S&T Bancorp - Q2 2023

Transcript

Operator (participant)

Welcome to the S&T Bancorp second quarter 2023 conference call. After the management's remarks, there will be a question and answer session. I'd like to turn the call over to Chief Financial Officer, Mark Kochvar. Please go ahead.

Mark Kochvar (CFO)

Great. Thank you. Good afternoon, everyone. Thank you for participating in today's conference call. You can follow along with the slide portion of the presentation by clicking on the Page Advance button at the bottom of your screen. Before beginning the presentation, I want to take time to refer you to our statement about forward-looking statements and risk factors, which is on page 2. This 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 2023 earnings release, as well as the 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 program over to Chris. Chris?

Chris McComish (CEO)

Great, Mark. Thank you, and good afternoon, everybody. Just for all of you, following along, I'm gonna begin my remarks on page 3. Welcome all of you to the call this afternoon. I certainly appreciate the analysts being here with us, and we look forward to your questions. I also want to take a second to thank our shareholders and employees and others listening in on the call. It's our employee commitment and engagement that drives these results, and we're all proud to share them with you and have them a part of this call. Before I get into the numbers, I do want to further emphasize how good I feel about the progress we're making around moving our company forward and what we've defined as our people-forward purpose.

This purpose is driving our actions and behaviors and is the cornerstone of our efforts to drive top-tier employee engagement and customer loyalty, the keys to us achieving our financial goals. During the quarter, we saw further evidence of this people-forward purpose coming to life as we received from Forbes, our second consecutive Best-In-State award, as defined by our customers. Turning to page 3, you'll see on this slide there's a lot that we feel good about in these numbers. For the quarter, we earned $0.89 a share, just under $35 million in a PPNR that was actually up 7 basis points compared to Q1. That improvement, in spite of all of the changes in the interest rate environment and everything, is really driven by two factors.

We ended up with a quarter at a 4.22 net interest margin. While that's down 10 basis points compared to Q1, we drove right at $88 million of net interest income. Mark's going to talk more about that on page 6, that is evidence of the revenue-generating power of the organization and the work that we did to really manage our balance sheet during this time. There's certainly incredible intensity for deposits in the marketplace. We've taken a very proactive and customer relationship focused to this work, working hard to protect all that we have and grow what we have, while at the same time, balancing balance sheet growth with maintaining our margin.

A 10 basis point decline on a starting point of 432 down to 422, you know, is not all declines are should be looked at equally, and we feel very good about what we've been able to work through. The other driver of that PPNR was our expense control. We ended up with an efficiency ratio of 48.2 for the quarter. Again, it speaks to the disciplined way in which we're running the business, you know, those two factors in the environment that we're in, resulting in the earnings is something that we feel good about. We did have net charge-offs of about $11 million in the quarter, Dave's going to provide more details in that.

Again, we're optimistic about the good work that we're doing. Certainly feel good about the engagement they have with our teams and the work that we're doing with our customers, and we're moving forward. With that, I'll turn it over to Dave and allow him to spend some time on the balance sheet.

Dave Antolik (President)

Great. Thank you, Chris. If I could direct your attention to slide 4, this slide depicts balance sheet changes for the quarter. Loans increased by sixty-eight and a half million dollars or 3.8% annualized. This is primarily a result of activity in our residential mortgage and CRE segments. Residential mortgage balances grew by $98 million, driven by purchase activity that has remained steady and our strategy of booking these loans to our balance sheet, given the current rate environment. We've also added seven mortgage bankers this year who've helped to boost production, and given current pipelines, we expect growth for in Q3 for this segment to look similar to Q2 and then to reduce somewhat in Q4. CRE growth of $79 million was driven by two factors.

First, the completion of several construction projects that moved from construction to CRE. Second, new activity in our warehouse and multifamily categories. As a follow-up to the information that we presented last quarter, our office exposure remained relatively unchanged in Q2. In our C&I book, balances declined by $70 million, focused in our manufacturing, wholesale and services segments. In addition, we saw some softening in C&I revolving line utilization during the quarter. Based on current pipelines, we anticipate low single-digit growth for the balance of the year. Shifting to deposits, balances were relatively unchanged. I will note that we booked $100 million of brokered CDs during the quarter. We continue to experience a shift in balances into interest-bearing accounts and into products that offer expanded FDIC insurance coverage. The competition for deposits remains intense.

We believe our approach to proactively managing our deposit book and our deposit customers has allowed us to retain balances, and at the same time, protect our NIM, as Chris mentioned. We've developed an active and efficient process for our bankers to respond to market pressures, have retained approximately $850 million in customer deposits without having to reprice the entire book. At the same time, we are investing in people and products to support our deposit franchise. Examples include the hiring of our Director of Treasury Management and our Director of Consumer Products. We've also enhanced product offerings by eliminating non-sufficient funds fees in April this year, by adding numerous treasury management sales and support roles in support of our business depositors. Turning to slide 5, we have an overview of our asset quality results.

I'll begin with a short review of the allowance for credit losses bridge between Q1 and Q2. The ACL balance as a percentage of total loans is down 5 basis points for the quarter. The decrease in the ACL is due largely to a charge-off of a previously established specific reserve of $4.2 million that we discussed last quarter, which was partially offset by a higher quantitative reserve related to loan growth and risk rating changes. The total reserve stands at 1.44% at the end of the quarter, which we believe is an adequate level given the current environment. During the second quarter, we had net charge-offs of $11 million, which were comprised of 2 C&I credits.

The first credit is a $4.2 million specific reserve that I mentioned that we established last quarter. This credit was brought to full resolution during the quarter through liquidation. The second C&I credit was a specialized manufacturer who lost two significant contracts. We're working through a resolution process with this customer. We charged the loan down by $6.8 million to the estimated realizable value. We expect to resolve this credit during the third quarter. Our non-performing asset levels remain low at only $18 million or 25 basis points of total loans in OREO. During the second quarter, our non-performing assets decreased $9.7 million from the prior quarter. We successfully resolved a $5.4 million commercial real estate non-performing loan that resulted in a $900,000 recovery.

The remaining decline related to the $4.2 million C&I charge-off that I mentioned earlier. I'll now turn the program over to Mark.

Mark Kochvar (CFO)

Yeah. Thanks, Dave. Slide six shows net interest income and net interest margin since before the beginning of this rate cycle. Before rates started moving higher back in fourth quarter of 2021, our quarterly net interest income was $68.4 million, and the net interest margin rate was 3.12%. While there has been and will continue to be some pressure on funding costs, our asset-sensitive balance sheet has provided significant revenue improvements over the past six quarters. Here in the second quarter of 2023, the net interest margin rate is 110 basis points higher, and we are generating almost 29% or $20 million of additional revenue per quarter compared to the beginning of the cycle.

Second quarter margin rate of 4.22, down 10 basis points from the first quarter, as earning asset yield improvement of 22 basis points did not keep pace with the 46 basis point increase in costing liabilities. The total cost of deposits, including DDA, increased by 28 basis points to 1.13%, representing a quarterly beta of 60% and bringing the cycle to date beta to 21%. While we have seen declines in DDA balances, as Dave described, our deposit mix remains much improved compared to the end of the last cycle, rate up cycle in 2019, when we had just 24% of deposits in DDA, compared to 33% today. We are experiencing a high level of customer interest in seeking higher rates, and the deposit market is very competitive.

A possibility of an additional Fed rate increase in July will be supportive of the NIM in the third quarter due to our high level stands at 50% of loans that float. Funding cost pressure is expected to continue, and we expect the Net Interest Margin compression in the range of 10 basis points per quarter in the back half of 2023. On slide 7, non-interest income increased by $1 million in the second quarter compared to the first. This primarily relates to a gain on OREO of $600,000, which shows up in the other line item. Mortgage banking was essentially flat compared to the first quarter, as almost all of our production continues to go to the portfolio, contributing to the loan growth we had in that category.

