S&T Bancorp Inc Q3 FY2022 Earnings Call

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the S&T Bancorp’s Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After management’s prepared remarks, there will be a question-and-answer session. I would now like to turn the call over to Chief Financial Officer, Mark Kochvar. Please go ahead.

Great. Thank you, and 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 third 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 by also clicking on the Earnings Supplement link on your screen or also on the website under Events and Presentations, Third quarter 2022 Earnings Conference Call, click on the Third Quarter 2022 Earnings Supplement link. With me today are Chris McComish, S&T’s CEO; and Dave Antolik, S&T’s President. I’d now like to turn the call and program over to Chris.

Thanks, Mark, and good afternoon, everyone. We are pleased to be here reporting solid results for the quarter. Before I discuss the numbers and hand it over to Mark and Dave for more details, I want to highlight the progress we continue to make in building this company to benefit our shareholders, customers, and employees. Over the past four or five quarters, we have been on a steady journey with a strategic focus on strengthening the foundation of S&T, which has been built over 120 years and is rooted in distinctive customer trust, all aimed at achieving sustainable, profitable top-tier growth and performance. I am happy to report that we are making significant progress in enhancing our leadership team, combining S&T's legacy knowledge with outside industry expertise, all designed for growth while maintaining safety and soundness in everything we do. Our leadership team recognizes that we are the current stewards of this 120-year legacy of strong customer trust and employee engagement, which, as I noted in our press release, has received awards on both fronts. Our company’s performance will depend on the effectiveness of this leadership going forward. While there’s always work to be done, which we embrace in our energized environment, I am very pleased with the progress we've made and optimistic about our future. Now, let me move on to the numbers. I am on page three of the deck, and you can see that we achieved $37 million in net income, representing a 28% increase in EPS for the quarter, marking records in both areas. Our PPNR is above 2% at 2.15%, and we have solid revenue growth that results in a 50% efficiency ratio. For the fifth consecutive quarter, we have seen meaningful asset quality improvement, and our return metrics have led to another increase in our dividend, the third in the last five quarters, which is now $0.31 per share. Turning to page four, before I pass it to Dave for additional details, you will notice that we are experiencing loan growth in the majority of our portfolios, although there is some contraction due to an asset quality focus. On the deposit side, there is also some contraction on a linked basis due to seasonal factors and the current rate environment. I look forward to your questions, and now I will turn it over to Dave.

Well, thank you, Chris, and thanks, everyone, on the line. We appreciate your interest in our company and participation in the call. As presented on slide four, we realized overall loan growth of nearly 4% for the quarter. By category, we saw increases in all consumer loan types and in our C&I balances. Consumer activities remain robust as we head into Q4 and our pipelines point towards a continuation of this growth. With regard to C&I activity, our aggregate total revolving commitments grew during the quarter, along with the total number of commitments. This growth, coupled with a 1% increase in utilization rates to 44% when compared to Q2 resulted in balanced growth of $20 million. We did experience declines in our CRE and construction portfolios during Q3, and we expect to see continued pressure on the construction portfolio as demand has declined due to increased interest rates, rising construction costs and most particularly availability and cost of labor. In the permanent CRE book, we saw normal course payoffs related to property sales and permanent market financing, along with several exits of negatively rated loans or those in less desirable segments. We continue to closely monitor economic conditions and look for signs of stress and adjust our risk appetite in order to support our desire to improve asset quality. Forecasting loan growth, given the current economic environment is certainly challenging, but we remain comfortable with our low single-digit guidance heading into Q4 and into early 2023. Shifting to deposits, we experienced an overall decline of $202 million in Q3 adding some color to the changes by category. On a point-to-point basis, demand deposit balance declines were primarily the result of activity in a handful of business customers. It’s important to note that we retain these customer relationships and that these changes were a result of their decision to utilize their cash to support business activities. Also important to note is that our average demand deposit balances actually increased in Q3 by $10 million. Additionally, interest-bearing demand, money market and CD changes were the result of market competition for those products and our active management of deposit costs. We remain focused on building upon our 120-year legacy deposit franchise by investing in people and infrastructure. We are proud to announce that in August, we hired a new Director of Treasury Management, who’s focusing on product and sales capabilities in order to support our commercial and business banking relationships. Turning to slide five, we are very pleased with the trajectory of our NPAs as presented. We had minimal charge-offs during Q3. Our ACL increased moderately in recognition of our qualitative analysis and impact of forecasted microeconomic and macroeconomic slowdowns. I will now turn the program over to Mark.

