Item 1A. RISK FACTORS
Investments in our common stock involve risk. The following discussion highlights the risks that we believe are material to S&T, potentially impacting our business, results of operations, financial condition and cash flows. However, other factors not discussed below or elsewhere in this Annual Report on Form 10-K could adversely affect our businesses, results of operations and financial condition. Therefore, the risk factors below do necessarily include all risks that we may face.
Risks Related to the COVID-19 Pandemic
The duration and severity of the COVID-19 pandemic, in our principal area of operations, nationally and globally, has adversely impacted and will likely continue to adversely impact S&T’s business, results of operations and financial condition. While it is difficult to predict the further impact of the COVID-19 pandemic (or any other outbreak) on the economy and S&T, the future impacts may include, but are not limited to, the following:
•Our results of operations may continue to be negatively impacted by general economic or business conditions and uncertainty, including the strength of economic conditions in our principal area of operations impacting the demand for our products and services.
•The low interest rate environment will continue to negatively impact our net interest income and net interest margin.
•Credit losses may be higher and our provision for credit losses may continue to increase, due to deterioration in the financial condition of S&T’s commercial and consumer loan customers.
•Declining asset and collateral values may necessitate increases in our provision for credit losses and net charge-offs.
•Continued negative impact on the hospitality industry and our hotel portfolio, which could result in additional credit losses and net charge-offs.
•Expense management will be impacted by the uncertainty of the effects of the pandemic and S&T’s continued efforts to promote the health and safety of our employees, and the customers and communities we serve.
•We may have an interruption or cessation of an important service provided by a third-party provider.
•S&T’s liquidity and regulatory capital could be adversely impacted.
•Any new or revised regulations regarding capital and liquidity adopted in response to the COVID-19 pandemic may require us to maintain materially more capital or liquidity.
•Investors may have less confidence in the equity markets in general and in financial services industry in particular, which could have a negative impact on S&T’s stock price and resulting market valuation.
•The economic downturn caused by the pandemic may be deeper and last longer in the areas where we do business, relative to other areas of the country, which could negatively affect our relative financial performance.
•We face heightened cyber security risk in connection with our operation in a remote working environment.
•It may become harder to maintain our corporate culture, which is somewhat dependent on a level of in-person interaction.
Even after the COVID-19 pandemic subsides, the U.S. economy will likely require time to recover.It is uncertain how long this recovery will take. As a result, we anticipate our business may be adversely affected during this recovery.
To the extent the COVID-19 pandemic continues to adversely affect the global economy it may also increase the likelihood and/or magnitude of other risks described in this section.
The impact that the COVID-19 pandemic will have on S&T’s credit losses is uncertain, and continued economic uncertainty and deterioration in the forward looking economic forecasts used to estimate credit losses, as well as the potential inability of our credit models to accurately predict the relevant financial metrics, may adversely affect our ACL.
S&T calculates the ACL in accordance with Current Expected Credit Loss, or CECL, accounting standard adopted January 1, 2020. The CECL methodology reflects expected credit losses and requires consideration of a broad range of reasonable and supportable information to form credit loss estimates. The CECL accounting standard bases the measurement of expected credit losses on historical loss experience, current conditions and reasonable and supportable forecasts that affect the collectability of the reported amount. S&T’s ability to assess expected credit losses may be impaired if the models and approaches we use become less predictive of future behaviors. In particular, the reliance on supportable economic forecasts in light of the COVID-19 pandemic has had and is expected to have an impact on the estimates of our ACL. These forecasts have deteriorated this year and continue to reflect adverse economic conditions and economic uncertainty.Given the unprecedented nature of the COVID-19 pandemic, if our credit models fail to adequately predict or forecast relevant financial metrics during and after the pandemic and these forecasts deteriorate and contain economic uncertainty, our ACL may be adversely affected.
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Risks Related to Fraudulent Activity
Fraudulent activity associated with our products and services could adversely affect our results of operations, financial condition and stock price, negatively impact our brand and reputation, and result in regulatory intervention or sanctions.
As a financial institution we are exposed to operational risk in the form of fraudulent activity that may be committed by customers, other third parties, or employees, targeting us and our customers. The risk of fraud continues to increase for the financial services industry. Fraudulent activity has escalated, become more sophisticated, and continues to evolve, as there are more options to access financial services. In our Form 8-K filed May 26, 2020, we disclosed that we discovered customer fraud resulting from a check kiting scheme by a business customer of S&T. We recognized a pre-tax loss of $58.7 million during the second quarter of 2020 related to this customer fraud. As a result of our internal review of the fraud, we have made process and monitoring enhancements. While we believe we have operational risk controls in place to prevent or detect future instances of fraud or to mitigate the impact of any fraud, we cannot provide assurance that we can prevent or detect fraud or that we will not experience future fraud losses or incur costs or other damage related to such fraud, at levels that adversely affect our results of operation, financial condition, or stock price. Furthermore, fraudulent activity could negatively impact our brand and reputation, which could also adversely affect our results of operation, financial condition, or stock price. Fraudulent activity could also lead to regulatory intervention or regulatory sanctions.
Risks Related to Credit
Our ability to assess the credit-worthiness of our customers may diminish, which may adversely affect our results of operations.
We incur credit risk by virtue of making loans and extending loan commitments and letters of credit. Credit risk is one of our most significant risks. Our exposure to credit risk is managed through the use of consistent underwriting standards that emphasize “in-market” lending while avoiding excessive industry and other concentrations. Our credit administration function employs risk management techniques to ensure that loans adhere to corporate policy and problem loans are promptly identified. There can be no assurance that such measures will be effective in avoiding undue credit risk. If the models and approaches that we use to select, manage and underwrite our consumer and commercial loan products become less predictive of future charge-offs, due to events adversely affecting our customers, including rapid changes in the economy, we may have higher credit losses.
The value of the collateral used to secure our loans may not be sufficient to compensate for the amount of an unpaid loans and we may be unsuccessful in recovering the remaining balances from our customers.
Decreases in real estate values, particularly with respect to our commercial lending and mortgage activities, could adversely affect the value of property used as collateral for our loans and our customers’ ability to repay these loans, which in turn could impact our profitability. Repayment of our commercial loans is often dependent on the cash flow of the borrower, which may become unpredictable. If the value of the assets, such as real estate, serving as collateral for the loan portfolio were to decline materially, a significant part of the loan portfolio could become under-collateralized. If the loans that are secured by real estate become troubled when real estate market conditions are declining or have declined, in the event of foreclosure, we may not be able to realize the amount of collateral that was anticipated at the time of originating the loan. This could result in higher charge-offs which could have a material adverse effect on our operating results and financial condition.
Changes in the overall credit quality of our portfolio can have a significant impact on our earnings.
Like other lenders, we face the risk that our customers will not repay their loans. We reserve for losses in our loan portfolio based on our assessment of inherent credit losses. This process, which is critical to our financial results and condition, requires complex judgment including our assessment of economic conditions, which are difficult to predict. Through a periodic review of the loan portfolio, management determines the amount of the ACL by considering historical losses combined with qualitative factors including changes in lending policies and practices, economic conditions, changes in the loan portfolio, changes in lending management, results of internal loan reviews, asset quality trends, collateral values, concentrations of credit risk and other external factors. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control. Although we have policies and procedures in place to determine future losses, due to the subjective nature of this area, there can be no assurance that our management has accurately assessed the level of allowances reflected in our Consolidated Financial Statements. We may underestimate our inherent losses and fail to hold an ACL sufficient to account for these losses. Incorrect assumptions could lead to material underestimates of inherent losses and an inadequate ACL. As our assessment of inherent losses changes, we may need to increase or decrease our ACL, which could significantly impact our financial results and profitability.
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The adoption of ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, referred to as CECL, effective for us on January 1, 2020, resulted in a significant change in how we recognize credit losses. If the assumptions or estimates we used in adopting the new standard are incorrect or we need to change our underlying assumptions, there may be a material adverse impact on our results of operations and financial condition.
Effective January 1, 2020, we adopted CECL, which replaces the incurred loss impairment methodology in current U.S. generally accepted accounting principles, or GAAP, with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to form credit loss estimates. The measurement of expected credit losses is to be based on historical loss experience, current conditions and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the incurred loss model which delayed recognition until it was probable a loss had been incurred. Upon origination of a loan, the estimate of expected credit losses, and any subsequent changes to such estimate, will be recorded through provision for credit losses in our consolidated statement of income. The CECL model may create more volatility in the level of our ACL.
The CECL model permits the use of judgment in determining the approach that is most appropriate for us, based on facts and circumstances. Changes in economic conditions affecting borrowers, new information regarding our loans and other factors, both within and outside of our control, may require an increase in the ACL. Actual credit losses may exceed our estimate of expected losses. We will continue to periodically review and update our CECL methodology, models and the underlying assumptions, estimates and assessments we use to establish our ACL under the CECL standard to reflect our view of current conditions and reasonable and supportable forecasts. We will implement further enhancements or changes to our methodology, models and the underlying assumptions, estimates and assessments, as needed. If the assumptions we used in developing our estimate of expected credit losses require updating over time, there may be a material adverse impact on our results of operations and financial condition.
For additional information on our adoption of the CECL standard, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
Our loan portfolio is concentrated within our market area, and our lack of geographic diversification increases our risk profile.
The regional economic conditions within our market area affect the demand for our products and services as well as the ability of our customers to repay their loans and the value of the collateral securing these loans. A significant decline in the regional economy caused by inflation, recession, unemployment or other factors could negatively affect our customers, the quality of our loan portfolio and the demand for our products and services. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in our market area could adversely affect the value of our assets, revenues, results of operations and financial condition. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market area.
Our loan portfolio has a significant concentration of commercial real estate loans.
The majority of our loans are to commercial borrowers and 53 percent of our total loans are commercial real estate, or CRE, and construction loans with real estate as the primary collateral. The CRE segment of our loan portfolio typically involves higher loan principal amounts, and the repayment of these loans is generally dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Because payments on loans secured by CRE often depend upon the successful operation and management of the properties, repayment of these loans may be affected by factors outside the borrower’s control, including adverse conditions in the real estate market or the economy. Additionally, we have a number of significant credit exposures to commercial borrowers, and while the majority of these borrowers have numerous projects that make up the total aggregate exposure, if one or more of these borrowers default or have financial difficulties, we could experience higher credit losses, which could adversely impact our financial condition and results of operations. In December 2015, the FDIC and the other federal financial institution regulatory agencies released a new statement on prudent risk management for commercial real estate lending. In this statement, the agencies express concerns about easing commercial real estate underwriting standards, direct financial institutions to maintain underwriting discipline and exercise risk management practices to identify, measure and monitor lending risks, and indicate that they will continue to pay special attention to commercial real estate lending activities and concentrations going forward.
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Risks Related to Our Operations
Failure to keep pace with technological changes could have a material adverse effect on our results of operations and financial condition.
The financial services industry is constantly undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better service customers and reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy their demands, as well as create additional efficiencies within our operations. Many of our large competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services quickly or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business, financial condition and results of operations.
A failure in or breach of our operational or security systems or infrastructure, or those of third parties, could disrupt our businesses, and adversely impact our results of operations, liquidity and financial condition, as well as cause reputational harm.
Our operational and security systems, infrastructure, including our computer systems, data management and internal processes, as well as those of third parties, are integral to our business. We rely on our employees and third parties in our day-to-day and ongoing operations, who may, as a result of human error, misconduct or malfeasance, or failure or breach of third- party systems or infrastructure, expose us to risk. We have taken measures to implement backup systems and other safeguards to support our operations, but our ability to conduct business may be adversely affected by any significant disruptions to us or to third parties with whom we interact. In addition, our ability to implement backup systems and other safeguards with respect to third-party systems is more limited than with our own systems.
We handle a substantial volume of customer and other financial transactions every day. Our financial, accounting, data processing, check processing, electronic funds transfer, loan processing, online and mobile banking, automated teller machines, or ATMs, backup or other operating or security systems and infrastructure may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control. This could adversely affect our ability to process these transactions or provide these services. There could be sudden increases in customer transaction volume, electrical, telecommunications or other major physical infrastructure outages, natural disasters, events arising from local or larger scale political or social matters, including terrorist acts, and cyber attacks. We continuously update these systems to support our operations and growth. This updating entails significant costs and creates risks associated with implementing new systems and integrating them with existing ones. Operational risk exposures could adversely impact our results of operations, liquidity and financial condition, and cause reputational harm.
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A cyber attack, information or security breach, or a technology failure of ours or of a third-party could adversely affect our ability to conduct our business or manage our exposure to risk, result in the disclosure or misuse of confidential or proprietary information, increase our costs to maintain and update our operational and security systems and infrastructure, and adversely impact our results of operations, liquidity and financial condition, as well as cause reputational harm.
