S&T Bancorp Inc Q2 FY2024 Earnings Call

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

Thank you, and good afternoon, everyone. Thanks for participating in today's earnings 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 second quarter 2024 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 will open up a panel 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 would now like to turn the program over to Chris. Chris?

Mark, thank you, and good afternoon, everybody, and welcome all of you to the call. We appreciate the analysts being here with us, and we look forward to your questions. I'm going to begin my remarks on Page 3. But before I do, I want to take a minute to thank our employees, shareholders, and others listening in on the call. To our leadership team and our employees, your commitment and engagement is what drives these financial results that we're going to discuss. These results are yours, and you should be very proud. Our performance this quarter reflects our continued progress centered on S&T's people-forward purpose and more specifically, how our focus on this purpose is delivering for our customers, shareholders, and the communities we serve. This purpose defines who we are, and our values define how we do our work. All of this is connected to the four core drivers of our performance: the health and growth of our customer deposit franchise, delivering consistent solid credit quality, best-in-class core profitability, all underpinned by the talent and engagement level of our teams. This is where we are focused, and this focus is what's delivering for our shareholders. To sum it up, we made strong progress on all four of our performance drivers, as they've shown great progress and produced the results that you will see in this deck. Turning to the quarter, our $34 million in net income equated to $0.89 per share, up $0.08 from Q1. Our return metrics were excellent, with a 15% ROTCE, while our PPNR remained strong at 1.82%, and the efficiency ratio was below 55% at 54.92%. Our NIM and NII both improved versus Q1, as our net interest margin was at 3.85%, which is very strong. This is a direct result of solid customer deposit growth and a mix shift in our deposits, which led to a moderating cost of funds. Mark will provide more detail here. Our credit quality remains stable to improving, and Dave is going to dive deeper into this in a few minutes. He will also provide additional detail on our multifamily and office CRE exposure, and we'll touch on the pickup we're seeing in our loan pipelines. Moving to Page 4, while loan growth was in line with previous guidance, we saw meaningful deposit growth. On the deposit side, customer deposit growth was more than $150 million in the quarter, after $75 million of growth in Q1, producing over 8.5% annualized growth. While mix shift continues, $17 million in DDA balance growth resulted in strong performance and overall DDA balances remained solid at 29% of total balances. The customer deposit growth allowed us to reduce wholesale deposits and borrowings by $85 million, which positively impacted our net interest margin. I'm going to stop right there and turn it over to Dave, and he can spend a little bit more time on the loan book and credit quality, then Mark will provide more color on the income statement and capital. I look forward to your questions.

Well, thanks, Chris, and good afternoon, everyone. If I can direct your attention to Slide 5 in order to walk you through our asset quality results for Q2. As presented, our allowance for credit losses grew by $1.3 million in the quarter, which represents a modest increase from 1.37% to 1.38% of total loans. A number of factors influenced this outcome. First, we are actively executing on our exit strategy with the Western Pennsylvania relationship that I mentioned last quarter, and have established a specific reserve for that credit of $2.9 million during Q2. Second, we continue to see improvement in our rating stack through reductions in our criticized and classified assets. Those criticized and classified assets declined by 12% quarter-over-quarter and are down 29% year-over-year, equating to a $107 million reduction in the past four quarters. Finally, we experienced a net recovery of $400,000 during Q2. In addition, NPLs remain at a manageable 45 basis points of total loans plus OREO. During this period of modest loan growth, our efforts continue to be focused on improving asset quality as a fundamental driver of our financial performance. Looking forward, we expect loan growth for Q3 to be in the low single-digits, driven primarily by consumer and retail mortgage activities. As our pipelines for commercial and business banking grow, we do expect that to point towards increased growth in Q4. Turning to Pages 6 and 7, we've included updates related to our office and multifamily CRE portfolios. Starting with office, we saw a reduction in balances of $20 million in total loans in this portfolio quarter-over-quarter as loans in this category continue to amortize and payoffs occur. Highlights include small average loan size, diverse geography, manageable maturity concentrations, and limited CBD exposure. Moving to multifamily CRE, we continue to have a positive outlook for this segment and the markets that we serve. As a reminder, that includes Pennsylvania and the contiguous states of Ohio, Maryland, and Delaware, and performance of these assets continues to meet our expectations. During Q2, outstandings in this portfolio increased by approximately $25 million, primarily the result of construction loans converting to permanent loans. In addition, we added new construction commitments of $15 million. It's important to note that these new construction loans are underwritten to current credit standards, including 25% to 30% equity, LTV below 65%, and debt service coverage ratios in excess of 120 at 25-year amortization, using current interest rates. We anticipate that the construction completion and stabilization cycle will continue to exert downward pressure on these balances, as permanent financing options for these loans become available and include favorable financing terms, including 30-year amortizations and extended interest-only periods. I'll now turn the program over to Mark.

