Indiana, PA, population 15,000, is one of those places where, as the saying goes, you can't get to from here-at least if "here" happens to be New York, Charlotte or even Cleveland. Instead, you must fly to Pittsburgh first and then drive two hours northeast into the rolling hills of Western Pennsylvania, passing through the countless small towns that could be featured in one of those "Heartbeat of America" commercials for Chevrolet. You know the kind of places: full of hard working-folk, with high school football games on Friday night, blue jeans and pickup trucks.

And if you happen to be a hotshot banker from New York, Charlotte or even Cleveland, you might think it would be pretty nice to plant your corporate flag in a place like that-where the local talent is, well, local talent.

And if you do happen to be a hotshot banker who thinks that way, David L. Krieger will pick your pocket faster than a New York minute.

As a senior vice president for lending at S&T Bancorp, a $1.3-billion-asset bank headquartered in Indiana, Krieger pretty much makes his living going up against larger competitors-and usually beating them. Since the early 1990s, S&T has been pushing its way into the Pittsburgh market, taking on the likes of PNC Bank Corp., Mellon Bank Corp. and Integra Financial Corp. in their own back yard.

Krieger likes to point out one success story in particular. In 1992, while recuperating from back surgery in a Pittsburgh hospital, he asked one of his doctors if he had any projects going. It just so happened the physician did have a medical-related project in the works, and Krieger eventually succeeded in getting the business for S&T. The man also had extensive personal holdings, and later referred other prospective customers to the bank. Krieger says that initial contact has generated nearly $300 million in commercial and consumer loans from the Pittsburgh area for S&T. "It just has been wonderful," he says. And of course, much of that business came at the expense of Krieger's larger competitors. "Why are they doing business with a bank in Indiana when they live in Pittsburgh?" Krieger asks.

It may have something to do with the way S&T hustles to attract new customers. The bank has a team of 10 lenders who cover its entire six-county region and average three days a week out of the office. "They're very sales-oriented, very people-oriented and they get out on the road," Krieger says. "We all have car phones."

Top Performer

Factor in S&T's excellent lending and credit management skills, a low cost structure and a strong service philosophy, and it all adds up to one of the best-performing small banks in the country. In this magazine's ranking two years ago of banks between the 100th and 351st largest in size (see "Ranking the Mid-Sized Banks," June 1994), S&T had the third highest score. [Editor's Note: U.S. Banker did not conduct a ranking of mid-sized banks in 1995.! And its performance has only improved since then. Net income through the first nine months of this year was $15 million, compared to $13.8 million in 1994. The bank's return on assets was a solid 1.54%; its ratio of non-performing loans to total loans a low 0.35%; its reserve coverage of non-performing loans a cautious 463% and its efficiency ratio a stellar 50.5%.

"I think they're a great bank," says analyst Ross A. Demmerle at Cleveland-based McDonald & Co. "They're one of the most efficient banks I cover."

The only performance category where S&T falls short is return on equity, which for the nine-month period stood at 14.59%. But S&T also has an unusually high 11.6% equity-to-assets ratio-which gives the bank a bullet-proof balance sheet but drags down its ROE. "They're sort of conservative," says Demmerle. "One way to get that (level of equity capital) down is to pay high dividends, but they are reluctant to do that."

To continue that strong performance, however, S&T must overcome two significant challenges. Indeed, the story of S&T is in many ways the story of community banks everywhere in an era of consolidation.

For starters, its remote location offers scant protection against both larger banks and tough non-bank competitors. S&T already slugs it out with PNC in much of the four-county area northeast of Pittsburgh that comprises its core market, and soon will face off against Cleveland-based National City Corp., which is acquiring Integra. And two regional brokers with offices in Indiana-Advest Inc. and Parker/Hunter-vie with it for investment management business. Part of the problem is that technology has made location increasingly irrelevant, leaving small banks with fewer places to hide. Says Demmerle, "Even as a community bank, an institution like S&T has to realize that technology is upon us."

"We do compete against the insurance companies and the mutual fund companies, and everyone knows how to dial an 800 number to get (Charles) Schwab," says chairman and chief executive officer Robert Duggan. Merely being local and friendly is not enough-as Duggan knows well. To survive, S&T must offer many of the same capabilities its larger competitors do.

Loan Rich, Deposit Poor

Like many banks today, S&T also has trouble attracting enough core deposits to support its lending activities-especially as it moves into the Pittsburgh area, where it owns no branches and already has a loan-to-deposit ratio of 100%. The bank has been forced to purchase wholesale funds despite being the deposit share leader in Indiana and Jefferson Counties, its two largest markets. Failure to solve the funding problem could pull down S&T's net interest margin, which stood at a respectable 4.77% for the first six months.

