S&T Bancorp Inc Q1 FY2020 Earnings Call

Good day, ladies and gentlemen, and welcome to the S&T Bancorp First Quarter 2020 Earnings Conference Call. At this time, I am pleased to turn the floor over to your host for today, Mr. Mark Kochvar, Chief Financial Officer. The floor is yours, sir.

All right. Thank you very much, and good afternoon, everyone. 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. The 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 first quarter 2020 earnings release can be obtained by clicking on the press release link on your screen or by visiting our Investor Relations website. 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 for the First Quarter 2020 Earnings Conference call, click on the First Quarter 2020 Earnings Supplement. I would now like to introduce Todd Brice, S&T's Chief Executive Officer, who will begin today's presentation.

Well, thank you, Mark, and good afternoon, everybody. I hope that you're all staying safe and healthy through these unprecedented times. COVID-19 has impacted operations and our economies in unprecedented ways. So we've expanded our presentation this quarter to provide some granularity on the loan portfolio as well as some of our customer assistance programs that we've implemented. For the quarter, we're reporting net income of $13.2 million or $0.34 per share, which included $2.3 million or $0.05 per share of merger-related expenses in the quarter that were associated with the DNB transaction that we consummated last year. So core earnings for the quarter were $0.39 per share, which translates into a 70 basis point return on average assets, 5.13% return on equity, 7.79% return on tangible equity. Managing expenses continues to be a strategic focus. Our efficiency ratio for the quarter was 52.89% and will continue to be a focus moving forward. We did elect to adopt CECL as of January 1, and the uncertainty around COVID-19 resulted in a $20 million provision expense in Q1 compared to $2.2 million in the fourth quarter. So now our allowance for credit losses stands at $96.9 million or 1.34% of loans versus 0.87% last quarter. Pre-COVID, we were seeing nice growth in all of our lines of business across all of our 5 regional markets. The DNB conversion went extremely well, and then we're experiencing nice activity in Southeastern Pennsylvania. For the quarter, portfolio loans increased $109.6 million or 6.2% annualized and were distributed across commercial real estate, C&I, and construction categories. Next slide, Mark. So the COVID-19 response was focused on 4 stakeholders: First of all our employees, and then customers and business customers, and finally our communities, protecting the health and well-being of our employees and customers was the initial concern. So working from home, rotating schedules, splitting our operational staffs between multiple facilities, bonus pay for people that were coming into the office, picking up some childcare expenses, drive-through only and a number of other initiatives that we did to really just try and make sure our employees were safe and healthy. So next, we focused on customer assistance programs for consumers and businesses, which entailed needs-based loan payment deferrals, SBA PPP lending, extended solution center hours and encouraging the use of online and mobile solutions. And finally, we are committed to supporting our communities, and have done so through contributions to food banks and a regional medical provider. Before I turn over to our President David Antolik, I want to share some very exciting news. We have been recognized by J.D. Power as The Best Retail Bank in the Mid-Atlantic region. It truly is an honor to receive this designation, and it really is a reflection of the confidence and trust that our customers have placed in S&T Bank. We have been serving our communities for 118 years through good times, challenging times, economic downturns, and national disasters. And today, we bring that same commitment to help our clients navigate through the COVID-19 pandemic. Common shares totaling 411,430 were repurchased during the first quarter of 2020 at a total cost of $12.6 million or an average of $30.52 per share, and as the impact of the COVID-19 pandemic spread, we did suspend repurchase activity in mid-March. And finally, I'm pleased to announce that our Board of Directors approved a $0.28 per share dividend for shareholders of record on May 19, payable on June 2, 2020. This is an increase of 3.7% compared to the dividend of $0.27 per share declared in the same period last year. I want to thank you for your continued support of S&T Bancorp. Now I'd like to turn the program over to our President, David Antolik.

