EFSCP - Enterprise Financial Services: A Strong Q4 Bodes Well For 2023

Summary

• EFSC reported a strong Q4 result as the net income increased to $1.59 per share.
• The bank has one series of preferred shares outstanding, yielding 6.4% at the current share price.
• Investors interested in capital gains should look at the common shares. Investors interested in income should focus on the preferred shares.

Introduction

About a year ago, I had a closer look at Enterprise Financial Services ( EFSC ) as the bank had completed its acquisition of the First Choice Bank in California. This helped the Missouri-based bank to expand its reach and become active in new regions.

The net interest income is increasing

During the final quarter of 2022, the bank saw its interest income increase by approximately 15% compared to the third quarter and although the interest expenses increased by just over 50%, the net interest income increased by about 10% as the relative increase in interest expenses represented an absolute increase of just $6.5M.

The bank was also able to boost its non-interest income from $9.5M to $16.9B but this was mainly caused by a tax credit income of $2.4M which was a $6M improvement from a tax credit loss in the third quarter. If one would compare apples to apples, the adjusted non-interest income would have come in at $14.5M in Q4 of 2022 versus about $13M in the third quarter. It still is an improvement, and that’s the most important.

The total amount of non-interest expenses increased to $77.1M and this resulted in a pre-tax and pre loan loss provision income of approximately $78.5M. As the bank recorded a $2.1M loan loss provision, its pre-tax income for the quarter was $76.4M while the bottom line shows a net income of $60M. From that result, we still need to deduct the just under $1M in preferred dividend payments which means the net income attributable to the common shareholders was just over $59M for an EPS of $1.59 (note: the image below shows the diluted EPS of $1.58).

Looking at the full-year results, Enterprise Financial Services reported a net income of $199M for an EPS of $5.32.

EFSC currently pays a quarterly dividend of $0.24 , for a dividend of approximately $0.96 per share on an annualized basis. This means that while the dividend is very well covered (the payout ratio is less than 20% based on the full-year EPS and just 15% based on the Q4 EPS), the dividend yield is pretty low and investors looking for a dividend income will likely glance over EFSC.

Looking for income? Try the preferred shares

Income-focused investors may be interested in having a look at Enterprise’s preferred shares. The non-cumulative preferred shares are trading with ( EFSCP ) as ticker symbol and offer a 5% preferred dividend ($1.25 per year, payable in four equal quarterly tranches). The preferred shares can be called from December 2026 on.

The share price of the preferred share has recently gained back a lot of the ground it lost during 2022 and closed on Tuesday at $19.41 per share. This means the yield has increased to just over 6.4%. That’s slightly higher than the preferred dividend yield offered by the mega-banks, but in line with the yields offered by other smaller and more regionally focused banks.

One could argue the yield to call is a very appealing 12.2% and while that is theoretically correct I don’t think that’s a fair or credible metric at this point. Given the current situation on the markets and the current market interest rates, I think the likelihood of EFSC calling perpetual equity with a cost of just 5% to be minimal. And as the preferred dividend is costing the bank just under $4M per year I don’t think they will bother calling the preferred shares. Never say never, and December 2026 still is almost 4 years away and the situation on the markets may change, but I am not counting on EFSC calling its preferred shares in 2026.

I like the preferred shares because the bank needs less than 2% of its net income to cover the preferred dividends, so even if the loan loss provisions would increase by a four digit percentage, the preferred dividend would still be very handsomely covered. Even if the bank would have to put aside 100 basis points per year of its entire $9.7B loan book, the payout ratio of the preferred dividends would still be less than 3%.

Investment thesis

Enterprise Financial Services should be in a position to rapidly increase its tangible book value per share, which will likely exceed $32 by the end of this year. Based on the Q4 performance, the bank should be able to retain in excess of $5/share in earnings on an annual basis and barring any unforeseen shocks in the value of the portfolio of securities available for sale, it is safe to assume its TBV will increase pretty fast.

That’s the main reason why I would not be opposed to paying 1.8-1.9 times the YE 2022 tangible book value of just over $28 per share. By the end of 2024, the TBVPS should increase into the high-$30s range which would reduce the premium to the tangible book value per share to just around 30% which is very reasonable for a bank which clearly focuses on building book value over paying dividends.

Investors focusing on capital gains should have a closer look at the common shares. But people looking for a steady income stream may consider the preferred shares which are currently yielding just over 6.4% per year, even after the 5% share price boost on Tuesday after the bank reported its financial results.

I currently have no position in the common shares nor the preferred shares, but I will be keeping close tabs on EFSC. I may buy some of the preferred shares on a weak day as I like how this bank is performing.

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