S&T Bancorp Inc (STBA) 2006 Q4 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the S&T Bancorp, Inc. fourth quarter financial results conference call. [OPERATOR INSTRUCTIONS] A brief question-and-answer session will follow the formal presentation. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Mr. Robert E. Rout, Senior Executive Vice President and Chief Financial Officer of S&T Bancorp. Thank you, you may begin.

Good afternoon, everyone, thank you for participating in the conference call. Before beginning the presentation, I want to take time to refer you to our statement about forward-looking statements and risk factors found on the second slide of our webcast slide presentation. This statement provides the required cautionary language required by the Securities and Exchange Commission for forward-looking statements that may be included in this presentation. Listeners are also reminded that a copy of the fourth quarter earnings release can be obtained at our investor relations website at www.stbancorp.com. In addition, a set of financial highlight slides is included with this webcast that support what we are about to discuss. We do not plan to review the slides in detail, but we'll be more than happy to respond to any questions concerning them or any other aspect of our financial performance. Now, I would like to introduce Jim Miller, S&T's Chairman and Chief Executive Officer, who will provide an overview of S&T Bancorp's results during the fourth quarter.

Thank you, Bob. And good afternoon, everyone. Todd Brice, Rob Rout and I appreciate the opportunity to be with you today to update you on what's been happening with S&T from both a financial performance and strategic perspective. We are, of course, disappointed that our earnings result this year have not followed the pattern of year-over-year increases that we've enjoyed historically. I believe it's the first year since at least 1989 that we've not reported an increase in earnings per share. Taking a full year perspective on earnings, 2006 was especially challenging due at least from our perspective, to the stubbornly unfavorable yield curve. several commercial loan problems which followed two years of pristine asset quality, and lackluster net commercial loan growth due primarily to higher than anticipated payoffs as conditions in the wholesale markets made it very attractive for our borrowers to lock up favorable long-term rates on a nonrecourse basis.

Earlier this year, we addressed four problem commercial relationships that were very expensive to get stabilized and moving toward resolution. These four credits were responsible for the lion's share of the $12.7 million of net chargeoffs, as well as significant other costs associated with these credits, including increases to delinquent interest reserves, valuation reserves on foreclosed properties and higher cost for legal and compiling services. As we mentioned in our October, 2006, call, two of the four problem credits have been fully resolved. The other two have combined remaining balances of $7.5 million, which we believe is adequately collateralized.

The other significant factor in our performance shortfall this year is one of the most difficult interest rate environments that I've seen in my 35 years of banking experience. The yield curve inversion not only compresses spreads, but also makes it more advantageous for some of our commercial real estate relationships to move more quickly than they ordinarily would have into the secondary market. The market conditions are such that conduits, insurance companies and REITs are offering very attractive long-term fixed rates and credit terms that we're not comfortable putting on our balance sheet.

Our lending folks actually had a great year generating new volume in 2006. The payoff of commercial loans going into the secondary market prevented us from achieving overall loan growth goals this past year. We are very pleased with the few revenue growth in 2006 retail, insurance, and wealth management product lines. That progress was somewhat masked by lower residential mortgage banking revenue which, as we all know is a very cyclical business. The unusual 2006 increases in non interest expense are primarily related to the aforementioned loan problems. The implementation of stock option expensing and the upgrading and construction of several new branch and administrative facilities.

From a fourth quarter perspective, we continue to experience some net interest margin compression. As a strategy to alleviate this compression, we have repositioned and repriced our $740 million of Green Plan and Plan B deposit balances. This repricing into our new S&T Cash Management Account will still give us a premiere product in the market but we anticipate reducing our cost of these funds by 25 to 30 basis points through this change.

Also during the fourth quarter, one of those four problem loan relationships was resolved through a sale contributing to a $2.2 million reduction in foreclosed properties. We did, however, see a $3 million increase in nonperforming loans in the quarter. Part of this increase is a $1 million loan relationship with a, an energy-related company which we believe is adequately collateralized. The other is a $3 million relationship that slipped temporarily but was fully resolved in early January. We did experience some pickup in new loan activity during December and noticed some slowing of secondary market refinancing as well.

