S&T Bancorp - 10-Q quarterly report FY

Basic earnings per share is calculated by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Options, warrants and other potentially dilutive securities are excluded from the basic calculation, but are included in computing diluted earnings per share.

Components of comprehensive income for S&T include net income and unrealized gains or losses on S&T's available-for-sale securities. During the three and nine months ended September 30, 2003 and 2002, total comprehensive income amounted to $6,273,000, $8,508,000, $37,835,000 and $28,424,000, respectively.

NOTE B - STOCK-BASED COMPENSATION

S&T accounts for stock options using the intrinsic value method. The following proforma information regarding net income and earnings per share assumes stock options granted subsequent to December 31, 1994 had been accounted for under the fair value method and the estimated fair value of the options was amortized to expense over the vesting period. Compensation expense, net of related tax, of $81,000 and zero for the three months and $243,000 and $1,300,000 for the nine months ended September 30, 2003 and 2002, is included in the proforma net income as reported below.

NOTE D - GOODWILL AND OTHER INTANGIBLES

S&T's balance sheet shows both tangible assets (such as loans, buildings, and investments) and intangible assets (such as goodwill and core deposit intangibles). Goodwill resulting from the acquisitions in 2002 was accounted for in accordance with Statement No. 142 and will be periodically reviewed for impairment as required. The remaining goodwill and other intangibles are comprised of the 1998 purchase of a branch office in Clarion, Pennsylvania and other mortgage servicing assets.

Continued

NOTE H - LITIGATION

S&T, in the normal course of business, is subject to various legal proceedings in which claims for monetary damages are asserted. The ultimate resolution of these matters is not expected to materially impact S&T's financial statements.

Management intends to continue to pursue quality loans in a variety of lending categories within our market area in order to honor our commitment to provide the best service possible to our customers. S&T's loan portfolio primarily represents loans to businesses and consumers in our market area of Western Pennsylvania rather than to borrowers in other areas of the country or to borrowers in other nations. S&T has not concentrated its lending activities in any industry or group. During the past several years, management has concentrated on building an effective credit and loan administration staff, which assists management in evaluating loans before they are made and in identifying problem loans early.

Security Activity

Average securities increased by $37.4 million in the first nine months of 2003 compared to the 2002 full year average. The average increase was comprised of $111.9 million in U.S. government agency securities, $32.4 million of states and political subdivisions and $6.3 million of Federal Home Loan Bank (FHLB) stock. Offsetting these increases were average decreases of $62.5 million of mortgage-backed securities, $24.8 million of corporate equity securities, $1.2 million in U.S. treasury securities and $24.7 million of other corporate securities.

The equity securities portfolio is primarily comprised of bank holding companies, as well as preferred and utility stocks, to take advantage of the dividends received deduction for corporations. At September 30, 2003, the equity portfolio had net unrealized gains of $27.8 million. The equity securities portfolio consists of securities traded on the various stock markets and are subject to changes in market value. The FHLB capital stock is a membership and borrowing requirement and is acquired and sold at stated value.

S&T's policy for security classification includes U.S. treasuries, U.S. government agencies, mortgage-backed securities, collateralized mortgage obligations, municipal securities, corporate securities and marketable equity securities as available for sale. Two securities are classified as held to maturity. At September 30, 2003, unrealized gains, net of unrealized losses, for securities classified as available for sale were $39.4 million.

Allowance for Loan Losses

The balance in the allowance for loan losses was $31.7 million or 1.54% of total loans at September 30, 2003 as compared to $30.1 million or 1.51% of total loans at December 31, 2002. The adequacy of the allowance for loan losses is determined by management through evaluation of the loss potential on individual nonperforming, delinquent and high-dollar loans; review of economic conditions and business trends; historical loss experience; and growth and composition of the loan portfolio, as well as other relevant factors.

A quantitative analysis is utilized to support the adequacy of the allowance for loan losses. This analysis includes review of the high and low historical loss rates by loan categories, fluctuations and trends in the amount of impaired and classified loans and economic factors. Economic factors consider the level of S&T's historical losses that have occurred within the credits' economic life cycle.

