S&T Bancorp, Inc.

Good day, ladies and gentlemen, and welcome to the S&T Bank Corp, Inc. Second Quarter Earnings Conference Call. After the presentation, there will be a question and answer session. If you should require assistance during the call, please press star zero and an operator will assist you. At this time, it's my pleasure to turn the floor over to Mr. Mark Kochvar. Sir, the floor is yours.

Thank you. Good afternoon, everyone, and thank you for participating in today's conference call. Before beginning the presentation, I want to take time to refer you to our statement about forward-looking statements and risk factors, which is on the screen in front of you. This statement provides the cautionary language required by the Securities and Exchange Commission for forward-looking statements that may be included in this presentation. A copy of the second quarter 2020 earnings release can be obtained by clicking on the press release link on your screen or by visiting our investor relations website at www.stbankcorp.com. We will be reviewing an earnings supplement slide deck as part of this presentation. You can obtain a copy of those slides on our website under events and presentations, second quarter 2020 earnings conference call. Click on the earnings supplement link. With me today are Todd Wright, CEO of S&T, and Dave Antola, S&T's president. I would now like to turn the program over to Todd, who will begin today's presentation.

Well, thank you, Mark, and good afternoon, everybody. As previously reported in our 8K webinar on May 26th, S&T Bank was subject to a significant check-paying scheme conducted by a single business customer. This criminal activity has negatively impacted our results this quarter, and we're reporting a loss of $33.1 million, or 85 cents per share. An independent internal review was conducted, and this was a one-time event relating to one customer, and there were no S&T employees involved. In addition, we've implemented a process of monitoring enhancements to prevent future frauds, We've also taken a number of steps and are actively pursuing collection activities through legal channels that may result in some recovery. Excluding the loss from the customer fraud, we posted core EPS of $0.34 per share, which translated into return on asset of 0.57%, return on equity of 4.48%, and return on tangible common equity of 6.86%. Our pre-tax pre-provision increased by 16% to $41.9 million. or 1.79% of average assets. Another bright spot is our efficiency ratio has came in at 50.51%. Controlling the expenses has been a hallmark for our company and will continue to be so going forward. For the quarter, we experienced significant deposit growth of $810 million. Over half of the growth, $548 million, was in non-interest-bearing demand deposit accounts. Interest rating demand, money market, and savings accounts increased $92 million, $154 million, and $80 million, respectively. And we do estimate that approximately 40% of deposit growth is associated with the PPP program and other government stimulus programs. Mortgage banking was a price plug this quarter as well. Year-to-date production of $213 million represents a 54% increase over the same period of last year. The breakout is about 70% refinancing, and we've sold about 78% of the loans to Fannie Mae. COVID-19 is certainly impacting how we operate, and we continue to protect the health and safety of our employees and customers. As we mentioned before, we have employees working remote. We've reopened with enhanced safety measures, and we've extended PPP funds to help our customers impacted by the pandemic. Also, with the heightened awareness on social inequality, we remain committed to fostering an environment that promotes diversity and inclusion. As you expect, year-over-year, brand transactions have declined by 24%. Call center volumes have increased by 41%. Mobile banking activation is up 50%. Dell Pay is up 57%, and Dell Payments are up 27%. So we're seeing a lot of migration into our digital channels. And also, I'm excited to announce that on Tuesday, We rolled out a new website to better serve our digital clients, and really the intent is to help them become more self-sufficient in their financial awareness. Our marketing team has been working on the project for about nine months, and the timing really couldn't have been better. Some of the features include a mobile-first design, easier navigation, an online digital sales tool that we're calling Merlin, and it's also going to provide enhanced data analytics to provide more customized sales offerings for our clients. As we mentioned last quarter, we were recognized by J.D. Power, the number one bank in customer satisfaction and retail banking in the Mid-Atlantic region. And the website, as well as other initiatives, are part of our commitment to continually improving the banking experience for our customers. Switching gears, I want to touch base on credit measures for the quarter. We did record an allowance net of the fraud of $28.1 million. We also incur a net charge of $9.4 million. This includes $4.2 million associated with the real estate loan pertaining to the customer perpetrated the cutting scheme. Our total reserve increased 18.34% to $114.6 million. The reserve to loan ratio is now 1.64%, excluding PPP. And finally, NPAs increased by $15.7 million to $92.5 million. 9 million or 1.19% of total loans. And again, the NPAs were negatively impacted by the 10.9 million that transferred in through the CROD loan, associated with fraud. I am filing a plea to report that our board of directors declared a dividend of 28 cents, which is a 3% increase over the same period last year. And before I do start a presentation over to David Antulik, our president, I do want to mention that we're a resilient company with a 118-year track record of serving our loyal customers, and communities through good times and challenging times, and we will continue to work very diligently every single day to deliver exceptional services that I do them. Thank you for your continued support of S&P Bancorp. And now I'll turn the program over to our president, Dave Antoli.

