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 June 30, 2003 [_] 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 (Exact Name of Registrant as Specified in its Charter) Delaware 43-1706259 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 150 North Meramec, Clayton, MO 63105 (Address of Principal Executive Offices) Zip Code) Registrant's telephone number, including area code: 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 (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities and Exchange Act of 1934). Yes [_] No [X] Indicate the number of shares outstanding of each of the Registrant's classes of common stock as of July 30, 2003: Common Stock, $.01 par value, 9,565,123 shares outstanding ================================================================================
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES TABLE OF CONTENTS Page ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements (unaudited): Consolidated Balance Sheets At June 30, 2003 and December 31, 2002...................................1 Consolidated Statements of Operations Three Months and Six Months Ended June 30, 2003 and 2002.................2 Consolidated Statements of Comprehensive Income Three Months and Six Months Ended June 30, 2003 and 2002.................3 Consolidated Statements of Cash Flows Six Months Ended June 30, 2003 and 2002..................................4 Notes to Consolidated Financial Statements...............................5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...............................12 Item 3. Quantitative and Qualitative Disclosures Regarding Market Risk ............................................24 Item 4. Controls and Procedures...........................................26 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders...............27 Item 6. Exhibits and Reports on Form 8-K..................................28 Signatures.................................................................29 Certifications.............................................................34
PART I - Item 1 ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Consolidated Balance Sheets (unaudited) <TABLE> <CAPTION> At June 30, At December 2003 31, 2002 -------------- -------------- <S> <C> <C> Assets - -------------------------------------------------------- Cash and due from banks $ 34,750,387 $ 39,052,123 Federal funds sold 19,374,035 33,367,011 Interest-bearing deposits 409,242 66,349 Investments in debt and equity securities: Available for sale, at estimated fair value 57,440,553 66,618,556 Held to maturity, at amortized cost (estimated fair value of $11,240 at June 30, 2003 and $12,780 at December 31, 2002) 11,042 12,600 -------------- -------------- Total investments in debt and equity securities 57,451,595 66,631,156 -------------- -------------- Loans held for sale 5,087,901 6,991,421 Loans, less unearned loan fees 735,733,218 679,799,399 Less allowance for loan losses 9,538,999 8,600,001 -------------- -------------- Loans, net 726,194,219 671,199,398 -------------- -------------- Other real estate owned 344,985 125,000 Fixed assets, net 7,051,019 7,685,682 Accrued interest receivable 3,265,711 3,458,596 Goodwill 1,937,537 2,087,537 Assets held for sale -- 36,401,416 Prepaid expenses and other assets 10,417,177 9,720,812 -------------- -------------- Total assets $ 866,283,808 $ 876,786,501 ============== ============== Liabilities and Shareholders' Equity - -------------------------------------------------------- Deposits: Demand $ 161,499,276 $ 155,596,970 Interest-bearing transaction accounts 49,764,531 59,058,224 Money market accounts 347,458,697 341,589,829 Savings 4,398,609 3,420,987 Certificates of deposit: $100,000 and over 138,271,640 105,030,371 Other 46,621,545 51,617,893 -------------- -------------- Total deposits 748,014,298 716,314,274 Guaranteed preferred beneficial interests in subordinated debentures 15,000,000 15,000,000 Federal Home Loan Bank advances 29,107,802 29,464,044 Notes payable and other borrowings 2,358,550 2,358,753 Accrued interest payable 1,137,479 1,264,600 Liabilities held for sale -- 50,053,023 Accounts payable and accrued expenses 7,544,844 3,521,857 -------------- -------------- Total liabilities 803,162,973 817,976,551 -------------- -------------- Shareholders' equity: Commonstock, $.01 par value; authorized 20,000,000 shares; issued and outstanding 9,565,123 shares at June 30, 2003 and 9,497,794 shares at December 31, 2002 95,651 94,978 Surplus 39,208,558 38,401,814 Retained earnings 22,025,146 18,673,619 Accumulated other comprehensive income 1,791,480 1,639,539 -------------- -------------- Total shareholders' equity 63,120,835 58,809,950 -------------- -------------- Total liabilities and shareholders' equity $ 866,283,808 $ 876,786,501 ============== ============== </TABLE> See accompanying notes to unaudited consolidated financial statements. 1
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Consolidated Statements of Operations (unaudited) <TABLE> <CAPTION> Three months ended June 30, Six months ended June 30, 2003 2002 2003 2002 ------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> Interest income: Interest and fees on loans $ 10,304,683 $ 10,963,836 $ 20,673,687 $ 21,425,740 Interest on debt and equity securities: Taxable 421,415 373,042 888,776 818,082 Nontaxable 4,366 -- 4,553 917 Interest on federal funds sold 48,091 35,400 86,083 127,226 Interest on interest-bearing deposits 50 5,444 107 22,576 Dividends on equity securities 18,875 14,640 33,561 27,284 ------------- ------------- ------------- ------------- Total interest income 10,797,480 11,392,362 21,686,767 22,421,825 ------------- ------------- ------------- ------------- Interest expense: Interest-bearing transaction accounts 48,906 68,817 101,283 137,228 Money market accounts 885,293 1,212,304 1,812,196 2,486,669 Savings 3,380 22,159 17,775 42,879 Certificates of deposit: $100,000 and over 740,637 789,423 1,408,884 1,618,699 Other 377,379 1,061,615 940,694 2,273,051 Guaranteed preferred beneficial interests in subordinated debentures 308,830 262,607 617,424 521,107 Federal Home Loan Bank borrowings 312,199 177,736 602,505 361,836 Notes payable and other borrowings 18,188 47,399 28,839 63,140 ------------- ------------- ------------- ------------- Total interest expense 2,694,812 3,642,060 5,529,600 7,504,609 ------------- ------------- ------------- ------------- Net interest income 8,102,668 7,750,302 16,157,167 14,917,216 Provision for loan losses 1,093,962 530,000 2,093,326 1,120,000 ------------- ------------- ------------- ------------- Net interest income after provision for loan losses 7,008,706 7,220,302 14,063,841 13,797,216 ------------- ------------- ------------- ------------- Noninterest income: Service charges on deposit accounts 406,192 448,747 892,819 860,641 Trust and financial advisory income 669,902 540,077 1,259,457 1,169,133 Other service charges and fee income 90,656 83,351 187,168 173,784 Gain on sale of mortgage loans 586,568 284,906 1,114,430 645,243 Gain on sale of securities -- -- 77,884 -- Gain on sale of branches 2,937,976 -- 2,937,976 -- Recoveries and income from Merchant Banc investments -- 88,889 -- 88,889 ------------- ------------- ------------- ------------- Total noninterest income 4,691,294 1,445,970 6,469,734 2,937,690 ------------- ------------- ------------- ------------- Noninterest expense: Salaries 4,039,882 3,352,464 7,802,776 6,812,546 Payroll taxes and employee benefits 634,805 650,949 1,348,889 1,322,153 Occupancy 498,879 460,250 974,917 917,826 Furniture and equipment 233,014 254,853 454,446 506,843 Data processing 269,843 259,550 512,233 512,594 Other 1,900,596 1,388,840 3,516,550 2,927,631 ------------- ------------- ------------- ------------- Total noninterest expense 7,577,019 6,366,906 14,609,811 12,999,593 ------------- ------------- ------------- ------------- Income before income tax expense 4,122,981 2,299,366 5,923,764 3,735,313 Income tax expense 1,524,609 850,124 2,190,294 1,414,713 ------------- ------------- ------------- ------------- Net income $ 2,598,372 $ 1,449,242 $ 3,733,470 $ 2,320,600 ============= ============= ============= ============= Per share amounts Basic earnings per share $ 0.27 $ 0.15 $ 0.39 $ 0.25 Basic weighted average common shares outstanding 9,560,529 9,399,560 9,541,552 9,349,433 Diluted earnings per share $ 0.26 $ 0.15 $ 0.38 $ 0.24 Diluted weighted average common shares outstanding 9,892,558 9,575,650 9,855,507 9,576,225 </TABLE> See accompanying notes to unaudited consolidated financial statements. 2
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (unaudited) <TABLE> <CAPTION> Three months ended June 30, Six months ended June 30, 2003 2002 2003 2002 ------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> Net income $ 2,598,372 $ 1,449,242 $ 3,733,470 $ 2,320,600 Other comprehensive income: Unrealized gain on investment securities arising during the period, net of tax 129,647 163,944 73,824 24,758 Less reclassification adjustment for realized gain on sale of securities included in net income, net of tax -- -- (51,903) -- Unrealized gain on cash flow type derivative instruments arising during the period, net of tax 89,100 786,060 130,020 560,340 ------------- ------------- ------------- ------------- Total other comprehensive income 218,747 950,004 151,941 585,098 ------------- ------------- ------------- ------------- Total comprehensive income $ 2,817,119 $ 2,399,246 $ 3,885,411 $ 2,905,698 ============= ============= ============= ============= </TABLE> See accompanying notes to unaudited consolidated financial statements. 3
