S&T Bancorp Inc Q4 FY2022 Earnings Call

Welcome to the S&T Bancorp's Fourth Quarter Earnings Conference Call. After management's remarks, there will be a question-and-answer session. Now, I would turn the call over to Chief Financial Officer, Mark Kochvar. Please go ahead.

Thank you, and good afternoon, everyone. And thank you for participating in today's conference call. You can follow along with the slide portion of the presentation by clicking on the page advance button at the bottom of your screen. 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 Page 2. This statement provides the cautionary language required by the Securities and Exchange Commission for forward-looking statements that may be included in this presentation. A copy of the fourth quarter 2022 earnings release as well as this earnings supplement slide deck can be obtained by clicking on the earnings materials button in the lower right button of your screen. This should open up a panel on the right where you can download these items. You can also obtain a copy of these materials by visiting our Investor Relations Web site at stbancorp. 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 over to Chris.

Good afternoon, everybody. And Mark, thanks for the introduction. Welcome everyone to the call. I certainly appreciate the analysts being here with us this afternoon, and we absolutely look forward to your questions. I also want to take a moment to thank our employees, shareholders, and others listening in on the call; your commitment and engagement is what drives these financial results, and these results are yours, and you should be very proud. 2022 was a historic year for S&T and in many ways was an inflection point for the company, both strategically and historically. We started the year by celebrating our 120th anniversary, which provided a great opportunity to not only celebrate our past but to think strategically about our future. During the year, we made significant enhancements and additions to our leadership team, all focused on building for the future while ensuring we delivered performance today. Our leadership team took this opportunity to also engage with all of our teammates to define our purpose for the next 120 years, all around building a future that's people-focused, a people-forward future. This purpose supported our values and provided the roadmap and blueprint for our growth and our impact and differentiation as we move forward in the market. While building for tomorrow, we certainly stayed focused on today as evidenced not only by the numbers we'll talk about in a few minutes but also by the achievement we had in the marketplace around things critically important to us around employee engagement and customer experience. We have multiple instances of market-leading recognition from third parties, and we are quite proud of these results also. We define them as our trophies, and there are many of them. We look forward to continuing success there as it's so foundational for everything that we're trying to do financially. In addition, we delivered a 13% shareholder return on our stock, which significantly outpaced our peer median. This return was aided over the past year by three separate dividend increases, equaling more than 10% growth in our dividend to the current $0.32 level that we announced yesterday. Now let me turn to Page 3 and give you a talk a little bit about the quarter as well as the year, and then I'm going to turn it over to Dave to talk about the balance sheet. But as you can see on Page 3, we had record earnings of $1.03, that's an 8% increase quarter over quarter, driven by a 29 basis point increase in our NIM, achieving 4.33%, obviously, aided by the higher interest rates as well as our asset-sensitive nature of our balance sheet. The return metrics were extremely strong with a $20.36 ROTE and a PPNR of $2.36, numbers that we feel very good about. What's not on here we will talk about later is also an efficiency ratio of 49% for the quarter. This efficiency ratio is important to us. While you'll see some expense growth, that expense growth is all around investing for the future, and having a starting point at an efficiency ratio like that gives us the flexibility needed to make the investments and move our company forward. Moving to Page 4. Again, a record year $3.46 earnings per share and $136 million of net income, approximately $25 million more than a year ago at this time. Again, very solid return metrics aided, obviously, and driven by NIM expansion, while at the same time continuing to see improved credit costs. We'll talk about those in a few minutes. Again, it's been a heck of a year from a performance standpoint. We feel very good about the opportunities as we head into 2023, not only on the strength of our financial performance but as I said, the engagement level of our team, the clarity of how we're moving forward together, and the opportunities in the marketplace. With that, I'll turn it over to Dave.

