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ST Bancorp Inc (NASDAQ:STBA)
Q2 2020 Earnings Call
Jul 30, 2020, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome, to the S&T Bancorp Inc. Second Quarter Earnings Conference Call. [Operator Instructions]

At this time, it's my pleasure to turn the floor over to Mr. Mark Kochvar. Sir, the floor is yours.

Mark Kochvar -- Senior Executive Vice President and Chief Financial Officer

Oh. 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.stbancorp.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 Brice, CEO of S&T and David Antolik, S&T's President. I would now like to turn the program over to Todd, who will begin today's presentation.

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

Well, thank you, Mark. And good afternoon, everybody. As previously reported in our 8-K filing on May 26th, S&T Bank was subject to a significant check kitting 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 $0.85 per share. An independent internal review is 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 process and monitoring enhancements to prevent future fraud. 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 1.7% of average assets. Another bright spot is our efficiency ratio, which came in 50.51%, controlling expenses have 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 bearing 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 growth program, another government stimulus programs.

Mortgage banking with the price -- by this quarter as well. Year-to-date production of $213 million represented 54% increase over the same period of last year and the breakout is about 70% refinancing and we've sold about 78% of 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 reopened with enhanced safety measures and we extended PPP funds that offers customers impacted by the pandemic. Also with the heightened awareness on social equality, we remain committed to fostering an environment that promotes diversity inclusion.

As you would expect, year-over-year branch transactions have declined by 24%, call center volumes have increased by 41%, low banking activation is up 50%. Bill pay is up 57% and Zelle payments are up 27%. So we've seen 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 that'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 as a number one bank in customer satisfaction in retail banking in the Mid-Atlantic region and the website as well as other issues are part of our commitment to continually improving the banking experience for our whole customers.

Now of switching gears, I want to touch base on credit metrics for the quarter and we did record an allowance net of the fraud of $28.1 million. We also incurred net charges of $9.4 million, this includes $4.2 million associated with the real estate loan pertaining to the customer perpetrating the kiting scheme.

Our total reserve increased 18.34% to $114.6 million. The reserve to loan ratio is now 1.64% excluding PPP. Yeah, and finally, NPAs increased by $15.7 million or 92 -- $9 million or 1.19% of total loans and again, the NPAs were negatively impacted by the $10.9 million that the Chancery and from the CRE loan associated with fraud.

I am finally, pleased to report that our Board of Directors declared a dividend of $0.28, which is a 3% increase over the same period last year. And before I do start the presentation over to David Antolik, our President. I do want to mention that we are a resilient company with 118-year track record of serving our loyal customers and communities in good times and challenging times and we will continue to work very diligently every single day to deliver exceptional services and value to them.

Thank you for your continued support of S&T Bancorp. And now I'll turn floor to our President, David Antolik.

David G. Antolik -- President and Chief Lending Officer

Yeah. Thank you, Todd, and Good afternoon, everyone. I'd like to direct your attention to Slide 9, which provides information on our loan mix. Worth noting here is the impact of PPP. Those loan balances were $548 million at the end of Q2 and were responsible for the growth in C&I loans and total portfolio amount of $359 million and $302 million respectively. During the quarter, our CRE balances declined by $97 million, primarily due to continued chaos from the permanent market and slower reproduction.

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 loans.

During the quarter, new commercial construction commitments outpaced funding resulting in a $6 million increase in available commitments. Excluding PPP, 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 positive note, C&I commitments expanded during the quarter by $50 million as a result of new customer acquisition. Factors impacting C&I balances including customers using a lower cost in PPP funds to reduce revolving borrowings and customers in certain segments struggling to maintain inventory levels. This was most noticable 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 drop by customers in order to build their liquidity. Commercial pipelines have decline 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 PPP to 15% of loans as of July 21st, down from 20% as of June 30th. Generally, we offered three to six months in interest-only or payment where there's -- 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 modify balances that you see through July 21st. Early results on slide 11 are encouraging with 68% of expiring commercial modifications were returning to contractual payments. This has resulted in a decline in commercial modifications from 22% as of 6\30 to 17% as of July 21, which is detailed by us on slide 12. For customers who were 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 details 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 breakeven points along with the examination of sponsorship support, franchise obligations in relationships, as well as geographical and location 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 hardship assistance program. This program expires at the end of July and modification expenses are not currently being offered. Our PPP results are displayed on slide 15. We have undergone a significant stroke process of all PPP loans to prepare them for the forgiveness process, which we will be prepared to launch on August 10th.