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Consolidated Statements of Cash Flows (unaudited) <TABLE> <CAPTION> Six months ended June 30, 2003 2002 ------------ ------------ <S> <C> <C> Cash flows from operating activities: Net income $ 3,733,470 $ 2,320,600 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 695,498 871,158 Provision for loan losses 2,093,326 1,120,000 Net amortization of debt and equity securities 511,517 388,346 Recovery on Merchant Banc investments -- 88,889 Mortgage loans originated (61,338,117) (29,149,314) Proceeds from mortgage loans sold 64,356,066 37,203,649 Gain on sale of mortgage loans (1,114,430) (645,243) Noncash compensation expense attributed to stock option grants 136,169 103,262 Decrease (increase) in accrued interest receivable 192,885 (637,396) (Decrease) increase in accrued interest payable (127,121) 265,292 Gain on sale of branches (2,937,976) -- Final settlement due in sale of branches 1,447,450 -- Other, net 658,042 59,883 ------------ ------------ Net cash provided by operating activities 8,336,779 11,989,126 ------------ ------------ Cash flows from investing activities: Cash paid in sale of branches (15,241,261) -- Purchases of available for sale debt and equity securities (32,732,760) (16,387,077) Proceeds from sale of available for sale debt securities 11,115,471 -- Proceeds from maturities and principal paydowns on available for sale debt and equity securities 30,303,217 21,162,540 Proceeds from maturities and principal paydowns on held to maturity debt securities 1,558 100,000 Proceeds from redemption of FHLB stock 300 1,000 Net increase in loans (49,448,499) (63,210,415) Recoveries of loans previously charged off 145,552 39,214 Proceeds from sale of fixed assets -- 15,578 Purchases of fixed assets (124,270) (324,702) ------------ ------------ Net cash used in investing activities (55,980,692) (58,603,862) ------------ ------------ Cash flows from financing activities: Net increase in non-interest bearing deposit accounts 5,218,562 13,201,141 Net increase (decrease) in interest bearing deposit accounts 24,540,469 (7,923,917) Maturities and paydowns of Federal Home Loan Bank advances (130,356,242) (3,035,621) Proceeds from borrowings of Federal Home Loan Bank advances 130,000,000 2,700,000 Paydowns of notes payable (100,000) (2,366,667) Proceeds from notes payable 100,000 1,000,000 Proceeds from sale of guaranteed preferred beneficial interest in subordinated debentures -- 4,000,000 Cash dividends paid (381,943) (327,917) Proceeds from the exercise of common stock options 671,248 587,050 ------------ ------------ Net cash provided by financing activities 29,692,094 7,834,069 ------------ ------------ Net decrease in cash and cash equivalents (17,951,819) (38,780,667) Cash and cash equivalents, beginning of period 72,485,483 84,236,186 ------------ ------------ Cash and cash equivalents, end of period $ 54,533,664 $ 45,455,519 ============ ============ Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 5,656,721 $ 7,239,317 Income taxes 1,566,062 1,079,100 ============ ============ Noncash transactions Transfer to other real estate owned in settlement of loans $ 344,985 $ 35,000 Write off of goodwill associated with sale of branches 150,000 -- </TABLE> See accompanying notes to unaudited consolidated financial statements. 4
ENTERPRISE FINANCIAL SERVICES CORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. The accompanying consolidated financial statements of Enterprise Financial Services Corp and subsidiaries (the "Company" or "Enterprise Financial") are unaudited and should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. In the opinion of management, all adjustments consisting of normal recurring accruals considered necessary for a fair presentation of the results of operations for the interim periods presented herein have been included. Operating results for the three and six month periods ended June 30, 2003 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2003. The consolidated financial statements include the accounts of Enterprise Financial Services Corp and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain amounts in the consolidated financial statements for the year ended December 31, 2002 have been reclassified to conform to the 2003 presentation. Such reclassifications had no effect on previously reported consolidated net income or shareholders' equity. (2) Segment Disclosure Management segregates the Company into three distinct businesses for evaluation purposes: Enterprise Bank; Enterprise Trust; and Corporate, Intercompany, and Reclassifications. The segments are evaluated separately on their individual performance, as well as their contribution to the Company as a whole. The Corporate, Intercompany, and Reclassifications segment includes the holding company and trust preferred securities activities. The Company incurs general corporate expenses and owns Enterprise Bank. The majority of the Company's assets and income result from Enterprise Bank (the "Bank"). The Bank consists of three banking branches and an operations center in the St. Louis County area, two banking branches in the Kansas City region and three banking branches in the Southeast Kansas region (which were sold on April 4, 2003). The products and services offered by the banking branches include a broad range of commercial and personal banking services, including certificates of deposit, individual retirement and other time deposit accounts, checking and other demand deposit accounts, interest checking accounts, savings accounts and money market accounts. Loans include commercial, financial and agricultural, real estate construction and development, commercial and residential real estate, consumer and installment loans. Other financial services include mortgage banking, debit and credit cards, automatic teller machines, internet account access, safe deposit boxes, and treasury management services. Enterprise Trust, which is a division of the Bank, provides fee-based personal and corporate financial consulting and trust services. Personal financial consulting includes estate planning, investment management, and retirement planning. Corporate consulting services are focused in the areas of retirement plans, management compensation and management succession issues. 5
The following are the financial results and balance sheet information for the Company's operating segments as of June 30, 2003 and December 31, 2002, and for the three and six month periods ended June 30, 2003 and 2002 (unaudited): <TABLE> <CAPTION> Corporate, Inter company, and Enterprise Enterprise Reclassifi- Bank Trust cations Total -------------- ------------ ------------ -------------- <S> <C> <C> <C> <C> Balance Sheet Information: June 30, 2003 - --------------------------------------- Loans, less unearned loan fees $ 735,733,218 $ -- $ -- $ 735,733,218 Goodwill 1,937,537 -- -- 1,937,537 Deposits 749,486,794 -- (1,472,496) 748,014,298 Borrowings 31,466,352 -- 15,000,000 46,466,352 Total assets $ 864,431,227 $ -- $ 1,852,581 $ 866,283,808 ============== ============ ============ ============== </TABLE> <TABLE> <CAPTION> Corporate, Inter company, and Enterprise Enterprise Reclassifi- Bank Trust cations Total -------------- ------------ ------------ -------------- <S> <C> <C> <C> <C> December 31, 2002 - --------------------------------------- Loans, less unearned loan fees $ 679,799,399 $ -- $ -- $ 679,799,399 Assets held for sale 36,401,416 -- -- 36,401,416 Goodwill 2,087,537 -- -- 2,087,537 Deposits 717,135,113 -- (820,839) 716,314,274 Borrowings 31,822,797 -- 15,000,000 46,822,797 Liabilities held for sale 50,053,023 -- -- 50,053,023 Total assets $ 873,035,220 $ -- $ 3,751,281 $ 876,786,501 ============== ============ ============ ============== </TABLE> 6
<TABLE> <CAPTION> Corporate, Inter company, and Enterprise Enterprise Reclassifi- Bank Trust cations Total -------------- ------------ ------------ -------------- <S> <C> <C> <C> <C> Income Statement Information: Three months ended June 30, 2003 - --------------------------------------- Net interest income $ 8,384,465 $ 27,783 $ (309,580) $ 8,102,668 Provision for loan losses 1,093,962 -- -- 1,093,962 Other noninterest income 4,018,588 689,675 (16,969) 4,691,294 Other noninterest expense 6,192,150 798,328 586,541 7,577,019 -------------- ------------ ------------ -------------- Income (loss) before income tax expense 5,116,941 (80,870) (913,090) 4,122,981 Income tax expense (benefit) 1,891,321 (29,922) (336,790) 1,524,609 -------------- ------------ ------------ -------------- Net income (loss) $ 3,225,620 $ (50,948) $ (576,300) $ 2,598,372 ============== ============ ============ ============== </TABLE> <TABLE> <CAPTION> Corporate, Inter company, and Enterprise Enterprise Reclassifi- Bank Trust cations Total -------------- ------------ ------------ -------------- <S> <C> <C> <C> <C> Three months ended June 30, 2002 - --------------------------------------- Net interest income $ 8,018,738 $ 13,949 $ (282,385) $ 7,750,302 Provision for loan losses 530,000 -- -- 530,000 Other noninterest income 803,923 553,156 88,891 1,445,970 Other noninterest expense 5,029,340 722,774 614,792 6,366,906 -------------- ------------ ------------ -------------- Income (loss) before income tax expense 3,263,321 (155,669) (808,286) 2,299,366 Income tax expense (benefit) 1,167,871 (67,598) (250,149) 850,124 -------------- ------------ ------------ -------------- Net income (loss) $ 2,095,450 $ (88,071) $ (558,137) $ 1,449,242 ============== ============ ============ ============== </TABLE> <TABLE> <CAPTION> Corporate, Inter company, and Enterprise Enterprise Reclassifi- Bank Trust cations Total -------------- ------------ ------------ -------------- <S> <C> <C> <C> <C> Six months ended June 30, 2003 - --------------------------------------- Net interest income $ 16,727,094 $ 47,313 $ (617,240) $ 16,157,167 Provision for loan losses 2,093,326 -- -- 2,093,326 Other noninterest income 5,192,620 1,298,676 (21,562) 6,469,734 Other noninterest expense 11,729,473 1,567,421 1,312,917 14,609,811 -------------- ------------ ------------ -------------- Income (loss) before income tax expense 8,096,915 (221,432) (1,951,719) 5,923,764 Income tax expense (benefit) 2,991,669 (81,930) (719,445) 2,190,294 -------------- ------------ ------------ -------------- Net income (loss) $ 5,105,246 $ (139,502) $ (1,232,274) $ 3,733,470 ============== ============ ============ ============== </TABLE> <TABLE> <CAPTION> Corporate, Inter company, and Enterprise Enterprise Reclassifi- Bank Trust cations Total -------------- ------------ ------------ -------------- <S> <C> <C> <C> <C> Six months ended June 30, 2002 - --------------------------------------- Net interest income $ 15,444,986 $ 28,544 $ (556,314) $ 14,917,216 Provision for loan losses 1,120,000 -- -- 1,120,000 Other noninterest income 1,668,052 1,197,943 71,695 2,937,690 Other noninterest expense 10,472,452 1,382,323 1,144,818 12,999,593 -------------- ------------ ------------ -------------- Income (loss) before income tax expense 5,520,586 (155,836) (1,629,437) 3,735,313 Income tax expense (benefit) 2,042,874 (78,880) (549,281) 1,414,713 -------------- ------------ ------------ -------------- Net income (loss) $ 3,477,712 $ (76,956) $ (1,080,156) $ 2,320,600 ============== ============ ============ ============== </TABLE> 7
