S&T Bancorp Inc Q1 FY2022 Earnings Call

Good day, everyone, and welcome to the S&T Bancorp First Quarter Earnings Conference Call. It is now my pleasure to hand it over to your host, Mark Kochvar, CFO at S&T Bancorp. Please go ahead.

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. This statement provides cautionary language required by the Securities and Exchange Commission for forward-looking statements that may be included in this presentation. A copy of the first quarter of 2022 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 on our website under Events and Presentation First Quarter 2022 Earnings Conference Call, click on the First Quarter 2022 Earnings Supplement. With me today are Chris McComish, S&T's CEO; and Dave Antolik, S&T's President. I'd now like to turn the program over to Chris. Chris?

Thank you, Mark, and good afternoon, everybody, and thanks for joining us. We look forward to the discussion of our Q1 performance as well as taking your questions. Before I give a brief overview of the numbers, I wanted to start off by making sure everybody is aware of some recognition that we received from J.D. Power recently around retail customer service and retail satisfaction here in what they define as the Pennsylvania region. We were named as the number 1 bank based on their survey of bank customers. That is a really big deal for our company and certainly for our employees. It's a tremendous compliment when you receive feedback like this from those that are talking to our customers on an independent basis. It's something that we do not take lightly; it is certainly something that we have great pride in. We obviously want to thank our customers for the confidence that they show in us and certainly congratulate our teammates for this achievement. It gives us great optimism and confidence as we move forward. As you see on the first slide, titled 'First Quarter Overview', we had a very nice quarter. From a numbers perspective, we posted $0.74 a share, up from $0.57 a share, resulting in a little over $29 million in net income. We observed improvements in both margins and credit quality in the quarter. Credit quality improvement is in line with our focus on achieving a better balance of growth underpinned by a focus on safety and soundness. The margin improvement was aided by better deposit mix as well as the asset-sensitive nature of our balance sheet in a rising rate environment. As we look forward, this asset-sensitive nature of our balance sheet gives us optimism as we move through the year for continued improvement in both net interest income as well as net interest margins. I also want to highlight our dividend increase for the quarter. We increased the dividend by 3.4% to $0.30 a share. This is the second increase that we've delivered in the last three quarters and reflects the value that we have in those investing in our company and our desire to give back to them as well. Turning to the next page, titled 'Balance Sheet', I will turn it over to Dave Antolik for more details. But a couple of notes here: as we talked about, this is really a reflection of customer relationships, and that is our deposits remain stable. In fact, the mix shows some improvement in the quarter as low-cost core deposit growth remains strong, and we migrated some higher-cost deposits off the balance sheet. Our securities portfolio also increased in the quarter, which will help improve NIM and yields, deploying about $117 million from cash into higher-yielding assets. There’s a lot to be proud of in the loan book over the quarter, particularly in the consumer space. This was strategic work that we've been doing within our customer base, believing there are opportunities with those customers. Good solid execution, not just in this quarter but over the past few months, has resulted in that growth. I'm going to turn it over to Dave for more details.

Well, thanks, Chris. And good afternoon, everyone. I'd like to continue with some additional details related to Page 4. As you may recall, in Q4, we saw broad-based loan growth. That growth allowed us to enjoy a $54 million increase in average loan balances here in Q1. In our consumer segment, as Chris mentioned, absolute net loan growth continued at an annualized rate of 9.8%, also evidenced by increases in all consumer segments. We continue to see success in all regions with our home equity and first lien residential mortgage and construction products. I'm very pleased with the progress our consumer team has made post-pandemic and fully engaging our Eastern Pennsylvania branch network. That region has seen significant increases in activity and pipeline. We carried improved consumer pipelines into Q2 and anticipate balanced growth to continue at a slightly higher annualized low double-digit growth rate in the coming quarters. Supporting this growth is the addition of three new mortgage loan officers year-to-date. On the commercial side, production in Q1 met our expectations and exceeded Q1 of 2021 by 13%. Growth was dampened in Q1 by elevated payoffs. The primary reason for this was based on our strategic decision to allow certain loans to pay off due to structural pricing. Our pipeline in Q2 on the commercial side is similar in size compared to Q1, and we've seen increases in our revolving C&I utilization rates quarter-over-quarter, which are now nearing pre-pandemic levels. Based on the decisions we've made to allow for certain C&I payoffs, our total revolving commitments reduced in the quarter by approximately 3%. We continue to closely monitor activities in the commercial segment. And based on the current pipeline levels, we anticipate similar results in Q2 and low to mid-single-digit annualized growth rates in the second half of the year. Slide 5 provides some details regarding our asset quality trends. As you can see, our NPAs declined by 25% when compared to Q4. Our special assets team was able to complete the full liquidation of two significant and long-lasting workout credits. We also saw positive movement of several hospitality credits as they return to accrual. There were no meaningful NPA inflows in Q1. We also experienced a 12% reduction in CMC assets in Q1, primarily related to the hospitality portfolio. I'll now turn it over to Mark to continue the conversation.

