S&T Bancorp Inc

NASDAQ:STBA

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Welcome to the S&T Bancorp Second Quarter 2024 Conference Call. [Operator Instructions]

Now I would like to turn the call over to Chief Financial Officer, Mark Kochvar. Please go ahead.

[Mark Kochvar, executive]

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. 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?

[Christopher McComish, executive]

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 do want to take a minute to thank our employee, 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. As we've discussed before on this call, this purpose defines who we are and our values define how we do our work. All of this is connected to the 4 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 of these 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 4 of our performance drivers as they've shown great progress, and they 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 [ to ] $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 very solid customer deposit growth and 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 more deeply here in a few minutes. He will also have additional detail provided on our multifamily and office CRE exposure, and we'll also touch on the pickup we're seeing in our loan pipelines.

Moving to Page 4. While loan growth was in line with previous guidance, while we saw meaningful deposit growth. On the deposit side, customer deposit growth was more than $150 million in the quarter. This was after $75 million of growth in Q1, and produced over 8.5% annualized growth.

While mix shift continues $17 million in DDA balance growth resulted in strong performance and overall DDA balances remained strong at 29% of total balances. The customer deposit growth allowed us to reduce wholesale deposits and borrowings by $85 million, which obviously has a positive impact on 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.

[Dave Antolik, executive]

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 1 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 C&C assets declined by 12% quarter-over-quarter and are down 29% year-over-year. That equates to a $107 million reduction in the past 4 quarters.

Finally, we experienced a net recovery of $400,000 during Q2. In addition, NPLs remain at a very 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, that will point towards increased growth in Q4.

Turning to Pages 6 and 7. We've included updates relative to our office and multifamily CRE portfolios. Starting with office, we saw a reduction in balances of $20 million, and the total number of 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 where we continue to have a positive outlook for this segment in 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 [indiscernible] 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 and using current interest rates. We anticipate that construction, completion and stabilization cycle to continue to put downward pressure on these balances, as permanent financing options for these loans are available and include favorable financing terms, including 30-year amortizations and extended interest-only periods.

I'll now turn the program over to Mark. Mark?

[Mark Kochvar, executive]

Thanks, Dave.

On 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 [indiscernible] 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 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.

Now interest expenses on [indiscernible] 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 relatively small securities portfolio. All of our securities are classified as AFS. Capital levels position us well for the environment, and will 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. So right now, our balance sheet on the loan side, we have about 39% of our loans are 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 kind 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 [ 5 18 ].

So with that, I'll turn the call over to the operator to allow for other questions to be asked.

[Operator]

[Operator Instructions] Your first question comes from the line of Daniel Tamayo with Raymond James.

[Daniel Tamayo, analyst]

Yes. So I apologize, I heard most of your guidance, especially on Mark 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?

[Mark Kochvar, executive]

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

[Daniel Tamayo, analyst]

Okay. So 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, and it seems like you lowered -- were able to lower broker deposits and FHLB. So 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?

[Mark Kochvar, executive]

Yes. So the -- at quarter end, we had another -- we had an additional $300 million of brokered, and we still have about $200 million in that BTFP program. That one doesn't mature until January, and it has a little bit of a favorable rate to take a couple of cuts before it would make sense to pay that off as a [ sub-5 ] rate.

The brokers will look at -- 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 that at any time. It's just depending on how the rest of the balance sheet look.

[Daniel Tamayo, analyst]

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

[Mark Kochvar, executive]

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 the 5, 6 duration level and picked up about 370 basis points on that trade.

[Daniel Tamayo, analyst]

370 basis points. Okay, great.

[Operator]

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

[Kelly Motta, analyst]

Great quarter. I was hoping, thanks for the commentary about the loan pipeline, the commercial pipeline strengthening. Just wondering if you could give us additional color on what you're seeing with that? Is there any particular area where the pipeline is strengthening, either by region or loan type, and what are you attributing that to? Is it the expectation of rate cuts? Is that impacting borrowers starting to come back with more demand, economic activity? Just any qualitative color around that would be excellent.

[Dave Antolik, executive]

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

[Christopher McComish, executive]

And Kelly, I'll just add to Dave's comments. This is Chris. I've had a number of conversations with our team leaders as have Dave, commercial banking team leaders throughout the geography over the last -- as we were heading into the end of the quarter. And they're seeing a lot more activity in the marketplace. I would agree with Dave, that it's across the board, probably a little more C&I than CRE, obviously, given the state of CRE, and our business banking pipeline continues to grow. I just think there's a feel, I sense almost a little bit more optimism out in the marketplace from a customer base standpoint is part of it.

[Kelly Motta, analyst]

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, I'd 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 sights here?

[Dave Antolik, executive]

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.

And 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. And we always have a kind of 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. So 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. And we'll continue to support them because we like the results that we see.

[Operator]

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

[Matthew Breese, analyst]

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 to 300 -- 250 basis points higher. Yes, that's the first one.

[Mark Kochvar, executive]

Yes. So new yields, yes, on the mortgage side, there -- just under 7, probably about [ 6 80 ] around there. And on the -- the other kind of ARM books, they're also right around 7.

[Matthew Breese, analyst]

Okay. And as we think about that dynamic of the low 5 rates resetting into the high 60s, 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?

[Mark Kochvar, executive]

Yes. So we're -- we generally see and expect to continue to see around 4 to 5 basis points on the loan side of repricing benefit before you get to any type of rate cuts. And 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 first quarter of '25. And so those will have a repricing or a maturity opportunity for us. Those are kind of in a negative position by anywhere from 250 to 350 basis points. So we'll have an opportunity to reset those starting in late Q1.

