SECURITIES AND EXCHANGE COMMISSION WASHINGTON D. C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1998 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-12508 S&T BANCORP, INC. (Exact name of registrant as specified in its charter) Pennsylvania 25-1434426 (State or other jurisdiction of (I.R.S.EMPLOYER incorporation or organization) Identification No.) 800 Philadelphia Street, Indiana 15701 (Address of principal executive offices) (Zip Code) (724) 349-2900 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes X No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common Stock, $2.50 Par Value -- 13,825,916 shares as of July 22, 1998
INDEX S&T BANCORP, INC. AND SUBSIDIARIES PART I. FINANCIAL INFORMATION Page No. Item 1. Financial Statements Condensed consolidated balance sheets - June 30, 1998 and December 31, 1997 3 Condensed consolidated statements of income - three months ended June 30, 1998 and 1997, and six months ended June 30, 1998 and 1997 4 Condensed consolidated statements of cash flows - six months ended June 30, 1998 and 1997 5 Notes to condensed consolidated financial statements 6-9 Item 2. Management's discussion and analysis of financial condition and results of operations 10-19 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 20 SIGNATURES 21
S&T BANCORP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS [CAPTION] <TABLE> June 30, December 31, 1998 1997 (000's omitted except share data) <S> <C> <C> ASSETS Cash and due from banks $36,284 $35,951 Interest-earning deposits with banks 101 102 Securities: Available for sale 561,513 521,117 Held to maturity (market value $32,864 in 1998 and $48,101 in 1997) 32,035 47,103 Total Securities 593,548 568,220 Loans, net of allowance for loan losses of $25,076 in 1998 and $20,427 in 1997 1,280,419 1,253,326 Premises and equipment 20,667 20,613 Other assets 42,504 42,079 TOTAL ASSETS $1,973,523 $1,920,291 LIABILITIES Deposits: Noninterest-bearing $181,041 $165,727 Interest-bearing 1,133,095 1,118,931 Total Deposits 1,314,136 1,284,658 Securities sold under repurchase agreements 210,509 170,124 Federal funds purchased 4,650 9,325 Long term borrowing 144,218 144,218 Other borrowed funds 130 130 Other liabilities 50,373 51,718 TOTAL LIABILITIES 1,724,016 1,660,173 SHAREHOLDERS' EQUITY Preferred stock, without par value, 10,000,000 shares authorized and none outstanding - - Common stock ($2.50 par value) Authorized - 50,000,000 shares in 1998 and 25,000,000 in 1997 Issued - 14,857,019 shares in 1998 and 1997 37,142 37,142 Additional paid in capital 20,717 19,369 Retained earnings 185,669 175,707 Accumulated other comprehensive income 40,077 40,524 Treasury stock (1,038,003 shares at June 30, 1998 and 715,864 at December 31, 1997, at cost (33,968) (12,494) Deferred compensation (130) (130) TOTAL SHAREHOLDERS' EQUITY 249,507 260,118 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,973,523 $1,920,291 See Notes to Condensed Consolidated Financial Statements </TABLE>
S&T BANCORP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME [CAPTION] <TABLE> For Three Months Ended For Six Months Ended June 30, June 30, 1998 1997 1998 1997 (000's omitted except per share data) <S> <C> <C> <C> <C> INTEREST INCOME Loans, including fees $28,467 $27,069 $56,528 $53,334 Deposits with banks 2 2 4 4 Federal funds sold 115 278 179 409 Investment securities: Taxable 7,725 6,043 15,446 12,640 Tax-exempt 397 581 882 1,191 Dividends 842 835 1,681 1,621 Total Interest Income 37,548 34,808 74,720 69,199 INTEREST EXPENSE Deposits 12,370 11,662 24,523 23,081 Securities sold under repurchase agreements 2,841 1,688 5,133 3,304 Federal funds purchased 83 65 237 240 Long term borrowing 1,975 1,615 4,206 3,438 Other borrowed funds 3 4 5 8 Total Interest Expense 17,272 15,034 34,104 30,071 NET INTEREST INCOME 20,276 19,774 40,616 39,128 Provision for loan losses 4,000 800 6,050 2,350 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 16,276 18,974 34,566 36,778 NONINTEREST INCOME: Trust fees 874 777 1,744 1,409 Service charges on deposit accounts 1,347 1,090 2,607 2,143 Net securities/other gains 5,126 2,038 7,443 3,540 Other 1,004 568 2,003 1,401 Total Noninterest Income 8,351 4,473 13,797 8,493 NONINTEREST EXPENSE Salaries and employee benefits 5,575 6,268 11,245 11,963 Occupancy, net 694 648 1,379 1,350 Furniture and equipment 799 1,285 1,544 2,022 Other taxes 366 333 722 654 Data processing 881 648 1,393 1,135 FDIC assessment 58 62 113 118 Other 2,676 2,412 5,239 5,360 Total Noninterest Expense 11,049 11,656 21,635 22,602 INCOME BEFORE INCOME TAXES 13,579 11,791 26,728 22,669 Applicable income taxes 4,131 3,478 8,040 6,615 NET INCOME $9,448 $8,313 $18,688 $16,054 PER COMMON SHARE Net Income - Basic $0.68 $0.59 $1.34 $1.14 Net Income - Diluted $0.67 $0.58 $1.32 $1.12 Dividends 0.33 0.28 0.63 0.53 Average Common Shares Outstanding 13,861 14,130 13,949 14,127 See Notes to Condensed Consolidated Financial Statements </TABLE>
