S&T Bancorp Inc Q3 FY2024 Earnings Call

Welcome to the S&T Bancorp Third Quarter 2024 Conference Call. After management's remarks, there will be a question-and-answer session. Now, I would like to turn the call over to Chief Financial Officer, Mark Kochvar. Please go ahead.

Great. Thank you, and good afternoon, everyone, and thank you for participating in today's 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 third 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 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 call and program over to Chris.

Mark, thank you. And good afternoon, everyone. I'm going to begin my comments on Page 3. I'd like to welcome everybody to the call. I certainly appreciate the analysts being here with us today, and we look forward to your questions. I also want to thank our employees, shareholders and others listening in on the call. To our leadership team and employees, your commitment and engagement is what drives these financial results. And as I've said every quarter, 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 the connection of our purpose to our core drivers of performance. Our drivers of performance are centered on the health and growth of our customer deposit franchise, consistently solid credit quality, strong core profitability, all of which are underpinned by the talent and engagement level of our teams, which lead to the results we're going to speak to today. To sum it up, we have made strong progress on all of our performance drivers and, in Q3, the continued growth of our deposit franchise and improving asset quality led the way to deliver very solid results for the quarter. Additionally, as you're aware, over the past few years, due to the results we've been able to deliver, we have been able to build a significant amount of capital. Our performance, combined with our strong capital levels, gives us real optimism as we head into the end of 2024 and into 2025. We're excited about our prospects for growth while delivering for our customers, shareholders, and the communities that we serve. Turning to the quarter, our $33 million in net income equated to $0.85 per share, down slightly from Q3. Our return metrics were again excellent with a 13.5% ROTCE, 1.35% ROA, and while our PPNR remained solid at 1.69%. It is important to note, our PPNR was impacted by a little bit more than $2 million of securities losses that we proactively decided to help mitigate impacts of a future declining rate environment. Our net interest income showed growth in Q2, while our net interest margin at 3.82% declined slightly but remained very strong. Again, this is the direct result of another quarter of very solid customer deposit growth. Mark will provide more details on both our net interest income and our net interest margin in a few minutes. Asset quality continues to improve, as we had another quarter of declining/accruing assets with Dave going to dive deeper here in a few minutes. He's also going to touch on the pick-up we are seeing in our loan pipelines and activity. Moving to Page 4, while loans did not grow during the quarter, it's a reflection of lower pipelines from earlier in the year combined with a higher level of payoffs. On the deposit side, customer deposit growth was more than $100 million in the quarter, producing over 5% growth annualized. While some mix shift continued, overall DDA balances remained very strong at 28% of total balances. The customer deposit growth allowed us to reduce wholesale and brokered deposits and borrowings by $150 million combined, which will obviously have a positive impact on our future net interest margin. I'm going to stop right there, and I'm going to turn it over to Dave, and he can talk a little bit more about the loan book and credit quality; then, Mark will provide more color on the income statement and capital; following that, we'll have some questions. I look forward to answering them. Dave, over to you.

Thank you, Chris. Yeah, wonderful. Continuing with the discussion of our balance sheet, particularly as it relates to loan balance activities, we did see a reduction in balances of nearly $25 million for the quarter. This was primarily the result of reduced commercial loan balances of $76 million. In the commercial segment, production in Q3 was just slightly lower than what we saw in Q2. What really impacted the balance reduction were payoffs that increased by nearly 50% in the quarter. These elevated payoff levels were driven by continued demand for multifamily loans in the permanent market, slightly lower C&I utilization rates, and payouts in our C&I portfolio as we manage asset quality. It's very important to note that we do not anticipate this high level of commercial payoff activity in the coming quarter. During the quarter, we also experienced growth in all segments of consumer loans with the exception of construction. When looking more closely at Q3 activity, production was slower early in the quarter and much stronger in September. We expect this positive growth momentum to carry forward into Q4. Looking forward and in support of a return to loan growth in Q4, our total pipeline has increased by over 50% quarter-over-quarter, primarily due to improved commercial both in the CRE and C&I spaces. We've also seen an increase in the consumer pipeline as customer activity shifts from purchases to home equity. If I can now direct your attention to Page 5 of the presentation in order to discuss our asset quality results for the quarter, I'm starting with the allowance for credit losses, which declined by approximately $2 million and moved from 1.38% to 1.36% of total loans. This reduction was a result of several factors, including a decline in our non-performing assets of $3 million. As you can see, non-performing assets remain low at $31.9 million or 41 basis points of total loans. We also saw further declines in our criticized and classified assets of almost 3% during the quarter. This represents the fourth consecutive quarter of reductions in criticized and classified loans, and they have reduced by 17% year-to-date and 31% year-over-year. Just as a reminder, these criticized and classified loans require higher levels of reserves. In addition, charge-offs for the quarter were in line with expectations at $2.1 million, up from the previous quarter's $400,000 net recovery. Finally, we anticipate loan growth in Q4 to be in the low- to mid-single-digit range, and we are targeting mid-single-digit loan growth for 2025. I'll now turn the program over to Mark.

