 
46,096

 
37,398

Occupancy
2,434

 
1,705

 
6,628

 
4,997

Data processing
1,389

 
1,150

 
4,828

 
3,441

Professional fees
922

 
757

 
2,838

 
2,160

FDIC and other insurance
882

 
780

 
2,356

 
2,241

Loan legal and other real estate expense
586

 
416

 
1,544

 
1,126

Merger related expenses
315

 
302

 
6,462

 
302

Other
5,786

 
3,613

 
16,039

 
11,264

Total noninterest expense
27,404

 
20,814


86,791


62,929

 
 
 
 
 
 
 
 
Income before income tax expense
24,171

 
18,148


59,168


54,158

Income tax expense
7,856

 
6,316

 
18,507

 
18,949

Net income
$
16,315

 
$
11,832


$
40,661


$
35,209

 
 
 
 
 
 
 
 
Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.70

 
$
0.59

 
$
1.77

 
$
1.76

Diluted
0.69

 
0.59

 
1.75

 
1.74

See accompanying notes to consolidated financial statements.

2




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

 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Net income
$
16,315

 
$
11,832

 
$
40,661

 
$
35,209

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 $(493) and $(494), and for nine months of $775 and $2,795, respectively
(805
)
 
(796
)
 
1,265

 
4,503

Less: Reclassification adjustment for realized gains on sale of securities available for sale included in net income, net of income tax expense for three months of $8 and $33, and for nine months of $8 and $33, respectively
(13
)
 
(53
)
 
(13
)
 
(53
)
Total other comprehensive income (loss)
(818
)
 
(849
)
 
1,252

 
4,450

Total comprehensive income
$
15,497

 
$
10,983

 
$
41,913

 
$
39,659


See accompanying notes to consolidated financial statements.


3



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Shareholders’ Equity (Unaudited)
(in thousands, except per share data)
Preferred Stock
 
Common Stock
 
Treasury Stock
 
Additional paid in capital
 
Retained earnings
 
Accumulated
other
comprehensive income (loss)
 
Total
shareholders' equity
Balance December 31, 2016
$

 
$
203

 
$
(6,632
)
 
$
213,078

 
$
182,190

 
$
(1,741
)
 
$
387,098

Net income

 

 

 

 
40,661

 

 
40,661

Reclassification adjustment for realized gain on sale of securities included in net income, net of tax

 

 

 

 

 
1,252

 
1,252

Total comprehensive income

 

 

 

 
40,661

 
1,252

 
41,913

Cash dividends paid on common shares, $0.33 per share

 

 

 

 
(7,709
)
 

 
(7,709
)
Repurchase of common shares

 

 
(16,636
)
 

 

 

 
(16,636
)
Issuance under equity compensation plans, 148,597 shares, net

 
1

 

 
(2,574
)
 

 

 
(2,573
)
Share-based compensation

 

 

 
2,514

 

 

 
2,514

Shares issued in connection with acquisition of Jefferson County Bancshares, Inc.

 
33

 

 
141,696

 

 

 
141,729

Reclassification for the adoption of ASU 2016-09

 

 

 
(5,229
)
 
5,229

 

 

Balance September 30, 2017
$

 
$
237

 
$
(23,268
)
 
$
349,485

 
$
220,371

 
$
(489
)
 
$
546,336

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except per share data)
Preferred Stock
 
Common Stock
 
Treasury Stock
 
Additional paid in capital
 
Retained earnings
 
Accumulated
other
comprehensive income (loss)
 
Total
shareholders' equity
Balance December 31, 2015
$

 
$
201

 
$
(1,743
)
 
$
210,589

 
$
141,564

 
$
218

 
$
350,829

Net income

 

 

 

 
35,209

 

 
35,209

Other comprehensive income

 

 

 

 

 
4,450

 
4,450

Cash dividends paid on common shares, $0.30 per share

 

 

 

 
(6,005
)
 

 
(6,005
)
Repurchase of common shares

 

 
(4,889
)
 

 

 

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

 
2

 

 
(1,652
)
 

 

 
(1,650
)
Share-based compensation

 

 

 
2,410

 

 

 
2,410

Excess tax benefit related to equity compensation plans

 

 

 
744

 

 

 
744

Balance September 30, 2016
$

 
$
203

 
$
(6,632
)
 
$
212,091

 
$
170,768

 
$
4,668

 
$
381,098


See accompanying notes to consolidated financial statements.

4



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
Nine months ended September 30,
(in thousands, except share data)
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
40,661

 
$
35,209

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation
2,426

 
1,628

Provision for loan losses
7,223

 
2,984

Deferred income taxes
1,239

 
3,881

Net amortization of debt securities
2,064

 
2,350

Amortization of intangible assets
1,920

 
718

Gain on sale of investment securities
(22
)
 
(86
)
Mortgage loans originated for sale
(115,365
)
 
(117,975
)
Proceeds from mortgage loans sold
118,798

 
117,639

Gain on sale of other real estate
(17
)
 
(602
)
Gain on state tax credits, net
(332
)
 
(899
)
Excess tax benefit of share-based compensation

 
(744
)
Share-based compensation
2,514

 
2,410

Net accretion of loan discount
(3,796
)
 
(8,165
)
Changes in:
 
 
 
Accrued interest receivable
(302
)
 
(127
)
Accrued interest payable
249

 
19

Other assets
755

 
(2,100
)
Other liabilities
(44,398
)
 
(8,057
)
Net cash provided by operating activities
13,617

 
28,083

Cash flows from investing activities:
 
 
 
Proceeds from JCB acquisition, net of cash purchase price
4,456

 

Net increase in loans
(201,715
)
 
(256,706
)
Proceeds from the sale of securities, available for sale
144,076

 
2,493

Proceeds from the paydown or maturity of securities, available for sale
126,073

 
46,017

Proceeds from the paydown or maturity of securities, held to maturity
4,145

 
2,592

Proceeds from the redemption of other investments
29,159

 
44,968

Proceeds from the sale of state tax credits held for sale
4,391

 
4,918

Proceeds from the sale of other real estate
2,513

 
8,072

Payments for the purchase/origination of:
 
 
 
Available for sale debt and equity securities
(263,453
)
 
(71,309
)
Other investments
(45,224
)
 
(48,283
)
State tax credits held for sale
(145
)
 
(2,349
)
Fixed assets
(1,864
)
 
(1,284
)
Net cash used in investing activities
(197,588
)
 
(270,871
)
Cash flows from financing activities:
 
 
 
Net increase in noninterest-bearing deposit accounts
20,684

 
44,695

Net increase in interest-bearing deposit accounts
39,998

 
295,539

Proceeds from Federal Home Loan Bank advances
1,394,181

 
1,309,000

Repayments of Federal Home Loan Bank advances
(1,145,681
)
 
(1,290,000
)
Proceeds from notes payable
10,000

 

Net decrease in other borrowings
(123,987
)
 
(80,304
)
Cash dividends paid on common stock
(7,709
)
 
(6,005
)
Excess tax benefit of share-based compensation

 
744

Payments for the repurchase of common stock
(16,636
)
 
(4,889
)
Issuance of common stock, net
(2,573
)
 
(1,650
)
Net cash provided by financing activities
168,277

 
267,130

Net increase (decrease) in cash and cash equivalents
(15,694
)
 
24,342

Cash and cash equivalents, beginning of period
198,802

 
94,157

Cash and cash equivalents, end of period
$
183,108

 
$
118,499

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
16,948

 
$
9,726

Income taxes
9,382

 
19,868

Noncash transactions:
 
 
 
Transfer to other real estate owned in settlement of loans
$
289

 
$
2,683

Sales of other real estate financed

 
140

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 nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2017. 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, 2016.

Basis of Financial Statement Presentation

The condensed consolidated financial statements of the Company and its subsidiaries have been prepared in accordance with the accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The condensed consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All intercompany accounts and transactions have been eliminated. In 2017, the Company changed its presentation of loans on the face of the Condensed Consolidated Balance Sheets to combine originated loans with purchased loans. See Note 5 - Loans for more information. The Company also changed its presentation of the Noninterest Income section on the face of the Condensed Consolidated Statements of Operations to separate card services revenue out of miscellaneous income. The Company adopted Accounting Standards Update (ASU) 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting during the first quarter of 2017. Among other elements, the ASU requires an entity to recognize all excess tax benefits and deficiencies related to stock-based compensation expense as income tax expense or benefit in the statements of operations. The ASU requires adjustments be reflected as of the beginning of the fiscal year of adoption and as a result, $5.2 million of previously recognized excess tax benefits were reclassified from Additional paid in capital to Retained earnings during the first quarter of 2017. The adoption resulted in a decrease to income tax expense of $1.8 million for the nine months ended September 30, 2017. Excess tax benefits related to stock compensation are presented as a cash inflow from operating activities for the nine months ended September 30, 2017 due to the prospective adoption of employee share-based payment guidance in 2017. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

Acquisitions

Acquisitions and business combinations are accounted for using the acquisition method of accounting.  The assets and liabilities of the acquired entities have been recorded at their estimated fair values at the date of acquisition. Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including the amount assigned to identifiable intangible assets.
 
The purchase price allocation process requires an estimation of the fair values of the assets acquired and the liabilities assumed. When a business combination agreement provides for an adjustment to the cost of the combination contingent on future events, the Company includes an estimate of the acquisition-date fair value as part of the cost of the combination. To determine the fair values, the Company relies on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. The results of operations of the

6



acquired business are included in the Company's consolidated financial statements from the date of acquisition. Merger-related costs are costs the Company incurs to effect a business combination. In 2017, the Company changed its presentation of Merger related expenses as a separate component of Noninterest expenses on the Condensed Consolidated Statements of Operations.  Merger related expenses include costs directly related to merger or acquisition activity and include legal and professional fees, system consolidation and conversion costs, and compensation costs such as severance and retention incentives for employees impacted by acquisition activity. The Company accounts for merger-related costs as expenses in the periods in which the costs are incurred and the services are received.

Purchased Credit Impaired ("PCI") Loans

Purchased credit impaired ("PCI") loans were acquired in a business combination or transaction that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable. PCI loans were initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance. The difference between the undiscounted cash flows expected at acquisition and the investment in the loans, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loans. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” are not recognized as a yield adjustment or as a loss accrual or a valuation allowance. The Company aggregates individual loans with common risk characteristics into pools of loans. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loans over their remaining lives. Decreases in expected cash flows due to an inability to collect contractual cash flows are recognized as impairment through the provision for loan losses account. Any allowance for loan loss on these pools reflect only losses incurred after the acquisition. Disposals of loans, including sales of loans, paydowns, payments in full or foreclosures result in the removal or reduction of the loan from the loan pool.

PCI loans are generally considered accruing and performing, as the loans accrete income over the estimated life of the loan, in circumstances where cash flows are reasonably estimable by management. Accordingly, PCI loans that could be contractually past due could be considered to be accruing and performing. If the timing and amount of future cash flows is not reasonably estimable or is less than the carrying value, the loans may be classified as nonaccrual loans and the purchase price discount on those loans is not recorded as interest income until the timing and amount of future cash flows can be reasonably estimable.

Allowance for Loan Losses on PCI Loans

The Company updates its cash flow projections for purchased credit-impaired loans on a periodic basis. Assumptions utilized in this process include projections related to probability of default, loss severity, prepayment, extensions and recovery lag. Projections related to probability of default and prepayment are calculated utilizing a loan migration analysis and management’s assessment of loss exposure including the fair value of underlying collateral. The loan migration analysis is a matrix that specifies the probability of a loan pool transitioning into a particular delinquency or liquidation state given its current performance at the measurement date. Loss severity factors are based upon industry data and historical experience.

Any decreases in expected cash flows after the acquisition date and subsequent measurement periods are recognized by recording an impairment in allowance for loan losses through a provision for loan losses.


NOTE 2 - ACQUISITIONS

Acquisition of Jefferson County Bancshares, Inc.
On February 10, 2017, the Company closed its acquisition of 100% of Jefferson County Bancshares, Inc. ("JCB") and its wholly-owned subsidiary, Eagle Bank and Trust Company of Missouri. JCB operated 13 full service retail and commercial banking offices in the metropolitan St. Louis area and one in Perry County, Missouri.

JCB shareholders received, based on their election, cash consideration in an amount of $85.39 per share of JCB common stock or 2.75 shares of EFSC common stock per share of JCB common stock, subject to allocation and proration procedures. Aggregate consideration at closing was 3.3 million shares of EFSC common stock and $29.3 million cash paid to JCB shareholders and holders of JCB stock options. Based on EFSC’s closing stock price of $42.95 on February 10, 2017, the overall transaction had a value of $171.0 million, including JCB’s common stock and stock options. The Company also recognized $6.5 million and $1.4 million of merger related costs that were recorded in noninterest expense in the statement of operations for the nine months ended September 30, 2017, and year ended December 31, 2016, respectively.

The acquisition of JCB has been accounted for as a business combination using the acquisition method of accounting which requires assets acquired and liabilities assumed to be recognized at fair value as of the acquisition date. Goodwill of $87.0 million arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of JCB into Enterprise. The goodwill is assigned as part of the Company's Banking reporting unit.  None of the goodwill recognized is expected to be deductible for income tax purposes.
  