S&T BANCORP, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS [CAPTION] <TABLE> Six Months Ended June 30 1998 1997 (000's omitted) <S> <C> <C> Operating Activities Net Income $18,688 $16,054 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 6,050 2,350 Provision for depreciation and amortization 1,052 1,115 Net amortizaton of investment security premiums 328 263 Net gains on sales of securities available for sale (7,449) (3,438) (Decrease) increase in deferred income taxes (627) 93 Decrease (increase) in interest receivable 552 (24) Decrease in interest payable (380) (252) Decrease in other assets 466 1,321 Decrease in other liabilities (1,863) (260) Net Cash Provided by Operating Activities 16,817 17,222 Investing Activities Net redemption of interest-earning deposits with banks 1 7 Net decrease in federal funds sold 0 5,665 Proceeds from maturities of investment securities 15,079 2,731 Proceeds from maturities of securities available for sale 113,765 67,696 Proceeds from sales of securities available for sale 67,328 38,202 Purchases of securities available for sale (215,068) (60,763) Net increase in loans (44,825) (46,401) Proceeds from the sale of loans 11,682 9,905 Purchases of premises and equipment (1,127) (114) Other, net 21 (641) Net Cash Used by Investing Activities (53,144) 16,287 Financing Activities Net increase in demand, NOW and savings deposits 27,965 11,492 Net increase (decrease) in certificates of deposit 1,513 (1,088) Net increase (decrease) in repurchase agreements 40,386 (7,470) Net decrease in federal funds purchased (4,675) (775) Repayments of FHLB long-term borrowings 0 (25,000) Acquisition of treasury stock (25,685) (4) Excercise of stock options and related tax benefit 5,560 619 Decrease in obligation under capital lease 0 (119) Cash dividends paid to shareholders (8,404) (6,300) Net Cash Used by Financing Activities 36,660 (28,645) Increase in Cash and Cash Equivalents 333 4,864 Cash and Cash Equivalents at Beginning of Period 35,951 40,710 Cash and Cash Equivalents at End of Period $36,284 $45,574 See Notes to Condensed Consolidated Financial Statements </TABLE>
S&T BANCORP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 1998 NOTE A--BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments consisting of normal recurring accruals considered necessary for a fair presentation have been included. Operating results for the six month period ended June 30, 1998 are not necessarily indicative of the results that may be expected for the year ending December 31, 1998. For further information, refer to the consolidated financial statements and footnotes thereto included in the annual report on Form 10-K for the year ended December 31, 1997. 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 diluted earnings per share. Average shares outstanding for computing basic earnings per share were 13,949,411 and 14,127,306 for the period ending June 30, 1998 and 1997. Average shares outstanding for computing dilutive earnings per share were 14,104,525 and 14,285,195 for the period ending June 30, 1998 and 1997. In computing dilutive earnings per share, average shares outstanding have been increased by the common stock equivalents relating to S&T's available stock options. As of January 1, 1998, S&T adopted Statement 130, Reporting Comprehensive Income. Statement 130 establishes new rules for the reporting and display of comprehensive income and its components. The adoption of this Statement had no impact on S&T's net income or shareholders' equity. Statement 130 requires unrealized gains or losses on S&T's available-for-sale securities, which prior to adoption were reported seperately in shareholders' equity, to be included in comprehensive income. Prior period financial statements have been reclassified to conform to the requirements of Statement 130. During the first half of 1998 and 1997, total comprehensive income amounted to $18,241,000 and $19,359,000. NOTE B--SECURITIES The amortized cost and estimated market value of securities as of June 30 are as follows: [CAPTION] <TABLE> 1998 Available for Sale Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value (000's omitted) <S> <C> <C> <C> <C> Obligations of U.S. government corporations and agencies $384,067 $2,756 ($141) $386,682 Mortgage-backed securities 11,557 336 (1) 11,892 U.S. Treasury securities 31,958 1,326 33,284 Corporate securities 10,842 252 11,094 Debt securities available for sale 438,424 4,670 (142) 442,952 Marketable equity securities 46,049 57,791 (663) 103,177 Other securities 15,384 15,384 Total $499,857 $62,461 ($805) $561,513 1998 Held to Maturity Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value (000's omitted) Obligations of states and political subdivisions $28,315 $641 ($1) $28,955 Corporate securities 1,998 189 2,187 Debt securities held to maturity 30,313 830 (1) 31,142 Other securities 1,722 1,722 Total $32,035 $830 ($1) $32,864 </TABLE>