Significant to this analysis is the shift in the loan portfolio composition to an increased mix of commercial loans. These loans are generally larger in size and, due to our continuing growth, many are not well seasoned and could be more vulnerable to an economic slowdown. Management relies on its risk rating process to monitor trends, which may be occurring relative to commercial loans to assess potential weaknesses within specific credits. Current economic factors and trends in risk ratings are considered in the determination of the allowance for loan losses. At this time, S&T's risk rating analysis of the portfolio remains relatively stable even though there has recently been a definitive decline in the general economy in our market area.

Net loan charge-offs totaled $4.2 million in the first nine months of 2003 compared to $3.6 million in the first nine months of 2002. Included in net loan charge-offs is $2.0 million incurred during the first quarter of 2003 for a single commercial loan, which was considered in the determination of the allowance for loan losses in previous quarters. The remaining balance of that partially charged-off commercial loan is $2.0 million and is included in nonperforming loans. Management believes that future business cash flows and/or collateral liquidation will be sufficient to substantially satisfy the outstanding balance. The third quarter net charge-offs of $1.3 million included two commercial loans in the food processing and automotive sales industries that were considered in the determination of the prior period allowance for loan losses. The balance of nonperforming loans, which included nonaccrual loans past due 90 days or more, at September 30, 2003, was $9.7 million or 0.47% of total loans. This compares to nonperforming loans of $5.8 million or 0.29% of total loans at December 31, 2002.

Asset quality is a major corporate objective at S&T, and management believes that the allowance for loan losses is adequate to absorb probable loan losses.

Deposits

Average total deposits increased by $207.6 million, or 12%, for the nine months ended September 30, 2003 as compared to the 2002 full year average. Included in the average increase is $293.0 million of deposits acquired in the Peoples acquisition. Changes in the average deposit mix included increases of $58.9 million in demand accounts, $77.5 million in money market and NOW accounts, $34.9 million in savings accounts and $36.3 million in time deposits. Some of these changes can be partially explained by customers shifting funds into demand, savings and money market accounts in anticipation of higher interest rates in the future. In addition, contributing to increases in core deposits were strategic initiatives and products such as free checking, online account opening and corporate cash management, as well as the deposits acquired in the Peoples acquisition.

Management believes that the S&T deposit base is stable and that S&T has the ability to attract new deposits, mitigating a funding dependency on volatile liabilities. Special rate deposits of $100,000 and over were 8% of total deposits at September 30, 2003 and 9% at December 31, 2002, respectively, and primarily represent deposit relationships with local customers in our market area. In addition, S&T believes it has the ability to access both public and private markets to raise long-term funding if necessary.

Borrowings

Average borrowings increased $123.5 million for the first nine months ended September 30, 2003 compared to the 2002 full year average and were comprised of retail repurchase agreements (REPOs), wholesale REPOs, federal funds purchased and long-term borrowings. S&T defines repurchase agreements with its local retail customers as retail REPOs; wholesale REPOs are those transacted with other banks and brokerage firms with terms normally ranging from 1 to 14 days.

The average balance in retail REPOs decreased approximately $6.9 million for the first nine months of 2003 compared to the full year 2002 average. S&T views retail REPOs as a relatively stable source of funds since most of these accounts are with local long-term customers. Average wholesale REPOs and federal funds increased by $120.6 million for the first nine months of 2003 compared to the full year 2002 average, in order to take advantage of low rate short-term funds and to better match commercial borrower shifts into more variable rate products.

Average long-term borrowings have increased by $9.8 million in the first nine months of 2003 as compared to the full year 2002 average. At September 30, 2003, S&T had average long-term borrowings outstanding of $246.0 million at a fixed rate with the FHLB. The purpose of these borrowings was to provide matched, fixed rate fundings for newly originated loans, to mitigate the risk associated with volatile liability fundings, to take advantage of lower cost funds through the FHLB's Community Investment Program and to fund stock buy-backs.

Capital Resources

Shareholders' equity increased $14.8 million at September 30, 2003, compared to December 31, 2002. Net income was $38.6 million and dividends paid to shareholders were $20.3 million for the nine months ended September 30, 2003. Also affecting capital is a decrease of $0.8 million in unrealized gains on securities available for sale, stock buybacks of 266,504 shares during 2003 at an average cost of $25.76 per share. Authorization for repurchasing up to 1,000,000 shares remains in effect for 2003.

