EFSCP - Enterprise Financial Services: One Of The Last Good 8% Regional Bank Preferred Shares

2023-08-10 14:00:04 ET

Summary

• Enterprise Financial Services' preferred shares offer an 8% yield, making them an attractive investment in the regional banking sector.
• The bank's second quarter earnings showed strong growth in interest income and net interest income, resulting in a 10% increase in net income.
• Enterprise Financial has experienced growth in its loan portfolio and deposits, bucking industry trends, and has successfully mitigated the risk posed by uninsured deposits.

Enterprise Financial Services ( EFSC ), a regional bank with ties to the Midwest and southwestern United States, announced their second quarter earnings a couple of weeks ago. Despite a broad rally in the regional banking sector, Enterprise Financial’s preferred shares ( EFSCP ) have continued to trade near the same levels they did earlier this spring. The result is one of the few remaining 8% yielding preferred shares in the regional banking sector that I would recommend buying.

Enterprise Financial’s second quarter earnings were strong relative to the same quarter a year ago. Interest income increased by more than $70 million. Since interest expenses increased by less than that ($40 million), the bank saw a $25 million increase in net interest income after accounting for loan loss provisions. The bank did see a majority of its net interest income gains consumed by higher overhead expenses, but net income still finished the quarter up nearly 10% from the same quarter a year ago at $49 million.

Enterprise Financial’s balance sheet has also showed good gains for the first six months of 2023. This year, the bank has grown its loan portfolio by more than $700 million to $10.3 billion, while simultaneously preserving its $2.3 billion securities portfolio and reducing its outside borrowings. The main driver behind the funding of the bank’s new loans comes from its growth in brokered CD deposits, which contributed greatly to a nearly $800 million increase in deposits.

Enterprise Financial Services is bucking the industry trends when it comes to growth and leverage. While the banking sector marginally grew its loans in the second quarter and lost deposits, Enterprise Financial grew loans by 5% and grew deposits by more than 4%. The bank’s 7.57 leverage ratio is also well under the industry’s benchmark of 9.45 to 1.

While practically all the major types of loans in Enterprise Financial’s loan portfolio have grown in 2023, an emphasis has been placed on commercial and industrial loans. These are not real estate loans, but loans that are used to finance working capital (like inventory) and capital expenditures. The bank does have commercial real estate loans that are equally divided between owner occupied and non-owner occupied.

While the emphasis across the economy has been to focus on commercial real estate as a risky loan investment, the CRE portfolio at Enterprise Financial has seen its nonperforming loans decrease this year. The commercial and industrial loans have seen their nonperformance tick up noticeably, but it is important to note that the collateral here is more liquid and can likely be partially recovered by the bank.

There are some risks to be aware of, the biggest being the growing interest expenses for the bank. While the bank is attracting new deposits, it has increased its interest expense by nearly 70 basis points in one quarter. Combined with a less than 30 basis point increase in interest bearing asset yields, the net interest spread is down 40 basis points in the quarter. The net interest margin, which considers the weights of assets and liabilities, is also down 22 basis points. Higher interest rates are becoming a headwind for the bank.

Another challenge that Enterprise Financial has taken head-on is uninsured deposits. At the end of 2022, more than half of the bank’s deposits were uninsured, leaving it vulnerable to a run. Now, thanks to reciprocal deposits and pass through insurance, uninsured deposits have dropped by $2.6 billion, to 28% of total deposits. With available liquidity of over $4 billion, the bank has successfully mitigated the risk posed by uninsured depositors.

Enterprise Financial Services’ second quarter earnings did nothing but bolster my confidence in the bank’s preferred shares. The growth in lending and deposits allowed the bank to grow shareholder equity and earnings in the second quarter. While interest rate headwinds may undermine the bank’s earnings, it is clearly generating enough net income to cover its preferred dividends.

For further details see: