S&T Bancorp, Inc. (NASDAQ:STBA) Q3 2022 Earnings Conference Call October 20, 2022 1:00 PM ET
Company Participants
Mark Kochvar – Chief Financial Officer
Chris McComish – Chief Executive Officer
Dave Antolik – President
Conference Call Participants
Daniel Tamayo – Raymond James
Michael Perito – KBW
Matthew Breese – Stephens, Inc.
Daniel Cardenas – Janney Montgomery Scott
Operator
Good day, ladies and gentlemen. Thank you for standing by. Welcome to the S&T Bancorp’s Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After management’s prepared remarks, there will be a question-and-answer session.
I would now like to turn the call over to Chief Financial Officer, Mark Kochvar. Please go ahead.
Mark Kochvar
Great. Thank you, and good afternoon, everyone. And thank you for participating in today’s conference call.
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 the screen in front of you. This statement provides 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 of 2022 earnings release can be obtained by clicking on the press release link on your screen or by visiting our Investor Relations website at www.stbancorp.com.
We will be reviewing an earnings supplement slide deck as part of this presentation. You can obtain a copy of those slides by also clicking on the Earnings Supplement link on your screen or also on the website under Events and Presentations, Third quarter 2022 Earnings Conference Call, click on the Third Quarter 2022 Earnings Supplement link.
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.
Chris McComish
Thanks, Mark, and good afternoon, everybody. We are certainly pleased to be here with you reporting on very solid results for the quarter. Before I get into the numbers and then turn it back over to Mark and Dave for some more details, I did want to briefly emphasize to you all the progress that we continue to make building this company to deliver for both our shareholders, customers and our employee base.
Over the past four quarters or five quarters, we have been on a steadfast journey and our strategic focus around strengthening the foundation of S&T, built over 120 years and rooted in our distinctive customer trust, all of this with an eye to sustainable, profitable top tier growth and performance.
I am pleased to report that we continue to make great progress, making progress both in building and enhancing our leadership team, with an important blend of S&T legacy knowledge, as well as outside industry expertise. All built for growth with the appropriate focus on safety and soundness in all that we do.
Our leadership team clearly understands that we are the current stewards of this 120-year legacy of great customer trust and strong employee engagement, and as I mentioned in our press release, award winning on both fronts. Our company’s performance will rise and fall going forward on the effectiveness of this leadership.
While there’s always work to do, which we do embrace in our energized by and the environment remains uncertain, I couldn’t be more pleased with the progress that we have made and optimistic for our future.
Now let me go ahead and turn to the numbers and I am on page three in the deck and as you can see, $37 million in net income, which is a 28% increase in EPS for the quarter, records on both front.
PPNR above 2% at 2.15% and solid revenue growth driving a 50% efficiency ratio. For the fifth straight quarter, we have had meaningful asset quality improvement and our return metrics have led to another increase in our dividend, the third in the last five quarters, up to now $0.31 per share.
Turning to page four and before I turn it over to Dave for more details, you will see that our loan growth in the majority of our portfolio — is it — we see loan growth in the majority of our portfolios with some contraction that also does have an asset quality focus. And on the deposit front, there is some contraction on a linked basis due to some seasonality, as well as the rate environment.
I look forward to your questions, and before that, I will turn it over to Dave.
Dave Antolik
Well, thank you, Chris, and thanks, everyone, on the line. We appreciate your interest in our company and participation in the call. As presented on slide four, we realized overall loan growth of nearly 4% for the quarter. By category, we saw increases in all consumer loan types and in our C&I balances.
Consumer activities remain robust as we head into Q4 and our pipelines point towards a continuation of this growth.
With regard to C&I activity, our aggregate total revolving commitments grew during the quarter, along with the total number of commitments. This growth, coupled with a 1% increase in utilization rates to 44% when compared to Q2 resulted in balanced growth of $20 million.
We did experience declines in our CRE and construction portfolios during Q3 and we expect to see continued pressure on the construction portfolio as demand has declined due to increased interest rates, rising construction costs and most particularly availability and cost of labor.
In the permanent CRE book, we saw normal course payoffs related to property sales and permanent market financing, along with several exits of negatively rated loans or those in less desirable segments.