Thank you, Dave. On the left side of the asset quality sheet on Page 5, we outline the changes in the allowance for credit losses between the quarters. The allowance increased by about 2 basis points or $1.3 million. The reduction in quantitative reserves resulted from rating upgrades and improved loss experience, which was counterbalanced by higher specific reserves and a more cautious outlook due to increasing macroeconomic uncertainty. Moving on to Page 6 regarding net interest income. Core net interest income, excluding PPP, rose by $0.7 million compared to the fourth quarter due to short rate increases at the end of the quarter. We saw an improved asset mix with higher average loans and securities, alongside a decrease in cash. However, total net interest income fell by $0.7 million due to lower PPP income, which dropped by $1.4 million compared to the fourth quarter, along with two fewer days in the period. The net interest margin, excluding PPP, increased by 7 basis points mainly due to the enhanced asset mix. We are well positioned to benefit from rising rates, with over 50% of our loans tied to LIBOR, SOFR, or PRIME. The positive impact was around $0.5 million in Q1, but we expect that to grow as we had a full quarter of a 25 basis point increase from March and anticipate further rate hikes this quarter. Our interest income is projected to improve by at least $7 million annualized for every 25 basis points increase. We expect early deposit beta to stay low, and we haven't faced significant pressure thus far, though this may change as the Federal Reserve accelerates its rate adjustments and competition responds. Moving to Slide 7, noninterest income decreased by $0.9 million in the first quarter compared to the fourth quarter, mainly due to valuation changes in the deferred compensation plan, which are reflected in the other category. This has no net impact on profit and loss as it is offset by lower expenses. Debit and credit card activity remained strong and improved further this quarter, increasing by about $0.7 million. On the other hand, mortgage banking income is moderating as refinances have slowed, and more origination volume is transitioning to the portfolio. We still expect the quarterly run rate to be in the $15 million to $16 million range. On Slide 8, noninterest expense declined by $2.8 million from the last quarter, with the most significant improvement in salaries and benefits, where we had considerably higher incentive payouts in the fourth quarter. This reduction was partially offset by increased OREO expenses appearing in other categories. We anticipate expenses to remain in the $49 million to $50 million range for the upcoming quarters as we continue investing in our business, while fee expenses are under pressure due to a tight labor market. Finally, on Slide 9, regarding capital, we have strong capital levels and are positioned well for growth. Our Board extended our share repurchase plan through March 2023, with approximately $37.4 million available in that plan. While we have no immediate plans for buybacks, we are evaluating the situation given the recent stock price changes. Our preference is to use the capital for organic growth and strategic investments. We experienced a tangible book value dilution of about 2.6% this quarter because of a relatively small securities portfolio, which is less than 11% of our assets. Our tangible common equity declined by just 17 basis points and stands at 8.91% at the end of the quarter. Thank you very much. I will now turn the call over to the operator for instructions on asking questions.

And the first question is coming from Daniel Tamayo from Raymond James.

Maybe we can start on the loan growth. I got your guidance on the low double-digit growth in the consumer book and then the low to mid-single-digit annualized on commercial. I think you said that second quarter is going to be similar to the first quarter in commercial. But putting that all together, is there a range that you would point us towards for loan growth for the rest of the year?

Yes. The growth is going to be concentrated in the second half of the year, and we would guide to mid-single-digit growth on an annualized basis for the remainder of the year.

Got it. All right. I appreciate that. And then maybe we can talk about the margin a little bit and the net interest income outlook with all the changes in REIT outlook. So you talked about the $7 million annualized on the asset side being the initial benefit. I think last quarter, you mentioned that may build up to $9 million over time as floors are reached. Just wanted to get your updated thoughts there. And then just thinking through how the excess cash assumptions are factored in as well?