S&T BANCORP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Continued NOTE B-SECURITIES The amortized cost and estimated market value of securities as of December 31 are as follows: [CAPTION] <TABLE> 1997 Available for Sale Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value (000's omitted) <S> <C> <C> <C> <C> Obligations of U.S. government corporations and agencies $338,855 $2,616 ($183) $341,288 Mortgage-backed securities 14,169 373 14,542 U.S. treasury securities 38,044 1,429 39,473 Corporate securities 10,848 228 (12) 11,064 Debt securities available for sale 401,916 4,646 (195) 406,367 Marketable equity securities 43,745 58,060 (166) 101,639 Other securities 13,111 13,111 Total $458,772 $62,706 ($361) $521,117 1997 Held to Maturity Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value (000's omitted) Obligations of states and political subdivisions $37,497 $794 ($5) $38,286 Corporate securities 1,998 209 2,207 Debt securities held to maturity 39,495 1,003 (5) 40,493 Other securities 7,608 7,608 Total $47,103 $1,003 ($5) $48,101 </TABLE> During the period ended June 30, 1998, there were $7,449,099 in realized gains relative to securites available for sale. The amortized cost and estimated market value of debt securities at June 30, 1998, by contractual maturity, are shown below. [CAPTION] <TABLE> Estimated Amortized Market Available for Sale Cost Value (000's omitted) <S> <C> <C> Due in one year or less $21,590 $21,769 Due after one year through five years 225,772 227,399 Due after five years through ten years 185,635 188,188 Due after ten years 5,427 5,596 Total $438,424 $442,952 </TABLE>
S&T BANCORP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Continued NOTE B-SECURITIES [CAPTION] <TABLE> Estimated Amortized Market Held to Maturity Cost Value (000's omitted) <S> <C> <C> Due in one year or less $5,404 $5,441 Due after one year through five years 14,353 14,781 Due after five years through ten years 8,471 8,740 Due after ten years 2,085 2,180 Total $30,313 $31,142 </TABLE> At June 30, 1998 and December 31, 1997 investment securities with a principal amount of $284,228,000 and $274,350,000 respectively, were pledged to secure repurchase agreements and public and trust fund deposits. NOTE C--LOANS AND ALLOWANCE FOR LOAN LOSSES The composition of the loan portfolio was as follows: [CAPTION] <TABLE> June 30, 1998 December 31, 1997 (000's omitted) <S> <C> <C> Real estate - construction $62,562 $47,967 Real estate - mortgages: Residential 500,044 512,417 Commercial 356,115 327,384 Commercial - industrial and agricultural 264,892 255,017 Consumer installment 121,882 130,968 Gross Loans 1,305,495 1,273,753 Allowance for loan losses (25,076) (20,427) Total Loans $1,280,419 $1,253,326 </TABLE> Changes in the allowance for loan losses for the six months ended June 30 were as follows: [CAPTION] <TABLE> 1998 1997 (000's omitted) <S> <C> <C> Balance at beginning of period $20,427 $18,729 Charge-offs (2,154) (1,524) Recoveries 753 415 Net charge-offs (1,401) (1,109) Provision for loan losses 6,050 2,350 Balance at end of period $25,076 $19,970 </TABLE>
S&T BANCORP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Continued The following table represents S&T's investment in loans considered to be impaired and related information on those impaired loans at June 30, 1998 and December 31, 1997. [CAPTION] <TABLE> 1998 1997 <S> <C> <C> Recorded investment in loans considered to be impaired $3,766,000 $1,869,000 Loans considered to be impaired that were on a nonaccrual basis - - Allowance for loan losses related to loans considered to be impaired 333,000 914,000 Average recorded investment in impaired loans 3,587,000 6,329,000 Total interest income recognized on impaired loans 365,000 656,000 Interest income on impaired loans recognized on a cash basis - - </TABLE> NOTE D--FINANCIAL INSTRUMENTS S&T, in the normal course of business, commits to extend credit and issue standby letters of credit. The obligations are not recorded in S&T's financial statements. Loan commitments and standby letters of credit are subject to S&T's normal credit underwriting policies and procedures and generally require collateral based upon management's evaluation of each customer's financial condition and ability to satisfy completely the terms of the agreement. S&T's exposure to credit loss in the event the customer does not satisfy the terms of agreement equals the notional amount of the obligation less the value of any collateral. Unfunded loan commitments totaled $360,109,000 and obligations under standby letters of credit totaled $64,841,000 at June 30, 1998. At June 30, 1998, S&T had marketable equity securities, totaling $2,005,612 at amortized cost and $3,432,725 at estimated market value, that were subject to covered call option contracts. The purpose of these contracts was to generate fee income for S&T. NOTE E - LITIGATION S&T, in the normal course of business, is subject to various legal proceedings in which claims for monetary damages are asserted. No material losses are anticipated by management as a result of these legal proceedings.