We continue to closely monitor economic conditions and look for signs of stress and adjust our risk appetite in order to support our desire to improve asset quality. Forecasting loan growth, given the current economic environment is certainly challenging, but we remain comfortable with our low single-digit guidance heading into Q4 and into early 2023.
Shifting to deposits, we experienced an overall decline of $202 million in Q3 adding some color to the changes by category. On a point-to-point basis, demand deposit balance declines were primarily the result of activity in a handful of business customers. It’s important to note that we retain these customer relationships and that these changes were a result of their decision to utilize their cash in order to support business activities.
Also important to note is that our average demand deposit balances actually increased in Q3 by $10 million. Additionally, interest-bearing demand, money market and CD changes were the result of market competition for those products and our active management of deposit costs.
We remain focused on building upon our 120-year legacy deposit franchise by investing in people and infrastructure. We are proud to announce that in August, we hired a new Director of Treasury Management, who’s focusing on product and sales capabilities in order to support our commercial and business banking relationships.
Turning to slide five, we are very pleased with the trajectory of our NPAs as presented. We had minimal charge-offs during Q3. Our ACL increased moderately in recognition of our qualitative analysis and impact of forecasted microeconomic and macroeconomic slowdowns.
I will now turn the program over to Mark.
Mark Kochvar
Thanks, Dave. Net interest income increased by $8.6 million or about 11% compared to the second quarter. The net interest margin rate in third quarter was 4.04%. That’s up 48 basis points from the second quarter. That’s up 52 basis points ex-PPP.
Loan yields improved by 58 basis points, the asset mix improved with lower average cash and the cost of total deposits increased by just 18 basis points during the quarter. Interest-bearing deposits increased by 29 basis points.
51% of our loan portfolio is tied to short-term rates, which has been a big driver of the net interest income and net interest margin improvement. As part of our outgo strategy to protect the interest income and net interest margin in a declining rate environment, we have hedged that floating rate loan concentration to approximately 44% with received fixed swaps. We continue to evaluate the right level of hedging, which will depend on the rate environment and our deposit pricing experience.
Our net interest income and net interest margin outlook for the next couple of quarters remains positive given expectations for additional short-term rate increases. We expect the net interest margin rate to improve and to continue as short rates increase, but moderate due to a little additional improvement in asset mix, higher expected deposit betas and the execution of our hedging strategy.
Non-interest income increased by $2.1 million in the third quarter compared to the second quarter. The largest item is a lower decline in the fair value of the assets in a non-qualified benefit plan, which relates to stock market performance and shows up in the other line. This was negative $0.4 million in the third quarter, compared to a negative $1.4 million in the second quarter, resulting in a $1 million quarter-over-quarter variance — favorable variance.
This also shows up as a reduction in salaries and benefits, but is P&L neutral. Also impacting the other income line was a gain on sale of an OREO property for $0.6 million. Mortgage banking was essentially flat compared to the second quarter as the majority of our production went to the portfolio. Our quarterly fee outlook remains in the range of $14 million to $15 million.
Expenses were up $1.2 million compared to the second quarter. Salary and benefits increased primarily due to the other side of the non-qualified benefit plan that impacted fee income. Pension expense was also higher due to settlement accounting from lump sum payments.
On retirees, improved revenue drove the efficiency ratios, as Chris mentioned, by over 4.5 percentage points to just above 50% and also resulted in positive operating leverage. Our quarterly expense expectations remain well controlled in the $49 million to $50 million range.
We have strong capital levels are well positioned for the environment. We executed $3.5 million in buybacks during the third quarter and we will continue to look for opportunities depending on economic conditions, our financial performance and the price of our stock. We have approximately $29.8 million in repurchase capacity remaining in our buyback authorization.
The smaller securities portfolio as a percent of assets, strong earnings and a more efficient balance sheet, we have seen stability in our TCE ratio over the course of the year despite higher AOCI adjustments.
Thanks very much. At this time, I’d like to turn the call over to the Operator to provide instructions for asking questions.
Question-and-Answer Session
Operator
Certainly. [Operator Instructions] Your first question is coming from Daniel Tamayo with Raymond James. Please pose your question. Your line is live.
Daniel Tamayo
Good afternoon, guys. Thanks for taking my questions.
Chris McComish
Hey, Daniel.
Mark Kochvar
Hi.