Yes, for the margin, those numbers haven't changed. The first 25 basis points is that the $7 million; by the time we reach about 100 basis points, we will have worked through our floors and should be closer to $9 million. Again, that's interest income before any increases on the deposit side. What was the second part of your question? I'm sorry.

Just what any excess cash deployment assumptions?

Yes. On the cash, we did put some cash to work here in the first quarter. We're taking another look at that given the changing outlook in loans. It's a little bit different than what we had anticipated earlier in the year with more uncertainty in the macro-outlook. So we may look to deploy a little bit more in securities as we move throughout the year, depending on how the loan growth materializes.

And the next question is coming from Michael Perito from KBW.

A quick clarification question. I'm wondering about the $15 million to $16 million quarterly noninterest income target. I'm curious, Mark, what you guys are assuming around the mortgage piece. I mean, on one hand, it sounds like you're adding some producers there. But on the other hand, you hear kind of supply issues that are starting to bake into the run rate here. I'm just curious where you have that pipeline and that overall kind of fee line trending off this low point we saw this quarter over the last two years.

Yes. That mortgage number is closer to about $1.25 million or so, which includes the servicing, making it more stable. It's probably about half and half between servicing and fees for origination. We are seeing more activity in the mortgage side building because they are larger loans going to the portfolio and also an increase in home equity activity, while the refinance boom is stopping, as people are looking to take advantage of equity in their homes. But in the fee side, it's probably about $1 million of that per quarter.

So it's fair to say then that with that $1 million in hand to maintain this run rate, you guys are expecting some of the debit and credit card and other deposit fees and things that have kind of ramped up nicely over the last few quarters to remain at these levels?

Yes, Mike, this is Chris. That's exactly right. We analyze the fee income line item and note that there is a lot of variability in the mortgage segment. We are concentrating on growth in true customer activities, such as debit card treasury management fee income. The level of this activity is very important to us and is central to the metrics we are monitoring. We hope to see significant growth in this area to compensate for the variability in the mortgage segment.

Got it. And then just two more quick ones. First on credit. Anything else to note? Obviously, the 12-month comparisons look great, but is there anything significant in the near term that we should be aware of regarding items that might improve or be removed, or anything else you can share visibility on today?

Nothing beyond what we commented on, Mike. I think broadly, if you look at delinquency, NPL, TDRs, special mention, and substandard, everything is trending in the right direction for Q1. As Mark mentioned regarding the reserve, we did add a little bit to the reserve in order to anticipate upcoming potential macroeconomic changes that might impact credit performance, but there’s nothing specifically that I would point out beyond what we mentioned.

Got it. And then just lastly, with the impacts on the balance sheet from AOCI this quarter and margins reflecting, I mean, we could theoretically be at a low point from a capital standpoint. I think you guys could build from here pretty materially. And with the non-performance, it’s such a smaller percentage now. Do you think there could be a bit more of an aggressive posture around capital deployment outside of the M&A and organic stuff that you've been considering all along?

As we look at that, that's also a function of how our stock price is performing. If we exceed certain thresholds, the return may seem less attractive to us. So that is something we're monitoring. But again, our preference is on growth and strategic initiatives. We are reluctant to deploy that in light of improvements in earnings coming from the REIT side. We aim to be mindful about additional spending purely for capital at this time.

Got it. And actually, just one last question, sorry. Just on that point. Do you think it's fair and comfortable to say that with the growth pipeline you have today, and with some excess cash still likely to normalize, that you could stay under $10 billion without materially altering your strategy for the duration of this year or next? Or do you think you think about it differently?

Yes. Again, we're not targeting a specific time frame to hit, but I think you're right; we still have $750 million of cash, and even with a bit lighter loan outlook, we're looking at potentially up to two years at that pace before we would naturally cross.

And the next question is coming from Russell Gunther from D.A. Davidson.

Do you have a view internally in terms of the number of rate hikes you're budgeting for? And if so, how are you guys thinking about deposit betas in the early innings of a high cycle versus later? I know you expect it to be viewed near-term. But as we move through a rate hike cycle potentially pretty quickly this year, has anything structurally changed in your view as to how deposit betas will perform in this cycle versus prior?