Great, Dave. Thanks. Next slide, we have the third quarter net interest margin rate at 3.82%, that's down 3 basis points from the second quarter, while net interest income improved by $900,000 compared to last quarter, primarily due to an extra day. The impact of the late September Fed rate decrease and the leading SOFR rate changes can be seen in the reduction of quarterly loan yield improvement to about 1 basis point in the third quarter compared to 5 to 6 basis points per quarter in the first half of the year. We're also still experiencing an increase in the cost of funds in the third quarter. That's driven by deposit mix changes and continued upward repricing activity throughout most of the quarter. We did implement non-maturity deposit repricing in response to the Fed cut in late September with CD rates being lowered earlier in the quarter. Strong customer deposit growth allowed for the reduction in more expensive brokered CDs of $126 million. Wholesale borrowings are down $25 million. But this did not happen until very late in the quarter. So, the third quarter should represent the peak in our cost of funds as we expect this to decline going forward as our liabilities reprice. So, looking ahead, we expect an additional 10 to 12 basis points of net interest margin compression from here. That assumes another 50 basis points of rate cuts or 100 basis points of cuts in total in 2024. After that first 100 basis point cuts and as we move into 2025, we do expect to find an equilibrium net interest margin rate in the low-3.70%s, and that should happen early in the year. We anticipate that level to hold even if the rate cuts continue as the market expects throughout 2025. Support for that net interest margin stability, despite those further cuts, will come from favorable fixed and ARM loan and securities repricings, our received fixed swap ladder beginning to mature, a very short duration CD portfolio that will reprice and an improving ability to implement non-maturity rate cuts as rates move lower. Moving on to noninterest income. Noninterest income declined in the third quarter by $1.4 million. The quarter-over-quarter variance is related to two main things: securities repositioning and our Visa Class B-1 shares. In the second quarter, we recognized a $3.2 million fair value adjustment in the Visa stock and also repositioned about $49 million of securities, taking a loss for approximately the same amount at $3.2 million. So, these two actions netted to zero. In the third quarter, however, we executed another securities repositioning, also for about $48 million, but this time, taking a loss of $2.2 million, but without an offset like we had in the second quarter. Our normal noninterest income run rate remains approximately $13 million to $14 million per quarter. Related to noninterest expenses on the next slide, we saw an increase of $1.8 million in the third quarter compared to the second. Two main things drove that: salaries and benefits are higher due to increased incentive payout expectations due to our performance, and in the data processing line, that's higher due to some timing related to technology investments. We expect run rates and expenses to be $54 million to $55 million per quarter. And lastly, on capital, TCE ratio increased by 64 basis points this quarter. A little over half of that, 36 basis points, was due to AOCI improvement. Our TCE and regulated capitals, as Chris mentioned, position us very well for the environment and will enable us to take advantage of both organic and 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.

The floor is now open for questions. Your first question comes from Daniel Tamayo with Raymond James. Please go ahead.

Thank you. Good afternoon, guys.

Hey, Dan.

Yeah. Maybe first on credit where the story just continually gets better every quarter seemingly for you guys. So, that's certainly good news. But, just curious now with NPAs down to the level they're at and net charge-offs seeming to slow, if you had updated thoughts on what would be kind of a more normalized or regular type of cadence for net charge-offs or provision, however, we should think about it going forward?

Yeah. I think what you saw in the quarter would be closer to what I would call as normalized relative to the charge-off levels. What we're hoping to see relative to provisioning is, as we return to loan growth, that we would need to keep provision in place to support that loan growth. We do think there is still room for us to improve though. I mentioned the criticized and classified assets. So, I think about adversely classified assets generally, there's still room for improvement there for us. So, the ACL level may move as a result of those continued improvements.

Okay. Terrific. I would like to ask Mark for clarification on the net interest margin guidance. You mentioned stabilization in early 2025 in the low-3.70% range, even with further rate cuts. If we don't see those rate cuts, do you expect the margin to stabilize at a higher level or drop to the low-3.70% range before rising again? I'm curious about the potential impact of rate cuts on your forecast.