(3) Derivative Instruments and Hedging Activities The Company began utilizing derivative instruments to assist in the management of interest rate sensitivity and to modify the repricing, maturity and option characteristics of certain assets and liabilities in the first quarter of 2002. The Company uses such derivative instruments solely to reduce its interest rate exposure. The following is a summary of the Company's accounting policies for derivative instruments and hedging activities under Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. Interest Rate Swap Agreements - Cash Flow Hedges. Interest rate swap agreements designated as cash flow hedges are accounted for at fair value. The effective portion of the change in the cash flow hedge's gain or loss is initially reported as a component of other comprehensive income net of taxes and subsequently reclassified into noninterest income when the underlying transaction affects earnings. The ineffective portion of the change in the cash flow hedge's gain or loss is recorded in earnings on each quarterly measurement date. The swap agreements are accounted for on an accrual basis with the net interest differential being recognized as an adjustment to interest income or interest expense of the related asset or liability. For the three and six months ended June 30, 2003, a net interest differential of $425,795 and $821,679, respectively, was included in interest income on loans. For the three and six months ended June 30, 2002, a net interest differential of $255,689 and $435,834, respectively, was included in interest income on loans. The Bank entered into three interest rate swaps in order to limit exposure from falling interest rates. The first swap was executed in January 2002 and had a $40 million notional amount, a term of two years and obligated the Bank to pay an adjustable rate equivalent to the prime rate and receive a fixed rate of 6.255%. The second swap was also executed in January 2002 and was a "receive fixed" interest rate of 6.97% and paid an adjustable rate equivalent to the prime rate, had a notional amount of $20 million and a term of three years. The third interest rate swap, executed in March 2003, was a "receive fixed" interest rate of 5.3425% and paid an adjustable rate equivalent to the prime rate, had a notional amount of $30 million and a term of three years. The swaps pay interest on a quarterly basis and the net cash flow paid or received is included in interest income on loans. The swaps qualify as "cash flow hedges" under SFAS No. 133, so changes in the fair value of the swaps are recognized as part of other comprehensive income. On June 30, 2003, the Bank had $2.4 million in cash collateral from the counter party on the interest rate swap agreements, which is included on the balance sheet as notes payable and other borrowings. The cash collateral is interest bearing at an interest rate that floats with the six month London Inter Bank Offered Rate ("LIBOR"). Interest Rate Swap Agreements - Fair Value Hedges. Interest rate swap agreements designated as fair value hedges are accounted for at fair value. Changes in the fair value of the swap agreements are recognized currently in noninterest income. The change in the fair value on the underlying hedged item attributable to the hedged risk adjusts the carrying amount of the underlying hedged item and is also recognized currently in noninterest income. All changes in fair value are measured on a quarterly basis. The Bank entered into two interest rate swaps to limit the risk of a change in the fair value of the fixed interest rate brokered CDs obtained simultaneously. In May 2002, the Bank executed a swap with a $20 million notional amount, a term of two years and obligated the Bank to pay an adjustable rate equivalent to the three-month LIBOR plus 19 basis points and receive a fixed rate of 3.55%. The terms allow for semiannual payments for both sides of the swap. In April 2003, the Bank executed a swap with a $10 million notional amount, a term of three years and obligated the Bank to pay an adjustable rate equivalent to the three-month LIBOR plus 11.3 basis points and receive a fixed rate of 2.45%. The terms allow for semiannual payments on both sides. The swaps qualify for the "shortcut method" under SFAS No. 133. As a result, changes in the fair value of the swaps directly offset changes in the fair value of the hedged item (i.e., brokered CDs). The impact of the swaps on the Company's statement of operations is that it converts the fixed interest rate on the brokered CDs to a variable interest rate. The swap agreements are accounted for on an accrual basis with the net interest differential being recognized as an adjustment to interest income or interest expense of the related asset or liability. For the three and six months ended June 30, 2003, a net interest differential of $132,933 and $231,045, respectively, decreased interest expense on certificates of deposit. For the three and six months ended June 30, 2002, a net interest differential of $39,726 decreased interest expense on certificates of deposit. 8
The maturity dates, notional amounts, interest rates paid and received and fair value of our interest rate swap agreements as of June 30, 2003 were as follows: Interest Maturity Notional Interest Rate Fair Hedge Date Amount Rate Paid Received Value - ---------- --------- ------------ --------- --------- ------------ Cash flow 1/29/2005 $ 20,000,000 4.00% 6.97% $ 978,542 Cash flow 1/29/2004 40,000,000 4.00 6.26 679,001 Fair Value 5/10/2004 20,000,000 1.47 3.55 434,229 Cash flow 3/21/2006 30,000,000 4.00 5.34 557,593 Fair Value 4/17/2006 10,000,000 1.41 2.45 153,838 The notional amounts of derivative financial instruments do not represent amounts exchanged by the parties and, therefore, are not a measure of the Banks' credit exposure through its use of these instruments. The credit exposure represents the accounting loss the Bank would incur in the event the counter parties failed completely to perform according to the terms of the derivative financial instruments and the collateral held to support the credit exposure was of no value. On June 30, 2003 the Bank had credit exposure of $1,148,780. (4) New Accounting Standards In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of SFAS No. 146 on January 1, 2003 did not have a material effect on the Company's consolidated financial statements. In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim and annual periods ending after December 15, 2002. We have implemented the requirements of FASB Interpretation No. 45 and determined they did not have a material effect on our consolidated financial statements other than the additional disclosure requirements. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosures modifications are required for fiscal years ending after December 15, 2002 and are included in note 6 to these consolidated financial statements. In April 2003, the FASB issued SFAS No.149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The provisions of this Statement are applied prospectively. We are currently evaluating the requirements of SFAS No. 149 and believe such requirements will not have a material effect on our consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer clarifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We are currently evaluating the requirements of SFAS No. 150 and believe such requirements will not have a material effect on our consolidated financial statements. 9
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. This Interpretation established accounting guidance for consolidation of variable interest entities (VIE) that function to support the activities of the primary beneficiary. The primary beneficiary of a VIE entity is the entity that absorbs a majority of the VIE's expected losses, receives a majority of the VIE's expected residual returns, or both, as a result of ownership, controlling interest contractual relationship or other business relationship with a VIE. Prior to the implementation of FIN 46, VIEs were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity. The provisions of FIN 46 were effective immediately for all arrangements entered into after January 31, 2003, and are otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company has two statutory trusts that were formed, prior to January 31, 2003, for the purpose of issuing Trust Preferred Securities (see note 11 to the annual consolidated financial statements). These statutory trusts will be subjected to FIN 46 in the third quarter of 2003. We currently believe the continued consolidation of these trusts is appropriate under FIN 46. However, the application of FIN 46 to this type of trust is an emerging issue and a possible unintended consequence of FIN 46 is the deconsolidation of these trusts. The deconsolidation of these statutory trusts would not have a material effect on our consolidated balance sheet or our consolidated statement of operations. In July 2003, the Board of Governors of the Federal Reserve System issued a supervisory letter instructing bank holding companies to continue to include the trust preferred securities in their Tier I capital for regulatory capital purposes until notice is given to the contrary. The Federal Reserve intends to review the regulatory implications of any accounting treatment changes and, if necessary or warranted, provide further appropriate guidance. There can be no assurance that the Federal Reserve will continue to allow institutions to include trust preferred securities in Tier I capital for regulatory capital purposes. (5) Sale of Southeast Kansas Branches On April 4, 2003, the Company transferred loans of $27.2 million, fixed assets of $1.1 million, and deposits of $48.2 when it sold its Humboldt, Chanute and Iola, Kansas branches ("Southeast Kansas branches") to Emprise Financial Corporation based in Wichita, Kansas. Assets of $36.4 million and deposits of $50.1 million associated with these branches are shown as "held for sale" on the Company's balance sheet at December 31, 2002. The Company received a 2.5% premium on loans and a 4.75% premium on deposits, which generated a $3.1 million pretax gain less a $150,000 write-off of related goodwill associated with these branches. All other items were sold at book value. There were approximately $343,000 in expenses incurred related to the sale. The sale was subject to the satisfaction of customary conditions, including regulatory approvals. The Southeast Kansas branches were included in the Enterprise Banking segment. (6) Stock Option Plans As allowed by SFAS No. 148, the Company has elected to apply the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, issued in March 2000, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 148. The following table illustrates the effect on net income if the fair-value-based method had been applied to all outstanding and unvested awards in each period. 10
<TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, 2003 2002 2003 2002 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Net income, as reported $ 2,598,372 $ 1,449,242 $ 3,733,470 $ 2,320,600 Deduct total stock-based employee compensation expense determined under fair-value-based method for all rewards, net of tax (298,187) (133,792) (519,650) (277,615) ------------ ------------ ------------ ------------ Pro forma net income $ 2,300,185 $ 1,315,450 $ 3,213,820 $ 2,042,985 ============ ============ ============ ============ Earnings per share: Basic: As reported $ 0.27 $ 0.15 $ 0.39 $ 0.25 Pro forma 0.24 0.14 0.34 0.22 Diluted: As reported $ 0.26 $ 0.15 $ 0.38 $ 0.24 Pro forma 0.23 0.14 0.33 0.21 </TABLE> (7) Disclosures about Financial Instruments The Bank 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 and standby letters of credit is represented by the contractual amount of these instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets. At June 30, 2003 and December 31, 2002, no amounts have been accrued for any estimated losses for these financial instruments. The contractual amount of off-balance-sheet financial instruments as of June 30, 2003 and December 31, 2002 is as follows: June 30, December 31, 2003 2002 -------------- -------------- Commitments to extend credit $ 212,545,104 $ 183,070,617 Standby letters of credit 20,985,636 17,755,979 ============== ============== 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 generally have fixed expiration dates or other termination clauses and may require payment of a fee. Of the total commitments to extend credit at June 30, 2003, $7,736,501 represents fixed rate loan commitments. Of the total commitments to extend credit at December 31, 2002, $6,070,659 represents fixed rate loan commitments. Since certain of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank 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. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support contractual obligations of the Bank's customers. The credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers. The approximate remaining terms of standby letters of credit range from 1 month to 9 years at June 30, 2003. 11
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 Readers should note that in addition to the historical information contained herein, some of the information in this report contains forward-looking statements within the meaning of the federal securities laws. Forward-looking statements typically are identified with use of terms such as "may," "will," "expect," "anticipate," "estimate" and similar words, although some forward-looking statements are expressed differently. You should be aware that the Company's actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including burdens imposed by federal and state regulation of banks, credit risk, exposure to local economic conditions, risks associated with rapid increase or decrease in prevailing interest rates and competition from banks and other financial institutions, all of which could cause the Company's actual results to differ from those set forth in the forward-looking statements. Introduction This discussion summarizes the significant factors affecting the consolidated financial condition, results of operations, liquidity and cash flows of the Company for the three and six month periods ended June 30, 2003 compared to the three and six month periods ended June 30, 2002 and the year ended December 31, 2002. This discussion should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. Financial Condition Total assets at June 30, 2003 were $866 million, a decrease of $11 million, or 1%, from total assets of $877 million at December 31, 2002. The decrease in total assets is the result of the transfer of $36.4 million in assets and $50.1 million in deposits at the closing of the sale of the Southeast Kansas branches on April 4, 2003. Loans and leases, net of unearned loan fees, were $736 million, an increase of $56 million, or 8%, over total loans and leases of $680 million at December 31, 2002. Federal funds sold, interest-bearing deposits and investment securities were $77 million and $100 million at June 30, 2003 and December 31, 2002, respectively. The reduction in these balances since December 31, 2002 supplemented the shortfall in deposit growth to fund new loan volume. Total deposits at June 30, 2003 were $748 million, an increase of $32 million, or 4%, over total deposits of $716 million at December 31, 2002. Certificates of deposits were $185 million, an increase of $28 million, or 18%, over certificates of deposits at December 31, 2002. The Bank executed three $10 million brokered certificates of deposit during the six months ended June 30, 2003. Total shareholders' equity at June 30, 2003 was $63.1 million, an increase of $4.3 million, or 7%, over total shareholders' equity of $58.8 million at December 31, 2002. The increase in equity is due to net income of $3.7 million for the six months ended June 30, 2003, the exercise of incentive stock options by employees, and an increase in accumulated other comprehensive income, offset by dividends paid to shareholders. Results of Operations Net income was $2,598,372 for the three month period ended June 30, 2003, an increase of 79% compared to the net income of $1,449,242 for the same period in 2002. Net income was $3,733,470 for the six month period ended June 30, 2003, an increase of 61% compared to net income of $2,320,600 for the same period in 2002. The increase in net income for the three and six months ended June 30, 2003 is attributable to an increase in net interest income and an increase in noninterest income including a $2,937,976 gain on the sale of branches partially offset by an increase in noninterest expense and provision for loan losses. Basic earnings per share for the three month periods ended June 30, 2003 and 2002 were $0.27 and $0.15, respectively. Fully diluted earnings per share for the three month periods ended June 30, 2003 and 2002 were $0.26 and $0.15, respectively. Basic earnings per share for the six month periods ended 12
June 30, 2003 and 2002 were $0.39 and $0.25, respectively. Fully diluted earnings per share for the six month periods ended June 30, 2003 and 2002 were $0.38 and $0.24, respectively. Net Interest Income Net interest income (on a tax equivalent basis) was $8.2 million, or 4.05%, of average interest-earning assets, for the three months ended June 30, 2003, compared to $7.8 million, or 4.16%, of average interest-earning assets, for the same period in 2002. The $392,000 increase in net interest income for the three months ended June 30, 2003 as compared to the same period in 2002 was the result of an increase in average interest-earning assets and a decrease in the interest rates on average interest-bearing liabilities partially offset by a decrease in interest rates of average interest-earning assets and an increase in average interest-bearing liabilities. Average interest-earning assets for the three months ended June 30, 2003 were $812 million, a $60 million, or 8%, increase over $752 million, during the same period in 2002. The increase in average interest-earning assets is attributable to the continued calling efforts of the Company's relationship officers. The yield on average interest-earning assets decreased to 5.38% for the three month period ended June 30, 2003 compared to 6.11% for the six month period ended June 30, 2002. The decrease in asset yield was primarily due to a 50 basis point decrease in the prime rate since June 30, 2002 and a general decrease in the average yield on new fixed rate loans and investment securities. Average interest-bearing liabilities increased to $640 million for the three months ended June 30, 2003 from $606 million for the same period in 2002. The cost of interest-bearing liabilities decreased to 1.69% for the three months ended June 30, 2003 compared to 2.41% for the same period in 2002. This decrease is attributed mainly to declines in market interest rates for all sources of funding and a change in the mix of liabilities. Average demand deposits increased $17 million, or 13%, to $144 million for the three months ended June 30, 2003 from $127 million for the same period in 2002. Average interest bearing liabilities as a percent of average assets decreased to 74.89% for the three months ended June 30, 2003 from 76.51% for the same period in 2002. The increase in demand deposit accounts, money market accounts and savings accounts is attributed to continued calling efforts of the Company's relationship officers. Average certificate of deposit accounts decreased to $179 million for the three months ended June 30, 2003 from $192 million during the same period in 2002. This decrease in certificate of deposit accounts is a result of their relative unattractiveness to customers as compared to money market and other more liquid products in the current rate environment. The decrease in certificate of deposit accounts was offset by increased Federal Home Loan Bank borrowings. The Company also issued $4 million in floating rate Trust Preferred Securities in June 2002. The increase in average balances are net of the decrease in balances from the sale of the Southeast Kansas branches. The Company transferred $27.2 million in loans, $1.1 million in fixed assets, and $48.2 million in deposits on April 4, 2003 when it sold its Southeast Kansas branches. The Southeast Kansas branches are included in the average balances for the three months ended June 30, 2002. 13