7



The following table presents the assets acquired and liabilities assumed of JCB as of February 10, 2017, and their preliminary estimated fair values:
(in thousands)
As Recorded by JCB
 
Adjustments
 
As Recorded by EFSC
Assets acquired:
 
 
 
 
 
Cash and cash equivalents
$
33,739

 
$

 
$
33,739

Interest-bearing deposits
1,715

 

 
1,715

Securities
148,670

 

 
148,670

Portfolio loans, net
685,905

 
(11,094
)
(a)
674,811

Other real estate owned
6,762

 
(5,082
)
(b)
1,680

Other investments
2,695

 

 
2,695

Fixed assets, net
21,780

 
(3,325
)
(c)
18,455

Accrued interest receivable
2,794

 

 
2,794

Goodwill
7,806

 
(7,806
)
(d)

Other intangible assets
25

 
11,489

(e)
11,514

Deferred tax assets
4,634

 
3,991

(f)
8,625

Other assets
19,107

 
(296
)
(g)
18,811

Total assets acquired
$
935,632

 
$
(12,123
)
 
$
923,509

 
 
 
 
 
 
Liabilities assumed:
 
 
 
 
 
Deposits
$
764,539

 
$
629

(h)
$
765,168

Other borrowings
55,430

 
681

(i)
56,111

Trust preferred securities
12,887

 
(382
)
(j)
12,505

Accrued interest payable
653

 

 
653

Other liabilities
5,006

 
65

(k)
5,071

Total liabilities assumed
$
838,515

 
$
993

 
$
839,508

 
 
 
 
 
 
Net assets acquired
$
97,117

 
$
(13,116
)
 
$
84,001

 
 
 
 
 
 
Consideration paid:
 
 
 
 
 
Cash
 
 
 
 
$
29,283

Common stock
 
 
 
 
141,729

Total consideration paid
 
 
 
 
$
171,012

 
 
 
 
 
 
Goodwill
 
 
 
 
$
87,011


(a)
Fair value adjustments based on the Company’s evaluation of the acquired loan portfolio, write-off of net deferred loan costs, reclassification from other real estate owned, and elimination of the allowance for loan losses recorded by JCB. The fair value discount recorded to the loan portfolio is $24.7 million.
(b)
Fair value adjustment based on the Company’s evaluation of the acquired other real estate portfolio, and reclassification to portfolio loans.
(c)
Fair value adjustments based on the Company’s evaluation of the acquired premises and equipment. A decrease of $1.1 million was recorded during the third quarter of 2017 due to continued refinement of the purchase accounting calculations.
(d)
Eliminate JCB’s recorded goodwill.
(e)
Record the core deposit intangible asset on the acquired core deposit accounts.  Amount to be amortized using a sum of years digits method over a 10 year useful life.
(f)
Adjustment for deferred taxes at the acquisition date. The adjustment decreased by $0.2 million during the current quarter due to continued refinement of the purchase accounting calculations.

8



(g)
Fair value adjustment based on evaluation of other assets.
(h)
Fair value adjustment to time deposits based on current interest rates. 
(i)
Fair value adjustment to the FHLB advances based on current interest rates. 
(j)
Fair value adjustment based on the Company's evaluation of the trust preferred securities.
(k)
A decrease of $0.1 million was recorded during the current quarter due to further refinement of the purchase accounting calculations.

The following table provides the unaudited pro forma information for the results of operations for the nine months ended September 30, 2017 and 2016, as if the acquisition had occurred on January 1, 2016. The pro forma results combine the historical results of JCB with the Company’s Consolidated Statements of Income, adjusted for the impact of the application of the acquisition method of accounting including loan discount accretion, intangible assets amortization, and deposit and trust preferred securities premium accretion, net of taxes.  The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisition actually occurred on January 1, 2016. No assumptions have been applied to the pro forma results of operations regarding possible revenue enhancements, expense efficiencies or asset dispositions. Only the acquisition related expenses that have been incurred as of September 30, 2017 are included in net income in the table below. 
 
Pro Forma
 
Nine months ended September 30,
(in thousands, except per share data)
2017
 
2016
Total revenues (net interest income plus noninterest income)
$
155,907

 
$
146,623

Net income
40,151

 
42,298

Diluted earnings per common share
1.70

 
1.80


NOTE 3 - EARNINGS PER SHARE

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

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

 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands, except per share data)
2017
 
2016
 
2017
 
2016
Net income as reported
$
16,315

 
$
11,832

 
$
40,661

 
$
35,209

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
23,324

 
19,997

 
22,914

 
20,002

Additional dilutive common stock equivalents
250

 
227

 
295

 
229

Weighted average diluted common shares outstanding
23,574

 
20,224

 
23,209

 
20,231

 
 
 
 
 
 
 
 
Basic earnings per common share:
$
0.70

 
$
0.59

 
$
1.77

 
$
1.76

Diluted earnings per common share:
$
0.69

 
$
0.59

 
$
1.75

 
$
1.74


For the three and nine months ended September 30, 2017 and 2016, there were no common stock equivalents excluded from the earnings per share calculations because their effect would have been anti-dilutive.

9



NOTE 4 - INVESTMENTS

The following table presents the amortized cost, gross unrealized gains and losses and fair value of securities available for sale and held to maturity:
 
 
September 30, 2017
(in thousands)
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
Available for sale securities:
 
 
 
 
 
 
 
Obligations of U.S. Government-sponsored enterprises
$
99,866

 
$
271

 
$
(14
)
 
$
100,123

Obligations of states and political subdivisions
32,684

 
887

 
(229
)
 
33,342

Agency mortgage-backed securities
470,941

 
1,760

 
(3,045
)
 
469,656

          Total securities available for sale
$
603,491

 
$
2,918

 
$
(3,288
)
 
$
603,121

Held to maturity securities:
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
14,704

 
$
159

 
$
(15
)
 
$
14,848

Agency mortgage-backed securities
61,464

 
93

 
(145
)
 
61,412

          Total securities held to maturity
$
76,168

 
$
252


$
(160
)

$
76,260


 
December 31, 2016
(in thousands)
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
Available for sale securities:
 
 
 
 
 
 
 
    Obligations of U.S. Government-sponsored enterprises
$
107,312

 
$
348

 
$

 
$
107,660

    Obligations of states and political subdivisions
36,486

 
630

 
(485
)
 
36,631

    Agency mortgage-backed securities
319,345

 
1,101

 
(3,940
)
 
316,506

          Total securities available for sale
$
463,143

 
$
2,079

 
$
(4,425
)
 
$
460,797

Held to maturity securities:
 
 
 
 
 
 
 
   Obligations of states and political subdivisions
$
14,759

 
$
11

 
$
(242
)
 
$
14,528

   Agency mortgage-backed securities
65,704

 
45

 
(638
)
 
65,111

          Total securities held to maturity
$
80,463

 
$
56

 
$
(880
)
 
$
79,639


At September 30, 2017, and December 31, 2016, there were no holdings of securities of any one issuer in an amount greater than 10% of shareholders’ equity, other than U.S. Government agencies and sponsored enterprises. The agency mortgage-backed securities are all issued by U.S. Government-sponsored enterprises. Available for sale securities having a fair value of $449.8 million and $407.3 million at September 30, 2017, and December 31, 2016, respectively, were pledged as collateral to secure deposits of public institutions and for other purposes as required by law or contract provisions.


10



The amortized cost and estimated fair value of debt securities at September 30, 2017, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The weighted average life of the mortgage-backed securities is approximately 4 years.
 
 
Available for sale
 
Held to maturity
(in thousands)
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
2,940

 
$
2,960

 
$

 
$

Due after one year through five years
110,538

 
111,122

 
184

 
194

Due after five years through ten years
15,710

 
16,241

 
12,996

 
13,126

Due after ten years
3,362

 
3,142

 
1,524

 
1,528

Agency mortgage-backed securities
470,941

 
469,656

 
61,464

 
61,412

 
$
603,491

 
$
603,121


$
76,168


$
76,260



The following table represents a summary of investment securities that had an unrealized loss:
 
 
September 30, 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
$
10,127

 
$
14

 
$

 
$

 
$
10,127

 
$
14

Obligations of states and political subdivisions
4,907

 
244

 

 

 
4,907

 
244

Agency mortgage-backed securities
332,037

 
2,721

 
11,307

 
469

 
343,344

 
3,190

 
$
347,071

 
$
2,979


$
11,307


$
469


$
358,378


$
3,448

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
Less than 12 months
 
12 months or more
 
Total
(in thousands)
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
Obligations of states and political subdivisions
$
21,361

 
$
408

 
$
3,553

 
$
320

 
$
24,914

 
$
728

Agency mortgage-backed securities
267,734

 
4,084

 
12,883

 
493

 
280,617

 
4,577

 
$
289,095

 
$
4,492


$
16,436


$
813


$
305,531


$
5,305



The unrealized losses at both September 30, 2017, and December 31, 2016, were primarily attributable to changes in market interest rates since the securities were purchased. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include among other considerations (1) the present value of the cash flows expected to be collected compared to the amortized cost of the security, (2) duration and magnitude of the decline in value, (3) the financial condition of the issuer or issuers, (4) structure of the security, and (5) the intent to sell the security or whether it is more likely than not the Company would be required to sell the security before its anticipated recovery in market value. At September 30, 2017, management performed its quarterly analysis of all securities with an unrealized loss and concluded no individual securities were other-than-temporarily impaired.



11



NOTE 5 - 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, or PCI, loans.
 
The table below shows the loan portfolio composition including carrying value by segment of loans accounted for under ASC 310-30 (PCI loans) and loans not accounted for under this guidance, which includes our originated loans. 

(in thousands)

September 30, 2017
 
December 31, 2016
Loans not accounted for as ASC 310-30
$
3,948,676

 
$
3,118,392

Loans accounted for as ASC 310-30
81,982

 
39,769

Total loans
$
4,030,658

 
$
3,158,161


The following tables refer to loans not accounted for as ASC 310-30 loans.

Below is a summary of loans by category at September 30, 2017 and December 31, 2016:
 
(in thousands)
September 30, 2017
 
December 31, 2016
Commercial and industrial
$
1,861,285

 
$
1,632,714

Real estate:
 
 
 
    Commercial - investor owned
737,986

 
544,808

    Commercial - owner occupied
553,512

 
350,148

    Construction and land development
302,182

 
194,542

    Residential
339,377

 
240,760

Total real estate loans
1,933,057

 
1,330,258

Consumer and other
155,514

 
156,182

Loans, before unearned loan fees
3,949,856

 
3,119,154

Unearned loan fees, net
(1,180
)
 
(762
)
    Loans, including unearned loan fees
$
3,948,676

 
$
3,118,392



12



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 September 30, 2017, and at December 31, 2016, 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, 2016
$
26,996

 
$
3,420

 
$
2,890

 
$
1,304

 
$
2,023

 
$
932

 
$
37,565

Provision (provision reversal) for loan losses
1,835

 
(105
)
 
(249
)
 
(11
)
 
(3
)
 
66

 
1,533

Losses charged off
(133
)
 

 

 

 
(9
)
 
(29
)
 
(171
)
Recoveries
80

 
9

 
89

 
9

 
25

 
9

 
221

Balance at March 31, 2017
$
28,778

 
$
3,324


$
2,730


$
1,302


$
2,036


$
978


$
39,148

Provision (provision reversal) for loan losses
2,955

 
(39
)
 
354

 
(51
)
 
451

 
(47
)
 
3,623

Losses charged off
(6,035
)
 

 
(45
)
 
(5
)
 
(265
)
 
(39
)
 
(6,389
)
Recoveries
57

 
102

 
1

 
49

 
62

 
20

 
291

Balance at June 30, 2017
$
25,755

 
$
3,387


$
3,040


$
1,295


$
2,284


$
912


$
36,673

Provision (provision reversal) for loan losses
1,126

 
376

 
245

 
305

 
299

 
71

 
2,422

Losses charged off
(613
)
 

 
(45
)
 

 
(503
)
 
(75
)
 
(1,236
)
Recoveries
205

 
12

 
6

 
25

 
172

 
13

 
433

Balance at September 30, 2017
$
26,473

 
$
3,775


$
3,246


$
1,625


$
2,252


$
921


$
38,292

(in thousands)
Commercial and industrial
 
CRE - investor owned
 
CRE -
owner occupied
 
Construction and land development
 
Residential real estate
 
Consumer and other
 
Total
Balance September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses - Ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,063

 
$
120

 
$

 
$
186

 
$
48

 
$

 
$
2,417

Collectively evaluated for impairment
24,410

 
3,655

 
3,246

 
1,439

 
2,204

 
921

 
35,875

Total
$
26,473

 
$
3,775


$
3,246


$
1,625


$
2,252


$
921


$
38,292

Loans - Ending balance:
 
 
 
 
 
 
 

 
 
 
 
 
 
Individually evaluated for impairment
$
7,646

 
$
544

 
$
1,513

 
$
323

 
$
667

 
$

 
$
10,693

Collectively evaluated for impairment
1,853,639

 
737,442

 
551,999

 
301,859

 
338,710

 
154,334

 
3,937,983

Total
$
1,861,285

 
$
737,986


$
553,512


$
302,182


$
339,377


$
154,334


$
3,948,676

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses - Ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,909