Daniel Tamayo
Hey. How are you doing? Let me start on the NIM and deposits, we saw a decline, as you mentioned in the quarter. Thanks for the color on the few commercial clients that drove the decline in the demand side. But just curious in your thoughts what how you think deposit betas trend in the fourth quarter and kind of beyond? And then how much impact that could have based on a need to grow deposits or as you kind of continue to creep up in terms of loan to deposit ratio? Thanks.
Mark Kochvar
Yeah. So, I mean, I think, we do think that the deposit betas are going to increase especially with the activity that is expected to have here in the fourth quarter with additional hikes in November and December as well. That is going to impact the incremental margin that we would expect. We would not expect it to continue at the pace that we have seen in the last couple of quarters.
The other thing is that the — as you recognize the balance sheet mix and the earning asset mix is changing. We have benefited from the reduction in cash, which has improved that mix. That has relatively little left to go as we move from the third quarter to the fourth quarter, so there only a few more basis points of benefit to be derived there.
So we do expect that increase to possibly be half of what we have seen in the last couple of quarters, assuming that the Fed continues at the current pace. We are continuing to evaluate how to position ourselves, both competitively and then overall with the balance sheet.
I mean, we have a history of operating at lower loan-to-deposit ratios. We are working hard to make permanent changes to that and investing in the deposit franchise. But we are comfortable and familiar with the trade-off between that and borrowing money in the wholesale market should that need arise.
Daniel Tamayo
Okay. Great. And then, I guess, related to the investments that you are making to strengthen deposit franchise that you called out, but the guidance has really been in a relatively tight range on a quarterly basis. Anything that we should think of in terms of as we go into 2023 from an expense base perspective, how you think about what growth may look like next year given those investments?
Mark Kochvar
Yeah. On the expense side, we would expect expenses to be a little bit higher, both because of those investments and just the inflationary environment is a little tighter. We continue to see a challenged labor market and expect things like merit to be higher. We are also still in the process of planning, but would expect to make additional hires to support the deposit franchise, especially on the business side, where we see a lot of opportunities on treasury management.
Chris McComish
Yeah. Daniel, this is Chris. I will also mean some additional investments from a technology and digital capability. Dave mentioned the hiring of a top tier treasury management leader for our company. That will between working with core providers, other providers continue to enhance service offerings for our customers, be it online additional capabilities, both in the consumer side of our business and certainly in the commercial and the business banking side of the business. So, some continued product capability enhancements, as well as some additions of people.
Daniel Tamayo
I appreciate that. And then, lastly, just a question on the asset yields. It looks like commercial real estate yields, in particular, have expanded a lot over the last couple of quarters. Is there — I guess, how much of that is floating relative to fix in that portfolio and if you — if there’s another reason for why those would be able to kind of increase so much in a short period of time. Appreciate it.
Mark Kochvar
There’s a couple of things going on there. There is a fair amount of floating. I’d say about 60% of it actually flows to us. Now those are — a lot of those have been swapped back to the customer, so that the customer has a fixed payment but it’s floating for us. So that has helped in that where you might think of the CRE as being a fixed portfolio for us, it’s probably 60% floating.
We also have the benefit — have had the benefit anyway of the received fixed swaps in there, which have been cash flow positive for the last couple of quarters. That is changing and we expect that to be become a little bit of a drag going into Q4 as the short rates go higher.
Daniel Tamayo
Okay. That’s terrific. Thanks for all the color. That’s all for me.
Chris McComish
Thank you.
Operator
Your next question is coming from Michael Perito with KBW. Please pose your question. Your line is live.
Michael Perito
Hey, guys. Good afternoon.
Mark Kochvar
Hi, Mike.
Michael Perito
I was wondering if you could spend a little bit more time, obviously, you guys are adding some to the reserve on a qualitative basis, as you mentioned in the prepared remarks and in the release. But as you guys think about, you talked a little bit about pipeline and the low single-digit growth expectation. But as we think about the mix of that growth and the opportunities you guys have the best appetite for the more comfortable with today. Any expansion you guys can provide on where you think some of the better and higher quality growth opportunities are for you guys over the next three months to six months at this point?
Dave Antolik
Sure. Mike, so one of the areas that we are focusing in on is our business banking segment. We feel that there is opportunity in essentially all of our markets to do a better job there and there is some opportunity for us and we have added the staff in that segment. We think the consumer area where we have been able to grow over the past several quarters will continue to yield positive results.