Well, thank you, Chris, and good afternoon, everyone. And thank you again for your support of our company and interest in our company. If I can direct you to Slide 5, which depicts balance sheet changes for the quarter. Total portfolio loans increased by $87 million or 4.9% annually, driven primarily by consumer activity. We continue to book residential mortgage production to our balance sheet versus selling, which has supported the majority of this growth. We also continue to experience growth in our home equity balances. In the home equity space, we have seen consistent growth through the year to continue into Q4. This includes increases in the number of customer commitments, total commitments, and outstandings. We've seen very consistent utilization from this customer base at 47%. Growing the home equity customer segment is incredibly important to us as it represents the manifestation of our focus on customer relationship banking and is clearly focused on growing the value of our deposit franchise. Moving forward, our pipelines indicate the ability to maintain home equity growth with some moderate pressure on our residential mortgage activity. Turning to the commercial book, total balances increased slightly in our C&I and commercial real estate construction categories. We've seen commercial revolving utilization rates stabilize at 46%. Calling activities in both CRE and C&I spaces have increased during Q4, and we anticipate growth to remain stable for the first half of '23 in the low to mid-single digit area. Our commercial banking efforts are focused on growing with and supporting our existing customer base and continuing to improve and develop more consistent asset quality results, particularly given the current economic pressures that exist. Deposits for the quarter were down $191 million as we continue to experience runoff due primarily to competitive rate environments. We are focused on building upon our strong legacy as a consumer relationship-driven bank, and recently, we hired a consumer deposit product manager to help lead our strategy and go-to-market efforts. Turning to Page 6. We are very happy with the progress being made in reducing our NPLs, both in Q4 and for the full year. The graph at the bottom of the page illustrates the outcomes of our efforts in support of our desire to reduce problem assets. We're also very pleased that much of this reduction came via the execution of individual customer exit strategies and not as a result of excessive charges. We continue to closely monitor all of our portfolios for potential economic impact that could result in future credit losses and added to the qualitative segment of our reserve during the quarter. We feel that our level of reserve supports our business strategy and positions us well to manage through any potential downturn. I'll now turn the program over to Mark.

Well, thanks, Dave. Slide 7 shows that net interest income increased by $5.3 million or 6.3% compared to the third quarter. The net interest margin rate in the fourth quarter was 4.33%, that's up 29 basis points from the third quarter and is up 130 basis points ex PPP compared to the fourth quarter of '21 before this rate cycle began. Loan yields improved this quarter by 69 basis points, and the cost of total deposits, including DDA, increased by 33 basis points to 60 basis points. Interest-bearing deposits increased by 50 basis points compared to the last quarter. We have seen increased interest in short-term CPEs, especially in the one to two year area. Half of our loan portfolio is either short-term rates, which continues to be a big driver of the net interest income and net interest margin improvement. As part of our ALCO strategy to protect the net interest income and margin in a declining rate environment, we have hedged that floating rate loan concentration to approximately 42%, which receive fixed swaps. We continue to evaluate the right level of hedging, which will depend on the rate environment and our deposit pricing experience. Our funding base is very different now than it was during the last rate up cycle, with a much better mix, including over $1 billion more in DDA, a money market product that no longer reprices immediately with Fed rate changes and lower wholesale borrowing levels. We do expect that net interest margin improvement to moderate in the first half of '23 as deposit betas catch up and the Fed increase has slowed down. And then with the Fed pause, we would expect some NIM compression in the back half of '23. However, based on the better funding mix I described earlier, we expect to see lower through-the-cycle deposit betas compared to the prior and most importantly, for us, better net interest margin betas. On Slide 8, noninterest income increased by about $883,000 in the fourth quarter compared to the third. The largest item is a gain on the sale of an OREO property for $2 million, which shows up in the other line. We also had an OREO gain in the third quarter of about $0.6 million, as we have had some success in resolving some credit issues. So net, that accounts for most of the favorable variance in fees. Mortgage banking was essentially flat compared to the third quarter. As Dave mentioned, almost all of our production went to the portfolio and contributed to the loan growth we had in that category. Our quarterly fee outlook is approximately $14 million. On Page 9, expenses were up $1.7 million compared to the third quarter. Salary and benefits increased primarily due to higher incentives of about $1 million related to our performance. Also, within salaries and benefits, pension expense was higher by $0.6 million due to settlement accounting from lump sum payments for some retirees. Improved revenue drove the efficiency ratio to below 50%. Our quarterly expense expectations going into '23 are in the $52 million to $53 million range as we invest in people and infrastructure. Page 10 shows our capital levels, which are strong and well positioned for the environment. We extended our buyback authorization through March of 2024 and that had $29.8 million remaining. We'll continue to look for opportunities depending on economic conditions, our financial performance, and the price of our stock. With the smaller securities portfolio as a percent of assets, strong earnings, and a more efficient balance sheet, we have seen stability in our TCE ratio over the course of the year despite AOCI adjustments. Thanks very much. At this time, I'd like to turn the call over to the operator to provide instructions for asking questions.