The following table sets forth, on a tax-equivalent basis, certain information relating to the Company's average balance sheet and reflects the average yield earned on interest-earning assets, the average cost of interest-bearing liabilities and the resulting net interest spread and net interest rate margin for the three month periods ended June 30, 2003 and 2002: <TABLE> <CAPTION> Three months ended June 30, 2003 2002 ------------------------------------------- ------------------------------------------ Percent Interest Average Percent Interest Average Average of Total Income/ Yield/ Average of Total Income/ Yield/ Balance Assets Expense Rate Balance Assets Expense Rate ---------- --------- ---------- -------- ---------- -------- ---------- -------- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> Assets Interest-earning assets: Loans (1)(2) $ 726,420 85.00% $ 10,398 5.74% $ 699,697 88.39% $ 11,020 6.32% Taxable investments in debt and equity securities 66,826 7.82 440 2.64 41,946 5.30 388 3.71 Non-taxable investments in debt and equity securities(2) 509 0.06 7 5.52 -- -- -- -- Federal funds sold 18,652 2.18 48 1.03 9,312 1.18 35 1.51 Interest-bearing deposits 80 0.01 0 0.25 817 0.10 5 2.45 ---------- --------- ---------- ---------- -------- ---------- Total interest-earning assets 812,487 95.07 10,893 5.38 751,772 94.97 11,448 6.11 Non-interest-earning assets: Cash and due from banks 29,095 3.40 25,912 3.27 Fixed assets, net 7,441 0.87 9,688 1.22 Prepaid expenses and other assets 15,179 1.78 12,262 1.55 Allowance for loan losses (9,552) (1.12) (8,062) (1.01) -- -- -- ---------- --------- ---------- -------- Total assets $ 854,650 100.00% $ 791,572 100.00% ========== ========= ========== ======== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing transaction accounts $ 54,099 6.33% $ 49 0.36% $ 59,578 7.53% $ 69 0.46% Money market accounts 347,255 40.63 885 1.02 312,387 39.46 1,212 1.56 Savings 4,081 0.48 3 0.29 8,809 1.11 22 1.00 Certificates of deposit 178,745 20.91 1,118 2.51 192,115 24.27 1,851 3.86 Guaranteed preferred beneficial interests in subordinated debentures 15,000 1.76 309 8.26 11,132 1.41 263 9.48 Borrowed funds 40,839 4.78 331 3.25 21,641 2.73 225 4.17 ---------- --------- ---------- ---------- -------- ---------- Total interest-bearing liabilities 640,019 74.89 2,695 1.69 605,662 76.51 3,642 2.41 Noninterest-bearing liabilities: Demand deposits 144,077 16.86 127,281 16.08 Other liabilities 8,401 0.98 4,720 0.60 ---------- --------- ---------- -------- Total liabilities 792,497 92.73 737,663 93.19 Shareholders' equity 62,153 7.27 53,909 6.81 ---------- --------- ---------- -------- Total liabilities & shareholders' equity $ 854,650 100.00% $ 791,572 100.00% ========== ========= ========== ======== Net interest income $ 8,198 $ 7,806 ========== ========== Net interest spread 3.69% 3.70% Net interest margin(3) 4.05% 4.16% ======== ======== <FN> <F1> (1) Average balances include non-accrual loans. The income on such loans is included in interest but is recognized only upon receipt. Loan fees included in interest income are approximately $299,000, and $394,000 for 2003 and 2002, respectively. <F2> (2) Non-taxable income is presented on a fully tax-equivalent basis assuming a tax rate of 34%. <F3> (3) Net interest income divided by average total interest earning assets. </FN> </TABLE> 14
Net interest income (on a tax equivalent basis) was $16.3 million, or 4.07%, of average interest-earning assets, for the six months ended June 30, 2003, compared to $15.0 million, or 4.04%, of average interest-earning assets, for the same period in 2002. The $1,350,000 increase in net interest income for the six months ended June 30, 2003 as compared to the same period in 2002 was the result of an increase in average interest-earning assets and a decrease in the interest rates on average interest-bearing liabilities partially offset by a decrease in interest rates of average interest-earning assets and an increase in average interest-bearing liabilities. Average interest-earning assets for the six months ended June 30, 2003 were $811 million, a $63 million, or 8%, increase over $748 million, during the same period in 2002. The increase in average interest-earning assets is attributable to the continued calling efforts of the Company's relationship officers. The yield on average interest-earning assets decreased to 5.44% for the six month period ended June 30, 2003 compared to 6.07% for the six month period ended June 30, 2002. The decrease in asset yield was primarily due to a 50 basis point decrease in the prime rate since June 30, 2002 and a general decrease in the average yield on new fixed rate loans and investment securities. Average interest-bearing liabilities increased to $644 million for the six months ended June 30, 2003 from $607 million for the same period in 2002. The cost of interest-bearing liabilities decreased to 1.73% for the six months ended June 30, 2003 compared to 2.49% for the same period in 2002. This decrease is attributed mainly to declines in market interest rates for all sources of funding and a change in the mix of liabilities. Average demand deposits increased $23 million, or 19%, to $144 million for the six months ended June 30, 2003 from $122 million for the same period in 2002. Average interest bearing liabilities as a percent of average assets decreased to 75.19% for the six months ended June 30, 2003 from 77.23% for the same period in 2002. The increase in demand deposit accounts, money market accounts and savings accounts is attributed to continued calling efforts of the Company's relationship officers. Average certificate of deposit accounts decreased to $180 million at June 30, 2003 from $191 million at June 30, 2002. This decrease in certificate of deposit accounts is a result of their relative unattractiveness to customers as compared to money market and other more liquid products in the current rate environment. The decrease in certificate of deposit accounts was offset by Federal Home Loan Bank borrowings. The Company issued $4 million in floating rate Trust Preferred Securities in June 2002. The increase in average balances are net of the decrease in balances from the sale of the Southeast Kansas branches. The Company transferred $27.2 million in loans, $1.1 million in fixed assets, and $48.2 million in deposits on April 4, 2003 when it sold its Southeast Kansas branches. The Southeast Kansas branches are included in the average balances for the six months ended June 30, 2002. 15
The following table sets forth, on a tax-equivalent basis, certain information relating to the Company's average balance sheet and reflects the average yield earned on interest-earning assets, the average cost of interest-bearing liabilities and the resulting net interest spread and net interest rate margin for the six month periods ended June 30, 2003 and 2002: <TABLE> <CAPTION> Six months ended June 30, 2003 2002 ------------------------------------------- -------------------------------------------- Percent Interest Average Percent Interest Average Average of Total Income/ Yield/ Average of Total Income/ Yield/ Balance Assets Expense Rate Balance Assets Expense Rate ---------- -------- --------- ------- ---------- -------- ---------- ------- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> Assets Interest-earning assets: Loans (1)(2) $ 727,402 84.99% $ 20,862 5.78% $ 684,183 87.00% $ 21,507 6.34% Taxable investments in debt and equity securities 66,235 7.74 922 2.81 44,919 5.71 845 3.79 Non-taxable investments in debt and equity securities(2) 269 0.03 7 5.25 37 0.00 1 5.45 Federal funds sold 16,798 1.96 86 1.03 16,649 2.12 127 1.54 Interest-bearing deposits 80 0.01 0 0.14 2,252 0.29 23 2.06 ---------- -------- --------- ---------- -------- ---------- Total interest-earning assets 810,784 94.73 21,877 5.44 748,040 95.12 22,503 6.07 Non-interest-earning assets: Cash and due from banks 30,991 3.62 25,114 3.19 Fixed assets, net 8,060 0.94 9,820 1.25 Prepaid expenses and other assets 15,325 1.80 11,267 1.43 Allowance for loan losses (9,338) (1.09) (7,817) (0.99) ---------- -------- ---------- -------- Total assets $ 855,822 100.00% $ 786,424 100.00% ========== ======== ========== ======== Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing transaction accounts $ 58,951 6.89% $ 101 0.35% $ 62,919 8.00% $ 137 0.44% Money market accounts 345,784 40.40 1.812 1.06 314,871 40.04 2,487 1.59 Savings 6,477 0.75 18 0.56 8,570 1.09 43 1.01 Certificates of deposit 179,800 21.01 2,350 2.64 191,428 24.34 3,892 4.10 Guaranteed preferred beneficial interests in subordinated debentures 15,000 1.75 617 8.29 11,066 1.41 521 9.49 Borrowed funds 37,588 4.39 631 3.39 18,497 2.35 425 4.63 ---------- -------- --------- ---------- -------- ---------- Total interest-bearing liabilities 643,570 75.19 5,529 1.73 607,351 77.23 7,505 2.49 Noninterest-bearing liabilities: Demand deposits 144,438 16.88 121,542 15.46 Other liabilities 6,253 0.73 4,099 0.52 ---------- -------- ---------- -------- Total liabilities 794,261 92.81 732,992 93.21 Shareholders' equity 61,561 7.19 53,432 6.79 ---------- -------- ---------- -------- Total liabilities & shareholders' equity $ 855,822 100.00% $ 786,424 100.00% ========== ======== ========== ======== Net interest income $ 16,348 $ 14,998 ========= ========== Net interest spread 3.71% 3.58% Net interest margin(3) 4.07% 4.04% ======= ======= <FN> <F1> (1) Average balances include non-accrual loans. The income on such loans is included in interest but is recognized only upon receipt. Loan fees included in interest income are approximately $680,000 and $731,000 for the six months ended June 30, 2003 and 2002, respectively. <F2> (2) Non-taxable income is presented on a fully tax-equivalent basis assuming a tax rate of 34%. <F3> (3) Net interest income divided by average total interest earning assets. </FN> </TABLE> 16