S&T BANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis is presented so that shareholders may review in further detail the financial condition and results of operations of S&T Bancorp, Inc. and subsidiaries (S&T). This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and the selected financial data presented elsewhere in this report. Financial Condition Total assets averaged $2.0 billion in the first six months of 1998, a $149.9 million increase from the 1997 full year average. Average loans increased $56.7 million and average securities and federal funds increased $72.0 million in the first six months of 1998 compared to the 1997 full year averages. Funding for this loan and security growth was primarily provided by a $35.5 million increase in average deposits, a $13.8 million increase in average retained earnings and a $93.7 million increase in average borrowings. Lending Activity Total loans at June 30, 1998 were $1.3 billion, a $31.7 million or 2.5% increase from December 31, 1997. Average loans increased $56.7 million, or 5% to $1.3 billion for the six months ended June 30, 1998 from the 1997 full year average. Changes in the composition of the loan portfolio during 1998 included increases of $9.9 million of commercial loans, $42.0 million of commercial real estate loans, offset by a decrease of $11.2 million of residential mortgages and $9.0 million of installment loans. Commercial real estate loans comprise 27% of the loan portfolio. Although commercial real estate loans can be an area of higher risk, management believes these risks are mitigated by limiting the percentage amount of portfolio composition, a rigorous underwriting review by loan administration and the fact that many of the commercial real estate loans are owner-occupied and/or seasoned properties. Residential mortgage lending continued to be a strategic area of focus during the first six months of 1998 through a centralized mortgage origination department, ongoing product redesign, the utilization of commission compensated originators and the implementation of a mortgage banking function. Management believes that if a downturn in the local residential real estate market occurs, the impact of declining values on the real estate loan portfolio will be negligible because of S&T's conservative mortgage lending policies. These policies generally require, for portfolio loans, a maximum term of twenty years for fixed rate mortgages and private mortgage insurance for loans with less than a 20% down payment. At June 30, 1998 the residential mortgage portfolio had a 25% composition of adjustable rate mortgages. Beginning in the fourth quarter of 1997, S&T sold $12.7 million of long-term, lower-yielding 1-4 family mortgages, acquired from the Peoples merger, to the Federal National Mortgage Association (FNMA). S&T retained ongoing servicing rights on the mortgages sold to FNMA. The rationale for these sales is to mitigate interest rate risk associated with holding long-term residential mortgages in the loan portfolio, to generate fee revenue from servicing, and still maintain the primary customer relationship. During the second quarter of 1998, S&T sold $4.2 million of 1-4 family mortgages to FNMA. S&T will continue to sell longer-term loans to FNMA in the future on a selective basis, especially during periods of lower interest rates.
S&T BANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Installment loan decreases are primarily associated with significantly lower volumes in the indirect auto loan category. Pricing pressures have been unusually intense in the indirect market during the last two years and the decision was made to temporarily deploy investable funds into other higher yielding and lower risk earning assets. In the second quarter of 1996, S&T implemented an indirect auto leasing program and currently has $4.2 million of outstanding auto leases. Installment loans have also decreased due to recent changes in government regulations which have significantly decreased the profit potential of guaranteed student loans. The remaining student loan portfolio of $7.0 million was sold in 1997. S&T will continue to distribute student loan applications for customer convenience, but will not fund or hold the loans. Loan underwriting standards for S&T are established by a formal policy administered by the S&T Bank Credit Administration Department, and subject to the periodic review and approval of the S&T Bank Board of Directors. Rates and terms for commercial real estate and equipment loans normally are negotiated, subject to such variables as economic conditions, marketability of collateral, credit history of the borrower and future cash flows. The loan to value policy guideline for commercial loans is generally 75%. The residential, first lien, mortgage loan to value policy guideline is 80%. Higher loan to value loans can be approved with the appropriate private mortgage insurance coverage. Second lien positions are sometimes incurred with home equity loans, but normally only to the extent that the combined credit exposure for both first and second liens do not exceed 100% of loan to value. A variety of unsecured and secured installment loan and credit card products are offered by S&T. However, the bulk of the consumer loan portfolio is automobile loans. Loan to value guidelines for direct loans are 90%-100% of invoice for new automobiles and 80%-90% of "NADA" value for used automobiles. Loan to value policy guidelines for automobile loans purchased from dealers on a third party basis are 90%-125% of invoice for new automobiles and 100%-125% of "Black Book" value for used automobiles. Management intends to continue to pursue quality loans in all 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 identifies problem loans early. Security Activity Average securities increased $75.0 million in the first six months of 1998 compared to the 1997 full year average. The increase in the average investment portfolio was related to an increase in average taxable securities of $84.6 million, offset by a decrease in tax-exempt state and municipal securities average balances of $9.6 million. This increase was comprised of $90.6 million in U.S. government agency securities, $1.6 million of mortgage-backed securities, $1.4 million of corporate equity securities and $3.8 million of Federal Home Loan Bank (FHLB) stock. Offsetting these increases were average decreases of $11.0 million of U.S. treasury securities and $1.8 million of corporate securities.
