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EX-32.2 - CHIEF FINANCIAL OFFICER CERTIFICATION PURSUANT TO 18 U.S.C SECT 1350 - ENTERPRISE FINANCIAL SERVICES CORPa2018930-ex322.htm
EX-32.1 - CHIEF EXECUTIVE OFFICER CERTIFICATION PURSUANT TO 18 U.S.C SECT 1350 - ENTERPRISE FINANCIAL SERVICES CORPa2018930-ex321.htm
EX-31.2 - CHIEF FINANCIAL OFFICER CERTIFICATION REQUIRED BY RULE 13(A)-14(A) - ENTERPRISE FINANCIAL SERVICES CORPa2018930-ex312.htm
EX-31.1 - CHIEF EXECUTIVE OFFICER CERTIFICATION REQUIRED BY RULE 13(A)-14(A) - ENTERPRISE FINANCIAL SERVICES CORPa2018930-ex311.htm
EX-12.1 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS - ENTERPRISE FINANCIAL SERVICES CORPa2018930-ex121.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, 2018.
 
 
 
[   ]
 
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ______ to ______
 
 
 
 
 
Commission file number 001-15373
 
ENTERPRISE FINANCIAL SERVICES CORP

Incorporated in the State of Delaware
I.R.S. Employer Identification # 43-1706259
Address: 150 North Meramec
Clayton, MO 63105
Telephone: (314) 725-5500
___________________
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes [X]  No [   ] 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X]  No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [X]
 
 
 
Accelerated filer [ ]
Non-accelerated filer [ ]
 
(Do not check if a smaller reporting company)
 
Smaller reporting company [ ]
 
 
 
 
Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Yes [   ]  No [X]
 
As of October 24, 2018, the Registrant had 23,073,472 shares of outstanding common stock, $0.01 par value per share.
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 3. Defaults Upon Senior Securities
 
 
 
Item 4. Mine Safety Disclosures
 
 
 
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, 2018
 
December 31, 2017
Assets
 
 
 
Cash and due from banks
$
78,119

 
$
91,084

Federal funds sold
1,571

 
1,223

Interest-bearing deposits (including $1,295 and $1,365 pledged as collateral, respectively)
76,375

 
61,016

Total cash and cash equivalents
156,065

 
153,323

Interest-bearing deposits greater than 90 days
3,405

 
2,645

Securities available for sale
670,328

 
641,382

Securities held to maturity
67,131

 
73,749

Loans held for sale
738

 
3,155

Loans
4,267,430

 
4,097,050

Less: Allowance for loan losses
44,186

 
42,577

Total loans, net
4,223,244

 
4,054,473

Other real estate
408

 
498

Other investments, at cost
37,885

 
26,661

Fixed assets, net
32,354

 
32,618

Accrued interest receivable
19,879

 
14,069

State tax credits held for sale (including $171 and $400 carried at fair value, respectively)
45,625

 
43,468

Goodwill
117,345

 
117,345

Intangible assets, net
9,148

 
11,056

Other assets
133,984

 
114,783

Total assets
$
5,517,539

 
$
5,289,225

 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
Demand deposits
$
1,062,126

 
$
1,123,907

Interest-bearing transaction accounts
743,351

 
915,653

Money market accounts
1,523,416

 
1,342,931

Savings
207,346

 
195,150

Certificates of deposit:
 
 
 
Brokered
202,323

 
115,306

Other
471,914

 
463,467

Total deposits
4,210,476

 
4,156,414

Subordinated debentures and notes (net of debt issuance cost of $1,038 and $1,136, respectively)
118,144

 
118,105

Federal Home Loan Bank advances
401,000

 
172,743

Other borrowings
161,795

 
253,674

Accrued interest payable
2,433

 
1,730

Other liabilities
36,854

 
37,986

Total liabilities
4,930,702

 
4,740,652

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

 

Common stock, $0.01 par value; 30,000,000 shares authorized; 23,919,261 and 23,781,112 shares issued, respectively
239

 
238

Treasury stock, at cost; 827,595 and 691,673 shares, respectively
(30,108
)
 
(23,268
)
Additional paid in capital
349,317

 
350,061

Retained earnings
284,016

 
225,360

Accumulated other comprehensive loss
(16,627
)
 
(3,818
)
Total shareholders' equity
586,837

 
548,573

Total liabilities and shareholders' equity
$
5,517,539

 
$
5,289,225

The accompanying notes are an integral part of these 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)
2018
 
2017
 
2018
 
2017
Interest income:
 
 
 
 
 
 
 
Interest and fees on loans
$
55,383

 
$
48,020

 
$
158,781

 
$
135,253

Interest on debt securities:
 
 
 
 
 
 
 
Taxable
4,482

 
3,855

 
12,697

 
10,670

Nontaxable
263

 
294

 
816

 
984

Interest on interest-bearing deposits
306

 
173

 
777

 
537

Dividends on equity securities
323

 
126

 
729

 
306

Total interest income
60,757

 
52,468


173,800


147,750

Interest expense:
 
 
 
 
 
 
 
Interest-bearing transaction accounts
799

 
523

 
2,422

 
1,721

Money market accounts
5,423

 
2,410

 
13,221

 
5,841

Savings accounts
157

 
125

 
429

 
332

Certificates of deposit
2,878

 
1,493

 
7,115

 
4,081

Subordinated debentures and notes
1,483

 
1,316

 
4,305

 
3,768

Federal Home Loan Bank advances
1,729

 
832

 
4,435

 
1,684

Notes payable and other borrowings
195

 
144

 
561

 
423

Total interest expense
12,664

 
6,843


32,488


17,850

Net interest income
48,093

 
45,625

 
141,312

 
129,900

Provision for portfolio loan losses
2,332

 
2,422

 
6,588

 
7,578

Provision reversal for purchased credit impaired loan losses
(69
)
 

 
(2,064
)
 
(355
)
Net interest income after provision for loan losses
45,830

 
43,203


136,788


122,677

Noninterest income:
 
 
 
 
 
 
 
Service charges on deposit accounts
2,997

 
2,820

 
8,855

 
8,146

Wealth management revenue
2,012

 
2,062

 
6,267

 
5,949

Card services revenue
1,760

 
1,459

 
4,926

 
3,888

Gain on sale of other real estate
13

 

 
13

 
17

Gain on state tax credits, net
192

 
77

 
508

 
332

Gain on sale of investment securities

 
22

 
9

 
22

Miscellaneous income
1,436

 
1,932

 
7,067

 
4,928

Total noninterest income
8,410

 
8,372


27,645


23,282

Noninterest expense:
 
 
 
 
 
 
 
Employee compensation and benefits
16,297

 
15,090

 
49,370

 
46,096

Occupancy
2,394

 
2,434

 
7,142

 
6,628

Data processing
1,634

 
1,389

 
4,634

 
4,828

Professional fees
1,023

 
922

 
2,619

 
2,838

FDIC and other insurance
845

 
882

 
2,682

 
2,356

Loan legal and other real estate expense
322

 
586

 
598

 
1,544

Merger related expenses

 
315

 

 
6,462

Other
7,407

 
5,786

 
21,239

 
16,039

Total noninterest expense
29,922

 
27,404


88,284


86,791

 
 
 
 
 
 
 
 
Income before income tax expense
24,318

 
24,171


76,149


59,168

Income tax expense
1,802

 
7,856

 
10,461

 
18,507

Net income
$
22,516

 
$
16,315


$
65,688


$
40,661

 
 
 
 
 
 
 
 
Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.97

 
$
0.70

 
$
2.84

 
$
1.77

Diluted
0.97

 
0.69

 
2.81

 
1.75

The accompanying notes are an integral part of these 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)
2018
 
2017
 
2018
 
2017
Net income
$
22,516

 
$
16,315

 
$
65,688

 
$
40,661

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 $(1,328) and $(493), and for nine months of $(3,926) and $775, respectively
(4,048
)
 
(805
)
 
(11,968
)
 
1,265

Less: Reclassification adjustment for realized gains on sale of securities available for sale included in net income, net of income tax expense for three months of $0 and $8, and for nine months of $2 and $8, respectively

 
(13
)
 
(7
)
 
(13
)
Total other comprehensive income (loss)
(4,048
)
 
(818
)
 
(11,975
)
 
1,252

Total comprehensive income
$
18,468

 
$
15,497

 
$
53,713

 
$
41,913


The accompanying notes are an integral part of these consolidated financial statements.


3



ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Shareholders’ Equity (Unaudited)
(in thousands, except per share data)
Common Stock
 
Treasury Stock
 
Additional paid in capital
 
Retained earnings
 
Accumulated
other
comprehensive income (loss)
 
Total
shareholders' equity
Balance at December 31, 2017
$
238

 
$
(23,268
)
 
$
350,061

 
$
225,360

 
$
(3,818
)
 
$
548,573

Net income

 

 

 
65,688

 

 
65,688

Other comprehensive loss

 

 

 

 
(11,975
)
 
(11,975
)
Total comprehensive income (loss)

 

 

 
65,688

 
(11,975
)
 
53,713

Cash dividends paid on common shares, $0.34 per share

 

 

 
(7,866
)
 

 
(7,866
)
Repurchase of common shares

 
(6,840
)
 

 

 

 
(6,840
)
Issuance under equity compensation plans, 138,149 shares, net
1

 

 
(3,298
)
 

 

 
(3,297
)
Share-based compensation

 

 
2,554

 

 

 
2,554

Reclassification adjustments for change in accounting policies



 

 
834

 
(834
)
 

Balance at September 30, 2018
$
239

 
$
(30,108
)
 
$
349,317

 
$
284,016

 
$
(16,627
)
 
$
586,837

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

 
$
(6,632
)
 
$
213,078

 
$
182,190

 
$
(1,741
)
 
$
387,098

Net income

 

 

 
40,661

 

 
40,661

Other comprehensive income

 

 

 

 
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., 3,299,865 shares, net
33

 

 
141,696

 

 

 
141,729

Reclassification for the adoption of share-based payment guidance

 

 
(5,229
)
 
5,229

 

 

Balance at September 30, 2017
$
237

 
$
(23,268
)
 
$
349,485

 
$
220,371

 
$
(489
)
 
$
546,336


The accompanying notes are an integral part of these 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)
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
65,688

 
$
40,661

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation
2,622

 
2,426

Provision for loan losses
4,524

 
7,223

Deferred income taxes
2,822

 
1,239

Net amortization of debt securities
1,338

 
2,064

Amortization of intangible assets
1,908

 
1,920

Gain on sale of investment securities
(9
)
 
(22
)
Mortgage loans originated for sale
(30,136
)
 
(115,365
)
Proceeds from mortgage loans sold
32,839

 
118,798

Gain on sale of other real estate
(13
)
 
(17
)
Gain on state tax credits, net
(508
)
 
(332
)
Share-based compensation
2,554

 
2,514

Net accretion of loan discount
(1,253
)
 
(3,796
)
Changes in:
 
 
 
Accrued interest receivable
(5,811
)
 
(302
)
Accrued interest payable
703

 
249

Other assets
(16,309
)
 
755

Other liabilities
(1,093
)
 
(44,398
)
Net cash provided by operating activities
59,866

 
13,617

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

 
4,456

Net increase in loans
(172,449
)
 
(201,715
)
Proceeds from the sale of securities, available for sale
1,451

 
144,076

Proceeds from the paydown or maturity of securities, available for sale
61,881

 
126,073

Proceeds from the paydown or maturity of securities, held to maturity
4,988

 
4,145

Proceeds from the redemption of other investments
30,593

 
29,159

Proceeds from the sale of state tax credits held for sale
3,056

 
4,391

Proceeds from the sale of other real estate
467

 
2,513

Payments for the purchase/origination of:
 
 
 
Available for sale debt securities
(108,121
)
 
(263,453
)
Other investments
(44,597
)
 
(45,224
)
State tax credits held for sale
(4,704
)
 
(145
)
Fixed assets, net
(2,369
)
 
(1,864
)
Net cash used in investing activities
(229,804
)
 
(197,588
)
Cash flows from financing activities:
 
 
 
Net (decrease) increase in noninterest-bearing deposit accounts
(61,781
)
 
20,684

Net increase in interest-bearing deposit accounts
115,843

 
39,998

Proceeds from Federal Home Loan Bank advances
1,142,500

 
1,394,181

Repayments of Federal Home Loan Bank advances
(914,000
)
 
(1,145,681
)
Proceeds from notes payable

 
10,000

Net decrease in other borrowings
(91,879
)
 
(123,987
)
Cash dividends paid on common stock
(7,866
)
 
(7,709
)
Payments for the repurchase of common stock
(6,840
)
 
(16,636
)
Payments for the issuance of equity instruments, net
(3,297
)
 
(2,573
)
Net cash provided by financing activities
172,680

 
168,277

Net increase (decrease) in cash and cash equivalents
2,742

 
(15,694
)
Cash and cash equivalents, beginning of period
153,323

 
198,802

Cash and cash equivalents, end of period
$
156,065

 
$
183,108

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
31,785

 
$
16,948

Income taxes
8,492

 
9,382

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

 
$
289

Common shares issued in connection with JCB acquisition

 
141,729


The accompanying notes are an integral part of these 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, 2018 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2018. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission.