Our business is highly dependent on the security and efficacy of our infrastructure, computer and data management systems, as well as those of third parties with whom we interact. Cyber security risks for financial institutions have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including foreign state actors. Our operations rely on the secure processing, transmission, storage and retrieval of confidential, proprietary and other information in our computer and data management systems and networks, and in the computer and data management systems and networks of third parties. We rely on digital technologies, computer, database and email systems, software, and networks to conduct our operations. In addition, to access our network and products and services, our customers and third parties may use personal mobile devices or computing devices that are outside of our network environment.
Financial services institutions have been subject to, and are likely to continue to be the target of, cyber attacks, including computer viruses, malicious or destructive code, phishing attacks, denial of service or other security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information of the institution, its employees or customers or of third parties, or otherwise materially disrupt network access or business operations. For example, denial of service attacks have been launched against a number of large financial institutions and several large retailers have disclosed substantial cyber security breaches affecting debit and credit card accounts of their customers. We have experienced cyber security incidents in the past and although not material, we anticipate that, as a growing regional bank, we could experience further incidents. There can be no assurance that we will not suffer material losses or other material consequences relating to technology failure, cyber attacks or other information or security breaches.
In addition to external threats, insider threats also present a risk to us. Insiders, having legitimate access to our systems and the information contained in them, have the opportunity to make inappropriate use of the systems and information. We have policies, procedures, and controls in place designed to prevent or limit this risk, but we cannot guarantee that these policies, procedures and controls fully mitigate this risk.
As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify and enhance our protective measures or to investigate and remediate any information security vulnerabilities or incidents. Any of these matters could result in our loss of customers and business opportunities, significant disruption to our operations and business, misappropriation or destruction of our confidential information and/or that of our customers, or damage to our customers’ and/or third parties’ computers or systems, and could result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in our security measures, reputational damage, reimbursement or other compensatory costs, and additional compliance costs. In addition, any of the matters described above could adversely impact our results of operations and financial condition.
We rely on third-party providers and other suppliers for a number of services that are important to our business. An interruption or cessation of an important service by any third-party could have a material adverse effect on our business.
We are dependent for the majority of our technology, including our core operating system, on third-party providers. If these companies were to discontinue providing services to us, we may experience significant disruption to our business. In addition, each of these third parties faces the risk of cyber attack, information breach or loss, or technology failure. If any of our third-party service providers experience such difficulties, or if there is any other disruption in our relationships with them, we may be required to find alternative sources of such services. We are dependent on these third-party providers securing their information systems, over which we have limited control, and a breach of their information systems could adversely affect our ability to process transactions, service our clients or manage our exposure to risk and could result in the disclosure of sensitive, personal customer information, which could have a material adverse impact on our business through damage to our reputation, loss of business, remedial costs, additional regulatory scrutiny or exposure to civil litigation and possible financial liability. Assurance cannot be provided that we could negotiate terms with alternative service sources that are as favorable or could obtain services with similar functionality as found in existing systems without the need to expend substantial resources, if at all, thereby resulting in a material adverse impact on our business and results of operations.
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Risks Related to Interest Rates and Investments
Our net interest income could be negatively affected by interest rate changes which may adversely affect our financial condition.
Our results of operations are largely dependent on net interest income, which is the difference between the interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. Therefore, any change in general market interest rates, including changes resulting from the Federal Reserve Board’s policies, can have a significant effect on our net interest income and total income. There may be mismatches between the maturity and repricing of our assets and liabilities that could cause the net interest rate spread to compress, depending on the level and type of changes in the interest rate environment. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and the policies of various governmental agencies. In addition, some of our customers often have the ability to prepay loans or redeem deposits with either no penalties or penalties that are insufficient to compensate us for the lost income. A significant reduction in our net interest income will adversely affect our business and results of operations. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially harmed.
Declines in the value of investment securities held by us could require write-downs, which would reduce our earnings.
In order to diversify earnings and enhance liquidity, we own both debt and equity instruments of government agencies, municipalities and other companies. We may be required to record impairment charges on our debt securities if they suffer a decline in value due to the underlying credit of the issuer. Additionally, the value of these investments may fluctuate depending on the interest rate environment, general economic conditions and circumstances specific to the issuer. Volatile market conditions may detrimentally affect the value of these securities, such as through reduced valuations due to the perception of heightened credit or liquidity risks. Changes in the value of these instruments may result in a reduction to earnings and/or capital, which may adversely affect our results of operations and financial condition.
Risks Related to Our Business Strategy
Our strategy includes growth plans through organic growth and by means of acquisitions. Our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.
We intend to continue pursuing a growth strategy through organic growth within our current footprint and through market expansion. We also actively evaluate acquisition opportunities as another source of growth. We cannot give assurance that we will be able to expand our existing market presence, or successfully enter new markets or that any such expansion will not adversely affect our results of operations. Failure to manage our growth effectively could have a material adverse effect on our business, future prospects, financial condition or results of operations and could adversely affect our ability to successfully implement our business strategy.
Our failure to find suitable acquisition candidates, or successfully bid against other competitors for acquisitions, could adversely affect our ability to fully implement our business strategy. If we are successful in acquiring other entities, the process of integrating such entities, including DNB, will divert significant management time and resources. We may not be able to integrate efficiently or operate profitably, DNB or any entity we may acquire. We may experience disruption and incur unexpected expenses in integrating acquisitions. These failures could adversely impact our future prospects and results of operation.
The transition in our CEO position will be critical to our success and our business could be negatively impacted if we do not successfully manage this transition.
On October 2, 2020, we announced that Todd D. Brice will retire as Chief Executive Officer of S&T and S&T Bank, and as a member of the Boards of Directors of S&T and S&T Bank, effective March 31, 2021. We are currently engaged in a search for a new Chief Executive Officer (CEO). Our future performance will depend, in part, on the successful transition of our new Executive. The departure of key leadership personnel, such as a CEO, can take from the company significant knowledge and experience. This loss of knowledge and experience can be mitigated through successful hiring and transition, but there can be no assurance that we will be successful in such efforts. Any failure to timely hire a qualified CEO could hinder the Company’s strategic planning, execution and future performance. The ability of a new CEO to quickly expand their knowledge of our business plans, operations and strategies will be critical to their ability to make informed decisions about our strategy and operations. Further, if our new CEO formulates different or changed views, the future strategy and plans of the Company may differ materially from those of the past. While Mr. Brice entered into a letter agreement intended to facilitate a smooth transition under which he has agreed to provide advisory services to S&T and S&T Bank during the period from his retirement until the third anniversary thereof, if we do not successfully manage this transition, it could be viewed negatively by our
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customers, employees or investors and could have an adverse impact on our business and strategic direction.
We are subject to competition from both banks and non-banking companies.
The financial services industry is highly competitive, and we encounter strong competition for deposits, loans and other financial services in our market area, including online providers of these products and services. Our principal competitors include other local, regional and national financial services providers, such as other financial holding companies, commercial banks, credit unions, finance companies and brokerage and insurance firms, including competitors that provide their products and services online. Many of our non-bank competitors are not subject to the same degree of regulation that we are and have advantages over us in providing certain services. Additionally, many of our competitors are significantly larger than we are and have greater access to capital and other resources. Failure to compete effectively for deposit, loan and other financial services customers in our markets could cause us to lose market share, slow our growth rate and have an adverse effect on our financial condition and results of operations.
We may be required to raise capital in the future, but that capital may not be available or may not be on acceptable terms when it is needed.
We are required by federal regulatory authorities to maintain adequate capital levels to support operations. While we believe we currently have sufficient capital, if we cannot raise additional capital when needed, we may not be able to meet these requirements. In addition, our ability to further expand our operations through organic growth, which includes growth within our current footprint and growth through market expansion, may be adversely affected by any inability to raise necessary capital. Our ability to raise additional capital at any given time is dependent on capital market conditions at that time and on our financial performance and outlook.
Risks Related to Regulatory Compliance and Legal Matters
We are subject to extensive governmental regulation and supervision.
We are subject to extensive state and federal regulation, supervision and legislation that govern nearly every aspect of our operations. The regulations are primarily intended to protect depositors, customers and the banking system as a whole, not shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes. Other changes to statutes, regulations or policies could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs of regulatory compliance and of doing business, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things, and could divert management’s time from other business activities. Failure to comply with applicable laws, regulations, policies or supervisory guidance could lead to enforcement and other legal actions by federal or state authorities, including criminal or civil penalties, the loss of FDIC insurance, the revocation of a banking charter, other sanctions by regulatory agencies, and/or damage to our reputation. The ramifications and uncertainties of the level of government intervention in the U.S. financial system could also adversely affect us.
Our controls and policies and procedures may fail or be circumvented, which may result in a material adverse effect on our business, financial condition and results of operations.
Management regularly reviews and updates our internal controls, disclosure controls and procedures, operating, risk management and corporate governance policies and procedures. Any system of controls, policies and procedures, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of internal controls, disclosure controls and procedures, or operating, risk management and corporate governance policies and procedures, whether as a result of human error, misconduct or malfeasance, or failure to comply with regulations related to controls and policies and procedures could have a material adverse effect on our business, results of operations and financial condition.
Furthermore, we may in the future discover areas of our internal controls, disclosure controls and procedures, or operating, risk management and corporate governance policies and procedures that need improvement. Failure to maintain effective controls or to timely implement any necessary improvement of our internal and disclosure controls, or operating, risk management and corporate governance policies and procedures, could, among other things, result in losses from errors, harm our reputation, or cause investors to lose confidence in our reported financial information, all of which could have a material adverse effect on our results of operations and financial condition.
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As a participating lender in the Paycheck Protection Program, or PPP, we are subject to risks of litigation from our customers or other parties in connection with our processing of loans for the PPP and risks that the Small Business Administration may not fund some or all PPP loans.
We participate as a lender in the PPP. Due to the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the program, which exposes us to risks relating to noncompliance with the PPP. Since the opening of the PPP, several large banks have been subject to litigation relating to the policies and procedures they used in processing applications for the program. We may be exposed to the risk of litigation, from both customers and non-customers who approached us requesting PPP loans, regarding the process and procedures used by us in processing applications for the PPP. Any such litigation filed against us may be costly, regardless of the outcome, and result in significant financial liability or adversely affect our reputation.
In addition, while the PPP loans are fully guaranteed by the Small Business Administration, or SBA, and we believe that the majority of these loans will be forgiven, there can be no assurance that the borrowers will use or have used the funds appropriately or will have satisfied the staffing or payment requirements to qualify for forgiveness in whole or in part. Any portion of the loan that is not forgiven must be repaid by the borrower. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded or serviced by us, which may or may not be related to an ambiguity in the laws, rules or guidance regarding operation of the PPP, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if we have already been paid under the guaranty, seek recovery from us of any loss related to the deficiency.
Negative public opinion could damage our reputation and adversely impact our earnings and liquidity.
Reputational risk, or the risk to our business, earnings, liquidity and capital from negative public opinion, is inherent in our operations. Negative public opinion could result from our actual or alleged conduct in a variety of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues or inadequate protection of customer information. Financial companies are highly vulnerable to reputational damage when they are found to have harmed customers, particularly retail customers, through conduct that is illegal or viewed as unfair, deceptive, manipulative or otherwise wrongful. We are dependent on third-party providers for a number of services that are important to our business. Refer to the risk factor titled, “We rely on third-party providers and other suppliers for a number of services that are important to our business. An interruption or cessation of an important service by any third-party could have a material adverse effect on our business.” for additional information. A failure by any of these third-party service providers could cause a disruption in our operations, which could result in negative public opinion about us or damage to our reputation. We expend significant resources to comply with regulatory requirements, and the failure to comply with such regulations could result in reputational harm or significant legal or remedial costs. Damage to our reputation could adversely affect our ability to retain and attract new customers and employees, expose us to litigation and regulatory action and adversely impact our earnings and liquidity.
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Our ability to pay dividends on our common stock may be limited
Holders of our common stock will be entitled to receive only such dividends as our Board of Directors may declare out of funds legally available for such payments. The payment of common dividends by S&T is subject to certain requirements and limitations of Pennsylvania law. Although we have historically declared cash dividends on our common stock, we are not required to do so and our Board of Directors could reduce, suspend or eliminate our dividend at any time. Substantial portions of our revenue consist of dividend payments we receive from S&T Bank. The payment of common dividends by S&T Bank is subject to certain requirements and limitations under federal and state laws and regulations that limit the amount of dividends it can pay to S&T. In addition, both S&T and S&T Bank are subject to various general regulatory policies relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. Any decrease to or elimination of the dividends on our common stock could adversely affect the market price of our common stock.
We may be adversely impacted by the transition from LIBOR as a reference rate.
On July 27, 2017, the Financial Conduct Authority in the United Kingdom announced that it would phase out LIBOR as a benchmark by the end of 2021. In late 2020, the ICE Benchmark Administration (IBA) extended the cessation date for submission and publication of rates for all LIBOR currency-tenor pairs until June 30, 2023, except for the one-week and two-month USD LIBOR tenors, which will cease on December 31, 2021. U.S. regulators, including the U.S. Federal Reserve, published a statement supporting the IBA’s plans but also urged banks to phase out LIBOR as soon as practicable. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, has identified the Secured Overnight Financing Rate, or SOFR, a new index calculated by short-term repurchase agreements, backed by Treasury securities, as its preferred alternative rate for LIBOR.
Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to provide submissions for the calculation of LIBOR or if the phase-out could cause LIBOR to perform differently than in the past. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in views or alternatives may be on the value of LIBOR-based securities and variable rate loans, subordinated debentures, or other securities or financial arrangements.
We have a significant number of loans, derivative contracts, borrowings and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. Although we are currently unable to assess what the ultimate impact of the transition from LIBOR will be, failure to adequately manage the transition could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to Liquidity
We rely on a stable core deposit base as our primary source of liquidity.
We are dependent for our funding on a stable base of core deposits. Our ability to maintain a stable core deposit base is a function of our financial performance, our reputation and the security provided by FDIC insurance, which combined, gives customers confidence in us. If any of these considerations deteriorates, the stability of our core deposits could be harmed. In addition, deposit levels may be affected by factors such as general interest rate levels, rates paid by competitors, returns available to customers on alternative investments and general economic conditions. Accordingly, we may be required from time to time to rely on other sources of liquidity to meet withdrawal demands or otherwise fund operations.
Our ability to meet contingency funding needs, in the event of a crisis that causes a disruption to our core deposit base, is dependent on access to wholesale markets, including funds provided by the FHLB of Pittsburgh.
We own stock in the Federal Home Loan Bank of Pittsburgh, or FHLB, in order to qualify for membership in the FHLB system, which enables us to borrow on our line of credit with the FHLB that is secured by a blanket lien on a significant portion of our loan portfolio. Changes or disruptions to the FHLB or the FHLB system in general may materially impact our ability to meet short and long-term liquidity needs or meet growth plans. Additionally, we cannot be assured that the FHLB will be able to provide funding to us when needed, nor can we be certain that the FHLB will provide funds specifically to us, should our financial condition and/or our regulators prevent access to our line of credit. The inability to access this source of funds could have a materially adverse effect on our ability to meet our customer’s needs. Our financial flexibility could be severely constrained if we were unable to maintain our access to funding or if adequate financing is not available at acceptable interest rates.
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Item 1A. RISK FACTORS - continued
Risks Related to Owning Our Stock
The market price of our common stock may fluctuate significantly in response to a number of factors.
Our quarterly and annual operating results have varied significantly in the past and could vary significantly in the future, which makes it difficult for us to predict our future operating results. Our operating results may fluctuate due to a variety of factors, many of which are outside of our control, including the changing U.S. economic environment and changes in the commercial and residential real estate market, any of which may cause our stock price to fluctuate. If our operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:
•volatility of stock market prices and volumes in general;
•changes in market valuations of similar companies;
•changes in the conditions of credit markets;
•changes in accounting policies or procedures as required by the Financial Accounting Standards Board, or FASB, or other regulatory agencies;
•legislative and regulatory actions, including the impact of the Dodd-Frank Act and related regulations, that may subject us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;
•government intervention in the U.S. financial system and the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board;
•additions or departures of key members of management;
•fluctuations in our quarterly or annual operating results; and
•changes in analysts’ estimates of our financial performance.
General Risk Factors
We may be a defendant from time to time in a variety of litigation and other actions, which could have a material adverse effect on our financial condition and results of operations.
From time to time, customers and others make claims and take legal action pertaining to the performance of our responsibilities. Whether customer claims and legal action related to the performance of our responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant expenses, attention from management and financial liability. Any financial liability or reputational damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
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Item 1B. UNRESOLVED STAFF COMMENTS
There are no unresolved SEC staff comments.
Item 2. PROPERTIES
S&T Bancorp, Inc. headquarters is located in Indiana, Pennsylvania. We operate in five markets including Western Pennsylvania, Eastern Pennsylvania, Northeast Ohio, Central Ohio and Upstate New York. At December 31, 2020, we operate 76 banking branches and 5 loan production offices, of which 45 are leased facilities.
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Item 3. LEGAL PROCEEDINGS
The nature of our business generates a certain amount of litigation that arises in the ordinary course of business. However, in management’s opinion, there are no proceedings pending that we are a party to or to which our property is subject that would be material in relation to our financial condition or results of operations. In addition, no material proceedings are pending nor are known to be threatened or contemplated against us by governmental authorities or other parties.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Stock Prices and Dividend Information
Our common stock is listed on the NASDAQ Global Select Market System, or NASDAQ, under the symbol STBA. As of the close of business on January 31, 2021, we had approximately 2,784 shareholders of record. The number of record-holders does not reflect the number of persons or entities holding stock in nominee name through banks, brokerage firms and other nominees.
As discussed under "Our ability to pay dividends on our common stock may be limited." included in Item 1A. Risk Factors in Part I, the amount and timing of dividends is subject to the discretion of the Board and depends upon business conditions and regulatory requirements. The Board has the discretion to change the dividend at any time for any reason.
Certain information relating to securities authorized for issuance under equity compensation plans is set forth under the heading Equity Compensation Plan Information in Part III, Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this Report.
Purchases of Equity Securities
The following table is a summary of our purchases of common stock during the fourth quarter of 2020:
(1)On September 16, 2019, our Board of Directors authorized a $50 million share repurchase plan. This repurchase authorization, which is effective through March 31, 2021, permits S&T to repurchase from time to time up to $50 million in aggregate value of shares of S&T's common stock through a combination of open market and privately negotiated repurchases. The specific timing, price and quantity of repurchases will be at the discretion of S&T and will depend on a variety of factors, including general market conditions, the trading price of common stock, legal and contractual requirements, applicable securities laws and S&T's financial performance. The repurchase plan does not obligate us to repurchase any particular number of shares. We expect to fund any repurchases from cash on hand and internally generated funds. Repurchase activity was suspended in March 2020 as the impact of the COVID-19 pandemic spread.
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Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES - continued
Five-Year Cumulative Total Return
The following chart compares the cumulative total shareholder return on our common stock with the cumulative total shareholder return of the NASDAQ Composite Index(1) and the NASDAQ Bank Index(2) assuming a $100 investment in each on December 31, 2015 and the reinvestment of dividends.
Period Ending
(1)The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on the Nasdaq Stock Market.
(2)The NASDAQ Bank Index contains securities of NASDAQ-listed companies classified according to the Industry Classification Benchmark as Banks. These companies include banks providing a broad range of financial services, including retail banking, loans and money transmissions.
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Item 6. SELECTED FINANCIAL DATA
The tables below summarize selected consolidated financial data as of the dates or for the periods presented and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 and the Financial Statements and Supplementary Data in Part II, Item 8 of this Report. The below tables include the merger with DNB on November 30, 2019, the sale of a majority interest of our insurance business on January 1, 2018 and the effects of the enactment of the Tax Act in 2017.
CONSOLIDATED BALANCE SHEETS
December 31,
CONSOLIDATED STATEMENTS OF NET INCOME
Years Ended December 31,
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Item 6. SELECTED FINANCIAL DATA - continued
SELECTED PER SHARE DATA AND RATIOS
Refer to Explanation of Use of Non-GAAP Financial Measures below for a discussion of common tangible book value, common return on average tangible common equity and the ratio of tangible common equity to tangible assets as non-GAAP financial measures.
December 31,
Per Share Data
Profitability Ratios
Capital Ratios
Asset Quality Ratios
Allowance for credit losses/nonperforming loans 80 % 115 % 132 % 236 % 124 %
Explanation of Use of Non-GAAP Financial Measures
In addition to traditional measures presented in accordance with GAAP, our management uses, and this Report contains or references, certain non-GAAP financial measures identified below. We believe these non-GAAP financial measures provide information useful to investors in understanding our underlying operational performance and our business and performance trends as they facilitate comparisons with the performance of other companies in the financial services industry. Although we believe that these non-GAAP financial measures enhance investors’ understanding of our business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP or considered to be more important than financial results determined in accordance with GAAP, nor are they necessarily comparable with non-GAAP measures which may be presented by other companies.
We believe the presentation of net interest income on an FTE basis ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Interest income per the Consolidated Statements of Net Income is reconciled to net interest income adjusted to an FTE basis in Part II, Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations in this Report.
The efficiency ratio is noninterest expense divided by noninterest income plus net interest income, on an FTE basis, which ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice.
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Item 6. SELECTED FINANCIAL DATA - continued
Common tangible book value, common return on average tangible common equity and the ratio of tangible common equity to tangible assets exclude goodwill and other intangible assets in order to show the significance of the tangible elements of our assets and common equity. Total assets and total average assets are reconciled to total tangible assets and total tangible average assets. Total shareholders' equity and total average shareholders' equity are also reconciled to total tangible common equity and total tangible average common equity. These measures are consistent with industry practice.
RECONCILIATIONS OF GAAP TO NON-GAAP RATIOS
December 31
Common tangible book value (non-GAAP)
Common return on average tangible common shareholders' equity (non-GAAP)
Efficiency Ratio (non-GAAP)
Less: merger related expenses (2,342) (11,350) — — —
Less: securities (gains) losses, net (142) 26 — (3,000) —
Tangible common equity (non-GAAP)
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Item 6. SELECTED FINANCIAL DATA - continued
The following profitability metrics are adjusted to exclude merger related expenses from the DNB merger for the year ended:
December 31,
Diluted Earnings Per Share
Adjust for merger related expenses 2,342 11,350
Tax effect of merger related expenses (492) (2,106)
Net income excluding merger related expenses (non-GAAP) $ 22,890 $ 107,478
Diluted adjusted earnings per share (non-GAAP) $ 0.59 $ 3.09
Common Return on Average Tangible Common Shareholders' Equity (non-GAAP)
Adjust for merger related expenses 2,342 11,350
Tax effect of merger related expenses (492) (2,106)
Net income excluding merger related expenses 22,890 107,478
Plus: amortization of intangibles 2,532 836
Tax effect of amortization of intangibles (532) (176)
Less: average goodwill and average other intangible assets (382,907) (298,228)
Tax effect of other intangible assets 2,061 639
Tangible average common shareholders' equity (non-GAAP) $ 788,643 $ 686,319
Return on Average Assets (non-GAAP)
Net income excluding merger related expenses $ 22,890 $ 107,478
Return on average assets (non-GAAP) 0.25 % 1.45 %
Return on Average Shareholders' Equity (non-GAAP)
Net income excluding merger related expenses $ 22,890 $ 107,478
Return on average shareholders' equity (non-GAAP) 1.96 % 10.92 %
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section reviews our financial condition for each of the past two years and results of operations for each of the past three years. Certain reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation. Some tables may include additional time periods to illustrate trends within our Consolidated Financial Statements. The results of operations reported in the accompanying Consolidated Financial Statements are not necessarily indicative of results to be expected in future periods.
Important Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains or incorporates statements that we believe are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally relate to our financial condition, results of operations, plans, objectives, outlook for earnings, revenues, expenses, capital and liquidity levels and ratios, asset levels, asset quality, financial position, and other matters regarding or affecting S&T and its future business and operations. Forward looking statements are typically identified by words or phrases such as “will likely result”, “expect”, “anticipate”, “estimate”, “forecast”, “project”, “intend”, “ believe”, “assume”, “strategy”, “trend”, “plan”, “outlook”, “outcome”, “continue”, “remain”, “potential”, “opportunity”, “believe”, “comfortable”, “current”, “position”, “maintain”, “sustain”, “seek”, “achieve” and variations of such words and similar expressions, or future or conditional verbs such as will, would, should, could or may. Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. The matters discussed in these forward-looking statements are subject to various risks, uncertainties and other factors that could cause actual results and trends to differ materially from those made, projected, or implied in or by the forward-looking statements depending on a variety of uncertainties or other factors including, but not limited to: credit losses and the credit risk of our commercial and consumer loan products; changes in the level of charge-offs and changes in estimates of the adequacy of the allowance for credit losses, or ACL; cyber security concerns; rapid technological developments and changes; operational risks or risk management failures by us or critical third parties, including fraud risk; our ability to manage our reputational risks; sensitivity to the interest rate environment including a prolonged period of low interest rates, a rapid increase in interest rates or a change in the shape of the yield curve; a change in spreads on interest-earning assets and interest-bearing liabilities; the transition from LIBOR as a reference rate; regulatory supervision and oversight, including changes in regulatory capital requirements and our ability to address those requirements; unanticipated changes in our liquidity position; changes in accounting policies, practices, or guidance, for example, our adoption of CECL; legislation affecting the financial services industry as a whole, and S&T, in particular; the outcome of pending and future litigation and governmental proceedings; increasing price and product/service competition; the ability to continue to introduce competitive new products and services on a timely, cost-effective basis; managing our internal growth and acquisitions; the possibility that the anticipated benefits from acquisitions, including DNB, cannot be fully realized in a timely manner or at all, or that integrating the acquired operations will be more difficult, disruptive or costly than anticipated; containing costs and expenses; reliance on significant customer relationships; an interruption or cessation of an important service by a third-party provider; our ability to attract and retain talented executives and employees; our ability to successfully manage our CEO transition; general economic or business conditions, including the strength of regional economic conditions in our market area; the duration and severity of the coronavirus (“COVID-19”) pandemic, both in our principal area of operations and nationally, including the ultimate impact of the pandemic on the economy generally and on our operations; our participation in the Paycheck Protection Program; deterioration of the housing market and reduced demand for mortgages; deterioration in the overall macroeconomic conditions or the state of the banking industry that could warrant further analysis of the carrying value of goodwill and could result in an adjustment to its carrying value resulting in a non-cash charge to net income; the stability of our core deposit base and access to contingency funding; re-emergence of turbulence in significant portions of the global financial and real estate markets that could impact our performance, both directly, by affecting our revenues and the value of our assets and liabilities, and indirectly, by affecting the economy generally and access to capital in the amounts, at the times and on the terms required to support our future businesses. Many of these factors, as well as other factors, are described elsewhere in this report, including Part I, Item 1A, Risk Factors and any of our subsequent filings with the SEC. Forward-looking statements are based on beliefs and assumptions using information available at the time the statements are made. We caution you not to unduly rely on forward-looking statements because the assumptions, beliefs, expectations and projections about future events may, and often do, differ materially from actual results. Any forward-looking statement speaks only as to the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect developments occurring after the statement is made.