The difficult earnings year we experienced in 2006 also made us re-examine some of our incentive programs. One of those plans, a highly high-profile plan, was our bankwide stock option program which typically would award between 400,000 to 450,000 grants of non-statutory stock options on an annual basis. Under the new accounting rules requiring expensing of those options, if we continued the practice, we knew we would be incurring significant expense regardless of our earnings performance. Therefore, in the fourth quarter of 2006, we discontinued the granting of stock options and moved toward performance-driven incentive programs based upon earnings per share growth. It's our long-held belief that earnings per share growth, more than any other factor, drives the value of our stock. As part of our transition plan, we incurred a $1 million one-time expense in 2006 that we expect to save us about $4 million in stock option expense over the next four years. Finally, we're very encouraged by the growth in our net assets and deposits, the strength we see in our core business activities and the continuing success of our relationship banking strategy.

In addition to these factors driving our organic growth, we expect to continue expanding our market presence through the addition of several new offices during 2007. As we have mentioned in our recent conference calls, we long ago continued the practice of providing specific earnings guidance each quarter. But with that in mind, Todd, Bob and I would be very happy to entertain any questions about our past performance and the future outlook for our business in general. We'll take questions at this time.

Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. [OPERATOR INSTRUCTIONS] Our first question is from Wilson Smith with Boenning & Scattergood. Please state your question.

Good afternoon, gentlemen.

Hi, Wilson.

Surprised you're not on the golf course today.

We're just happy to be here talking to you.

Okay. Although year-over-year, your fee income sources were up, it seemed as throughout the year especially in the fourth quarter a number of those line items -- service charge, wealth management and insurance revenues were all off. Could you give us a little color on kind of the direction and then what you're seeing in some of your fee income sources there?

Yes. Wilson, this is Bob Rout. The fee income in general, of course, is impacted by the slowdown in mortgage banking activities. We saw about a $800,000 decline year-over-year. But when you're looking at the linked quarters for a couple of those line items, let's just take the wealth management line items, in the third quarter of this year, we had a significant amount of probate activity, which is sort of one-time revenue. We also had done some restructuring with our brokerage products, and as a result, we had some falling off of the revenue from that area. In fact, we just recently changed vendors here in the fourth quarter, away from Raymond James into a company called ITI. So we're look forward to that conversion getting stabilized and back on track. With the insurance revenue, our insurance agency just had a real bang-up quarter in the third quarter. And there's several large accounts that came on, and of course were not repeated here in the fourth quarter. We're very pleased with both of those areas in performing, but there was a little bit of fluctuations between the third quarter and the fourth quarter, after stripping out the mortgage banking issue. Does that answer your question, Wilson?

Yes, that helps. I mean, although the wealth management -- Bob, honestly, it looks as though it peaked in the first quarter. You had a one-time shot there and it declined throughout the rest of the year. So, at this point, you feel that you bottomed?

I'm sorry. Would you repeat the last part of that question?

Wealth management. You started off very strongly in the first quarter of '06. And then it trended down through the rest of the year and I understand it was a one-time item in the first quarter.

That's correct.

But looking at the fourth quarter, do you think that you bottomed?

I don't know if we bottomed. But we expect double digit revenue growth out of that area going forward.

Okay.

Again, the true wealth management fees is up quite significantly year-over-year; it was brought down by lower brokerage activities in 2006. That was the biggest change, the investment management business has been pretty strong throughout the year. And I don't have the percentages in front of me, but the overall numbers I think were decent. The -- and we continue to see good activity there and acquiring new customers in that area. The conversion from Raymond James to ITI and then there are a couple of folks that we had in line to bring over, a lot of it's a function of the number of brokers that you have. And it didn't make sense to move them, their license through Raymond James for a short period of time, and try and move their customers until we had the ITI conversion in place. And that's just occurred.

So we're looking to add several people into that area and have added some already, and expect to see decent growth in that area, in the brokerage area next year and going forward. But all in all, we think wealth management should be a bright spot for us quite frankly. And the performance has been very good.