Thanks, Dave. Net interest income rose by $8.6 million, or approximately 11%, in comparison to the second quarter. The net interest margin rate for the third quarter was 4.04%, which is an increase of 48 basis points from the previous quarter. Excluding PPP, this rate improved by 52 basis points. Loan yields increased by 58 basis points, the asset mix enhanced with lower average cash, and the total deposit cost rose by just 18 basis points during the quarter. Interest-bearing deposits went up by 29 basis points. 51% of our loan portfolio is linked to short-term rates, which has significantly driven the improvement in net interest income and margin. As part of our strategy to safeguard interest income and net interest margin in a declining rate environment, we've hedged our floating rate loan concentration to approximately 44% using received fixed swaps. We continue to assess the appropriate level of hedging, depending on the interest rate environment and our deposit pricing experience. Our outlook for net interest income and margin in the coming quarters remains positive due to anticipated short-term rate increases. We expect the net interest margin rate to continue to improve with rising short rates, but this may moderate slightly due to a minor enhancement in asset mix, higher expected deposit betas, and the execution of our hedging strategy. Non-interest income increased by $2.1 million in the third quarter compared to the second quarter, primarily due to a smaller decline in the fair value of assets in a non-qualified benefit plan, which was influenced by stock market performance. This amounted to a negative $0.4 million in the third quarter, down from a negative $1.4 million in the second quarter, resulting in a favorable $1 million variance. This reduction also appeared in salaries and benefits but was neutral to the P&L. Additionally, we saw a gain of $0.6 million from the sale of an OREO property, while mortgage banking remained flat compared to the second quarter since most of our production went to the portfolio. Our quarterly fee outlook stays between $14 million and $15 million. Expenses increased by $1.2 million compared to the second quarter, mainly due to the impact of the non-qualified benefit plan on fee income. Pension expenses also rose from settlement accounting on lump sum payments to retirees. Improved revenue positively affected the efficiency ratios, increasing by over 4.5 percentage points to just above 50%, which also resulted in favorable operating leverage. We expect our quarterly expenses to remain well controlled in the $49 million to $50 million range. We have strong capital levels and are well positioned for the current environment. We executed $3.5 million in buybacks during the third quarter and will continue to explore opportunities based on economic conditions, our financial performance, and stock prices. We have about $29.8 million left in our buyback authorization. Despite a smaller securities portfolio as a percentage of assets, strong earnings, and a more efficient balance sheet, we've maintained stability in our TCE ratio throughout the year, even with higher AOCI adjustments. Thank you. I will now hand the call back to the Operator for instructions on how to ask questions.

Your first question is coming from Daniel Tamayo with Raymond James. Please pose your question. Your line is live.

Good afternoon, guys. Thanks for taking my questions.

Hey, Daniel.

Hi.

Hey. How are you doing? Let me start on the NIM and deposits, we saw a decline, as you mentioned in the quarter. Thanks for the color on the few commercial clients that drove the decline in the demand side. But just curious in your thoughts on how you think deposit betas trend in the fourth quarter and kind of beyond? And then how much impact that could have based on a need to grow deposits or as you kind of continue to creep up in terms of loan to deposit ratio? Thanks.