Thanks, Dave. On the next slide, the second quarter net interest margin rate of 3.85% is up 1 basis point from the first quarter, and net interest income increased as well, which represents an improvement from the last several quarters of declines. Strong customer deposit growth allowed paydowns of brokered CDs and wholesale borrowings. Mix changes continue to moderate with an increase in DDA for the quarter, both point in time and average. This resulted in the slowing of the increase in the cost of funds shown on the bottom left to just 5 basis points in the second quarter. We expect funding cost pressure to continue to moderate with net interest margin at or close to the bottom now, not factoring any Fed increases. We are still asset sensitive on the front of the curve, and should the Fed decide to move rates lower, we would expect 2 to 3 basis points of net interest margin compression for each of the first couple of 25 basis point cuts. Moving on to noninterest income, we saw improvement here, but it was primarily due to some seasonal changes in debit and credit card fees. We did recognize a $3.1 million gain related to Visa Class B-1 shares that we own. That is in the other category here. We took the opportunity to sell about $49 million of lower-yielding securities, picking up about 370 basis points with an earn back of just over 2 years. Noninterest expenses on the next slide declined $0.9 million in the second quarter compared to first, that's in line with our expectations. Most of the favorable variances here are timing-related. We are experiencing higher-than-normal medical expense this year, especially in the second quarter as a self-funded plan. We have seen some higher claims. We expect our run rate though on the expense side to continue to be approximately $54 million per quarter moving ahead. Lastly, on capital, the TCE ratio increased by 18 basis points this quarter. 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 well for the environment and enable us to take advantage of organic or inorganic growth opportunities as we look forward to move into the latter part of this year. I would like to add a question that came in prior to this call. It was related to the amount of pure floating rate loans that we have currently on the balance sheet and the yield on those loans. Right now, on the loan side, we have about 39% of our loans tied to prime or SOFR, an additional 25% are ARMs, and the remaining 36% are fixed. In addition to that, we do have about $500 million of swaps. If you factor that in, those are received fixed swaps. That would bring kind of that floating exposure down to about 33% of the net loan book if you factor that in. The yield on those on the floating side is right at 8% on a blended basis, the ARMs are at about 5.36%, and the fixed rate is about 5.18%. With that, I'll turn the call over to the operator to allow further questions to be asked.

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

Good afternoon, guys. Thanks for taking my questions. I apologize. I heard most of your guidance, especially on Mark's side. But I think I missed the NIM before you talked about the rate cuts. Can you just repeat what you said about where you expect the NIM to go from here?

Yes. I guess we do expect some cost of funds pressure, but the NIM, we think we're really pretty close to the bottom here. It might be plus or minus a couple of basis points either way, but we think that's stabilized a little bit sooner than we had thought.

I guess it was a bit of a surprise to see the margin expand in the quarter and that was driven by the good performance on the funding side. It seems like you've lowered broker deposits in FHLB. I guess, first, where are broker deposits in terms of balances at the quarter end? And then second, what do you think your abilities or opportunities to reduce those as well as the FHLB going forward are?