That's a really interesting question. I mean, one thing I should mention is I am not very good at predicting what the Fed will do. We tend to run a lot of different scenarios just to understand where our pressure points are on the beta side. The one thing that is different for us this time compared to last cycle is that our balance sheet mix is different, especially on the liability side. In the last cycle, we had almost $1 billion worth of short borrowing debt, making us a net borrower. Now we have a much better liquidity position. So I believe our approach to deposit pricing this time around can be more controlled. The second thing is, in the last rate cycle, we had deposit products tied directly to Fed funds, which had almost $1 billion close to $1.5 billion in it. We've restructured that product so it's no longer directly indexed to Fed funds, allowing us more control over timing for potential pricing increases. Therefore, our outlook on deposit betas is more positive, but it still depends on how competition and customer responses play out in this cycle.

That's really helpful. I appreciate it. And then just back to the asset quality discussion, certainly a good quarter in terms of how things have trended? Can you provide any additional color in terms of the specific increase in the reserve this quarter that you mentioned, the $2.7 million? And then any additional thoughts on what that qualitative adjustment attempts to capture and where that conservatism might manifest itself on the balance sheet?

So on the specific reserve, there are a couple of credits that we are watching closely that resulted in that increase to specific reserves. We do expect resolution of those possibly in the second quarter, but I also expect it will take until the third quarter. We hope to clear that without significant additional P&L impact because we believe we have that mostly covered, if not all covered. In terms of the reserve side, on a broader forecast, our primary indicators are unemployment, and those look pretty good. If we only looked at unemployment as an indicator for the forecast, we probably wouldn't make any adjustments. However, looking beyond that, which we have the ability to do in our model—this is where some uncertainty may arise—given the nature and type of challenges present in the macro economy, they may not be as predictive as they have in the past.

Yes, it's not necessarily a specific portfolio or bucket. But Russell, it doesn't take long to turn on the news to discuss inflation in relation to rates, commodities, and costs to people. We are mindful and need to be diligent about monitoring and conducting the necessary stress tests on the portfolio. Like all financial institutions, we are proactively watching these aspects.

I appreciate that. Thank you. The last one for me is you answered the organic $10 billion in asset question. I'd just be curious to get an update regarding M&A, your appetite geographically and in the business model you are particularly interested in, along with thoughts on the pace of those conversations.

Yes. We continue to have active discussions. And this is Chris; it is a significant reason why I joined this team. We are building a solid foundation, focusing on customer satisfaction, which is why we received the J.D. Power recognition. We’re adding processes to enhance our focus on credit quality and safety, as well as investing in talent both internally and externally. All of these factors represent a foundation for growth that we are optimistic about. We find this area of the country attractive. If you put a pin in a map around Pittsburgh, you'll find about 60% of the population of this country nearby, along with plenty of middle-market businesses that fit with our company culture. All these aspects give us optimism for the future; however, our job is to execute every day and every quarter, delivering performance similar to what we did this quarter. This will give us opportunities for inorganic growth, but it is beyond our control when that will happen. We are focused on execution and performance.

And the next question is coming from Matthew Breese from Stephens.

I wanted to go back to the deposit cost discussion, not specifically betas. But have you changed your core rates at all or promotional rates? Are you seeing customers becoming more eager and asking more often for exception-based pricing?

We've mostly lowered ours as far as we could lower them in the second half of last year. So there was not a lot of room. I mentioned the restructuring we did on these floating indexed accounts that only took place in the first quarter resulting in a slight decrease in the overall rate of that book of business. As for exceptions, we are meeting frequently on that, and we’ve had fewer than a handful of outright requests from individuals for rate increases. We do expect that to increase, but for now, it is very light.

I think where we're seeing some of it is with a little municipal business. We see certain cities and municipalities asking for transaction rates. Outside of that, there hasn't been much demand.

On the growth front, it sounds like in the near term, we should expect more consumer-heavy growth compared to commercial. I was curious, beyond just the near term, how much of that change in the mix shift of growth is strategic versus simply taking what the market gives you? Should we expect more consumer-based growth from S&T?

We are fundamentally a commercial bank focused on middle-market commercial and real estate, and we excel at it. We've uncovered latent business within our consumer book, and I'm pleased to see the expansion of customer relationships that do not resemble mere transactional business. We are taking that deposit book and providing more product and service to those customers as needed. Strategically, this was indeed a discovery and we're executing diligently on these opportunities. However, this does not imply a shift away from our commercial business, which remains critically important to us. Our commercial middle market and business banking is paramount. Recently, we've reassessed our credit risk appetite and return expectations in our business, allowing us to make proactive decisions on some transactions that just didn’t meet our hurdles. Our teams are clearly engaged. As Dave mentioned earlier, we produced as much commercial business this quarter as we did last year, but that resulted in a different balance sheet makeup.