Basis of Financial Statement Presentation

The accompanying unaudited condensed consolidated financial statements of the Company and its subsidiaries have been prepared in accordance with the accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The condensed consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All intercompany accounts and transactions have been eliminated.

During the first quarter of 2018, the Company adopted Accounting Standards Update ("ASU") 2016-01, "Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." ASU 2016-01 requires equity investments to be measured at fair value through earnings, and eliminates the available-for-sale classification for equity securities with readily determinable fair values. The guidance also provides an alternative to measure equity securities without readily determinable fair values at cost less impairment (if any), plus or minus observable price changes from an identical or similar investment of the same issuer (the “measurement alternative”). The Company elected the measurement alternative for its qualifying equity securities. The adoption of this update resulted in an insignificant increase to retained earnings which was reclassified from accumulated other comprehensive income.

In addition, the Company early adopted ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities" during the first quarter of 2018. The objective of ASU 2017-12 is to improve the financial reporting of hedging relationships by better aligning an entity's risk management activity with the economic objectives in undertaking those activities. The adoption of this update did not have a material effect on the Company's consolidated financial statements.

The Company also early adopted ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" during the first quarter of 2018. The ASU allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017, which among other things, reduced the maximum federal corporate tax rate from 35% to 21%. The adoption of this update resulted in an increase to retained earnings of $0.8 million which was reclassified from accumulated other comprehensive income.

In the opinion of management, the consolidated financial statements contain all adjustments (consisting of normal recurring accruals) considered necessary for the fair presentation of the statements of financial position, results of operations, and cash flow for the interim periods.

6




Revenue

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

Income Taxes

The SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Cuts and Jobs Act of 2017 (“Tax Act”). SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act. The Company has recorded amounts for the effects of the Tax Act using reasonable estimates based on currently available information and its interpretations thereof. This accounting may change due to, among other things, changes in interpretations the Company has made and the issuance of new tax or accounting guidance.

NOTE 2 - EARNINGS PER SHARE

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


7



The following table presents a summary of per common share data and amounts for the periods indicated.
 
Three months ended
September 30,
 
Nine months ended
September 30,
(in thousands, except per share data)
2018
 
2017
 
2018
 
2017
Net income as reported
$
22,516

 
$
16,315

 
$
65,688

 
$
40,661

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
23,148

 
23,324

 
23,129

 
22,914

Additional dilutive common stock equivalents
181

 
250

 
211

 
295

Weighted average diluted common shares outstanding
23,329

 
23,574

 
23,340

 
23,209

 
 
 
 
 
 
 
 
Basic earnings per common share:
$
0.97

 
$
0.70

 
$
2.84

 
$
1.77

Diluted earnings per common share:
$
0.97

 
$
0.69

 
$
2.81

 
$
1.75


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

8



NOTE 3 - INVESTMENTS

The following table presents the amortized cost, gross unrealized gains and losses and fair value of securities available for sale and held to maturity:
 
 
September 30, 2018
(in thousands)
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
Available for sale securities:
 
 
 
 
 
 
 
Obligations of U.S. Government-sponsored enterprises
$
99,914

 
$

 
$
(2,233
)
 
$
97,681

Obligations of states and political subdivisions
30,563

 
238

 
(268
)
 
30,533

Agency mortgage-backed securities
551,552

 
180

 
(19,385
)
 
532,347

U.S. Treasury bills
9,960

 

 
(193
)
 
9,767

          Total securities available for sale
$
691,989

 
$
418

 
$
(22,079
)
 
$
670,328

Held to maturity securities:
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
12,521

 
$
6

 
$
(324
)
 
$
12,203

Agency mortgage-backed securities
54,610

 

 
(2,397
)
 
52,213

          Total securities held to maturity
$
67,131

 
$
6


$
(2,721
)

$
64,416


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

 
$
6

 
$
(660
)
 
$
99,224

    Obligations of states and political subdivisions
34,181

 
674

 
(213
)
 
34,642

    Agency mortgage-backed securities
513,082

 
727

 
(6,293
)
 
507,516

          Total securities available for sale
$
647,141

 
$
1,407

 
$
(7,166
)
 
$
641,382

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

 
$
69

 
$
(46
)
 
$
14,054

   Agency mortgage-backed securities
59,718

 
16

 
(330
)
 
59,404

          Total securities held to maturity
$
73,749

 
$
85

 
$
(376
)
 
$
73,458


At September 30, 2018, and December 31, 2017, there were no holdings of securities of any one issuer in an amount greater than 10% of shareholders’ equity, other than U.S. Government agencies and sponsored enterprises. The agency mortgage-backed securities are all issued by U.S. Government agencies and sponsored enterprises. Securities having a fair value of $365.3 million and $500.0 million at September 30, 2018, and December 31, 2017, respectively, were pledged as collateral to secure deposits of public institutions and for other purposes as required by law or contract provisions.


9



The amortized cost and estimated fair value of debt securities at September 30, 2018, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The weighted average life of the mortgage-backed securities is approximately 5 years.
 
 
Available for sale
 
Held to maturity
(in thousands)
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
$
12,193

 
$
12,107

 
$

 
$

Due after one year through five years
110,517

 
108,231

 
868

 
856

Due after five years through ten years
12,688

 
12,678

 
11,294

 
10,995

Due after ten years
5,039

 
4,965

 
359

 
352

Agency mortgage-backed securities
551,552

 
532,347

 
54,610

 
52,213

 
$
691,989

 
$
670,328


$
67,131


$
64,416



The following table represents a summary of investment securities that had an unrealized loss:
 
 
September 30, 2018
Less than 12 months
 
12 months or more
 
Total
(in thousands)
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
Obligations of U.S. Government-sponsored enterprises
$
58,592

 
$
1,353

 
$
39,089

 
$
880

 
$
97,681

 
$
2,233

Obligations of states and political subdivisions
24,152

 
468

 
3,296

 
124

 
27,448

 
592

Agency mortgage-backed securities
297,577

 
8,216

 
270,949

 
13,566

 
568,526

 
21,782

U.S. Treasury bills
9,767

 
193

 

 

 
9,767

 
193

 
$
390,088

 
$
10,230


$
313,334


$
14,570


$
703,422


$
24,800

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
Less than 12 months
 
12 months or more
 
Total
(in thousands)
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
Obligations of U.S. Government-sponsored enterprises
$
89,309

 
$
660

 
$

 
$

 
$
89,309

 
$
660

Obligations of states and political subdivisions
13,951

 
259

 

 

 
13,951

 
259

Agency mortgage-backed securities
469,655

 
6,034

 
12,229

 
589

 
481,884

 
6,623

 
$
572,915

 
$
6,953


$
12,229


$
589


$
585,144


$
7,542



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

10



NOTE 4 - LOANS

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

(in thousands)

September 30, 2018
 
December 31, 2017
Loans accounted for at amortized cost
$
4,218,341

 
$
4,022,896

Loans accounted for as PCI
49,089

 
74,154

Total loans
$
4,267,430

 
$
4,097,050


The following tables refer to loans accounted for at amortized cost.

Below is a summary of loans by category at September 30, 2018 and December 31, 2017:
 
(in thousands)
September 30, 2018
 
December 31, 2017
Commercial and industrial
$
2,032,929

 
$
1,918,720

Real estate:
 
 
 
Commercial - investor owned
826,447

 
769,275

Commercial - owner occupied
589,045

 
554,589

Construction and land development
326,858

 
303,091

Residential
308,385

 
341,312

Total real estate loans
2,050,735

 
1,968,267

Consumer and other
136,025

 
137,234

Loans, before unearned loan fees
4,219,689

 
4,024,221

Unearned loan fees, net
(1,348
)
 
(1,325
)
Loans, including unearned loan fees
$
4,218,341

 
$
4,022,896



11



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, 2018, and at December 31, 2017, is as follows:
(in thousands)
Commercial and industrial
 
CRE - investor owned
 
CRE -
owner occupied
 
Construction and land development
 
Residential real estate
 
Consumer and other
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
$
26,406

 
$
3,890

 
$
3,308

 
$
1,487

 
$
2,237

 
$
838

 
$
38,166

Provision (provision reversal) for loan losses
780

 
648

 
190

 
35

 
259

 
(41
)
 
1,871

Losses charged off
(732
)
 

 

 

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

 
8

 
4

 
206

 
73

 
14

 
1,261

Balance at March 31, 2018
$
27,410

 
$
4,546


$
3,502


$
1,728


$
2,315


$
762


$
40,263

Provision (provision reversal) for loan losses
2,852

 
5

 
340

 
(206
)
 
(573
)
 
(33
)
 
2,385

Losses charged off
(956
)
 

 

 

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

 
10

 
3

 
168

 
59

 
28

 
386

Balance at June 30, 2018
$
29,424

 
$
4,561


$
3,845


$
1,690


$
1,763


$
724


$
42,007

Provision (provision reversal) for loan losses
2,569

 
3

 
(197
)
 
154

 
(187
)
 
(10
)
 
2,332

Losses charged off
(2,405
)
 

 
(22
)
 

 
(122
)
 
(46
)
 
(2,595
)
Recoveries
2

 
8

 
4

 
21

 
88

 
25

 
148

Balance at September 30, 2018
$
29,590

 
$
4,572


$
3,630


$
1,865


$
1,542


$
693


$
41,892

(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, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses - Ending balance:
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
4,128

 
$

 
$
177

 
$

 
$
9

 
$

 
$
4,314

Collectively evaluated for impairment
25,462

 
4,572

 
3,453

 
1,865

 
1,533

 
693

 
37,578

Total
$
29,590

 
$
4,572


$
3,630


$
1,865


$
1,542


$
693


$
41,892

Loans - Ending balance:
 
 
 
 
 
 
 

 
 
 
 
 
 
Individually evaluated for impairment
$
12,197

 
$
770

 
$
2,655

 
$

 
$
2,477

 
$
312

 
$
18,411

Collectively evaluated for impairment
2,020,732

 
825,677

 
586,390

 
326,858

 
305,908

 
134,365

 
4,199,930

Total
$
2,032,929

 
$
826,447


$
589,045


$
326,858


$
308,385


$
134,677


$
4,218,341

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

 
$

 
$
71

 
$

 
$

 
$

 
$
2,579

Collectively evaluated for impairment
23,898

 
3,890

 
3,237

 
1,487

 
2,237

 
838

 
35,587

Total
$
26,406

 
$
3,890


$
3,308


$
1,487


$
2,237


$
838


$
38,166

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

 
$
422

 
$
1,975

 
$
136

 
$
1,602

 
$
375

 
$
17,175

Collectively evaluated for impairment
1,906,055

 
768,853

 
552,614

 
302,955

 
339,710

 
135,534

 
4,005,721

Total
$
1,918,720

 
$
769,275


$
554,589


$
303,091


$
341,312


$
135,909


$
4,022,896



12



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

 
September 30, 2018
(in thousands)
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance
 
Recorded
Investment
With
Allowance
 
Total
Recorded Investment
 
Related Allowance
 
Average
Recorded Investment
Commercial and industrial
$
20,938

 
$
3,266

 
$
8,931

 
$
12,197

 
$
4,128

 
$
10,414

Real estate:
 
 
 
 
 
 
 
 
 
 
 
    Commercial - investor owned
1,039

 
770

 

 
770

 

 
657

    Commercial - owner occupied
1,328

 
826

 
462

 
1,288

 
177

 
1,074

    Construction and land development

 

 

 

 

 

    Residential
2,600

 
2,008

 
469

 
2,477

 
9

 
2,410

Consumer and other
329

 
312

 

 
312

 

 
334

Total
$
26,234

 
$
7,182


$
9,862


$
17,044


$
4,314


$
14,889


 
December 31, 2017
(in thousands)
Unpaid
Contractual
Principal Balance
 
Recorded
Investment
With No Allowance
 
Recorded
Investment
With
Allowance
 
Total
Recorded Investment
 
Related Allowance
 
Average
Recorded Investment
Commercial and industrial
$
20,750

 
$
2,321

 
$
10,344

 
$
12,665

 
$
2,508

 
$
16,270

Real estate:
 