Yes. At quarter end, we had another additional $300 million of brokered deposits, and we still have about $200 million in that BTFP program. That one doesn't mature until January. It has a little bit of a favorable rate to take a couple of cuts before it would make sense to pay that off. It has a sub-five rate. The brokers, we'll look, depending on how the deposit and loan books go over the quarter, we have some maturing, I think, over $100 million maturing in Q3 that we should be able to reduce. We also have some floating rate brokers that are not CDs or money markets. Those we could reduce at any time, depending on how the rest of the balance sheet looks.

Okay. Perfect. And then lastly, the balance sheet repositioning in the second quarter, when did that take place? What was sold and what was purchased if you have used those funds already?

Yes. So it was done in the latter part of June, so late in the quarter. So there's not a whole lot of impact of that in the margin. We sold $49 million primarily a couple of treasuries and a few mortgage-backed agency CMOs that we have, or excuse me, commercial backed mortgages that we have. We've repurchased similar CMBS-related assets and CMOs farther out the curve, kind of with a 5, 6 duration level and picked up about 370 basis points on that trade.

370 basis points. Okay, great. Okay, I'll step back. Thanks for all the detail.

Sure.

Your next question comes from the line of Kelly Motta with KBW.

Good afternoon. It was a great quarter. I appreciate the insights regarding the strengthening commercial pipeline. Could you provide more details on what you're experiencing with that? Are there specific regions or loan types where the pipeline is showing improvement? What do you think is driving this change? Are expectations of rate cuts influencing borrowers to return with increased demand, or is it due to economic activity? Any additional qualitative insights would be greatly valued.

Yeah. It's a mix of activity and it's throughout our regions. I think there is some pent-up demand relative to rates moving downwards. So I think folks are, with that anticipation of rates down, they're looking at possibilities of refinancing or moving forward with projects now that there's some better visibility amongst our customers relative to rates.

And Kelly, I'll add to Dave's comments. This is Chris. I've had several discussions with our team leaders, as has Dave, with commercial banking team leaders across the regions as we approached the end of the quarter. They are noticing significantly more activity in the marketplace. I agree with Dave that the activity is broad-based, likely with a slightly higher focus on commercial and industrial lending than commercial real estate, given the current situation in that sector. Our business banking pipeline continues to expand. Overall, there seems to be a sense of optimism in the marketplace from our customers, which contributes to this dynamic.

Got it. That's super helpful. And then on the commercial real estate side, I appreciate that it was excellent here and you actually had net recoveries this quarter. But, how are you feeling? It seems like the tone not just on growth but also on credit might be a bit more optimistic than last quarter. I'm hoping, what are you still watching closely? Any pockets of weakness that we should keep in our sites here?

The way we manage that risk is to look at what those results look like for those customers relative to current financing options, right? So if you have something that's in the midst of a 5-year arm, maybe you're 2 years in, we re-underwrite that to the current conditions and see what that cash flow looks like to get ahead of potential issues. Our performance relative to that kind of stress testing has been good. So we're happy with the results. And as I mentioned in my prepared comments, our underwriting standards have moved to be a little more conservative relative to loan to value. We always have a Plan B relative to refinancing of these assets or the sale of these assets. That's why we've stuck to things like 25-year amortizations in the multifamily space to give ourselves room in the event that we need to reposition an asset. The challenge in the CRE space is really construction costs and the borrowers' and developers' ability to get a decent cash-on-cash return, given the cash flows that these assets and projects can produce. The good ones will find a way to get a project done with additional equity and get a return, and that's what we're seeing relative to the movement I described in our multifamily construction portfolio. We'll continue to support them because we like the results that we see.

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

Good afternoon, everybody. Mark, I appreciate the color on the floating rate exposure and the yields. What was interesting there was how low the fixed rate and the ARM portfolios are in the low 5% range? I guess my first question there is, one, what are the new loan yields for those books? I'm assuming they're a good 250 basis points higher. Yes, that's the first one.

New yields on the mortgage side, they're just under 7%, probably about a 6.80% around there. On the other ARM book, they're also kind of right around 7%.

