S&T Bancorp Inc Q1 FY2024 Earnings Call

Welcome to the S&T Bancorp First Quarter 2024 Conference Call. Now I would like to turn the call over to Chief Financial Officer, Mark Kochvar. Please go ahead.

Great. Thank you very much. Good afternoon, everyone. Thank you for participating in today's call. Before beginning the presentation, I want to take time to refer you to our statement about forward-looking statements and risk factors. 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 2024 earnings release as well as this earnings supplement slide deck can be attained by clicking on the Materials button in the lower right section of your screen. This will 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 website at stbancorp.com. 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.

Mark, thank you, and good afternoon everyone. Welcome to the call. We appreciate the analysts joining us today, and we look forward to your questions. I also want to express my gratitude to our employees, shareholders, and others listening in. Before we discuss the numbers, I want to share my positive feelings about the progress we've made centered on S&T's people-forward purpose and how our strategic focus on this purpose is benefiting our customers, shareholders, and communities. A few weeks ago, we completed a nearly two-week road trip where we met face to face with all 1,250 of our employees in small groups. The energy, commitment, and engagement they showed during these meetings were truly inspiring to me and the entire executive leadership team. Our people-forward purpose aligns with our core performance drivers, including the health and growth of our deposit franchise, solid credit quality, best-in-class core profitability, all supported by the talent and engagement of our teams focused on delivering for our shareholders. Beyond the numbers we will review on Page 5, in Q1 we received recognition from Forbes as one of America's best banks based on financial performance, as well as one of America's best companies for employee loyalty and engagement. This employee loyalty award goes beyond financial services and considers mid-sized employers across the United States, marking our second consecutive year with this recognition. Looking at our quarter on Page 5, we earned $0.81 per share, which is about $0.02 above consensus estimates, with net income exceeding $31 million. Our return metrics were impressive with nearly a 14% ROTCE, and our PPNR remains robust at $176 million. While our net interest margin contracted to 3.84%, it remains strong. The 8 basis point contraction is less than half of what we experienced in Q4 of last year, and our net interest income stayed above $83 million for the quarter. Mark will provide further details in a few moments. From a credit perspective, there was slight movement, but it's very manageable and primarily related to a couple of strategic exits. Dave will delve deeper into this shortly. I also want to point out Page 7, where we included more details about our multifamily CRE portfolio, consistent with the information shared in previous quarters regarding office exposure. We will discuss this further in a few minutes. Moving to Page 4, although loan growth for the quarter was modest, we experienced significant deposit growth. Historically, Q1 is usually a slower loan growth quarter for us. On the deposit side, customer deposit growth exceeded $78 million, yielding over 4% annualized growth, which we are quite pleased with. Although we saw some shifts in the deposit mix, the rate of decline in DDA balances slowed, with overall DDA balances remaining strong at 29% of total balances. Additionally, our growth in customer deposits enabled us to reduce borrowings by $130 million in the quarter, positively impacting our net interest margin. I will now turn it over to Dave to discuss the loan book and credit quality, and Mark will provide more insights on the income statement and capital. We look forward to your questions after their remarks. Dave, it's your turn.