 
 
 
 
 
 
 
 
 
 
    Commercial - investor owned
560

 
422

 

 
422

 

 
521

    Commercial - owner occupied
487

 

 
487

 
487

 
71

 
490

    Construction and land development
441

 
136

 

 
136

 

 
331

    Residential
1,730

 
1,602

 

 
1,602

 

 
1,735

Consumer and other
375

 
375

 

 
375

 

 
375

Total
$
24,343

 
$
4,856


$
10,831


$
15,687


$
2,579


$
19,722


 
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Total interest income that would have been recognized under original terms
$
614

 
$
306

 
$
1,615

 
$
961

Total cash received and recognized as interest income on non-accrual loans
68

 
117

 
157

 
156

Total interest income recognized on accruing, impaired loans
110

 
8

 
133

 
55



13



The recorded investment in nonperforming loans by category at September 30, 2018 and December 31, 2017, is as follows: 
 
September 30, 2018
(in thousands)
Non-accrual
 
Restructured, not on non-accrual
 
Loans over 90 days past due and still accruing interest
 
Total
Commercial and industrial
$
10,088

 
$
820

 
$
1,289

 
$
12,197

Real estate:
 
 
 
 
 
 
 
    Commercial - investor owned
770

 

 

 
770

    Commercial - owner occupied
1,288

 

 

 
1,288

    Construction and land development

 

 

 

    Residential
2,477

 

 

 
2,477

Consumer and other
312

 

 

 
312

       Total
$
14,935

 
$
820


$
1,289


$
17,044


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

 
$
719

 
$
12,665

Real estate:
 
 
 
 
 
    Commercial - investor owned
422

 

 
422

    Commercial - owner occupied
487

 

 
487

    Construction and land development
136

 

 
136

    Residential
1,602

 

 
1,602

Consumer and other
375

 

 
375

       Total
$
14,968

 
$
719

 
$
15,687


There were no loans over 90 days past due and still accruing interest at December 31, 2017.


14



The recorded investment by category for the portfolio loans that have been restructured during the three and nine months ended September 30, 2018 and 2017, is as follows:

 
Three months ended September 30, 2018
 
Three months ended September 30, 2017
(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

 
$
187

 
$
187

 

 
$

 
$

Total
1

 
$
187

 
$
187

 

 
$

 
$



 
Nine months ended September 30, 2018
 
Nine months ended September 30, 2017
(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

 
$
187

 
$
187

 
1

 
$
676

 
$
676

Total
1

 
$
187

 
$
187

 
1

 
$
676

 
$
676



As of September 30, 2018, the Company had $2.6 million in specific reserves allocated to $8.0 million of loans that have been restructured. During the three and nine months ended September 30, 2018 and 2017, there were no portfolio loans that subsequently defaulted.

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

 
September 30, 2018
(in thousands)
30-89 Days
 Past Due
 
90 or More
Days
Past Due
 
Total
Past Due
 
Current
 
Total
Commercial and industrial
$
11,213

 
$
6,020

 
$
17,233

 
$
2,015,696

 
$
2,032,929

Real estate:
 
 
 
 
 
 
 
 
 
Commercial - investor owned
1,362

 
129

 
1,491

 
824,956

 
826,447

Commercial - owner occupied
258

 
808

 
1,066

 
587,979

 
589,045

Construction and land development

 

 

 
326,858

 
326,858

Residential
864

 
1,156

 
2,020

 
306,365

 
308,385

Consumer and other

 

 

 
134,677

 
134,677

Total
$
13,697

 
$
8,113


$
21,810


$
4,196,531


$
4,218,341



15



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

 
$
1,770

 
$
9,652

 
$
1,909,068

 
$
1,918,720

Real estate:
 
 
 
 
 
 
 
 
 
Commercial - investor owned
934

 

 
934

 
768,341

 
769,275

Commercial - owner occupied

 

 

 
554,589

 
554,589

Construction and land development
76

 

 
76

 
303,015

 
303,091

Residential
1,529

 
945

 
2,474

 
338,838

 
341,312

Consumer and other
407

 

 
407

 
135,502

 
135,909

Total
$
10,828

 
$
2,715


$
13,543


$
4,009,353


$
4,022,896


The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as current financial information, payment experience, credit documentation, and current economic factors among other factors. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:
Grades 1, 2, and 3 Includes loans to borrowers with a continuous record of strong earnings, sound balance sheet condition and capitalization, ample liquidity with solid cash flow, and whose management team has experience and depth within their industry.
Grade 4 Includes loans to borrowers with positive trends in profitability, satisfactory capitalization and balance sheet condition, and sufficient liquidity and cash flow.
Grade 5 Includes loans to borrowers that may display fluctuating trends in sales, profitability, capitalization, liquidity, and cash flow.
Grade 6 Includes loans to borrowers where an adverse change or perceived weakness has occurred, but may be correctable in the near future. Alternatively, this rating category may also include circumstances where the borrower is starting to reverse a negative trend or condition, or has recently been upgraded from a 7, 8, or 9 rating.
Grade 7 – Watch credits are borrowers that have experienced financial setback of a nature that is not determined to be severe or influence ‘ongoing concern’ expectations. Although possible, no loss is anticipated, due to strong collateral and/or guarantor support.
Grade 8Substandard credits 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.


16



The recorded investment by risk category of the loans by portfolio class and category at September 30, 2018, which is based upon the most recent analysis performed, and December 31, 2017, is as follows:

 
September 30, 2018
(in thousands)
Pass (1-6)
 
Watch (7)
 
Classified (8 & 9)
 
Total
Commercial and industrial
$
1,835,230

 
$
142,768

 
$
54,931

 
$
2,032,929

Real estate:
 
 
 
 
 
 
 
Commercial - investor owned
798,116

 
22,275

 
6,056

 
826,447

Commercial - owner occupied
540,961

 
43,399

 
4,685

 
589,045

Construction and land development
315,022

 
11,775

 
61

 
326,858

Residential
298,076

 
3,058

 
7,251

 
308,385

Consumer and other
134,359

 
7

 
311

 
134,677

Total
$
3,921,764

 
$
223,282

 
$
73,295

 
$
4,218,341


 
December 31, 2017
(in thousands)
Pass (1-6)
 
Watch (7)
 
Classified (8 & 9)
 
Total
Commercial and industrial
$
1,769,102

 
$
94,002

 
$
55,616

 
$
1,918,720

Real estate:
 
 
 
 
 
 
 
Commercial - investor owned
754,010

 
10,840

 
4,425

 
769,275

Commercial - owner occupied
514,616

 
34,440

 
5,533

 
554,589

Construction and land development
292,766

 
9,983

 
342

 
303,091

Residential
329,742

 
3,648

 
7,922

 
341,312

Consumer and other
134,704

 
10

 
1,195

 
135,909

Total
$
3,794,940

 
$
152,923


$
75,033

 
$
4,022,896



17



Below is a summary of PCI loans by category at September 30, 2018 and December 31, 2017:
 
 
September 30, 2018
 
December 31, 2017
(in thousands)
Weighted-
Average
Risk Rating1
Recorded
Investment
PCI Loans
 
Weighted-
Average
Risk Rating1
Recorded
Investment
PCI Loans
Commercial and industrial
6.39
$
2,923

 
6.38
$
3,212

Real estate:
 
 
 
 
 
Commercial - investor owned
7.23
25,172

 
7.36
42,887

Commercial - owner occupied
7.45
9,520

 
6.48
11,332

Construction and land development
6.01
5,168

 
5.99
5,883

Residential
6.35
6,291

 
5.99
10,781

Consumer and other
7.08
15

 
2.84
59

Total
 
$
49,089

 
 
$
74,154

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

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

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

 
$

 
$

 
$
2,923

 
$
2,923

Real estate:
 
 
 
 
 
 
 
 
 
Commercial - investor owned
627

 
1,190

 
1,817

 
23,355

 
25,172

Commercial - owner occupied
6,230

 
744

 
6,974

 
2,546

 
9,520

Construction and land development
146

 

 
146

 
5,022

 
5,168

Residential
33

 
46

 
79

 
6,212

 
6,291

Consumer and other

 

 

 
15

 
15

Total
$
7,036

 
$
1,980


$
9,016


$
40,073


$
49,089


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

 
$

 
$

 
$
3,212

 
$
3,212

Real estate:
 
 
 
 
 
 
 
 
 
Commercial - investor owned

 
3,034

 
3,034

 
39,853

 
42,887

Commercial - owner occupied

 
673

 
673

 
10,659

 
11,332

Construction and land development

 

 

 
5,883

 
5,883

Residential
328

 
255

 
583

 
10,198

 
10,781

Consumer and other

 

 

 
59

 
59

Total
$
328

 
$
3,962


$
4,290


$
69,864


$
74,154



18



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

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

 
$
29,005

 
$
13,964

 
$
69,741

Principal reductions and interest payments
(38,165
)
 

 

 
(38,165
)
Accretion of loan discount

 

 
(5,118
)
 
5,118

Changes in contractual and expected cash flows due to remeasurement
4,341

 
(8,939
)
 
3,179

 
10,101

Balance September 30, 2018
$
78,886

 
$
20,066


$
12,025


$
46,795

 
 
 
 
 
 
 
 
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


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 $68.6 million and $94.9 million as of September 30, 2018, and December 31, 2017, respectively.


NOTE 5 - COMMITMENTS AND CONTINGENCIES

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

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

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

The contractual amounts of off-balance-sheet financial instruments as of September 30, 2018, and December 31, 2017, are as follows:
 
(in thousands)
September 30, 2018
 
December 31, 2017
Commitments to extend credit
$
1,315,284

 
$
1,298,423

Letters of credit
49,633

 
73,790


Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments usually have fixed expiration dates or other termination clauses, may have

19



significant usage restrictions, and may require payment of a fee. Of the total commitments to extend credit at September 30, 2018, and December 31, 2017, approximately $91.8 million and $112.0 million, respectively, represent fixed rate loan commitments. Since certain of the commitments may expire without being drawn upon or may be revoked, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, premises and equipment, and real estate. Other liabilities includes $0.4 million for estimated losses attributable to the unadvanced commitments at September 30, 2018, and December 31, 2017.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance or payment of a customer to a third party. These standby letters of credit are issued to support contractual obligations of the Company’s customers. The credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers. As of September 30, 2018, the approximate remaining terms of standby letters of credit range from 1 month to 3 years and 3 months.

Contingencies

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

NOTE 6 - DERIVATIVE FINANCIAL INSTRUMENTS

The Company is a party to various derivative financial instruments 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 swap agreements and option contracts and foreign exchange forward contracts. The Company does not enter into derivative financial instruments for trading purposes.

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

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

 
 
Asset Derivatives
(Other Assets)
 
Liability Derivatives
(Other Liabilities)
 
Notional Amount
 
Fair Value
 
Fair Value
(in thousands)
September 30,
2018
 
December 31,
2017
 
September 30,
2018
 
December 31,
2017
 
September 30,
2018
 
December 31,
2017
Non-designated hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap contracts
$
433,664

 
$
394,852

 
$
4,772

 
$
2,061

 
$
4,772

 
$
2,061

Foreign exchange forward contracts
123

 
1,528

 
123

 
1,528

 
123

 
1,528


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



20




NOTE 7 - FAIR VALUE MEASUREMENTS

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

The following table summarizes financial instruments measured at fair value on a recurring basis as of September 30, 2018 and December 31, 2017, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
 
 
September 30, 2018
(in thousands)
Quoted Prices in
Active Markets
for Identical Assets
(Level 1)
 
Significant
Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Fair
Value
Assets
 
 
 
 
 
 
 
Securities available for sale
 
 
 
 
 
 
 
Obligations of U.S. Government-sponsored enterprises
$

 
$
97,681

 
$

 
$
97,681

Obligations of states and political subdivisions

 
30,533

 

 
30,533

Residential mortgage-backed securities

 
532,347

 

 
532,347

U.S. Treasury bills

 
9,767

 

 
9,767

Total securities available for sale
$

 
$
670,328


$


$
670,328

Other investments
144

 

 

 
144

State tax credits held for sale

 

 
171

 
171

Derivative financial instruments

 
4,895

 

 
4,895

Total assets
$
144

 
$
675,223


$
171


$
675,538

 
 
 
 
 
 
 
 
Liabilities
 

 
 

 
 

 
 

Derivative financial instruments
$

 
$
4,895

 
$

 
$
4,895

Total liabilities
$

 
$
4,895


$


$
4,895


 
December 31, 2017
(in thousands)
Quoted Prices in
Active Markets
for Identical Assets
(Level 1)
 
Significant
Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Fair
Value
Assets
 
 
 
 
 
 
 
Securities available for sale
 
 
 
 
 
 
 
Obligations of U.S. Government-sponsored enterprises
$

 
$
99,224

 
$

 
$
99,224

Obligations of states and political subdivisions

 
34,642

 

 
34,642

Residential mortgage-backed securities

 
507,516

 

 
507,516

Total securities available for sale
$

 
$
641,382


$


$
641,382

State tax credits held for sale

 

 
400

 
400

Derivative financial instruments

 
3,589

 

 
3,589

Total assets
$

 
$
644,971


$
400


$
645,371

 
 
 
 
 
 
 
 
Liabilities
 

 
 
 
 

 
 
Derivative financial instruments
$

 
$
3,589

 
$

 
$
3,589

Total liabilities
$

 
$
3,589


$


$
3,589



21



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.
Other investments. At September 30, 2018, of the $37.9 million of other investments on the condensed consolidated balance sheet, approximately $0.2 million were carried at fair value. The remaining $37.7 million of other investments were accounted for at cost. Other investments reported at fair value represent equity securities with quoted market prices (Level 1).
State tax credits held for sale. At September 30, 2018, of the $45.6 million of state tax credits held for sale on the condensed consolidated balance sheet, approximately $0.1 million were carried at fair value. The remaining $45.5 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 fair value.
The remaining state tax credits carried at fair value are expected to be sold within the next several quarters. The state tax credit assets are reported as Level 3 assets.
Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs. The Company obtains counterparty quotations to value its interest rate swaps. In addition, the Company validates the counterparty quotations with third party valuation sources. Derivatives with negative fair values are included in Other liabilities in the consolidated balance sheets. Derivatives with positive fair value are included in Other assets in the consolidated balance sheets.
There were no transfers between Level 1 and Level 2 during the three and nine months ended September 30, 2018 and 2017.