Yeah. I mean, a lot of the finer details are going to depend on the timing and on the competition, but if the Fed moves a lot slower, I would expect it to take potentially longer to get to that stabilization point. And as you kind of alluded to, it probably would be slightly higher than the low-3.70%s that we're looking at now with a much deeper cut.

Okay. Yeah, that makes sense. Okay. All right. Well, I'll step back. Thanks, guys.

Thank you.

Thanks, Dan.

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

Hey, good afternoon. Thanks for the question. It sounds like the pipeline is really strong, and you were impacted by some elevated payoffs and paydowns this quarter. I'm just wondering what gives you the confidence that that kind of headwind will flow, and how should we be thinking about the potential risk of that going forward with customers potentially looking to refinance as rates come down.

Yeah. As rates reduce, of course, customers will be looking at the potential to refinance. We do have rate protection in many of our loan products with prepayment penalties and make whole. So, we're able to get ahead of those and understand when those maturities or rate changes occur and the bankers have proactive conversations relative to those. And if we can get ahead of them, make sure that we understand what the impact is and what really what the customer desires and what's best for them, that's our focus. And then, in terms of adding additional volume, we've seen some pretty good activity, as I mentioned, at the end of Q3 that carries into the beginning of Q4 here relative to new customer calling activities.

And Kelly, this is Chris. A significant number of our customers have been hesitant to make capital expenditures in the commercial and industrial sector while they wait to understand the future of interest rates, including some of our commercial real estate clients. With clearer direction on rates, we believe customers are feeling more confident in making investment decisions, which is expected to expand our pipeline. Although it was somewhat unusual to experience a high level of payoffs, as Dave mentioned, some of that was related to credit as we continue to focus on credit quality and returns. Additionally, the incoming pipeline was lower this year due to uncertainty regarding customer expectations about the future.

Got it. That's helpful. Maybe a bit of a housekeeping question for the model. Just looking at the average balance sheet, it looks like interest-bearing cash was a bit elevated. Just wondering how we should be thinking about managing liquidity levels and the size of the balance sheet? Was that because loan growth was a little slower and you're expecting to deploy that as we look to Q4? Just any color on managing the liquidities there and how you guys are looking to optimize that?

So, on an average basis, we were a little bit high. I mentioned these brokered CDs that we paid off, and that happened at the very end of the quarter. So, we knew that was coming and it's our intent to pay those off. So, we let some of the cash levels build that was coming from our customer deposit growth so that we could pay those off and not replace them at the end of the quarter. So, on average, we did have a little bit higher cash, but I think it got to a more normal level if you looked at just the quarter-end point.

Got it. Okay. That's really helpful. And then, as we look ahead, you're just under $10 billion in assets. Just wondering if you have any updated thoughts on potentially crossing next year and how you guys are thinking about what potential levers you have to offset that initial hit from Durbin.

Yeah. And some of it obviously is timing associated with Durbin. And as we've talked about before, Kelly, it's about $6 million to $7 million of initial impact. Normal loan growth, as we've talked about, kind of in that mid-single-digit range would put us there sometime in 2025. We have really no concerns from the standpoint of will we be able to absorb the additional regulatory oversight we've been building for that over the course of the past couple of years. If you look, that's where a lot of our expense growth has come in enhancing all of our risk management, audit, compliance, BSA, AML, all of those areas that are critical to growing the franchise whether we go over $10 billion or not. So, we recognize organically it's $6 million to $7 million. That's a big reason why we're so focused on things like our treasury management initiatives and deepening some other forms of fee income to offset some of that, as well as just expanding our customer base. So, it's not a huge hit for us. We made $33 million this quarter. So, we're going to have to absorb it, but it's something that we'll be able to grow into. And then, again, we believe as inorganic opportunities will present themselves and we're preparing for that as well.

Got it. That's helpful. I'll step back. Thank you so much.

Thank you.

Thanks, Kelly.

Your next question comes from the line of Manuel Navas with D.A. Davidson. Please go ahead.

Hey. I appreciate the NIM outlook, but could you just dive a little bit deeper into some of the assumptions there? You talked about some swaps. I'm interested in what you're assuming on loan and deposit betas initially and maybe through the cycle. Just any extra color you could add there as you build that 10 to 12 basis point decline into next year? It's not immediate, but just any extra color there would be really helpful.