And certainly, within the — in the C&I book, within certain segments, we will continue to focus and look for growth. As I mentioned in the prepared remarks, we will feel some pressure and some challenges to grow the construction book and the permanent CRE book as well.
Michael Perito
That’s helpful. Thank you. And then just geographically, I guess, any additional thoughts to add on the kind of the same context of that question?
Dave Antolik
Yeah. I — if you look at our franchise and the legacy growth that we have seen in Pittsburgh, we are certainly focused on continuing that and to grow out Western PA. Eastern PA is more of a CRE market, but we have also built C&I teams there as well. So we think there’s opportunity.
And Ohio in both Northeast Ohio and Central Ohio, there will be incremental opportunities. Where there are some vertical opportunities within the ABL world, we have added some exposure to our — we have a small REIT book that we participate in. We have added some exposure there.
So we think that we are adding in a risk-friendly way where we get a return that’s commensurate with the risk we take and we believe there will continue to be opportunities that will lead to this kind of low-to-mid single-digit growth that we have pointed towards.
Michael Perito
Right. Thank you. And then just lastly for me, just — is there any — as we think about — you guys mentioned kind of the near-term expectation around non-interest income. But as we think to next year and beyond, I mean, the focus on treasury management and business banking. I mean is there opportunities the products and technology that you have to kind of grow fee income around some of these business customers as we look at like swap income or wealth management or treasury management or any of those elements that we should be thinking of?
Chris McComish
Yeah. This is Chris, Mike. There are opportunities there. We are bullish in the underpinnings of our treasury management opportunities simply because of the current depth of relationships that we have and we think there’s latent opportunities within the book, both within our business banking space and somewhat in the C&I space as well.
On the — if you look at the slide, the wealth management income, that actually has held up pretty well if you think about it. That’s all asset under management base. It’s not transaction fees sort of remain flat in the market that’s down 20%, 25%. That’s telling you that we are picking up new business and expanding assets under management in spite of some headwinds there.
So it’s still going to be very dependent upon what’s going on in the external market. But in talking with our teams, our asset bankers that are focused there is there are really good alternatives for our customers in this ever-changing environment. So those conversations will remain important.
There is pressure on the consumer side and we will continue to look at what we are defining as deposit optimization and ensuring that we have got the right product set from a depository standpoint for our consumers.
And at the same time, we are on the right side of everything that we need to be doing from a customer experience standpoint relative to NSFPs [ph] and things like that. So there’s a little…
Michael Perito
Yeah.
Chris McComish
There is a little balance of both, but big emphasis certainly on the business commercial side in the treasury management space.
Michael Perito
That makes sense. Perfect. Thanks. Thank you, guys. Appreciate the color and for taking my questions.
Chris McComish
Sure. Thanks. Thank you.
Dave Antolik
Thanks, Mike.
Operator
Your next question is coming from Matthew Breese with Stephens, Inc. Please pose your question. Your line is live.
Matthew Breese
Good afternoon.
Chris McComish
Hi, Matthew.
Matthew Breese
I wanted to just discuss a little bit more about the NIM outlook. Maybe first, can you give us a sense for what the spot rate of deposits all in were at the end of the quarter or as of today?
Mark Kochvar
So at the — in the last month of the quarter, the kind of the overall deposit rates had ticked up a little bit to about 56 basis points. I think at the quarter we were closer to 43%.
Matthew Breese
Okay. I mean, to-date, you have done a nice job kind of keeping the composition, non-interest-bearing deposits are 36% of the total CDs continue to come down. Have you adjusted your outlook for deposit betas through cycle at all or can you give us some update there?
Mark Kochvar
I think it’s still evolving. The speed of the Fed is still troublesome and how long the catch-up takes. But we still think we are better positioned overall compared to last cycle, even though that cycle is very different in terms of how long it took.
In that cycle, we have kind of hit the mid-30s with the better composition that you referenced, especially on the DDA side to extend our emphasis on the business side to maintain a lot of that. If we are successful with that, we would still expect our cumulative betas to be mid-20s to low 20s compared to that mid-30s in the last cycle.