Okay. Thank you, Todd. Good afternoon, everyone. If I can direct your attention to Slide 5, we thought it would be helpful to provide an overview by category of the entire loan portfolio in order to frame our discussion today regarding credit risk and COVID-19 hardship assistance, focusing on those categories that have been most impacted by the crisis. As you can see on Slide 6, we have provided payment assistance in the form of principal deferrals and payment forbearance for loans that totaled $1.258 billion. The approximate ratio of principal deferral versus payment forbearance is 50-50, and the length of these modifications is generally between 3 and 6 months. Segments with the largest modified percentages include our floorplan customers where we waived curtailment payments for essentially the entire book as the various stay-at-home orders did not allow for continued operations. And as the overwhelming bulk of these dealers, who are also long-standing customers are located in Pennsylvania, where automobile dealers were prohibited from selling cars until just last week when the state allowed for online sales only to restart. Other high-impact categories include retailers and restaurants who have been forced to close or severely limit operations. This is having an impact on our strip mall and retail CRE borrowers as tenants ask for rent concessions. On Page 7, we have provided more detailed information on our most negatively impacted category hotels. It's important to note that approximately 84% of these properties carry solid mid-tier flags and that our hotel portfolio was primarily comprised of business travel locations rather than leisure-focused locations. I would also note that our oil and gas outstandings totaled $88 million at the end of the quarter with approximately $66 million of that amount concentrated in several well-yield convenience store brands and continue to perform well at this time. Turning to Page 8, we have the most recent results of our consumer hardship assistance programs, where we have modified $60 million worth of loans or 5% of the total balance. For both the commercial and consumer hardship assistance programs, we have seen requests for new relief reduce rapidly and are assessing the need for these programs as we move forward. On Page 9, you will see the results of our participation in the Paycheck Protection Program. We are very proud of these results in our ability to refocus resources towards helping our customers access this program. We have taken a very disciplined and thoughtful approach to our participation and believe that our mission of providing exceptional customer service is represented in these results. On Slide 10, you can see our utilization experience. The bottom line here is that we did not see significant line activity as a result of COVID-19. Finally, we are preparing for our return to business as usual activities in the coming weeks. As you know, the Commonwealth of Pennsylvania has announced a multi-phase reopening plan that they have described as cautious that divides the state into 6 regions where reopening of various segments of the economy will take place at varying times. We will continue to monitor closely on the guidance, and we will adjust our operations accordingly. I'd now like to turn the presentation over to Mark Kochvar, our Chief Financial Officer.

Well, thanks, Dave. Slide 11 shows the progression of the allowance for credit losses from the incurred methodology at the 12/31/19 to CECL, which is impacted by the COVID-19 as of 3/31/20. The original day 1 impact was $18.4 million, $8.2 million related to the legacy S&P loan book and $10.2 million for the acquired DNB loan portfolio, which, under prior accounting, carried no reserve. The additional day 1 adjustment primarily relates to the $9.9 million charge-off we had in the first quarter, due to the timing of when we learned that the charge-off was appropriate, which was after the filing of the 10-K, but prior to the end of Q1, a specific reserve for that loan was included in the day 1 adjustment since that had not been previously disclosed. That loan made up the majority of the $11.2 million in net charge-offs in the first quarter. And finally, the reserve build, which mainly relates to pandemic influenced economic forecast changes added approximately $18.6 million. Our allowance stands at just under $97 million and 1.34% of loans at the end of the first quarter. This does not include the reserve for unfunded commitments, which stood at $6.1 million at the end of Q1. The net interest income improvement of $5.6 million compared to Q4 was primarily related to the DNB merger, which closed on November 30, 2019. With our first full quarter of combined results, average loan balances increased by $666 million. The net interest margin compression in quarter-over-quarter was just 2 basis points as we aggressively repriced deposit costs and we benefited from a lag in the decrease of LIBOR. As LIBOR has come down in April, we expect additional NIM compression in Q2, more consistent with our prior experience of approximately 4 basis points for every quarter point that decreased due to our asset-sensitive balance sheet as seen on Slide 12. We will get some relief on the liability side at CDs, money market and borrowing through price over the next 12 months. This implies the core net interest margin rate ultimately declining to the 3.35% to 3.40% range. Included in net interest income in the first quarter is approximately 5 basis points of purchase accounting accretion. The next couple of quarters will be impacted by the SBA PPP program and the amount dependent on the pace of the forgiven. Noninterest income in the first quarter was impacted significantly by the stock market as the mark-to-market in a nonqualified deferred benefit plan combined with a decline in the value of some bank stocks we own resulted in a $3.5 million decrease in other income. Swap fees were strong again in the first quarter, and mortgage banking picked up with heavy refi activity. We expect some weakness in consumer fees with lower transaction volume moving into the second quarter, along with a slowdown in swaps. We remain comfortable with a run rate of about $13.5 million to $14.5 million per quarter. Noninterest expense included $2.3 million of merger-related items. Expense was favorably impacted in salaries and benefits by $1.5 million from the other side of the valuation of the nonqualified deferred benefit plan that decreased other income. The net of these two is P&L neutral. And although we are experiencing some additional expenses related to the pandemic, they are being offset for now by reductions elsewhere, such as T&E and slower hiring. We continue to expect our expense run rate to be in the $45 million to $46 million range per quarter. We expect our tax rate in 2020 to be somewhat lower than originally anticipated due to pressure on pretax income in the range of 17% to 18%. Capital levels 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. And finally, we have ample liquidity, both on and off balance sheet. Thanks very much. At this time, I'd like to turn it back over to the operator to provide instructions for asking questions.