During the three months ended June 30, 2003, an increase in the average volume of interest-earning assets resulted in an increase in interest income of $629,000. Interest income decreased $1,184,000 due to a decrease in rates on average interest-earning assets. Increases in the average volume of money market accounts, guaranteed preferred beneficial interests in subordinated debentures, and borrowed funds offset by decreases in the average volume of interest-bearing transaction, savings and time deposits resulted in an increase in interest expense of $241,000. Changes in interest rates on the average volume of interest-bearing liabilities resulted in a decrease in interest expense of $1,188,000. The net effect of the volume and rate changes associated with all categories of interest-earning assets during the six months ended June 30, 2003 as compared to the same period in 2002 was a decrease in interest income of $555,000, while the net effect of the volume and rate changes associated with all categories of interest-bearing liabilities was a decrease in interest expense of $947,000. During the six months ended June 30, 2003, an increase in the average volume of interest-earning assets resulted in an increase in interest income of $1,642,000. Interest income decreased $2,268,000 due to a decrease in rates on average interest-earning assets. Increases in the average volume of money market accounts, guaranteed preferred beneficial interests in subordinated debentures, and borrowed funds offset by decreases in the average volume of interest-bearing transaction, savings and time deposits resulted in an increase in interest expense of $215,000. Changes in interest rates on the average volume of interest-bearing liabilities resulted in a decrease in interest expense of $2,191,000. The net effect of the volume and rate changes associated with all categories of interest-earning assets during the six months ended June 30, 2003 as compared to the same period in 2002 was a decrease in interest income of $626,000, while the net effect of the volume and rate changes associated with all categories of interest-bearing liabilities was a decrease in interest expense of $1,976,000. The increase in average balances are net of the decrease in balances from the sale of the Southeast Kansas branches. The Company transferred $27.2 million in loans, $1.1 million in fixed assets, and $48.2 million in deposits on April 4, 2003 when it sold its Southeast Kansas branches. The Southeast Kansas branches are included in the average balances for the three and six month periods ended June 30, 2002. The following table sets forth on a tax equivalent basis, for the three and six months ended June 30, 2003 compared to the same periods ended June 30, 2002, a summary of the changes in interest income and interest expense resulting from changes in yield/rates and volume: <TABLE> <CAPTION> 2003 Compared to 2002 3 months ended June 30 6 months ended June 30 Increase (decrease) due to Increase (decrease) due to -------------------------------------------- -------------------------------------------- Volume(1) Rate(2) Net Volume(1) Rate(2) Net ------------ ------------ ------------ ------------ ------------ ------------ (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> Interest earned on: Loans (3) $ 418 $ (1,040) $ (622) $ 1,315 $ (1,960) $ (645) Taxable investments in debt and equity securities 187 (135) 52 332 (255) 77 Nontaxable investments in debt and equity securities(3) -- 7 7 6 (0) 6 Federal funds sold 27 (14) 13 1 (42) (41) Interest-earning deposits (3) (2) (5) (12) (11) (23) ------------ ------------ ------------ ------------ ------------ ------------ Total interest-earning assets $ 629 $ (1,184) $ (555) $ 1,642 $ (2,268) $ (626) ------------ ------------ ------------ ------------ ------------ ------------ Interest paid on: Interest-bearing transaction accounts $ (6) $ (14) $ (20) $ (8) $ (28) $ (36) Money market accounts 128 (455) (327) 223 (898) (675) Savings (8) (11) (19) (9) (16) (25) Certificates of deposit (122) (611) (733) (225) (1,317) (1,542) Guaranteed preferred beneficial interests in subordinated debentures 84 (38) 46 149 (53) 96 Borrowed funds 165 (59) 106 85 121 206 ------------ ------------ ------------ ------------ ------------ ------------ Total interest-bearing liabilities 241 (1,188) (947) 215 (2,191) (1,976) ------------ ------------ ------------ ------------ ------------ ------------ Net interest income (loss) $ 388 $ 4 $ 392 $ 1,427 $ (77) $ 1,350 ============ ============ ============ ============ ============ ============ <FN> <F1> (1) Change in volume multiplied by yield/rate of prior period. <F2> (2) Change in yield/rate multiplied by volume of prior period. <F3> (3) Nontaxable investment income is presented on a fully tax-equivalent basis assuming a tax rate of 34%. </FN> </TABLE> 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. 17
Provision for Loan Losses The provision for loan losses was $1,094,000 and $2,093,000 for the three and six month periods ended June 30, 2003, respectively, compared to $530,000 and $1,120,000 for the same periods in 2002. The increase in provision for loan losses during the first six months of 2003 as compared to the same period in 2002 is considered prudent by management in view of strong loan growth in a still-weakened economy, increased concern for credit quality and the company's recent charge-offs. The company experienced $1,154,000 in net charge-offs for the six months ended June 30, 2003 compared to net charge-offs of $190,000 during the same period ended June 30, 2002. Gross charge-offs in the first half of 2003 totaled $1,300,000. This amount is largely associated with one problem loan relationship consisting of several loans which came to Enterprise as part of the acquisition of First Commercial Bank in 2000. 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 that have been charged to the provision: <TABLE> <CAPTION> Three months ended June 30, Six months ended June 30, 2003 2002 2003 2002 ------------ ------------ ------------ ------------ (Dollars in thousands) (Dollars in thousands) <S> <C> <C> <C> <C> Allowance at beginning of period $ 9,175 $ 7,856 $ 8,600 $ 7,296 Loans charged off: Commercial and industrial 805 107 1,299 138 Real estate: Commercial -- -- -- 14 Construction -- -- -- Residential -- -- -- Consumer and other 1 68 1 77 ------------ ------------ ------------ ------------ Total loans charged off 806 175 1,300 229 ------------ ------------ ------------ ------------ Recoveries of loans previously charged off: Commercial and industrial -- 10 3 20 Real estate: Commercial 66 3 66 8 Construction -- -- -- -- Residential 10 -- 28 -- Consumer and other -- 2 49 11 ------------ ------------ ------------ ------------ Total recoveries of loans previously charged off 76 15 146 39 ------------ ------------ ------------ ------------ Net loans charged off 730 160 1,154 190 ------------ ------------ ------------ ------------ Provision for loan losses 1,094 530 2,093 1,120 ------------ ------------ ------------ ------------ Allowance at end of period $ 9,539 $ 8,226 $ 9,539 $ 8,226 ============ ============ ============ ============ Average loans $ 726,420 $ 699,697 $ 727,402 $ 684,183 Total loans 735,733 669,465 735,733 669,465 Nonperforming loans 2,808 2,913 2,808 2,913 Net charge-offs to average loans (annualized) 0.40% 0.09% 0.32% 0.06% Allowance for loan losses to total loans 1.30 1.23 1.30 1.23 Allowance for loan losses to nonperforming loans 339.71 282.39 339.71 282.39 </TABLE> The Company's credit management policies and procedures focus on identifying, measuring, and controlling credit exposure. These procedures employ a lender-initiated system of rating credits, which is ratified in the loan approval process and subsequently tested in internal loan reviews and regulatory bank examinations. The system requires rating all loans at the time they are made. 18
Adversely rated credits, including loans requiring close monitoring, which would not normally be considered criticized credits by regulators, are included on a monthly loan watch list. Other loans are added whenever any adverse circumstance is detected which might affect the borrower's ability to meet the terms of the loan. This could be initiated by the delinquency of a scheduled loan payment, a deterioration in the borrower's financial condition identified in a review of periodic financial statements, a decrease in the value of the collateral securing the loan, or a change in the economic environment in which the borrower operates. Loans on the watch list require detailed loan status reports prepared by the responsible officer every three months, which are then discussed in formal meetings with the Senior Lending Officer and the Executive Loan Committee. Downgrades of loan risk ratings may be initiated by the responsible loan officer, internal loan review, or credit analyst department at any time. However, upgrades of risk ratings may only be made with the concurrence of the Executive Loan Committee or at the time of the formal quarterly watch list review meetings. Each month, management prepares a detailed list of loans on the watch list and summaries of the entire loan portfolio categorized by risk rating. These are coupled with an analysis of changes in the risk profiles of the portfolios, changes in past due and non-performing loans and changes in watch list and classified loans over time. In this manner, the overall increases or decreases in the levels of risk in the portfolios are monitored continually. Factors are applied to the loan portfolios for each category of loan risk to determine acceptable levels of allowance for loan losses. These factors are derived primarily from the actual loss experience. The calculated allowance for loan losses required for the portfolios are then compared to the actual allowance balances to determine the provision necessary to maintain the allowance for loan losses at an appropriate level. In addition, management exercises judgment in its analysis of determining the overall level of the allowance for loan losses. In its analysis, management considers the change in the portfolio, including growth and composition, and the economic conditions of the region in which the Company operates. Based on this quantitative and qualitative analysis, the allowance for loan losses is adjusted. Such adjustments are reflected in the consolidated statements of operations. The Company does not engage in foreign lending. Additionally, the Company does not have any concentrations of loans exceeding 10% of total loans, which are not otherwise disclosed in the loan portfolio composition table provided in the most recent 10-K Annual Report. The Company does not have a material amount of interest-bearing assets, which would have been included in non-accrual, past due or restructured loans if such assets were loans. Management believes the allowance for loan losses is adequate to absorb probable losses in the loan portfolio. While management uses available information to recognize loan losses, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require the Company to increase the allowance for loan losses based on their judgments and interpretations about information available to them at the time of their examinations. 19