S&T BANCORP , INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The significant increase in U.S. government agency securities, classified as available for sale, during 1998 was due to a balance sheet leveraging strategy to maximize net interest income by taking advantage of low, short-term funding rates. Interest rate risks associated with this strategy is managed and monitored through S&T's Asset Liability Committee (ALCO). 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. During 1998, the equity portfolio yielded 10.6% on a fully taxable equivalent basis and had unrealized gains, net of nominal unrealized losses, of $57.1 million. The equity securities portfolio consists of securities traded on the various stock markets and are subject to change 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 included U.S. treasuries, U.S. government agencies, mortgage-backed securities, CMOs and corporate equities as available for sale. Municipal securities and other debt securities are classified as held to maturity. At June 30, 1998, unrealized gains, net of unrealized losses, for securities classified as available for sale were $61.7 million. Allowance for Loan Losses 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, growth and composition of the loan portfolio as well as other relevant factors. Asset quality is a major corporate objective at S&T and management believes that the total allowance for loan losses is adequate to absorb probable loan losses. The balance of nonperforming loans at June 30, 1998, which includes nonaccrual loans past due 90 days or more, was $3.2 million, or 0.24% of total loans. This compares to nonperforming loans of $3.6 million or 0.28% of total loans at December 31, 1997. S&T had a $56.7 million, or 5%, increase in average loans during the first half of 1998 as compared to the 1997 average. All of this portfolio growth occurred in the industrial and commercial real estate classifications. Despite currently favorable credit quality statistics, S&T recognizes the increased risks of these types of loans, especially when the current economic expansion slows or declines. Also unknown is the effect that the Year 2000 issue will have on the businesses of commercial customers, pending completion of a Year 2000 risk assessment program currently in process for major S&T commercial customers. Therefore, S&T believed it prudent to increase the allowance for loan losses to $25.1 million, or 1.92% of total loans at June 30, 1998, as compared to $20.4 million, or 1.60% at December 31, 1997. Deposits Average total deposits increased by $35.5 million, or 2% for the six months ended June 30, 1998 as compared to the 1997 average. Changes in the average deposit mix included a $12.1 million increase in time deposits, $31.2 million increase in money market accounts and a $12.0 million increase in demand accounts, offset by a $12.7 million decrease in savings accounts and a $7.1 million decrease in NOW accounts. Special rate deposits of $100 thousand and over were 7% of total deposits at June 30, 1998 and December 31, 1997 and primarily represent deposit relationships with local customers in our market area. Retail time deposit increases of $12.1 million were the result of expanded promotional programs.
S&T BANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS During the second half of 1995, S&T issued $25.0 million of retail certificates of deposits through two brokerage firms, further broadening the availability of reasonably priced deposit funds. At June 30, 1998, there were $26.6 million of these brokered retail certificates of deposits outstanding. Money market accounts were recently repriced in order to be more competitive with money funds offered by brokerage firms. As a result of this repricing and proactive sales activities to high-balance deposit customers, S&T has experienced a significant shift in funds from savings to money market accounts. Although this strategy tends to increase cost of funds, management believes it is necessary for customer retention and the development of long-term relationships. The decrease in NOW balances is attributable to the implementation of a NOW/money market sweep product on the accounts acquired from Peoples that reduces the amount of Federal Reserve Requirements. 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. In addition, S&T has the ability to access both public and private markets to raise long-term funding if necessary. Borrowings Average borrowings increased $93.7 million for the six months ended June 30, 1998 compared to the 1997 annual average and were comprised of retail repurchase agreements (REPO's), wholesale REPO's, 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 increased approximately $6.2 million for the first six months of 1998 compared to the full year 1997 average. This increase is primarily attributable to new REPO sweep relationships in our cash management department. S&T views retail REPOS as a relatively stable source of funds since most of these accounts are with local, long-term customers. Wholesale REPOS and federal funds increased $57.7 million for the first six months of 1998 compared to the full year 1997 average. The aforementioned balance sheet leveraging strategy has increased the usage of wholesale REPO fundings in 1998. Average long-term borrowings have increased $29.9 million in the first six months of 1998 as compared to the full year 1997 average. At June 30, 1998, S&T had long-term borrowings outstanding of $49.6 million at a fixed rate and $94.6 million at an adjustable 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 decreased $10.6 million at June 30, 1998, compared to December 31, 1997. Net income was $18.7 million and dividends paid to shareholders were $8.4 million for the six months ended June 30, 1998. The decrease is attributable to the conclusion of the Modified Dutch Auction in which S&T repurchased approximately 440,000 shares of its common stock. An authorization to buy-back up to 1,060,000 shares not acquired in the Modified Dutch Auction remains in effect until December 31, 1998. During the second quarter of 1998, S&T repurchased an additional 73,000 shares of its common stock.