It is partly for this reason that S&T needs to expand beyond its traditional territory, where growth prospects are more modest. Duggan would like to reach $2 billion in assets by the end of 1996, preferably through an acquisition of a bank in the Pittsburgh area. "The objective is to remain independent and be an acquirer," he says. So far he has yet to interest another bank in that proposition.

Assuming it does, S&T has the management platform to run a much larger organization because many of its senior managers came from big banks. The 62-year-old Duggan spent 20 years with the Federal Reserve, running its Cincinnati and Pittsburgh branches before joining S&T in 1981. Krieger came from Equibank in Pittsburgh. J. Jeffrey Smead, a senior vice president who oversees loan administration, spent 15 years at Ameritrust in Cleveland. Two other senior vice presidents-James C. Barone, the treasurer, and chief financial officer Robert E. Rout-came from Integra and Mellon. And the head of marketing, senior vice president H. William Klump, recently joined S&T from Huntington Bancshares.

The institution dates back to 1903, when it was organized as the Savings and Trust Co. of Indiana by local business people with ties to the region's coal and petroleum industries, once an important part of the local economy. (Oil City, PA, birthplace of the petroleum industry in the U.S., is just an hour and a half drive north of Indiana.) The bank once owned lots of coal and gas rights and still has about $175 million in such non-conforming assets, according to Duggan.

Today it is primarily a lending bank, with fees accounting for only 11.6% of operating income, according to McDonald & Co. At year-end 1994, 53% of S&T's loan portfolio was comprised of consumer loans-and the vast majority of those were mortgage loans. The commercial loan segment was pretty much evenly split between commercial mortgages and commercial and industrial loans. While the biggest concentration of loans is in Indiana County, the bank's fastest-growing market has been in Allegheny County, where Pittsburgh is located.

Krieger says that real estate accounts for most of S&T's commercial loan growth-and the majority of that has been in Pittsburgh-although it also lends to manufacturers, retailers and energy-related concerns, and additionally does some asset-based lending. Commercial customers range in size from $1 million to $100 million in annual sales.

The key to S&T's success is a service philosophy that is partly built around fast turnaround. S&T doesn't make prospective borrowers wait long for an answer. Krieger says he has sufficient authority to commit the bank to a deal, even though all significant loans must be approved by the loan committee. "I can go into a deal, and if I think it's good I can pretty much say it's done," he explains. The bank also tries to maintain the continuity of its lending team. "People want service," Krieger says. "They don't want you to change lending officers constantly." The bank's focus on customer service seems to have paid off. "Our renewal business is just unbelievably strong," he adds. "We don't have to push down doors."

S&T takes the same customer service focus on the mortgage side, as well. It permits applicants to come in at their convenience without making an appointment, as is customary with some of its competitors-mostly larger banks and mortgage brokers. A more recent product enhancement is the "five-day okay," where S&T tries to give prospective borrowers the same quick response as on the commercial side. "We want to build lasting relationships with the customer, and the mortgage is a good chance to do that," says vice president and mortgage product manager Joanne Duggan. She contrasts S&T's style with that of some mortgage brokers, whose focus is on origination rather than relationship building. "Get the customer, get the loan, make the loan and move on," she says.

Hold 'Em Strategy

As of late September, the bank was holding 8,800 first mortgages, and has been originating new loans at the rate of $6 million to $7 million a month. Most of the volume comes from S&T's four-county core market, although it is trying to expand origination efforts to Allegheny County, as well. Two-thirds of the bank's loans are fixed-rate loans, and it sells relatively few of them into the secondary market. The average term for fixed-rate loans is 15 years, although it will go out to 20. Treasurer Barone says that since most of S&T's commercial loans are variable-rate, the fixed-rate mortgages tend to act as a natural hedge.

S&T is successful in part because it can do three very important things in concert with one another: growing the loan portfolio while making good individual credit decisions and tightly controlling expenses. The benefit of a strong credit culture is probably self-evident. But the relationship between low costs and high asset quality may not be. When a bank has its costs under control, it is not forced to reach for the marginal loan that offers a higher yield. Moreover, it has more pricing latitude if it decides to compete for a choice customer.

The bank's credit analysts review all loan applications over $100,000, and they try to complete the process as quickly as possible so the applicant isn't left hanging. The key, says Smead, is "being thorough quickly." The regular loan committee meets weekly to review all applications between $100,000 and $350,000. The senior loan committee also meets weekly to look at anything over $350,000, while the director's committee convenes as necessary to review especially large loans or problem situations. S&T's legal limit is $16 million, although the house limit is $8 million.