Yes. Thank you, Chris. Turning to Page 5. I'd like to spend some time discussing asset quality results for the first quarter. The ACL reduction that is presented on this slide reflects improving asset quality, particularly in our commercial loan book and is the direct result of the significant amount of work being done by our bankers and credit teams to manage and reduce credit risk in the current economic environment. We have seen improvement in our ratings stack via a combination of strategic exits, coupled with some modest improvement in the remaining book. Net charges for the quarter of $6.6 million were related to one of those strategic exits, which was a CRE relationship in western Pennsylvania and the progression of one western Pennsylvania operating company through the workout process. The commercial real estate loans related to this operating company account for the majority of our NPA increased during the quarter from $23 million to $33 million, but remain at a very manageable level of 44 basis points. We have a defined exit strategy for this credit, and we're actively engaged in the execution of that strategy. As Chris mentioned, we've included additional details on Page 6 and 7 of this presentation regarding our office and multifamily portfolios. Starting on Page 6 with office, you'll see the granular nature of this segment with an average loan size of $1.1 million and average loan to value of 55% based on the most recent appraisal available. It's also important to note that geographic distribution of these properties and our limited exposure to central business district assets that totaled $47 million. Looking at that $47 million segment, it is comprised of 30 loans averaging $1.6 million and the largest loan in that group totaling $7 million and the majority of those dollars being located in the Pittsburgh, Columbus and Buffalo MSAs. I'd like to call your attention to the pie chart on this and the next page and clarify that the other category is primarily made up of loans within our defined market of Pennsylvania and states adjacent to Pennsylvania. Also included in this detail are maturities by year. This information reflects limited maturity concentration in any one individual year. Digging into the large exposures, the 29 that are represented on this page exceed $5 million. These loans include two non-owner-occupied properties, totaling $11 million, and in whole, there is a debt service coverage ratio well over 1.2% for the entirety of these loans. And the four loans over $10 million average debt service coverage ratio of over 1.4. I'll also note that our construction exposure in the office segment is insignificant. Turning to Page 7, you'll see similar statistics relating to our multifamily portfolio. As with office, you will see very granular exposure as evidenced by an average size of $1 million and an equally diverse geographic distribution. In this segment, we have 30 loans exceeding $5 million that reflect an average debt service coverage ratio of over 1.4 with the largest 9 displaying an average debt service coverage ratio of 1.6. These debt service coverage ratios exclude approximately 7 properties representing $78 million in exposure that are still in their lease-up and stabilization phase. We monitor this lease-up and stabilization versus our underwriting assumptions and limit the number of construction loans that we make to very top-tier borrowers who have experience and the appropriate capital. And we have no concern with these projects at this time. In addition, we have multifamily construction commitments totaling $215 million with outstandings of $115 million at the end of the quarter. All of these construction loans are within the contiguous states of Pennsylvania, Ohio and Maryland as well as one deal in Delaware. We continue to have a positive outlook for these multifamily properties, and this has been a portfolio that's performed very well for us. Finally, both our office and multifamily portfolios have limited credit size classified and NPL categorized loans. I'll now turn it over to Mark to dig a little deeper.

Great. Thanks, Dave. On Slide 8, we have net interest income. The first quarter net interest margin rate, as Chris mentioned, is 3.84%. That's down about 8 basis points from last quarter, which does represent an improvement over the last several quarters in terms of the decline. It is in line with our expectations as the pace of deposit mix shift and exception pricing moderates. We also see this in the slowing increase in the cost of funds that's shown at the bottom left of this page. Cost of funds is up about 15 basis points in the first quarter. It was up 28 and 27 basis points the prior two quarters. Our emphasis on the deposit franchise has aided in helping keep that DDA mix strong at 29% and has returned us to net customer deposit growth allowing us to reduce the more expensive wholesale funding. That shift on the balance graph of about $100 million of brokered between money market and CDs was cost neutral. We expect funding cost pressure to continue to moderate with the net interest margin bottoming out in the mid-3.70% range in the second quarter and third quarter. We're still asset sensitive on the front of the curve. So should the Fed decide to move rates lower, we would expect 2 to 3 basis points of additional margin compression for each of the first few 25 basis point cuts. On Slide 9, we have non-interest income, which returned to more normal levels in the first quarter after some unusual items in the fourth quarter. Those included a $3.3 million OREO gain and over $1 million of noncash valuation adjustments; those are all in the other categories. We did experience some seasonality in debit card as well as in service charges in Q1. The Q1 results were in line with our recurring fee outlook of approximately $13 million per quarter. On the expense side, expenses were down $1.7 million in the first quarter compared to the fourth, more in line with our expectations. The largest decline was in salaries and benefits where medical expense returned to more normal levels after an unusually high fourth quarter. Our run rate expectation is approximately $54 million per quarter for expenses. And lastly, on Slide 11, capital TCE ratio increased by 15 basis points this quarter, overcoming 8 basis points of drag from a greater AOCI impact. TCE remains quite strong due to good earnings and a relatively small securities portfolio. All of our securities are classified as AFS. Capital levels position us very well for the environment and will enable us to take advantage of organic or inorganic growth opportunities. Thanks very much. At this time, I'd like to turn the call back over to the operator to provide instructions for asking questions.