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Critical Accounting Policies and Estimates
Our Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles, or GAAP. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the Consolidated Financial Statements and accompanying Notes. These estimates, assumptions and judgments are based on information available as of the date of the Consolidated Financial Statements; accordingly, as this information changes, the Consolidated Financial Statements could reflect different estimates, assumptions and judgments. Certain policies are based to a greater extent on estimates, assumptions and judgments of management and, as such, have a greater possibility of producing results that could be materially different than originally reported.
Our most significant accounting policies are presented in Note 1 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Report. These policies, along with the disclosures presented in the Notes to Consolidated Financial Statements, provide information on how significant assets and liabilities are valued in the Consolidated Financial Statements and how those values are determined.
We view critical accounting policies to be those which are highly dependent on subjective or complex estimates, assumptions and judgments and where changes in those estimates and assumptions could have a significant impact on the Consolidated Financial Statements. We currently view the determination of the ACL, goodwill and other intangible assets and accounting for acquisitions to be critical accounting policies. We have updated our ACL policy in response to the adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. During 2019, we identified accounting for business combinations as a critical accounting policy due to our merger with DNB. Otherwise, we did not significantly change the manner in which we applied our critical accounting policies or developed related assumptions or estimates. We have reviewed these critical accounting estimates and related disclosures with the Audit Committee.
Allowance for Credit Losses
The ACL is a valuation reserve established and maintained by charges against operating income and is deducted from the
amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are
charged off against the ACL when they are deemed uncollectible. The ACL is an estimate of expected credit losses, measured
over the contractual life of a loan, that considers our historical loss experience, current conditions and forecasts of future
economic conditions. Determination of an appropriate ACL is inherently subjective and may have significant changes from
period to period.
The methodology for determining the ACL has two main components: evaluation of expected credit losses for certain
groups of homogeneous loans that share similar risk characteristics and evaluation of loans that do not share risk characteristics
with other loans.
The ACL for homogeneous loans is calculated using a life-time loss rate methodology with both a quantitative and a
qualitative analysis that is applied on a quarterly basis. The ACL model is comprised of six distinct portfolio segments: 1)
Construction, 2) Commercial Real Estate, or CRE, 3) Commercial and Industrial, or C&I, 4) Business Banking, 5) Consumer
Real Estate and 6) Other Consumer. Each segment has a distinct set of risk characteristics monitored by management. We
further evaluate the ACL at a disaggregated level which includes type of collateral and our internal risk rating system for the
commercial segments and type of collateral, lien position, and FICO score, for the consumer segments. Historical credit loss
experience is the basis for the estimation of expected credit losses. Our quantitative model uses historic data back to the second quarter of 2009. We apply historical loss rates to pools of loans with similar risk characteristics. After consideration of the historic loss calculation, management applies qualitative adjustments to reflect the current conditions and reasonable and supportable forecasts not already reflected in the historical loss information at the balance sheet date. Our reasonable and supportable forecast adjustment is based on the unemployment forecast and management judgment. For periods beyond our two year reasonable and supportable forecast, we revert to historical loss rates utilizing a straight-line method over a one year reversion period. The qualitative adjustments for current conditions are based upon changes in lending policies and practices, experience and ability of lending staff, quality of the bank’s loan review system, value of underlying collateral, the existence of and changes in concentrations and other external factors. These modified historical loss rates are multiplied by the outstanding principal balance of each loan to calculate a required reserve. A similar process is employed to calculate a reserve assigned to off-balance sheet commitments, specifically unfunded loan commitments and letters of credit, and any needed reserve is recorded in other liabilities.
The ACL for individual loans begins with the use of normal credit review procedures to identify whether a loan no longer
shares similar risk characteristics with other pooled loans and therefore, should be individually assessed. We evaluate all
commercial loans greater than $0.5 million that meet the following criteria: 1) when it is determined that foreclosure is
probable, 2) substandard, doubtful and nonperforming loans when repayment is expected to be provided substantially through
the operation or sale of the collateral, 3) any commercial troubled debt restructuring, or TDR, or any loan reasonably expected
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to become a TDR whether on accrual or nonaccrual status and 4) when it is determined by management that a loan does not
share similar risk characteristics with other loans. Specific reserves are established based on the following three acceptable
methods for measuring the ACL: 1) the present value of expected future cash flows discounted at the loan’s original effective
interest rate; 2) the loan’s observable market price; or 3) the fair value of the collateral when the loan is collateral dependent.
Our individual loan evaluations consist primarily of the fair value of collateral method because most of our loans are collateral
dependent. Collateral values are discounted to consider disposition costs when appropriate. A specific reserve is established or a
charge-off is taken if the fair value of the loan is less than the recorded investment in the loan balance.
Our ACL Committee meets quarterly to verify the overall appropriateness of the ACL. Additionally, on an annual basis, the ACL Committee meets to validate our ACL methodology. This validation includes reviewing the loan segmentation, critical model assumptions, forecast and the qualitative framework. As a result of this ongoing monitoring process, we may make changes to our ACL to be responsive to the economic environment.
Although we believe our process for determining the ACL appropriately considers all the factors that would likely result in
credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual losses
are higher than management estimates, additional provision for credit losses could be required and could adversely affect our
earnings or financial position in future periods.
Allowance for Loan Losses
Prior to the adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, we calculated our allowance for loan losses, or ALL, using an incurred loan loss methodology. The following policy related to the ALL in prior periods.
Our loan portfolio is our largest category of assets on our Consolidated Balance Sheets. We have designed a systematic ALL methodology which is used to determine our provision for loan losses and ALL on a quarterly basis. The ALL represents management’s estimate of probable losses inherent in the loan portfolio at the balance sheet date and is presented as a reserve against loans in the Consolidated Balance Sheets. The ALL is increased by a provision charged to expense and reduced by charge-offs, net of recoveries. Determination of an adequate ALL is inherently subjective and may be subject to significant changes from period to period.
The methodology for determining the ALL has two main components: evaluation and impairment tests of individual loans and evaluation and impairment tests of certain groups of homogeneous loans with similar risk characteristics.
We individually evaluate all substandard and nonaccrual commercial loans greater than $0.5 million for impairment. A loan is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the original contractual terms of the loan agreement. For all troubled debt restructurings, or TDRs, regardless of size, as well as all other impaired loans, we conduct further analysis to determine the probable loss and assign a specific reserve to the loan if deemed appropriate. Specific reserves are established based upon the following three impairment methods: 1) the present value of expected future cash flows discounted at the loan’s effective interest rate, 2) the loan’s observable market price or 3) the estimated fair value of the collateral if the loan is collateral dependent. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific impaired loans, including estimating the amount and timing of future cash flows, the current estimated fair value of the loan and collateral values. Our impairment evaluations consist primarily of the fair value of collateral method because most of our loans are collateral dependent. We obtain appraisals annually on impaired loans greater than $0.5 million.
The ALL methodology for groups of homogeneous loans, or the reserve for loans collectively evaluated for impairment, is comprised of both a quantitative and qualitative analysis. We first apply historical loss rates to pools of loans, with similar risk characteristics, using a migration analysis where losses in each pool are aggregated over the loss emergence period, or LEP. The LEP is an estimate of the average amount of time from when an event happens that causes the borrower to be unable to pay on a loan until the loss is confirmed through a loan charge-off.
In conjunction with our annual review of the ALL assumptions prior to 2020, we updated our analysis of LEPs for our Commercial and Consumer loan portfolio segments using our loan charge-off history. Based on our updated analysis, we shortened our LEP over the construction portfolio from 4 years to 3 years and made no other changes. We estimate an LEP of 3 years for CRE, 3 years for construction and 1.25 years for C&I. We estimate an LEP of 2.75 years for Consumer Real Estate and 1.25 years for Other Consumer.
Another key assumption is the look-back period, or LBP, which represents the historical period utilized to calculate loss rates. We used 10.5 years for our LBP for all portfolio segments which encompasses our loss experience during the 2008 - 2010 Financial Crisis and our more recent improved loss experience.
After consideration of the historic loss calculations, management applies additional qualitative adjustments so that the ALL is reflective of the inherent losses that exist in the loan portfolio at the balance sheet date. Qualitative adjustments are made based upon changes in lending policies and practices, economic conditions, changes in the loan portfolio, changes in
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lending management, results of internal loan reviews, asset quality trends, collateral values, concentrations of credit risk and other external factors. The evaluation of the various components of the ALL requires considerable judgment in order to estimate inherent loss exposures.
Our ALL Committee meets at least quarterly to verify the overall adequacy of the ALL. Additionally, on an annual basis, the ALL Committee meets to validate our ALL methodology. This validation includes reviewing the loan segmentation, LEP, LBP and the qualitative framework. As a result of this ongoing monitoring process, we may make changes to our ALL to be responsive to the economic environment.
Although we believe our process for determining the ALL adequately considers all of the factors that would likely result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual losses are higher than management estimates, additional provisions for loan losses could be required and could adversely affect our earnings or financial position in future periods.
Goodwill and Other Intangible Assets
As a result of acquisitions, we have recorded goodwill and identifiable intangible assets in our Consolidated Balance Sheets. Goodwill represents the excess of the purchase price over the fair value of net assets acquired.
We have one reporting unit, Community Banking. Existing goodwill relates to value inherent in the Community Banking reporting unit and that value is dependent upon our ability to provide quality, cost-effective services in the face of competition from other market participants. This ability relies upon continuing investments in processing systems, the development of value-added service features and the ease of use of our services. As such, goodwill value is supported ultimately by profitability that is driven by the volume of business transacted. A decline in earnings as a result of a lack of growth or the inability to deliver cost-effective services over sustained periods can lead to impairment of goodwill, which could adversely impact our earnings in the period in which impairment occurs.
The carrying value of goodwill is tested annually for impairment each October 1st or more frequently if events and circumstances indicate that it may be impaired. We test for impairment by comparing the fair value of our Community Banking reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value.
Determining the fair value of a reporting unit is judgmental and involves the use of significant estimates and assumptions. The fair value of the reporting unit is determined by using both a discounted cash flow model and market based models. The discounted cash flow model has many assumptions including future earnings projections, a long-term growth rate and discount rate. The market based method calculates the fair value based on observed price multiples for similar companies. The fair values of each method are then weighted based on the relevance and reliability in the current economic environment.
We determine the amount of identifiable intangible assets based upon independent core deposit and insurance contract valuations at the time of acquisition. Intangible assets with finite useful lives, consisting primarily of core deposit and customer list intangibles, are amortized using straight-line or accelerated methods over their estimated weighted average useful lives, ranging from 10 to 20 years. Intangible assets with finite useful lives are evaluated for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. No such events or changes in circumstances occurred during the years ended December 31, 2020, 2019 and 2018.
The financial services industry and securities markets can be adversely affected by declining values. If economic conditions result in a prolonged period of economic weakness in the future, our business may be adversely affected. In the event that we determine that our goodwill is impaired, recognition of an impairment charge could have a significant adverse impact on our financial position or results of operations in the period in which the impairment occurs.
Business Combinations
We account for business combinations using the acquisition method of accounting. All identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree are recognized and measured as of the acquisition date at fair value. We record goodwill for the excess of the purchase price over the fair value of net assets acquired. Results of operations of the acquired entities are included in the consolidated statement of income from the date of acquisition.
