S&T Bancorp Inc Q1 FY2023 Earnings Call

Welcome to the S&T Bancorp First Quarter 2023 Conference Call. After the management remarks, there will be a question-and-answer session. Now I’d like to turn the call over to Chief Financial Officer, Mark Kochvar. Please go ahead, sir.

All right. Thank you. Good afternoon 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 Advanced button on the 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 two. 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 first quarter 2023 earnings release, as well as this earnings supplement slide deck can be obtained by clicking on the Materials button in the lower right section of your screen. This should open 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 website at stbancorp.com. With me today are Chris McComish, S&T’s CEO; and Dave Antolik, S&T’s President. I’d like to now turn the call over to Chris.

Thank you, Mark, and good afternoon, everyone. I will start my comments on page three. I appreciate you all joining us today and thank the analysts for their presence. We will be addressing more information than usual this quarter due to significant industry developments since early to mid-March. Our goal is to enhance clarity and transparency regarding our financial performance, especially concerning our deposit franchise and commercial real estate exposure. This quarter has been very active for S&T, particularly following events since March 10th. Additionally, our leadership team engaged with our employees extensively at the end of February and early March to refine our vision for S&T’s future performance. We spent the last year and a half clarifying our values and defining how we operate, which centers around a shared future with our employees, customers, communities, and shareholders. This shared future includes a focus on our financial health across four main areas: the strength of our deposit franchise, asset quality, improving our core profitability, and ensuring employee talent and engagement. We emphasized communication around these principles, spending 12 days connecting face-to-face with all 1,200 employees in various sessions. This interaction came at a crucial time, coinciding with the challenging events starting March 10th, and helped reinforce our commitment to customer focus, confidence, stability, and soundness. As leaders, we feel it is vital to not only guide employees in actions but also in understanding the rationale behind them. The past four weeks have provided a compelling reason for our emphasis on the deposit franchise and other performance drivers. Turning to page three, you’ll see a summary that Mark and Dave will elaborate on. For the quarter, our earnings were $1.02, marking the second consecutive quarter with earnings exceeding $1, resulting in net income just below $40 million. Our return metrics are strong, with an ROTCE of 19.61% and a PPNR of 2.23%. We maintained controlled expenses with an efficiency ratio around 50%. The net interest margin decreased by 1 basis point to 4.32%, benefiting from a net recovery leading to a 29 basis point recovery that we’ll discuss further. On page four, we noted loan growth of nearly 4% this quarter, largely driven by over $65 million in consumer loan growth. We are optimistic about our commercial business pipelines, which are at their highest in months, reflecting our growth focus and talent attraction. On the deposits side, we ended with approximately $7.2 billion, experiencing a $67 million decrease for the quarter, primarily early on in January, followed by growth as the quarter progressed. This trend is important given the external environment, and page five provides insights on the deposit side of our balance sheet. Our deposit base is well-diversified across nearly 230,000 customers, with a mix of 60-40 between personal and business deposits. The uninsured deposits include over $300 million in collateralized municipal deposits. The green line on the trend chart indicates growth following the early March events. I’d like to recognize our teams for their excellent work starting on that early Monday with proactive outreach and support for customers, helping them navigate the marketplace and understand our institution's stability and available options. We remain committed to this effort daily and are proud of the growth since March 10th. I will now hand it over to Mark for further details.