Debit card and wealth activity, did show some improvement in the quarter. Our fee outlook for the quarterly going forward is in the $13.5 million-$14 million range. On page 8, expenses were well controlled, down $2 million compared to the first quarter, with an efficiency ratio just 48%. Decrease in expenses came primarily in salaries and benefits, as expectations for the year have moderated and incentive plans have reset. These will normalize in the third quarter, so our quarterly expense expectations remain in the $52 million-$53 million range per quarter as we continue to make investments in people and infrastructure. Slide 9 shows a 23 basis point quarterly decline in NIM at $20 million of share repurchases, combined with higher rates and an AOCI that was also higher.

TCE remained very stable last year despite these challenges, due to strong earnings and a relatively small securities portfolio. All of our securities are classified as available for sale. Our regulatory capital ratios are strong and well-positioned for the environment, with ample excess capital levels. Our remaining share repurchase authorization is $9.8 million after the activity in the second quarter. We'll cautiously look for opportunities to deploy the remaining authorization depending on economic conditions, financial performance and outlook, and the price of our stock. Thank you. At this time, I'd like to turn the call over to the operator to provide some instructions for asking questions.

Operator (participant)

The floor is now open for your questions. If you have any questions, please press star one on your telephone. We ask that while asking your question, please pick up your phone and turn off speakerphone for enhanced audio quality. Please hold while we poll for questions. Our first question comes from the line of Daniel Tamayo from Raymond James. Please go ahead.

Daniel Tamayo (Director of Banking)

Hi, good afternoon, everybody. Thanks for taking my question.

Mark Kochvar (CFO)

Sure.

Daniel Tamayo (Director of Banking)

Maybe first on the margin and specifically on the, on the funding cost. The net sparing balances as a whole and percentage of overall costs really hung in there better than a lot of your peers and I think expectations. Just curious how you're thinking about, you know, within the guidance that you gave for contraction, you know, how are you thinking about those balances moving forward?

Mark Kochvar (CFO)

We do continue to expect some continued normalization on the DDA front. There's continued to be some migration to both interest-bearing and then, and also out of the bank, as there appears to be some increasing in spend, both on the consumer and the business side. A lot of the compression margin we expect, you know, is driven by that shift out of DDA. We saw a moderation in other shifts. In the first quarter, we saw a lot of movement from money markets into CDs. That has slowed down considerably. We expect it to continue, but at a lower pace. A lot of it's driven by that DDA migration that we're seeing.

Daniel Tamayo (Director of Banking)

Okay.

Chris McComish (CEO)

Daniel, it's Chris. I just want to add the point that Dave made, and that is our proactive engagement from a banker with customer and an efficient process that we're utilizing for rate exceptions in order to retain balances for our relationship customers. We feel very good about the processes that we've built, you know, the tracking that we're doing, changes that we need to make in order to respond. You know, so far so good. As you said, it seems to be working. I think that's reflective of this customer loyalty that we have and the customer experience that's been driven over a long period of time. It is a competitive advantage for us to be able to have those conversations with our customers.

Daniel Tamayo (Director of Banking)

Understood. I guess on the guidance, the 10 basis points, a quarter of compression over the next couple of quarters. You know, you've got the July 25 basis point hike built into that for the third quarter, where you'll get the benefit on the variable rate side. And then flat in the fourth quarter. As we think about how your balance sheet reacts, are you assuming there's that essentially the migration on the funding cost is slowing in the fourth quarter? Or is there some, you know, fixed hit, excuse me, fixed rate, assets level continuing to help on the, and as you get beyond the rate hikes?

Just help me think about how the balance sheet reacts once rate hikes stop, basically.

Mark Kochvar (CFO)

Yeah, I mean, there's a couple of things that will begin to moderate the, the compression. You know, one is just the slowing of the migration from DDA. Exactly the pace of that remains to be seen, but we do anticipate that will slow some. We'll pick up a little bit of repricing on both the fixed in the securities book. That's relatively slow. We also do have a fairly sizable ARM portfolio. It's mostly three- and five-year resets. We'll start to see some benefit of that. That's more in 2024 and beyond. The other thing that helps us is that going into this, we had a pretty short CD portfolio. Those started to reprice significantly in the fourth quarter of last year.