S&T BANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS S&T paid 45% of net income in dividends, equating to an annual dividend rate of $1.26 per share during the first six months of 1998. The book value of S&T's common stock decreased slightly from $18.39 at December 31, 1997 to $18.06 at June 30,1998, primarily due to the stock buy-backs during the first half of 1998. Equity associated with the available for sale securities portfolio decreased $0.4 million during the first six months of 1998. The market price of S&T's common stock was $55.25 per share at June 30, 1998, an increase from $43.25 per share at December 31, 1997. S&T continues to maintain a strong capital position with a leverage ratio of 10.7% as compared to the minimum regulatory guideline of 3.0%. S&T's risk-based capital Tier I and Total ratios were 15.7% and 17.0% respectively, at June 30, 1998. These ratios place S&T well above the Federal Reserve Board's risk-based capital guidelines of 4.0% and 8.0% for Tier I and Total, respectively. RESULTS OF OPERATIONS Six months ended June 30, 1998 compared to Six months ended June 30, 1997 Net Income Net income increased to $18.7 million or $1.32 per diluted earnings per share in the first six months of 1998 from $16.1 million or $1.12 per diluted earnings per share for the same period of 1997. The significant improvement during the first six months of 1998 was the result of higher net interest income, noninterest income and security gains. Operating expenses were lower due to the People's merger related costs and post merger restructurings incurred in the first half of 1997. Net Interest Income On a fully taxable equivalent basis, net interest income increased $1.3 million or 3% in the first six months of 1998 compared to the same period of 1997. The net yield on interest-earning assets was 4.64% in the first six months of 1998 as compared to 4.92% in the same period of 1997. The decline in the net yield on interest earning assets during 1998 was attributed the aforementioned balance sheet leveraging strategy with arbitraged securities, and stock buybacks during the first six months of 1998. In the first six months of 1998, average securities increased $75.0 million and average loans increased $56.7 million. The yields on average securities decreased by 3 basis points during the period and the yield on average loans remained constant. In the fourth quarter of 1997, S&T implemented a balance sheet leveraging strategy through the purchase of approximately $100 million of intermediate-term U.S. government securities, funded with short-term borrowings. The strategy provided pre-tax spreads of 100-125 basis points during the period with manageable risks, contributing positively to net interest income, but also causing a 21 basis points decline in the net yield on interest earning assets. Average interest bearing deposits provided $39.4 million of the funds for the growth in securities and loans; cost of deposits totaled 4.26%, a decrease of 1 basis point from 1997. The cost of REPOS and other borrowed funds increased 5 basis points to 5.47%. More longer-term borrowings were utilized in 1998 in order to take advantage of low, long-term funds rates and to mitigate interest rate risk.
S&T BANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Also positively affecting net interest income was a $22.1 million increase to average net free funds. Average net free funds are the excess of demand deposits, other non-interest bearing liabilities and shareholders' equity over non-earning assets. This increase is net of the reduction to shareholders equity resulting from stock buy-backs. Maintaining consistent spreads between earning assets and costing liabilities is very significant to S&T's financial performance since net interest income comprises 87% of operating revenue. A variety of asset/liablity management strategies were successfully implemented within prescribed ALCO risk parameters that enabled S&T to maintain a net interest margin reasonably consistent with historical levels. The level and mix of funds is continually monitored by ALCO in order to mitigate the interest rate sensitivity and liquidity risks of the balance sheet. Provision for Loan Losses The provision for loan losses increased to $6.1 million for the first six months of 1998 as compared to $2.4 million in the same period of 1997. The increase was the result of management's assessment of economic conditions, credit quality statistics, loan administration effectiveness and other factors that would have an impact on future probable losses in the loan portfolio. Credit quality statistics are an important factor in determining the amount of provision expense. Net loan charge-offs totaled $1.4 million for the first six months of 1998 compared to $1.1 million for the same period 1997. Nonperforming loans to total loans was 0.24% at June 30, 1998 and 0.58% in the same period of 1997. Also affecting the amount of provision expense is the amount and types of loan growth. Recent loan growth has been primarily in the commercial sectors, which can be areas of higher risks in the event of an economic downturn. Therefore, despite currently favorable credit quality statistics, S&T believed that a significant increase to the allowance for loan losses was warranted. Noninterest Income Noninterest income increased $5.3 million or 62% in the first six months of 1998 compared to the same period of 1997. Increases included $0.5 million in service charges and fees, $0.3 million in trust income, $3.9 million in security gains and $0.6 million in other income. The 22% increase in service charges on deposit accounts was primarily the result of expanding new cash management relationships and management's continual effort to implement reasonable fees for services performed, to manage closely the collection of these fees, as well as the implementation of foreign ATM service charges in the fourth quarter of 1997. The increase in trust fees is attributable to expanded marketing efforts to develop new trust business and to expand current relationships. The People's merger presents new trust opportunites within the Allegheny County market for trust products. The increase in other income was a result of increased performance for brokerage activities, credit insurance, letters of credit fees and fees on covered call options. These areas were the focus of several strategic initiatives and product enhancements implemented in order to expand this source of revenue.