S&T paid 53% of net income in dividends, equating to an annual dividend rate of $1.02 per share during the first nine months of 2003. The book value of S&T's common stock increased from $11.51 at December 31, 2002 to $12.12 at September 30, 2003. The market price of S&T's common stock was $28.50 per share at September 30, 2003, compared to $25.05 per share at December 31, 2002.

S&T continues to maintain a strong capital position with a leverage ratio of 8.7% as compared to the minimum regulatory guideline of 3.0%. S&T's risk-based capital Tier I and Total ratios were 10.5% and 12.3%, respectively, at September 30, 2003. These ratios place S&T above the Federal Reserve Board's risk-based capital guidelines of 4.0% and 8.0% for Tier I and Total, respectively.

Net income was $38.6 million or $1.45 per share diluted earnings for the first nine months of 2003 as compared to $35.7 million or $1.33 per share diluted earnings for the same period of 2002. The increase during the first nine months of 2003 was primarily the result of increases in net interest income and noninterest income, offset by lower equity security gains and higher loan loss provision expense.

Net Interest Income

On a fully taxable equivalent basis, net interest income increased $10.4 million or 15% in the first nine months of 2003 compared to the same period of 2002. The net interest margin on a fully taxable equivalent basis was 4.05% in the first nine months of 2003 as compared to the 4.11% in the same period of 2002.

In the first nine months of 2003 average loans increased $343.3 million, and average securities and average federal funds sold increased $34.1 million as compared to the same period of 2002. The yields on average securities decreased by 193 basis points from the comparable period in 2002 and the yield on average loans decreased by 77 basis points.

In the first nine months of 2003 balances of average interest-bearing deposits increased by $205.2 million as compared to the same period of 2002. The cost of deposits totaled 2.02%, a decrease of 81 basis points from the comparable period in 2002 due to decreased rates paid on both core and time deposits. The cost of REPOs and other borrowed funds decreased 118 basis points to 3.06%.

Positively affecting net interest income was a $32.7 million increase in average net free funds. Average net free funds are the excess of demand deposits, other non-interest bearing liabilities and shareholders' equity over nonearning assets. During the first quarter of 2003, dividend income included the impact of special dividends. Also during the first nine months of 2003, $0.9 million of prepayment penalties were received for the early prepayment of large commercial loans.

Maintaining consistent spreads between earning assets and interest-bearing liabilities is very significant to S&T's financial performance because net interest income comprises 79% of operating revenue. A variety of asset/liability management strategies were successfully implemented within prescribed Asset/Liability Committee risk parameters that enabled S&T to maintain a net interest margin reasonably consistent with historical levels during a volatile interest rate environment. The level and mix of funds are monitored by the Asset/Liability Committee in order to mitigate the interest rate sensitivity and liquidity risks of the balance sheet.

The provision for loan losses was $5.8 million for the first nine months of 2003 and $4.8 million for the same period of 2002. The provision is the result of management's assessment of economic conditions, credit quality statistics, loan administration effectiveness and other factors that would have an impact on probable losses in the loan portfolio. Also affecting the amount of provision expense is loan growth, portfolio composition and trends within risk ratings.

Credit quality indicators are important factors in determining the amount of provision expense. Nonperforming loans to total loans was 0.47% at September 30, 2003 compared to 0.29% at December 31, 2002 and 0.46% at September 30, 2002. Net charged-off loans were $4.2 million and $3.6 million for the first nine months of 2003 and 2002, respectively. Also affecting the amount of provision expense are the amount and types of loan growth and portfolio composition. Most of the non-merger related loan growth in 2003 and 2002 is attributable to larger-sized commercial loans, which present an inherently higher risk than other types of loans in the portfolio.

Noninterest Income

Noninterest income, excluding security gains, increased $3.0 million or 16% in the first nine months of 2003 as compared to the same period of 2002. Increases included $0.9 million or 15% in service charges and fees, $0.7 million or 31% in insurance and $1.4 million or 23% in other income. Security gains decreased $2.3 million in the first nine months of 2003 as compared to the same period of 2002.