Got it. And maybe just to follow up on that, Chris. In the spirit of understanding how you plan to change the direction of S&T, can you share your key priorities since entering the CEO role? What are the top three or four priorities for you over the next 12 to 24 months?

Some of my focus has been on building the team. You may have seen in our last deck just the amount of change at the C-suite and executive levels within the company, and we will continue to enhance our talent there. We are heavily focused on transitioning our Chief Credit Officer role due to an impending retirement. We’re making that transition a priority. We're also focused on all things commercial banking, particularly the loan origination and portfolio management processes. We've initiated a project internally defined as 'Steel Curtain', which aims for optimal execution regarding portfolio and credit risk management while engaging proactively with our customers to improve turnaround times during the credit origination process. That work has gone remarkably well in bringing our teams together. Dave's earlier comments about growth in Eastern Pennsylvania align with our efforts to operate more consistently and effectively across our network. We're actively working to promote foundational elements for efficiency and then think strategically about where growth could come from moving forward. While we are still early in this process, we recognize the importance of taking advantage of these opportunities. We are also enhancing our digital capabilities and effectiveness, particularly in online banking. Getting our name out better in the market is critical. My message to the team has been about maximizing our potential. The J.D. Power award is an excellent illustration; we had nothing to do with selecting the customers or their timing of feedback, yet our customers reported better experiences than those of our competitors. We’ve been somewhat modest, and I believe there is an opportunity for us to exhibit more confidence, particularly in Western Pennsylvania and areas like Pittsburgh where we have excellent name recognition.

And the next question is coming from Daniel Cardenas from Boenning and Scattergood.

A quick question about the securities portfolio, the growth we saw this quarter and expectations for perhaps some additional growth. Does the rising rate environment really impact the timing of growth in the securities portfolio?

The timing for me is more about the loan growth trajectory than rates per se.

Okay. Good. And then any thoughts on moving some of that available-for-sale portfolio into a held-to-maturity component to smooth out the ups and downs of OCI?

No. I mean, we do have a smaller security portfolio, so liquidity is always on our minds. With a small security book, it feels like there’s less room for us to make that move. We do not have plans right now to do anything along those lines.

What's your duration on that portfolio?

That's around 3.5 years, 3.5 to 4.

All right. And then as we look at operating expenses, and thank you for the guidance on that, will the majority of the increases going forward primarily be in compensation line items? Or are there other areas where we could see significant growth as you continue to grow the footprint?

I would expect the highest dollar increase to come from salaries and benefits. However, we also have several initiatives underway that will lead to increases in both equipment and data processing line items. Those will be two or three primary areas where we anticipate expense increases.

Okay. And then last question, just for modeling purposes, how should I think about your tax rate for the remainder of the year?

We're staying right around 19 or so. To the extent that we have better pre-tax results from rate increases and how that materializes, that 19 could fluctuate by 0.25 points or so, depending on the amount of additional pre-tax income. That 19 is a result of a fixed amount of permanent items and tax credits, which won’t change significantly; thus, the rate will vary depending on that. Any additional pre-tax would be taxed at 21%, and that needs to be factored in that way.

Okay. Good. And then any comments from customers regarding inflationary pressures impacting their ability to meet their borrowing obligations?

Yes. I don't believe there has been significant concern expressed about that recently. I've been out in the market quite a bit, Dan. There are ongoing issues regarding supply chains and labor costs, but access to capital has not been prevalent in those conversations. However, I do expect that to become a more significant topic in the coming quarters. It is a reasonable conclusion to ask this question given the current inflationary environment.

Yes. Certainly, in our portfolio, we review our processes with our customers. Those are exactly the questions we're asking: how are you planning for those things? What do you see happening?

How many more rate increases do we need to see before you begin digging deeper into the loan portfolio than you have so far?

Well, we're doing that now. We're looking at all of our deals on the front end and through the portfolio management process, reviewing stress perspectives on EBITDA or NOI in real estate deals quarterly. So we've incorporated that into our processes.

Thank you. And there are no other questions from the queue at this time.

Well, listen, thanks for the great dialogue and your interest in our organization. Again, we're very proud of the performance we delivered this quarter. We're certainly proud of the recognition we received, and we look forward to talking again soon. In the meantime, we'll go back to work. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.