Your first question will come from the line of Daniel DeMille with Raymond James.

Just wanted to start, just a clarification on the NIM path and then deposit beta assumptions you mentioned, still expecting lower than prior cycle. I think last quarter, you talked about a mid to high 20s. Is that still the thought there?

Yes.

And then another just clarification on the noninterest expense and income guidance, the $14 million and then the $52 million to $53 million. Is that to be taken as kind of first quarter guidance to build off of, or is that more of a range that you're looking at for the year?

More the latter, range for the year.

There hasn't been much growth throughout the year. Can we discuss margins? I'm curious about when you expect the margin to peak. You mentioned some pressure in the latter half of the year, but are you anticipating the peak to occur in the first or second quarter, and what level do you expect it to reach? Additionally, what degree of compression are you anticipating in your budget?

There are many assumptions and models at play. However, based on our analysis and the Federal Reserve's expectations for possibly one or two small rate hikes in the first quarter or early second quarter, we anticipate a slight increase in margins during the first half of the year, peaking around the second quarter. After that, with the Fed potentially stepping back, we foresee some ongoing pressure, which could be mitigated by a better replacement rate for loan maturities. Additionally, growth on the liability side may help counterbalance some of our higher-cost borrowings. Overall, we expect a compression of roughly 5 basis points per quarter if our assumptions hold true.

So maybe a little bit lower than we are here at the fourth quarter level or 33% by the fourth quarter of 2023?

Kind of about in the same place approximately by the time we get to the end of the year.

It's just going to rise from here early and then in the fall...

Your next question will come from the line of Michael Perito with KBW.

Chris, I wanted to start, you know, really productive year kind of about the help for you guys, and that's got a lot done. Curious what's the agenda look like for '23 here? I mean, obviously, the macro backdrop is uncertain, but we always charge on anyway. Curious where you guys are focused and just what we should be mindful of as the year progresses just from a strategic standpoint?

Thank you for your question. I could elaborate on this for quite some time because it's related to the collaborative efforts of our team over the past year. We capitalized on our 120th anniversary, which highlighted the unique aspects of this company that initially attracted me here 18 months ago. This journey begins with employee engagement and customer experience, as well as our reputation in the market, providing a solid foundation for growth. We've dedicated considerable time to reflecting on our origins and current state, emphasizing our people and relationships, with a focus on being people-oriented. While the industry evolves and customer needs change, especially in digital spaces, the emotional connection individuals have with their banks remains crucial. We have identified and streamlined our identity and how we plan to stand out in the market by clearly defining what success looks like for us. Our deposit franchise is robust, and it was a topic of discussion even before the recent interest rate hikes. We've been strengthening our teams and talent, recently bringing in a Head of Commercial Deposits from a major national bank, as well as a Head of Consumer Deposits from another large institution, both eager to contribute to our future. Understanding opportunities within our current and potential customer base is a priority. We are enhancing our product capabilities, particularly in treasury management and digital banking, ensuring we offer the right solutions to our clients. Additionally, we are aligning our incentive plans to support the importance of our deposit franchise, as it shapes how customers perceive their bank. Our focus on this area has intensified compared to the past at S&T. While we will continue to prioritize loan growth, we recognize that a healthy deposit franchise enables us to effectively deploy capital in the market. Our credit quality has improved, reflecting our strategic efforts as noted by Dave, as we define our areas of focus and approach our goals. Although we take pride in our net interest margin, we understand that compromising credit quality is not the path forward. We are also committed to maintaining our efficiency ratio and profitability while recognizing the need for prudent investments. Ultimately, everything rests on the engagement and talent of our 1,100 employees, and these pillars are where we are concentrating our efforts and discussions.

I have a couple of financial questions. Mark, regarding the efficiency ratio being below 50%, I asked a similar question to another bank this morning. As we invest in technology and work towards greater efficiency, it seems like having a low efficiency ratio is becoming standard. I'm curious about your perspective on this. It appears to be quite low given the current net interest margin compared to its historical peaks. Are you optimistic that this level of efficiency will be appropriate as we move forward?