We'll go first to Russell Gunther at D.A. Davidson.

I appreciate all the detail in the slide deck. It's even more than the robust deck we usually get from you guys, as well as increased granularity around the hotel exposure. But I'm wondering, if we look at Slide 5, I mean, can this serve almost as a heat map in terms of where your initial concern may reside within the loan portfolio? Or how would you, beyond the hotels, kind of staff rank potential pockets of weakness within the S&T portfolio?

Yes. I think if you look at Slide 6, Russell, where we have the COVID loan modifications and look at the categories where we have the highest percentage of modified balance, that would indicate the areas where we have the most risk. Now, what we're in the process of determining is, is it short-term risk due to COVID or is there a long-term impact on the underlying operations of these various businesses.

Okay. Got it. And then sort of sticking with that, are there any kind of underwriting characteristics you could share whether it's current LTVs within some of those more at-risk buckets or just a reminder of sort of the general framework whether it's a max LTV or minimum debt service coverage?

Yes. So in the hotel portfolio, Russell, we typically write to 70% loan-to-value. We haven't been booking new assets in that category. We have 2 loans that were under construction that are being completed that are in strong markets. But generally speaking, we're 70% on hotels. The remainder of the portfolio, depending on asset classes traditionally underwritten to 75% to 80% loan-to-value. And our debt service coverage ratios are 120 to 125 based on the asset class. Those were kind of pre-COVID underwriting standards. So we're looking at each individual deal and are including as part of our underwriting and analysis a thorough discussion and understanding of how each geography and industry is impacted by COVID. So it goes beyond kind of a broad underwriting guideline. It's really deeper into what the impact of COVID will have on each industry and geography.

Okay, great. Looking at Slide 11 and the reserve trajectory, do you have any remaining credit marks on acquired loans that might lead us to consider that the current 1.34 reserve could increase?

This is Mark. We still have about $9 million in other reserves from acquisitions. And then we also have about $6 million in the unfunded commitment reserve.

Okay. Great. And then the last one for me. You guys mentioned you hadn't seen much. I think it was, yes, Slide 10 in terms of a significant pickup in line usage. Just curious for your outlook for organic growth, non-PPP for the rest of the year. And if you could just kind of comment, is there a pent-up demand? Is it reflective of just a deceleration in pay down expectations? Just any kind of commentary there would be appreciated.

Yes, Russell, I think it's still uncertain. Pennsylvania is somewhat behind other states; the businesses that were allowed to open faced many restrictions. For example, starting tomorrow, they will finally begin to allow construction projects to resume, which will help in ramping up supply chains. As for what this means, we are actively working with the states and engaging in lobbying efforts to support our clients and anticipate the situation. However, it seems they are still figuring out how to approach their businesses currently. We will continue to monitor the situation closely and remain available for our customers whenever they need us.

We will now hear from Collyn Gilbert at KBW.

Mark, could you elaborate on the reserve assumptions? You built the reserve more robustly than many of your peers, which is encouraging. Can you share the economic forecast assumptions that influenced this? Also, what factors contributed to your methodology?

We adopted CECL, and the primary factor in our model is the unemployment rate, which leads to some volatility in our estimates. We are still assessing those figures. We have exercised some management judgment in this process and increased our estimates for unplanned events. This evaluation began in early April. Additionally, we can consider more general factors in our analysis, but the unemployment rate remains the key driver of our forecasts.

And what were you using just for unemployment? I mean, were you following one of the Moody's forecast?