The Bank had no loans 90 days past due still accruing interest at June 30, 2003 or December 31, 2002. The following table sets forth information concerning the Company's non-performing assets as of the dates indicated: June 30, December 31, 2003 2002 ------------ ------------ (Dollars in Thousands) Non-accrual loans $ 2,808 $ 2,212 Restructured loans -- 1,676 ------------ ------------ Total nonperforming loans 2,808 3,888 Foreclosed property 345 125 ------------ ------------ Total non performing assets $ 3,153 $ 4,013 ============ ============ Total assets $ 866,284 $ 876,787 Total loans, less unearned loan fees 735,733 679,799 Total loans plus foreclosed property 736,078 679,924 Nonperforming loans to loans 0.38% 0.57% Nonperforming assets to loans plus foreclosed property 0.43 0.59 Nonperforming assets to total assets 0.36 0.46 Noninterest Income Noninterest income was $4,691,294 and $6,469,734 for the three and six month periods ended June 30, 2003, respectively, compared to $1,445,970 and $2,937,690 for the same periods in 2002. The increases are primarily attributed to a $3,087,976 gain on the sale of the Southeast Kansas branches, less a $150,000 write-off of related goodwill, increases in service charges on deposit accounts, an increase in the gain on the sale of mortgage loans, increases in trust and financial advisory income, and a $77,884 gain on the sale of securities. Service charges on deposit accounts were $406,192 and $892,819 for the three and six month periods ended June 30, 2003, as compared to $448,747 and $860,641 for the same periods in 2002. The decrease in service charges on deposit accounts for the three month period ended June 30, 2003 as compared to the same period in 2002, is the result of reduced retail banking activity at the Southeast Kansas Branches which were sold on April 4, 2003. The Southeast Kansas branch activity is included in the three and six month periods ended June 30, 2002. The increase in service charges on deposit accounts for the six months ended June 30, 2003, as compared to the six months ended June 30, 2002 is a result of a decrease in the earnings credit rate on business accounts and an increase in the number of accounts, account activity and services provided offset by decreases related to the sale of the Southeast Kansas branches. Gains on the sale of mortgage loans were $586,568 and $1,114,430 for the three and six month periods ended June 30, 2003, as compared to $284,906 and $645,243 for the same periods in 2002. The increase in these gains is a result of continued high volumes of new originations and refinancings as a result of low mortgage interest rates. These loans are sold into the secondary market with release of the servicing rights. Trust and financial advisory income was $669,902 and $1,259,457 for the three and six month periods ended June 30, 2003 as compared to $540,077 and $1,169,133 for the periods in 2002. The increases in trust and financial advisory income is the result of an increase in the number of accounts and an increase in assets under management to over $1 billion at June 30, 2003, as compared to $879 million at June 30, 2002. Noninterest income was $1,753,318 and $3,531,758 for the three and six months ended June 30, 2003 after adjusting out the $2,937,976 gain on the sale of the Southeast Kansas branches. This is a $307,348, or 21%, and $594,068, or 20%, increase over the three and six month periods ended June 30, 2002. 20
Noninterest Expense Total noninterest expense was $7,577,019 and $14,609,811 for the three and six months ended June 30, 2003, representing a $1,210,113, or 17% and $1,610,218 or 12% increase from the same periods in 2002. Expenses related to the sale of the Southeast Kansas branches totaling $343,000 increased performance-based employee compensation, occupancy costs, and director expenses offset by declines in various discretionary expense categories and equipment costs. Employee compensation and benefits increased $671,274 and $1,016,966 for the three and six months ended June 30, 2003, respectively, as compared to the same periods in 2002. Approximately $356,000 and $534,000 of these increases were due to increased accruals under the Company's incentive bonus and 401K match program as the Company exceeded budgeted performance for the quarter and first half of the year. The Company paid employees $177,000 in retention and severance bonuses related to the sale of the Southeast Kansas branches during April 2003. Another $86,000 and $150,000 of this increase was related to higher commission payouts in the mortgage department of the Bank for the three and six month periods ended June 30, 2003 as compared to the same periods in 2002. The remaining variance in this category was attributable to annual merit increases for personnel and higher compensation associated with new middle and senior management hired during 2002. Offsetting some of these costs was an overall reduction in staffing levels required, as there were 39 fewer full-time equivalent employees at June 30, 2003 versus June 30, 2002. Occupancy expense increased $38,629 and $57,091 for the three and six month periods ended June 30, 2003 as compared to the same periods in 2002. Most of the increase in occupancy expenses was due to scheduled rent increases on various Company facilities offset by a decrease in building depreciation expense related to the sale of the buildings with the Southeast Kansas branches. Other noninterest expense was $1,900,596 and $3,516,550 for the three and six month periods ended June 30, 2003 as compared to the $1,388,840 and $2,927,631 for the three and six month periods ended June 30, 2002. The increase in other noninterest expense for the six months ended June 30, 2003 as compared to the same period in 2002 is the result of $83,000 in expenses related to the sale of the Southeast Kansas branches, an increase in director expenses, $380,000 in expenses related to noncompete agreements with two former key employees, and the recognition of a $50,000 legal settlement related to a loan dispute with another bank, offset by a decrease in meals and entertainment expenses and fraud and trading losses. Director expenses were $49,000 and $162,000 for the three and six month periods ended June 30, 2003, respectively, as compared to $24,000 and $48,000 for the same periods in 2002. The Company increased its compensation paid to certain directors whose appointed duties require additional time commitments. In addition, several Board members chose to forfeit their stock appreciation rights and receive cash payments for meeting attendance. The stock appreciation rights still outstanding are marked to the Company's stock market price on a quarterly basis. The $1.30 increase in the stock price from December 31, 2002 to March 31, 2003 resulted in a $66,000 mark to market expense, which is included in the $162,000 of directors expenses mentioned above. There was no expense for marking the stock appreciation rights to market for the three months ended June 30, 2003; the stock price was $13.45 on June 30, 2003, slightly less than the stock price on March 31, 2003. In January 2003, the Company recognized $160,000 in amortization related to a noncompete agreement with a former key employee who resigned on September 30, 2002. During May 2003, the Company recognized $220,000 in expense related to a noncompete agreement with another former key employee. Declines in certain expense categories like 1) meals and entertainment, 2) stationary and office supplies, and 3) fraud and trading losses were due to a concerted effort by management during the six month periods ended June 30, 2003. The $52,758 decrease in furniture, equipment and data processing expenses along with decreases in communications expense was the result of savings from communications upgrades and the discontinuation of depreciation on Southeast Kansas assets sold in April 2003. The ratio of noninterest expense to average assets for the three and six month periods ended June 30, 2003 was 3.56% and 3.44%, respectively, versus 3.23% and 3.33% and for the same periods in 2002. The efficiency ratio, which is total noninterest expenses as a percent of total revenues, was 59.22% and 64.57% for the three and six month periods ended June 30, 2003 as compared to 69.23% and 72.81% for the same periods in 2002. After adjusting for the gain and expenses related to the sale of the Southeast Kansas branches and the non compete expenses, the efficiency ratio was 21
71.17% and 70.53% and the ratio of noninterest expense to average assets was 3.29% and 3.27%, for the three and six month periods ended June 30, 2003, respectively. Management is focused on improving these ratios in future years through employee productivity and expense controls. The following table presents a breakdown of the gain and expenses related to the sale of the Southeast Kansas branches. The table also presents noninterest income, noninterest expense and the related ratios adjusted for the gain and expenses related to the sale of the Southeast Kansas branches and noncompete expenses. <TABLE> <CAPTION> Three months ended June 30, Six months ended June 30, 2003 2002 2003 2002 ------------- ------------- -------------- -------------- <S> <C> <C> <C> <C> Net interest income $ 8,102,668 $ 7,750,302 $ 16,157,167 $ 14,917,216 ============= ============= ============== ============== Total noninterest income $ 4,691,294 $ 1,445,970 $ 6,469,734 $ 2,937,690 Gain on the sale of Southeast Kansas branches 3,087,976 -- 3,087,976 -- Less writeoff of related goodwill 150,000 -- 150,00 -- ============= ============= ============== ============== Adjusted noninterest income $ 1,753,318 $ 1,445,970 $ 3,531,758 $ 2,937,690 ============= ============= ============== ============== Total noninterest expense $ 7,577,019 $ 6,366,906 $ 14,609,811 $ 12,999,593 Severance and retention bonuses 177,161 -- 177,161 -- Occupancy 27,544 -- 27,544 -- Furniture and equipment 17,626 -- 17,626 -- Data Processing 37,475 -- 37,475 -- Other 82,897 -- 82,897 -- Noncompete expenses 220,000 -- 380,000 -- ------------- ------------- -------------- -------------- Adjusted noninterest expense $ 7,014,316 $ 6,366,906 $ 13,887,108 $ 12,999,593 ============= ============= ============== ============== Efficiency ratio 59.22% 69.23% 64.57% 72.81% Adjusted efficiency ratio 71.17% 69.23% 70.53% 72.81% Noninterest expense to average assets 3.56% 3.23% 3.44% 3.33% Adjusted noninterest expense to average assets 3.29% 3.23% 3.27% 3.33% </TABLE> Liquidity Liquidity is provided by the Bank's earning assets, including short-term investments in federal funds sold, maturities in the loan and investment portfolios, and amortization of term loans, along with deposit inflows, and proceeds from borrowings. At June 30, 2003, the loan to deposit ratio was 98%, as compared to 95% at December 31, 2002. Federal funds sold, interest bearing deposits and investment securities were $77 million and $100 million at June 30, 2003 and December 31, 2002, respectively. During the six months ended June 30, 2003, the Bank funded net new loans of $56 million, while deposits increased a net $32 million. During 2003, the Bank obtained three $10 million brokered certificates of deposit, which supplemented its core deposit activities. The Bank has a total of $50 million in brokered certificates of deposit or 7% of its total deposits at June 30, 2003. In April 2003, the Bank absorbed about $15 million in lost liquidity when it closed on the sale of the Southeast Kansas Branches, as they were a net provider of funds. The Bank closely monitors its current liquidity position and believes there are sufficient backup sources of liquidity. As of June 30, 2003, the Bank has over $110 million available from the Federal Home Loan Bank of Des Moines under a blanket loan pledge, and $45 million from the Federal Reserve under a pledged loan agreement. The Bank also has access to over $70 million in overnight fed funds lines from various banking institutions. In addition, the Company has a $5 million credit line, which can be drawn upon for additional capital injections into the Bank. 22