I will turn the program over to Mark for details on our results.

Mark Kochvar -- Senior Executive Vice President and Chief Financial Officer

Thanks, Dave. Net interest 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 PPP loans. The net interest margin compression quarter-over-quarter was 22 basis points. Approximately 5 basis points of the compression was due to PPP implying core rate of about 3.36% in line with our expectations. With short rates stabilizing, albeit at a very low levels we anticipate 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 modifications.

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. Certainly deposits in the second quarter came mostly in low-cost core deposits. We were able to substantially reduce our short-term borrowings and maintain higher than normal cash balances ahead of an opportunity to reduce floating rate brokered CDs later this quarter. On balance, we don't believe the increase in deposits had and will have much of an impact on net interest margin rate.

Net 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 with the primary drivers in a $3.7 million increase in other income. We saw the impact of the pandemic in several key categories including service charges on deposits, accounts, particularly NSF fees and in commercial loan swappings.

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 the run rate of $13 to $14 million a 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 merger-related items in the first quarter.

Other expense in the first quarter includes $1.2 million related to some historic tax credits and we expect our expense run rates to be in the $45 million, $46 million range per quarter. Capital levels on Slide 17 remained strong and in excess to regulatory well capitalized levels we are comfortable with our ability to absorb losses based on internal stress tests that we have completed, including COVID related scenarios. Both the leverage and TCE ratios are impacted by the PPP loans.

Now I'd like to turn the call over to our operator for questions.

Questions and Answers:

Operator

[Operator Instructions] We'll take our first question from Russell Gunther with DA Davidson.

Russell Gunther -- D.A. Davidson -- Analyst

Hey, good afternoon guys.

Mark Kochvar -- Senior Executive Vice President and Chief Financial Officer

Hi Russell.

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

Hey Russell.

Russell Gunther -- D.A. Davidson -- Analyst

Mark just 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 the 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 or are you guys looking at your branch network or any other moving pieces that might help generate some positive operating leverage?

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

Yeah, Russell, you are seeing a lot of releases of people cutting back on branches, but we have 72 branches in our system, 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 we are on the table with market come out today we commit to say we're going to close with 10% anyway that. But we look at all facets of the organization. I mean we're just reviewing things last week and so we've had 12 positions that have been exited from the company, whether be retires or someone take another job, we got replaced those, so that totals about 1.3 million when we are looking at other positions as those become open and how we shift resources around, we're looking at some up 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 continue to look for ways we got to squeeze expense out of the organization and then manage with that low 50 number, I guess, would be my answer Russell.

Russell Gunther -- D.A. Davidson -- Analyst

Okay, great. Thank you, Todd. And then on the deferrals, 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, when we're talking at next quarter. Do you have a sense for where that could shake out?

David G. Antolik -- President and Chief Lending Officer

Yes so Russell, what you see there most of the activity in terms of the modifications happen at the end of March and in early April. Those things expire in the first part of July. Our expectation would be that we'll continue to see reductions in the amount of modified loans that we are keeping very close tab on segments where we have concern. That's why we included some additional information on our digital portfolio, other segments are concerned with retail CRE and we're gathering information and doing deep dives in terms of understanding what impact the economic crises will have those customers.

And with regards to consumer modifications. Yeah with regard to consumer modifications, those worked their way through other process by the end of July.

Russell Gunther -- D.A. Davidson -- Analyst

Okay. Thanks, Dave. And then I guess just given those comments be particularly on the commercial side of things. Is the expectation than for that reduction, but whatever remains, are those -- do you consider to be more out 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?

Mark Kochvar -- Senior Executive Vice President and Chief Financial Officer

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

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

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

Russell Gunther -- D.A. Davidson -- Analyst

Okay, thanks guys. And then just last one for me, I mean it doesn't sound like loan growth opportunities on the 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 potentially around the quarter how you're thinking about that?

David G. Antolik -- President and Chief Lending Officer

I certainly don't see any kind of significant loan growth through the balance of the year, where partially resources to attack the -- some modifications and making sure that we've got our arms around credit risk. We are on-boarding some new customers quickly in the C&I space, we've had some set in with our ABL Group.