 
$

 
$

 
$
155

 
$

 
$

 
$
3,064

Collectively evaluated for impairment
24,087

 
3,420

 
2,890

 
1,149

 
2,023

 
932

 
34,501

Total
$
26,996

 
$
3,420


$
2,890


$
1,304


$
2,023


$
932


$
37,565

Loans - Ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
12,523

 
$
430

 
$
1,854

 
$
1,903

 
$
62

 
$

 
$
16,772

Collectively evaluated for impairment
1,620,191

 
544,378

 
348,294

 
192,639

 
240,698

 
155,420

 
3,101,620

Total
$
1,632,714

 
$
544,808


$
350,148


$
194,542


$
240,760


$
155,420


$
3,118,392



13



A summary of nonperforming loans individually evaluated for impairment by category at September 30, 2017 and December 31, 2016, and the income recognized on impaired loans is as follows:

 
September 30, 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
$
13,981

 
$
6,407

 
$
1,044

 
$
7,451

 
$
2,020

 
$
11,735

Real estate:
 
 
 
 
 
 
 
 
 
 
 
    Commercial - investor owned
562

 
259

 
285

 
544

 
120

 
542

    Commercial - owner occupied

 

 

 

 

 

    Construction and land development
444

 
322

 

 
322

 
186

 
337

    Residential
673

 
668

 

 
668

 
48

 
676

Consumer and other

 

 

 

 

 

Total
$
15,660

 
$
7,656


$
1,329


$
8,985


$
2,374


$
13,290


 
December 31, 2016
(in thousands)
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance
 
Recorded
Investment
With
Allowance
 
Total
Recorded Investment
 
Related Allowance
 
Average
Recorded Investment
Commercial and industrial
$
12,341

 
$
566

 
$
11,791

 
$
12,357

 
$
2,909

 
$
4,489

Real estate:
 
 
 
 
 
 
 
 
 
 
 
    Commercial - investor owned
525

 
435

 

 
435

 

 
668

    Commercial - owner occupied
225

 
231

 

 
231

 

 
227

    Construction and land development
1,904

 
1,947

 
359

 
2,306

 
155

 
1,918

    Residential
62

 
62

 

 
62

 

 
64

Consumer and other

 

 

 

 

 

Total
$
15,057

 
$
3,241


$
12,150


$
15,391


$
3,064


$
7,366


 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Total interest income that would have been recognized under original terms
$
306

 
$
226

 
$
961

 
$
703

Total cash received and recognized as interest income on non-accrual loans
117

 
203

 
156

 
253

Total interest income recognized on accruing, impaired loans
8

 
32

 
55

 
63



14




There were no loans over 90 days past due and still accruing interest at September 30, 2017 or December 31, 2016. The recorded investment in nonperforming loans by category at September 30, 2017 and December 31, 2016, is as follows: 
 
September 30, 2017
(in thousands)
Non-accrual
 
Restructured, not on non-accrual
 
Total
Commercial and industrial
$
6,730

 
$
721

 
$
7,451

Real estate:
 
 
 
 
 
    Commercial - investor owned
544

 

 
544

    Commercial - owner occupied

 

 

    Construction and land development
322

 

 
322

    Residential
668

 

 
668

Consumer and other

 

 

       Total
$
8,264

 
$
721


$
8,985


 
December 31, 2016
(in thousands)
Non-accrual
 
Restructured, not on non-accrual
 
Total
Commercial and industrial
$
10,046

 
$
2,311

 
$
12,357

Real estate:
 
 
 
 
 
    Commercial - investor owned
435

 

 
435

    Commercial - owner occupied
231

 

 
231

    Construction and land development
2,286

 
20

 
2,306

    Residential
62

 

 
62

Consumer and other

 

 

       Total
$
13,060

 
$
2,331

 
$
15,391



15



There were no portfolio loans restructured during the three months ended September 30, 2017 and 2016. The recorded investment by category for the portfolio loans that have been restructured during the nine months ended September 30, 2017 and 2016, is as follows:

 
Nine months ended September 30, 2017
 
Nine months ended September 30, 2016
(in thousands, except for number of loans)
Number of loans
 
Pre-Modification Outstanding Recorded Balance
 
Post-Modification Outstanding Recorded Balance
 
Number of loans
 
Pre-Modification Outstanding Recorded Balance
 
Post-Modification Outstanding Recorded Balance
Commercial and industrial
1

 
$
676

 
$
676

 
2

 
$
2,341

 
$
2,341

Real estate:
 
 
 
 
 
 
 
 
 
 
 
Commercial - investor owned

 

 

 
1

 
248

 
248

Commercial - owner occupied

 

 

 

 

 

Construction and land development

 

 

 
1

 
20

 
20

Residential

 

 

 

 

 

Consumer and other

 

 

 

 

 

Total
1

 
$
676

 
$
676

 
4

 
$
2,609

 
$
2,609


As of September 30, 2017, the Company had $2.2 million in specific reserves allocated to $9.5 million of loans that have been restructured. During the three and nine months ended September 30, 2016, there were no portfolio loans that subsequently defaulted. There were no portfolio loans restructured that subsequently defaulted during the three months ended September 30, 2017. Portfolio loans restructured that subsequently defaulted during the nine months ended September 30, 2017, are as follows:

 
Nine months ended September 30, 2017
(in thousands, except for number of loans)
Number of loans
 
Recorded Balance
Commercial and industrial
2

 
$
343

Real estate:
 
 
 
Commercial - investor owned

 

Commercial - owner occupied

 

Construction and land development

 

Residential
1

 
5

Consumer and other

 

Total
3

 
$
348


16




The aging of the recorded investment in past due loans by portfolio class and category at September 30, 2017 and December 31, 2016 is shown below.

 
September 30, 2017
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
    Commercial and industrial
$
9,147

 
$
283

 
$
9,430

 
$
1,851,855

 
$
1,861,285

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned
986

 

 
986

 
737,000

 
737,986

       Commercial - owner occupied
266

 

 
266

 
553,246

 
553,512

       Construction and land development

 
323

 
323

 
301,859

 
302,182

       Residential
485

 
668

 
1,153

 
338,224

 
339,377

    Consumer and other
1,542

 

 
1,542

 
152,792

 
154,334

          Total
$
12,426

 
$
1,274


$
13,700


$
3,934,976


$
3,948,676


 
December 31, 2016
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
    Commercial and industrial
$
334

 
$
171

 
$
505

 
$
1,632,209

 
$
1,632,714

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned

 
175

 
175

 
544,633

 
544,808

       Commercial - owner occupied
212

 
225

 
437

 
349,711

 
350,148

       Construction and land development
355

 
1,528

 
1,883

 
192,659

 
194,542

       Residential
91

 

 
91

 
240,669

 
240,760

    Consumer and other
7

 

 
7

 
155,413

 
155,420

          Total
$
999

 
$
2,099


$
3,098


$
3,115,294


$
3,118,392


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.

17



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 September 30, 2017, which is based upon the most recent analysis performed, and December 31, 2016 is as follows:

 
September 30, 2017
(in thousands)
Pass (1-6)
 
Watch (7)
 
Substandard (8)
 
Doubtful (9)
 
Total
    Commercial and industrial
$
1,708,153

 
$
90,885

 
$
62,247

 
$

 
$
1,861,285

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned
720,912

 
12,592

 
4,482

 

 
737,986

       Commercial - owner occupied
513,939

 
33,249

 
6,324

 

 
553,512

       Construction and land development
298,613

 
2,558

 
1,011

 

 
302,182

       Residential
328,434

 
3,989

 
6,954

 

 
339,377

    Consumer and other
153,113

 
375

 
846

 

 
154,334

          Total
$
3,723,164

 
$
143,648

 
$
81,864

 
$

 
$
3,948,676


 
December 31, 2016
(in thousands)
Pass (1-6)
 
Watch (7)
 
Substandard (8)
 
Doubtful (9)
 
Total
    Commercial and industrial
$
1,499,114

 
$
57,416

 
$
76,184

 
$

 
$
1,632,714

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned
530,494

 
10,449

 
3,865

 

 
544,808

       Commercial - owner occupied
306,658

 
39,249

 
4,241

 

 
350,148

       Construction and land development
185,505

 
6,575

 
2,462

 

 
194,542

       Residential
233,479

 
2,997

 
4,284

 

 
240,760

    Consumer and other
153,984

 

 
1,436

 

 
155,420

          Total
$
2,909,234

 
$
116,686


$
92,472


$


$
3,118,392



18



Below is a summary of PCI loans by category at September 30, 2017 and December 31, 2016:
 
 
September 30, 2017
 
December 31, 2016
(in thousands)
Weighted-
Average
Risk Rating1
Recorded
Investment
PCI Loans
 
Weighted-
Average
Risk Rating1
Recorded
Investment
PCI Loans
Commercial and industrial
6.26
$
3,676

 
5.87
$
3,523

Real estate:
 
 
 
 
 
    Commercial - investor owned
7.29
45,865

 
6.95
8,162

    Commercial - owner occupied
6.50
11,786

 
6.39
11,863

    Construction and land development
5.93
7,927

 
5.80
4,365

    Residential
6.05
12,661

 
5.64
11,792

Total real estate loans
 
78,239

 
 
36,182

Consumer and other
2.99
67

 
1.64
64

    Purchased credit impaired loans
 
$
81,982

 
 
$
39,769

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

The aging of the recorded investment in past due PCI loans by portfolio class and category at September 30, 2017 and December 31, 2016 is shown below:

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

 
$

 
$

 
$
3,676

 
$
3,676

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned
429

 
396

 
825

 
45,040

 
45,865

       Commercial - owner occupied
46

 
909

 
955

 
10,831

 
11,786

       Construction and land development

 
478

 
478

 
7,449

 
7,927

       Residential
748

 
992

 
1,740

 
10,921

 
12,661

    Consumer and other

 

 

 
67

 
67

          Total
$
1,223

 
$
2,775


$
3,998


$
77,984


$
81,982


 
December 31, 2016
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
    Commercial and industrial
$

 
$

 
$

 
$
3,523

 
$
3,523

    Real estate:
 
 
 
 
 
 
 
 
 
       Commercial - investor owned

 

 

 
8,162

 
8,162

       Commercial - owner occupied

 

 

 
11,863

 
11,863

       Construction and land development

 

 

 
4,365

 
4,365

       Residential
169

 
51

 
220

 
11,572

 
11,792

    Consumer and other

 

 

 
64

 
64

          Total
$
169

 
$
51


$
220


$
39,549


$
39,769



19



The following table is a rollforward of PCI loans, net of the allowance for loan losses, for the nine months ended September 30, 2017 and 2016.

(in thousands)
Contractual Cashflows
 
Non-accretable Difference
 
Accretable Yield
 
Carrying Amount
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
(16,319
)
 

 

 
(16,319
)
Accretion of loan discount

 

 
(5,473
)
 
5,473

Changes in contractual and expected cash flows due to remeasurement
11,110

 
(702
)
 
3,776

 
8,036

Reductions due to disposals
(6,393
)
 
(1,612
)
 
(1,595
)
 
(3,186
)
Balance September 30, 2017
$
123,164

 
$
30,884


$
15,196


$
77,084

 
 
 
 
 
 
 
 
Balance December 31, 2015
$
116,689

 
$
26,765

 
$
25,341

 
$
64,583

Principal reductions and interest payments
(20,417
)
 

 

 
(20,417
)
Accretion of loan discount

 

 
(4,984
)
 
4,984

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

 
975

 
(1,043
)
 
9,262

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

 
$
20,961


$
15,601


$
41,016


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 $107.8 million and $54.6 million as of September 30, 2017, and December 31, 2016, respectively.


NOTE 6 - COMMITMENTS AND CONTINGENCIES

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

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

The Company uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets. At September 30, 2017, the amount of unadvanced commitments on impaired loans was insignificant.

The contractual amounts of off-balance-sheet financial instruments as of September 30, 2017, and December 31, 2016, are as follows:
 
(in thousands)
September 30, 2017
 
December 31, 2016
Commitments to extend credit
$
1,263,809

 
$
1,075,170

Letters of credit
74,007

 
78,954



20



Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments usually have fixed expiration dates or other termination clauses, may have significant usage restrictions, and may require payment of a fee. Of the total commitments to extend credit at September 30, 2017, and December 31, 2016, approximately $113 million and $90 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 September 30, 2017, and December 31, 2016.

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 September 30, 2017, the approximate remaining term of standby letters of credit range from 1 month to 4 years.

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 7 - DERIVATIVE FINANCIAL INSTRUMENTS

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

Risk Management Instruments. At September 30, 2017, the company has no 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)
September 30,
2017
 
December 31,
2016
 
September 30,
2017
 
December 31,
2016
 
September 30,
2017
 
December 31,
2016
Non-designated hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
$
270,542

 
$
124,322

 
$
1,902

 
$
982

 
$
1,902

 
$
982

Foreign exchange forward contracts
1,376

 
3,034

 
1,376

 
3,034

 
1,376

 
3,034


Changes in the fair value of client-related derivative instruments are recognized currently in operations. For the three and nine months ended September 30, 2017 and 2016, 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.

