S&T Bancorp Inc Q3 FY2021 Earnings Call

Good day, ladies and gentlemen, and welcome to the S&T Bancorp Third Quarter Earnings Conference Call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Mark Kochvar. Sir, the floor is yours.

Thank you very much. Good afternoon, everyone, and thank you for participating in today’s conference call. Before beginning the presentation, I want to take time to refer you to our statement about forward-looking statements and risk factors, which is on the screen in front of you. These statements provide cautionary language required by the Securities and Exchange Commission for forward-looking statements that may be included in this presentation. A copy of the third quarter 2021 earnings release can be obtained by clicking on the press release link on your screen or by visiting our Investor Relations website at www.stbancorp.com. We will be reviewing an earnings supplement slide deck as part of this presentation. You can obtain a copy of those slides by clicking on the link on your screen or on our website under Events & Presentations Third quarter 2021 Earnings Conference Call, click on the Third Quarter 2021 Earnings Supplement link. With me today are Chris McComish, S&T’s CEO, and Dave Antolik, S&T’s President. I would now like to turn the program over to Chris.

Thanks, Mark, and good afternoon, everybody. I’m very pleased to be with you this afternoon. And on behalf of Mark and Dave, welcome to our call. Firstly, I’m particularly pleased as I wrap up my first two months. Needless to say, it’s been a very busy eight weeks as the new CEO at S&T Bank, and today is another milestone. And as you know, when you’re new, you have a lot of firsts. This quarterly earnings call is the last of my significant firsts, and we’re now 100% focused on moving forward. I’m going to touch on a couple of things, two main aspects in my remarks: one, where we’ve been focused since I arrived, and briefly touch on our financial performance. I don’t want to steal Dave or Mark’s thunder as they will provide more detail, and they, along with our entire leadership team and employee base, deserve real credit for some solid results. First, on what I’ve been doing front. You’ll see on the slide, page 3, on the left-hand side. I view these first days as simply an integration into this company. I’m becoming part of S&T, S&T is learning about me, and we’re moving forward together. The term integration is something that we’ve used collectively as a leadership team and an employee base in order to, one, understand a lot about who we are, how we differentiate ourselves, how we’re winning in the market and where the opportunities may be for growth and improved performance. That will build to our future state, and we’ll have more details around that as we head into 2022. Within this activity and this integration, it’s been a very busy one. We’ve had a significant number of employee meetings, both one-on-one and in group sessions. And I’ve had the opportunity over the past eight weeks to be in front of almost one-third of our entire employee base. We’ve also had significant senior leadership engagement, including a few day offsite strategic planning session at the end of September. They did a lot to build the team as well as organize our focus around how we move forward together. Obviously, significant engagement with our Board, shareholders, and the investor community to not only introduce myself but discuss our future, as well as most importantly, significant customer engagement out in the marketplace. By the end of the week, I will have been in all of our markets and have come away from this time extremely optimistic about our future. We have many strengths. Most importantly, we have a very talented employee base, driving customer engagement and customer experience. And that speaks a lot to the bottom left-hand side of this page. And there are really three big areas of focus. How I think about this business and where our leadership team is focused is very much around doing everything we can to drive employee engagement first. Engaged, excited employees that have the tools and the skills to perform and deliver for customers are going to lead to high levels of customer engagement as well as market following. We have a great name and reputation in the marketplace, and focusing in this way is only going to enhance it. That work is very much underpinned by an everyday focus on not only safety and soundness, delivering our results as we expect them, but operational excellence, whether we’re face-to-face with our customers, through a digital interaction, or in the back office from an operations standpoint. This focuses on operational excellence, safety and soundness, and delivering for those engaged customers in markets that we have the honor to serve. Our focus is on profitable growth and the consistency thereof. That’s the output of the work that we’re doing around these two big inputs of engagement, soundness, and operational excellence. Again, more to come; a lot more details to follow. This is the perfect time of the year for us to be planning for 2022 and beyond. I look forward to discussing those things with you in the future. On the right-hand side of the page, a couple of highlights that I want you to hear, and again, Dave and Mark will go into more details. First, we had earnings of $0.70 a share. We feel very good about those solid earnings, primarily because of how they were driven, and that was through some very strong loan growth of north of $100 million linked quarter. That loan growth was broad-based, both in our commercial C&I business as well as in our consumer portfolios. The good news here is our pipelines remain strong. And again, Dave will give you more details. And during all of this change, one of the things that we also want to pay attention to and is a testament to this leadership team, is that we’ve also stayed focused on expenses. The efficiency of this company is part of what we’re known for. And in spite of changes in transition and new leadership, we kept our eye on that ball. Lastly, as we’ve talked about in the earnings release, we’re seeing positive trends in our hotel portfolio. This is a topic that’s been of discussion for the past few quarters and past few months, and things seem to be moving in the right direction, certainly stabilizing compared with where they were. As it relates to confidence in our future, I am very pleased to reemphasize the decision that was made in our Board meeting earlier this week, and that was an increase in our dividend by $0.01 or 3.6% to $0.29 a share. I look forward to your questions as we move forward in the call. But for now, I’m going to turn it over to Dave, and he can provide more details.