Level 3 financial instruments

The following table presents the changes in Level 3 financial instruments measured at fair value on a recurring basis as of September 30, 2018 and 2017.

 
Securities available for sale, at fair value
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Beginning balance
$

 
$

 
$

 
$
3,089

   Total gains:
 
 
 
 
 
 
 
Included in other comprehensive income

 

 

 
4

   Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
Purchases

 

 

 

Transfer in and/or out of Level 3

 

 

 
(3,093
)
Ending balance
$

 
$

 
$

 
$

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

 
$

 
$

 
$




22



 
State tax credits held for sale
Three months ended September 30,
 
Nine months ended September 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Beginning balance
$
299

 
$
1,274

 
$
400

 
$
3,585

   Total gains:
 
 
 
 
 
 
 
Included in earnings
7

 

 
13

 
49

   Purchases, sales, issuances and settlements:
 
 
 
 
 
 
 
Sales
(135
)
 

 
(242
)
 
(2,360
)
Ending balance
$
171

 
$
1,274

 
$
171

 
$
1,274

 
 
 
 
 
 
 
 
Change in unrealized gains (losses) relating to assets still held at the reporting date
$
(34
)
 
$

 
$
(60
)
 
$
(655
)

From time to time, the Company measures certain assets at fair value on a nonrecurring basis. These include assets 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, 2018.
 
 
(1)
 
(1)
 
(1)
 
(1)
 
 
 
 
(in thousands)
Total Fair Value
 
Quoted Prices in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total losses for the three
months ended September 30, 2018
 
Total losses for the nine
months ended September 30, 2018
Impaired loans
$
485

 
$

 
$

 
$
485

 
$
248

 
$
457

Other real estate

 

 

 

 

 

Total
$
485

 
$


$


$
485


$
248

 
$
457


(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, 2018, impaired loans measured on a non-recurring basis had a principal balance of $0.7 million, with a valuation allowance of $0.2 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.


23



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, 2018 and December 31, 2017. Fair values that are not estimable are listed at the carrying value.

 
September 30, 2018
 
December 31, 2017
(in thousands)
Carrying Amount
 
Estimated fair value
 
Carrying Amount
 
Estimated fair value
Balance sheet assets
 
 
 
 
 
 
 
Cash and due from banks
$
78,119

 
$
78,119

 
$
91,084

 
$
91,084

Federal funds sold
1,571

 
1,571

 
1,223

 
1,223

Interest-bearing deposits
79,780

 
79,780

 
63,661

 
63,661

Securities available for sale
670,328

 
670,328

 
641,382

 
641,382

Securities held to maturity
67,131

 
64,416

 
73,749

 
73,458

Other investments, at cost
37,885

 
37,885

 
26,661

 
26,661

Loans held for sale
738

 
738

 
3,155

 
3,155

Derivative financial instruments
4,895

 
4,895

 
3,589

 
3,589

Portfolio loans, net
4,223,244

 
4,254,581

 
4,054,473

 
4,096,741

State tax credits, held for sale
45,625

 
48,622

 
43,468

 
44,271

Accrued interest receivable
19,879

 
19,879

 
14,069

 
14,069

 
 
 
 
 
 
 
 
Balance sheet liabilities
 
 
 
 
 
 
 
Deposits
4,210,476

 
4,203,913

 
4,156,414

 
4,153,323

Subordinated debentures and notes
118,144

 
105,611

 
118,105

 
105,031

Federal Home Loan Bank advances
401,000

 
400,977

 
172,743

 
172,893

Other borrowings
161,795

 
161,676

 
253,674

 
253,530

Derivative financial instruments
4,895

 
4,895

 
3,589

 
3,589

Accrued interest payable
2,433

 
2,433

 
1,730

 
1,730


For information regarding the methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practical to estimate such value, refer to Note 18Fair Value Measurements in the Company's Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission.


24



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, 2018, and December 31, 2017.
 
 
Estimated Fair Value Measurement at Reporting Date Using
 
Balance at September 30, 2018
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Financial Assets:
 
 
 
 
 
 
 
Securities held to maturity
$

 
$
64,416

 
$

 
$
64,416

Portfolio loans, net

 

 
4,254,581

 
4,254,581

State tax credits, held for sale

 

 
48,451

 
48,451

Financial Liabilities:
 
 
 
 
 
 
 
Deposits
3,536,239

 

 
667,674

 
4,203,913

Subordinated debentures and notes

 
105,611

 

 
105,611

Federal Home Loan Bank advances

 
400,977

 

 
400,977

Other borrowings

 
161,676

 

 
161,676

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

 
$
73,458

 
$

 
$
73,458

Portfolio loans, net

 

 
4,096,741

 
4,096,741

State tax credits, held for sale

 

 
43,871

 
43,871

Financial Liabilities:
 
 
 
 
 
 
 
Deposits
3,577,641

 

 
575,682

 
4,153,323

Subordinated debentures and notes

 
105,031

 

 
105,031

Federal Home Loan Bank advances

 
172,893

 

 
172,893

Other borrowings

 
253,530

 

 
253,530



NOTE 8 - NEW AUTHORITATIVE ACCOUNTING GUIDANCE

Financial Accounting Standards Board (the "FASB") ASU 2018-15 "Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement" In August 2018, the FASB issued ASU 2018-15, which amends ASC 350-402 to address a customer’s accounting for implementation costs incurred in a cloud computing arrangement (CCA) that is a service contract. ASU 2018-15 aligns the accounting for costs incurred to implement a CCA that is a service arrangement with the guidance on capitalizing costs associated with developing or obtaining internal-use software. Specifically, the ASU amends ASC 350 to include in its scope implementation costs of a CCA that is a service contract and clarifies that a customer should apply ASC 350-40 to determine which implementation costs should be capitalized in a CCA that is considered a service contract. The amendments are effective for public business entities for annual periods beginning after December 15, 2019, including interim periods within those annual periods, with early adoption being permitted. The Company is currently evaluating the new guidance and has not yet determined the impact this standard may have on its consolidated balance sheets.

FASB ASU 2018-13 "Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement" In August 2018, the FASB issued ASU 2018-13, which changes the fair value measurement disclosure requirements of ASC 820. The amendments in this ASU are the result of a broader disclosure project called FASB Concepts Statement, Conceptual Framework for Financial Reporting — Chapter 8: Notes to Financial Statements, which the Board finalized on August 28, 2018. The Board used the guidance in the Concepts Statement, including consideration of costs and benefits, to improve the effectiveness of

25



ASC 820’s disclosure requirements. The Company is currently evaluating the new guidance and has not yet determined the impact this standard may have on its consolidated balance sheets.

FASB ASU 2018-11 "Leases (Topic 842): Targeted Improvements" In July 2018, the FASB issued ASU 2018-11 to provide entities with relief from the costs of implementing certain aspects of the new leasing standard, ASU 2016-02 (codified as ASC 842). Specifically, under the amendments in ASU 2018-11 (1)entities may elect not to recast the comparative periods presented when transitioning to ASC 842 (2) lessors may elect not to separate lease and nonlease components when certain conditions are met. The Company intends to utilize the optional transition method and apply the new leases standard at the adoption date of January 1, 2019. The Company is evaluating the impact of separating lease and nonlease components on its 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 permitted. The Company has evaluated the new guidance and does not expect it to have a material impact on the Company's consolidated financial statements. At September 30, 2018, the book value of callable bonds purchased at a premium totaled $22.0 million, and the amount of unamortized premium remaining on these securities was $0.7 million.

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

FASB ASU 2016-02 "Leases (Topic 842)" In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)" which requires organizations that lease assets ("lessees") to recognize the assets and liabilities for the rights and obligations created by leases with terms of more than 12 months. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee remains dependent on its classification as a finance or operating lease. The criteria for determining whether a lease is a finance or operating lease has not been significantly changed by this ASU. The ASU also requires additional disclosure of the amount, timing, and uncertainty of cash flows arising from leases, including qualitative and quantitative requirements. The guidance becomes effective for periods beginning after December 15, 2018, including interim periods therein. Early adoption will be permitted. The Company has formed a lease implementation team that includes members of accounting, facilities and operations to review lease contracts and the requirements of ASU 2016-02. The Company is currently evaluating the impact of this amendment on its financial statements; however, it does not expect the adoption of the new standard to have a material impact on its results of operations or balance sheet as a result of the recognition of right-to-use assets and lease liabilities related to operating leases.








26



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

Forward Looking Statements
Some of the information in this Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.. Forward-looking statements typically are identified with use of terms such as “may,” “might,” “will,” “would,” “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” under Part 1, Item 1A of our 2017 Annual Report on 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 2018 compared to the financial condition as of December 31, 2017. In addition, this discussion summarizes the significant factors affecting the results of operations, liquidity and cash flows of the Company for the three and nine months ended September 30, 2018, compared to the same periods in 2017. This discussion should be read in conjunction with the accompanying condensed consolidated financial statements included in this report and our Annual Report on Form 10-K for the year ended December 31, 2017.


 

27



Executive Summary

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

(in thousands, except per share data)
For the Three Months ended/At
 
For the Nine Months ended
September 30,
2018
 
June 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
EARNINGS
 
 
 
 
 
 
 
 
 
Total interest income
$
60,757

 
$
57,879

 
$
52,468

 
$
173,800

 
$
147,750

Total interest expense
12,664

 
10,831

 
6,843

 
32,488

 
17,850

Net interest income
48,093

 
47,048

 
45,625

 
141,312

 
129,900

Provision for portfolio loans
2,332

 
2,385

 
2,422

 
6,588

 
7,578

Provision reversal for PCI loans
(69
)
 
(1,995
)
 

 
(2,064
)
 
(355
)
Net interest income after provision for loan losses
45,830

 
46,658

 
43,203

 
136,788

 
122,677

Total noninterest income
8,410

 
9,693

 
8,372

 
27,645

 
23,282

Total noninterest expense
29,922

 
29,219

 
27,404

 
88,284

 
86,791

Income before income tax expense
24,318

 
27,132


24,171

 
76,149

 
59,168

Income tax expense
1,802

 
4,881

 
7,856

 
10,461

 
18,507

Net income
$
22,516

 
$
22,251

 
$
16,315

 
$
65,688

 
$
40,661

 
 
 
 
 
 
 
 
 
 
Basic earnings per share
$
0.97

 
$
0.96

 
$
0.70

 
$
2.84

 
$
1.77

Diluted earnings per share
0.97

 
0.95

 
0.69

 
2.81

 
1.75

 
 
 
 
 
 
 
 
 
 
Return on average assets
1.63
%
 
1.65
%
 
1.27
%
 
1.62
%
 
1.11
%
Return on average common equity
15.22
%
 
15.70
%
 
11.69
%
 
15.41
%
 
10.37
%
Return on average tangible common equity
19.42
%
 
20.23
%
 
15.23
%
 
19.85
%
 
13.25
%
Net interest margin (fully tax equivalent)
3.78
%
 
3.77
%
 
3.88
%
 
3.78
%
 
3.87
%
Efficiency ratio
52.96
%
 
51.50
%
 
50.75
%
 
52.25
%
 
56.66
%
Tangible book value per common share
$
19.94

 
$
19.32

 
$
18.09

 
 
 
 
 
 
 
 
 
 
 
 
 
 
ASSET QUALITY (1)
 
 
 
 
 
 
 
 
 
Net charge-offs
$
2,447

 
$
641

 
$
803

 
$
2,862

 
$
6,851

Nonperforming loans
17,044

 
14,801

 
8,985

 
 
 
 
Classified assets
73,704

 
74,001

 
80,757

 
 
 
 
Nonperforming loans to portfolio loans
0.40
%
 
0.35
%
 
0.23
%
 
 
 
 
Nonperforming assets to total assets (1)
0.32
%
 
0.28
%
 
0.18
%
 
 
 
 
Allowance for loan losses to portfolio loans
0.99
%
 
1.00
%
 
0.97
%
 
 
 
 
Net charge-offs to average loans (annualized)
0.23
%
 
0.06
%
 
0.08
%
 
0.09
%
 
0.24
%
 
 
 
 
 
 
 
 
 
 
(1) Excludes purchased credit impaired loans and related assets, except for their inclusion in total assets.