Your first question comes from the line of Daniel Tamayo of Raymond James.

I appreciate all the commentary on the credit side, and it seemed like the increase in net charge-offs and nonperformers were related to the single commercial real estate credit. But as we get through a bumpier time and enter a period of uncertainty, obviously, you provided a lot of color on the office and multifamily portfolios. But can you just provide where you think credit costs go for you from here? I mean just a high-level thought on what NCOs might look like for you as we go through the year or provision, whatever is easier?

Yes. I believe that starting with the ACL showed some improvement. In this quarter, we saw some charges, but we are confident that we are enhancing our asset quality, and we anticipate that this will continue throughout the year. However, there are still risks in these portfolios, and we believe we have set aside adequate reserves for those risks.

Is the run rate, or whatever you prefer to call it, with net charge-offs around 20 basis points per quarter, reasonable? Before the first quarter, they were a bit higher. How do you view what a reasonable number could be going forward? Should we expect it to stay close to 20 basis points, or should we consider 35 basis points or another figure as a more appropriate rate for credit costs?

Yes, this is Mark. I don't believe the first quarter significantly alters our perspective for the medium and near term. We had anticipated that charges would average in the 20s over the next several quarters.

Okay. All right. And then I guess, secondly, and I apologize if I missed this, but obviously, getting the balance sheet right now, you're adding deposits and loan growth is not the most important thing, but just curious what the most current outlook on loan growth is.

Yes. So if you look at Q4, we saw relatively higher than normal loan growth. Those average balances carried into Q1 pipelines were relatively low at the beginning of Q1. They've grown into the balance of Q1, but we're still not expecting any significant balance growth throughout the year, low single-digit numbers is what we would budget for.

Dan, we've been pretty consistent about that kind of in that 3% range is where we've been looking.

Comes from the line of Kelly Motta from KBW.

Maybe just carrying on, on that loan growth question from before. Just wondering, understanding that pipelines are relatively low, where you're still seeing opportunities versus where demand for credit from your borrowers is more muted at this point in the cycle?

Sure. Sure. We spent a lot of time building out our business banking teams. We think that's the space. Lower middle market C&I as well where we can differentiate ourselves from many of our competitors and drive some growth. Those often come with deposit opportunities as well. So our approach to building relationships with these customers from a deposit perspective as well as supporting those customers with loan needs is important to us in terms of our people-forward strategy.

Yes. The things are not as robust in the commercial real estate area, Kelly, as you'd expect, right, given the rate environment. This is as much customer caution as anything. The good news is we've got very deep relationships in the commercial real estate space. So we're able to be proactive with them. So we don't believe we're missing opportunities. It's really lower demand. I think Dave is exactly right. Small business space has been one that's been a real positive for us, both on the loan and deposit side, and it's an area that we'll continue to focus.

That's super helpful. And in the absence of stronger growth if capital continues to build quite nicely. Just wondering, as you look ahead, what your priorities are for capital return here?

Yes. We get that question a lot, seeing where we are relative to $10 billion in size and the regulatory responsibilities that come with that. As we've talked about in previous quarters and for the past couple of years, we've really done a nice job of building this foundation for growth relative to regulatory and compliance oversight. And we feel like we're there today. We also are highly interested in organic growth. And we believe there may be opportunities down the road, and those are long-term relationships that we're working hard to continue to build. We believe that we've got a great story to tell in that regard. When you think about the capital levels of the company, the efficiency of our company, the customer experience recognition that we have, employee engagement, all of those things give us a good foundation to be able to potentially be a good partner for somebody that's looking to become part of a larger organization. So very interested in the states that we're in today in both Pennsylvania and Ohio in this geography.