We are not using Moody's; instead, we are relying on the Fed's forecast, which is slightly delayed in its updates. Therefore, we utilized our management's insights to adjust that forecast and suggest a higher unemployment rate.

Okay, that's helpful. Mark, in your guidance you mentioned the net interest margin, and I'm considering the pricing for CDs. It seems that much of this has been influenced by DNB coming on board. With CDs around 180 and money markets at 127, there appears to be significant opportunity to lower some funding costs. How do you anticipate this will evolve in the next quarter regarding funding?

I believe much of this is difficult to gauge in the quarter's figures since a lot of the activity occurred right at the end of the quarter. As a result, I think you'll notice that we accomplished a great deal, which will be more apparent in Q2 than it was in Q1. Additionally, regarding the asset side, the impact of the 150 basis points cut really translated to only about 40 basis points for this quarter, leaving another 110 basis points to address. Furthermore, due to the LIBOR delay, we anticipate a more significant decrease in the asset yield side in Q2. However, this will be counterbalanced by the timing of our deposit rate changes in the first quarter.

Okay, good. And then just lastly, what does the loan pipeline look like? And just kind of what is your expectation for loan growth? As you guys pointed out, Pennsylvania looks like it's going to open up, I know you feel like you're behind, Todd, but at least you're well ahead of what's happening, I think, in New Jersey and New York. So what's your outlook for loan demand as we move into the back half of the year? And how some of your borrowers are anticipating to react once things start to open up again?

Collyn, it's Dave. In the commercial and business banking sectors, pipelines are down 40% to 50% compared to the beginning of the year. Most people are focusing on utilizing PPP proceeds and working on forgiveness efforts. We're currently reforecasting our expectations, so we can't provide guidance at the moment, but it's clear that demand has decreased as businesses assess their working capital needs. However, we are starting to hear discussions about potential revenue opportunities and how businesses might find a silver lining in this situation. Additionally, our retail mortgage pipeline has remained robust, and we continue to see strong demand as interest rates stay low. I believe our mortgage banking activities will remain solid throughout this low-interest-rate period, but we will have more clarity for you next quarter.

We'll go next to William Wallace at Raymond James.

On the $537 million of PPP loans that you highlighted in your deck, is that spread across both the first and second round?

Yes.

Could you separate those out and then also give us a sense of the average fees?

The average fee is slightly below 3%.

Okay. And are the fundings of those loans kind of spread evenly between both of the rounds?

No. No. The first round was probably right under $500 million. And we had a pretty significant number, but we've been able to chew through a bunch of those over the last couple of days. And we're pretty comfortable where we are, but they were not only the sole proprietors and small businesses that couldn't apply until April 10. The program started on April 3. So they got jammed up in round one. But the average loan book range is $190,000. We funded the loan as low as $370. So round two is maybe, I'm going to say, we're still finalizing numbers because we're still working through this. It's probably in the $35 million range, maybe $40 million range in the last few.

Okay. So that core margin guidance of 3.35% to 3.40%, does that include any impact from these loans? Or would that be on top of the guide?

That would be in addition to this. The timing is likely to impact the margin calculations, especially if we see a significant amount of forgiveness in Q3, which could boost the margin considerably. Therefore, that guidance is excluding SDX.

On your loan modifications, are they all 90-day interest-only modifications across the board? Or are there variations in the types of modifications you offered or provided?

In the commercial sector, there are several types of modifications that vary in duration, including 30, 60, 90, and some extending to 180 days. We are adhering to the TER guidance as a reference. The modifications can include principal deferrals as well as payment and interest deferrals, based on the operational capacity of the businesses in this environment. For consumer modifications, we are offering a 90-day option.

And some of those are interest-only. We can suspend principal if they're still paying interest on some of those consumer loans.

Okay, that's helpful. I wanted to follow up on a previous question where you mentioned there are still $9 million in marks from purchased loans. These marks are interest rate marks, correct?

Well, they are related to interest and credit, but they now function differently in that those will simply be accumulated as they are paid down.

And with no other questions holding, I'll turn the conference back to management for any additional or closing comments.

Well, thank you for participating in today's conference call. Mark, Dave, and I appreciate the opportunity to discuss this quarter's results and look forward to hearing from you on our next conference call at the end of Q2. And I hope you all stay safe and healthy.

Ladies and gentlemen, that will conclude today's call. We thank you for your participation. You may disconnect at this time, and have a great day.