We believe that deposit betas are likely to rise, particularly with the anticipated activity in the fourth quarter due to additional rate hikes in November and December. This will affect the incremental margin we expect. However, we do not anticipate it continuing at the rate we have observed in the past couple of quarters. Additionally, as you may have noticed, the balance sheet and earning asset mix is evolving. We have seen benefits from reducing cash, which has improved that mix, but there is little left to gain as we transition from the third to the fourth quarter, resulting in just a few more basis points of improvement. We expect any increase to be about half of what we've experienced in recent quarters if the Fed maintains its current pace. We are actively assessing how to strategically position ourselves both competitively and with the balance sheet. Historically, we have operated with lower loan-to-deposit ratios, and we are committed to making permanent changes and investing in our deposit franchise. However, we are also well aware of the balance between that and the necessity of borrowing from the wholesale market if needed.

Okay. Great. And then, I guess, related to the investments that you are making to strengthen the deposit franchise that you called out, but the guidance has really been in a relatively tight range on a quarterly basis. Anything that we should think of in terms of as we go into 2023 from an expense base perspective, how you think about what growth may look like next year given those investments?

Yeah. On the expense side, we would expect expenses to be a little bit higher, both because of those investments and just the inflationary environment is a little tighter. We continue to see a challenged labor market and expect things like merit to be higher. We are also still in the process of planning but would expect to make additional hires to support the deposit franchise, especially on the business side, where we see a lot of opportunities in treasury management.

Yeah. Daniel, this is Chris. I will also mean some additional investments from a technology and digital capability. Dave mentioned the hiring of a top-tier treasury management leader for our company. That will, between working with core providers, other providers continue to enhance service offerings for our customers, be it online additional capabilities, both in the consumer side of our business and certainly in the commercial and the business banking side of the business. So, some continued product capability enhancements, as well as some additions of people.

I appreciate that. Lastly, I have a question regarding asset yields. It seems that commercial real estate yields have significantly increased over the past few quarters. Could you clarify how much of that is floating compared to fixed in that portfolio? Also, is there another reason why those yields have risen so much in such a short time? Thank you.

There are a few factors at play here. Approximately 60% of our portfolio is floating. Many of those have been swapped back to the customer, providing them a fixed payment while remaining floating for us. This means that although you might consider the commercial real estate portfolio as fixed, around 60% is actually floating. Additionally, we've benefitted from received fixed swaps, which have been cash flow positive for us in recent quarters. However, we anticipate a shift where this will become a bit of a challenge in Q4 as short rates increase.

Okay. That’s terrific. Thanks for all the color. That’s all for me.

Thank you.

Your next question is coming from Michael Perito with KBW. Please pose your question. Your line is live.

Hey, guys. Good afternoon.

Hi, Mike.

I was wondering if you could spend a little bit more time, obviously, you guys are adding some to the reserve on a qualitative basis, as you mentioned in the prepared remarks and in the release. But as you guys think about, you talked a little bit about pipeline and the low single-digit growth expectation. But as we think about the mix of that growth and the opportunities you guys have the best appetite for the more comfortable with today. Any expansion you guys can provide on where you think some of the better and higher quality growth opportunities are for you guys over the next three months to six months at this point?

Sure. One of the areas we are focusing on is our business banking segment. We believe there is an opportunity in virtually all of our markets to improve, and we have increased our staff in that segment. We expect the consumer area, where we have seen growth over the past few quarters, to continue to produce positive results. Additionally, we will keep looking for growth within certain segments of the commercial and industrial book. However, as I mentioned earlier, we anticipate experiencing some pressure and challenges in expanding the construction and permanent commercial real estate books.

That’s helpful. Thank you. And then just geographically, I guess, any additional thoughts to add on the kind of the same context of that question?

If you examine our franchise and the legacy growth we've experienced in Pittsburgh, we are definitely focused on maintaining that momentum and expanding in Western Pennsylvania. Eastern Pennsylvania is primarily a commercial real estate market, but we have also established commercial and industrial teams there. We see potential opportunities in that area. Additionally, in both Northeast and Central Ohio, we anticipate further opportunities. We have identified some verticals within the asset-based lending sector and have increased our involvement there, along with a small real estate investment trust portfolio. We aim to enhance our exposure in a way that balances risk with returns, and we believe there will be continued opportunities that support the low-to-mid single-digit growth we have indicated.