21






NOTE 8 - FAIR VALUE MEASUREMENTS

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

The following table summarizes financial instruments measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
 
 
September 30, 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
$

 
$
100,123

 
$

 
$
100,123

Obligations of states and political subdivisions

 
33,341

 

 
33,341

Residential mortgage-backed securities

 
469,657

 

 
469,657

Total securities available for sale
$

 
$
603,121


$


$
603,121

State tax credits held for sale

 

 
1,274

 
1,274

Derivative financial instruments

 
3,278

 

 
3,278

Total assets
$

 
$
606,399


$
1,274


$
607,673

 
 
 
 
 
 
 
 
Liabilities
 

 
 

 
 

 
 

Derivative financial instruments
$

 
$
3,278

 
$

 
$
3,278

Total liabilities
$

 
$
3,278


$


$
3,278


 
December 31, 2016
(in thousands)
Quoted Prices in
Active Markets
for Identical Assets
(Level 1)
 
Significant
Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Fair
Value
Assets
 
 
 
 
 
 
 
Securities available for sale
 
 
 
 
 
 
 
Obligations of U.S. Government-sponsored enterprises
$

 
$
107,660

 
$

 
$
107,660

Obligations of states and political subdivisions

 
33,542

 
3,089

 
36,631

Residential mortgage-backed securities

 
316,506

 

 
316,506

Total securities available for sale
$

 
$
457,708


$
3,089


$
460,797

State tax credits held for sale

 

 
3,585

 
3,585

Derivative financial instruments

 
4,016

 

 
4,016

Total assets
$

 
$
461,724


$
6,674


$
468,398

 
 
 
 
 
 
 
 
Liabilities
 

 
 
 
 

 
 
Derivative financial instruments
$

 
$
4,016

 
$

 
$
4,016

Total liabilities
$

 
$
4,016


$


$
4,016



22



Securities available for sale. Securities classified as available for sale are reported at fair value utilizing Level 2 and Level 3 inputs. Fair values for Level 2 securities are based upon dealer quotes, market spreads, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, credit information and the bond's terms and conditions at the security level. At September 30, 2017, there were no Level 3 Auction Rate Securities. Auction Rate Securities at September 30, 2017 were valued using a Level 2 pricing source similar to our other securities available for sale.
State tax credits held for sale. At September 30, 2017, of the $35.3 million of state tax credits held for sale on the condensed consolidated balance sheet, approximately $1.3 million were carried at fair value. The remaining $34.0 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 fair value measurement is calculated using an internal valuation model with market data including discounted cash flows based upon the terms and conditions of the tax credits. If the underlying project remains in compliance with the various federal and state rules governing the tax credit program, each project will generate about 10 years of tax credits. The inputs to the discounted cash flow calculation include: the amount of tax credits generated each year, the anticipated sale price of the tax credit, the timing of the sale and a discount rate. The discount rate is estimated using the LIBOR swap curve at a point equal to the remaining life in years of credits plus a 205 basis point spread. With the exception of the discount rate, the other inputs to the fair value calculation are observable and readily available. The discount rate is considered a Level 3 input because it is an “unobservable input” and is based on the Company’s assumptions. An increase in the discount rate utilized would generally result in a lower estimated fair value of the tax credits. Alternatively, a decrease in the discount rate utilized would generally result in a higher estimated fair value of the tax credits. 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.
Level 3 financial instruments

The following table presents the changes in Level 3 financial instruments measured at fair value on a recurring basis as of September 30, 2017 and 2016.
Purchases, sales, issuances and settlements. There were no Level 3 purchases during the quarters ended September 30, 2017 or 2016.
Transfers in and/or out of Level 3. There were no Level 3 transfers during the quarters ended September 30, 2017 and 2016.

23



 
Securities available for sale, at fair value
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Beginning balance
$

 
$
3,093

 
$
3,089

 
$
3,077

   Total gains:
 
 
 
 
 
 
 
Included in other comprehensive income

 
1

 
4

 
17

   Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
Purchases

 

 

 

Transfer in and/or out of Level 3

 

 
(3,093
)
 

Ending balance
$

 
$
3,094

 
$

 
$
3,094

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

 
$
1

 
$

 
$
17



 
State tax credits held for sale
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Beginning balance
$
1,274

 
$
4,774

 
$
3,585

 
$
5,941

   Total gains:
 
 
 
 
 
 
 
Included in earnings

 
27

 
49

 
144

   Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
Sales

 

 
(2,360
)
 
(1,284
)
Ending balance
$
1,274

 
$
4,801

 
$
1,274

 
$
4,801

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

 
$
27

 
$
(655
)
 
$
(237
)


24



From time to time, the Company measures certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or fair value that were recognized at fair value below cost at the end of the period. The following table presents financial instruments and non-financial assets measured at fair value on a non-recurring basis as of September 30, 2017.
 
 
(1)
 
(1)
 
(1)
 
(1)
 
 
 
 
(in thousands)
Total Fair Value
 
Quoted Prices in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total losses for the three
months ended
September 30, 2017
 
Total losses for the nine
months ended
September 30, 2017
Impaired loans
$
2,743

 
$

 
$

 
$
2,743

 
$
613

 
$
5,876

Other real estate
26

 

 

 
26

 
38

 
38

Total
$
2,769

 
$


$


$
2,769


$
651

 
$
5,914


(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 September 30, 2017, impaired loans measured on a non-recurring basis had a principal balance of $3.9 million, with a valuation allowance of $1.2 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. Certain state tax credits are reported at cost.


25



Following is a summary of the carrying amounts and fair values of the Company’s financial instruments on the consolidated balance sheets at September 30, 2017 and December 31, 2016.

 
September 30, 2017
 
December 31, 2016
(in thousands)
Carrying Amount
 
Estimated fair value
 
Carrying Amount
 
Estimated fair value
Balance sheet assets
 
 
 
 
 
 
 
Cash and due from banks
$
76,777

 
$
76,777

 
$
54,288

 
$
54,288

Federal funds sold
1,155

 
1,155

 
446

 
446

Interest-bearing deposits
107,821

 
107,821

 
145,048

 
145,048

Securities available for sale
603,121

 
603,121

 
460,797

 
460,797

Securities held to maturity
76,168

 
76,260

 
80,463

 
79,639

Other investments, at cost
29,436

 
29,436

 
14,840

 
14,840

Loans held for sale
6,411

 
6,411

 
9,562

 
9,562

Derivative financial instruments
3,278

 
3,278

 
4,016

 
4,016

Loans, net
3,987,467

 
4,009,071

 
3,114,752

 
3,125,701

State tax credits, held for sale
35,291

 
37,781

 
38,071

 
41,264

Accrued interest receivable
14,213

 
14,213

 
11,117

 
11,117

 
 
 
 
 
 
 
 
Balance sheet liabilities
 
 
 
 
 
 
 
Deposits
4,059,211

 
4,057,561

 
3,233,361

 
3,232,414

Subordinated debentures and notes
118,093

 
100,062

 
105,540

 
86,052

Federal Home Loan Bank advances
248,868

 
249,168

 

 

Other borrowings
219,104

 
219,012

 
276,980

 
276,905

Derivative financial instruments
3,278

 
3,278

 
4,016

 
4,016

Accrued interest payable
2,007

 
2,007

 
1,105

 
1,105


For information regarding the methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practical to estimate such value, refer to Note 19 – Fair Value Measurements in the Company's Annual Report on Form 10-K for the year ended December 31, 2016.

The following table presents the level in the fair value hierarchy for the estimated fair values of only the Company’s financial instruments that are not already presented on the condensed consolidated balance sheets at fair value at September 30, 2017, and December 31, 2016.
 

26



 
Estimated Fair Value Measurement at Reporting Date Using
 
Balance at
September 30, 2017
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Financial Assets:
 
 
 
 
 
 
 
Securities held to maturity
$

 
$
76,260

 
$

 
$
76,260

Portfolio loans, net

 

 
4,009,071

 
4,009,071

State tax credits, held for sale

 

 
36,508

 
36,508

Financial Liabilities:
 
 
 
 
 
 
 
Deposits
3,442,015

 

 
615,546

 
4,057,561

Subordinated debentures and notes

 
100,062

 

 
100,062

Federal Home Loan Bank advances

 
249,168

 

 
249,168

Other borrowings

 
219,012

 

 
219,012

 
 
Estimated Fair Value Measurement at Reporting Date Using
 
Balance at December 31, 2016
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Financial Assets:
 
 
 
 
 
 
 
Securities held to maturity
$

 
$
79,639

 
$

 
$
79,639

Portfolio loans, net

 

 
3,125,701

 
3,125,701

State tax credits, held for sale

 

 
37,679

 
37,679

Financial Liabilities:
 
 
 
 
 
 
 
Deposits
2,760,202

 

 
472,212

 
3,232,414

Subordinated debentures and notes

 
86,052

 

 
86,052

Other borrowings

 
276,905

 

 
276,905



NOTE 9 - NEW AUTHORITATIVE ACCOUNTING GUIDANCE

Financial Accounting Standards Board (the "FASB") Accounting Standards Update ( the "ASU") 2017-12 "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities" In August 2017, the FASB issued ASU 2017-12, "Targeted Improvement to Accounting for Hedging Activities". 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. In addition, the amendments in this update simplify the application of hedge accounting for preparers of financial statements, as well as improve the understandability of an entity's risk management activities being conveyed to financial statement users. The new guidance becomes effective for periods beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the new guidance and timing of adoption to determine the impact this standard may have on its financial statements.

FASB ASU 2017-09 "Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting" In May 2017, the FASB issued ASU 2017-09, "Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting" which amends the scope of modification accounting for share-based payment awards. The amendments provide guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting with an intent to simplify the accounting under ASC 718. The amendments are effective for public business entities for annual periods beginning after December 15, 2017, 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.

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

27



permitted. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its financial statements.

FASB ASU 2017-04 "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment" In January 2017, the FASB issued ASU 2017-04 "Simplifying the Test for Goodwill Impairment" which simplifies the measurement of goodwill impairment by removing step two of the goodwill impairment test. The new guidance requires goodwill impairment to be measured as the amount by which a reporting unit's carrying value exceeds its fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendments should be applied on a prospective basis. The guidance becomes effective for testing periods beginning after January 1, 2017. The new guidance will be applied in the Company's 2017 annual impairment testing and is expected to not have an impact on the Company's consolidated financial statements.

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

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

FASB ASU 2016-02 "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 is currently evaluating the new guidance and has not determined the impact this standard may have on its consolidated balance sheets.

FASB ASU 2016-01 "Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" In January 2016, the FASB issued ASU 2016-01, "Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." ASU 2016-01 requires equity investments to be measured at fair value through earnings, and eliminates the available-for-sale classification for equity securities with readily determinable fair values. For financial liabilities where the fair value option has been elected, changes in fair value due to instrument-specific credit risk must be recognized in other comprehensive income. When measuring the fair value of financial instruments at amortized cost, the exit price must be used for disclosure purposes. The ASU also requires that financial assets and liabilities be presented separately in the notes to the financial statements. This ASU becomes effective for fiscal years beginning after December 15, 2017,

28



including interim periods therein. Early adoption is permitted with some exceptions. The Company has evaluated its applicable equity investments and determined that they qualify for the measurement exception which allows those investments to be measured at their cost minus impairment. Any valuation adjustments will be recorded prospectively through net income, and the related disclosure will be included in the Notes to the Consolidated Financial Statements.


FASB ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)" In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers”. The objective of ASU 2014-09 is to establish a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most of the existing revenue recognition guidance, including industry-specific guidance. The core principle of ASU 2014-09 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the new guidance, an entity will (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the contract’s performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification. The new guidance was originally effective for annual reporting periods (including interim periods within those periods) beginning after December 15, 2016 for public companies. In August 2015, the FASB issued ASU 2015-14, which defers the effective date of this guidance to annual reporting periods beginning after December 15, 2017 for public companies, and permits early adoption on a limited basis. The Company has conducted its initial assessment and is currently evaluating contracts to assess and quantify accounting methodology changes resulting from the adoption of ASU 2014-09. The majority of the Company’s revenues are derived from loans which are excluded from the new standard; therefore, the new guidance is not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flows. The Company has decided upon the modified retrospective adoption method.





29



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 nine months of 2017 compared to the financial condition as of December 31, 2016. In addition, this discussion summarizes the significant factors affecting the results of operations, liquidity and cash flows of the Company for the three and nine months ended September 30, 2017, compared to the same periods in 2016. 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, 2016.


 

30



Executive Summary

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. See Item 1-Note 2 - Acquisitions for more information.
 
Below are highlights of our financial performance for the three and nine months ended September 30, 2017, as compared to the linked quarter ended June 30, 2017, and prior year period.