Great. Thank you, Chris, and good afternoon, everyone. I will refer you to slide 4. As Chris mentioned, we’re pleased to report loan growth, excluding PPP, of $118 million during the quarter. This represents a 7% annualized growth rate when compared to Q2. Drivers of growth include increased revolving line utilization in our C&I book from 31% to 33%, which translates into approximately $31 million of balance growth. We also experienced an increase in our total revolving commitments of $23 million during Q3 as new customer acquisition remained solid. Most of this commitment growth was in our asset-based lending division, where we continue to carve a niche of providing a unique banking solution for the lower middle market. Asset-based lending will continue to be a strategic focus for us moving forward. For the quarter, we also experienced total consumer loan growth of $38 million, driven primarily by residential mortgage balance increases, which are primarily the result of a shift in customer activity away from refinancing to purchases where our balance sheet products are preferred. Looking forward, our commercial loan pipeline improved quarter-over-quarter. This includes C&I, commercial real estate, and our business banking segment. We also anticipate increased utilization from the 33% that I mentioned earlier, as our commercial borrowers seek additional working capital to support growth. As a comparison, pre-pandemic utilization rates averaged approximately 42%. Getting back to pre-pandemic levels would result in approximately $200 million of additional loan growth. The consumer pipeline also grew quarter-over-quarter and reflects the shift in customer activity that I mentioned earlier with demand for portfolio, residential first mortgage and home equity loans both increasing. I thank you for your continued support and interest in our company, and I’ll now turn the call over to Mark for his comments.