Thank you, Chris. Slide six highlights that net interest income decreased by $267,000 compared to the fourth quarter, even with two fewer days affecting revenue by over $1.5 million. The net interest margin rate remained steady at 4.32% compared to the fourth quarter. This quarter, loan yields saw an improvement of 43 basis points, and total deposits, including DDA, rose by 25 basis points to 0.85%. Interest-bearing deposits increased by 37 basis points from the previous quarter, while the cost of liabilities rose by 59 basis points due to a decline in deposits and an increase in loans, which led to some additional borrowings. Approximately half of our loan portfolio is linked to short-term rates, significantly contributing to the improvement in net interest income and margin over the past year. We've observed a shift in customer preference toward fixed rates this year due to the inverted curve, which has added pressure on new loan yields. To safeguard net interest income and margin against potential Fed rate cuts, we have hedged our floating rate loan concentration with $500 million of receive-fixed swaps. We are continually assessing the appropriate level of hedging based on the rate environment and its effects on the interest rate sensitivity of deposits and loans. Most of the pressure on net interest margin this quarter arose from the liability side. Similar to the rest of the industry, we encountered a significant level of customer interest in seeking higher rates than we had anticipated. We believe we have reached peak net interest margin sooner than expected. As illustrated in the chart on the bottom left, the net interest margin rate for March was lower than that of the entire quarter. We anticipate some stabilization of the net interest margin soon, as April will reflect the delayed repricing of our $425 million HELOC portfolio. There is a chance of additional Fed rate hikes in May, and we have noticed some easing in changes to deposit mix and net deposit outflows. We foresee a compression in net interest margin of about 5 to 10 basis points per quarter over the next few quarters. Next, on slide seven, we will provide a little more detail on the first quarter deposit changes. The top graph shows the quarterly point of point changes by deposit types. The bottom graph shows the migration or how much it moved from one type to another during the quarter. This is aggregated at the customer level. So for example, overall, we saw DDA decline $120 million. That’s on the top graph. Of that decline, $88 million is from customers moving funds from DDA to other deposit types within the bank. That’s the bottom graph. The difference between the two, the $32 million is the net decrease from closed and new DDA accounts, and the net DDA inflows and outflows to and from the bank. Now within that DDA, $23 million of the $88 million DDA migration went to NOW, which is how we classify the IntraFi product, which is what provides the additional FDIC insurance coverage for our customers. Separately, on CDs, we were up $240 million total bank. That’s the top graph, $153 million of which came from other deposit types that’s the bottom graph. Here, the $88 million CD difference is the net addition of new funds from both new and existing customers. Our liquidity, first and foremost, relies on a well-diversified deposit base. If you turn to slide eight, you can see that to supplement that, we have access to funding the Federal Home Loan Bank of Pittsburgh and at the Federal Reserve. The Federal Reserve capacity is split between loans already pledged through the Borrower-In-Custody program or BIC, labeled here as Federal Reserve window and the newly implemented BTLF funding facilities that accept bonds as collateral at par. Between these two programs from the Federal Reserve, we have approximately $1.5 billion of funding capacity, of which we are using none. Including the FHLB availability, we have more than enough capacity to cover our uninsured deposits. Next, Dave will provide some additional details on asset quality.

Thank you, Mark, and good afternoon, everyone. Please look at slide nine for our asset quality results for the quarter. On the right side of the page, we reported a net recovery of $5.1 million during Q1. This result was primarily influenced by a $9.3 million recovery related to a customer fraud loss we encountered in 2020. However, we also had total charges of $4.5 million for the quarter, which included a $3.4 million charge from a successful strategic note sale. Non-performing loans rose by $5.6 million, mainly due to one commercial and industrial relationship that shifted during the quarter, leading us to establish a $4.2 million specific reserve for this account. On the left side, you will find a detailed bridge of the allowance for credit losses from Q4 to Q1. We increased the overall reserve due to the specific reserve I mentioned, along with growth and changes in risk ratings that affected the quantitative component and a $1.85 million increase in the qualitative segment of the reserve reflecting macroeconomic uncertainty. As a result, our total allowance grew from 1.41% of total loans to 1.49%. Moving to page 10, we remain focused on our commercial real estate exposures. We provided an analysis of our CRE as a percentage of total loans, along with its sub-segments and our office exposure. This is a highly diversified portfolio with an average loan size of $1.1 million. Additionally, the average loan-to-value ratio is 63%, and the portfolio has modest maturities over the next eight quarters, which positions it well in the current climate. We also analyzed our office portfolio to separate central business district exposure from non-central business district exposure. Notably, 83% of our office exposure is non-CBD, reflecting our strategy to keep this risk finely tuned. Importantly, only one of our four largest office exposures matures within the next 24 months, specifically in Q4 of 2024. As part of our portfolio management practices, we consistently stress test each property to account for stressed net operating income assumptions and the current rate environment, allowing us to identify potential future issues. On page 11, we present the entire CRE portfolio, showcasing a very granular structure with an average size of $1.7 million and about 15% maturing in the next 24 months. The higher level of maturities in the healthcare and hotel segments stem from our strategic management of these relationships, aiming to maintain tighter terms due to their greater pandemic impact. We actively monitor our concentration limits and adjust them based on stress test results and updates to our credit risk appetite. Regarding our construction loan balances, we anticipate a natural decline as projects are completed and replacement rates decrease. Current economic conditions have made it difficult to underwrite new deals, and we have maintained strict standards, paying close attention to reserves and contingencies. We recently reviewed our largest construction loans, which revealed that these projects are, on average, approximately 75% complete, and most material and labor availability issues are behind us. I will now hand it back to Mark to discuss some non-interest income matters.