Overall, for the full years '24 and '25, we are modeling a 200-basis-point decline, which seems to align with market and Fed expectations. This would result in a shift from $5.50 to $3.50, establishing our baseline for Fed rates. The reductions we anticipate in core rates largely stem from our approach to managing the exception pricing book. Our aim is to make more significant cuts to the lower deposit levels as we progress through the rate tranches. For instance, in our initial adjustment of 50 basis points, we reached that level in the highest tranches, but some lower tranches remained untouched. As we explore lower rates over time, we expect to impact more balances. Additionally, we anticipate adjustments to the rates in our non-exception book. The swap book you mentioned consists of approximately $500 million in received fixed swap ladders created when rates were rising, with maturities beginning at about $50 million each quarter starting in the first quarter. Currently, we are operating at a loss of 200 to 300 basis points on those swaps. As they mature, allowing them to fully go will provide margin support, particularly reflected in the loan line rather than the deposit space. We've also crafted the CD book with short-term pricing over the past year, and we've already reduced rates starting in early September to late August. Most of those CDs are within the six-month range, and we expect to see some price reductions throughout the year. Regarding securities and fixed loans, as they reprice, we'll see better rates at the new levels compared to their maturities. I can't provide exact beta values since they will fluctuate throughout the year, but they will initially differ entering the cycle and should improve as we apply more deposit rate changes later in '25.

That's really helpful information. How should I view the end-of-period deposit costs for this quarter? You're indicating that this is the peak, so are you expecting that excluding the pricing adjustments you've made, deposit costs will decrease next quarter?

Right. With the Fed making changes in September, we responded shortly after, but it didn't have much effect. Most of the momentum for the quarter came in July, August, and early September. We are still experiencing changes in our mix and continued exceptional pricing. Therefore, when we examine spot rates, our rates as of September 30 were already lower than the average for that month. We anticipate having a better cost of funds and cost of deposits in the fourth quarter.

Is your deposit strength potentially a wild card here that could even help the NIM more? Could you just kind of talk about your success in deposit flows and where that could go going forward?

Yeah, we think so. I mean, there's a lot of emphasis being placed on that both on the business side, commercial side and also on the consumer side. We still have about $375 million of wholesale borrowings that are also very short and relatively high priced that we can pick up some advantage if we're able to replace those with a decent mix of customer deposits.

Manuel, it's Chris. This is more anecdotal than anything, but the good news is, with rates being discussed in the marketplace overall, it leads to more customer conversations, both with existing customers as well as prospective customers. So, we feel very good about the progress that we've made and kind of the infrastructure that we built in order to continue this. And I think changing rates lead to customer conversations, and that's a good thing.

That's good color. Can I switch over to fees for a moment? If you have 200 basis points in cuts, what could that do on the fee side for you next year?

This year, I mean, I think we're relooking and repositioning our mortgage business. We've really been portfolying most of that activity, but we're getting ready to make a concerted effort to sell more of that production going into next year. So that's probably our biggest kind of interest rate-related ability or potential on the fee side that we expect. Right now, the only mortgage activity we're seeing is just the fees from the servicing side. But there's an opportunity as we shift some of that production to sales that we would pick up possibly a couple of million dollars next year of fee income.

Do you feel like you have the right capacity, or is that part of the adjustments you're going to make? You might have to make it higher. How do you compare your capacity versus where you were three years ago, for example?

I think from a capacity standpoint, it's similar in terms of origination. We haven't been selling a lot. So, some of the back-office functions need to be reset to make that process smoother.

But it's not a significant increase. The only factor that could change this, specifically regarding mortgages, is if mortgage rates drop quickly and lead to a large refinancing surge, which could create capacity challenges for us and others in the industry since we are operating at a much lower rate than we were three years ago when refinancing activity was very high.

I appreciate that insight. We could be heading in that direction. Referring back to the discussion on inorganic growth, what areas are you considering for expansion, and which geographic opportunities excite you?

We have discussed this previously, but I want to emphasize it again. Our primary geographic area of focus is the southern part of Pennsylvania, extending east to west, and into Northeast and Central Ohio, which are very appealing markets for us. We are also seeing significant interest throughout Ohio and into the Midwest. Additionally, we are looking further south into Maryland, Northern Virginia, and Washington, D.C. When you consider the distance from Pittsburgh to Washington, D.C., it’s not much farther than getting to Philadelphia, for instance. As we evaluate markets, we consider their alignment with our culture and our aspirations. There are promising opportunities both to the east and west, as well as in Western Pennsylvania. We are actively building relationships, and the most effective way to establish connections from an inorganic growth perspective is by delivering strong performance and having the necessary resources to engage in these discussions. That remains our focus.

Thank you very much. I'll step back into the queue.

Your next question comes from the line of Matthew Breese with Stephens. Please go ahead.

Hey, good afternoon.

Hey, Matt.

Hi, Matt.

I have a few questions, most of which have already been addressed. First, are you considering any additional securities restructurings? If so, could you provide some sense of the amount? And is that factored into your 2025 NIM outlook in any way?