28



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

 
For the Three Months ended
 
For the Nine Months ended
(in thousands)
September 30,
2018
 
June 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
CORE PERFORMANCE MEASURES (1)
 
 
 
 
 
 
 
 
Net interest income
$
47,558

 
$
46,757

 
$
44,069

 
$
139,720

 
$
124,685

Provision for portfolio loans
2,332

 
2,385

 
2,422

 
6,588

 
7,578

Noninterest income
8,403

 
9,026

 
8,350

 
25,949

 
23,260

Noninterest expense
29,228

 
29,209

 
27,070

 
87,566

 
79,814

Income before income tax expense
24,401

 
24,189

 
22,927

 
71,515

 
60,553

Income tax expense
4,372

 
4,145

 
7,391

 
11,857

 
18,636

Net income
$
20,029

 
$
20,044

 
$
15,536

 
$
59,658

 
$
41,917

 
 
 
 
 
 
 
 
 
 
Earnings per share
$
0.86

 
$
0.86

 
$
0.66

 
$
2.56

 
$
1.81

Return on average assets
1.45
%
 
1.48
%
 
1.21
%
 
1.47
%
 
1.14
%
Return on average common equity
13.54
%
 
14.14
%
 
11.13
%
 
14.00
%
 
10.69
%
Return on average tangible common equity
17.28
%
 
18.22
%
 
14.50
%
 
18.03
%
 
13.66
%
Net interest margin (fully tax equivalent)
3.74
%
 
3.75
%
 
3.75
%
 
3.74
%
 
3.71
%
Efficiency ratio
52.23
%
 
52.36
%
 
51.64
%
 
52.86
%
 
53.95
%

For the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017, the Company noted the following trends:

The Company reported net income of $65.7 million, or $2.81 per diluted share, for the nine months ended September 30, 2018, compared to $40.7 million, or $1.75 per diluted share, for the same period in 2017. The $1.06 increase in earnings per share primarily increased from growth in the balance sheet resulting from organic loan and deposit growth, fee income growth, and corporate tax reform.

On a core basis1, net income grew 42% to $59.7 million, or $2.56 per diluted share, for the nine months ended September 30, 2018, compared to $41.9 million, or $1.81 per diluted share, in the prior year period. The diluted core earnings per share1 increase of $0.75 continues to be driven by revenue growth, which expanded $17.7 million, or 12%.

Net interest income for the first nine months of 2018 increased $11.4 million or 9%, from the prior year period due to strong portfolio loan growth and a higher average yield partially offset by an increase in cost of funds and a reduction in incremental accretion on non-core acquired loans.

Net interest margin for the first nine months of 2018 decreased nine basis points to 3.78% when compared to the prior year period of 3.87%. Core net interest margin1, which excludes incremental accretion on non-core acquired loans, increased three basis points to 3.74% for the first nine months of 2018 from the prior year period primarily due to the impact of interest rate increases on portfolio loans out-pacing the increase in deposit and borrowing costs.




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

29




Noninterest income for the first nine months of 2018 increased $4.4 million or 19%, compared to the prior year period primarily due to $2.0 million of nonrecurring revenue along with higher income from deposit service charges and card services from growth in the client base.

Noninterest expense was $88.3 million for the nine months ended September 30, 2018, compared to $86.8 million for the comparable period in 2017. Noninterest expense for the 2017 period included $6.5 million of merger related expenses. Core noninterest expense1 was $87.6 million for the nine months ended September 30, 2018, compared to $79.8 million for the prior year period primarily due to increases in compensation and benefit expense from investments in revenue producing personnel, tax credit amortization of $2.0 million, and other operating expenses from the acquisition of JCB.

Balance sheet highlights:

Loans – Portfolio loans increased to $4.2 billion at September 30, 2018, increasing $183 million when compared to December 31, 2017 primarily in the commercial and industrial, and commercial real estate categories.
Deposits – Total deposits at September 30, 2018 were $4.2 billion, an increase of $54 million, or 1% from December 31, 2017. Core deposits, defined as total deposits excluding time deposits, were $3.5 billion at September 30, 2018, a decrease of $41 million, or 1% when compared to December 31, 2017.
Asset quality – Nonperforming loans were $17.0 million at September 30, 2018, compared to $14.9 million at December 31, 2017. Nonperforming loans represented 0.40% and 0.35% of portfolio loans at September 30, 2018 and December 31, 2017, respectively.
Provision for portfolio loan losses was $6.6 million for the nine months ended September 30, 2018, compared to $7.6 million for the nine months ended September 30, 2017. See Item 1, Note 4 – 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."

30



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 $31 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,
 
2018
 
2017
(in thousands)
Average Balance
 
Interest
Income/Expense
 
Average
Yield/
Rate
 
Average Balance
 
Interest
Income/Expense
 
Average
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Taxable portfolio loans (1)
$
4,196,242

 
$
54,086

 
5.11
%
 
$
3,866,434

 
$
45,526

 
4.67
%
Tax-exempt portfolio loans (2)
34,392

 
483

 
5.57

 
38,202

 
623

 
6.47

Non-core acquired loans - contractual
21,891

 
399

 
7.23

 
35,120

 
553

 
6.25

Non-core acquired loans - incremental accretion
 
 
535

 
9.70

 
 
 
1,556

 
17.57

Total loans
4,252,525

 
55,503

 
5.18

 
3,939,756


48,258

 
4.86

Taxable investments in debt and equity securities
715,846

 
4,805

 
2.66

 
667,520

 
3,981

 
2.37

Non-taxable investments in debt and equity securities (2)
39,283

 
349

 
3.52

 
43,537

 
475

 
4.33

Short-term investments
64,919

 
306

 
1.87

 
61,859

 
173

 
1.11

Total securities and short-term investments
820,048

 
5,460

 
2.64

 
772,916


4,629

 
2.38

Total interest-earning assets
5,072,573

 
60,963

 
4.77

 
4,712,672

 
52,887

 
4.45

Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
88,924

 
 
 
 
 
76,661

 
 
 
 
Other assets
354,788

 
 
 
 
 
348,100

 
 
 
 
Allowance for loan losses
(44,781
)
 
 
 
 
 
(41,939
)
 
 
 
 
 Total assets
$
5,471,504

 
 
 
 
 
$
5,095,494

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
758,621

 
$
799

 
0.42
%
 
$
805,073

 
$
523

 
0.26
%
Money market accounts
1,523,822

 
5,423

 
1.41

 
1,314,274

 
2,410

 
0.73

Savings
208,057

 
157

 
0.30

 
200,394

 
125

 
0.25

Certificates of deposit
678,214

 
2,878

 
1.68

 
580,951

 
1,493

 
1.02

Total interest-bearing deposits
3,168,714

 
9,257

 
1.16

 
2,900,692


4,551

 
0.62

Subordinated debentures
118,134

 
1,483

 
4.98

 
118,086

 
1,316

 
4.42

FHLB advances
311,522

 
1,729

 
2.20

 
249,462

 
832

 
1.31

Other borrowed funds
160,151

 
195

 
0.48

 
206,533

 
144

 
0.28

Total interest-bearing liabilities
3,758,521

 
12,664

 
1.34

 
3,474,773


6,843

 
0.78

Noninterest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
1,086,809

 
 
 
 
 
1,031,346

 
 
 
 
Other liabilities
39,409

 
 
 
 
 
35,662

 
 
 
 
Total liabilities
4,884,739

 
 
 
 
 
4,541,781

 
 
 
 
Shareholders' equity
586,765

 
 
 
 
 
553,713

 
 
 
 
Total liabilities & shareholders' equity
$
5,471,504

 
 
 
 
 
$
5,095,494

 
 
 
 
Net interest income
 
 
$
48,299

 
 
 
 
 
$
46,044

 
 
Net interest spread
 
 
 
 
3.43
%
 
 
 
 
 
3.67
%
Net interest margin
 
 
 
 
3.78
%
 
 
 
 
 
3.88
%
Core net interest margin (3)
 
 
 
 
3.74
%
 
 
 
 
 
3.75
%
(1)
Average balances include non-accrual loans. The income on such loans is included in interest but is recognized only upon receipt. Loan fees, net of amortization of deferred loan origination fees and costs, included in interest income are approximately $1.0 million and $0.9 million for the three months ended September 30, 2018 and 2017 respectively.
(2)
Non-taxable income is presented on a fully tax-equivalent basis using a 24.7% and 38.0% tax rate in 2018 and 2017, respectively. The tax-equivalent adjustments were $0.2 million and $0.4 million for the three months ended September 30, 2018 and 2017, respectively.
(3)
A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial measures."

31



 
Nine months ended September 30,
 
2018
 
2017
(in thousands)
Average Balance
 
Interest
Income/Expense
 
Average
Yield/
Rate
 
Average Balance
 
Interest
Income/Expense
 
Average
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Taxable portfolio loans (1)
$
4,144,319

 
$
154,760

 
4.99
%
 
$
3,713,188

 
$
127,046

 
4.57
%
Tax-exempt portfolio loans (2)
35,561

 
1,446

 
5.44

 
41,703

 
1,998

 
6.41

Non-core acquired loans - contractual
25,705

 
1,342

 
6.98

 
37,043

 
1,753

 
6.33

Non-core acquired loans - incremental accretion
 
 
1,592

 
8.28

 
 
 
5,215

 
18.82

Total loans
4,205,585

 
159,140

 
5.06

 
3,791,934

 
136,012

 
4.80

Taxable investments in debt and equity securities
705,894

 
13,426

 
2.54

 
624,126

 
10,976

 
2.35

Non-taxable investments in debt and equity securities (2)
40,576

 
1,084

 
3.57

 
48,165

 
1,588

 
4.41

Short-term investments
63,416

 
777

 
1.64

 
75,125

 
537

 
0.96

Total securities and short-term investments
809,886

 
15,287

 
2.52

 
747,416

 
13,101

 
2.34

Total interest-earning assets
5,015,471

 
174,427

 
4.65

 
4,539,350

 
149,113

 
4.39

Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
88,763

 
 
 
 
 
76,086

 
 
 
 
Other assets
349,827

 
 
 
 
 
325,808

 
 
 
 
Allowance for loan losses
(44,657
)
 
 
 
 
 
(43,901
)
 
 
 
 
 Total assets
$
5,409,404

 
 
 
 
 
$
4,897,343

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
814,679

 
$
2,422

 
0.40
%
 
$
786,945

 
$
1,721

 
0.29
%
Money market accounts
1,470,177

 
13,221

 
1.20

 
1,272,939

 
5,841

 
0.61

Savings
206,213

 
429

 
0.28

 
185,218

 
332

 
0.24

Certificates of deposit
638,889

 
7,115

 
1.49

 
576,906

 
4,081

 
0.95

Total interest-bearing deposits
3,129,958

 
23,187

 
0.99

 
2,822,008

 
11,975

 
0.57

Subordinated debentures
118,123

 
4,305

 
4.87

 
116,239

 
3,768

 
4.33

FHLB advances
302,937

 
4,435

 
1.96

 
192,662

 
1,684

 
1.17

Other borrowed funds
178,245

 
561

 
0.42

 
228,514

 
423

 
0.25

Total interest-bearing liabilities
3,729,263

 
32,488

 
1.16

 
3,359,423

 
17,850

 
0.71

Noninterest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
1,073,903

 
 
 
 
 
982,788

 
 
 
 
Other liabilities
36,323

 
 
 
 
 
30,809

 
 
 
 
Total liabilities
4,839,489

 
 
 
 
 
4,373,020

 
 
 
 
Shareholders' equity
569,915

 
 
 
 
 
524,323

 
 
 
 
Total liabilities & shareholders' equity
$
5,409,404

 
 
 
 
 
$
4,897,343

 
 
 
 
Net interest income
 
 
$
141,939

 
 
 
 
 
$
131,263

 
 
Net interest spread
 
 
 
 
3.49
%
 
 
 
 
 
3.68
%
Net interest margin
 
 
 
 
3.78
%
 
 
 
 
 
3.87
%
Core net interest margin (3)
 
 
 
 
3.74
%
 
 
 
 
 
3.71
%
(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 $2.9 million and $2.5 million for the nine months ended September 30, 2018 and 2017 respectively.
(2)
Non-taxable income is presented on a fully tax-equivalent basis using a 24.7% and 38.0% tax rate in 2018 and 2017, respectively. The tax-equivalent adjustments were $0.6 million and $1.4 million for the nine months ended September 30, 2018 and 2017, respectively.
(3)
A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial measures."