(in thousands, except per share data)
For the Three Months ended/At
 
For the Nine Months ended
September 30,
2017
 
June 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
EARNINGS
 
 
 
 
 
 
 
 
 
Total interest income
$
52,468

 
$
51,542

 
$
37,293

 
$
147,750

 
$
109,786

Total interest expense
6,843

 
5,909

 
3,463

 
17,850

 
9,745

Net interest income
45,625

 
45,633

 
33,830

 
129,900

 
100,041

Provision for portfolio loans
2,422

 
3,623

 
3,038

 
7,578

 
4,587

Provision reversal for PCI loans

 
(207
)
 
(1,194
)
 
(355
)
 
(1,603
)
Net interest income after provision for loan losses
43,203

 
42,217

 
31,986

 
122,677

 
97,057

Total noninterest income
8,372

 
7,934

 
6,976

 
23,282

 
20,030

Total noninterest expense
27,404

 
32,651

 
20,814

 
86,791

 
62,929

Income before income tax expense
24,171

 
17,500


18,148

 
59,168

 
54,158

Income tax expense
7,856

 
5,545

 
6,316

 
18,507

 
18,949

Net income
$
16,315

 
$
11,955

 
$
11,832

 
$
40,661

 
$
35,209

 
 
 
 
 
 
 
 
 
 
Basic earnings per share
$
0.70

 
$
0.51

 
$
0.59

 
$
1.77

 
$
1.76

Diluted earnings per share
0.69

 
0.50

 
0.59

 
1.75

 
1.74

 
 
 
 
 
 
 
 
 
 
Return on average assets
1.27
%
 
0.96
%
 
1.23
%
 
1.11
%
 
1.26
%
Return on average common equity
11.69
%
 
8.78
%
 
12.46
%
 
10.37
%
 
12.83
%
Return on average tangible common equity
15.23
%
 
11.49
%
 
13.64
%
 
13.25
%
 
14.10
%
Net interest margin (fully tax equivalent)
3.88
%
 
3.98
%
 
3.80
%
 
3.87
%
 
3.87
%
Efficiency ratio
50.75
%
 
60.95
%
 
51.01
%
 
56.66
%
 
52.41
%
Tangible book value per common share
$
18.09

 
$
17.89

 
$
17.43

 
 
 
 
 
 
 
 
 
 
 
 
 
 
ASSET QUALITY (1)
 
 
 
 
 
 
 
 
 
Net charge-offs (recoveries)
$
803

 
$
6,104

 
$
1,038

 
$
6,851

 
$
530

Nonperforming loans
8,985

 
13,081

 
19,942

 
 
 
 
Classified assets
80,757

 
93,795

 
101,545

 
 
 
 
Nonperforming loans to portfolio loans
0.23
%
 
0.34
%
 
0.66
%
 
 
 
 
Nonperforming assets to total assets (1)
0.18
%
 
0.27
%
 
0.59
%
 
 
 
 
Allowance for loan losses to portfolio loans
0.97
%
 
0.96
%
 
1.23
%
 
 
 
 
Net charge-offs to average loans (annualized)
0.08
%
 
0.64
%
 
0.14
%
 
0.24
%
 
0.02
%
 
 
 
 
 
 
 
 
 
 
(1) Excludes purchased credit impaired loans and related assets, except for their inclusion in total assets.


31



Below are highlights of the Company's Core performance measures, which we believe are important measures of financial performance, but are non-GAAP measures. Core performance measures include contractual interest on non-core acquired loans, but exclude incremental accretion on these loans, gain or loss on the sale of other real estate from non-core acquired loans, 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, which the Company believes to be not indicative of or useful to measure the Company's operating performance on an ongoing basis. A reconciliation of Core performance measures has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures".

 
For the Three Months ended
 
For the Nine Months ended
(in thousands)
September 30,
2017
 
June 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
CORE PERFORMANCE MEASURES (1)
 
 
 
 
 
 
 
 
Net interest income
$
44,069

 
$
43,049

 
$
31,534

 
$
124,685

 
$
91,340

Provision for portfolio loans
2,422

 
3,623

 
3,038

 
7,578

 
4,587

Noninterest income
8,350

 
7,934

 
6,828

 
23,260

 
18,938

Noninterest expense
27,070

 
27,798

 
20,242

 
79,814

 
61,123

Income before income tax expense
22,927

 
19,562

 
15,082

 
60,553

 
44,568

Income tax expense
7,391

 
6,329

 
5,142

 
18,636

 
15,276

Net income
$
15,536

 
$
13,233

 
$
9,940

 
$
41,917

 
$
29,292

 
 
 
 
 
 
 
 
 
 
Earnings per share
$
0.66

 
$
0.56

 
$
0.49

 
$
1.81

 
$
1.45

Return on average assets
1.21
%
 
1.06
%
 
1.04
%
 
1.14
%
 
1.05
%
Return on average common equity
11.13
%
 
9.72
%
 
10.47
%
 
10.69
%
 
10.67
%
Return on average tangible common equity
14.50
%
 
12.72
%
 
11.46
%
 
13.66
%
 
11.73
%
Net interest margin (fully tax equivalent)
3.75
%
 
3.76
%
 
3.54
%
 
3.71
%
 
3.53
%
Efficiency ratio
51.64
%
 
54.52
%
 
52.77
%
 
53.95
%
 
55.43
%
 
 
 
 
 
 
 
 
 
 
(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 nine months ended September 30, 2017 compared to the nine months ended September 30, 2016, the Company noted the following trends:

The Company reported net income of $40.7 million, or $1.75 per diluted share, for the nine months ended September 30, 2017, compared to $35.2 million, or $1.74 per diluted share, for the same period in 2016. The $0.01 increase in earnings per share primarily resulted from increases in net interest income and noninterest income including growth from the JCB acquisition, offset by a decline in contribution from non-core acquired assets and the impact of merger related expenses in 2017.

On a core basis1, net income was $41.9 million, or $1.81 per share, for the nine months ended September 30, 2017, compared to $29.3 million, or $1.45 per share, in the prior year period. The earnings per share increase of $0.36 was primarily due to higher levels of core net interest income from continued growth in earning asset balances combined with 18 basis points of core net interest margin expansion. This increase was partially offset by an increase in core noninterest expense primarily from employee compensation and benefits as a result of the JCB acquisition.

Net interest income for the first nine months of 2017 increased $29.9 million or 30%, from the prior year period due to strong portfolio loan growth, net interest margin expansion and the acquisition of JCB.


32



Net interest margin for the first nine months of 2017 remained stable at 3.87% when compared to the prior year period. Core net interest margin1, which excludes incremental accretion on non-core acquired loans, increased 18 basis points for the first nine months of 2017 from the prior year primarily due to core deposit-funded portfolio loan growth improving the earning asset mix, increased yield on portfolio loans, controlled increases in deposit costs, and the acquisition of JCB.

Noninterest income for the first nine months of 2017 increased $3.3 million or 16%, compared to the prior year period due primarily to the acquisition of JCB ($3.6 million). This increase was partially offset by prior year non-core gain on sale of other real estate and other non-core income from acquired assets.

Noninterest expenses were $86.8 million for the nine months ended September 30, 2017, compared to $62.9 million for the nine months ended September 30, 2016. Noninterest expenses for the nine months included $6.5 million of merger related expenses. Core noninterest expenses1 were $79.8 million for the nine months ended September 30, 2017, compared to $61.1 million for the prior year period due to the JCB acquisition and two full quarters of JCB's expense base.

Balance sheet highlights:

Loans – Portfolio loans increased to $4.0 billion at September 30, 2017, increasing $878 million when compared to December 31, 2016. Excluding the acquisition of JCB, portfolio loans organically grew by $200 million in the first nine months of 2017. On a year-over-year basis, portfolio loans increased $959 million of which $281 million was organic loan growth and $678 million was from the acquisition of JCB. See Item 1, Note 5 – Portfolio Loans for more information.
Deposits – Total deposits at September 30, 2017 were $4.1 billion, an increase of $826 million, or 26% from December 31, 2016, and $934 million, or 30%, from September 30, 2016. $774 million of the increase in both periods is attributed to the acquisition of JCB. Core deposits, defined as total deposits excluding time deposits, were $3.4 billion at September 30, 2017, an increase of $114 million, or 3% , and $805 million, or 31%, from the linked quarter and prior year period, respectively. The trends in deposits reflect continued progress across our business lines, $636 million of core deposits from JCB, and some seasonality.
Asset quality – Nonperforming loans were $9.0 million at September 30, 2017, compared to $14.9 million at December 31, 2016. Nonperforming loans represented 0.23% of portfolio loans at September 30, 2017 versus 0.48% at December 31, 2016. There were no portfolio loans that were over 90 days delinquent and still accruing at September 30, 2017 or December 31, 2016.
Provision for portfolio loan losses was $7.6 million for the nine months ended September 30, 2017, compared to $4.6 million for the nine months ended September 30, 2016. 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."

33



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 $48 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 September 30,
 
2017
 
2016
(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)
$
3,866,434

 
$
45,526

 
4.67
%
 
$
2,916,678

 
$
30,980

 
4.23
%
Tax-exempt portfolio loans (2)
38,202

 
623

 
6.47

 
41,495

 
611

 
5.86

Non-core acquired loans - contractual
35,120

 
553

 
6.25

 
53,198

 
789

 
5.90

Non-core acquired loans - incremental accretion
 
 
1,556

 
17.57

 
 
 
2,296

 
17.17

Total loans
3,939,756

 
48,258

 
4.86

 
3,011,371


34,676

 
4.58

Taxable investments in debt and equity securities
667,520

 
3,981

 
2.37

 
479,755

 
2,462

 
2.04

Non-taxable investments in debt and equity securities (2)
43,537

 
475

 
4.33

 
47,761

 
521

 
4.34

Short-term investments
61,859

 
173

 
1.11

 
50,193

 
67

 
0.53

Total securities and short-term investments
772,916

 
4,629

 
2.38

 
577,709


3,050

 
2.10

Total interest-earning assets
4,712,672

 
52,887

 
4.45

 
3,589,080

 
37,726

 
4.18

Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
76,661

 
 
 
 
 
58,178

 
 
 
 
Other assets
348,100

 
 
 
 
 
213,352

 
 
 
 
Allowance for loan losses
(41,939
)
 
 
 
 
 
(45,692
)
 
 
 
 
 Total assets
$
5,095,494

 
 
 
 
 
$
3,814,918

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
805,073

 
$
523

 
0.26
%
 
$
600,707

 
$
332

 
0.22
%
Money market accounts
1,314,274

 
2,410

 
0.73

 
1,075,747

 
1,143

 
0.42

Savings
200,394

 
125

 
0.25

 
108,075

 
68

 
0.25

Certificates of deposit
580,951

 
1,493

 
1.02

 
516,159

 
1,319

 
1.02

Total interest-bearing deposits
2,900,692

 
4,551

 
0.62

 
2,300,688


2,862

 
0.49

Subordinated debentures
118,086

 
1,316

 
4.42

 
56,807

 
369

 
2.59

Other borrowed funds
455,995

 
976

 
0.85

 
286,896

 
232

 
0.32

Total interest-bearing liabilities
3,474,773

 
6,843

 
0.78

 
2,644,391


3,463

 
0.52

Noninterest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
1,031,346

 
 
 
 
 
768,468

 
 
 
 
Other liabilities
35,662

 
 
 
 
 
24,198

 
 
 
 
Total liabilities
4,541,781

 
 
 
 
 
3,437,057

 
 
 
 
Shareholders' equity
553,713

 
 
 
 
 
377,861

 
 
 
 
Total liabilities & shareholders' equity
$
5,095,494

 
 
 
 
 
$
3,814,918

 
 
 
 
Net interest income
 
 
$
46,044

 
 
 
 
 
$
34,263

 
 
Net interest spread
 
 
 
 
3.67
%
 
 
 
 
 
3.66
%
Net interest margin
 
 
 
 
3.88
%
 
 
 
 
 
3.80
%
Core net interest margin (3)
 
 
 
 
3.75
%
 
 
 
 
 
3.54
%
(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 $0.9 million and $0.8 million for the three months ended September 30, 2017 and 2016 respectively.
(2)
Non-taxable income is presented on a fully tax-equivalent basis using a 38.0% and 38.3% tax rate in 2017 and 2016, respectively. The tax-equivalent adjustments were $0.4 million for the three months ended September 30, 2017 and 2016, 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."