We're still evaluating the situation and don't expect anything significant. We've completed two transactions, both just under $50 million, and any future opportunities would likely be less than that. The changing dynamics of the market, along with what we've already sold, are the best indicators for us. The cost-benefit of further activity is not as favorable as it was before. If we decide to proceed with anything else, it wouldn't be larger than the transactions we've already completed, and there's a good chance we may not do any more at all.

And remind us again what the yield pickup was on both of those restructurings?

So, the first one was about 370 basis points. The second one was maybe 270 basis points.

Okay. And the other topic I just wanted to touch on, and it's been brought up a handful of times on the call, is just payoff activity, commercial real estate, multifamily related. How much of that was by design, meaning these were non-strategic or non-full-relationship-type customers? And then, how much of it was rate-driven? One thing we've been hearing a lot of this quarter is that there's been some stiffer competition on the commercial real estate front from insurance companies, some of the agencies, some of the bigger banks even. And so, I wanted to get a sense for how much of that was going on and how different the types of rate offerings were between yourselves and some of the other players?

Certainly. There remains considerable competition concerning permanent mortgages for multifamily properties. In the third quarter, we had two notable deals in the $20 million range, both with existing customers and not part of transactional agreements. These are standard business practices where a construction loan transitions into a permanent loan on a temporary basis, usually leading to permanent financing. It is typical for these customers to seek a permanent facility. The primary reason for this is to secure a long-term fixed rate, usually for ten years, and eliminate recourse, which is crucial for large builders and developers looking to maintain equity in their projects within a single-asset entity without recourse to the sponsors. These elements generally fall outside our credit risk constraints. Therefore, we consider this activity part of our normal business operations for such transactions.

Got it. Was there any meaningful delta between yourselves and other sources, other competition or other competitors?

From a structure perspective, LTVs are generally similar; rates maybe slightly more aggressive depending on if it's an insurance company or a CMBS. Insurance companies looking for assets tend to be a little more aggressive. But the big difference in structure is the recourse, right? We require recourse even if it's limited after some point of stabilization, these facilities in the permanent market tend to be completely non-recourse.

And if you're talking about bank competitive pressures from a rate standpoint, I would say that any of that is more anecdotal one-off-driven specific transactions than it is anything that we're seeing in the marketplace. We have seen in some areas of our geography, which makes you scratch your head. We've seen some deals that were maybe, as you described, not necessarily long-term relationship deals that were actually taken out by large credit unions. That is an unusual place for a C&I or a commercial real estate customer of ours, but there are some pockets of the geography particularly in the eastern part of the state of Pennsylvania where we're seeing some of that activity.

Yeah, I think, Matt, the bottom line for us relative to asset quality, I think it speaks well for that segment in our geographies. Those multifamily projects continue to perform very well. They can take advantage of the permanent market, and we can continue to play a role as the depository institution for those borrowers and look at their ongoing construction needs.

Yes, absolutely. Good for asset quality, but headwind to growth.

Yeah, you got it.

That's why we have four drivers.

Your next question comes from the line of Daniel Cardenas with Janney Montgomery Scott. Please go ahead.

Hey, good afternoon, guys.

Hey, Dan.

Hey, Daniel.

Just a couple of questions here for you all. In terms of deposit, your deposit growth outlook for 2025 on a percentage basis, do you think that can mirror what you're looking for on the lending side or could you be a little bit better, just kind of given where the loan to deposit ratio is right now?

We are optimistic about the momentum we have and our focus on the deposit business. We have made investments in personnel, products, and process improvements, and we plan to maintain that focus. The current interest rate environment presents opportunities for both existing and new customers. As Mark mentioned, the decline in rates will lead to significant movement of funds. Therefore, our goal is to continue seeking growth within the range we are experiencing.

Okay. And then, given where capital levels are right now, what are your thoughts in terms of stock repurchase activities going forward?

Yeah. I mean, that's going to be our least favorite of ones, especially given the run up in price. It just makes it a little more difficult for that to make economic sense. So, our first priorities are going to be on the growth side and to use the capital that way.

So, kind of growth dividends and then maybe buybacks if it makes sense mathematically?

Right.

Okay. And then just a housekeeping question. What was your AOCI number for the quarter?

End of the quarter was $77 million.

Okay. Great. All my other questions have been asked and answered. Thanks, guys.

Okay, Dan, thanks.

Thank you.

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.

Okay. Well, thanks everybody for the great questions and the dialogue. We really appreciate your engagement and your interest in our company. We look forward to being with you over the coming weeks and months. And let's have a great rest of the earnings season. Thank you. Bye-bye.

This does conclude today's call. You may now disconnect.