Acquired loans are recorded at fair value on the date of acquisition with no carryover of the related ACL. Determining the fair value of acquired loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. In estimating the fair value of our acquired loans, we considered a number of factors including loss rates, internal risk rating, delinquency status, loan type, loan term, prepayment rates, recovery periods and the current interest rate environment. The premium or discount estimated through the loan fair value calculation is recognized into interest income on a level yield basis over the remaining life of the loans.
Acquired loans, including those acquired in a business combination, are evaluated to determine if they have experienced more-than-insignificant deterioration in credit quality since origination. When the condition exists, these loans are referred to as purchased credit deteriorated, or PCD. An allowance is recognized for a PCD loan by adding it to the purchase price or fair
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value in a business combination. There is no provision for credit losses, or PCL, recognized upon acquisition of a PCD loan since the initial allowance is established through the purchase accounting. After initial recognition, the accounting for a PCD loan follows the credit loss model that applies to that type of asset. Purchased financial loans that do not have a more-than-significant deterioration in credit quality since origination are accounted for in a manner consistent with originated loans. An ACL is recorded with a corresponding charge to PCL. Subsequent to the acquisition date, the methods utilized to estimate the required ACL for these loans is similar to the method used for originated loans.
Prior to the adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, the methods utilized to estimate the required ALL for acquired loans was similar to the method used for originated loans; however, we recorded a provision for credit losses only when the required allowance exceeded the remaining fair value adjustment. Acquired loans were considered impaired if there was evidence of credit deterioration since origination and if it was probable at time of acquisition that all contractually required payments would not be collected.
Recent Accounting Pronouncements and Developments
Note 1 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements, which is included in Part II, Item 8 of this Report, discusses new accounting pronouncements that we have adopted and the expected impact of accounting pronouncements recently issued or proposed, but not yet required to be adopted.
Executive Overview
We are a bank holding company that is headquartered in Indiana, Pennsylvania with assets of $9.0 billion at December 31, 2020. We operate in five markets including Western Pennsylvania, Eastern Pennsylvania, Northeast Ohio, Central Ohio and Upstate New York.
We provide a full range of financial services with retail and commercial banking products, cash management services, trust and brokerage services. Our common stock trades on the NASDAQ Global Select Market under the symbol "STBA".
We earn revenue primarily from interest on loans and securities and fees charged for financial services provided to our customers. We incur expenses for the cost of deposits and other funding sources, provision for credit losses and other operating costs such as salaries and employee benefits, data processing, occupancy and tax expense.
Our mission is to become the financial services provider of choice within the markets that we serve which will enable us to be a high performing regional community bank. We strive to do this by delivering exceptional service and value. Our strategic plan follows a disciplined approach focused on organic growth, which includes both growth within our current footprint and through market expansion. We employ a geographic market-based growth platform in order to drive organic growth. We acknowledge that each of our five markets are in different stages of development and that our market based strategy will allow us to customize our approach to each market given its developmental stage and unique characteristics. We also actively evaluate acquisition opportunities that align with our strategic objectives as another source of growth. Our strategic plan includes a collaborative model that combines expertise from all areas of our business and focuses on satisfying each customer’s individual financial objectives. We continuously work to maintain and improve the efficiency of our different lines of business.
As we continue to navigate through the uncertainty resulting from the COVID-19 pandemic, our first priority is the safety of both our employees and customers. Our financial performance has been negatively impacted in many ways due to the COVID-19 pandemic. We are closely monitoring our asset quality with a focus on the portfolios that have been significantly impacted by the COVID-19 pandemic, including our hotel portfolio. We have increased our ACL to be responsive to this additional risk within our loan portfolio. Our balance sheet is asset sensitive so we have experienced a negative impact to our net interest income and net interest margin, or NIM, as interest rates declined in the first half of 2020. Our net interest income is also being impacted by declining loan balances as new loan originations have decreased in the current environment. Offsetting this impact was the origination of $555.9 million of Paycheck Protection Program, or PPP, loans during 2020. Our noninterest income has also been negatively impacted due to changes in our customers' behavior during these times which has been somewhat mitigated by strong mortgage banking income due to significant refinance activity. We are taking a prudent approach to capital management given the economic uncertainty. Our internally-run capital stress test results demonstrate that we have adequate capital cushions. We are well capitalized and we believe that we have sufficient excess capital to manage through the uncertainty resulting from the COVID-19 pandemic.
In response to the current economic environment as a result of the COVID-19 pandemic, we completed an interim quantitative goodwill impairment analysis as of November 30, 2020 and updated our analysis as of December 31, 2020. Based upon our impairment analysis, we determined that our goodwill of $373.4 million was not impaired at December 31, 2020.
We experienced a pre-tax loss of $58.7 million related to a customer fraud resulting from a check kiting scheme during 2020. This matter was disclosed in our Form 8-K filed on May 26, 2020. The fraud was perpetrated by a single business customer and the customer has plead guilty in a criminal investigation. This fraud loss reduced net income by $46.3 million, or $1.19 per diluted share, in 2020. We continue to pursue all available sources of recovery to mitigate the loss. An internal review of the matter has been completed and various process and monitoring enhancements have been implemented. The customer also
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had a lending relationship of $14.8 million, including a $14.0 million CRE loan and an $0.8 million line of credit. We recognized a $8.9 million charge-off related to this lending relationship during 2020.
Results of Operations
Year Ended December 31, 2020
COVID-19 Update
S&T has monitored the impact of the COVID-19 pandemic throughout the year and has taken steps to mitigate the potential risks and impact on S&T and to promote the health and safety of our employees, and the customers and communities that we serve. We have taken preventive health measures for our employees through rigorous sanitation, social distancing, wearing masks, remote work where feasible and providing access to financial wellness programs. We reopened our branches with extensive safety measures and are encouraging our customers to use online and mobile banking solutions. We have also extended our solution center hours to allow for customer consultation without entering a branch. Our Business Continuity teams were activated and have guided our efforts to respond to the rapidly developing situation.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security, or CARES Act was signed into law. It contained substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act included the Paycheck Protection Program, or PPP, a $349 billion program designed to aid small and medium sized businesses through federally guaranteed loans distributed through banks. The Paycheck Protection Program and Health Care Enhancement Act, or PPP/HCEA, was signed into law on April 24, 2020. The PPP/HCEA authorized an additional $310 billion of funding under the CARES Act for PPP loans among other provisions. On July 4, 2020, legislation was passed to extend the application period for the PPP through August 8, 2020. These loans are intended to cover eight weeks of payroll and other permitted expenses to help those businesses remain viable.
As of December 31, 2020, we originated $555.9 million of PPP loans. PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted expenses in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00 percent and a term of two years, or five years for loans approved by the SBA, on or after June 5, 2020. Payments are deferred for at least six months of the loan. The loans are 100 percent guaranteed by the SBA.
The extent to which COVID-19 may adversely impact our business depends on future developments which are highly uncertain and unpredictable. The COVID-19 pandemic has had, and we expect that it will continue to have, negative impacts on
S&T’s commercial and consumer loan customers and the economy as a whole. The pandemic caused, among other things, an increase in the provision for credit losses, a higher ACL as a percentage of total portfolio loans for each of the quarters ended in 2020 compared to December 31, 2019, and exclusive of the increase in portfolio loans due to the PPP portfolio, a decrease in portfolio loans compared to December 31, 2019. The severity and length of the COVID-19 pandemic’s impact on S&T and the U.S. and global economies continues to be unknown.
In order to assist our customers through this difficult period, we have provided the following assistance, which may have an adverse impact on our results in the short term, but which we believe will provide better outcomes in the long term for our customers and for S&T.
•We provided needs-based payment deferrals and modifications to interest only periods to commercial loans during 2020 totaling $1.2 billion. Only $195.6 million remain on deferral at December 31, 2020.
•We provided loan payment deferrals, with no negative credit bureau reporting, to mortgage and consumer loans during 2020 totaling $69.0 million. No loans remain on deferral at December 31, 2020.
•We paused foreclosures/repossessions for mortgages and consumer loans.
Earnings Summary
Net income decreased $77.2 million, or 78.6 percent, to $21.0 million, or $0.53 per diluted share, in 2020 compared to $98.2 million, or $2.82 per diluted share in 2019. Net income in 2020 was significantly impacted by a $46.3 million after-tax, or $1.19 per diluted share, fraud loss. The 2019 results included $11.4 million, or $0.27 per diluted share, of merger related
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expenses. The DNB merger results have been included in our financial statements since the consummation of the merger on November 30, 2019.
Net interest income increased $32.6 million, or 13.2 percent, to $279.4 million compared to $246.8 million in 2019 primarily due to the merger with DNB in late 2019. Average interest-earnings assets increased $1.5 billion, or 21.6 percent, to $8.4 billion compared to 2019. Average interest-bearing liabilities increased $862.2 million, or 17.7 percent, to $5.7 billion compared to 2019 with increases in average interest-bearing deposits of $923.1 million offset by decreases in borrowings of $61.0 million. Net interest margin, on a fully taxable-equivalent, or FTE, basis (non-GAAP), decreased 26 basis points to
3.38 percent for 2020 compared to 3.64 percent for 2019.
Net interest margin is reconciled to net interest income adjusted to an FTE basis below in the "Net Interest Income" section of this MD&A.
The provision for credit losses was $131.4 million for 2020 compared to $14.9 million in 2019. Excluding the customer fraud loss of $58.7 million, the provision for credit losses increased $57.8 million to $72.7 million for 2020 compared to $14.9 million in 2019. The significant increase in the provision for credit losses during the year was mainly due to the impact of the COVID-19 pandemic and our adoption of CECL on January 1, 2020. The COVID-19 pandemic has negatively impacted the hospitality industry resulting in deterioration in our $248 million hotel portfolio. Net loan charge-offs increased $89.7 million to $103.4 million, or 1.40 percent of average loans, for 2020 compared to $13.6 million, or 0.22 percent of average loans, in 2019. Excluding the customer fraud, net loan charge-offs were $44.7 million, or 0.60 percent in 2020.
Total noninterest income increased $7.1 million to $59.7 million compared to $52.6 million in 2019. Total noninterest income includes a full-year impact of the DNB merger for 2020 compared to one month in 2019. Additionally, the increase in noninterest income related to an increase of $8.4 million in mortgage banking income to $10.9 million compared to 2019 due to the strong refinance activity in the current interest rate environment.
Noninterest expense increased $19.5 million to $186.6 million for 2020 compared to $167.1 million for 2019. Total noninterest expense includes a full-year impact of the DNB merger for 2020 compared to one month in 2019 with increases in most noninterest expense categories. FDIC insurance increased $4.3 million due to the DNB merger, the impact of recent financial results on certain components of the assessment calculation and Small Bank Assessment Credits received in 2019. These increases were offset by a $9.0 million decrease in merger related expenses compared to 2019.
The income tax provision decreased to nearly zero for 2020 compared to an expense of $19.1 million in 2019. The decrease in our income tax provision was mainly due to a $96.3 million decrease in taxable income in 2020 compared to 2019.
Net Interest Income
Our principal source of revenue is net interest income. Net interest income represents the difference between the interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. Net interest income is affected by changes in the average balance of interest-earning assets and interest-bearing liabilities and changes in interest rates and spreads. The level and mix of interest-earning assets and interest-bearing liabilities is managed by our Asset and Liability Committee, or ALCO, in order to mitigate interest rate and liquidity risks of the balance sheet. A variety of ALCO strategies were implemented, within prescribed ALCO risk parameters, to produce what we believe is an acceptable level of net interest income.
The interest income on interest-earning assets and the net interest margin are presented on an FTE basis. The FTE basis adjusts for the tax benefit of income on certain tax-exempt loans and securities and the dividend-received deduction for equity securities using the federal statutory tax rate of 21 percent and the dividend-received deduction for equity securities. We believe this to be the preferred industry measurement of net interest income that provides a relevant comparison between taxable and non-taxable sources of interest income.
The following table reconciles interest income per the Consolidated Statements of Net Income to net interest income and rates on an FTE basis for the periods presented:
Years Ended December 31,
Net Interest Margin (FTE) (non-GAAP) 3.38 % 3.64 % 3.64 %
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Average Balance Sheet and Net Interest Income Analysis
The following table provides information regarding the average balances, interest and rates earned on interest-earning assets and the average balances, interest and rates paid on interest-bearing liabilities for the years ended December 31:
ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent .
(3)Taxable investment income is adjusted for the dividend-received deduction for equity securities.
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The following table sets forth for the periods presented a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates:
(dollars in thousands) Volume(4) Rate(4) Net Volume(4) Rate(4) Net
Interest earned on:
Interest paid on:
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent.
(3)Taxable investment income is adjusted for the dividend-received deduction for equity securities.
(4)Changes to rate/volume are allocated to both rate and volume on a proportionate dollar basis.
Net interest income on an FTE basis (non-GAAP) increased $32.0 million, or 12.8 percent, compared to 2019. Net interest income was favorably impacted by purchase accounting fair value adjustments of $4.8 million mainly related to the DNB merger. The net interest margin on an FTE basis (non-GAAP) decreased 26 basis points to 3.38% compared to 2019. This is mostly due to decreases in short-term interest rates of approximately 225 basis points. Purchase accounting fair value adjustments favorably impacted the net interest margin rate on an FTE basis by 6 basis points for 2020.