34



 
Nine months ended September 30,
 
2017
 
2016
(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)
$
3,713,188

 
$
127,046

 
4.57
%
 
$
2,830,365

 
$
88,667

 
4.18
%
Tax-exempt portfolio loans (2)
41,703

 
1,998

 
6.41

 
41,526

 
1,899

 
6.11

Non-core acquired loans - contractual
37,043

 
1,753

 
6.33

 
60,420

 
2,693

 
5.95

Non-core acquired loans - incremental accretion
 
 
5,215

 
18.82

 
 
 
8,701

 
19.24

Total loans
3,791,934

 
136,012

 
4.80

 
2,932,311

 
101,960

 
4.64

Taxable investments in debt and equity securities
624,126

 
10,976

 
2.35

 
474,981

 
7,385

 
2.08

Non-taxable investments in debt and equity securities (2)
48,165

 
1,588

 
4.41

 
48,475

 
1,591

 
4.38

Short-term investments
75,125

 
537

 
0.96

 
47,771

 
186

 
0.52

Total securities and short-term investments
747,416

 
13,101

 
2.34

 
571,227

 
9,162

 
2.14

Total interest-earning assets
4,539,350

 
149,113

 
4.39

 
3,503,538

 
111,122

 
4.24

Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
76,086

 
 
 
 
 
56,618

 
 
 
 
Other assets
325,808

 
 
 
 
 
214,860

 
 
 
 
Allowance for loan losses
(43,901
)
 
 
 
 
 
(44,567
)
 
 
 
 
 Total assets
$
4,897,343

 
 
 
 
 
$
3,730,449

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
786,945

 
$
1,721

 
0.29
%
 
$
578,373

 
$
967

 
0.22
%
Money market accounts
1,272,939

 
5,841

 
0.61

 
1,056,565

 
3,162

 
0.40

Savings
185,218

 
332

 
0.24

 
102,589

 
191

 
0.25

Certificates of deposit
576,906

 
4,081

 
0.95

 
460,667

 
3,521

 
1.02

Total interest-bearing deposits
2,822,008

 
11,975

 
0.57

 
2,198,194

 
7,841

 
0.48

Subordinated debentures
116,239

 
3,768

 
4.33

 
56,807

 
1,078

 
2.53

Other borrowed funds
421,176

 
2,107

 
0.67

 
339,849

 
826

 
0.32

Total interest-bearing liabilities
3,359,423

 
17,850

 
0.71

 
2,594,850

 
9,745

 
0.50

Noninterest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
982,788

 
 
 
 
 
739,705

 
 
 
 
Other liabilities
30,809

 
 
 
 
 
29,196

 
 
 
 
Total liabilities
4,373,020

 
 
 
 
 
3,363,751

 
 
 
 
Shareholders' equity
524,323

 
 
 
 
 
366,698

 
 
 
 
Total liabilities & shareholders' equity
$
4,897,343

 
 
 
 
 
$
3,730,449

 
 
 
 
Net interest income
 
 
$
131,263

 
 
 
 
 
$
101,377

 
 
Net interest spread
 
 
 
 
3.68
%
 
 
 
 
 
3.74
%
Net interest margin
 
 
 
 
3.87
%
 
 
 
 
 
3.87
%
Core net interest margin (3)
 
 
 
 
3.71
%
 
 
 
 
 
3.53
%
(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 $2.5 million and $1.6 million for the nine months ended September 30, 2017 and 2016 respectively.
(2)
Non-taxable income is presented on a fully tax-equivalent basis using a 38.0% and 38.3% tax rate in 2017 and 2016, respectively. The tax-equivalent adjustments were $1.4 million and $1.3 million for the nine months ended September 30, 2017 and 2016, 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."


35



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.
  
 
2017 compared to 2016
 
Three months ended September 30,
 
Nine months ended September 30,
 
Increase (decrease) due to
 
Increase (decrease) due to
(in thousands)
Volume(1)
 
Rate(2)
 
Net
 
Volume(1)
 
Rate(2)
 
Net
Interest earned on:
 
 
 
 
 
 
 
 
 
 
 
Taxable portfolio loans
$
10,986

 
$
3,560

 
$
14,546

 
$
29,551

 
$
8,828

 
$
38,379

Tax-exempt portfolio loans (3)
(50
)
 
62

 
12

 
8

 
91

 
99

Non-core acquired loans
(1,075
)
 
99

 
(976
)
 
(4,408
)
 
(18
)
 
(4,426
)
Taxable investments in debt and equity securities
1,081

 
438

 
1,519

 
2,527

 
1,064

 
3,591

Non-taxable investments in debt and equity securities (3)
(45
)
 
(1
)
 
(46
)
 
(11
)
 
8

 
(3
)
Short-term investments
19

 
87

 
106

 
142

 
209

 
351

Total interest-earning assets
$
10,916

 
$
4,245

 
$
15,161

 
$
27,809

 
$
10,182

 
$
37,991

 
 
 
 
 
 
 
 
 
 
 
 
Interest paid on:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
127

 
$
64

 
$
191

 
$
406

 
$
348

 
$
754

Money market accounts
298

 
969

 
1,267

 
742

 
1,937

 
2,679

Savings
58

 
(1
)
 
57

 
148

 
(7
)
 
141

Certificates of deposit
170

 
4

 
174

 
835

 
(275
)
 
560

Subordinated debentures
573

 
374

 
947

 
1,603

 
1,087

 
2,690

Borrowed funds
197

 
547

 
744

 
235

 
1,046

 
1,281

Total interest-bearing liabilities
1,423

 
1,957

 
3,380

 
3,969

 
4,136

 
8,105

Net interest income
$
9,493

 
$
2,288

 
$
11,781

 
$
23,840

 
$
6,046

 
$
29,886

(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 $46.0 million for the three months ended September 30, 2017, compared to $34.3 million for the same period of 2016, an increase of $11.8 million, or 34%. The tax-equivalent net interest margin was 3.88% for the third quarter of 2017, compared to 3.98% for the second quarter of 2017, and 3.80% in the third quarter of 2016. Portfolio loan growth and higher rates, combined with the acquisition of JCB, supported the $15.2 million increase in interest income over the prior year period. The yield on taxable portfolio loans increased 44 basis points from the prior year period to 4.67% for the three months ended September 30, 2017. The increase was due to the impact of interest rate increases which increased yields on variable rate loans and an improved earning asset mix. The run-off of higher yielding non-core acquired loans continues to negatively impact net interest margin and resulted in a $1.0 million decrease in interest income for the three months ended September 30, 2017 compared to the prior year period.


36



Net interest income (on a tax equivalent basis) was $131.3 million for the nine months ended September 30, 2017, compared to $101.4 million for the same period of 2016, an increase of $29.9 million, or 29%. The tax-equivalent net interest margin was 3.87% for the nine months ended September 30, 2017, consistent with 3.87% for the prior year period. The increase in net interest income was primarily due to the impact of rising interest rates which increased yields on variable rate loans and to an improved earning asset mix, partially offset by a decline in contributions from non-core acquired assets and higher rates on interest bearing liabilities.

Core net interest margin1 expanded 18 basis points from the prior year to 3.71% for the nine months ended September 30, 2017, primarily due to loan growth improving the earning asset mix, combined with increased yield on portfolio loans out-pacing the increase to borrowing costs. Core net interest margin also increased modestly from JCB purchase accounting adjustments. The Company continues to manage its balance sheet to grow core net interest income and expects to maintain core net interest margin over the coming quarters; however, pressure on funding costs could negate 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 Nine Months ended
(in thousands)
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Accelerated cash flows and other incremental accretion
$
1,556

 
$
2,296

 
$
5,215

 
$
8,701

Provision reversal for non-core acquired loan losses

 
1,194

 
355

 
1,603

Gain (loss) on sale of other real estate

 
(225
)
 

 
480

Other income from other real estate

 
287

 

 
526

Other expenses
(19
)
 
(270
)
 
(126
)
 
(922
)
Non-core acquired assets income before income tax expense
$
1,537

 
$
3,282

 
$
5,444

 
$
10,388


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 September 30, 2017, the remaining accretable yield on the remaining non-core acquired portfolio was estimated to be $10 million and the non-accretable difference was approximately $15 million. Accelerated cash flows and other incremental accretion from these was $5.2 million for the nine months ended September 30, 2017, and $8.7 million for the same period in 2016. The Company estimates income from accelerated cash flows and other incremental accretion to be between $6 million and $8 million in total for 2017 and between $3 million and $5 million in 2018.













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

37



Noninterest Income

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

 
Three months ended September 30,
(in thousands)
2017
 
2016
 
Increase (decrease)
Service charges on deposit accounts
$
2,820

 
$
2,200

 
$
620

 
28
 %
Wealth management revenue
2,062

 
1,694

 
368

 
22
 %
Card services revenue
1,459

 
804

 
655

 
81
 %
Gain on state tax credits, net
77

 
228

 
(151
)
 
(66
)%
Miscellaneous income - core
1,932

 
1,902

 
30

 
2
 %
Core noninterest income (1)
8,350

 
6,828

 
1,522

 
22
 %
Loss on sale of other real estate from non-core acquired loans

 
(225
)
 
225

 
100
 %
Gain on sale of investment securities
22

 
86

 
(64
)
 
(74
)%
Other income from non-core acquired assets

 
287

 
(287
)
 
(100
)%
Total noninterest income
$
8,372

 
$
6,976

 
$
1,396

 
20
 %
 
 
 
 
 
 
 
 
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

 
Nine months ended September 30,
(in thousands)
2017
 
2016
 
Increase (decrease)
Service charges on deposit accounts
$
8,146

 
$
6,431

 
$
1,715

 
27
 %
Wealth management revenue
5,949

 
5,000

 
949

 
19
 %
Card services revenue
3,888

 
2,236

 
1,652

 
74
 %
Gain on state tax credits, net
332

 
899

 
(567
)
 
(63
)%
Gain on sale of other real estate - core
17

 
122

 
(105
)
 
(86
)%
Miscellaneous income - core
4,928

 
4,250

 
678

 
16
 %
Core noninterest income (1)
23,260

 
18,938

 
4,322

 
23
 %
Gain on sale of other real estate from non-core acquired loans

 
480

 
(480
)
 
(100
)%
Gain on sale of investment securities
22

 
86

 
(64
)
 
(74
)%
Other income from non-core acquired assets

 
526

 
(526
)
 
(100
)%
Total noninterest income
$
23,282

 
$
20,030

 
$
3,252

 
16
 %
 
 
 
 
 
 
 
 
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."


Noninterest income increased $3.3 million, or 16% in the first nine months of 2017 compared to the first nine months of 2016. Core noninterest income1 grew 23% in the first nine months of 2017 due primarily to the JCB acquisition contributing approximately $3.6 million. In addition, the Company's customer swap, card services and wealth management businesses all experienced growth due to increased customer activity and new customer additions. The Company expects continued growth in fee income of 5% - 7% for 2018.


38



Noninterest Expense

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

 
Three months ended September 30,
(in thousands)
2017
 
2016
 
Increase (decrease)
Core expenses (1):
 
 
 
 
 
 
 
 Employee compensation and benefits - core
$
15,090

 
$
11,910

 
$
3,180

 
27
 %
 Occupancy - core
2,434

 
1,679

 
755

 
45
 %
 Data processing - core
1,389

 
1,135

 
254

 
22
 %
 FDIC and other insurance
731

 
780

 
(49
)
 
(6
)%
 Professional fees - core
920

 
540

 
380

 
70
 %
 Loan, legal and other real estate expense - core
567

 
310

 
257

 
83
 %
 Other - core
5,939

 
3,888

 
2,051

 
53
 %
Core noninterest expense (1)
27,070

 
20,242

 
6,828

 
34
 %
Merger related expenses
315

 
302

 
13

 
4
 %
Other expenses related to non-core acquired loans
19

 
270

 
(251
)
 
(93
)%
Total noninterest expense
$
27,404

 
$
20,814

 
$
6,590

 
32
 %
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

 
Nine months ended September 30,
(in thousands)
2017
 
2016
 
Increase (decrease)
Core expenses (1):
 
 
 
 
 
 
 
 Employee compensation and benefits - core
$
46,096

 
$
36,560

 
$
9,536

 
26
 %
 Occupancy - core
6,628

 
4,920

 
1,708

 
35
 %
 Data processing - core
4,828

 
3,396

 
1,432

 
42
 %
 FDIC and other insurance
2,356

 
2,241

 
115

 
5
 %
 Professional fees - core
2,833

 
1,942

 
891

 
46
 %
 Loan, legal and other real estate expense - core
1,418

 
782

 
636

 
81
 %
 Other - core
15,655

 
11,282

 
4,373

 
39
 %
Core noninterest expense (1)
79,814

 
61,123

 
18,691

 
31
 %
Executive severance

 
332

 
(332
)
 
(100
)%
Merger related expenses
6,462

 
302

 
6,160

 
2,040
 %
Other non-core expenses
389

 
250

 
139

 
56
 %
Other expenses related to non-core acquired loans
126

 
922

 
(796
)
 
(86
)%
Total noninterest expense
$
86,791

 
$
62,929

 
$
23,862

 
38
 %
(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 $86.8 million for the nine months ended September 30, 2017, compared to $62.9 million for the nine months ended September 30, 2016. The increase was primarily due to the acquisition of JCB including merger related expenses. Core noninterest expenses1 increased $18.7 million to $79.8 million for the nine months ended September 30, 2017, from $61.1 million for the prior year period. Core expenses increased from the acquisition as well as from increases in Employee compensation and benefits from investments in revenue producing personnel.

The Company's Core efficiency ratio1 decreased to 54.0% for the nine months ended September 30, 2017, compared to 55.4% for the prior year period, and reflects continuing efforts to leverage its expense base and execution of the initiatives necessary to realize the expected cost savings from the JCB acquisition. The conversion of JCB's core

39



systems was completed late in the second quarter of 2017. 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 modest improvement to the Company's efficiency ratio.


Income Taxes

The Company's income tax expense for the nine months ended September 30, 2017, which includes both federal and state taxes, was $7.9 million compared to $6.3 million for the same period of 2016. The combined federal and state effective income tax rate for the nine months ended September 30, 2017 was 31.3%, compared to 35.0% for the same period in 2016. The decrease in the effective tax rate over the prior year period was caused by additional tax credit investments and a change in accounting guidance that requires recording excess tax benefits on equity compensation awards to the income statement. For additional discussion of this guidance, refer to Note 1, Summary of Significant Accounting Policies.