Thank you. Lastly, as we consider your expectations for non-interest income in the near term, what opportunities do you see for products and technology within treasury management and business banking that could help grow fee income from business customers? Should we be thinking about areas like swap income, wealth management, or treasury management?

This is Chris, Mike. We see opportunities ahead and are optimistic about our treasury management prospects due to our strong relationships. We believe there are untapped opportunities within our business banking and commercial and industrial sectors. Looking at the wealth management income slide, it has remained stable despite a market downturn of 20% to 25%. This stability indicates that we are acquiring new business and growing assets under management despite the challenges. The external market will still impact us, but our asset bankers are confident that there are valuable alternatives for our customers in this changing environment. Those discussions will be crucial. There is some pressure on the consumer side, and we will continue to focus on deposit optimization, ensuring we offer the right products for our customers. Additionally, we are committed to enhancing the customer experience in relation to our various services.

Yeah.

There is a little balance of both, but big emphasis certainly on the business commercial side in the treasury management space.

That makes sense. Perfect. Thanks. Thank you, guys. Appreciate the color and for taking my questions.

Sure. Thanks. Thank you.

Thanks, Mike.

Your next question is coming from Matthew Breese with Stephens, Inc. Please pose your question. Your line is live.

Good afternoon.

Hi, Matthew.

I wanted to just discuss a little bit more about the NIM outlook. Maybe first, can you give us a sense for what the spot rate of deposits all in were at the end of the quarter or as of today?

So in the last month of the quarter, the overall deposit rates had increased slightly to about 56 basis points. I believe at the end of the quarter we were closer to 43%.

Okay. I mean, to-date, you have done a nice job kind of keeping the composition, non-interest-bearing deposits are 36% of the total CDs continue to come down. Have you adjusted your outlook for deposit betas through cycle at all or can you give us some update there?

I think it’s still evolving. The speed of the Fed is still troublesome and how long the catch-up takes. But we still think we are better positioned overall compared to the last cycle, even though that cycle is very different in terms of how long it took. In that cycle, we have kind of hit the mid-30s with the better composition that you referenced, especially on the DDA side to extend our emphasis on the business side to maintain a lot of that. If we are successful with that, we would still expect our cumulative betas to be mid-20s to low 20s compared to that mid-30s in the last cycle.

Okay. Assuming the Fed is finished by early 2023, how long do you expect it will take for the net interest margin to stop increasing and potentially start to compress, considering the asset-sensitive nature of the balance sheet?

Yeah. I mean, I think there definitely will be some. We do have a fair amount of ARM product that would give us some continued improvement. Those are re-pricing higher and we expect that to continue, but it’s nowhere near the impact that the float has. And on the liability side, there’s very little CDs that will be there to offset that. So it will be how long that pressure from the transactional especially the money market continues. So, I mean, I think it probably continues as long as they are flat. There’s always going to be a little bit of pressure to price higher and depending on the competition, if we get back into a growth mode, us as well as others will be out there chasing deposits again. So I think it depends a little bit on the trajectory of growth post Fed stopping.

Got it. Okay. And then the last one for me. I wanted to discuss the construction portfolio. Can you remind us about the underlying composition of the end projects in the construction book? Many people are beginning to express concerns about residential development due to the rise in mortgage rates from 3% a year ago to nearly 7% today and how that affects the affordability for the end consumer of such projects.

Yeah. So in the commercial construction segment, there’s very limited exposure to residential development. In the largest categories would be multifamily. There’s some warehouse. We also have some wholesale and there’s some other transportation kind of related construction projects.

Okay. And any signs of deterioration within the construction book to-date?

No. No. We monitor it very, very closely. We have a very robust review process that we use, and frankly, that’s why you have seen some of the reduction in the exposure, because we manage it tightly and it’s just really tough to get something approved today to get it built on budget, on time, so this demand has declined and we would expect to see that decline continue.