Thanks, Dave. Net interest income improved by about $400,000 compared to the second quarter. This is due in part to an increase in PPP activity, which was $4.2 million compared to $4.1 million in the second quarter. An extra day in the third quarter also helped net interest income, along with an increase in average loan balances, excluding PPP, of almost $100 million. These improvements were offset by lower loan yields as the rates on new loans are tracking about 50 basis points lower than pay rates. The headline net interest margin rate decreased just 2 basis points as the loan yield decrease combined with higher average cash balances of $129 million were offset by relatively higher PPP revenue. Although the dollar amount of PPP revenue increased only slightly compared to the second quarter, the average balance of the PPP loans declined by $193 million, resulting in an outsized impact on the NIM rate. There remains about $181 million of PPP loans on our balance sheet and approximately $5.7 million of related fees to be recognized. Looking ahead with loan growth returning and PPP coming to an end, we should begin to deploy the higher cash level on the balance sheet. This should help offset the loan yield pressure I mentioned earlier and stabilize the net interest margin rate, and importantly, improve net interest income. The influence of PPP should end after the first quarter of ‘22, and forgiveness is expected to be essentially completed. Next, noninterest income in the third quarter increased by about $400,000 compared to the second quarter. The largest increase was in mortgage banking, which improved by about $400,000, primarily due to a higher mortgage servicing right valuation. Wealth management showed continued improvement through a combination of higher assets under management and increased customer activity. We expect the run rate in noninterest income to be $15 million to $16 million per quarter. Noninterest expense increased by $1.4 million compared to the second quarter, but remained well controlled at $47.2 million, in line with our expectations. Higher salary and benefits of $0.7 million came mainly through incentives and higher base dollars related to some new hires. Other expense categories were in line with the prior quarter. We expect our expenses to be $48 million to $49 million in the fourth quarter as investments in our production capacity will continue and incentives will be higher related to the increased activity we experience. Next, our allowance for credit losses to loans decreased from 1.56% in the second quarter to 1.55% in the third quarter with the release of about $1.3 million. There were some removing parts of the reserve this quarter. First, specific reserves were higher than second quarter and related about $0.5 million of $6.5 million as of the end of the second quarter, mostly related to the hotel by improved valuations resulting in the elimination of those specific reserves. Second, we added a new $9.3 million specific reserve related to the C&I relationship. This resulted in an increase in specific reserves of about $3.4 million. Third, for the ACL in total, offsetting the net addition in specific reserves with lower qualitative adjustments related to continued improvement in economic conditions and forecasts. Unrelated to the allowance that impacted NPLs, we moved two relationships totaling $12.2 million to OREO. So, although NPLs decreased by $1.3 million, with this move to OREO, NPAs increased by $10.9 million. Our capital ratios improved in the third quarter and are in excess of regulatory well-capitalized levels, and our capital cushion continues to expand. While we have $37.4 million remaining on our buyback authorization, we have no immediate plans for buybacks. We’re monitoring valuations and are prepared to respond should conditions warrant. Our preference is to utilize our capital to support growth organically or through M&A. Thank you very much. At this time, I’d like to turn the call back over to the operator to provide instructions for asking questions.

Your first question for today is coming from Michael Perito with KBW.

Thank you. Good afternoon. Chris, it’s nice to talk with you. Dave, Mark, it’s great to chat again. I want to start by discussing loan growth. It was encouraging to see the reacceleration this quarter. Dave, from your comments, it appears that both consumer and commercial pipelines have improved compared to last quarter. Considering the factors like paydowns and closings, do you believe that with the PPP balances mostly cleared out, we could achieve loan growth of around 5% to 7% in the near term, annualized? Is that what you are anticipating based on the pipelines, and would any growth beyond that likely stem from increased line utilization?

Yes. Your description is right on, Mike. So, with the existing pipeline of new business activity that we have, we are comfortable guiding towards that low single digits loan growth number through the balance of the year with the additional tailwinds of increased utilization in both our revolving C&I book, the higher utilization that comes along with some of the ABL book, and as construction projects continue to fund through the balance of the year, I think we would look at a higher number or guidance for overall loan growth. And then, in the consumer business, as I mentioned, the activity has moved more towards a purchase market, which is where our balance sheet plays more of a role in terms of growth in assisting those customers.

Helpful. I would like to hear about any particular areas of investment or focus for you as we consider expenses. Looking ahead to next year, how do you view expense growth alongside potential revenue growth, especially with a shift towards more digital initiatives? I’ll start there and then I have a follow-up.

Yes. So, I’ll put it in a couple of buckets. Mark touched on it a little bit. We will continue to look for talented teams of commercial, middle market, asset-based bankers that are in the marketplace and continue to look for expansion there. That would require additional FTEs in kind of the frontline commercial banking space. We’re also looking at what I’ve defined and what we talked about is what does operational excellence look like. There are opportunities within the organization to continue to digitize processes and take paper out of what we’re doing, anything from front-end capabilities that may look like CRM opportunities to, as I said, back office, more loan processing and origination functions in the mortgage standpoint. But today, we’re in the assessment phase and thinking about where the needs are and the prioritization of those needs. But, we do know that growth does require continued investments. We do have, again, as I said earlier, I’m very pleased with the discipline that’s shown within the Company around expense management. It’s not a new thing to talk about with our organization, but we do also need to recognize the fact that in order to grow, investments are required, and we’ll continue to balance those things up.