Capital Adequacy The Bank is subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank 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 Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets, and of Tier I capital to average assets. Management believes the Bank is well capitalized. As of June 30, 2003, the most recent notification from the Company's primary regulator categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. At June 30, 2003 and December 31, 2002, Enterprise Financial Services Corp and Enterprise Bank had required and actual capital ratios as follows: <TABLE> <CAPTION> To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions (1) ----------------------- ---------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio ------------ --------- ---------------------- ------------- -------- <S> <C> <C> <C> <C> <C> <C> At June 30, 2003: Total Capital (to Risk Weighted Assets) Enterprise Financial Services Corp $ 83,400,434 11.18% $ 59,653,914 8.00% $ -- --% Enterprise Bank 79,705,939 10.72 59,503,855 8.00 74,379,819 10.00 Tier I Capital (to Risk Weighted Assets) Enterprise Financial Services Corp $ 74,076,818 9.93% $ 29,826,957 4.00% $ -- --% Enterprise Bank 70,405,480 9.47 29,751,928 4.00 44,627,891 6.00 Tier I Capital (to Average Assets) Enterprise Financial Services Corp $ 74,076,818 8.69% $ 25,571,924 3.00% $ -- --% Enterprise Bank 70,405,480 8.28 25,511,446 3.00 42,519,077 5.00 At December 31, 2002: Total Capital (to Risk Weighted Assets) Enterprise Financial Services Corp $ 78,207,875 10.95% $ 57,136,811 8.00% $ -- --% Enterprise Bank 75,204,737 10.58 56,885,394 8.00 71,106,743 10.00 Tier I Capital (to Risk Weighted Assets) Enterprise Financial Services Corp $ 69,607,874 9.75% $ 28,568,406 4.00% $ -- --% Enterprise Bank 66,604,736 9.37 28,442,697 4.00 42,664,046 6.00 Tier I Capital (to Average Assets) Enterprise Financial Services Corp $ 69,607,874 7.93% $ 26,346,052 3.00% $ -- --% Enterprise Bank 66,604,736 7.60 26,283,571 3.00 43,805,951 5.00 <FN> (1) There are no regulatory guidelines for defining "well capitalized" for Bank Holding Companies as opposed to Banks. </FN> </TABLE> 23
Effects of Inflation Changes in interest rates may have a significant impact on a commercial bank's performance because virtually all assets and liabilities of commercial banks are monetary in nature. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Inflation does have an impact on the growth of total assets in the banking industry, often resulting in a need to increase equity capital at higher than normal rates to maintain an appropriate equity to asset ratio. The Company's operations are not currently impacted by inflation. Item 3: Quantitative and Qualitative Disclosures Regarding Market Risk The Company's exposure to market risk is reviewed on a regular basis by its Asset/Liability Committee. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the interest rate risk while at the same time maximizing income. Management realizes that certain interest rate risks are inherent in our business and that the goal is to identify and minimize those risks. Tools used by management include the standard repricing or "GAP" report subject to different rate shock scenarios. At June 30, 2003, the rate shock scenario models indicated that annual net interest income would increase by less than 12% should rates rise 100 basis points and decrease by less than 13% should rates fall 100 basis points from their current level over a one year period. The Bank has no market risk sensitive instruments held for trading purposes. 24
The following tables (dollars in thousands) present the scheduled maturity of market risk sensitive instruments at June 30, 2003: <TABLE> <CAPTION> Beyond 5 Years or No Stated Year 1 Year 2 Year 3 Year 4 Year 5 Maturity Total --------- --------- --------- --------- -------- -------- --------- <S> <C> <C> <C> <C> <C> <C> <C> ASSETS Investments in debt and equity securities $ 21,668 $ 17,864 $ 2,713 $ 3,573 $ 4,068 $ 7,566 $ 57,452 Interest-bearing deposits 409 -- -- -- -- -- 409 Federal funds sold 19,374 -- -- -- -- -- 19,374 Loans (1) 545,290 60,902 80,342 12,078 19,337 17,784 735,733 Loans held for sale 5,088 -- -- -- -- -- 5,088 --------- --------- --------- --------- -------- -------- --------- Total $ 591,829 $ 78,766 $ 83,055 $ 15,651 $ 23,405 $ 25,350 $ 818,056 ========= ========= ========= ========= ======== ======== ========= LIABILITIES Savings, NOW, money market deposits $ 401,622 $ -- $ -- $ -- $ -- $ -- $ 401,622 Certificates of deposit (1) 126,944 47,039 8,597 1,963 350 -- 184,893 Guaranteed preferred beneficial interest in subordinated debentures -- -- -- -- -- 15,000 15,000 Borrowed funds 19,208 3,820 1,350 1,425 950 4,713 31,466 --------- --------- --------- --------- -------- -------- --------- Total $ 547,774 $ 50,589 $ 9,947 $ 3,388 $ 1,300 $ 19,713 $ 632,981 ========= ========= ========= ========= ======== ======== ========= </TABLE> Average Interest Rate for Six Months Ended Carrying June 30, Estimated Value 2003 Fair Value ---------- ----------- ---------- ASSETS Investments in debt and equity securities $ 57,452 2.82% $ 57,452 Interest-bearing deposits 409 0.14 409 Federal funds sold 19,374 1.03 19,374 Loans 735,733 5.78 749,113 Loans held for sale 5,088 5,088 ---------- ---------- Total $ 818,056 $ 831,436 ========== ========== LIABILITIES Savings, NOW, money market deposits $ 401,622 0.95% $ 401,622 Certificates of deposit 184,893 2.64 186,633 Guaranteed preferred beneficial interest in subordinated debentures 15,000 8.29 15,122 Borrowed funds 31,466 3.39 31,819 ---------- ---------- Total $ 632,981 $ 635,196 ========== ========== (1) Adjusted for the impact of the interest rate swaps. 25
Item 4: Controls and Procedures As of June 30, 2003, 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. Based on that evaluation, the CEO and CFO concluded that the Company's disclosure controls and procedures were effective as of June 30, 2003. There were no changes in internal control over financial reporting that occurred during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to affect, the Company's internal control over financial reporting. 26
PART II - Item 4: Submission of Matters to a Vote of Security Holders ANNUAL MEETING OF SHAREHOLDERS: The annual meeting of shareholders was held on April 23, 2003. Proxies were solicited pursuant to Regulation 14A of the Securities Exchange Act of 1934. There was no solicitation in opposition to management's nominees for Directors and all nominees were elected. The appointment of KPMG LLP to serve as independent auditor for the Company in 2003 was ratified and shareholders approved adoption of the 2002 Incentive Stock Plan. The results of the voting on each proposal submitted at the meeting are as follows: PROPOSAL NO. 1: ELECTION OF DIRECTORS ------------------------------------- Director For Against Abstain - -------------------- --------- ------- ------- Paul J. McKee, Jr. 6,842,645 0 3,813 Kevin C. Eichner 6,840,370 0 3,813 Peter F. Benoist 6,840,370 0 3,813 Paul R. Cahn 6,842,645 0 3,813 William H. Downey 6,842,645 0 3,813 Robert E. Guest, Jr. 6,842,645 0 3,813 Ronald E. Henges 6,572,796 0 252,857 Richard S. Masinton 6,575,071 0 252,857 Jerry McElhatton 6,842,645 0 3,813 William B. Moskoff 6,826,390 0 3,813 Birch M. Mullins 6,826,390 0 3,813 James J. Murphy 6,842,645 0 3,813 Ted A. Murray 6,577,346 0 252,857 Stephen A. Oliver 6,842,645 0 3,813 Robert E. Saur 6,842,645 0 3,813 Jack L. Sutherland 6,842,645 0 3,813 Paul L.Vogel 6,842,645 0 3,813 Henry D. Warshaw 6,842,645 0 3,813 Ted C. Wetterau 6,566,571 0 261,357 James L. Wilhite 6,842,645 0 3,813 James A. Williams 6,842,651 0 3,813 PROPOSAL NO. 2: INDEPENDENT PUBLIC ACCOUNTANTS ---------------------------------------------- Accountants For Against Abstain - ----------- --------- ------- ------- KPMG LLP 6,794,761 40,123 6,280 PROPOSAL NO. 3: 2002 STOCK INCENTIVE PLAN ----------------------------------------- For Against Abstain Delivered N Vote --------- ------- ------- ---------------- Stock Plan 5,063,636 481,940 103,516 1,192,072 27
Item 6: Exhibits and Reports on Form 8-K (a). Exhibits. Exhibit Number Description -------- -------------------------------------------------------------- 11.1 Statement regarding computation of per share earnings 31.1 Chief Executive Officer's Certification required by Rule 13a-14(a) 31.2 Chief Financial Officer's Certification required by Rule 13a-14(a) 32.1 Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section Section 906 of the Sarbanes-Oxley Act of 2002 (b). During the three months ended June 30, 2003, the Registrant filed one current report on form 8-K, dated April 21, 2003, in which the Registrant reported the first quarter results. 28
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 14/th/ day of August 2003. ENTERPRISE FINANCIAL SERVICES CORP By: /s/ Kevin C. Eichner ------------------------------------- Kevin C. Eichner Chief Executive Officer By: /s/ Frank H. Sanfilippo ------------------------------------- Frank H. Sanfilippo Chief Financial Officer 29