I mean, we think it is sustainable. Part of that, though, is we're much more focused on maintaining the margin stability, and that's going to be the key to maintaining that type of efficiency ratio.

And then just on fees, I think it was $14 million of the quarterly outlook. Is that correct?

Yes.

There wasn't much growth on a core basis this quarter. Can you break that down further? Is that based on a stable mortgage environment and a stable investment environment despite market volatility? Are there any areas where you might be too conservative as you think about next year?

I mean, the one thing that could potentially change is on the mortgage side, if we were to see the kind of pricing, and just the way Fannie’s pricing relative to what we think is a fair value for their mortgage production that we could see some additional sales in the secondary market on the mortgage side. Right now, that $14 million assumes a pretty low level of sales. So we're kind of assuming that that market looks the same. So that could change that number, but it would have an impact on the potential on the balance sheet growth as well, especially kind of in the first half. Wealth does not assume a big increase in the stock market, which would help us out as well. If AUM sort of naturally grew just because the market is up, that would be beneficial for us as well. We do see some pressure that we need to overcome on the overdraft side, as we look at that product and how it's positioned for the year. So those are the things that I can think of that would...

And then I would say on the commercial side, the treasury management business, I mean it's a growth focus for us, and we're going to be intensely focused on that as we move forward. The counter, the offset to that is the earnings credit rate in environment. And then as the earnings credit rates increase through the year, there's an offset some of that on your service charge. So we're trying to measure it in absolute terms of growth and not so much look at the net relative to the earnings credit.

Just kind of, Mike, on a year-over-year basis, we had about $3 million worth of OREO gains this year. We don't expect that to repeat itself next year.

The one area where we do have opportunities within our business banking segment, where we have not actively sold treasury products. We have a dedicated group who's focusing on mining that customer segment in order to drive product into that customer and provide a service that they desperately need. So design the product, supporting it with the people, and we believe is going to drive some better treasury management results.

Your next question will come from the line of Matthew Breese with Stephens.

I wanted to focus on the noninterest-bearing deposit line item. Your deposit beta cycle so far and your ability to manage the mix of deposits has been better than I expected at this stage, especially considering some of the fourth-quarter results. Could you provide more insight into the noninterest-bearing deposit category? Specifically, how much of it is from retail versus business, how has account growth been compared to balanced growth, and what are the structural factors that might sustain this or where might it trend in the future?

The consumer business is roughly split 60-40, with significant growth observed in the business segment over the past several years. We are focusing more on the business side because we believe it holds substantial opportunity. Compared to other banks with similar loan distributions that lean heavily on commercial loans, we see even larger potential in that area. As Dave and Chris mentioned, we are concentrating on treasury management for both commercial accounts and small businesses. Although we might experience some decline in existing customer relationships, we see considerable opportunity with customers who hold loans with us but have not actively engaged in establishing deposit relationships. We believe there is significant potential for growth in that area.

And do you have the cost of all-in deposits at quarter end just for frame of reference, what we're dealing with going into the first quarter?

At quarter end, I don't have. For the full quarter, it was 60 basis points all in. I don't have the right in front of me for the quarter end.

Last one for me, just thoughts around the projected outlook and then the $10 billion threshold, timing on crossing $10 billion, potential expenses from crossing, and then the updated loss driven amount?

I'll let Mark address the timing. However, I want to highlight that I've been concentrating on this for the past 18 months since I've joined. The level of talent we have enhanced in our organization and the new talent we have recruited are all in preparation for this development. A significant portion of the current personnel-related expenses is already included in our current run rate because we are preparing for the future and laying the groundwork for this process. Even when we surpass the $10 billion mark, we will still need time to adapt. This is crucial for us, as whether we reach $10 billion or $15 billion, our focus is on establishing a solid foundation for growth. We want to ensure that our growth is not only focused on increasing revenue but also compliant with regulations.

From a timing perspective, we're currently around $9 billion with mid-single-digit or slightly higher loan growth. We're likely a couple of years away from organically crossing the $10 billion mark. Regarding the Durbin amendment, last time we checked, it accounted for about half of our debit card transactions, which translates to roughly $7 million on an annual basis.

From a timing perspective, we're currently just around $9 billion based on mid-single-digit or slightly higher loan growth. We anticipate being a couple of years away from organically crossing the $10 billion mark. Regarding the Durbin amendment, the last time we examined it, it accounted for about half of our debit card transactions, which translates to approximately $7 million on a full-year basis.