32



Rate/Volume
The following table sets forth, on a tax-equivalent basis for the periods indicated, a summary of the changes in interest income and interest expense resulting from changes in yield/rates and volume.
  
 
2018 compared to 2017
 
Three months ended September 30,
 
Nine months ended September 30,
 
Increase (decrease) due to
 
Increase (decrease) due to
(in thousands)
Volume(1)
 
Rate(2)
 
Net
 
Volume(1)
 
Rate(2)
 
Net
Interest earned on:
 
 
 
 
 
 
 
 
 
 
 
Taxable portfolio loans
$
4,067

 
$
4,493

 
$
8,560

 
$
15,506

 
$
12,208

 
$
27,714

Tax-exempt portfolio loans (3)
(58
)
 
(82
)
 
(140
)
 
(272
)
 
(280
)
 
(552
)
Non-core acquired loans
(664
)
 
(511
)
 
(1,175
)
 
(1,766
)
 
(2,268
)
 
(4,034
)
Taxable investments in debt and equity securities
306

 
518

 
824

 
1,510

 
940

 
2,450

Non-taxable investments in debt and equity securities (3)
(43
)
 
(83
)
 
(126
)
 
(229
)
 
(275
)
 
(504
)
Short-term investments
9

 
124

 
133

 
(95
)
 
335

 
240

Total interest-earning assets
$
3,617

 
$
4,459

 
$
8,076

 
$
14,654

 
$
10,660

 
$
25,314

 
 
 
 
 
 
 
 
 
 
 
 
Interest paid on:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing transaction accounts
$
(32
)
 
$
308

 
$
276

 
$
63

 
$
638

 
$
701

Money market accounts
441

 
2,572

 
3,013

 
1,026

 
6,354

 
7,380

Savings
5

 
27

 
32

 
41

 
56

 
97

Certificates of deposit
285

 
1,100

 
1,385

 
478

 
2,556

 
3,034

Subordinated debentures
1

 
166

 
167

 
62

 
475

 
537

FHLB advances
240

 
657

 
897

 
1,262

 
1,489

 
2,751

Borrowed funds
(38
)
 
89

 
51

 
(109
)
 
247

 
138

Total interest-bearing liabilities
902

 
4,919

 
5,821

 
2,823

 
11,815

 
14,638

Net interest income
$
2,715

 
$
(460
)
 
$
2,255

 
$
11,831

 
$
(1,155
)
 
$
10,676

(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 $48.3 million for the three months ended September 30, 2018, compared to $46.0 million for the same period of 2017, an increase of $2.3 million, or 5%. The tax-equivalent net interest margin was 3.78% for the third quarter of 2018, compared to 3.88% in the third quarter of 2017. Portfolio loan growth and higher rates supported the $8.1 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 5.11% for the three months ended September 30, 2018, due to increasing interest rates on the existing variable-rate loan portfolio and higher rates on newly originated loans. The run-off of higher yielding non-core acquired loans continues to negatively impact net interest margin and resulted in a $1.2 million decrease in interest income for the three months ended September 30, 2018 compared to the prior year period.

Net interest income (on a tax equivalent basis) was $141.9 million for the nine months ended September 30, 2018, compared to $131.3 million for the same period of 2017, an increase of $10.7 million, or 8%. The tax-equivalent net interest margin was 3.78% for the nine months ended September 30, 2018, compared to 3.87% for the prior year period. The decrease in net interest margin was primarily due to a decline in contributions from non-core acquired

33



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

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

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

 
For the Three Months ended
 
For the Nine Months ended
(in thousands)
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Accelerated cash flows and other incremental accretion
$
535

 
$
1,556

 
$
1,592

 
$
5,215

Provision reversal for non-core acquired loan losses
69

 

 
2,064

 
355

Other income
7

 

 
1,038

 

Less: Other expenses (credits)
12

 
19

 
(203
)
 
126

Non-core acquired assets income before income tax expense
$
599

 
$
1,537

 
$
4,897

 
$
5,444


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, 2018, the remaining accretable yield on the remaining non-core acquired portfolio was estimated to be $9 million and the non-accretable difference was approximately $10 million. Accelerated cash flows and other incremental accretion from these loans was $1.6 million for the nine months ended September 30, 2018, and $5.2 million for the same period in 2017. The Company estimates income from accelerated cash flows and other incremental accretion to be between $2 million and $3 million in total for 2018 and 2019.

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


34



Noninterest Income

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

 
Three months ended September 30,
(in thousands)
2018
 
2017
 
Increase (decrease)
Service charges on deposit accounts
$
2,997

 
$
2,820

 
$
177

 
6
 %
Wealth management revenue
2,012

 
2,062

 
(50
)
 
(2
)%
Card services revenue
1,760

 
1,459

 
301

 
21
 %
Gain on state tax credits, net
192

 
77

 
115

 
149
 %
Gain on sale of other real estate - core
13

 

 
13

 
 %
Miscellaneous income - core
1,429

 
1,932

 
(503
)
 
(26
)%
Core noninterest income (1)
8,403

 
8,350

 
53

 
1
 %
Gain on sale of investment securities

 
22

 
(22
)
 
(100
)%
Other income from non-core acquired assets
7

 

 
7

 
NM

Total noninterest income
$
8,410

 
$
8,372

 
$
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."


 
Nine months ended September 30,
(in thousands)
2018
 
2017
 
Increase (decrease)
Service charges on deposit accounts
$
8,855

 
$
8,146

 
$
709

 
9
 %
Wealth management revenue
6,267

 
5,949

 
318

 
5
 %
Card services revenue
4,926

 
3,888

 
1,038

 
27
 %
Gain on state tax credits, net
508

 
332

 
176

 
53
 %
Gain on sale of other real estate
13

 
17

 
(4
)
 
(24
)%
Miscellaneous income - core
5,380

 
4,928

 
452

 
9
 %
Core noninterest income (1)
25,949

 
23,260

 
2,689

 
12
 %
Gain on sale of investment securities
9

 
22

 
(13
)
 
(59
)%
Other income from non-core acquired assets
1,038

 

 
1,038

 
NM

Other
649

 

 
649

 
NM

Total noninterest income
$
27,645

 
$
23,282

 
$
4,363

 
19
 %
 
 
 
 
 
 
 
 
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

Noninterest income increased $4.4 million, or 19% in the first nine months of 2018 compared to the first nine months of 2017. During the nine months ended September 30, 2018, the Company received a gain of $0.6 million from the sale of an equity partnership, and a $1.0 million gain from non-core acquired assets. Core noninterest income1 grew 12% in the first nine months of 2018. The improvement over the prior year period was primarily due to increases on deposit service charges and card services along with death benefit proceeds on an insurance policy.

The Company expects growth in core fee income of a high single digit percentage for 2019 over 2018 levels.


35



Noninterest Expense

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

 
Three months ended September 30,
(in thousands)
2018
 
2017
 
Increase (decrease)
Core expenses (1):
 
 
 
 
 
 
 
 Employee compensation and benefits
$
16,297

 
$
15,090

 
$
1,207

 
8
 %
 Occupancy
2,394

 
2,434

 
(40
)
 
(2
)%
 Data processing
1,634

 
1,389

 
245

 
18
 %
 FDIC and other insurance
845

 
731

 
114

 
16
 %
 Professional fees
1,023

 
920

 
103

 
11
 %
 Loan, legal and other real estate expense
310

 
567

 
(257
)
 
(45
)%
 Other
6,725

 
5,939

 
786

 
13
 %
Core noninterest expense (1)
29,228

 
27,070

 
2,158

 
8
 %
Merger related expenses

 
315

 
(315
)
 
(100
)%
Other non-core
682

 

 
682

 
 %
Other expenses related to non-core acquired loans
12

 
19

 
(7
)
 
(37
)%
Total noninterest expense
$
29,922

 
$
27,404

 
$
2,518

 
9
 %
(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)
2018
 
2017
 
Increase (decrease)
Core expenses (1):
 
 
 
 
 
 
 
 Employee compensation and benefits
$
49,370

 
$
46,096

 
$
3,274

 
7
 %
 Occupancy
7,142

 
6,628

 
514

 
8
 %
 Data processing
4,634

 
4,828

 
(194
)
 
(4
)%
 FDIC and other insurance
2,682

 
2,356

 
326

 
14
 %
 Professional fees
2,619

 
2,833

 
(214
)
 
(8
)%
 Loan, legal and other real estate expense
800

 
1,418

 
(618
)
 
(44
)%
 Other
20,319

 
15,655

 
4,664

 
30
 %
Core noninterest expense (1)
87,566

 
79,814

 
7,752

 
10
 %
Merger related expenses

 
6,462

 
(6,462
)
 
(100
)%
Other non-core
921

 
389

 
532

 
137
 %
Other expenses related to non-core acquired loans
(203
)
 
126

 
(329
)
 
(261
)%
Total noninterest expense
$
88,284

 
$
86,791

 
$
1,493

 
2
 %
(1) A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."


Noninterest expense was $88.3 million for the nine months ended September 30, 2018, compared to $86.8 million for the nine months ended September 30, 2017. The current year period includes a $0.7 million non-recurring excise tax expense which was offset by lower income tax expenses discussed below. Noninterest expenses for the 2017 period included $6.5 million of merger related expenses. Core noninterest expenses1 increased $7.8 million to $87.6 million for the nine months ended September 30, 2018, from $79.8 million for the prior year period. Core expenses1 increased over the prior year period due to increases in employee compensation and benefits from investments in revenue producing personnel and $2.0 million of tax credit amortization.

36




The Company's core efficiency ratio1 improved to 52.9% for the nine months ended September 30, 2018, compared to 54.0% for the prior year period, and reflects continuing efforts to leverage its expense base. The Company expects to continue to invest in revenue producing associates and other infrastructure that supports additional growth. These investments are expected to result in expense growth, at a rate of 35% - 45% of projected revenue growth for 2019, resulting in continued improvements to the Company's efficiency ratio.


Income Taxes

The Company's income tax expense for the three months ended September 30, 2018, which includes both federal and state taxes, was $1.8 million compared to $7.9 million for the same period in 2017. During the current quarter, the Company finalized its 2017 corporate income tax returns. Tax planning activities associated with the excise tax discussed above, reduced income tax expense by $2.7 million. For the nine months ended September 30, 2018, income tax expense totaled $10.5 million compared to $18.5 million for the prior year period.
 
The Company's effective tax rate was 13.7% for the nine months ended September 30, 2018 compared to 31.3% for the same period in 2017 due to the impact of federal income tax reform, which includes finalizing the Company's 2017 tax returns.

The Company expects its effective tax rate for the remainder of 2018 and 2019 to be approximately 18% - 20%.



Summary Balance Sheet

(in thousands)
September 30,
2018
 
December 31,
2017
 
Increase (decrease)
Total cash and cash equivalents
$
156,065

 
$
153,323

 
$
2,742

1.8
 %
Securities
737,459

 
715,131

 
22,328

3.1
 %
Portfolio loans
4,249,758

 
4,066,659

 
183,099

4.5
 %
Non-core acquired loans
17,672

 
30,391

 
(12,719
)
(41.9
)%
Total assets
5,517,539

 
5,289,225

 
228,314

4.3
 %
Deposits
4,210,476

 
4,156,414

 
54,062

1.3
 %
Total liabilities
4,930,702

 
4,740,652

 
190,050

4.0
 %
Total shareholders' equity
586,837

 
548,573

 
38,264

7.0
 %

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.