As we think about that dynamic of the low 5% rates resetting into the high 6s, is that helping the NIM outlook as we think about rate cuts later this year and into 2025? I mean cycle-to-date, your loan beta is kind of knocking on about 50%. Would you expect that to be better, as we head into the next rate cutting cycle?

Yes. We generally see and expect to continue to see around four to five basis points on the loan side of repricing benefit before you get to any type of rate cuts. That's just kind of the natural repricing of the fixed book and those ARM resets. The other thing that will begin to help us in '25, starting at the end of the first quarter, is that the $500 million that we have in swaps, those are laddered out pretty much $50 million a quarter starting in the first quarter of '25. Those will have a repricing or a maturity opportunity for us. Those are in a negative position by anywhere from 250 to 350 basis points. We'll have an opportunity to reset those starting in late Q1, that we will report later.

Very helpful. One of the things that was really nice this quarter was the provision with the net recoveries. I was hoping you could provide some color on how you think the provision will shake out for the back half of the year and if you can't answer that directly, how comfortable you feel with the overall reserve level at 1.38% here?

I think overall, I mean, we're, by definition, comfortable with that 1.38%. What we are seeing, and Dave alluded to this, is over the past several years, we've been working with a much higher relative to peer amount of criticized and classified, special mention substandard loans. That has forced us to have a higher-than-peer ACL level. Those are improving quite a bit, as Dave mentioned, over $100 million this year-to-date. So as that moves to that pipeline, the need for reserve begins to moderate. We're seeing that already where the quantitative part of our model is directing us to a lower level of needed reserve. We do expect that to continue barring anything unexpected on the macro front. So that will provide continued support just from an ACL need standpoint. On the charge-off side, we don't have anything on our sites other than the one significant credit that Dave mentioned. But that, again, can change at any time, but we're feeling pretty good about asset quality at this juncture.

Okay. Great. I appreciate that. And then with the balance sheet of $9.6 billion. I know in past quarters, you guys have provided plenty of detail on the Durbin impact. One thing I was curious about is just the preference on how you cross. Is there a preference to do it organically or through M&A? Just love some color there.

Yes, all of our plans matter are to focus on that, which we have direct control over, which is our organic growth. And so we're preparing to cross over as the result of our organic growth. We had approximately $100 million a quarter of assets that should take us between now and this time next year, right? Over the past three years, we've been firmly focused on building the foundation of our company and the infrastructure to move through that level, so that we have compliance with rules and regulations and all the additional standards that are required. That being said, we believe the marketplace is becoming more, with many more discussions relative to inorganic growth opportunities, and that's a key component of our future and our desire to be a bigger player in the markets that we serve and in this general geography. So it's a balance. We're not going to slow down organic growth to wait for something that could happen down the line. By the same token, we're preparing for that event should it happen for us.

What is your preference in terms of geography for deals or types of banks that you look to partner with?

Yes. So we're very focused on kind of the geography that we're in, in contiguous states. You could look as far south of here into the Maryland, West Virginia, Virginia area, east into Ohio, and then obviously, here in Pennsylvania, in the markets that we're in, looking to expand there.

Your next question comes from Manuel Navas with D.A. Davidson.

Can you talk about deposit pipelines a bit more and then the competition there? It seems like you might have a little increase in deposit costs, but you're still getting some nice flows. If you could just talk through that a bit?

I'll begin, and then Dave will add to this because it is fundamental to our company values. Even before the significant increase in interest rates, we believed that customers identify themselves by their banking relationships, particularly their deposit connections and our customer experience and loyalty, along with our product capabilities. This has been a key focus for us in recent years, and we are starting to see positive results. We have introduced new products, including improvements in treasury management for both commercial and business banking clients. We have also concentrated on strengthening our existing customer relationships, understanding that we enjoy high customer loyalty. In times of significant disruption, our proactive outreach has proven beneficial. We have witnessed growth in our customer relationships across the board, with retail, business banking, and commercial customers all increasing their engagement and share of wallet due to our focus and alignment with their loyalty. I believe Dave will discuss activity levels and pipelines in more detail.