Got it. That's helpful. Maybe last question from me. On the fee side, both the card revenues and service charges were a little weaker. How much of that was just seasonality? Or are there any other changes that were made that we should be cognizant of as we kind of think about the year ahead?

I think most of it was seasonality. It was primarily in the cards, it was primarily debit card activity driven. And then in the service charges, it's primarily NSF that's often seasonal as tax returns and some spending slow. So we typically see some slower ends up in the first quarter of years. A year ago, we did make some changes with NSS changes. So the year-over-year comparison on service charges was impacted by that, but from fourth quarter to first, that's more seasonality.

Your next question comes from the line of Manuel Navas of D.A. Davidson Companies.

This is Sharanjit speaking on behalf of Manuel Navas. I was wondering what you would anticipate for deposit betas in a rate-down scenario.

Yes, it can get a bit complicated because in the early stages, if the Fed makes a move, we still expect our deposit costs to rise, but at a slower rate. This makes it difficult to quantify the beta. The simplest way for me to approach this is to say that our margin will be around 2 to 3 basis points lower than it would have been without the Fed rate cuts. We anticipate a compression to about the mid-3.70s during the second and third quarters. If the Fed were to take action, for example in September, I would expect our margin to drop from the mid-3.70s to the low 3.70s, and this trend would likely continue if the Fed continues to make cuts over the next several meetings.

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

Mark, can you give me the AOCI impact this quarter?

The change was like 8 basis points.

And what was the dollar amount, last quarter, you were at $90.9 million. Where did that go to this quarter?

About $98 million.

Okay. Excellent. Excellent. All right. And then on the credit quality front, can you give us a little bit of color as to the industry that the company knows that you guys had some issues with? What industry were they operating in and then maybe some thoughts as to just overall watch list trends, I mean they sound pretty good, but maybe just a little bit more color on that.

Yes, Dan, with regard to the one credit that didn't work out, it is an active workout. So I don't want to disclose anything that might disrupt our ability to collect. With regard to the overall rating stack, we have seen some improvement. And as I mentioned in the prepared comments, it is a combination of some strategic exits. And we've got some additional execution there to continue to build momentum in reducing the C&C assets because they continue to be higher than where we'd like to have them, as well as making sure that we're monitoring and actively following the remainder of the ratings stack where we have seen improvement. And then on top of that, making sure that we're underwriting to the current environment, meaning costs, rates, all of those things, those things combined will help to continue us or allow us to tell a better credit story as we move forward.

Okay. Got it. And then with that one credit that you're working out, do you think you'll have any additional losses associated with that? Or do you think what happened this quarter is pretty much will cover those losses?

Yes. I think we're in good shape relative to future losses. It's just really a matter of timing of the final resolution with this customer.

Okay. And regarding deposits, do you believe the trends we observed in the first quarter will continue for the rest of the year? I understand that it’s challenging for everyone to achieve strong core deposit growth, but what is your outlook for overall deposit growth in 2024?

Yes, it's Chris. We are very optimistic about our team's efforts on both the commercial side of the business and our focus on treasury management, as well as the various channels we are utilizing to attract deposits and strengthen customer relationships. We have made significant changes within our teams in branches and contact centers, including new incentive plans. These changes have taken time and were underway well before the recent increase in interest rates. As you mentioned, this competitive environment has been challenging. Nevertheless, we believe we have made substantial progress in enhancing our deposit franchise. We have seen two consecutive quarters of meaningful deposit growth, with $100 million last quarter and $70 million this quarter. Our percentage of demand deposits remains healthy. We believe the stability of current interest rates works to our advantage, and we will stay proactive moving forward.

All right. Good to hear. And then last question for me. How should we be thinking about your tax rate on a go-forward basis? It looks like it was a little bit higher in Q1 versus last year? And is that 20%-ish kind of a good run rate going forward?