Some of the decrease is due to projects finishing up or being reassigned, and there isn't much new work coming in as Dave mentioned.

Got it. Okay. I appreciate it. That’s all I had. Thank you.

Your next question is coming from Daniel Cardenas with Janney Montgomery Scott. Please pose your question. Your line is live.

Hey. Good afternoon, guys.

Hi, Dan.

Hi, Dan.

Could you please repeat the line utilization number you mentioned, and also compare it to pre-pandemic levels?

Yeah. It’s about the same level that it was pre-pandemic. It was 44% for Q3, up from 43% in the prior quarter. We troughed in the low 30%s, 32%, 33% during the pandemic, so we are at about the same utilization level that we were pre-pandemic. The one exception to that would be the floor plan portfolio, which has not recovered and it’s half of what it was pre-pandemic.

Okay. Okay. Good. And maybe a little bit of color in terms of paydowns and payoffs. Have they kind of normalized here in the last couple of quarters or are you still seeing some pretty good headwinds?

Yeah. In Q3, as I mentioned, it was a combination of normal course and some payouts that were credit related, and we took the opportunity to exit a few credits that we felt weren’t within our risk appetite from a credit perspective at this point. So I would expect there to be a modest decline in Q4 in terms of payouts. That’s what we forecast.

And then kudos on the reduction in your non-performers, as we look at the commercial ones, so was that primarily one large credit that either returned to performing status or paid down or was that multiple credits?

It was one credit primarily driving that number and it was an exit. It was a real estate entity.

And what are your watch list trends looking like right now as you come into the fourth quarter and are thinking about in 2023, I mean, just given that you bulked up your provision levels and your reserve levels a little bit this quarter?

Yeah. So Q3 there were a fair amount of inflows and outflows that kind of balanced each other. So we are looking again at some additional macroeconomic pressure. That’s driving the additional provision.

And then what’s the M&A environment looking like right now, is it fairly quiet or are you guys seeing a pickup in deal flow?

It’s Chris. I would say it’s been fairly quiet, and quite honestly, we are concentrating on what we can control and are very focused on achieving results and performance while building a foundation for future opportunities.

That’s all I have for right now. I will step back. Thanks, guys.

Thank you.

Thanks, Dan.

Mark Kochvar: Operator, we have received one online question that we would like to address. Operator: Of course. Mark Kochvar: The question is regarding the last time your net interest margin was above 4%, which was in 2010. Are there structural or competitive factors that might prevent the NIM from staying above 4% in a flat to rising rate environment? Or do you believe that net interest margin will eventually return to the pre-pandemic level of 3.60% to 3.70% as funding costs catch up? It's true that the last time we were above 4% was in 2010, making it quite some time since we experienced that low rate environment. We believe that we can maintain a much higher rate, and that 4% is a reasonable target. There are several structural advantages we are currently experiencing, particularly our focus on the deposit franchise, which is helping us retain a higher level of deposits and achieve a better mix. The percentage of demand deposits in the mid-30s, compared to the mid-20s or low 20s before 2010, indicates that if we can keep these levels, we have a better structural opportunity to sustain that 4%. Additionally, maintaining a higher level of deposits while keeping our loan-to-deposit ratio below 100, ideally even lower, should help us avoid relying on more costly wholesale funding as rates increase. This is a primary reason we are so focused on enhancing our deposit franchise, especially as we anticipate a prolonged higher rate environment. That takes care of the question we had anything else that you are seeing? No. There are no additional questions in the queue from the lines at this time. At this time, I would like to turn the floor back over to S&T Bancorp’s CEO, Chris McComish, for any closing remarks.

No. Again, thanks to everybody on the call and for your interest in our company. Obviously, we are very proud of the quarter. I am really proud of this leadership team and our employee base, what we are doing every day to take care of customers and we look forward to being back with you in another quarter, if not between now and then. So thank you all very much.

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.