Yes. Just to add to Chris's comments, if you look at Q2, the growth was really widespread across all of our divisions: the commercial, the treasury management that supports commercial and business banking as well as consumers. The focus has been and will continue to be growing wallet share with the existing customer base. That being said, we are also in the business of attracting new clients as well. That activity has been, I'll call it, consistent for the last six months. We're seeing new opportunities, and those tend to be more rate competitive opportunities. So we feel that continuing to focus on the existing customer base, building out capabilities from a product and service perspective will propel us forward. We still believe there's ample opportunity within the existing customer base to move the needle and continue to grow deposits.

The other part of your question, which I think relates to the competitive environment, is that customers are still rate sensitive. However, it's not at the kind of fevered pitch as it was when rates were moving up very quickly. There's more stability in the market. Therefore, we have the ability to have conversations through our proactive outreach that give us a better chance of winning versus losing and achieving it at a rate and a fee structure that makes sense.

That's really great color. In terms of the deposit flows, is that kind of where the NIM is kind of bottoming and maybe some stability here before rate cuts? Is that kind of where there could be a wild card? Do you have borrowing paydown in your guidance or any excess deposit growth that pays down broker that paid down borrowings, could that offer a little bit of upside on NII and NIM?

Perhaps a little bit. I mean we still have wholesale levels of around $0.5 billion, so there's still some opportunity to replace those higher-cost funds. That is somewhat built into where we're headed over the next several quarters.

Okay. Great. And if there's extreme access that would be where it could potentially be some option.

Had that.

Has this improved net interest margin changed your assessment of where it might reach its lowest point next year? I believe we are likely to see some rate cuts. Where do you think that lowest point could be, and could it be somewhat higher than previously expected?

Yes. I think overall, we think we've landed at a bottom that's maybe around 10 basis points higher than we had anticipated. Our expectations for the impact on a per-cut basis aren't kind of changed. So all else equal, it would be around 10 higher depending on how many cuts there are.

That's great and transformative. Can you provide some insight on the recovery? This is my final question.

I think it was more about that there weren't any charges. We typically have a certain small level of recoveries that our special assets folks are working on, but the fact that there were no significant charges at all in the quarter.

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

Mark, I'm sorry. I missed your comments on the criticized and classified levels that you made earlier. Can you maybe just kind of repeat those for me? I'm just trying to get a sense as to where those levels were at the end of the quarter versus last quarter.

Yes. So we're down 12% quarter-over-quarter and 29% year-over-year. I think the dollar amount for the quarter was about $38 million for the quarter and $107 million year-over-year. We think there's still some room to improve there as well.

Our four drivers include asset quality as a key focus area. The entire team is dedicated to enhancing and building relationships that represent long-term opportunities for us. We're moving away from those that do not align with our long-term credit profile. The results so far reflect this approach.

And then on the fee income side, so the core number that we saw this quarter, backing out the Visa transaction and the offset on the security side, is that kind of a good run rate to build off of here for the back half of '24?

Yes. We expect around that $13 million a quarter level.

Okay. Perfect. And then what was your AOCI number for this quarter?

$93 million.

Okay. Perfect. Based on Dave's comments about expecting low single-digit growth in Q3, does that trend continue into Q4, perhaps with less focus on mortgage and more on commercial activities?

Yes. I think that's accurate, Dan.

That's what we talked about relative to the growth in the pipeline and what we're seeing. There's seasonality to it, and there's better activities.

I would like to turn the call over to Chief Executive Officer, Chris McComish, for closing remarks.

Okay. Well, again, to the group on the phone, great questions. I really appreciate the dialogue and your engagement with us. If you have further follow-ups, feel free to reach out. We're very proud of this quarter and, most importantly for me and Dave and Mark and everybody, it's the continued trends that we're seeing, the engagement level of our teams, the commitment that they have to our customers. All of that represents a lot of positivity for us, and we appreciate your interest in our company. So have a great rest of the day.

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