Right. Thanks, Dave. On slide 12, non-interest income decreased by $2.4 million in the first quarter compared to the fourth. This primarily related to a gain on the sale of an OREO property for $2 million in the fourth quarter. That shows up in the other line item. Mortgage banking was essentially flat compared to the fourth quarter as almost all of our production continues to go to the portfolio contributing to the loan growth that we had in that category. Our quarter fee outlook is in the $13.5 million to $14 million range. On slide 13, expenses were well controlled up just $424,000 compared to the fourth quarter, the largest variance being the FDIC assessment, which increased across the board by 2 basis points and marketing, which is related to some seasonal promotional activity. Efficiency ratio is just over 50% and our quarterly expense expectations remain in the $52 million to $53 million range as we invest in people and infrastructure. Slide 14 has some additional detail on our securities portfolio, which runs only about 11% of total assets. We favor well-structured products as evidenced by mix by the mix and the nominal extension of duration we have seen over the past year. All of our securities are classified as available for sale. So the $69.4 million securities related AOCI covers the entire portfolio and is very manageable given our strong earnings and capital levels. Those capital levels can be seen on slide 15. TCE improved due to the quarterly earnings and lower term rates, which decreased the AOCI compared to the fourth quarter. Our regulatory capital ratios are strong and well positioned for the environment with ample excess capital levels. Our buyback authorization has $29.8 million remaining and we will look for opportunities, depending on economic conditions, our financial performance and outlook and the price of our stock. 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.

Thank you. We will take our first question from Daniel Tamayo with Raymond James. Your line is open.

Hey. Thanks. Good afternoon, everyone.

Hi, Daniel.

Hi, Daniel.

Maybe we can start with the balance sheet. The deposit to loan ratio is just over 100%. I know you've seen similar situations before, but deposits have decreased over the last five quarters, and things are becoming more challenging. How are you planning to grow deposits, which areas do you identify for potential growth, and where do you anticipate loan growth in relation to the funding side?

Hi, Dan. This is Mark. I will start off on the deposit side. Just recently, just in the last month or so and especially since some of the bank failures, we actually have seen a firming in the deposit levels, some of the runoff that we experienced during 2022 seems to have slowed. So we think we are near the bottom there. The level of exception requests has declined here in April. So we are encouraged by that. Category-wise, we would expect the migration to continue. So we would expect to see additional movement from some of the core deposit categories into CDs. But we expect that the overall level of deposits would start to turn around and possibly trend a little bit higher. We are not expecting huge growth, but that we would be near at least the bottom here. I will turn it over to Dave to talk about loan growth expectations.

Thanks, Mark. For loan growth in Q1, I anticipate similar growth in Q2 and Q3 considering the current micro and macroeconomic conditions I've mentioned. We face some challenges in achieving deal sizes, particularly as we are focused on commercial real estate, which is where we feel secure. That being said, we've brought on several bankers to help increase our pipeline, and we're making significant strides in our business banking sector as well, aimed at keeping things manageable. So, the low-to-mid single-digit growth rate I mentioned last quarter should hold steady for the rest of the year.

Daniel, in addition to our bankers, we are enhancing our leadership within our treasury management business for both our core commercial sector and our business banking and branch-based customers. There is significant demand for treasury management services, and we are experiencing considerable activity due to our increased focus, which is closely linked to the strength of our deposit franchise. This will remain a crucial area of work for us that we will continue to prioritize.

Okay. Terrific. Thanks for all that color. And I will let someone else tackle the margin question, maybe just a clarifying question on fee income. I was expecting the second quarter outlook to be a little bit lower from the removal of the NSF fees. Can you just remind us what that impact will be and when that will be felt?