Yes, we expect it right around 20% effective.

Your next question comes from the line of Matthew Breese of Stephens.

Matt, I wanted to go back to the disclosures on the office book. One quick one is just the average LTVs, could you confirm for us, are those at origination? Or are there any updates? Or how do you kind of go about that process?

Yes, it would be the most recent appraisal available. So in some cases, where we have a reason to update the appraisal, we would use that number; otherwise, at that origination.

Is there any sort of way to frame that time-wise weighted average of 2, 3 years old? Or is it, for the most part, 4 or 5 years old?

Look, the way we look at this book and the way that I look at value is we focus on debt service coverage, right? And that operating income because that ultimately determines the value of the property. So that's what we spend most of our time looking at testing, stressing, so the rent roll that goes into making up that service coverage is what we focus in on.

And how often are those debt service coverage ratios updated?

At a minimum annually. Yes. So all the numbers that I referenced today would have come out of the most recent annual review, and most of those are done in the back half of the year. So those are pretty current numbers that I referenced relative to debt service coverage.

So along those lines, if I look at the maturity by year, you have $48 million maturing in 2024. I'm assuming some of those have kind of already matured and renewed or gone elsewhere. I'm just curious as even if it's a limited sample set, as those have kind of come up for renewal, how have the debt service coverage ratios reacted? And have they been able to kind of maintain a north of 1 or 1.2x level from what you've seen?

In the first part of the question, these numbers are simply moving forward. The things in Q1 that would have reset have already done so. They've matured, and we've either rewritten them or they have been taken over by others. We haven't observed any decline concerning resetting in the current interest rate environment. The main question for Randy Bank is what the occupancy levels are like. Unlike multifamily properties, office commercial real estate is typically limited by the number of tenants, and those tenants pay a fixed rental rate for a longer duration. As I noted in the call, the office commercial real estate debt service coverage ratios usually lag behind multifamily since multifamily landlords can adjust rental rates more frequently, generally on an annual basis.

Okay. That makes sense. Could you just go into the biggest office loans, the $10 million bucket and the biggest multifamily loans, similar to the $10 million north. How are those larger loans performing? Any sort of past dues or any sort of issues there? Just some broader color on the big stuff.

Yes. I think the biggest takeaway is that those largest loans, particularly those above $10 million have stronger debt service coverage ratios for both office and multifamily. And in the multifamily space, the debt service coverage ratios are significantly higher than what we would test to in terms of an annual review for a debt service coverage covenant that we have in place on most of these loans. And they're geographically diverse for the most part. As I said, that other category is really just a deeper dive into our geography. But they're pretty well dispersed. Obviously, the larger concentration by number and dollar is in Pittsburgh, but they're not outsized. It's not a $140 million loan. The average sizes are significantly larger than $10 million for the largest type of loan that we would have.

And then are any of these loans criticized or classified, not considered best?

There's one loan in the office space that's criticized, referring to the top 29 here is what...

Yes. The biggest ones tend to do the most damage when they go sideways. I just wanted to get a...

There's one loan in the office pool. There's nothing in the multifamily. There's one loan in the office pool of those $5 million and larger that is a criticized loan.

The last one I had just in regards to the NIM, and I appreciate you taking all my questions. The pace of loan yield expansion has also slowed. And I was just curious, in the absence of rate cuts, is this kind of 4 to 6 basis point range of loan yield increase? Is this a good kind of near-term proxy for what we should expect until there's rate cuts?

Yes. I think in that 5% to 6% right around in there, that's what we expect for the next several quarters at least.

There are no further questions at this time. I would like to turn the call over to Chief Executive Officer, Chris McComish for closing remarks.

Yes. Thank you all for the engagement and the thoughtful questions. Anything to follow up, feel free to reach out. Again, we feel real good about the start of the year, particularly this deposit growth and where things stand, and we certainly appreciate your time and your interest. Look forward to talking to you soon. Bye-bye.

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.