Interest income on an FTE basis (non-GAAP) decreased $0.6 million, or 0.2 percent, compared to 2019. The change was primarily due to increases in average interest-earning assets of $1.5 billion offset by lower short-term interest rates compared to 2019. Average loan balances increased $1.3 billion compared to 2019 due to the DNB merger and organic loan growth. PPP loans contributed $380.1 million of the average increase in loans. The average rate earned on loans decreased 86 basis points primarily due to lower short-term interest rates. Average interest-bearing deposits with banks increased $119.9 million and the average rate earned decreased 177 basis points compared to 2019. Average investment securities increased $86.2 million and the average rate earned decreased 15 basis points. Overall, the FTE rate on interest-earning assets (non-GAAP) decreased 84 basis points compared to 2019.
Interest expense decreased $32.6 million compared to 2019. The decrease was primarily due to lower short-term interest
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rates. Average interest-bearing deposits increased $923.1 million compared to 2019 due to the DNB merger and organic deposit growth. We experienced deposit growth throughout 2020 due to customer PPP loans and stimulus payments along with customers conservatively holding cash deposits in these uncertain times. The average rate paid decreased 74 basis points compared to 2019 primarily due to lower short-term interest rates. Average borrowings decreased $61.0 million due to increased deposits and the average rate paid decreased 120 basis points due to lower short-term interest rates. Overall, the cost of interest-bearing liabilities decreased 79 basis points compared to 2019.
Provision for Credit Losses
The provision for credit losses, which includes a provision for losses on loans and on unfunded loan commitments, is a charge to earnings to maintain the ACL at a level consistent with management's assessment of expected losses in the loan portfolio at the balance sheet date. The provision for credit losses increased $116.5 million to $131.4 million for 2020 compared to $14.9 million for 2019.
We recognized a charge-off of $58.7 million related to a customer fraud from a check kiting scheme during the second quarter of 2020. The fraud was perpetrated by a single business customer and the customer has plead guilty in a criminal investigation. We continue to pursue all available sources of recovery to mitigate the loss. The customer also had a lending relationship of $14.8 million, including a $14.0 million commercial real estate loan and an $0.8 million line of credit which resulted in an additional $8.9 million charge-off in 2020. At December 31, 2020, $5.9 million remains outstanding as a nonperforming loan that has been fully charged down to the estimated sale price of the collateral.
Excluding the customer fraud loss of $58.7 million, the provision for credit losses increased $57.8 million to $72.7 million for 2020 compared to $14.9 million in 2019. The significant increase in the provision for credit losses during the year was mainly due to the impact of the COVID-19 pandemic and our adoption of CECL on January 1, 2020. The COVID-19 pandemic has negatively impacted the hospitality industry resulting in deterioration in our $248 million hotel portfolio.
The impact of COVID-19 was captured in our quantitative reserve as certain impacted loans were downgraded to special mention and substandard and in our qualitative reserve through our economic forecast and other qualitative adjustments. Commercial special mention, substandard and doubtful loans increased $281 million to $572 million compared to $290 million at December 31, 2019, with an increase of $162 million in substandard loans, $113 million in special mention loans and $11.4 million in doubtful loans. The increase in both special mention and substandard loans was mainly due to downgrades in our hotel portfolio. Specific reserves on loans individually assessed increased $11.3 million to $13.5 million compared to $2.2 million in 2019. Included in the $13.5 million of specific reserves was $6.7 million for loans in our hotel portfolio. Specific reserves for hotels were based on liquidation values from appraisals received in the fourth quarter of 2020. Our qualitative reserve increased $14.1 million in 2020 which included $8.6 million for the economic forecast and $3.2 million for portfolio allocations made in our hotel, business banking and C&I portfolios due to the COVID-19 pandemic. The change in reserve attributed to the economic forecast reflected reductions in the second and third quarters due to an improved economic forecast. Our forecast covers a period of two years and is driven primarily by national unemployment data. The change attributed to the portfolio allocations was primarily due to $3.0 million of ACL added for our business banking portfolio.
Net loan charge-offs were $103.4 million, or 1.40% of average loans, in 2020 compared to $13.6 million, or 0.22% of average loans, during 2019. Excluding the customer fraud, net loan charge-offs were $44.7 million, or 0.60% in 2020.
Refer to the Credit Quality section of this MD&A for further details.
Noninterest Income
Years Ended December 31,
(dollars in thousands) 2020 2019 $ Change % Change
Securities gains, net $ 142 $ (26) $ 168 NM
NM- percentage change not meaningful
Noninterest income increased $7.2 million, or 13.6 percent, in 2020 compared to 2019. Total noninterest income includes a full-year impact of the DNB merger for 2020 compared to one month in 2019. Our noninterest income has been negatively impacted due to changes in our customers' behavior during the pandemic. The increase in noninterest income primarily related
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to higher mortgage banking income of $8.4 million compared to 2019 due to an increase in the volume of loans originated for sale in the secondary market resulting from a decline in mortgage interest rates. Debit and credit card fees increased $1.7 million compared to the prior year due to increased debit and credit card usage and the Merger. Wealth management fees increased $1.3 million due to the Merger. The $2.1 million decrease in other noninterest income was attributable to a change in the valuation of a deferred compensation plan, which has a corresponding offset in salaries and benefit expense resulting in no impact to net income, a change in the equity securities portfolio and a change in the credit valuation adjustment for our commercial loan swaps for risk associated with our hotel loan portfolio. Service charges on deposit accounts also decreased $1.6 million due to reduced activity related to the COVID-19 pandemic.
Noninterest Expense
Years Ended December 31,
(dollars in thousands) 2020 2019 $ Change % Change
Other expenses:
NM - percentage not meaningful
Noninterest expense increased $19.5 million, or 11.7 percent, to $186.6 million in 2020 compared to 2019. Total noninterest expense includes a full-year impact of the DNB merger for 2020 compared to one month in 2019. Total merger expenses decreased $9.0 million compared to 2019. Total merger related expenses of $2.3 million in 2020 were comprised of $1.4 million of salaries and employee benefits, $0.4 million for data processing, $0.2 million for professional services and $0.3 million in various other expenses. The increases in net occupancy expense, furniture, equipment and software and other taxes related to the DNB merger. The increase in FDIC insurance of $4.3 million was due to the impact of recent results on certain components of the assessment calculation, such as our net loss in the second quarter of 2020 and also the Small Bank Assessment Credits that were received by all banking institutions with assets of less than $10 billion in third quarter 2019 that were not received in 2020. Also in addition to the merger, the increase of $3.3 million in other taxes was due to a one-time adjustment related to a state sales tax assessment in 2019. Salaries and employee benefits increased $6.1 million during 2020 primarily due to additional employees, mainly related to the merger, annual merit increases and higher pension expense due to an increase in retirees electing lump-sum distributions. Partially offsetting these increases were a decrease in restricted stock of $1.7 million and $3.0 million of deferred origination costs due to PPP loans and increased mortgage activity. Loan related expenses increased $1.8 million due to the customer fraud and increased mortgage volume. Professional services and legal expenses increased $2.1 million mainly due to higher legal expense.
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Federal Income Taxes
The income tax provision was nearly zero compared to $19.1 million in 2019. The decrease in our income tax provision was mainly due to a $96.3 million decrease in net income before taxes in 2020 compared to 2019.
The effective tax rate, which is total tax expense as a percentage of net income before taxes, decreased 16.3 percent in 2020 to a nominal negative annual effective tax rate compared to 16.3 percent in 2019. The decrease in the effective tax rate was primarily due to significantly lower net income before taxes in 2020 compared to 2019. Historically, we have generated an annual effective tax rate that is less than the statutory rate of 21 percent due to benefits resulting from tax-exempt interest, excludable dividend income, tax-exempt income on BOLI and tax benefits associated with Low Income Housing Tax Credits, or LIHTC.
Results of Operations
Year Ended December 31, 2019
Earnings Summary
Net income decreased $7.1 million, or 6.7 percent, to $98.2 million, or $2.82 per diluted share, in 2019 compared to $105.3 million, or $3.01 per diluted share, in 2018. The 2019 results included $11.4 million, or $0.27 per diluted share, of merger related expenses. The DNB merger results have been included in our financial statements since the consummation of the merger on November 30, 2019.
The decrease in net income was primarily due to an increase in noninterest expense of $21.7 million, that included $11.4 million of merger related expenses. This decrease was partially offset by increases in net interest income of $12.4 million and noninterest income of $3.4 million compared to 2018.
Net interest income increased $12.4 million, or 5.3 percent, to $246.8 million compared to $234.4 million in 2018. Average interest-earning assets increased $335.7 million compared to 2018 to $6.9 billion. Average interest-bearing liabilities increased $182.5 million with increases in average interest-bearing deposits of $460.8 million offset by decreases in borrowings of $278.3 million. Net interest margin, on a fully taxable-equivalent, or FTE, basis (non-GAAP), remained unchanged at 3.64 percent. Net interest margin is reconciled to net interest income adjusted to an FTE basis below in the "Net Interest Income" section of this MD&A.
The provision for loan losses was $14.9 million for 2019 compared to $15.0 million in 2018. Net loan charge-offs increased $3.2 million to $13.6 million, or 0.22 percent of average loans, for 2019 compared to $10.4 million, or 0.18 percent of average loans, in 2018. Nonperforming loans increased $8.0 million and impaired loans increased $25.8 million with an increase in specific reserves of $0.4 million to $2.2 million compared to 2018.
Total noninterest income increased $3.4 million to $52.6 million compared to $49.2 million in 2018. The increase in noninterest income primarily related to higher commercial loan swap income of $4.3 million compared to 2018 as we continue to see a high demand for this product in the current interest rate environment. Offsetting this increase was a $1.9 million gain on the sale of a majority interest in S&T Evergreen Insurance, LLC in 2018. Wealth management fees decreased $1.5 million compared to the prior year due to a decline in financial service revenue.
Noninterest expense increased $21.7 million in part due to merger related expenses of $11.4 million in 2019, an increase of $7.9 million in salaries and employee benefits and an increase of $3.8 million in data processing and information technology. These expense increases were partially offset by a $2.8 million decrease in other taxes mainly due to a one-time adjustment related to a state sales tax assessment and a decrease of $2.5 million in FDIC insurance primarily due to Small Bank Assessment Credits that were received during 2019.
The federal income tax provision decrease $1.3 million to $19.1 million in 2019 compared to $17.8 million in 2018. The increase in our 2019 income tax provision was mainly due to non-recurring items related to the tax benefit from the pension contribution in 2018 offset by the sale of a majority interest of our insurance business in 2018.
Net Interest Income
Our principal source of revenue is net interest income. Net interest income represents the difference between the interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. Net interest income is affected by changes in the average balance of interest-earning assets and interest-bearing liabilities and changes in interest rates and spreads. The level and mix of interest-earning assets and interest-bearing liabilities is managed by our Asset and Liability Committee, or ALCO, in order to mitigate interest rate and liquidity risks of the balance sheet. A variety of ALCO strategies were implemented, within prescribed ALCO risk parameters, to produce what we believe is an acceptable level of net interest income.
The interest income on interest-earning assets and the net interest margin are presented on an FTE basis. The FTE basis adjusts for the tax benefit of income on certain tax-exempt loans and securities and the dividend-received deduction for equity
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securities using the federal statutory tax rate of 21 percent for 2019 and 2018 and 35 percent for 2017. We believe this to be the preferred industry measurement of net interest income that provides a relevant comparison between taxable and non-taxable sources of interest income.
The following table reconciles interest income per the Consolidated Statements of Net Income to net interest income and rates on an FTE basis for the periods presented:
Years Ended December 31,
Net Interest Margin (FTE) (non-GAAP) 3.64 % 3.64 % 3.56 %
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Average Balance Sheet and Net Interest Income Analysis
The following table provides information regarding the average balances, interest and rates earned on interest-earning assets and the average balances, interest and rates paid on interest-bearing liabilities for the years ended December 31:
ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent for 2019 and 2018 and 35 percent for 2017.
(3)Taxable investment income is adjusted for the dividend-received deduction for equity securities.
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The following table sets forth for the periods presented a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates:
(dollars in thousands) Volume(4) Rate(4) Net Volume(4) Rate(4) Net
Interest earned on:
Interest paid on:
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent for 2019 and 2018 and 35 percent for 2017.
(3)Taxable investment income is adjusted for the dividend-received deduction for equity securities.
(4)Changes to rate/volume are allocated to both rate and volume on a proportionate dollar basis.
Net interest income on an FTE basis (non-GAAP) increased $12.3 million, or 5.2 percent, compared to 2018. The net interest margin on an FTE basis (non-GAAP) remained unchanged at 3.64 percent.