The other thing we did was we rolled out in a mutual fund product just very recently, and while that probably won't make us any money in '07, we think the long-term it has very good prospects for it.

Okay, great.

-- this is Todd. Just to expand on Jim's comments on the brokerage area. They undertook that initiative on November 1, and I think we had approximately 10,000 accounts over in the Raymond James portfolio. So their main focus was gathering those accounts and getting them converted over to the ITI platform and, you know, our production did suffer but, we were able to convert close to 90-some percent of those accounts back to the ITI platform. In addition to what we feel bringing on a new partner which is going to enhance that line of business, we also expect to experience some significant cost savings as well.

Excellent. Okay. Bob, of the salary [implicit] expense increase in the fourth quarter, you say they had about $1 million of stock option expense in there -- or I guess it was FAS 123R expense -- is that a one-time shot or will we see that recur in '07 but spread out over four quarters?

Wilson, no, the $1 million that you're referring to is not FAS 123R expense.

Okay.

We made a decision here in the fourth quarter that by eliminating the stock options, which have an estimated cost of $4 million over four years, they vest over 4 years. When we decided to take that away from the employees of the bank, the Board agreed to do a one-time payment to those, to help offset the loss of those stock options. And equated to about 0.25 of the value of their options would have been had we went ahead with the normal grants. That was a cash expenditure. And not an equity-based one. And it was made because we have gone away from the stock options.

If we had done the stock options we would not have seen that $1 million expense in December.

We would have seen it in '07. That's correct. And we felt it was -- our stock options, you know, have been awarded in the past every year since we initiated the program since the expensing, starting to see the impact of that. We determined that it was probably, it was probably a better solution, going forward, and a better incentive program, to have something that was more performance-driven. And in fairness to people that anticipated receiving the stock options without a performance indicator, we felt that that was a reasonable solution. And so it was one-time. You won't see that again. And again, we've discontinued the stock options. Now, we did replace it with a performance-driven program that will, that will award cash incentives to grades 1 through 11. That's everyone up through the Vice President level. If we reach certain earnings per share growth goals, and it will award restricted stock incentives to Senior Vice Presidents and above, again, based on the achievement of certain earnings per share growth goals. Which we think makes a lot more sense from a shareholder perspective and it's tied to performance.

Okay. And can you give us some feel for what additional expense we recognized through the restricted stock?

Well, it depends on how well we do with our earnings growth, honestly. I don't know what to say about that.

And I guess salaries and benefits, in addition to that $1 million, were up another about $850,000. Were that primarily bonus accruals?

What are comparing -- linked quarters or full years?

Linked.

Oh, linked quarters. No, we had some benefits in the third quarter related to some medical plan expenses. There's a couple hundred thousand dollars. And we also had some market swings in the deferred compensation plans. As the value of those plans go up you recognize more expense. And we have additional staff as well.

Okay. Well, I'll let other some people get in and I'll hop back in if I need to, thank you very much, gentlemen.

Thanks, Wilson.

The next question is from Steve Moss with Janney Montgomery Scott

Good afternoon, guys.

Hi, Steve.

Just want to ask with regard to the margin and the repricing of deposits. Do you think your net interest margin's bottomed here?

We hope so. I mean, the -- a lot is going to depend on when we get slope back in the yield curve and how our customers behave. And a lot will depend on the customer behavior with the introduction of this new rate schedule. We took a very careful look at the customer base that is in the Green Plan and our Plan B product and most of them are long-term customers of the bank. And, you know, we anticipate that most of those deposits will remain with the bank. The hot money may find a better option somewhere, but those people that are our long-term customers, we believe will stay. Exactly how they will behave, we don't know. It's still a very good rate for liquid funds. It ranges between 4.25% and 5%. Depending on the tier, the level of deposit.

You know, if people stay, want to stay liquid, than we'll get the anticipated 25 to 30 basis points improvement, maybe a little more. If people decide they need to have that 5% rate, or something a little better, and they want to move in, they're willing to move into a CD product to get it, then that will, that will take away from the improvement that we're hoping for. And expecting.