I would like to hear more about the capital situation. You mentioned a dividend increase, but it seems that buybacks are not a priority right now. According to my calculations, the tangible ratio is likely to exceed 10% next year, even with a loan growth of 5% to 7%. The economic environment appears to be stable. While I understand the $10 billion threshold is a factor, I would appreciate your updated thoughts on capital and how comfortable you are with allowing these ratios to build up before we see a more diversified deployment.

Yes. I mean, that’s something we constantly look at. I mean, the one thing with our balance sheet is we have a heavier loan base, and it’s commercial oriented. It uses or requires more regulatory capital than the average balance sheet I think of some of our peers. So, even though our intangibles might look high on a regulatory basis, we tend to be in line or actually a little bit below some of our peers. So, we have to be cognizant not only of the tangible impact but also the regulatory impact to make sure we maintain the correct, especially cushions to weather any storm. So, I think that puts some limits on how much we would be comfortable buying back in the current environment. That said, as Chris mentioned, we’re in that assessment phase and are reluctant before we kind of flush that out a little bit more to do anything that would impede our options when it comes to our first and second parties, which are organic and M&A.

That’s helpful. I mean just one quick clarification. I mean, so as we think about what you just laid out there, Mark, I mean, so your Tier 1 leverage is like 9.7%, your total risk base is 14%. I mean is it fair though to think that closer to 9% and maybe 13%, 13.5%. I mean, would you guys consider these current levels still in excess, I guess, relative to how you think about the capital and the balance sheet needs?

Yes, a little bit and not overly. So, Mike, there would be room for a significant buyback program that would really move the needle. The other thing to be that we will pay attention to is where our stock is trading and what the implied earn-back of those buybacks are. Even in that kind of low-30 range, the earn back on that gets to be a little bit long, and you have to wonder if that’s the right way to deploy the capital.

Your next question is coming from Daniel Tamayo with Raymond James.

I wanted to start by discussing the expenses. I appreciate the guidance for the fourth quarter, which indicates a range of around $48 million to $49 million. However, regarding your comments about ongoing investments and increased incentives, how should we approach this as we plan for 2022? What would be a reasonable baseline or expected growth rate?

Well, in the half, we’ve always strived to hit that pretty low single digits, so that 2% to 3% range. I think with the reassessment that we’re doing and the need to have a higher growth rate, that could be higher in ‘22 than in prior years as some of those investments need to be made and they may not come right away with revenue that follows immediately. So, one of the things we’re thinking about in the planning process is potentially a little bit higher expense run rate in ‘22, but that will begin to normalize as the revenue starts to catch up, and we can go back to a more normal increased number in part of the outer years.

And then, second, just a modeling question. Do you have the amount of what the MSR valuation adjustment was in the quarter?

The amount wasn’t very much; it’s about $160,000. It’s more of a change. It was negative last quarter. So, the delta was about $400,000. It was negative 200-some, followed by positive $160,000. So overall, the overall change was about $400,000.

And then, finally, just maybe to touch a little bit on the C&I credit that was moved into nonperforming status in the quarter. If there’s anything else you could disclose there in terms of industry or the type of borrower. And I’m assuming that that was a one-off situation, but if there’s anything else that you discovered in the portfolio and finding that credit, that would be helpful. Thank you.

Yes. Sure, Daniel. So, I’m not prepared to comment on the industry because it is an active work out, but the total exposure in that relationship, and it is a C&I relationship, is $21.7 million. We continue to work with the customer, and the customer has been cooperative in an effort to resolve the credit. The loan was downgraded to substandard and moved to nonperforming during Q3. The customer was impacted to a certain extent by COVID, but there were some other operational issues that were evident in our review of the credit. We expect to formalize our workout strategy during Q4, which could result in a charge-off. We do expect to resolve this credit sometime in 2022.