Summary Balance Sheet

(in thousands)
September 30,
2017
 
December 31,
2016
 
Increase (decrease)
Total cash and cash equivalents
$
183,108

 
$
198,802

 
(15,694
)
(7.9
)%
Securities
679,289

 
541,260

 
138,029

25.5
 %
Loans
4,030,658

 
3,158,161

 
872,497

27.6
 %
Non-core acquired loans
34,157

 
39,769

 
(5,612
)
(14.1
)%
Total assets
5,231,488

 
4,081,328

 
1,150,160

28.2
 %
Deposits
4,059,211

 
3,233,361

 
825,850

25.5
 %
Total liabilities
4,685,152

 
3,694,230

 
990,922

26.8
 %
Total shareholders' equity
546,336

 
387,098

 
159,238

41.1
 %


40



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. The following table summarizes the composition of the Company's loan portfolio:
(in thousands)
September 30,
2017
 
December 31,
2016
 
Increase (decrease)
Commercial and industrial
$
1,861,935

 
$
1,632,714

 
$
229,221

 
14.0
 %
Commercial real estate - investor owned
776,425

 
544,808

 
231,617

 
42.5
 %
Commercial real estate - owner occupied
555,686

 
350,148

 
205,538

 
58.7
 %
Construction and land development
306,410

 
194,542

 
111,868

 
57.5
 %
Residential real estate
341,695

 
240,760

 
100,935

 
41.9
 %
Consumer and other
154,350

 
155,420

 
(1,070
)
 
(0.7
)%
   Portfolio loans
3,996,501

 
3,118,392

 
878,109

 
28.2
 %
Non-core acquired loans
34,157

 
39,769

 
(5,612
)
 
(14.1
)%
   Total loans
$
4,030,658

 
$
3,158,161

 
$
872,497

 
27.6
 %

Portfolio loans grew by $878.1 million, ($678 million from JCB) to $4.0 billion at September 30, 2017, when compared to December 31, 2016. Non-core acquired loans totaled $34.2 million at September 30, 2017, a decrease of $5.6 million, or 14%, from December 31, 2016, 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)
September 30,
2017
 
December 31,
2016
 
Increase (decrease)
Enterprise value lending
$
455,983

 
$
388,798

 
$
67,185

 
17.3
 %
C&I - general
886,498

 
794,451

 
92,047

 
11.6
 %
Life insurance premium financing
330,957

 
305,779

 
25,178

 
8.2
 %
Tax credits
188,497

 
143,686

 
44,811

 
31.2
 %
CRE, Construction, and land development
1,638,521

 
1,089,498

 
549,023

 
50.4
 %
Residential real estate
341,695

 
240,760

 
100,935

 
41.9
 %
Consumer and other
154,350

 
155,420

 
(1,070
)
 
(0.7
)%
Portfolio loans
$
3,996,501

 
$
3,118,392

 
$
878,109

 
28.2
 %

Specialized lending products, especially Enterprise value lending, Life insurance premium financing, and Tax credits, consist of primarily C&I loans, and have contributed significantly to the Company's loan growth. These loans are sourced through relationships developed with estate planning firms and private equity funds, and are not bound geographically by our traditional three markets. These specialized loan products offer opportunities to expand and diversify geographically by entering into new markets. The Company continues to focus on originating high-quality C&I relationships as they typically have variable interest rates and allow for cross selling opportunities involving other banking products. C&I loan growth also supports our efforts to maintain the Company's asset sensitive interest rate risk position. The Company continues to expect portfolio loan growth, excluding the acquisition of JCB, at or above 10% for 2017. For 2018, the Company expects organic loan growth in dollars to be at least equivalent to 2017 levels. With continued organic growth and the impact of the JCB acquisition increasing portfolio loan balances, 2018 portfolio loan growth is expected to be approximately 7% - 9%.

41



Provision and Allowance for Loan Losses
The following table summarizes changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off, by loan category, and additions to the allowance charged to expense.
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Allowance at beginning of period, for portfolio loans
$
36,673

 
$
35,498

 
$
37,565

 
$
33,441

Loans charged off:
 
 
 
 
 
 
 
Commercial and industrial
(613
)
 
(2,044
)
 
(6,781
)
 
(2,269
)
Real estate:
 
 
 
 
 
 
 
Commercial
(45
)
 

 
(90
)
 

Construction and land development

 

 
(5
)
 

Residential
(503
)
 
(25
)
 
(777
)
 
(25
)
Consumer and other
(75
)
 
(4
)
 
(143
)
 
(15
)
Total loans charged off
(1,236
)
 
(2,073
)

(7,796
)

(2,309
)
Recoveries of loans previously charged off:
 
 
 
 
 
 
 
Commercial and industrial
205

 
69

 
342

 
624

Real estate:
 
 
 
 
 
 
 
Commercial
18

 
25

 
219

 
123

Construction and land development
25

 
913

 
83

 
927

Residential
172

 
26

 
259

 
96

Consumer and other
13

 
2

 
42

 
9

Total recoveries of loans
433

 
1,035


945


1,779

Net loan charge-offs
(803
)
 
(1,038
)

(6,851
)

(530
)
Provision for loan losses
2,422

 
3,038

 
7,578

 
4,587

Allowance at end of period, for portfolio loans (1)
$
38,292

 
$
37,498


$
38,292


$
37,498

 
 
 
 
 
 
 
 
Allowance at beginning of period, for purchased credit impaired loans
$
5,126

 
$
8,551

 
$
5,844

 
$
10,175

   Loans charged off
(175
)
 
(312
)
 
(223
)
 
(1,295
)
   Recoveries of loans

 

 

 

Other
(52
)
 
(612
)
 
(367
)
 
(844
)
Net loan charge-offs
(227
)
 
(924
)

(590
)

(2,139
)
Provision reversal for purchased credit impaired loan losses

 
(1,194
)
 
(355
)
 
(1,603
)
Allowance at end of period, for purchased credit impaired loans
$
4,899

 
$
6,433


$
4,899


$
6,433

 
 
 
 
 
 
 
 
Total allowance at end of period
$
43,191

 
$
43,931

 
$
43,191

 
$
43,931

 
 
 
 
 
 
 
 
Portfolio loans, average
$
3,904,636

 
$
2,947,949

 
$
3,754,891

 
$
2,864,916

Portfolio loans, ending (1)
3,948,676

 
3,037,705

 
3,948,676

 
3,037,705

Net charge-offs to average portfolio loans (1)
0.08
%
 
0.14
%
 
0.24
%
 
0.02
%
Allowance for portfolio loan losses to loans (1)
0.97
%
 
1.23
%
 
0.97
%
 
1.23
%
 
 
 
 
 
 
 
 
(1) Excludes PCI loans.

The provision for loan losses on portfolio loans for the nine months ended September 30, 2017 was $7.6 million, compared to $4.6 million for same period in 2016. The provision is reflective of a chargeoff and reserve increase on a single nonperforming relationship, growth in the portfolio, and maintaining a prudent credit risk posture.  

42




There was $0.4 million of provision reversal for loan losses on PCI loans for the nine months ended September 30, 2017, compared to provision reversal of $1.6 million for the comparable 2016 period.

The allowance for loan losses on portfolio loans was 0.97% of portfolio loans at September 30, 2017 compared to 1.23% at September 30, 2016. The decrease year over year was due to the addition of the JCB loan portfolio at fair value. 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)
September 30,
2017
 
December 31,
2016
 
September 30,
2016
Non-accrual loans
$
8,264

 
$
12,585

 
$
17,622

Restructured loans
721

 
2,320

 
2,320

Total nonperforming loans (1)
8,985

 
14,905

 
19,942

Other real estate from originated loans
251

 
740

 
2,719

Other real estate from acquired loans
240

 
240

 
240

Total nonperforming assets (1) (2)
$
9,476

 
$
15,885

 
$
22,901

 
 
 
 
 
 
Total assets
$
5,231,488

 
$
4,081,328

 
$
3,909,644

Portfolio loans (1)
3,948,676

 
3,158,161

 
3,037,705

Portfolio loans plus other real estate (1)
3,949,167

 
3,159,141

 
3,040,664

Nonperforming loans to portfolio loans (1)
0.23
%
 
0.47
%
 
0.66
%
Nonperforming assets to total loans plus other real estate (1) (2)
0.24

 
0.50

 
0.75

Nonperforming assets to total assets (1) (2)
0.18

 
0.39

 
0.59

Allowance for loans to nonperforming loans (1)
426
%
 
252
%
 
188
%
 
 
 
 
 
 
(1) Excludes PCI loans, except for their inclusion in total assets.
(2) Other real estate from PCI loans included in Nonperforming assets beginning with the year ended December 31, 2015 due to termination of all existing FDIC loss share agreements.


43



Nonperforming loans 
Nonperforming loans exclude PCI loans that are accounted for on a pool basis, as the pools are considered to be performing. See Item 1, Note 5 – Loans for more information on these loans.
 
Nonperforming loans based on loan type were as follows:
 
(in thousands)
September 30, 2017
 
December 31, 2016
 
September 30, 2016
Commercial and industrial
$
7,451

 
$
12,284

 
$
13,160

Commercial real estate
544

 
655

 
252

Construction and land development
322

 
1,904

 
1,907

Residential real estate

 
62

 
124

Consumer and other
668

 

 
4,499

Total
$
8,985

 
$
14,905


$
19,942


The following table summarizes the changes in nonperforming loans:
 
Nine months ended September 30,
(in thousands)
2017
 
2016
Nonperforming loans beginning of period
$
14,905

 
$
9,100

Additions to nonaccrual loans
8,680

 
18,354

Additions to restructured loans
676

 
2,320

Charge-offs
(7,678
)
 
(2,104
)
Other principal reductions
(7,315
)
 
(6,058
)
Moved to other real estate
(283
)
 
(283
)
Moved to performing

 
(1,387
)
Loans past due 90 days or more and still accruing interest

 

Nonperforming loans end of period
$
8,985

 
$
19,942


Other real estate
Other real estate at September 30, 2017, was $0.5 million, compared to $3.0 million at September 30, 2016.

The following table summarizes the changes in Other real estate:
 
Nine months ended September 30,
(in thousands)
2017
 
2016
Other real estate beginning of period
$
980

 
$
8,366

Additions and expenses capitalized to prepare property for sale
2,063

 
2,203

Writedowns in value
(56
)
 

Sales
(2,496
)
 
(7,610
)
Other real estate end of period
$
491

 
$
2,959


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 $4.7 billion at September 30, 2017, compared to $3.7 billion at December 31, 2016. The increase in liabilities was largely due to a $826 million increase in total deposits and a $249 million increase in Federal Home Loan Bank advances, partially offset by a decrease of $68 million in other borrowings.

Deposits
(in thousands)
September 30,
2017
 
December 31,
2016
 
Increase (decrease)
Demand deposits
$
1,047,910

 
$
866,756

 
181,154

 
20.9
%
Interest-bearing transaction accounts
814,338

 
731,539

 
82,799

 
11.3
%
Money market accounts
1,375,844

 
1,050,472

 
325,372

 
31.0
%
Savings
203,923

 
111,435

 
92,488

 
83.0
%
Certificates of deposit:
 
 
 
 
 
 
 
Brokered
170,701

 
117,145

 
53,556

 
45.7
%
Other
446,495

 
356,014

 
90,481

 
25.4
%
Total deposits
$
4,059,211

 
$
3,233,361

 
825,850

 
25.5
%
 
 
 
 
 
 
 
 
Non-time deposits / total deposits
85
%
 
85
%
 
 
 
 
Demand deposits / total deposits
26
%
 
27
%
 
 
 
 

Total deposits at September 30, 2017 were $4.1 billion, an increase of 26%, from December 31, 2016, primarily from the acquisition of JCB ($675 million). The composition of our noninterest bearing deposits remained relatively stable at 26% of total deposits at September 30, 2017 compared to 27% at December 31, 2016.

Shareholders' Equity

Shareholders' equity totaled $546 million at September 30, 2017, an increase of $159.2 million from December 31, 2016. Significant activity during the nine months ended September 30, 2017 was as follows:

Issuance of 3.3 million shares common stock for the JCB acquisition of $141.7 million,
Repurchase of 429,955 shares at an average price of $38.69, or $16.6 million pursuant to its publicly announced program,
Net income of $40.7 million, and
Dividends paid on common shares of $7.7 million.

Liquidity and Capital Resources

Liquidity

The objective of liquidity management is to ensure we have the ability to generate sufficient cash or cash equivalents in a timely and cost-effective manner to meet our commitments as they become due. Typical demands on liquidity are run-off from demand deposits, maturing time deposits which are not renewed, and fundings under credit commitments to customers. Funds are available from a number of sources, such as from the core deposit base and from loans and securities repayments and maturities.

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

The Bank's Asset-Liability Management Committee oversees our liquidity position, the parameters of which are approved by the Bank's Board of Directors. Our liquidity position is monitored monthly by producing a liquidity report, which measures the amount of liquid versus non-liquid assets and liabilities. Our liquidity management framework includes measurement of several key elements, such as the loan to deposit ratio, a liquidity ratio, and a dependency ratio. The Company's liquidity framework also incorporates contingency planning to assess the nature

44



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). A $15 million dividend was paid to the parent company from the Bank in October of 2017. 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. The subordinated notes will initially bear an annual interest rate of 4.75%, with interest payable semiannually. The notes were registered pursuant to a Form S-3 which was declared effective in August 2014. 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 used a portion of the proceeds from the issuance to pay the cash consideration at the closing of the acquisition of JCB. Regulatory guidance allows for this subordinated debt to be treated as tier 2 regulatory capital for the first five years of its term, subject to certain limitations, and then phased out of tier 2 capital pro rata over the next five years.