Thank you, Todd. Good afternoon, everyone. I'd like to direct your attention to slide 9, which provides information on our loan mix. What I'm noting here is the impact of Triple B. Those loan balances were $548 million at the end of T2 and were responsible for the growth in C&I loans and total portfolio loans of $359 million and $302 million respectively. During the quarter, our CRE balances declined by $97 million, primarily due to continued payoffs from the permit market and slower new production. We did experience growth in our construction balances of $62 million in the quarter, as projects proceeded through the spring and summer building season. COVID-19 has had minimal impact on our construction funds. During the quarter, new commercial construction commitments outgaged funding, resulting in a $6 million increase in available commitments. Excluding Triple P, C&I balances declined by $189 million. This reduction was a result of significant deleveraging by these customers. Quarter over quarter, revolving C&I utilization rates declined from 45% to 37%. On a bottom note, C&I commitments expanded during the quarter by $15 million as a result of new customer acquisition. Factors impacting C&I balances, including customers using lower-costing Triple P funds to reduce revolving borrowings, and customers in certain segments struggling to maintain inventory levels. This was most noticeable in our automobile dealer floor plan portfolio, where balances declined by $58 million, while commitments were flat quarter over quarter. We have not experienced defensive line drops by customers in order to build their liquidity. Commercial pipelines have declined across the board, while activity in our residential mortgage area remains very robust. Slide 10 provides an update to our hardship assistance programs. We have seen a decline in the overall percentage modified, excluding triple P to 15% of loans as of July 21st, down from 20% as of June 30th. Generally, we offer three- to six-month interest-only or payment for bearers to commercial borrowers based on our assessment of the hardship. As commercial modifications begin to expire, we have seen customers return to original contractual payment terms, resulting in the reduced modified balances that you see through July 21st. Early results on slide 11 are encouraging, with 68% of expiring commercial modifications returning to contractual payments. This has resulted in a decline in commercial modifications from 22% as of 6-30 to 17% as of July 21st, which is detailed by loan type on slide 12. For customers who are granted shorter-term modifications that have expired, we have in certain cases extended modified terms in order to provide ongoing assistance as pandemic and economic events unfold. Slide 13 provides detail on our most severely impacted loan segment, hotels. We have implemented an extremely robust monitoring process for this segment that focuses on frequent data collection, including occupancy, average daily rates, cash flows, net working capital assessments, payable trends, and break-even points, along with examination of sponsorship support, franchise obligations and relationships, as well as geographical and locational influences. COVID relief and through documentation review of this portfolio. We anticipate a longer recovery period for this segment as we move forward. Slide 14 details our consumer loan and hardship assistance program. This program expires at the end of July, and modification extensions are not currently being offered. Our Triple P results are displayed on slide 15. We have honored on a significant scrub process of all Triple P loans to prepare them for the forgiveness process, which we will be preparing to launch on August 10th. I'll turn the program over to Mark for additional details on our results. Thanks, Dave. The denture's income was essentially flat compared to the first quarter as pressure from lower short-term rates was offset by higher average earning assets, primarily related to PPP loans. The denture's margin compression quarter over quarter was 22 basis points. Approximately five basis points of the compression was due to PPP, implying a core rate of about 3.36% in line with our expectations. With short rates stabilizing, albeit at very low levels, we anticipate a relatively stable interest margin percentage for the next couple of quarters. Volatility will come with the forgiveness timing of PPP and the resolution of loan bond applications. Slide 16 shows that we do have some liability repricing over the next 12 months to help offset lower new versus paid rates on the loan side. Surging deposits in the second quarter came mostly in low-cost court deposits. we were able to substantially reduce our short-term borrowings and are maintaining highly normal cash balances ahead of an opportunity to reduce floating rate broker CDs later this quarter. On balance, we don't believe the increase in deposits had or will have much of an impact on the NENIX margin rates. Non-interest income in the second quarter was impacted significantly by the stock market as the mark-to-market in a non-qualified benefit plan combined with an increase in the value of some bank stocks that we own were the primary drivers in a $3.7 million increase in other income. We saw the impact of the pandemic in several fee categories, including service charges on deposit accounts, particularly NSF fees, and in commercial loan swap fees. Mortgage banking revenue improved significantly as the low-rate interest environment led to heavy refinancing activity. We do expect some continued weakness in service charges and swaps in the second half, but continue to anticipate good mortgage activity, although not at the levels we saw in the second quarter. We expect a run rate of $13 to $14 million per quarter the remainder of the year in non-interest income. Non-interest expense declined compared to the first quarter, primarily due to $2.3 million of merger-related items in the first quarter. Other expense in the first quarter included $1.2 million related to some historic tax credits. We expect our expense run rate to be in the $45 to $46 million range. Capital levels on slide 17 remain strong and in excess of regulatory well-capitalized levels. We're comfortable with our ability to absorb losses based on internal stress tests that we have completed, including COVID-related scenarios. Both the leverage and PPE ratios are impacted by the PPE months. Now I'd like to turn the call over to the operator for questions.