S&T BANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS S&T recognized $7.4 million of gains on equity securities in the first six months of 1998. $3.0 million were the result of Emerging Issues Task Force #91-5, Nonmonetary Exchange of Cost-Method Investments (EITF 91-5). This accounting pronouncement requires the mark to market of equity securities when an acquisition of the company in which securities are owned occurs. Gains recognized included $2.6 million from the First Union/Corestates merger and $0.4 million from the CFX/Peoples Heritage merger. The remaining security gains were taken on available for sale equities securities in the first six months of 1998 in order to maximize returns by taking advantage of market opportunities when presented. Unrealized gains, net of unrealized losses, in the available for sale equities portfolio totaled $57.1 million at June 30, 1998. Noninterest Expense Noninterest expense decreased $1.0 million or 4% at June 30, 1998 compared to June 30, 1997. The decrease is primarily attributable to $2.2 million of merger related and other nonrecurring expenses associated with the acquisition of Peoples during the first half of 1997. Merger related and other nonrecurring expenses included costs for severance and early retirement programs, the write-off and conversion of data processing systems, as well as legal, accounting and investment banker expenses. Other expenses of $1.0 million were provided for during the first six months of 1998 and included $0.3 million of consulting fees for reengineering of retail loan delivery services, $0.3 million for Year 2000 projected costs and $0.4 million of costs associated with the conversion of data processing systems for a branch purchase. Recurring expenses were relatively flat during the first half of 1998 as compared to the first half 1997. Severance and early retirement programs were implemented in May 1997 in order to eliminate duplicate positions following post merger restructuring and consolidation of operations. Average full-time equivalent staff decreased from 666 to 653. S&T's efficiency ratio, which measures noninterest expense as a percent of recurring noninterest income plus net interest income on a fully taxable equivalent basis, improved to 42.85% at June 30, 1998 as compared to 44.84% at June 30, 1997. Federal Income Taxes Federal income tax expense increased $1.4 million at June 30, 1998 as compared to June 30, 1997 primarily as a result of higher pre-tax income in 1998. The effective tax rate for the first six months of 1998 was 30%, and 29% during the same period of 1997, which is below the 35% statutory rate due to benefits resulting from tax-exempt interest, excludable dividend income and low income housing tax credits (LIHTC). RESULTS OF OPERATIONS Three months ended June 30, 1998 compared to Three months ended June 30, 1997 Net Income Net income increased to $9.4 million or $0.67 per diluted earnings per share in the second quarter of 1998 from $8.3 million or $0.58 per diluted earnings per share for the same period of 1997, a 16% improvement. This significant improvement is due to higher net interest income, higher noninterest income, higher security gains and reduced operating expenses due to the Peoples merger related costs incurred in the second quarter of 1997.
S&T BANCORP, INC, AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net Interest Income On a fully taxable equivalent basis, net interest income increased $0.4 million or 2% in the second quarter of 1998 compared to the same period of 1997. This improvement in net interest income primarily resulted from a higher level of earning assets while spreads decreased. Average earning assets increased by $156.2 million as compared to the second quarter of 1997, primarily as a result $76.8 million of loan growth and $88.1 million of security growth. Funding for this asset growth was provided by available for sale securities sales, deposits, borrowings and retained earnings. Net interest margin on a fully taxable equivalent basis was 4.58% for the second quarter of 1998, as compared to 4.97% for the same period of 1997. The decline in the net interest margin is primarily the result of the aforementioned balance sheet leveraging strategy utilizing securities arbitrage. Provision for Loan Losses The provision for loan losses increased to $4.0 million for the second quarter of 1998 compared to $0.8 million in the same period of 1997. Net loan charge-offs totaled $0.7 million for the second quarter of 1998 compared to $0.8 million for the same period 1997. The provision expense in 1998 was a result of an effort to maintain S&T's allowance for loan losses to total loans at a relatively consistent level with loan growth, and the continuing change in the loan portfolio mix to a greater percentage of commercial loans. The provision expense also considers management's assessment of economic conditions , credit quality statistics, loan administration effectiveness and other factors that would have an impact on future probable losses in the loan portfolio. Noninterest Income Noninterest income increased $3.9 million or 87% in the second quarter of 1998 compared to the same period of 1997. Increases included $3.1 million in security/nonrecurring gains, $0.3 million in service charges and fees, $0.1 million in trust income and $0.4 million in other income during the second quarter of 1998. S&T recognized $5.1 million of gains on equity securities in the second quarter of 1998; $3.0 million were the result of Emerging Issues Task Force #91-5, Nonmonetary Exchange of Cost-Method Investments (EITF 91-5). This accounting pronouncement requires the mark to market of equity securities when an acquisition of the company in which securities are owned occurs. Gains recognized included $2.6 million from the FirstUnion/Corestates merger and $0.4 million from the CFX/Peoples Heritage merger. The remaining security gains were taken on available for sale equities securities in the second quarter of 1998 in order to maximize returns by taking advantage of market opportunities when presented. The increase in service charges on deposit accounts was primarily the result of expanding new cash management relationships, management's continual effort to implement reasonable fees for services performed to manage closely the collection of these fees, as well as the implementation of foreign ATM service charges in the fourth quarter of 1997. The increase in trust fees is attributable to expanded marketing efforts to develop new trust business and expand current relationships. The People's merger also provides new trust opportunities within the Allegheny County market. The increase in other income was a result of increased performance for brokerage activities, letters of credit fees, insurance and fees on covered call options. These areas were the focus of several strategic initiatives and product enhancements implemented in order to expand this source of revenue.