Interest income on an FTE basis (non-GAAP) increased $30.6 million, or 10.4 percent, compared to 2018. The increase was primarily due to an increase in average interest-earning assets of $335.7 million and higher short-term interest rates compared to 2018. Average loan balances increased $345.3 million and the average rate earned on loans increased 23 basis points primarily due to higher average short-term interest rates. Average investment securities decreased $4.7 million and the average rate earned increased two basis points. Overall, the FTE rate on interest-earning assets (non-GAAP) increased 23 basis points compared to 2018.
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Interest expense increased $18.3 million compared to 2018. The increase was primarily due to an increase in costing liabilities of $182.5 million and higher average short-term interest rates. Average interest-bearing deposits increased $460.8 million. Average money market balances increased $392.7 million and the average rate paid increased 39 basis points due to higher average short-term interest rates and promotional pricing. Average non-interest bearing deposits also increased $99.6 million. Average borrowings decreased $278.3 million due to increased deposits and the average rate paid increased 57 basis points due to higher average short-term interest rates. Overall, the cost of interest-bearing liabilities increased 33 basis points compared to 2018.
Provision for Loan Losses
The provision for loan losses is the adjustment to the ALL after net loan charge-offs have been deducted to bring the ALL to a level determined to be adequate to absorb probable losses inherent in the loan portfolio. The provision for loan losses was$14.9 million for 2019 compared to $15.0 million for 2018.
Commercial special mention, substandard and doubtful loans decreased $11.6 million to $258.7 million compared to $270.3 million at December 31, 2018, with a decrease of $28.5 million in substandard loans offset by increases of $16.5 million in special mention loans and $0.4 million in doubtful loans. The decrease in substandard loans was mainly due to loan pay-offs and upgrades of risk ratings. Special mention loans increased due to upgrades from substandard and other downgrades as a result of updated financial information.
Impaired loans increased $25.8 million to $75.3 million at December 31, 2019 compared to $49.5 million at December 31, 2018 with an increase in specific reserves of $0.4 million compared to December 31, 2018. The increase in specific reserves related to a new $5.4 million CRE impaired loan in the third quarter of 2019 that required a $0.8 million specific reserve at December 31, 2019. Other new significant impaired loans during 2019 did not require a specific reserve.
Net charge-offs increased $3.2 million to $13.6 million, or 0.22 percent of average loans in 2019, compared to $10.4 million, or 0.18 percent of average loans in 2018.
Total nonperforming loans increased $8.0 million to $54.1 million, or 0.76 percent of total loans at December 31, 2019, compared to $46.1 million, or 0.77 percent of total loans at December 31, 2018. The increase in nonperforming loans is primarily related to a $10.0 million C&I loan that moved to nonperforming, impaired during the fourth quarter of 2019.
The ALL at December 31, 2019, was $62.2 million, or 0.87 percent of total portfolio loans, compared to $61.0 million, or 1.03 percent of total portfolio loans at December 31, 2018. The decrease in the level of ALL as a percent of total portfolio loans is due to the DNB merger which added $899.3 million of loans with no carry-over of ALL. Acquired loans are recorded at fair value at the time of merger. Refer to the Allowance for Loan Losses section of this MD&A for further details.
Noninterest Income
Years Ended December 31,
(dollars in thousands) 2019 2018 $ Change % Change
Securities gains, net $ (26) $ — $ (26) NM
Gain on sale of a majority interest of insurance business — 1,873 (1,873) NM
Other Income:
NM- percentage change not meaningful
Noninterest income increased $3.4 million, or 6.9 percent, in 2019 compared to 2018. The increase in noninterest income primarily related to higher commercial loan swap income of $4.3 million compared to 2018 as we continue to see a high demand for this product in the current interest rate environment. The $1.9 million increase in other noninterest income was primarily attributable to a change in the valuation of our rabbi trust related to a deferred compensation plan, which has a
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corresponding offset in salaries and benefit expense resulting in no impact to net income. Offsetting these increases was a $1.9 million gain on the sale of a majority interest in S&T Evergreen Insurance, LLC in 2018. Wealth management fees decreased $1.5 million due to a decline in financial service revenue. Debit and credit card fees increased $0.7 million compared to the prior year due to increased debit and credit card usage. Service charges on deposit accounts also increased $0.2 million due to increases in fees.
Noninterest Expense
Years Ended December 31,
(dollars in thousands) 2019 2018 $ Change % Change
Other expenses:
Noninterest expense increased $21.7 million, or 14.9 percent, to $167.1 million in 2019 compared to 2018. Total merger related expenses of $11.4 million were comprised of $4.7 million for data processing, $3.4 million of salaries and employee benefits, mainly related to severance payments, $2.8 million for professional services and $0.5 million in various other expenses. Salaries and employee benefits increased $7.9 million during 2019 primarily due to additional employees, annual merit increases, and higher pension and incentive expense. Data processing and information technology increased $3.8 million compared to 2018 due to the outsourcing agreement for certain components of our information technology function and the annual increase with our third-party data processor. These increases were partially offset by a $2.8 million decrease in other taxes due to a one-time adjustment related to a state sales tax assessment. FDIC insurance decreased $2.5 million related to Small Bank Assessment Credits that were received by all banking institutions with assets of less than $10 billion and improvements in our financial ratios which are used to determine the assessment.
Our efficiency ratio (non-GAAP), which measures noninterest expense as a percent of noninterest income plus net interest income, on an FTE basis, excluding security gains/losses and $11.4 million of merger related expenses, was 51.39 percent for 2019 and 50.60 percent for 2018. Refer to Explanation of Use of Non-GAAP Financial Measures in Part II, Item 6 Selected Financial Data in this Report for a discussion of this non-GAAP financial measure.
Federal Income Taxes
The income tax provision increased $1.3 million to $19.1 million in 2019 compared to $17.8 million in 2018. The increase in our 2019 income tax provision was mainly due to non-recurring items related to the tax benefit from the pension contribution in 2018 offset by the sale of a majority interest of our insurance business in 2018.
The effective tax rate, which is total tax expense as a percentage of net income before taxes, increased to 16.3 percent in 2019 compared to 14.5 percent in 2018. The increase in the effective tax rate was primarily due to lower net income before taxes in 2019 compared to 2018. Historically, we have generated an annual effective tax rate that is less than the statutory rate of 21 percent due to benefits resulting from tax-exempt interest, excludable dividend income, tax-exempt income on BOLI and tax benefits associated with Low Income Housing Tax Credits, or LIHTC.
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Financial Condition
December 31, 2020
Total assets increased $203.2 million to $9.0 billion at December 31, 2020 compared to $8.8 billion at December 31, 2019. Total portfolio loans increased $88.7 million to $7.2 billion at December 31, 2020 compared to $7.1 billion at December 31, 2019. The increase in portfolio loans primarily related to growth in the commercial loan portfolio of $160.9 million with increases of $233.6 million in C&I, which included $465.5 million of loans from the PPP, and $98.8 million in commercial construction offset by a decrease of $171.5 million in the CRE portfolio compared to December 31, 2019. Excluding the PPP loans, portfolio loans decreased $376.8 million compared to December 31, 2019 due to decreased activity related to the COVID-19 pandemic. Consumer loans decreased $72.2 million compared to December 31, 2019 primarily due to a decrease in the residential mortgage portfolio of $80.2 million.
Securities decreased $10.6 million to $773.7 million at December 31, 2020 from $784.3 million at December 31, 2019. The decrease in securities is primarily due to a reduction in overall investing activities mainly during the first half of the year due to the declining interest rate environment. These reductions were partially offset by increases in unrealized gains. The bond portfolio had an unrealized gain of $33.4 million at December 31, 2020 compared to $10.7 million at December 31, 2019 due to a decrease in interest rates.
Our deposits increased $384.0 million, with total deposits of $7.4 billion at December 31, 2020 compared to $7.0 billion at December 31, 2019. Customer deposits increased $676.2 million from December 31, 2019. The increase in customer deposits primarily related to PPP and stimulus programs along with customers conservatively holding cash deposits during these uncertain times. Customer noninterest-bearing demand deposits increased $563.9 million, interest-bearing demand increased $102.4 million, money market deposits increased $37.4 million and savings increased $138.6 million offset by a decrease in certificates of deposit of $166.1 million. Total brokered deposits decreased $292.2 million from December 31, 2019 due to the customer deposit growth. Brokered deposits are an additional source of funds utilized by ALCO as a way to diversify funding sources, as well as manage our funding costs and structure.
Total borrowings decreased $188.5 million to $227.9 million at December 31, 2020 compared to $416.4 million at December 31, 2019 due to an increase in deposits. The decrease in borrowings primarily related to a decline in short-term borrowings of $206.3 million offset by an increase in securities sold under repurchase agreements of $45.3 million due to demand for the product by our REPO customers.
Total shareholders’ equity decreased by $37.3 million to $1.2 billion at December 31, 2020 compared to $1.2 billion at December 31, 2019. The decrease was primarily due to the previously disclosed fraud loss, net of tax, of $46.3 million that significantly decreased net income to $21.0 million for 2020. Net income was offset by decreases from the cumulative-effect adjustment related to the adoption of ASU 2016-13, Credit Losses, of $22.6 million, share repurchases of $12.6 million, and dividends of $43.9 million and increased by a $20.6 million increase in other comprehensive income. The increase in other comprehensive income was primarily due to a $18.0 million increase in unrealized gains on our available-for-sale securities, net of tax, and a $2.8 million change in the funded status of our employee benefit plans.
Securities Activity
The balances and average rates of our securities portfolio are presented below as of December 31:
(1)Weighted-average yields are calculated on a taxable-equivalent basis using the federal statutory tax rate of 21 percent for 2020, 2019 and 2018.
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We invest in various securities in order to maintain a source of liquidity, to satisfy various pledging requirements, to increase net interest income, and as a tool of ALCO to reposition the balance sheet for interest rate risk purposes. Securities are subject to market risks that could negatively affect the level of liquidity available to us. Security purchases are subject to an investment policy approved annually by our Board of Directors and administered through ALCO and our treasury function. Securities decreased $10.6 million to $773.7 million at December 31, 2020 from $784.3 million at December 31, 2019. The decrease in securities is primarily due to a reduction in overall investing activities mainly during the first half of the year due to the declining interest rate environment. These reductions were partially offset by increases in unrealized gains.
At December 31, 2020 our bond portfolio was in a net unrealized gain position of $33.4 million compared to a net unrealized gain position of $10.7 million at December 31, 2019. At December 31, 2020, total gross unrealized gains in the bond portfolio were $33.5 million compared to December 31, 2019, when total gross unrealized gains were $11.7 million offset by gross unrealized losses of $1.0 million. Management evaluates the securities portfolio to determine if an ACL is needed each quarter. We did not record an ACL related to the securities portfolio at December 31, 2020.
Management evaluates the bond portfolio for impairment on a quarterly basis. The unrealized losses on debt securities were primarily attributable to changes in interest rates and not related to the credit quality of these securities. All debt securities were determined to be investment grade and paying principal and interest according to the contractual terms of the security at December 31, 2020. We do not intend to sell and it is more likely than not that we will not be required to sell any of the securities in an unrealized loss position before recovery of their amortized cost. We did not recognize any impairment charges on our securities portfolio in 2020, 2019 or 2018. The performance of the debt securities markets could generate impairments in future periods requiring realized losses to be reported.
The following table sets forth the maturities of securities at December 31, 2020 and the weighted average yields of such securities. Taxable-equivalent adjustments for 2020 have been made in calculating yields on obligations of state and political subdivisions.
Maturing
Available-for-Sale
U.S. Treasury securities $ — — % $ 10,282 1.87 % $ — — % $ — — % $ — — %
Marketable equity securities — — % — — % — — % — — % 3,300 2.90 %
(1)Weighted-average yields are calculated on a taxable-equivalent basis using the federal statutory tax rate of 21 percent for 2020.
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Lending Activity
The following table summarizes our loan portfolio as of December 31:
Commercial
Consumer
The loan portfolio represents the most significant source of interest income for us. The risk that borrowers will be unable to pay such obligations is inherent in the loan portfolio. Other conditions such as downturns in the borrower’s industry or the overall economic climate can significantly impact the borrower’s ability to pay.
We maintain a General Lending Policy to control the quality of our loan portfolio. The policy delegates the authority to extend loans under specific guidelines and underwriting standards. The General Lending Policy is formulated by management and reviewed and ratified annually by the Board of Directors.
Total portfolio loans increased $88.7 million, or 1.2 percent, to $7.2 billion at December 31, 2020 compared to $7.1 billion at December 31, 2019. Commercial and industrial loans, or C&I, included $465.5 million of loans originated under the PPP at December 31, 2020. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security, or CARES Act was signed into law. The CARES Act included the PPP, a program designed to aid small and medium sized businesses through federally guaranteed loans distributed through banks. PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted expenses in accordance with the requirements of the PPP. The loans are 100 percent guaranteed by the SBA. These loans carry a fixed rate of 1.00 percent and a term of two years, or five years for loans approved by the SBA, on or after June 5, 2020. Payments are deferred for at least six months of the loan. The SBA pays us a processing fee ranging from 1 percent to 5 percent based on the size of the loan. Interest is accrued as earned and loan origination fees and direct costs are deferred and accreted or amortized into interest income over the life of the loan using the level yield method. When a PPP loan is paid off or forgiven by the SBA, the remaining unaccreted or unamortized net origination fees or costs will be immediately recognized into income.