Thank you, sir. And again, ladies and gentlemen, that's star 1 on your touchtone telephone if you would like to ask a question at this time. Star 1, please. Please make sure your mute function is turned off to allow your signal to reach our equipment. We'll take our first question from Russell Gunther with DA Davidson.

Hey, good afternoon, guys. Hi, Russell. Hey, Russell. You know, Mark, you're following up on the expense guide you gave for the back half of the year and Todd comments in your prepared remarks about track record of expense discipline. Just given the challenging operating environment, are there initiatives contemplated that might reduce the expense rate beyond the second half guide in 2021? Are you guys looking at your branch network or any other moving pieces that might help generate some positive operating leverage?

Yeah, Russell, you've seen a lot of releases of people cutting back on branches, but we have a study to branches in our system, our average branch size is about 100, over $100 million. So, I mean, it's something we continue to look at on an annual basis. And, you know, we'll be on the table with, you know, I'm not going to come out today and commit to say we're going to close, you know, 10% or anything like that. But we look at all facets of the organization. I mean, you know, we were just reviewing some things, you know, last week. And, you know, so we've had 12 positions. whether DP retires or someone takes another job. We've not replaced those, but that totals about $1.3 million. And we're looking at other positions as those become open. How do we shift resources around? We're looking at some technology to help create some efficiencies and capacity. So this is something we do every day. And, again, we know we're going to have margin pressure next year. So we're continuing to look for ways. We've got to squeeze. squeeze, you know, expense out of the organization and manage that low 50 number, I guess would be my answer, Russell.

Okay, great. Thank you, Todd. And then on the deferrals in slide 10 that you referenced, about 15% of loans as of last week, how do you expect that to trend over the next couple of months? And when we're talking next quarter, do you have a sense for where that could shake out?

Yeah, so, Russell, what you see there is most of the activity in terms of the modifications happened at the end of March and into early April. Those things expired in the first part of July. Our expectation would be that we'll continue to see reductions in the amount of modified loans. We aren't. keeping very close tabs on segments where we have concern. That's why we've included some additional information on our hotel portfolio. You know, other segments of concern would be retail, retail CRE. You know, and we're gathering information and doing deep dives in terms of understanding what impact, you know, the economic crisis will have on those customers. And with regards to the consumer market, Yeah, with regard to the consumer modifications, you know, those will all work their way through the process by the end of July.

Okay. Thanks, Dave. And then I guess just, you know, given those comments, particularly on the commercial side of things, you know, is the expectation then, you know, for that reduction, but, you know, whatever remains, are those, do you consider to be more at-risk loans and therefore that's already accounted for and qualitative reserves that may have been taking, or as those kind of work their way through, is that an incremental provision headwind?

Russell, this is Mark. We have started to factor some of that in both through the forecast, which relies on the unemployment rate, but also with some specific portfolios that do have higher risk that we do anticipate there being some issues with by the time they get to the end of their modification period. So we have made some qualitative adjustments, particularly for the hotel portfolio, to try to get ahead of the fact that we do think there's going to be some issues with that portfolio.

Right. We started last quarter as well. So, you know, this quarter, as I mentioned in my comments, the PPP, you know, that reserves alone is about a 1.64. So, you know, we We're comfortable with where that is today, but it's something we're going to evaluate every quarter.