Operator, we did have one question in the queue; it was regarding outlook for loan growth for 2023. And the simple answer is, mid-single-digit loan growth. If you look at kind of what I described in my prepared comments regarding consumer activity, as I said, we continue to expect that to perform as it has. And on the commercial side, kind of back half of the year, focused growth, and we do understand, and as Mark and Chris described, we expect the NIM expansion to temper and stop at some point. So we do understand that growth in terms of revenue will have to be driven by some asset growth. And we're building the teams out. We have the infrastructure in place to do that, and we're very comfortable executing on that strategy.

Our next question comes from the line of Daniel Cardenas with Janney Montgomery Scott.

Could you provide some details on a monthly basis regarding the loan yields for the fourth quarter? Additionally, what are the current production yields and what yields are rolling off?

In total for Q4, our new loan yields were in the 6.25% range, compared to the roll off, both payments and payoffs at about 5.60%. This resulted in an improvement of around 60 to 65 basis points.

And what were paydowns and payoffs like this quarter?

They were, I mean, in line. We didn't see heavy path by any stretch. So they were kind of more normal of what we'd expect both on the consumer and the commercial side.

And then maybe for Chris, thoughts on M&A, what's the environment looking like right now for you guys?

My primary focus since joining the company has been to prepare for growth and establish a solid foundation for it. We have significantly more control over organic growth compared to inorganic growth. However, we believe our financial results indicate that we should engage in future consolidations. The timing and method of this will unfold in the future, but it remains a key area of focus as we prepare.

As we establish our foundation, what size of institution are you most interested in?

Some of it relates to size or makeup, which is probably a better response. We discuss the health of our deposit franchise and its significance as a foundation for our growth. The regions we operate in and the nearby markets have a strong cultural appeal to us. We don't envision pursuing opportunities in the billion dollar and below range, as that would require a lot of effort for minimal return. However, it's important to note that this process is largely event-driven. Therefore, it involves building relationships and ensuring that there is both a suitable strategic and cultural alignment, while also recognizing the potential financial opportunity for growth.

And last question for me then. How should we be thinking about deposit growth in 2023 for you guys?

I mean our expectations for growth are pretty modest on the deposit side. I think we're going to be focusing a lot on mix and developing the relationships that Dave and Chris were talking about. So we would expect, especially on the business side, a decent improvement in the DDA quality. We might not see the largest increase in the balances, but the quality of that DDA should be better, but a lot of shifting. We would expect to see some higher CD balances by the end of the year, but some of that's going to come just from migration from other areas of the bank. So net-net, we're not looking for huge deposit increases. We'd consider that successful given the rate pressure that we expect.

We're very focused on the quality of the franchise and the mix and how it relates to customer relationships.

Your next question will come from the line of Manuel Navas with D.A. Davidson.

Can you add a little bit more color around how you're thinking about protecting the margin? You said you brought down the floating rate to like 42%. In general, like where could that go, is it kind of opportunistic, and what level are you trying to protect?

We are focusing on two aspects of protection. The first is related to potential interest rate decreases if the Fed changes its stance. Our hedging strategy is primarily designed to safeguard against this. We have established internal thresholds for analysis and are working to limit any decline in net income to an acceptable percentage. This additional hedging, along with the structure of our deposit portfolio and borrowings, contributes to our strategy. Presently, we are borrowing a bit on the short end, which also offers some protection against falling rates. If rates decrease due to the Fed’s actions, we anticipate a greater level of compression compared to a scenario where rates remain stable. Our goal is to mitigate this impact. On the maintenance side, we are focused on enhancing our deposit franchise quality to attract customers who are less sensitive to interest rates and not as reliant on top market rates, which can be volatile. We aim to improve the quality of our deposit base throughout the year, which we believe will help reduce any margin compression we might experience.

I'd now like to turn the call over to Chief Executive Officer, Christopher McComish, for closing remarks.

Okay. Well, thanks to all of the analysts on the call and your engagement and your questions. We greatly appreciate your interest in the company, and you help make us better, and we thank you for that. So we're off into the new year. And again, we're very proud of 2022, and we're moving forward into 2023. So thanks. Look forward to talking to you again soon.

That does conclude today's meeting. Thank you all for joining. You may now disconnect.