37



The following table summarizes the composition of the Company's loan portfolio:
(in thousands)
September 30,
2018
 
December 31,
2017
 
Increase (decrease)
Commercial and industrial
$
2,033,278

 
$
1,919,145

 
$
114,133

 
5.9
 %
Commercial real estate - investor owned
846,607

 
769,275

 
77,332

 
10.1
 %
Commercial real estate - owner occupied
596,481

 
554,589

 
41,892

 
7.6
 %
Construction and land development
329,288

 
345,209

 
(15,921
)
 
(4.6
)%
Residential real estate
309,414

 
342,518

 
(33,104
)
 
(9.7
)%
Consumer and other
134,690

 
135,923

 
(1,233
)
 
(0.9
)%
   Portfolio loans
4,249,758

 
4,066,659

 
183,099

 
4.5
 %
Non-core acquired loans
17,672

 
30,391

 
(12,719
)
 
(41.9
)%
   Total loans
$
4,267,430

 
$
4,097,050

 
$
170,380

 
4.2
 %

Portfolio loans grew by $183.1 million to $4.2 billion at September 30, 2018, when compared to December 31, 2017. Non-core acquired loans totaled $17.7 million at September 30, 2018, a decrease of $12.7 million, or 42%, from December 31, 2017, primarily as a result of principal paydowns and accelerated loan payoffs.

The following table illustrates portfolio loan growth with selected specialized lending detail:
 
At the quarter ended
(in thousands)
September 30,
2018
 
December 31,
2017
 
Increase (decrease)
C&I - general
$
967,525

 
$
936,588

 
$
30,937

 
3.3
 %
CRE investor owned - general
841,309

 
801,156

 
40,153

 
5.0
 %
CRE owner occupied - general
480,106

 
468,151

 
11,955

 
2.6
 %
Enterprise value lending1
442,439

 
407,644

 
34,795

 
8.5
 %
Life insurance premium financing1
378,826

 
364,876

 
13,950

 
3.8
 %
Residential real estate - general
309,053

 
342,140

 
(33,087
)
 
(9.7
)%
Construction and land development - general
309,879

 
294,123

 
15,756

 
5.4
 %
Tax credits1
256,666

 
234,835

 
21,831

 
9.3
 %
Agriculture1
137,761

 
91,031

 
46,730

 
51.3
 %
Consumer and other - general
126,194

 
126,115

 
79

 
0.1
 %
Portfolio loans
$
4,249,758

 
$
4,066,659

 
$
183,099

 
4.5
 %
 
 
 
 
 
 
 
 
Note: Certain prior period amounts have been reclassified among the categories to conform to the current period presentation.
1Specialized categories may include a mix of C&I, CRE, construction and land development, or consumer and other loans.

Specialized lending products, especially Enterprise value lending, life insurance premium financing, and tax credits, consist of primarily C&I loans, and have contributed significantly to the Company's loan growth. These loans are sourced through relationships developed with estate planning firms and private equity funds, and are not bound geographically by our traditional three markets. These specialized loan products offer opportunities to expand and diversify geographically by entering into new markets. The Company continues to focus on originating high-quality C&I relationships as they typically have variable interest rates and allow for cross selling opportunities involving other banking products. C&I loans increased $114 million during the first nine months of 2018 and represented 48% of the Company's loan portfolio at September 30, 2018. We expect continued total portfolio loan growth in 2018 and 2019 to be a high single digit percentage.

38



Provision and Allowance for Loan Losses
The following table summarizes changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off, by loan category, and additions to the allowance charged to expense.
 
Three months ended
September 30,
 
Nine months ended
September 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Allowance at beginning of period, for portfolio loans
$
42,007

 
$
36,673

 
$
38,166

 
$
37,565

Loans charged off:
 
 
 
 
 
 
 
Commercial and industrial
(2,405
)
 
(613
)
 
(4,093
)
 
(6,781
)
Real estate:
 
 
 
 
 
 
 
Commercial
(22
)
 
(45
)
 
(22
)
 
(90
)
Construction and land development

 

 

 
(5
)
Residential
(122
)
 
(503
)
 
(414
)
 
(777
)
Consumer and other
(46
)
 
(75
)
 
(128
)
 
(143
)
Total loans charged off
(2,595
)
 
(1,236
)

(4,657
)

(7,796
)
Recoveries of loans previously charged off:
 
 
 
 
 
 
 
Commercial and industrial
2

 
205

 
1,076

 
342

Real estate:
 
 
 
 
 
 
 
Commercial
12

 
18

 
37

 
219

Construction and land development
21

 
25

 
395

 
83

Residential
88

 
172

 
220

 
259

Consumer and other
25

 
13

 
67

 
42

Total recoveries of loans
148

 
433


1,795


945

Net loan charge-offs
(2,447
)
 
(803
)

(2,862
)

(6,851
)
Provision for loan losses
2,332

 
2,422

 
6,588

 
7,578

Allowance at end of period, for portfolio loans (1)
$
41,892

 
$
38,292


$
41,892


$
38,292

 
 
 
 
 
 
 
 
Allowance at beginning of period, for purchased credit impaired loans
$
2,363

 
$
5,126

 
$
4,411

 
$
5,844

   Loans charged off

 
(175
)
 

 
(223
)
   Recoveries of loans

 

 

 

Other

 
(52
)
 
(53
)
 
(367
)
Net loan charge-offs

 
(227
)

(53
)

(590
)
Provision reversal for purchased credit impaired loan losses
(69
)
 

 
(2,064
)
 
(355
)
Allowance at end of period, for purchased credit impaired loans
$
2,294

 
$
4,899


$
2,294


$
4,899

 
 
 
 
 
 
 
 
Total allowance at end of period
$
44,186

 
$
43,191

 
$
44,186

 
$
43,191

 
 
 
 
 
 
 
 
Portfolio loans, average
$
4,230,090

 
$
3,904,636

 
$
4,178,900

 
$
3,754,891

Portfolio loans, ending (1)
4,218,341

 
3,948,676

 
4,218,341

 
3,948,676

Net charge-offs to average portfolio loans (1)
0.23
%
 
0.08
%
 
0.09
%
 
0.24
%
Allowance for portfolio loan losses to loans (1)
0.99
%
 
0.97
%
 
0.99
%
 
0.97
%
 
 
 
 
 
 
 
 
(1) Excludes PCI loans.

The provision for loan losses on portfolio loans for the nine months ended September 30, 2018 was $6.6 million, compared to $7.6 million for same period in 2017. The provision is reflective of growth in portfolio loan balances, and maintaining a prudent credit risk posture.

39




The allowance for loan losses on portfolio loans was 0.99% of portfolio loans at September 30, 2018, compared to 0.97% at September 30, 2017. Management believes the allowance for loan losses is adequate to absorb inherent losses in the loan portfolio.


Nonperforming assets

The following table presents the categories of nonperforming assets and other ratios as of the dates indicated.
 
(in thousands)
September 30,
2018
 
December 31,
2017
 
September 30,
2017
Non-accrual loans
$
14,935

 
$
14,968

 
$
8,264

Loans past due 90 days or more and still accruing interest
1,289

 

 

Restructured loans
820

 
719

 
721

Total nonperforming loans (1)
17,044

 
15,687

 
8,985

Other real estate
408

 
498

 
491

Total nonperforming assets (1)
$
17,452

 
$
16,185

 
$
9,476

 
 
 
 
 
 
Total assets
$
5,517,539

 
$
5,289,225

 
$
5,231,488

Portfolio loans (1)
4,218,341

 
4,022,896

 
3,948,676

Portfolio loans plus other real estate (1)
4,218,749

 
4,023,394

 
3,949,167

Nonperforming loans to portfolio loans (1)
0.40
%
 
0.39
%
 
0.23
%
Nonperforming assets to total loans plus other real estate (1)
0.41

 
0.40

 
0.24

Nonperforming assets to total assets (1)
0.32

 
0.31

 
0.18

Allowance for loans to nonperforming loans (1)
246
%
 
243
%
 
426
%
 
 
 
 
 
 
(1) Excludes PCI loans, except for their inclusion in total assets.


40



Nonperforming loans 
Nonperforming loans exclude PCI loans that are accounted for on a pool basis as the pools are considered to be performing. See Item 1, Note 4 – Loans for more information on these loans.
 
Nonperforming loans based on loan type were as follows:
 
(in thousands)
September 30, 2018
 
December 31, 2017
 
September 30, 2017
Commercial and industrial
$
12,197

 
$
12,665

 
$
7,451

Commercial real estate
2,058

 
909

 
544

Construction and land development

 
136

 
322

Residential real estate
2,477

 
1,602

 

Consumer and other
312

 
375

 
668

Total
$
17,044

 
$
15,687


$
8,985


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

 
$
14,905

Additions to nonaccrual loans
6,966

 
8,680

Additions to restructured loans
274

 
676

Charge-offs
(4,546
)
 
(7,678
)
Other principal reductions
(2,426
)
 
(7,315
)
Moved to other real estate
(200
)
 
(283
)
Loans past due 90 days or more and still accruing interest
1,289

 

Nonperforming loans end of period
$
17,044

 
$
8,985


Other real estate
Other real estate was $0.4 million at September 30, 2018 compared to $0.5 million at September 30, 2017.

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

 
$
980

Additions and expenses capitalized to prepare property for sale
408

 
383

Additions from acquisition

 
1,680

Writedowns in value
(44
)
 
(56
)
Sales
(454
)
 
(2,496
)
Other real estate end of period
$
408

 
$
491


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

Liabilities

Liabilities totaled $4.9 billion at September 30, 2018, compared to $4.7 billion at December 31, 2017. The increase in liabilities was due to $54 million of growth in total deposits and a $228 million increase in Federal Home Loan Bank advances, partially offset by a decrease of $92 million in other borrowings.

41




Deposits
(in thousands)
September 30,
2018
 
December 31,
2017
 
Increase (decrease)
Demand deposits
$
1,062,126

 
$
1,123,907

 
$
(61,781
)
 
(5.5
)%
Interest-bearing transaction accounts
743,351

 
915,653

 
(172,302
)
 
(18.8
)%
Money market accounts
1,523,416

 
1,342,931

 
180,485

 
13.4
 %
Savings
207,346

 
195,150

 
12,196

 
6.2
 %
Certificates of deposit:
 
 
 
 
 
 
 
Brokered
202,323

 
115,306

 
87,017

 
75.5
 %
Other
471,914

 
463,467

 
8,447

 
1.8
 %
Total deposits
$
4,210,476

 
$
4,156,414

 
$
54,062

 
1.3
 %
 
 
 
 
 
 
 
 
Non-time deposits / total deposits
84
%
 
86
%
 
 
 
 
Demand deposits / total deposits
25
%
 
27
%
 
 
 
 

Total deposits at September 30, 2018 were $4.2 billion, an increase of 1%, from December 31, 2017, primarily from increases in money market accounts and brokered certificates of deposit. The composition of our noninterest bearing deposits remained relatively stable at 25% of total deposits at September 30, 2018 compared to 27% at December 31, 2017.

Shareholders' Equity

Shareholders' equity totaled $586.8 million at September 30, 2018, an increase of $38.3 million from December 31, 2017. Significant activity during the nine months ended September 30, 2018 was as follows:

Net income of $65.7 million,
decrease in fair value of securities of $12.0 million,
issuance under equity compensation plans of $3.3 million,
dividends paid on common shares of $7.9 million, and
repurchase of 135,922 shares at an average price of $50.32 per share, or approximately $6.8 million in the aggregate, pursuant to the publicly announced program.

Liquidity and Capital Resources

Liquidity

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

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

The Bank's Asset-Liability Management Committee oversees our liquidity position, the parameters of which are approved by the Bank's Board of Directors. Our liquidity position is monitored monthly by producing a liquidity report, which measures the amount of liquid versus non-liquid assets and liabilities. Our liquidity management framework

42



includes measurement of several key elements, such as the loan to deposit ratio, a liquidity ratio, and a dependency ratio. The Company's liquidity framework also incorporates contingency planning to assess the nature and volatility of funding sources and to determine alternatives to these sources. While core deposits and loan and investment repayments are principal sources of liquidity, funding diversification is another key element of liquidity management and is achieved by strategically varying depositor types, terms, funding markets, and instruments.

Parent Company liquidity
The parent company's liquidity is managed to provide the funds necessary to pay dividends to shareholders, service debt, invest in subsidiaries as necessary, and satisfy other operating requirements. The parent company's primary funding sources to meet its liquidity requirements are dividends and payments from the Bank and proceeds from the issuance of equity (i.e. stock option exercises, stock offerings). $22.5 million in dividends has been paid to the parent company from the Bank in 2018. Another source of funding for the parent company includes the issuance of subordinated debentures and other debt instruments.