Okay. Thanks, guys. And then just last one for me. I mean, it doesn't sound like, you know, loan growth opportunities on an organic side are all that robust at the moment for the back half of the year and so unlikely an issue. But just your thoughts on the balance sheet in general, where you might end the year and with the thought of the $10 billion threshold, you know, potentially around the corner, how you're thinking about that.

Yeah, I certainly don't see any kind of significant loan growth through the balance of the year. You know, we're marshalling resources to attack the modifications and making sure that we've got our arms around credit risk. We are onboarding some new customers, you know, quickly in the C&I space. We've had some set up with our ADL group. But as I mentioned, the de-leveraging has been significant. So some of this is going to come down to existing borrowers, you know, re-advancing online. You know, as I pointed out in the floor plan portfolio, it's just amazing to me that our balances reduce over a two-month period in Q2 by 45%. And those... customers are flourishing. They're doing very well. They're profitable, but they can't get inventory. So some of this is going to be the macro economic issues and the availability of inventory and whether or not the C&I borrowers re-leverage. So some of that is kind of unknown as we move forward through the balance of the year.

The other thing that will weigh in will be the forgiveness on the PPP loan and the F-550 loan. And we're estimating, you know, about 80% of that gets forgiven by your end as well. So those will unwind.

Got it. Great. Well, thank you all. That's it for me. Thank you, Rob. Thanks, Rob.

We'll take our next question from Matthew Breeze with Stevens Inc. Good afternoon.

Hi, Matthew.

Just one question on the fraud. So I struggle to understand fraud. how and why the fraud was classified and fell into a commercial loan charge-off bucket. I figured it would have hit the P&L elsewhere. Can you just help me kind of walk me through how it ends up there versus elsewhere?

Well, Matt, technically, because it creates an overdraft, it becomes a loan. Okay. That's a technical loan, so that prescribes that it works its way through the allowance process like any other, like any, like a charge-off would, a loan charge-off. And so typically, you don't typically see it, but we'll have DBA charge-offs or overdraft charge-offs essentially every quarter, but they're very, very small, but they run through the reserve process as well.

Okay, great. That's very helpful. On page 11, it looks like the bulk of the loans requiring a second deferral, they consist of office flex mixed-use and hotels, You provide the hotel LTV on one of the ensuing pages, but can you just talk about the LTVs and the office and flex space that requires second deferral? Just want to get a sense for buffer against losses.

Yeah, Matt, we don't have that right now. We can get that for you.

Okay. And then lastly... On page 17, I know you talked about having capital in excess of regulatory minimums. We have seen a number of your peers with similar excess capital but still raising preferred or sub-debt. Just curious your thoughts there and whether that's something we might see you pursue.

No, this is Mark. I mean, that's something we continue to evaluate, you know, the market. But, you know, that does have a cost to it. So looking at it, we don't have any firm plans as of right now to do any issuance.

Okay. Okay. That's all I had. I appreciate it. Thank you. Thanks, Brent.

And we do have a question that's coming through from Colin Gilbert with KBW.

Thanks. Good afternoon, guys. Hi. Just a credit question. Do you happen to have what the average loan size is within the hotel book and then what the average loan size is within the retail CRE book?

Yeah, it's on the slide.

Oh, is it? Okay.

Yeah, so slide 13 has the average hotel. So average hotel in the total book is $3.1 million, and the modified average is A little bit higher, 3.8.

Okay, sorry. Yep, I see that right there. Sorry. Okay, got it. Thank you. That's helpful. And then just in terms of the fraud, and I apologize if you happen to cover it at all of your comments, Todd. I got on a little late. But is there anything that you guys have done differently internally from a process perspective because of how that came through? And then also, too, just curious when that relationship originated with the bank. Okay.

Yeah, so I think it goes back to 2016 as a relationship, and, you know, we did a very thorough investigation, and really, you know, we just enhanced processes and oversight, really, you know, of common is what it comes down to.

Okay. Okay. Okay. That's all I had. Thank you.

Thanks, Ellen.

And at this time, there are no further questions in the queue. I'd like to turn the call back over to management for any closing remarks.

So I'd just like to thank everybody for participating in the call today. Mark, Dave, and I appreciate the opportunity to discuss this quarter's results and look forward to hearing from you at our next conference call. Thank you and have a good day.

Ladies and gentlemen, this does conclude today's conference. We appreciate your participation. You may disconnect at this time and have a great day.