The $0.9 million increase in service charges on deposit accounts was primarily the result of management's continual effort to implement reasonable fees for services performed and to manage closely the collection of these fees. Also positively affecting this period's service charges on deposit accounts were the addition of deposit customers from the Peoples acquisition. The $0.7 million increase in insurance is primarily attributable to the acquisition of Evergreen Insurance in the third quarter of 2002. The $1.4 million increase in other income was primarily related to higher performance levels for mortgage banking.

S&T recognized $3.3 million of gains on available for sale equity securities in the first nine months of 2003 as compared to $5.6 million in the same period of 2002. The equity security gains were taken on available for sale securities in the first nine months of 2003 and 2002 in order to maximize returns in the portfolio by taking advantage of market opportunities when presented and to reduce the holdings of corporate debt securities. Unrealized gains, net of unrealized losses, in the available for sale equity portfolio totaled $27.8 million at September 30, 2003.

Noninterest Expense

Noninterest expense increased by $5.1 million or 14% during the nine months ended September 30, 2003 compared to the nine months ended September 30, 2002. Staff expense increased $3.3 million or 17% primarily attributable to higher medical and pension costs, and higher staffing levels required to implement new initiatives in fee based business lines and from the Evergreen and Peoples acquisitions. Average full-time equivalent staff was 765 at September 30, 2003 and 689 at September 30, 2002. Occupancy expense increased $0.4 million or 9% for the nine months ended September 30, 2003 as compared to the same period of 2002 and data processing expense increased $0.3 million or 12% for the nine months ended September 30, 2003 as compared to the same period of 2002, reflecting the increased size of S&T's infrastructure following the two acquisitions in 2002. Other expense increased $1.1 million or 10%. These increases reflect the normal changes due to increased activity levels. S&T's efficiency ratio, whic h measures noninterest expense as a percent of recurring noninterest income plus net interest income on a fully taxable equivalent basis, was 42% at September 30, 2003 and 2002, respectively. Tax-exempt income on a fully-taxable equivalent basis using the statutory corporate income tax rate of 35% was $2.7 million and $2.3 million for the nine months ended September 30, 2003 and 2002, respectively.

Federal Income Taxes

Federal income tax expense increased $1.5 million for the nine months ended September 30, 2003 as compared to the same period of 2002. The effective tax rate for the first nine months of 2003 was 29% and 28% in 2002, which is below the 35% statutory rate due to benefits resulting from tax-exempt interest, excludable dividend income, low income housing tax credits and the defined contribution retirement plan dividend deduction which became effective in the first quarter of 2002.

Net income was $13.3 million or $0.50 per share diluted earnings in the third quarter of 2003 compared to $12.4 million or $0.46 per share diluted earnings for the same period of 2002.

Net Interest Income

On a fully taxable equivalent basis, net interest income increased $1.6 million or 6% in the third quarter of 2003 compared to the same period of 2002. The significant cause of this increase in net interest income was an increase of $320.8 million of average earning assets, primarily from the Peoples acquisition. The Peoples acquisition added approximately $60.0 million of investment securities, $237.4 million of loans and $293.0 million of deposits at the time of merger in September of 2002. Net interest margin on a fully taxable equivalent basis was 3.87% for the third quarter of 2003, as compared to 4.13% for the same period of 2002. The decrease in the net interest margin is primarily due to significant loan refinancing activities and accelerated repayments in mortgage-backed securities during a period of historically low interest rates. This affect to net interest income was offset through higher earning asset volumes and the growth in net free funds.

The provision for loan losses was $1.5 million in the third quarter of 2003 and $2.3 million for the same period of 2002. Net loan charge-offs totaled $1.3 million for the third quarter of 2003 compared to $2.6 million for the same period of 2002. The third quarter net charge-offs included two commercial loans in the food processing and automotive sales industries that were considered in the determination of the prior period allowance for loan losses. The provision is the result of management's assessment of economic conditions, credit quality statistics, loan administration effectiveness and other factors that could have an impact on inherent losses in the loan portfolio. Also affecting the amount of provision expense is loan growth, portfolio composition and trends within risk ratings.