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

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

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

As of September 30, 2018, the Company had $69.2 million of outstanding subordinated debentures as part of ten Trust Preferred Securities Pools. These securities are classified as debt but are included in regulatory capital and the related interest expense is tax-deductible, which makes them an attractive source of funding.

Management believes our current level of cash at the holding company of $16.5 million, along with the Company's other available funding sources, will be sufficient to meet all projected cash needs for the remainder of 2018.

Bank liquidity
The Bank has a variety of funding sources available to increase financial flexibility. In addition to amounts currently borrowed, at September 30, 2018, the Bank had borrowing capacity of $266.2 million from the FHLB of Des Moines under blanket loan pledges, and has an additional $1.1 billion available from the Federal Reserve Bank under a pledged loan agreement. The Bank has unsecured federal funds lines with six correspondent banks totaling $95.0 million, and $79.0 million of unsecured credit through the American Financial Exchange.

Investment securities are another important tool to the Bank's liquidity objectives. Total securities available for sale of $670.3 million at September 30, 2018, included $352.4 million of securities that were pledged as collateral for deposits of public institutions, treasury, loan notes, and other requirements. The remaining $317.9 million could be pledged or sold to enhance liquidity, if necessary. In addition, $51.5 million of unpledged held to maturity securities could also be pledged for liquidity purposes.

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

43



Company's liquidity. The Bank has $1.4 billion in unused commitments as of September 30, 2018. 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, 2018, and December 31, 2017, the Company and the Bank met all capital adequacy requirements to which they are subject.
 
The Bank continues to exceed regulatory standards and met the definition of “well-capitalized” (the highest category) at September 30, 2018. The Company adopted the Regulatory Capital Framework (Basel III) in 2015, and has implemented the necessary processes and procedures to comply.

The following table summarizes the Bank's various capital ratios at the dates indicated:
(in thousands)
September 30,
2018
 
December 31, 2017
 
Well Capitalized Minimum %
Total capital to risk-weighted assets
11.09
%
 
10.46
%
 
10.00
%
Tier 1 capital to risk-weighted assets
12.00
%
 
11.36
%
 
8.00
%
Common equity tier 1 capital to risk-weighted assets
11.09
%
 
10.46
%
 
6.50
%
Leverage ratio (Tier 1 capital to average assets)
10.27
%
 
9.68
%
 
5.00
%
Tier 1 capital
$
548,712

 
$
503,312

 
 
Total risk-based capital
593,322

 
546,314

 
 

The following table summarizes the Company's various capital ratios at the dates indicated:
(in thousands)
September 30,
2018
 
December 31, 2017
 
Well Capitalized Minimum %
Total capital to risk-weighted assets
12.94
%
 
12.21
%
 
N/A
Tier 1 capital to risk-weighted assets
11.03
%
 
10.29
%
 
N/A
Common equity tier 1 capital to risk-weighted assets
9.66
%
 
8.88
%
 
N/A
Leverage ratio (Tier 1 capital to average assets)
10.20
%
 
9.72
%
 
N/A
Tangible common equity to tangible assets1
8.54
%
 
8.14
%
 
N/A
Tier 1 capital
$
546,891

 
$
496,045

 
 
Total risk-based capital
641,502

 
589,047

 
 
 
 
 
 
 
 
1 Not a required regulatory capital ratio
 
 
The Company believes the tangible common equity ratio and the common equity tier 1 capital ratio are important measures of capital strength even though they are considered to be non-GAAP measures. A reconciliation has been included in this MD&A section under the caption "Use of Non-GAAP Financial Measures."

44




Use of Non-GAAP Financial Measures:

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

45



Core Performance Measures
 
For the Three Months ended
 
For the Nine Months ended
(in thousands)
September 30,
2018
 
June 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Net interest income
$
48,093

 
$
47,048

 
$
45,625

 
$
141,312

 
$
129,900

Less: Incremental accretion income
535

 
291

 
1,556

 
1,592

 
5,215

Core net interest income
47,558

 
46,757

 
44,069

 
139,720

 
124,685

 
 
 
 
 
 
 
 
 
 
Total noninterest income
8,410

 
9,693

 
8,372

 
27,645

 
23,282

Less: Gain on sale of investment securities

 

 
22

 
9

 
22

Less: Other income from non-core acquired assets
7

 
18

 

 
1,038

 

Less: Other non-core income

 
649

 

 
649

 

Core noninterest income
8,403

 
9,026

 
8,350

 
25,949

 
23,260

 
 
 
 
 
 
 
 
 
 
Total core revenue
55,961

 
55,783

 
52,419

 
165,669

 
147,945

 
 
 
 
 
 
 
 
 
 
Provision for portfolio loans
2,332

 
2,385

 
2,422

 
6,588

 
7,578

 
 
 
 
 
 
 
 
 
 
Total noninterest expense
29,922

 
29,219

 
27,404

 
88,284

 
86,791

Less: Other expenses related to non-core acquired loans
12

 
(229
)
 
19

 
(203
)
 
126

Less: Merger related expenses

 

 
315

 

 
6,462

Less: Facilities disposal charge

 
239

 

 
239

 
389

Less: Non-recurring excise tax2
682

 

 

 
682

 

Core noninterest expense
29,228

 
29,209

 
27,070

 
87,566

 
79,814

 
 
 
 
 
 
 
 
 
 
Core income before income tax expense
24,401

 
24,189

 
22,927

 
71,515

 
60,553

 
 
 
 
 
 
 
 
 
 
Total income tax expense
1,802

 
4,881

 
7,856

 
10,461

 
18,507

Less: Other non-core income tax expense1, 2
(2,570
)
 
736

 
465

 
(1,396
)
 
(129
)
Core income tax expense
4,372

 
4,145

 
7,391

 
11,857

 
18,636

Core net income
$
20,029

 
$
20,044

 
$
15,536

 
$
59,658

 
$
41,917

 
 
 
 
 
 
 
 
 
 
Core diluted earnings per share
$
0.86

 
$
0.86

 
$
0.66

 
$
2.56

 
$
1.81

Core return on average assets
1.45
%
 
1.48
%
 
1.21
%
 
1.47
%
 
1.14
%
Core return on average common equity
13.54
%
 
14.14
%
 
11.13
%
 
14.00
%
 
10.69
%
Core return on average tangible common equity
17.28
%
 
18.22
%
 
14.50
%
 
18.03
%
 
13.66
%
Core efficiency ratio
52.23
%
 
52.36
%
 
51.64
%
 
52.86
%
 
53.95
%
 
 
 
 
 
 
 
 
 
 
1Other non-core income tax expense calculated at 24.7% of non-core pretax income for 2018. For 2017, the calculation is 38.0% of non-core pretax income plus an estimate of taxes payable related to non-deductible JCB acquisition costs.
2Income tax for the quarter ended September 30, 2018, includes a $2.7 million income tax planning benefit, associated with the excise tax expense, recognized upon finalization of the Company's 2017 tax returns.

46




Net Interest Margin to Core Net Interest Margin (fully tax equivalent)
 
Three months ended
September 30,
 
Nine months ended
September 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Net interest income
$
48,299

 
$
46,047

 
$
141,939

 
$
131,290

Less: Incremental accretion income
535

 
1,556

 
1,592

 
5,215

Core net interest income
$
47,764

 
$
44,491

 
$
140,347

 
$
126,075

 
 
 
 
 
 
 
 
Average earning assets
$
5,072,573

 
$
4,712,672

 
$
5,015,471

 
$
4,539,350

Reported net interest margin
3.78
%
 
3.88
%
 
3.78
%
 
3.87
%
Core net interest margin
3.74
%
 
3.75
%
 
3.74
%
 
3.71
%


Tangible common equity ratio
(in thousands)
September 30, 2018
 
December 31, 2017
Total shareholders' equity
$
586,837

 
$
548,573

Less: Goodwill
117,345

 
117,345

Less: Intangible assets
9,148

 
11,056

Tangible common equity
$
460,344

 
$
420,172

 
 
 
 
Total assets
$
5,517,539

 
$
5,289,225

Less: Goodwill
117,345

 
117,345

Less: Intangible assets
9,148

 
11,056

Tangible assets
$
5,391,046

 
$
5,160,824

 
 
 
 
Tangible common equity to tangible assets
8.54
%
 
8.14
%

47



Regulatory Capital to Risk-Weighted Assets
(in thousands)
September 30, 2018
 
December 31, 2017
Total shareholders' equity
$
586,837

 
$
548,573

Less: Goodwill
117,345

 
117,345

Less: Intangible assets, net of deferred tax liabilities
6,888

 
6,661

Plus: Unrealized gains (losses)
(16,627
)
 
(3,818
)
Plus: Other

 
12

Common equity Tier 1 capital
479,231

 
428,397

Plus: Qualifying trust preferred securities
67,600

 
67,600

Plus: Other
60

 
48

Tier 1 capital
546,891

 
496,045

Plus: Tier 2 capital
94,611

 
93,002

Total risk-based capital
641,502

 
589,047

 
 
 
 
Total risk-weighted assets determined in accordance with prescribed regulatory requirements
$
4,958,999

 
$
4,822,695

 
 
 
 
Common equity tier 1 to risk-weighted assets
9.66
%
 
8.88
%
Tier 1 capital to risk-weighted assets
11.03
%
 
10.29
%
Total risk-based capital to risk-weighted assets
12.94
%
 
12.21
%

Critical Accounting Policies

The impact and any associated risks related to the Company's critical accounting policies on business operations are described throughout "Management's Discussion and Analysis of Financial Condition and Results of Operations," where such policies affect our reported and expected financial results. For a detailed description on the application of these and other accounting policies, see the Company's Annual Report on Form 10-K for the year ended December 31, 2017.


48



ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

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

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

Rate Shock
Annual % change
in net interest income
+ 300 bp
5.2%
+ 200 bp
3.5%
+ 100 bp
1.8%
 - 100 bp
(2.7)%

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

The Company occasionally uses interest rate derivative financial instruments as an asset/liability management tool to hedge mismatches in interest rate exposure indicated by the net interest income simulation described above. They are used to modify the Company's exposures to interest rate fluctuations and provide more stable spreads between loan yields and the rate on their funding sources.

49



ITEM 4: CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

Based on that evaluation, the CEO and CFO concluded the Company’s disclosure controls and procedures were effective as of September 30, 2018 to provide reasonable assurance of the achievement of the objectives described above.

Changes to Internal Controls

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

PART II - OTHER INFORMATION


ITEM 1: LEGAL PROCEEDINGS

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


ITEM 1A: RISK FACTORS

For information regarding risk factors affecting the Company, please see the cautionary language regarding forward-looking statements in the introduction to Item 2 of Part I of this Report on Form 10-Q, and Part I, Item 1A of our Report on Form 10-K for the fiscal year ended December 31, 2017. There have been no material changes to the risk factors described in such Annual Report on Form 10-K.


50



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

Issuer Purchases of Equity Securities

The following table provides information on repurchases by the Company of its common stock, pursuant to its stock repurchase program, in each month of the quarter ended September 30, 2018.

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, 2018 through July 31, 2018

 

 

 
1,319,412

August 1, 2018 through August 31, 2018

 

 

 
1,319,412

September 1, 2018 through September 30, 2018
71,007

 
53.26

 
71,007

 
1,248,405

Total
71,007

 
$
53.26

 
71,007

 
1,248,405

 
 
 
 
 
 
 
 
(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 stock 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 3: DEFAULTS UPON SENIOR SECURITIES

None
ITEM 4: MINE SAFETY DISCLOSURES

Not applicable.
ITEM 5: OTHER INFORMATION

None

51



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.

2.1

3.1

3.2

3.3

3.4

3.5

3.6

3.7

3.8

*12.1

*31.1

*31.2

**32.1

**32.2

101
Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2018, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheet at September 30, 2018 and December 31, 2017; (ii) Consolidated Statement of Income for the three and nine months ended September 30, 2018 and 2017; (iii) Consolidated Statement of Comprehensive Income for the three and nine months ended September 30, 2018 and 2017; (iv) Consolidated Statement of Changes in Equity for the nine months ended September 30, 2018 and 2017; (v) Consolidated Statement of Cash Flows for the nine months ended September 30, 2018 and 2017; and (vi) Notes to Financial Statements.

* Filed herewith

52



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

53



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Clayton, State of Missouri on the day of October 26, 2018.
 
 
ENTERPRISE FINANCIAL SERVICES CORP
 
 
 
By:
/s/ James B. Lally
 
 
 
James B. Lally
 
 
 
Chief Executive Officer
 
 
 
 
By: 
/s/ Keene S. Turner
 
 
 
Keene S. Turner
 
 
 
Chief Financial Officer
 



54