So the annual number is about $1 million. So just that for the quarter would be about $250,000.

Okay. And that will be fully felt in the second quarter?

The changes were implemented at the beginning of April.

Terrific. All right. I will step back. Thanks for the questions and answers.

Sure.

Thank you.

Next we will go to Michael Perito with KBW. Your line is open.

Hey, guys. Thanks for taking the questions.

Hi, Mike.

Hi, Mike.

It was an extraordinary month. Generally speaking, you didn't see a lot of impact on daily operations despite feeling some alarm. However, there are developments related to CD growth and the remix, and I'm curious about how sustainable that will be as a new norm. Is CD growth still making up the majority at the beginning of the second quarter? If the credit environment remains uncertain and the additional funding is primarily high-cost CDs, could that potentially affect your appetite for loan growth?

I will discuss the deposit aspect first. So far, the migration within our portfolio has not slowed down; we continue to see movement towards CDs. There has been some migration on the business side from DDA to the FDIC protected product, but this has minimal impact on our margins and typically results in either no or only a slight increase in funding costs. Now, regarding the loan side...

Yeah. I think that we should have sufficient funding and liquidity in order to do what we are projecting to do in terms of low-to-mid single-digit growth. Our emphasis on having the bankers focus on the entire relationship, the investments we are making in treasury management to make sure that we can capture those and safeguard those deposits and allow those customers to manage those deposits and deploy them as efficiently as they can, will help us. If you think about the last 10 years as a commercial banker, it’s been growth focused on the asset side of the balance sheet and making a switch to focusing on deposit gathering and maintaining the relationship and building that relationship is really the opportunity that we have right now. And as Chris said, we are investing in that, and we continue to see positive results there.

We have observed some changes from the fourth quarter to the first quarter. There was a notable increase in the borrowing portfolio, particularly on an average basis, which significantly affected the margin, contributing approximately 19 basis points. This has stabilized as we enter the second quarter. Currently, we are maintaining about $450 million to $500 million in borrowing, which has remained relatively stable over the past month and a half. Therefore, we do not anticipate the same impact from changes as we progress into the second quarter, assuming some deposit rates remain steady. We may face increased costs on the shifting side within the deposit portfolio, but the impact from the transition from deposits to borrowings will be less significant.

Yeah. And Mike, this is Chris. The only other thing I will add is a lot of this growth in CDs is built on our strategy and philosophy is taking care of our customers. So this is very much proactive engagement with our customer base who are looking for options and we are proactively making sure that we are doing everything we can to protect those relationships and grow them and that’s the source of some of the growth that’s potentially dollars coming from other institutions. We are not out in the marketplace with aggressive rates that’s mass market sort of marketing to attract dollars. This is very much strategically built around customer relationships and it’s been effective to this point. We have built processes internally when employees need help with rates and things like that, they know where to go and get answers quickly and that seems to have paid dividends for us.

That’s all helpful. And then, Mark, are you able to give us some indication, as a function of that, right, I mean, NIM is obviously probably going down from here. But are you able to maybe give us some indication of where NIM was maybe towards the end of the quarter, like, in March or something like that as we think about the impact of some of this remix and the fully baking that into the NIM before we start maybe bleeding it down a little for the environment?

On the non-interest income and the net interest income slide, I apologize, but if you look on page six, in the bottom left-hand corner, there's a box that outlines the main components of the net interest margin. For the entire quarter, it was 4.32%, and for March, it was 4.21%. To your point, we have observed a slight decrease in the margin rate.

Sorry, I missed that. Yeah. No. That’s fair.

Okay.

Thank you.

We have looked at this a lot longer than you have, Mike. No issue.

I just want to say that some of the new slides are very helpful, so thank you for including that level of detail. I have one last question. Have you been conducting more reviews than usual on the office CRE portfolio? Additionally, have you done any new appraisals or anything regarding that portfolio, and can you share any general insights on the valuations? A competitor operating in similar markets mentioned earlier today that they are seeing a 15% to 20% decrease broadly across their areas. I'm curious if you could provide any similar insights.