We saw those reprice from practically nothing to 4% and even 5% more recently. As those turn, you know, starting here in the fourth quarter, their reset rates will be a lot less than they were prior. We'll see less of a degradation in the margin from the CD book repricing, because it'll have less, you know, less distance to travel to market.

Daniel Tamayo (Director of Banking)

That's great. I guess just finally, again, on the margin. I think last quarter, you talked about expecting 5-10 basis points of compression a quarter. We got 10 this quarter. You're saying now about 10 for the rest of the year, which would take us, you know, down close to 4%. Which kind of jives with what you said last quarter as well, about the, where the Fed funds rate is and where the NIM could end up. Just curious, you know, assuming we don't get rate cuts, if where you see the margin kind of settling at? Is it around that 4% range still, or you think it drifts down into threes or, you know, kind of more materially?

Mark Kochvar (CFO)

Yeah, that gets a lot more difficult to project. I mean, I think there's probably a little bit more compression to go after, you know, after fourth quarter, but we should see a significant slowing there because some of these other factors, like the CD book repricing begins to stabilize. We'll get a more steady stream of ARM and security resets. You know, hopefully, the consumer demand for migrating from, you know, DDA and savings rates slows down considerably. Probably a little bit below four, but hopefully not meaningful below that. You know, I think we'll know more as time progresses here in Q3 and four, before we can get to 2024 guidance.

Daniel Tamayo (Director of Banking)

Terrific. Well, thanks for all that color. I know it's a difficult dive into a difficult question, so appreciate it.

Chris McComish (CEO)

No, thanks for your questions.

Operator (participant)

Our next question comes from the line of Michael Perito from KBW. Please go ahead.

Michael Perito (Managing Director and Analyst)

Hey, good afternoon, guys.

Daniel Tamayo (Director of Banking)

Hey, Mike.

Michael Perito (Managing Director and Analyst)

Thanks for taking my questions. I wanted to start on the credit side. I mean, you know, I know one of these credits was kind of a carryover from last quarter, and it really doesn't sound like, you know, just based on the broad detail, that there's really kind of any concerns that would permeate to the rest of the portfolio from these two specific C&I credits. I guess just generally, just listening to you guys kind of describe, like, some of the catalysts to what brought us to this point, I mean, are you guys seeing just more like?

You mentioned something about losing 2 larger customers for the one, and then, you know, there was another comment when talking about deposits, about how you're seeing, you know, consumers and small businesses kind of run their cash lower. I mean, are we just getting to a point in the credit cycle here where, you know, the borrower is just getting kind of weaker as every quarter that passes? Or you think that that's kind of reading too much into the events of that you're seeing with these 2 particular credits over the last couple quarters?

Mark Kochvar (CFO)

Yeah, Mike, I think there are indications within the book that it's the latter of your thoughts. You know, we're monitoring, particularly the C&I book, for anything that has higher leverage, because these companies obviously are more suspect to negative changes in their operating environments and in the rate environment. We feel really good about our CRE book. You know, we disclosed quite a bit of information last quarter around the office book, which hasn't changed significantly. I, you know, I think things like, you know, declines in utilization rates, like we saw this quarter, would indicate that, you know, there's not a liquidity crunch at the customer level. I think, you know, ultimately, we're adequately reserved as presented in the ACL analysis that we presented.

Chris McComish (CEO)

Yeah, Mike, it's Chris. I'll just add to that. I've spent a lot of time in the past few weeks out with customers throughout our footprint. You know, it's still, you know, you hear a lot of talk from those middle-market businesses that say, you know, "There's revenue growth opportunities out there. We feel good about the future," while at the same time, those that may be oriented more closely to a consumer may see some slowing down from a revenue standpoint, but nothing that's dramatic. I would say, as Dave talked about, these couple of instances related to either some really some customer concentration and some things there that we had to work through.

Michael Perito (Managing Director and Analyst)

That's really helpful. Thank you. Then, just, can you maybe spend an additional minute here just on the outlook for loan growth at this point, and kind of just the internal appetite for net growth at this point? Is it... You know, we're halfway through the year. You guys have a good sense of where the pipeline and credit is here, and some of the liquidity concerns, I think, appear a little bit more manageable today than they were when they were more uncertain 90 days ago. Just curious if you can maybe even the just broad, like, qualitative thoughts just about net growth.