Your next question is coming from Russell Gunther with D.A. Davidson.

I just want to start with the ABL portfolio and a reminder of what the size of the portfolio is today. Some comments on what that contributed to growth in the quarter and then how you ultimately would look to scale that going forward?

Yes. So, the commitments at the end of the quarter were around $165 million. Utilization rates in that portfolio tend to run in the 60% range. That vertical is two years old. The folks that we brought on board to lead that charge just celebrated their second anniversary. We plan to accelerate our growth in that space; we do feel that from a risk perspective, we have a very strong practice. There’s a very rigid monitoring in that space. Our risk appetite in terms of size of credit is unique in the market. Most of our competitors are going upstream. We’re kind of at the lower end of the middle market. So, it’s a product that we can charge for in terms of yield and fees that surround it. We always demand it and get a full service relationship with these customers. There are treasury management and private banking opportunities that revolve around these customers. So, 30% kind of annualized growth rate in the commitment, perhaps beyond that. The folks that joined had non-solicits with their previous employer that expired earlier at the end of last year. So, that aided in some of the growth that we saw this year. But, as Chris mentioned earlier, we’re looking to add resources, human capital. We’ve got a very robust technology platform that supports that effort and is scalable as well. So, we see that becoming more of an integral part of our growth strategy as we move through 2022.

Russ, this is Chris. I want to add my perspective on the company's progress. Firstly, I’m impressed with how we've established this business. We’ve developed a cutting-edge technology infrastructure necessary to handle these credits, along with a strong treasury management system that keeps us competitive against our banking rivals. Additionally, we've hired experienced professionals who are well-versed in credit risk management. I've invested considerable time in this area recently, including a thorough portfolio review last week. I commend Dave, Mark, and the team for their foresight in directing us this way a couple of years ago. This exemplifies how we can achieve organic growth with a modest investment and a talented team that truly understands the business and can drive results for us.

Thanks, Dave. And Chris, I appreciate your thoughts there. It’s really helpful. I guess, just last one for me, Chris, would be as you look to leverage your background into the legacy S&T business model, are there any loan products or niche verticals that you’re not in to be or a different approach to fee income to try to get that as a greater contribution of revenue to peers? And are those type of strategic shifts, if there are any, something we might learn about in the first 100 days or...

Yes. I think it will be a little later than the first 100 days, if you think about it, depending on how we lap here about defining it in 100 business days or working a calendar date, and it depends on which way it turns in my favor, which way I go. But we’re thinking as we get to the latter half of Q1, January and February is a tough time to be out there, talking just from where people have their attention. So, we’re working through the end of the year that aligns with our budgeting process. I would define it as more to come. Again, part of my own due diligence before I even started was looking strategically at where the Company had put its emphasis. You can look on the income statement, some good double-digit growth, though— it’s small, double-digit growth across the board. An important customer, things like treasury management, fee income growth, our wealth management fee income growth; something as simple as debit card activity and growth. That actually does require our employees and our company being actively engaged with our customer base to utilize those cards. And that does something, but connect those customers more closely to us. So, we’re going to look at our online and digital offerings as we can do to upgrade and make them more user-friendly. We’re not missing anything, but I think there are enhancements that we can do as much as anything drive that customer experience and customer engagement. That’s where we’re focused right now.

Your next question is coming from Matthew Breese with Stephens Inc.

Hey. Chris, maybe away from potential new products and services, could you give us a sense for how you’re measuring success at the bank? I mean, are there metrics that you would kind of point us to that you’re watching as well that you’d say, from point A to point B, we were successful in our new strategy?

Yes, we've discussed quite a bit about examining our pretax, pre-provision figures in relation to the size of our balance sheet and considering future infrastructure needs. When thinking about organic growth, we might need to enhance our capabilities and bring in more personnel. Another key focus for us is credit metrics, which ties back to how we ensure the safety and soundness of our operations. We're actively monitoring our credit portfolio to align with our expectations. There are many variables at play right now, making it challenging to define what is considered normal, especially with the PPP loans ending and a persistently low interest rate environment, coupled with unprecedented liquidity on our balance sheet. Thus, it's quite difficult to pinpoint a number that accurately represents historical trends, but these are some areas we are concentrating on in the short term.