Referring to slide 10, we aimed to provide detailed information. The portfolio is highly granular, with an average size of $1.1 million. We have only four exposures exceeding $10 million, and the loan-to-value ratios are at 63% based on the latest valuations and current outstanding amounts. We've examined the maturities expected over the next 12 to 24 months, which is illustrated in a chart showing the total maturities. We believe the portfolio is well positioned for the current environment, especially since we have limited exposure to central business districts where we perceive higher risks. We've conducted thorough reviews, focusing on specific segments, and have invested considerable effort into stress testing based on current net operating incomes and rates. This includes evaluating tenancy rollover risks and the potential effects if these deals were marketed today.

You can see the bridge in the LTV in the bottom right, which reflects the LTV based on our most recent appraisal.

Got it. Okay. All right. So and those appraisal… I mean, how recent are those appraisals? Sorry, go ahead.

If we haven’t performed a recent appraisal, it wouldn’t be included in this.

Got it. I understand that it's difficult to provide a broad overview. In any cases where you conducted appraisals during the first quarter, do you have an idea of the directional impact on the proper valuation?

Yeah. I mean, directionally, values are down because cap rates are up. I can’t give you an exact percentage, but we have seen deals that and I am speaking particularly from underwriting new deals has become much more challenging, because the equity required to finance something today from a purchase or a construction perspective is significantly higher than it was seven months, eight months, 10 months ago, two years ago, when rates were significantly lower and values were higher.

Yeah. Does that 15 days to 20 days, though, feel reasonable or is that still heavy?

Yeah. It feels a little bit heavy for our markets, Mike. I mean, because Pittsburgh, Northeast Ohio, where a lot of our exposure is and even in Columbus, it doesn’t necessarily always feel the same impact that some of the more urban areas feel in terms of valuation. So we don’t get the highs and we don’t necessarily get the lows. But the fact of the matter is, rates are up, cap rates are up, values are down.

And that’s one of the reasons why we wanted to split out the non-CBD versus the CBD and that gains us some comfort in more of a suburban environment and smaller pieces.

Yeah. Got it. Great, guys. I really appreciate all the color. Thank you.

Thanks, Mike.

Thanks, Mike.

Next we will go to Manuel Navas with D.A. Davidson. Your line is now open.

Good afternoon. Does the NIM guide take into account how the May increase will affect the NIM guide for next quarter?

We expect to see some support from that. You should potentially see a couple of months contributing to it, which might bring it closer to the 5 instead of the 10, assuming we have another quarter.

Okay. And then do you have an updated thought on kind of through-the-cycle deposit betas, you are targeting a little bit better than historical previously?

I believe the numbers will be slightly higher than we initially anticipated, but still anywhere from 7 to 10 points better than the previous cycle. We remain confident due to the improved starting mix and the projected better ending mix.

Okay. As you think about hedging, is there kind of and the potential for rates to come back down at some point, longer term, what do you think the NIM can settle at. Is there any structural change to that? In the past, you have been in the 360 range, just kind of big picture thoughts on where that could go long-term?

If short-term rates decrease, we could see higher settling levels, but we would face further pressure if the short end of the curve drops significantly. If we remain in this 5% range, it will likely be closer to 4%. However, if we experience a notable rate decrease, we could see levels below 4% and potentially in the mid-3% range, depending on how much the Fed lowers rates.

Okay. With some of the deposit flows you have had, is the deposits that didn’t migrate that exited, were there account closures associated with it or was it just folks mainly just using funds, and if there were exits or closures, was there any consistent reason for it?

I don’t think that closures were a huge amount. It was certainly a factor. But most of the rest of the change was just existing customers changing their net balance. So there’s a lot of plus and minus in just the net of all that has decreased. So we haven’t seen significant increases in the kind of the normal closure rate on the deposit side.

That’s really helpful. Can you provide more details on how you have utilized the IntraFi product and whether it has helped you protect your deposit base beyond what is currently signed up? Any insights on this would be appreciated.