S&T BANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Noninterest Expense Noninterest expense decreased $0.6 million or 5% in the second quarter of 1998 as compared to 1997. The decrease is primarily attributable to the aforementioned merger related and other nonrecurring expenses associated with the acquisition of Peoples during the second quarter of 1997, offset by other expenses of $1.0 million which were provided for during the second quarter of 1998. The increase in other expense included $0.3 million of consulting fees for reengineering of retail loan delivery services, $0.3 million for Year 2000 projected costs and $0.4 million of costs associated with the conversion of data processing systems for a branch purchase. Other recurring noninterest expenses were relatively flat during the second quarter of 1998. Federal Income Taxes Federal income tax expense increased $0.7 million at June 30, 1998 as compared to June 30, 1997 primarily as a result of higher pre-tax income in 1998. The effective tax rate for the second quarter of 1998 was 30%, which is below the 35% statutory rate due to benefits resulting from tax-exempt interest, excludable dividend income and low income housing tax credits (LIHTC). Year 2000 The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of S&T's computer programs or hardware that have date-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. Based on recent assessments, S&T determined that it will be required to modify or replace some portions of hardware and software so that those systems will properly utilize dates beyond December 31, 1999. S&T presently believes that with modifications and replacement of existing hardware and software, the Year 2000 Issue can be mitigated. However, if such modifications and replacements are not made, or are not completed timely, the Year 2000 Issue could have a material impact on the operations of S&T. S&T's plan to resolve the Year 2000 Issue involves four phases; assessment, remediation, testing and implementation. In June 1997, S&T management formed a task force (Y2K Task Force) to evaluate the process of preparing its computer systems and applications for the Year 2000. This process involves modifying or replacing certain hardware and software maintained by S&T, as well as communication with external service providers and customers to ensure that they are taking the appropriate action to remedy their Year 2000 Issues. To date, the Y2K Tack Force has completed its assessment of the Year 2000 Issue with internal systems and third party vendors. Assessment of the effect of Year 2000 Issue on commercial business customers is still being evaluated. Significant to S&T's data processing abilities is the services provided by M&I Data Services (M&I) which provides the majority of computer services for S&T customer accounts and transactions. M&I is also currently involved in a similar Year 2000 assessment and remediation. S&T has been notified by M&I that the project is on target. M&I expects to be fully Year 2000 compliant in the fourth quarter of 1998. If compliance assurance is not received from M&I at that time, S&T will develop contingency plans.
All internal data processing systems aare in the process of being tested for Year 2000 compliance. The testing also includes validations of third party software/hardware vendors that have provided assurance or certifications of compliance. To date, 70% of the testing for critical systems has been completed and software/hardware replacements have been scheduled where problems have been identified. The testing is expected to be completed in the fourth quarter of 1998; the remediation of critical internal systems is expected to be completed by December 31, 1998. The effect of Year 2000 on the businesses of commercial customers is unknown and is currently being evaluated as part of this risk assessment process. The assessment identified 31 high-risk commercial cutomers as being significant to S&T's future financial performance. Each of these significant business customers will be called upon and interviewed to determine their respective company's awareness and preparedness for the Year 2000 Issue. Results of these interviews are reported to the S&T Senior Loan Committee and credit administration so that remedial action can be taken when appropriate. Communications to all commercial customers via mail and calling officers has been ongoing to ensure effective planning to meet the Year 2000 compliance requirements. Management and the Y2K Task Force expect to have substantially all of the critical systems and application changes completed and tested by the end of 1998 and believe that its level of preparedness is appropriate. S&T has estimated the total cost of the project to be $0.3 million and is not expected to materially impact future operations. Purchased hardware and software will be capitalized in accordance with normal policy. Personnel and all other costs related to the project will be expensed as incurred. The Y2K Task Force reports to the S&T Board of Directors each quarter. "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995 The statements in this Form 10-Q 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 pricing, and other risks detailed in S&T's Securities and Exchange Commission filings.
PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None (b) Reports of Form 8-K None
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. S&T Bancorp, Inc. Registrant /s/ Robert E. Rout Principal Accounting Officer Date: August 12, 1998