But as I mentioned, the deleveraging has been significant, so some of this is going to come down to existing borrowers readvancing online, like pointing out the floor plan portfolio. It is amazing to me that our balances reduced 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 inventories. So some of it's going to be the macro-economic issues and the availability of inventory and whether or not the C&I borrowers releverage. So some of that is kind of unknown as we move forward through the balance of the year.

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

The other thing that will weigh in will be the forgiveness on the PPP loans of that $550 million, we're estimating about 80% of that gets forgiven by year-end as well. So those will unwind.

Russell Gunther -- D.A. Davidson -- Analyst

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

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

Thank you, Russel.

David G. Antolik -- President and Chief Lending Officer

Thanks, Russel.

Operator

We'll take our next question from Matthew Breese with Stephens Inc.

Matthew Breese -- Stephens Inc. -- Analyst

Good afternoon.

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

Hi, Matt.

Matthew Breese -- Stephens Inc. -- Analyst

Hey, Matt. Just one question on the fraud. So I struggle to understand 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?

Mark Kochvar -- Senior Executive Vice President and Chief Financial Officer

Matt, technically, because it creates an overdraft becomes loan.

Matthew Breese -- Stephens Inc. -- Analyst

Okay.

Mark Kochvar -- Senior Executive Vice President and Chief Financial Officer

Matt -- it's technically a loan, so that prescribe that it works its way through the allowance process like any other -- like any -- like a charge-off, with loan charge-off. And so typically, you don't typically see it, but we will have a lot of DDA charge-offs and overdraft charge-offs essentially every quarter, but they're very, very small, but they run through the reserve process as well.

Matthew Breese -- Stephens Inc. -- Analyst

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 in the office and flex space that require second deferral? Just wanted to get a sense for buffer against losses.

Mark Kochvar -- Senior Executive Vice President and Chief Financial Officer

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

Matthew Breese -- Stephens Inc. -- Analyst

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.

David G. Antolik -- President and Chief Lending Officer

Yeah, it is a -- I mean that's something we continue to evaluate into the market, but you know that we have a cost to it. So, looking at it, we don't have any firm plans as of right now to do any issuance.

Matthew Breese -- Stephens Inc. -- Analyst

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

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

Thank Matt.

Operator

And we do have a questions that's coming through from Collyn Gilbert with KBW.

Collyn Gilbert -- Keefe Bruyette & Woods Inc. -- Analyst

Thanks. Good afternoon, guys.

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

Hi Collyn.

Collyn Gilbert -- Keefe Bruyette & Woods Inc. -- Analyst

Just to start -- 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?

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

Yeah. It's on this slide.

Collyn Gilbert -- Keefe Bruyette & Woods Inc. -- Analyst

Oh, is it? Okay.

Mark Kochvar -- Senior Executive Vice President and Chief Financial Officer

Yeah. Slide 13, has the average hotels so...

David G. Antolik -- President and Chief Lending Officer

So, average hotel is -- in the total book is $3.1 million and the modified average is little bit higher $3.8.

Collyn Gilbert -- Keefe Bruyette & Woods Inc. -- Analyst

Okay, sorry. Yeah. I see that right there. Sorry. I -- OK, got it. Thank you. That's helpful. And then just in terms of the fraud and I apologize if you happen to covered it 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, to -- just curious, when that relationship originated with the bank.

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

Yeah. So I think, it goes back in 2016, this relationship and we do have a very thorough investigation and then really, we've just enhanced processes and oversight really if you know Collyn is what it comes down to.

Collyn Gilbert -- Keefe Bruyette & Woods Inc. -- Analyst

Okay. Okay. Okay, that's all I had. Thank you.

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

Thanks Collyn.

Operator

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.

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

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 a good day.

Operator

[Operator Closing Remarks]

Duration: 25 minutes

Call participants:

Mark Kochvar -- Senior Executive Vice President and Chief Financial Officer

Todd D. Brice -- Chief Executive Officer of S&T and S&T Bank

David G. Antolik -- President and Chief Lending Officer

Russell Gunther -- D.A. Davidson -- Analyst

Matthew Breese -- Stephens Inc. -- Analyst

Collyn Gilbert -- Keefe Bruyette & Woods Inc. -- Analyst

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