Yeah. So, as Chris mentioned, when the events occurred on March 10th, we put together a comprehensive calling list to get out in front of our largest, particularly those that have largest depositors, particularly those that have uninsured deposits and we kind of led with that product beyond just having a conversation about retitling, because there were opportunities to simply retitle in order to expand the coverage. So, we didn’t have an immediate reaction from customers. They wanted to understand the product, and now we are starting to onboard or move deposits into that product. And as Mark mentioned, they are showing up in the NOW balances. So it’s really helped us in order to provide protection for those customers who were concerned. So I would anticipate further growth in that category as well.

Really it’s an important proactive conversation to be having with our large customers and that’s how we are approaching it. And they value the conversations to Dave’s point, lots of education around how it works. We have a team of treasury management professionals that work with the transition and so far it’s been received positively. But I would say the customers have reacted in a measured way.

Okay. All right. This is very helpful. I appreciate it. Thank you.

Thanks.

Okay. Next we will go to Matthew Breese with Stephens. Your line is open.

Hi. Good afternoon.

Hey, Matt.

Hi, Matt.

First, I just wanted to touch on the overall reserve. Obviously, up a little bit this quarter. Could you give us a sense for some of the macro assumptions that are contemplated there under CECL?

There are several factors that influenced us this quarter. The primary one was the CRE Pricing Index, which showed some decline, prompting us to increase our reserves for the CRE portfolio. Another indicator we monitor is the ISM Index, which also experienced some deterioration, leading us to add reserves for the C&I book. Additionally, we've identified certain segments, like C&I and healthcare, where we believe the risks are not fully captured, prompting us to allocate reserves due to potential weaknesses observed in those portfolios.

What was the index to use for commercial real estate?

It’s called the CoStar Index, it’s a commercial real estate price index.

Understood. Okay. And then in the release you had mentioned in your comments as well, you had mentioned that there was a $4.2 million specific reserve set aside for a credit. I am just curious if you could provide a little bit more color on the credit, what asset class is exposed to and what kind of happened and do you expect any sort of charge-off on that in the second quarter or third quarter here?

Well, we think we are adequately reserved. We will start with that, having placed that specific reserve on this account. But it’s a C&I account involved in manufacturing that was originated out of Western Pennsylvania.

Okay. Got it. Okay. And then maybe going back to page 10 and commercial real estate. You show for the second quarter of this year, there’s $10 million of office maturing with a 65% LTV. I am assuming there was some level of office that matured this quarter and just based on the average is probably, call it, a low to mid-60s kind of LTV. So two-part question. One, you had indicated that cap rates have changed, could you give us some indication of how cap rates have changed from the time these loans were underwritten assuming 2018, 2019 to today? And then when they are being reappraised and reevaluated, what is the change in the original to the updated LTV?

Yeah. So the LTV adjustment is kind of secondary to how we underwrite, but it still fits within our standards. What we really are focused in on is making sure that the cash flow coverage ratios remain in place and that there’s no significant tenant rollover issues that have occurred. I think, as Mike asked earlier, it’s 15% the range. I mean it depends on where the product is, what the project looks like, who the tenant is, the creditworthiness of the underlying tenant. But to date, through Q1, we haven’t had issues being able to extend or rewrite or have these folks refinance elsewhere. So I think that speaks again to the granular nature of the portfolio. It’s a relatively mature portfolio. Also, if you look at that LTV and those that are maturing are typically coming off of a five-year or 10-year amortization, maybe along our amortization schedule, but a five-year or 10-year maturity into a longer amortization schedule. They have had time to season and build equity. But that has not been the major issue for us in terms of getting things at maturity to reappraise. Again, where we are running into the issues is really impacting new production where borrowers are looking for higher leverage levels in order to undertake a construction project or purchase a project, that’s what we are running into issues with values.

Right. Okay. And what are you underwriting new office loans at in terms of cap rate and yeah?

Yeah. I don’t have the cap rate off the top of my head, Matt, I want to get back to you on that.

Okay. I will leave it there. That’s all I had. Thanks for taking my questions.

Yeah.

Thank you.

Well, those are all the questions we have at this time. I will now turn the call back over to Chief Executive Officer, Chris McComish for any additional or closing remarks.

Okay. Thanks. And thanks everybody for your interest and engagement. Again, we wanted to provide additional transparency to you. We feel good about the quarter in light of the environment that we are in. We look forward to Q2. So thank you very much.

This concludes today’s conference call. You may now disconnect.