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 2018.  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 September 30, 2017, there was $10 million in outstanding balances under the Revolving Agreement, which has subsequently been paid off.

As of September 30, 2017, the Company had $69.3 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 $13.9 million will be sufficient to meet all projected cash needs for the remainder of 2017.

Bank liquidity
The Bank has a variety of funding sources available to increase financial flexibility. In addition to amounts currently borrowed, at September 30, 2017 the Bank has borrowing capacity of $423.3 million from the FHLB of Des Moines under blanket loan pledges, and has an additional $861.2 million available from the Federal Reserve Bank under a pledged loan agreement. The Bank has unsecured federal funds lines with five correspondent banks totaling $75 million.

Investment securities are another important tool to the Bank's liquidity objectives. Of the $603.1 million of the securities available for sale at September 30, 2017, $449.8 million was pledged as collateral for deposits of public institutions, treasury, loan notes, and other requirements. The remaining $153.3 million could be pledged or sold to enhance liquidity, if necessary.

In the normal course of business, the Bank enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Bank's various risk management

45



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 September 30, 2017. While this commitment 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 September 30, 2017, and December 31, 2016, the Company and the Bank met all capital adequacy requirements to which they are subject.
 
The Bank continues to exceed regulatory standards and met the definition of “well-capitalized” (the highest category) at September 30, 2017. The Company adopted the Regulatory Capital Framework (Basel III) in 2015, and has implemented the necessary processes and procedures to comply.

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

(in thousands)
September 30,
2017
 
December 31, 2016
 
Well Capitalized Minimum %
Total capital to risk-weighted assets
12.33
%
 
13.48
%
 
10.00
%
Tier 1 capital to risk-weighted assets
10.36
%
 
10.99
%
 
8.00
%
Common equity tier 1 capital to risk-weighted assets
8.93
%
 
9.52
%
 
6.50
%
Leverage ratio (Tier 1 capital to average assets)
9.88
%
 
10.42
%
 
5.00
%
Tangible common equity to tangible assets1
8.18
%
 
8.76
%
 
N/A

Tier 1 capital
$
491,315

 
$
412,865

 
 
Total risk-based capital
584,931

 
506,349

 
 
 
 
 
 
 
 
1 Not a required regulatory capital ratio
 
 

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

46



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, 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.

47



Core Performance Measures
 
For the Three Months ended
 
For the Nine Months ended
(in thousands)
September 30,
2017
 
June 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Net interest income
$
45,625

 
$
45,633

 
$
33,830

 
$
129,900

 
$
100,041

Less: Incremental accretion income
1,556

 
2,584

 
2,296

 
5,215

 
8,701

Core net interest income
44,069

 
43,049

 
31,534

 
124,685

 
91,340

 
 
 
 
 
 
 
 
 
 
Total noninterest income
8,372

 
7,934

 
6,976

 
23,282

 
20,030

Less: Gain (loss) on sale of other real estate from non-core acquired loans

 

 
(225
)
 

 
480

Less: Gain on sale of investment securities
22

 

 
86

 
22

 
86

Less: Other income from non-core acquired assets

 

 
287

 

 
526

Core noninterest income
8,350

 
7,934

 
6,828

 
23,260

 
18,938

 
 
 
 
 
 
 
 
 
 
Total core revenue
52,419

 
50,983

 
38,362

 
147,945

 
110,278

 
 
 
 
 
 
 
 
 
 
Provision for portfolio loans
2,422

 
3,623

 
3,038

 
7,578

 
4,587

 
 
 
 
 
 
 
 
 
 
Total noninterest expense
27,404

 
32,651

 
20,814

 
86,791

 
62,929

Less: Other expenses related to non-core acquired loans
19

 
(16
)
 
270

 
126

 
922

Less: Merger related expenses
315

 
4,480

 
302

 
6,462

 
302

Less: Facilities disposal charge

 
389

 

 
389

 

Less: Executive severance

 

 

 

 
332

Less: Other non-core expenses

 

 

 

 
250

Core noninterest expense
27,070

 
27,798

 
20,242

 
79,814

 
61,123

 
 
 
 
 
 
 
 
 
 
Core income before income tax expense
22,927

 
19,562

 
15,082

 
60,553

 
44,568

 
 
 
 
 
 
 
 
 
 
Total income tax expense
7,856

 
5,545

 
6,316

 
18,507

 
18,949

Less: Non-core income tax expense1
465

 
(784
)
 
1,174

 
(129
)
 
3,673

Core income tax expense
7,391

 
6,329

 
5,142

 
18,636

 
15,276

Core net income
$
15,536

 
$
13,233

 
$
9,940

 
$
41,917

 
$
29,292

 
 
 
 
 
 
 
 
 
 
Core diluted earnings per share
$
0.66

 
$
0.56

 
$
0.49

 
$
1.81

 
$
1.45

Core return on average assets
1.21
%
 
1.06
%
 
1.04
%
 
1.14
%
 
1.05
%
Core return on average common equity
11.13
%
 
9.72
%
 
10.47
%
 
10.69
%
 
10.67
%
Core return on average tangible common equity
14.50
%
 
12.72
%
 
11.46
%
 
13.66
%
 
11.73
%
Core efficiency ratio
51.64
%
 
54.52
%
 
52.77
%
 
53.95
%
 
55.43
%
 
 
 
 
 
 
 
 
 
 
1Non-core income tax expense calculated at 38% of non-core pretax income plus an estimate of taxes payable related to non-deductible JCB acquisition costs.

48




Net Interest Margin to Core Net Interest Margin (fully tax equivalent)
 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Net interest income
$
46,047

 
$
34,263

 
$
131,290

 
$
101,377

Less: Incremental accretion income
1,556

 
2,296

 
5,215

 
8,701

Core net interest income
$
44,491

 
$
31,967

 
$
126,075

 
$
92,676

 
 
 
 
 
 
 
 
Average earning assets
$
4,712,672

 
$
3,589,080

 
$
4,539,350

 
$
3,503,538

Reported net interest margin
3.88
%
 
3.80
%
 
3.87
%
 
3.87
%
Core net interest margin
3.75
%
 
3.54
%
 
3.71
%
 
3.53
%


Tangible common equity ratio
(in thousands)
September 30, 2017
 
December 31, 2016
Total shareholders' equity
$
546,336

 
$
387,098

Less: Goodwill
117,345

 
30,334

Less: Intangible assets
11,745

 
2,151

Tangible common equity
$
417,246

 
$
354,613

 
 
 
 
Total assets
$
5,231,488

 
$
4,081,328

Less: Goodwill
117,345

 
30,334

Less: Intangible assets
11,745

 
2,151

Tangible assets
$
5,102,398

 
$
4,048,843

 
 
 
 
Tangible common equity to tangible assets
8.18
%
 
8.76
%

49



Regulatory Capital to Risk-Weighted Assets

(in thousands)
September 30, 2017
 
December 31, 2016
Total shareholders' equity
$
546,336

 
$
387,098

Less: Goodwill
117,345

 
30,334

Less: Intangible assets, net of deferred tax liabilities
5,825

 
800

Less: Unrealized gains (losses)
(489
)
 
(1,741
)
Plus: Other
12

 
24

Common equity Tier 1 capital
423,667

 
357,729

Plus: Qualifying trust preferred securities
67,600

 
55,100

Plus: Other
48

 
36

Tier 1 capital
491,315

 
412,865

Plus: Tier 2 capital
93,616

 
93,484

Total risk-based capital
584,931

 
506,349

 
 
 
 
Total risk-weighted assets determined in accordance with prescribed regulatory requirements
$
4,743,393

 
$
3,757,161

 
 
 
 
Common equity tier 1 to risk-weighted assets
8.93
%
 
9.52
%
Tier 1 capital to risk-weighted assets
10.36
%
 
10.99
%
Total risk-based capital to risk-weighted assets
12.33
%
 
13.48
%

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 below under caption Acquisitions, as well as, the Company's Annual Report on Form 10-K for the year ended December 31, 2016.

Acquisitions

Acquisitions and Business Combinations are accounted for using the acquisition method of accounting.  The assets and liabilities of the acquired entities have been recorded at their estimated fair values at the date of acquisition. Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including the amount assigned to identifiable intangible assets.
 
The purchase price allocation process requires an estimation of the fair values of the assets acquired and the liabilities assumed. When a business combination agreement provides for an adjustment to the cost of the combination contingent on future events, the Company includes an estimate of the acquisition-date fair value as part of the cost of the combination. To determine the fair values, the Company relies on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. The results of operations of the acquired business are included in the Company's consolidated financial statements from the respective date of acquisition.  Merger-related costs are costs the Company incurs to effect a business combination. In 2017, the Company changed its presentation of Merger related expenses as a separate component of Noninterest expenses on the Condensed Consolidated Statements of Operations.  Merger related expenses include costs directly related to merger or acquisition activity and include legal and professional fees, system consolidation and conversion costs, and compensation costs such as severance and retention incentives for employees impacted by acquisition activity. The Company accounts for merger-related costs as expenses in the periods in which the costs are incurred and the services are received.


50



Purchased Credit Impaired ("PCI") Loans

Purchased credit impaired ("PCI") loans were acquired in a business combination or transaction that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable. PCI loans were initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance. The difference between the undiscounted cash flows expected at acquisition and the investment in the loans, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loans. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” are not recognized as a yield adjustment or as a loss accrual or a valuation allowance. The Company aggregates individual loans with common risk characteristics into pools of loans. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loans over their remaining lives. Decreases in expected cash flows due to an inability to collect contractual cash flows are recognized as impairment through the provision for loan losses account. Any allowance for loan loss on these pools reflect only losses incurred after the acquisition. Disposals of loans, including sales of loans, paydowns, payments in full or foreclosures result in the removal or reduction of the loan from the loan pool.

PCI loans are generally considered accruing and performing, as the loans accrete income over the estimated life of the loan, in circumstances where cash flows are reasonably estimable by management. Accordingly, PCI loans that could be contractually past due could be considered to be accruing and performing. If the timing and amount of future cash flows is not reasonably estimable or is less than the carrying value, the loans may be classified as nonaccrual loans and the purchase price discount on those loans is not recorded as interest income until the timing and amount of future cash flows can be reasonably estimable.

Allowance for Loan Losses on PCI Loans

The Company updates its cash flow projections for purchased credit-impaired loans on a periodic basis. Assumptions utilized in this process include projections related to probability of default, loss severity, prepayment, extensions and recovery lag. Projections related to probability of default and prepayment are calculated utilizing a loan migration analysis and management’s assessment of loss exposure including the fair value of underlying collateral. The loan migration analysis is a matrix that specifies the probability of a loan pool transitioning into a particular delinquency or liquidation state given its current performance at the measurement date. Loss severity factors are based upon industry data and historical experience.

Any decreases in expected cash flows after the acquisition date and subsequent measurement periods are recognized by recording an impairment in allowance for loan losses through a provision for loan losses.


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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
4.7%
+ 200 bp
3.2%
+ 100 bp
1.6%
 - 100 bp
-6.1%

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.

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ITEM 4: CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of the Company’s Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15, as of September 30, 2017. Disclosure controls and procedures include without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Based on that evaluation, the CEO and CFO concluded the Company’s disclosure controls and procedures were effective as of September 30, 2017 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, 2016. There have been no material changes to the risk factors described in such Annual Report on Form 10-K.


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

Issuer Purchases of Equity Securities

The following table provides information on repurchases by the Company of its common stock in each month of the quarter ended September 30, 2017.

Period
Total number of shares purchased (a)
 
Weighted-average price paid per share
 
Total number of shares purchased as part of publicly announced plans or programs
 
Maximum number of shares that may yet be purchased under the plans or programs
July 1, 2017 through July 31, 2017
67,201

 
39.84

 
67,201

 
1,747,081

August 1, 2017 through August 31, 2017
123,179

 
38.70

 
123,179

 
1,623,902

September 1, 2017 through September 30, 2017
239,575

 
38.37

 
239,575

 
1,384,327

Total
429,955

 
$
38.69

 
429,955

 
1,384,327

 
 
 

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


ITEM 5: OTHER INFORMATION

Appointment to the Board of Directors

On October 27, 2017, the Enterprise Board of Directors appointed Michael T. Normile as a Director, filling the current vacancy on the Board. Effective immediately, Mr. Normile will serve as a Director of the Board until the Company's 2018 annual meeting of stockholders (when he is expected to be nominated for election by the stockholders of the Company). The Board of Directors has not yet determined on which board committees Mr. Normile will serve. There are no transactions between the Company and Mr. Normile that would be required to be reported under Item 404(a) of Regulation S-K.

The press release announcing the appointment of Michael T. Normile to the Board is being furnished as Exhibit 99.1 to this Quarterly Statement on Form 10-Q.



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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

*31.1

*31.2

**32.1

**32.2

**99.1

101
Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2017, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheet at September 30, 2017 and December 31, 2016; (ii) Consolidated Statement of Income for the three and nine months ended September 30, 2017 and 2016; (iii) Consolidated Statement of Comprehensive Income for the three and nine months ended September 30, 2017 and 2016; (iv) Consolidated Statement of Changes in Equity for the nine months ended September 30, 2017 and 2016; (v) Consolidated Statement of Cash Flows for the nine months ended September 30, 2017 and 2016; 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.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Clayton, State of Missouri on the day of October 27, 2017.
 
 
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
 



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