Credit quality indicators are important factors in determining the amount of provision for loan losses. Nonperforming loans to total loans was 0.47% at September 30, 2003 compared to 0.29% at December 31, 2002 and 0.46% at September 30, 2002. Net charged-off loans were $1.3 million and $2.6 million for the third quarter of 2003 and 2002, respectively. Also affecting the provision for loan losses is the amount and types of loan growth and portfolio composition. Most of the non-merger related loan growth in 2003 and 2002 is attributable to larger commercial loans, which present an inherently higher risk than other types of loans in the portfolio.

Noninterest Income

Noninterest income, excluding security gains, increased $1.4 million or 20% in the third quarter of 2003 as compared to 2002. Increases included $0.1 million or 4% in service charges, $0.1 million or 9% in insurance and $1.2 million or 54% in other income. Security gains decreased $1.1 million in the third quarter of 2003 as compared to the same period of 2002.

The $0.1 million increase in service charges on deposit accounts was primarily the result of management's continual effort to implement reasonable fees for services performed and to manage closely the collection of these fees. The $0.1 million increase in insurance is primarily attributable to the acquisition of Evergreen in the third quarter of 2002. The increase of $1.2 million in other income was primarily related to higher performance levels for mortgage banking. Included in mortgage banking income for the third quarter of 2003 is a $0.6 million reduction in the valuation allowance for residential mortgage servicing rights as a result of favorable changes in mortgage pricing during the quarter. Increases in long and intermediate term interest rates during the third quarter significantly reduced the prepayment speeds in the $157.2 million serviced loan portfolio. Noninterest income areas continue to be the focus of several strategic initiatives and product enhancements that were implemented in order to ex pand these sources of revenue.

S&T recognized $1.1 million of gains on available for sale securities in the third quarter of 2003 as compared to $2.2 million in the same period of 2002. The equity security gains were taken on available for sale securities in the third quarter of 2003 and 2002 in order to maximize returns in the portfolio by taking advantage of market opportunities when presented. Included in gains on available for sale securities for the third quarter of 2003 is $0.4 million related to appreciated equity securities donated to the S&T Charitable Foundation. Unrealized gains, net of unrealized losses, in the available for sale equity portfolio totaled $27.8 million at September 30, 2003.

Noninterest Expense

Noninterest expense increased $1.4 million or 11% in the third quarter of 2003 as compared to the third quarter of 2002. Staff expense increased $1.4 million or 21% and primarily attributable to higher medical and pension costs, and higher staffing levels required to implement new initiatives in fee based business lines and the Evergreen and Peoples acquisitions. Other expense increased $0.1 million or 2%. These increases reflect the normal changes due to increased activity levels and larger organizational size following the two acquisitions in 2002, the aforementioned charitable contribution, offset by $0.6 million of acquisition expenses incurred in the third quarter of 2002. Occupancy expense decreased $0.1 million or 4% as compared to the same period of 2002, primarily as a result of a gain on the disposition of a branch building.

Federal Income Taxes

Federal income tax expense increased $0.3 million in the third quarter of 2003 as compared to the third quarter of 2002. The effective tax rate for the third quarter of 2003 and 2002 was approximately 28% and 29%, respectively, which is below the 35% statutory rate due to benefits resulting from tax-exempt interest, excludable dividend income, low income housing tax credits and the donation of appreciated equity securities.

Critical Accounting Policies and Judgements

S&T's consolidated financial statements are prepared based upon the application of certain critical accounting policies affecting accounts such as: securities, allowance for loan losses and goodwill and other intangibles. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variations and may significantly affect S&T's reported results and financial position for the period or in future periods. Changes in underlying factors, assumptions or estimates in any of these areas could have a material impact on S&T's future financial condition and results of operations. S&T's critical accounting policies are presented in Management's Discussion and Analysis in S&T's Annual Report on Form 10-K, filed with the SEC on March 21, 2003. There have been no material changes in S&T's critical accounting policies since December 31, 2002.

"Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995

The statements in this Annual Report, which are not historical fact, are forward looking statements that involve risks and uncertainties, including, but not limited to, the interest rate environment, the effect of federal and state banking and tax regulations, the effect of economic conditions, the impact of competitive products and pricings, and other risks detailed in S&T's Securities and Exchange Commission filings.

Not Applicable

Not Applicable

Not Applicable

Certifications of the Chief Executive Officer and Chief Financial Officer

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for James C. Miller, Chief Executive Officer and Robert E. Rout, Chief Financial Officer