Chris McComish (CEO)

This is an anecdotal, and again, qualitative for me, spending a good amount of time out with our teams, with our customers. We are hearing that, you know, this deposit focus in our industry is real, you're, you know, there, you're hearing a lot of discussion about, you know, particularly in the commercial real estate world, that there's opportunities in the marketplace for growth if you want it. It's, it feels like it's a lot of loan-only relationships that, you know, our competitor banks are looking and saying: Where do we want us to allocate and spend our capital?

We're going to be very smart and judicious about what we do, and we are very focused, as others are, on building meaningful, deep relationships and staying away from transactions. It's clear in the marketplace, you know, that our industry is looking at things in a similar way.

Mark Kochvar (CFO)

Yeah, and to add to that, you know, we lend money in support of our deposit franchise, right? We lend money to our depositors. That's a key emphasis of ours and a key driver of what's going to make us successful.

Michael Perito (Managing Director and Analyst)

Got it. Just lastly, you know, you guys have mostly rectified these two C&I credits. The reserve still stands at a fairly healthy level. You know, I don't know that there's great clarity today in you know, in terms of the credit outlook, but, you know, I mean, everything seems to be reasonable, I guess, from a risk management standpoint today. I mean, do buybacks kind of continue here if the valuations for the industry remain kind of trough or softer, from your perspective for S&T?

Mark Kochvar (CFO)

I mean, I think it's still a something we'll look at when we, you know, we are and do anticipate to have, you know, good core earnings that can be supportive of that. We don't have a lot. It says just under $10 million left on this authorization, so we'll see how it goes for the quarter, see how the price and the market behaves, and then we'll be revisiting, you know, how to think about it going forward with our board, with management as we get through the rest of the year. We don't quite be limited for this.

Michael Perito (Managing Director and Analyst)

Thank you, guys.

Mark Kochvar (CFO)

Okay, thanks.

Michael Perito (Managing Director and Analyst)

See you, Mike.

Operator (participant)

Our final question comes from the line of Manuel Navas from D.A. Davidson. Please go ahead.

Manuel Navas (SVP and Equity Research Analyst)

Hey, good afternoon. As you consider that, the loan growth guide of low single digits, are you seeing any change in the mix there or how that should progress in the back half of the year? What kind of trends are you seeing in demand there?

Mark Kochvar (CFO)

Based on the pipelines, I think we'll see similar mix in the back half of the year, driven primarily by residential mortgage growth. You know, our pipeline there is pretty predictable. We haven't seen any kind of payoff pressure in that book, obviously, with elevated rates. I think you're going to see consistent growth. The commercial growth should be similar, you know, maybe in that 1.5% range in the back half of the year. Similar to the first half.

Manuel Navas (SVP and Equity Research Analyst)

Okay. That's really helpful. I think a lot of my questions have been answered. Thank you very much.

Mark Kochvar (CFO)

Okay. Thank you. Thank you, Manuel.

Operator (participant)

It appears we do have one more question from the line of Daniel Cardenas from Janney Montgomery Scott. Please go ahead.

Daniel Cardenas (Director of Banks and Thrifts)

Hey, good afternoon, guys.

Mark Kochvar (CFO)

Hey, Dan.

Daniel Cardenas (Director of Banks and Thrifts)

Maybe just a little bit of color in terms of the yield that you're seeing on new production right now on the loan portfolio.

Mark Kochvar (CFO)

I'm sorry, Dan, on which portfolio?

Daniel Cardenas (Director of Banks and Thrifts)

just your overall loan portfolio.

Mark Kochvar (CFO)

Overall, we've seen kind of in the low 6%s on new production weighted average.

Daniel Cardenas (Director of Banks and Thrifts)

Okay. Then, you know, in a few weeks here into the third quarter, are you seeing any pickup in line utilization rates?

Mark Kochvar (CFO)

Line utilization rates, here early in the third quarter, you know, it looks like they're going to return to some kind of normalized level. I think what we saw in the second quarter was more seasonal.