[Matthew Breese, analyst]

Great. 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?

[Mark Kochvar, executive]

I think overall, I mean we're, by definition, comfortable with that [ 1 38 ]. What we are seeing, and Dave alluded to that, 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 loan. That has forced us essentially 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. So we're seeing that already where the kind of the quantitative part of our model is directing us to a lower level of need 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 standpoint, we're not -- 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 junction.

[Matthew Breese, analyst]

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 on 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.

[Christopher McComish, executive]

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. And you think we had approximately $100 million a quarter of assets that would take us between now and this time next year, right?

And so we've been -- over the past 3 years, we've been firmly focused on building the foundation of our company, building the infrastructure to move through that level so that we have -- we're in compliance with rules and regs and all the additional standards that are required.

That being said, we believe we're more -- the marketplace is becoming more -- 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 an [indiscernible]. We're not going to slow down organic growth to wait for something that could happen in the -- down in the future. By the same token, we're preparing for the -- that event should it happen for us.

[Matthew Breese, analyst]

Okay. And then just my last one and tied to M&A. It's just -- what is your preference in terms of geography for deals or types of banks that you look to partner with?

[Christopher McComish, executive]

Yes. So we're very focused on kind of the geography that we're in, in kind of contiguous states. And so you could look or 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, in Pennsylvania and looking to expand there.

[Operator]

[Operator Instructions] Your next question comes from the line of Manuel Navas with D.A. Davidson.

[Manuel Navas, analyst]

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

[Christopher McComish, executive]

Yes. I'll start and then have Dave jump in because it's just so core to what we believe as a company, and it was long before this dramatic rise in interest rates, we believe that the customers define themselves as to where they bank with -- from their deposit relationship and our -- the customer experience, customer loyalty that we have, along with -- we're big enough to have the product capabilities that we need. It's been a strategic focus of ours over the past few years, and it's starting to pay dividends.

So we've developed products. You may have -- I mean we've talked about some of the work we've done on the treasury management side, not just with more people but also product capability. That's both for our commercial customers and business banking customers. That's been a big focus of ours.

We also have been very focused on our existing customer relationships, and recognizing that we've got tremendous customer loyalty. And during a time of great disruption, our proactive outreach pays dividends for us. And so what we've seen is expansion of customer relationships throughout the company, our retail consumer customers, our business banking customers and our commercial customers all getting a greater share of wallet with those relationships due to our focus as well as alignment with the loyalty.

I think Dave can talk about activity levels and pipelines and things like that.

[Dave Antolik, executive]

Yes. Just to add to Chris' 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. So 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 6 months. We're seeing new opportunities. 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 is going to propel us forward. And we still believe there's ample opportunity within the existing customer base to move the needle and continue to grow deposits.

[Christopher McComish, executive]

The other part of your question, and while I think were related to kind of what's the competitive environment look like. And customers are still rate sensitive. But it's not at a kind of a fevered pitch as it was as rates were moving up very quickly.

I think there's more stability in the market. And therefore, we have the ability to -- through our proactive outreach, to have conversations that give us a better chance of winning versus losing and doing it at a rate in a fee structure that makes sense.

[Manuel Navas, analyst]

That's really great color. In terms of the deposit flows, is that kind of where with the NIM 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?

[Mark Kochvar, executive]

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 kind of built -- it is somewhat built into where we're headed over the next several quarters.

[Manuel Navas, analyst]

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

[Mark Kochvar, executive]

Had that [indiscernible].

[Manuel Navas, analyst]

Has this changed your -- this better NIM? Has this changed your evaluation of where it could bottom at some point next year? We are going to have some -- I believe we're going to have some rate cuts. Where do you think it could bottom, and could that be a little bit higher than maybe expectations previously?

[Mark Kochvar, executive]

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

[Manuel Navas, analyst]

That's great. That's transformative. Do you have -- can you just -- can you give a little color on the recovery? This is my last kind of question.

[Mark Kochvar, executive]

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

[Manuel Navas, analyst]

Perfect. Appreciate that.

[Operator]

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

[Daniel Cardenas, analyst]

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.

[Mark Kochvar, executive]

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. It was about 38 for the -- Yes, for the quarter and $107 million year-over-year. And we think there's still some room to improve there as well.

[Christopher McComish, executive]

And that goes right back to that -- we talked about our 4 drivers, and number 2 is asset quality. And the entire team is focused on it, and we're really working proactively to enhance and build relationships that represent long-term opportunities for us and those that don't necessarily fit are the credit profile of where we're headed long term. That's -- those are those that we're moving out. And the results are kind of speak for themselves so far.

[Daniel Cardenas, analyst]

Got you. Okay. Perfect. And then on the fee income side, so the core number that we saw this quarter, backing out the Visa transaction and the securities, 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?

[Mark Kochvar, executive]

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

[Daniel Cardenas, analyst]

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

[Mark Kochvar, executive]

$93 million.

[Daniel Cardenas, analyst]

Okay. All right. Perfect. Perfect. So then given -- I think it was Dave's comments that we're kind of looking for low single-digit growth in Q3, does that trend kind of carry into Q4, maybe not so much mortgage you are going to do maybe more commercially driven?

[Dave Antolik, executive]

Yes. I think that's accurate, Dan.

[Christopher McComish, executive]

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.

[Daniel Cardenas, analyst]

Okay. Great. All right. That's all I have. All my other questions have been asked and answered.

[Operator]

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

[Christopher McComish, executive]

Okay. Well, again, to the group on the phone, great questions. Really appreciate the dialogue and your engagement with us. You've got other follow-up, feel free to reach out. We're darn 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.

[Operator]

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