So we will have a lot better handle on that once we get through this first quarter because the change, while we notified customers at the end of November, the change was really effective January 2nd. They'll be seeing their first statement with the new rates at the end of January. The people at the highest levels won't see a change in the rate. People at the lower balance levels will.

Okay. And I guess with regard to your loan yield, what's the kind of rates you're getting these days for commercial loans versus your current portfolio?

Well, it varies. We're still doing a fair amount of business at prime. On, you know, lines and construction loans and that type of thing, although there is a lot of pressure for a good credits out there. And we've seen some slowing in the people that are coming back in and saying gosh, I've got a competitor offering me LIBOR plus 2.25 or something. But there's still that threat is still out there, as long as the yield curve remains inverted and people wanting to fix, that threat remains. If we're looking at a five-year fixed rate today, you're probably in the 7.25% to 7.75% range is what we're seeing competitively in the market.

Okay. Thank you very much.

You're welcome.

[OPERATOR INSTRUCTIONS] The next question is from Collyn Gilbert with Ryan Beck. Please state your question.

Thanks. Good afternoon, guys. Just a follow-up to that, to what you're saying on the Green Plan strategy. Which you sort of touched on. I was just curious to know a little bit more about retention strategies in order to keep those accounts in the bank -- outside of price. And then, two, if you could just remind us kind of what the crossover issues are for that account or product.

Okay. The, I don't know if you recall, but on the front end and one of the things that we've kind of prided ourselves on, in terms of keeping faith with our customers, when we introduced the Green Plan initially, which was the indexed account, we didn't limit it to new money. So consequently a lot of folks that were in money market accounts here, or savings accounts moved into the Green Plan. And by the same token, our expectation is that those people are probably -- and a lot of them are because we profiled the group. A lot of them are long-term customers to the bank. They're not shoppers. We did have a fair number of people come in at the higher levels, a couple of institutional school districts or municipalities that weren't our customers in a very deep sense with our operating accounts and everything to move money in. Those people, you know, we're not sure what they'll do. But we expect the behavior of those long-term customers to hopefully to stay in those liquid accounts. And if they do, we'll experience some significant savings.

When we decided to make this change, one of the things that we did was to get all of our branch managers on the phone prior to the introduction of this new cash management account. And had a conference call with them, explained the rationale of why it was important for us to make the change, took their questions, tried to address the concerns that they had. They were pretty proactive in contacting, we sent out lists of their customers, and sorted by balance so that they could contact people ahead of time, even before they get their letters. And we've been monitoring the activity in the Green Plan and Plan, former Green Plan and Plan B accounts to date. And quite up to now, you know, we've seen a pretty benign response. But again, people haven't received their first month's statement at the new rate yet. So we'll have a lot better handle at the end of this month or probably by the middle of February as to exactly what behavior to expect.

What we're hearing, just anecdotally from the managers, we had a managers meeting yesterday, and what we're hearing is that the people that have reacted to the letter are the kind of the single-service customers. And that was our experience when we implemented changes through the last year as we were trying to rein the Green Plan in and move to Plan B. The people that seem to have reaction to that where the single service customers. So the long-term customers that have deep relationships with us, we are anticipating that they will stay with us and that the people in the offices will be able to manage this change without a lot of disruption. We're not making a short-term high-rate CD option available to them, which might be attractive. So we're going to try and encourage them to stay in the savings product. If they want the 5% rate, you know, we're going to take them out. Where are we?

11 months.

11 months. They're going to have to go out close to a year to get that. But that's kind of where we are with it.

You know, one of the things we pride ourselves on is communicating with the staff and having the people that are on the ground understand what we're doing and why we're doing it so that they can have those conversations with our customers. And for the most part, we found that to be pretty effective in terms of retaining the relationships that we think it's important for us to retain.

Okay. And in terms of your non-interest-bearing deposit growth trends, do you have seasonality in the fourth quarter numbers that is would inflate that? Or maybe can you give some guidance as to what you're expecting for the growth rate of that line next year or this year, '07?

Yes. We were pretty pleased, actually, with the '06 performance there. I mean, you know, with short-term rates rising so dramatically the last couple of years, people have been managing their excess cash a lot more aggressively than they did back when the short-term rates were very low. And we saw some really nice improvement in demand deposit balances through that period. So we actually had a little incentive plan in place, tied to demand deposit growth last year. And we were fairly well pleased.