Commercial loans, including CRE, C&I and commercial construction, comprised 78.5 percent of total portfolio loans at December 31, 2020 and 77.2 percent at December 31, 2019. The increase of $160.9 million in commercial loans related to $233.6 million in C&I, which included $465.5 million of loans from the PPP, and $98.8 million in commercial construction loans offset by a decrease of $171.5 million in CRE compared to December 31, 2019. Excluding the PPP loans, portfolio loans decreased $376.8 million compared to December 31, 2019 due to decreased activity related to the COVID-19 pandemic.
Consumer loans represent 21.5 percent of our total portfolio loans at December 31, 2020 and 22.8 percent at December 31, 2019. Consumer loans decreased $72.2 million compared to December 31, 2019 with decreases of $80.2 million in residential mortgages and $3.2 million in home equity loans offset by increases in consumer construction of $9.3 million and installment and other consumer of $1.9 million. Residential mortgage lending continues to be a focus through a centralized mortgage origination department, secondary market activities and the utilization of commission compensated originators. Management believes that continued adherence to our conservative mortgage lending policies for portfolio mortgage loans will continue to be important. The LTV policy guideline is 80 percent for residential first lien mortgages. Higher LTV loans may be approved with the appropriate private mortgage insurance coverage. We primarily limit our fixed rate portfolio mortgage loans to a maximum term of 20 years for traditional mortgages, 30 year fixed rate construction loans and adjustable rate or balloon mortgages with a maximum amortization term of 30 years. We may originate home equity loans with a lien position that is second to unrelated third party lenders, but normally only to the extent that the combined LTV considering both the first and second liens does not
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exceed 100 percent of the fair value of the property. Combo mortgage loans consisting of a residential first mortgage and a home equity second mortgage are also available.
We originate and sell loans into the secondary market, primarily to Fannie Mae. We sell these loans in order to mitigate interest-rate risk associated with holding lower rate, long-term residential mortgages in the loan portfolio and to generate fee revenue from sales and servicing of the loans. During 2020 and 2019, we sold $345.1 million and $94.5 million of 1-4 family mortgages to Fannie Mae. Our servicing portfolio of mortgage loans that we had originated and sold into the secondary market was $718.2 million at December 31, 2020 compared to $509.2 million at December 31, 2019.
We also offer a variety of unsecured and secured consumer loan products. LTV guidelines for direct loans are generally 90-100 percent of invoice for new automobiles and 80-90 percent of National Automobile Dealer Association value for used automobiles.
The following table presents the maturity of commercial and consumer loans outstanding as of December 31, 2020:
Maturity
Credit Quality
On a quarterly basis, a criticized asset meeting is held to monitor all special mention and substandard loans greater than $1.5 million. These loans typically represent the highest risk of loss to us. Action plans are established and these loans are monitored through regular contact with the borrower, review of current financial information and other documentation, review of all loan or potential loan restructures or modifications and the regular re-evaluation of assets held as collateral.
Additional credit risk management practices include periodic review and update of our lending policies and procedures to support sound underwriting practices and portfolio management through portfolio stress testing. We have a portfolio monitoring process in place that includes a review of all commercial loans greater than $1.5 million. Commercial loans less than $1.5 million are monitored through portfolio management software that identifies credit risk indicators. Our Loan Review process serves to independently monitor credit quality and assess the effectiveness of credit risk management practices to provide oversight of all corporate lending activities. The Loan Review function has the primary responsibility for assessing commercial credit administration and credit decision functions of consumer and mortgage underwriting, as well as providing input to the loan risk rating process.
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Nonperforming assets, or NPAs, consist of nonaccrual loans, nonaccrual TDRs and OREO. The following represents NPAs as of December 31:
Nonperforming Loans
Consumer construction — — — — —
Nonperforming Troubled Debt Restructurings
Installment and other consumer — 4 9 7 88
Our policy is to place loans in all categories in nonaccrual status when collection of interest or principal is doubtful, or generally when interest or principal payments are 90 days or more past due. We had $0.5 million of loans 90 days or more past due and still accruing at December 31, 2020 related to the DNB merger and $3.8 million of loans 90 days or more past due and still accruing at December 31, 2019. The DNB merger loans were recorded at fair value at the time of acquisition.
Nonperforming loans increased $92.7 million to $146.8 million at December 31, 2020 compared to $54.1 million at December 31, 2019. The significant increase in nonperforming loans primarily related to the addition of $56.3 million of hotel loans which moved to nonperforming during the fourth quarter of 2020 as a result of continued deterioration due to the COVID-19 pandemic. Also moving to nonperforming during 2020 were $11.3 million and $6.7 million CRE relationships, which experienced financial deterioration that led to cash flow shortfalls, a $5.9 million CRE relationship, which was associated with the customer fraud and a $15.1 million C&I relationship, which experienced financial deterioration that led to cash flow shortfalls. The $11.3 million CRE relationship became a performing TDR in the third quarter of 2019. The relationship then moved to nonperforming in the first quarter of 2020 when the borrower experienced financial deterioration that led to cash flow issues.
TDRs are loans where we, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to the borrower that we would not otherwise grant. We strive to identify borrowers in financial difficulty early and work with them to modify the terms before their loan reaches nonaccrual status. These modified terms generally include extensions of maturity dates at a stated interest rate lower than the current market rate for a new loan with similar risk characteristics, reductions in contractual interest rates or principal deferment. While unusual, there may be instances of principal forgiveness. These modifications are generally for longer term periods that would not be considered insignificant. Additionally, we classify loans where the debt obligation has been discharged through a Chapter 7 bankruptcy and not reaffirmed by the borrower as TDRs.
An accruing loan that is modified into a TDR can remain in accrual status if, based on a current credit analysis, collection of principal and interest in accordance with the modified terms is reasonably assured and the borrower has demonstrated sustained historical repayment performance for a reasonable period before the modification. All commercial TDRs are individually evaluated and all consumer TDRs are reserved for at the pool level based on their similar risk characteristics. For all commercial TDRs, regardless of size, we conduct further analysis to determine the loss and assign a specific reserve to the loan if deemed appropriate. TDRs can be returned to accruing status if the ultimate collectability of all contractual amounts due,
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according to the restructured agreement, is not in doubt and there is a period of a minimum of six months of satisfactory payment performance by the borrower either immediately before or after the restructuring.
As an example, consider a substandard commercial construction loan that is currently 90 days past due where the loan is restructured to extend the maturity date for a period longer than would be considered an insignificant period of time. The post-modification interest rate given to the borrower is considered to be lower than the current market rate for new debt with similar risk and all other terms remain the same according to the original loan agreement. This loan will be considered a TDR as the borrower is experiencing financial difficulty and a concession has been granted due to the long extension of the maturity date, resulting in payment delay as well as the rate being lower than the current market rate for new debt with similar risk. The loan will be reported as nonaccrual TDR and will be individually evaluated. In addition, the loan could be charged down to the fair value of the collateral if a confirmed loss exists. If the loan subsequently performs, by means of making on-time principal and interest payments according to the newly restructured terms for a period of six months, and it is expected that all remaining principal and interest will be collected according to the terms of the restructured agreement, the loan will be returned to accrual status and reported as an accruing TDR.
TDRs increased $0.8 million to $46.7 million at December 31, 2020 compared to $45.9 million at December 31, 2019. Total TDRs of $46.7 million at December 31, 2020 included $17.4 million, or 37.3 percent, that were performing and $29.3 million, or 62.7 percent, that were not performing. This is an increase from December 31, 2019 when we had $45.9 million in TDRs, including $37.0 million that were performing and $8.9 million that were nonperforming. The significant increase in nonperforming TDRs during 2020 primarily related to an $11.3 million CRE relationship that moved to nonperforming in the first quarter of 2020 due to financial deterioration that led to cash flow shortfalls. The loan was modified to reduce monthly payments and became a TDR during the third quarter of 2019. During the third quarter of 2020, $10.1 million was charged-off when the customer notified the bank they planned to cease operations. The increase in nonperforming TDRs during 2020 was also attributed to the addition of a $9.6 million C&I loan that was modified during the fourth quarter of 2020. The modification granted a concession to the borrower that resulted in a payment delay.
Loan modifications resulting in new TDRs during 2020 included 40 modifications for $22.7 million compared to 53 modifications for $32.2 million of new TDRs in 2019. Included in the 2020 new TDRs were 23 loans totaling $1.0 million related to consumer bankruptcy filings that were not reaffirmed, thus resulting in discharged debt, which compares to 36 loans totaling $1.1 million in 2019.
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The following represents delinquency as of December 31:
90 days or more:
Consumer construction — — % — — % — — % — — % — — %
Consumer construction — — % — — % — — % — — % — — %
Loans held for sale — — % — — % — — % — — % — — %
Closed-end installment loans, amortizing loans secured by real estate and any other loans with payments scheduled monthly are reported past due when the borrower is in arrears two or more monthly payments. Other multi-payment obligations with payments scheduled other than monthly are reported past due when one scheduled payment is due and unpaid for 30 days or more. We monitor delinquency on a monthly basis, including early stage delinquencies of 30 to 89 days past due for early identification of potential problem loans.
Loans past due 90 days or more increased $92.7 million compared to December 31, 2019 and represented 2.03 percent of total loans at December 31, 2020. The change in loans past due 90 days or more is explained above. Loans past due by 30 to 89 days decreased $15.1 million and represented 0.12 percent of total loans at December 31, 2020.
Allowance for Credit Losses
We maintain an ACL at a level determined to be adequate to absorb estimated expected credit losses within the loan portfolio over the contractual life of a loan that considers our historical loss experience, current conditions and forecasts of future economic conditions as of the balance sheet date. We develop and document a systematic ACL methodology based on the following portfolio segments: 1) CRE, 2) C&I, 3) Commercial Construction, 4) Business Banking, 5) Consumer Real Estate and 6) Other Consumer.
Our charge-off policy for commercial loans requires that loans and other obligations that are not collectible be promptly charged-off when the loss becomes probable, regardless of the delinquency status of the loan. We may elect to recognize a partial charge-off when management has determined that the value of collateral is less than the remaining investment in the loan. A loan or obligation does not need to be charged-off, regardless of delinquency status, if (i) management has determined there exists sufficient collateral to protect the remaining loan balance and (ii) there exists a strategy to liquidate the collateral. Management may also consider a number of other factors to determine when a charge-off is appropriate. These factors may include, but are not limited to:
•The status of a bankruptcy proceeding;
•The value of collateral and probability of successful liquidation; and/or
•The status of adverse proceedings or litigation that may result in collection.
Consumer unsecured loans and secured loans are evaluated for charge-off after the loan becomes 90 days past due. Unsecured loans are fully charged off and secured loans are charged down to the estimated fair value of the collateral less the cost to sell.
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The following summarizes our loan charge-off experience for each of the four years presented below:
Years Ended December 31,
Charge-offs:
Recoveries:
Impact of CECL adoption 27,346 — — —
(1)Represents ALL for year presented
Net loan charge-offs for 2020 were $103.4 million, or 1.40 percent of average loans, compared to $13.6 million, or 0.22 percent of average loans for 2019. In addition to the $58.7 million charge-off from the customer fraud and the $8.9 million loan charge-off for the lending relationship with this customer, the most significant charge-offs during 2020 were a $10.1 million CRE relationship and a $9.9 million C&I relationship that occurred in the first quarter of 2020. We obtained information on the C&I relationship subsequent to filing our Annual Report on Form 10-K for the year ended December 31, 2019 but before the end of the first quarter of 2020; therefore, we recorded a $9.9 million specific reserve in the day one CECL adjustment. The updated information supported a loss existed at January 1, 2020.
The following table summarizes net charge-offs as a percentage of average loans for the years presented:
Net charge-offs to average loans outstanding 1.40 % 0.22 % 0.18 % 0.18 % 0.25 %
NM - percentage not meaningful
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The following is the ACL balance by portfolio segment as of December 31:
Significant to our ACL is a higher concentration of commercial loans. The ability of borrowers to repay commercial loans is dependent upon the success of their business and general economic conditions. Due to the greater potential for loss within our commercial portfolio, we monitor the commercial loan portfolio through an internal risk rating system. Loan risk ratings are assigned based upon the creditworthiness of the borrower and are reviewed on an ongoing basis according to our internal policies. Loans rated special mention or substandard have potential or well-defined weaknesses not generally found in high quality, performing loans, and require attention from management to limit loss.
The following table summarizes the ACL balance as of December 31: