S&T Bancorp, Inc. (STBA) Q1 2020 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the S&T Bancorp First Quarter 2020 Earnings Conference Call. [Operator Instructions]. At this time and it is my pleasure to turn the floor over to your host for today, Mr. Mark Kochvar, Chief Financial Officer. Sir, the floor is yours.

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 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 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 continue 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 the Southeastern Pennsylvania. For the quarter, portfolio loans increased $109.6 million or 6.2% annualized and was 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 program for consumers and businesses, which entail 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, 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 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, was 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 floorplans 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 on Slide 13 remained 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, Slide 14 shows that 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.

[Operator Instructions]. 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. And then just looking at Slide 11 and the glide path of the reserve. Do you guys have much in the way of remaining credit marks on acquired loans that -- if we were to kind of look at the 134 reserve today and consider those that would take that higher?

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 unknown. I mean, Pennsylvania is a little bit behind other states, the businesses that were able to be opened were very restrictive, like tomorrow, finally, they're going to open up construction project, going to be able to ramp back up, everything into supply chains. So what that does or doesn't mean, I think -- we work with the states, we're doing a lot of lobbying to clients to try and anticipate, but I think they're still trying to weigh through kind of how they are going to view their businesses right now, but something we're going to stay on top of it and we will be there for our customers when they need us, and we'll continue to do so.

[Operator Instructions]. We'll go next to Collyn Gilbert at KBW.

Mark, if we could just dig into the reserve kind of assumptions, again, you guys did -- you built the reserve probably even more so than many of your peers now. That was certainly good to see. Can you just share with us what some of your economic forecast assumptions were on that? And -- yes, just sort of what went into that methodology?

Well, we did adopt CECL. And so the biggest factor in our model is the unemployment rate. So there is some volatility just in the estimates there. So we're still evaluating those. We did put some -- there's some management judgment that we can exercise with that, and we did ramp that up as some of the estimates for what unplanned were going to be. We're still in the early stages when we were doing this early in April. And then we have other more general factors that we could bring into the analysis as well. We're not just limited to unemployment, but the unemployment rate is the major thing that drives the forecast for us.

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. We're actually using just the Fed's forecast. So they are a little behind on producing a new one. So we used our management piece of that to essentially override that and use -- and imply higher unemployment rate.

Okay. Okay. That's helpful. And then, Mark, you had given in your guidance, the NIM, but just trying to -- just looking at that -- just thinking -- looking at some of the CD pricing, and I'm assuming a lot of that has come just because of, with DNB coming on, but looking at CDs at 180 kind of money markets at 127, it seems like there's a lot more you can do there to reduce some of those funding costs. How are you seeing that kind of play out here in the next quarter or so on the funding side?

Well, I think a lot of that has -- it's hard to see in the quarter's numbers because so much of the activity happened right at the end of the quarter. So I think you'll see that we did do a lot. It will show up more in Q2 than it did in Q1. The other thing is -- on the asset side, it's the same thing. With 150 basis points cut which the timing of it really worked out to only maybe 40 basis points for the quarter, so there's another 110 basis points to go. And then with the LIBOR lag, we're going to see a bigger drop on the asset yield side in Q2. Again, that will be offset because of the lateness of when we changed our deposit rates in the first quarter.

Okay. 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 -- but kind of what's your outlook for loan demand as we move into kind of 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. So in the commercial and business banking sectors, pipelines are off 50% -- 40%, 50% from where they were coming into the year, but most folks are looking at just getting through -- getting the PPP proceeds used and focusing on forgiveness efforts. So we're in the process of reforecasting and recasting where we think we might be so, we don't have guidance right at this time, but demand is clearly off as people are looking -- balancing and weighing working capital needs, but we're starting to hear the conversations about revenue opportunities for people, and how they might be able to find a silver lining in this storm. The other pipeline that I will speak to is our retail mortgage pipeline, which has been at sort of good levels for us, and we continue to see that kind of demand as rates remain low. So I think our mortgage banking activities will remain strong through this low interest rate period, but we'll have some better 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 -- I think it's a shade under 3%.

Okay. And as -- 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 -- so 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 on top of this. The timing of that is going to -- it's going to throw a little wrench in the margin calculations, if we do get a lot of forgiveness, say in Q3, it's going to pop margin pretty significantly. So that guidance is ex-SDX.

Okay. On your loan mods, are those -- it was a little bit confusing. Are they all 90-day interest-only modifications across the board? Or are there variations around what types of mods you offered or gave?

Yes. In the commercial space, there are various modifications. So some of those are 30, 60, 90 days, some as long as 180 days. We were following the TER guidance and using that as a guide. Some of them are principal deferrals, some are P&I deferrals depending on the ability of the businesses to operate during this environment. And I think on the consumer -- yes, just 90 days.

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

Okay, great. That's helpful. And then I wanted to follow-up on a question earlier where you said there's still $9 million in marks from purchased loans. Those are marks -- those are interest rate marks. Is that correct?

Well, they're interest and credit, but they operate differently now where those will just get accreted basically over -- as those pay down.

Right. So you couldn't -- those loans -- those marks are tied to specific loans, so they cannot be used to support credit somewhere else. Is that correct? I think some people are trying to say they're -- it's double counting?

Yes. I view those as not really -- I mean, I view those as -- they're going to run through margin no matter what. The timing is just whenever they get paid.

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.