Got it. And as you hone down that list, the top three or four items that need execution and focus and the most focus. I’m curious, where does M&A stand on that list? And it’s important just given the size of the balance sheet, approximately $10 billion.

Yes, we are open to opportunities and would be interested in the right ones. As you know, these things happen at their own pace. I've instructed the team to concentrate on what we can manage, which is organic growth. Dave and I have distinct roles; Dave is focused on current performance while I’m focused on future development. Building for the future will manifest in a few ways, with organic growth being crucial to our potential for meaningful inorganic opportunities. We need to maintain strong performance, like the team demonstrated this quarter, as that will provide us with the leverage needed for future actions. We are definitely not opposed to this aspect of the business that I have experience with.

Last one from me, last handful of quarters, we’ve seen the securities portfolio increase anywhere from, call it, $20 million to $40 million. As you consider the cash position of the bank, is that something we should think about continuing until cash normalizes?

Yes. I think, especially with a little bit better rate environment further out the curve, we see a little bit more value into securities purchases. So I would anticipate that we would continue to see some increase on a quarter-over-quarter basis for now.

Your next question is coming from Daniel Cardenas with Boenning and Scattergood.

I have a quick question, Mark. You might have already mentioned this, but I may have missed it. What are the current replacement yields on the loan portfolio compared to historical yields? Additionally, what options are available on the funding side? Your cost of funds is relatively low, so what can be done to stabilize the margin at least for the next quarter or couple of quarters?

So, on the loan side, lately, the new rate, this is overall weighted is around 330 and the paid rate includes full payoffs and amortization. It’s been around 380. So, that’s where that kind of 50 basis-point drop is coming. On the funding side, there’s not many levers to pull, but we’re taking a hard look at what’s left in the interest expense category. There are a few rocks yet to cover when it comes to the exceptions and some of the higher-priced products that we have. There’s a very small amount of CDs that are dribbling off. There’s a little bit of opportunity there. But, it’s probably less than $1 million, $1.5 million overall on an annualized basis kind of left to get.

And then maybe on the lending side, any comments you can provide or color you can provide on competitive factors if you’re starting to see competitors show signs of weakness on covenants and doing stuff that’s perhaps a little crazy in any part of your footprint?

So, there is some competitive pressure, particularly on rate. I haven’t seen significant competition where it’s based on structure. That’s one of the things we like about the ABL vertical and our ability to grow there because it is a product offering that’s unique to a bank of our size and is targeted at a section of the market that is, we believe, underserved. It’s not as competitive in terms of great returns. We can manage our credit risk, maintain our credit risk profile, and get a return. You always have the one-off competitive situation on a deal where a competitor wants the business and they’re going to do whatever they have to do to win it or retain it, but that’s more business as usual than anything that’s outstanding in this environment.

Yes. We’re hearing from our customers the same thing that you’re hearing elsewhere, right? The desire for growth is there. They’re hamstrung by labor costs or labor shortages, issues relative to supply chain, those sorts of things. But people want to move forward. There are just some external factors that are causing them to slow down.

And Dan, during the quarter, we did see a modest decline in payoffs, and a lot of that was related to some of the rate movement in the permanent market. So, some of those borrowers who are looking at the permanent market as a solution either delayed or decided to retain a bank relationship.

There are no more questions in the queue.

All right. Well, we’ll wrap it up. And my last first is over. So, listen, thanks to all of you for your interest in our company and for the really good dialogue and questions that we’ve had this afternoon. Again, I’m proud of this team and what they’ve accomplished. Dave has led this group through a lot. Mark’s been here, and we’ve got a lot to be optimistic about as we move forward. We look forward to further dialogue. So, thank you.

Thank you, ladies and gentlemen. This does conclude today’s conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.