Daniel Cardenas (Director of Banks and Thrifts)

Okay. Good. Good. Just kind of a quick question for my model. What kind of tax rate should I assume for you guys, in the back half of the year?

Mark Kochvar (CFO)

Our full year number is, kind of like mid-18.

Daniel Cardenas (Director of Banks and Thrifts)

Okay. Okay, great. Just one question quickly on deposit trends here. As we've kind of started third quarter, have you seen any slowdown in the migration shift, or is it kind of continuing at the pace that you were seeing here in Q2?

Mark Kochvar (CFO)

Yeah, I mean, just early overall, you know, deposit numbers have been pretty flat, so we haven't noticed any acceleration for sure, and it's been slow so far. Sometimes there's, you know, within the month, there's some outsized activity towards the end of the month. It could go either way. It's hard to give a good answer without a full month or full quarter picture. So far, we haven't seen any acceleration.

Daniel Cardenas (Director of Banks and Thrifts)

Gotcha. Gotcha. Okay, last question for me. I guess, just given your asset-sensitive balance sheet, what kind of steps are you guys thinking of taking, you know, once rates do kind of flatten out here, to protect that margin?

Mark Kochvar (CFO)

Well, we have taken some. We do have about $500 million of received fixed swaps that are on the books. The deposit repricing that we've done, and it's primarily either non-maturity or relatively short CDs, you know, provides, you know, some cushion to rates down and our ability to reprice those as things seem stable. The other thing we're doing on the loan side is we've seen a little bit more migration to fixed rate preferences on our customers to have.

For example, what the mortgage production is really all fixed, to the extent that, you know, if rates move down and that their rate down movement is on the short end of the curve, we wouldn't expect there to be as much of a drop out on the curve, you know, which should provide some support in that we wouldn't see the prepay numbers tick up on that mortgage portfolio in a short rates down situation. Those would be more stable, and so that should also provide some, you know, some benefit to the margin or some offset to the margin with that floating rate.

We continue to model those out and look for opportunities or potential changes to that outlook and other things that we might need to do.

Daniel Cardenas (Director of Banks and Thrifts)

... I guess just one more question. On the residential, growth that you're seeing in your portfolio, is that primarily, 30-year fixed, or is it, adjustables? How, what's kind of the type of the, you know, the type of loan that you're adding to that, to your books?

Mark Kochvar (CFO)

It's mostly, just standard fixed, mostly 30, you know, some 15 in there, but mostly 30.

Daniel Cardenas (Director of Banks and Thrifts)

Okay. Great. All right, thanks, guys. I'll step back.

Chris McComish (CEO)

Okay. Thanks, Dan.

Mark Kochvar (CFO)

Thanks, Dan. Okay, we did receive a couple of other questions that we got through email today. I'll just go over those very quickly. The first was whether we would expect to see any other recoveries from the customer fraud that we had. As a reminder, we had a recovery in the first quarter of about $9 million. At this point, we are still pursuing various avenues to recoveries. We have nothing for sure that we can talk about at this point, but that's something that we'll continue to work on and, you know, have some anticipation that we'll have, you know, potentially have something, but nothing is for certain. The second question is, have we gone to the Federal Reserve for any borrowings?

We have not, either with the discount window or the new BTFP program, we have not borrowed. There, our borrowings are primarily from the Home Loan Bank. Another question was whether long-term bonds held by S&T have been devalued. All of our bonds, as I've mentioned, are available for sale. So they're marked to market on the balance sheet. There is a AOCI impact with those, we do not have any held to maturity bonds at all. Finally, what was the deposit change since the beginning of the year? If you put the two quarters that we've had together, we're down about $79 million, or about 1.1% since the end of 2023. 2022, sorry. That's all the questions that we got online.

I'll turn it back over to Chris here for final comments.

Chris McComish (CEO)

Yeah, I'll just wrap it up. Again, thank everybody for being on the call and your interest in our company and these good questions. We will look forward to being back with you again about 90 days from now. In the meantime, we're going to go back to work and focus on our customers. Thank you. Have a great day.

Operator (participant)

Thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation. You may now disconnect.