Asked if there is any tension in credit committee meetings, a sign that both sides are doing their jobs, Smead replies, "I hope so. Most of the time the decision to approve or disapprove a loan is fairly clear." But when it isn't, Smead adds, the review committee works the problem until the loan is properly structured. Lenders and credit analysts are helped by having a set of shared expectations as to what constitutes a good loan. Krieger says his calling officers understand the process quite well, and that "there are a lot of deals that never get to the loan committee." For his part, Smead sends his analysts out on customer visits with the lenders "because then they deal with reality rather than Ivory Tower."

The credit management process works quite well, judging by S&T's excellent track record of managing asset quality. At year-end 1990, when the industry was mired in probably the most severe downturn since the 1930s, S&T's ratio of non-performing assets to total assets was only 0.66%. According to SNL Securities, the bank's five-year average, 1990 through 1994, was 0.41%.

Chairman Duggan says the bank has spent the last 10 years re-building its credit culture. "You can't be 99% right in this business," he says, since a bank can ill-afford to let loan losses reach even 1% of total loans. When Duggan arrived at S&T, the bank did not have the thorough review process it has today. The directors made a lot of the loans, some of which were demand notes that never amortized.

S&T's ability to control expenses is another source of strength. At the mid-year point, it had the second best ranking of 12 small-cap stocks that McDonald & Co. covers in Pennsylvania, Michigan, Indiana, Ohio and West Virginia. The median of the group was 60.44%. President and chief operating officer James Miller says the bank is very careful about adding people, and about spending in general. "I think this is a long-term thing," he says. S&T needs to get its efficiency ratio even lower in order to meet some of its strategic objectives, according to CFO Rout. But the bank decided not to proceed with a reengineering program after an extensive review. "The deeper we dug into the process, the more we understood the impact it has on the overall organization and we weren't that dissatisfied," he explained.

The bank's most immediate challenge is raising deposits to fund its lending operation. Its loan-to-deposit ratio in the second quarter was 101.6%, second highest in McDonald's small-cap universe "It's a problem for everyone and it's going to get worse," Duggan says. Adds Barone, "All banks, S&T included, are going to have to use their imagination in tapping sources of funding."

Barone has been attacking the problem in a number of different ways, including going to various wholesale sources. It is one of many banks that has been borrowing money from the Federal Home Loan System. Barone also has been raising brokered deposits through Merrill Lynch & Co. and Smith Barney Group, and he oversees a growing bank note program. Additionally, Barone says the bank needs to use its leverage with corporate borrowers, many of whom are small business people and entrepreneurs. S&T is a good deposit-gathering institution that leads with the loan, but it needs to get deposits in return when the loan is made. "That's when you have leverage," he says. "He wants something from us at that point in time. We need to make sure we get something from him, and that's his deposits."

The bank has even started selling participations in some of its commercial loans to ease the funding strains. Through mid-September it had sold about $35 million in such arrangements, mostly to other Pennsylvania banks.

Ideally, S&T would like to solve the problem through an acquisition of a bank having a much lower loan-to-deposit ratio-preferably in Allegheny County. "We have lots of friends down there, and hopefully when they're ready to do something, they'll talk to us," he says. S&T also is waiting to see whether National City decides to sell off some of Integra's branches outside the Pittsburgh market, which it would like to bid for. These would bring in new depositors as well.

Another of S&T's challenges is that customers in Indiana, PA, want pretty much the same things as those who live in Chicago or San Francisco. This means that S&T confronts the same issues that preoccupies its larger competitors. A perfect example is retail distribution, where S&T operates a network of 34 branches. And contrary to conventional thinking, Edward C. Hauck, the bank's senior vice president for retail operations, offers a strong endorsement for the enduring value of bricks and mortar. S&T's branches gives it an important physical identity with its customers. "Name recognition in our market is crucial in gaining trust and respect," Hauck explains. "That's why we think bricks and mortar is important."

Hauck has even broken ground for a new branch in Greensburg, a small town located southeast of Pittsburgh where S&T would like to expand. "This is contrary to everything you hear about branches," concedes Hauck. "But we believe you at least need a presence in a community like Greensburg to be a player." S&T also has opened branches in an Indiana grocery store and Wal-Mart. Says Hauck, "I believe there's a wonderful opportunity in branch banking for the next 10 to 15 years."

And yet S&T faces the same "Why are they doing business with a bank in Indiana when they live in Pittsburgh?"

S&T at a GlanceAssets $1.3 BillionROA 1.54%ROE 14.51%Efficiency Ratio 50.5%Equity Capital 11.6%Net Income $15 Milion

Source: S&T Bancorp as of 9/30/95

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