What we anticipate in '07? Well, again, if we have the status quo, and hopefully we'll get some decent growth that will be tied to kind of our new business acquisition. We also have a program that we're introducing that's going to target some what I'll call high-value customers that we haven't really targeted in the past. Municipalities and school districts and foundations and universities. And we have in addition to a very nice suite of cash management products and remote deposit capture and those types of things.

And we're also going to make our own intranet product available for some of those folks to help sweeten the deal and provide something really unique to them that we have been selling to some other banks for the last four or five years. We do have some strategies to do that, we have a great suite of cash management products. We're doing all the imaging things and the intranet, which is really taking hold. We have a pretty significant percentage of our customer base already that elected for e-statements and one good really tangible indicator of the acceptance of the of the new e-statements and electronic internet banking is the fact that we've seen a pretty significant dropoff in our call center activity as people have access to images of their checks and the ability to do stop payments online and things that they might have called our direct bank center for in the past. We're seeing some very tangible results from that.

And again, just kind of evidencing -- I know your question was about demand deposit growth, but just kind of evidencing the fact that we're pretty far off the curve in terms of convenience of these products and delivery systems for folks. So with the emphasis we're putting on that line of business, I hope we'll see some improvement in '07 but we're not getting any help right now from the yield curve and short term rates.

Okay, great. And then just one last question on the leverage, did you add some leverage to the books? It looks like securities balances and borrowings rose during the quarter.

I don't think so, Collyn.

Okay.

I don't think there was any intention to leverage, it was probably just normal maintenance.

Okay. Okay.

[inaudible].

Okay, great. Thank you.

The next question is from Wilson Smith from Boenning & Scattergood. Please state your question.

Just a follow-up on what Collyn had asked. It looked to me as though your purchase money or wholesale funding did pick up in the fourth quarter from the third quarter, Bob. Was that just due to pricing differentials in the market?

Repeat your question again, Wilson?

It looked to me like purchase money borrowed funds and wholesale CDs and so forth increased in the fourth quarter over the third quarter.

Yes. we had a little resurgent loan growth in the fourth quarter as compared to the third quarter.

But --

I think it was just loan growth. There's some seasonality in the point and time numbers. Collyn had a question earlier about the DDA accounts being updated. They are up, but sometimes that's an impact on when the last day of the month is. And when some of your government payments go into the bank, on average, it was up but not up as much as maybe the point in time numbers show. And I think there's a similar effect here when you look at our loan growth, it came probably late in December. And caused just a point in time spike in some of our borrowed funds.

Okay, so it's more of a timing issue, you replace that with core funding as the year goes on?

That's right. And the same issue when we look at securities, too. It looked like a fairly significant increase in the point in time compared to last quarter. But when I look at some of the averages here on some of the detail pages of that press release that we provide, you'll see the averages are probably slightly down or about the same.

Right, okay. And can you give us a little color on the watch list trends, and how things are looking for you now? As you said, it was a little bit of a bumpy '06.

Yes, it was a little bumpy '06. I always go back to because I -- Todd and I get a projected delinquency list every month. And look at that. And our 30-day numbers are still very good. I mean, they're just a shade above 1% delinquency. You know, we did see a little tick up in nonperforming numbers in the fourth quarter but a lot of that was very temporary and got resolved early in January. So that's kind of leveled. In terms of the watch list, you know, I think there are some -- you know, bound to be and you're seeing this in kind of that stuff that goes 15 or 20 or 25 days but doesn't quite hit 30. But when you think about the increase in interest costs, that people that are tied to prime have incurred the last couple of years, it's more than doubled their carrying costs on their lines of credit and those construction loans and things like that. So there's a little, bound to be some stress there, but we don't have anything that we see that -- we're hoping that we'll get back and expecting to get back to a fairly normal environment.

I always go back and I know people get tired of hearing this, but, you know, I think when it comes to credit quality, you really have to take a long view. And if you look at the 10 years prior to 2004, you know, we were between 25 and 35 basis points in net chargeoffs and averaged about 28 or 29. '04 and '05, we had 7 basis points of chargeoffs. We probably got lulled to sleep a little bit. You tend to think when things are that good that everything is always going to be good. Well, the rise in short-term rates, you know, slowed some things down and put some stress on some borrowers and we saw a lot of stuff bubble up there in '06, late '05, that really came to fruition in early '06. And since then, things have pretty much settled down. So I would expect that we'll be back in that maybe 30 basis point range for net chargeoffs. And that probably is a reasonable run rate for us. And you know at $2.5 billion, you're looking at $7 million to $8 million net chargeoffs on an annual basis,.which would be probably very respectable. When I look at our nonperforming year-end number, I think it was 60 basis points, roughly.

Yes. [inaudible]

On assets, I'm sorry. Yes. 60 basis points on assets -- and I see some of the other reports that are coming out, it seems like not a bad area. There are a couple of issues, always, and always will be when you've got several thousand commercial relationships. But, you know, in the -- I don't see anything out there that gives me terrible heartburn. I don't see any systemic kind of issues of -- I'm not saying something couldn't jump up, but if we had another 49 basis point chargeoff year, I'd be pretty disappointed, quite honestly. And I'm sure a lot of other people would be as well.

The other thing that's kind of, we had a transition last year in our credit area from Jeff Smead to Tony Kallsen. Tony's background is in special assets, too, and he's made some changes in how he processes some of those loans if and when he experienced difficulty. I think that will benefit us in the long run.

Yes, that's a good point. Maybe we could just expand on that a little bit. One of the thing that is is probably our good fortune is to have someone with a fresh set of eyes coming in at a time when we've experienced some stress in that area. Because if everything was still pristine and the new guy shows up to be manager of credit administration, anything he wanted to do, we'd probably be saying well, what do you want to do that for? Now that we've experienced these issues this year, everybody's kind of agreeable to be open to some of the suggestions that a fresh set of eyes is bringing. And I think that's healthy. Not to take anything away from Jeff, I think he did a wonderful job as our Chief Credit Officer for the more than 10 years he was here. But it never hurts to have a fresh set of eyes. Tony is a very experienced guy. He comes from a large bank background. As Todd mentioned, a lot of his experience was on the work out side. But he's smart and he understands how to, what's important to us in terms of managing our credit processes. He's got a lot of good ideas. And people here have been very receptive to, across the board, been open to his suggestions. So from that standpoint, this is probably a silver lining in this whole situation.

Great. And just to [inaudible] down here, when you were talking before, you said that $3 million increase in NPAs, $1 million was due to an energy company. And then was it a $2 million credit that paid off in January or a 3?

Well, there's probably some other give and take in there, but -- Linda's showing me something here. The overall increase was $3 million? From 17 to --

Well, we need to look at the nonperforming assets, Wilson?

Right.

So you had a $1 million increase from the energy company.

Right.

You had a $2.2 million reduction in your foreclosed properties. And you had that temporary one for $3 million.

Actually, those are two separate credits and they were more, they were mature notes that we just didn't get resolved before year-end. They're not any credit issues, they're more of a paperwork function and getting through the system. But we did those executed right after the first of the year and they will not be showing up.

You're starting off, then, from a $3 million lower base than what it looks like?

That's correct.

And just real quick here. Other expense was up $0.5 million in the fourth quarter over the third quarter, was there any one-time items in there?

One of the things that's driving that, Wilson, is we had some loan related expenses for about $200,000. As we cleaned up on some of these trouble credits. And also we have about a $150,000 increase to our reserve for unfunded commitments. One of the things that drives that number is not just the volume of unfunded commitments you have, but also your historical track record with chargeoffs in those particular loan categories. So those were the major ones.

Thank you very much, gentlemen.

Thank you, Wilson.

There are no further questions at this time.

If there are no further questions, I want to thank you all for participating in today's conference call. Todd, Bob and I appreciate the opportunity to discuss the financial results of S&T Bancorp and we'll look forward to talking with you again at our next conference call in April. Thank you very much.

This concludes today's conference. Thank you for your participation.