Matthew Breese
Okay. And then maybe along those same lines, assuming the Fed is done by early 2023 or wherever you choose them or assume that they stop. How far after that or how long after that, just given the asset-sensitive nature of the balance sheet, do you expect to see the NIM, perhaps, stop to — stop increasing maybe even start to see some compression.
Mark Kochvar
Yeah. I mean, I think, there definitely will be some. We do have a fair amount of ARM product that would give us some continued improvement. Those are re-pricing higher and we expect that to continue, but it’s nowhere near the impact that the float has. And on the liability side, there’s very little CDs that will be there to offset that. So it will be how long that pressure from the transactional especially the money market continues.
So, I mean, I think, it probably continues as long as they are flat. There’s always going to be a little bit of pressure to price higher and depending on the competition, if we get back into a growth mode, us as well as others will be out there chasing deposits again. So I think it depends a little bit on the trajectory of growth post Fed stopping.
Matthew Breese
Got it. Okay. And then last one for me. I just wanted to talk a little bit about the construction portfolio. Can you remind us of kind of the underlying composition what the end projects are in — within the construction book? The area that I think a lot of folks are starting to have some concern with is resi development, just given the movement in mortgage rates from 3% a year ago to knocking on 7% today and the ultimate end consumers affordability of that same kind of project.
Dave Antolik
Yeah. So in the commercial construction segment, there’s very limited exposure to resi development. In the largest categories would be multifamily. There’s some warehouse. We also have some wholesale and there’s some other transportation kind of related construction projects.
Matthew Breese
Okay. And any signs of deterioration within the construction book to-date?
Dave Antolik
No. No. We monitor it very, very closely. We have a very robust review process that we use, and frankly, that’s why you have seen some of the reduction in the exposure, because we manage it tightly and it’s just really tough to get something approved today to get it built on budget, on time, so this demand has declined and we would expect to see that decline continue.
Chris McComish
Yeah. So some of the contraction relates to those projects coming off being paid out or moving into another category and then the — not as much new coming on simply because of what Dave talked about.
Matthew Breese
Got it. Okay. I appreciate it. That’s all I had. Thank you.
Operator
Your next question is coming from Daniel Cardenas with Janney Montgomery Scott. Please pose your question. Your line is live.
Daniel Cardenas
Hey. Good afternoon, guy.
Chris McComish
Hi, Dan.
Mark Kochvar
Hi, Dan.
Daniel Cardenas
Maybe just — I missed the line utilization number that you threw out, Dave. Maybe if you could just repeat that for me and then maybe compare it to what it was versus pre-pandemic levels?
Dave Antolik
Yeah. It’s about the same level that it was pre-pandemic. It was 44% for Q3, up from 43% in the prior quarter. We troughed in the low 30%s, 32%, 33% during the pandemic, so we are at about the same utilization level that we were pre-pandemic. The one exception to that would be the floor plan portfolio, which has not recovered and it’s half of what it was pre-pandemic.
Daniel Cardenas
Okay. Okay. Good. And maybe a little bit of color in terms of paydowns and payoffs. Have they kind of normalized here in the last couple of quarters or are you still seeing some pretty good headwinds.
Dave Antolik
Yeah. In Q3, as I mentioned, it was a combination of normal course and some payouts that were credit related and we took the opportunity to exit a few credits that we felt weren’t within our risk appetite from a credit perspective at this point. So I would expect there to be a modest decline in Q4 in terms of payouts. That’s what we forecast.
Daniel Cardenas
And then kudos on the reduction in your non-performers, as we look at the commercial ones, so was that primarily one large credit that either return to performing status or paid down or was that multiple credits?
Dave Antolik
It was one credit primarily driving that number and it was an exit. It was a real estate entity.
Daniel Cardenas
And what are your watch list trends looking like right now as you come into the fourth quarter and are thinking about in 2023, I mean, just given that you bulked up your provision levels and your reserve levels a little bit this quarter?
Dave Antolik
Yeah. So Q3 there were a fair amount of inflows and outflows that kind of balanced each other. So we are looking again at some additional macroeconomic pressure. That’s driving the additional provision.
Daniel Cardenas
And then what’s the M&A environment looking like right now, is it fairly quiet or are you guys seeing a pickup in deal flow?
Chris McComish
I would — it’s Chris. I would define it as fairly quiet, and quite honestly, what we are — we are focused on what we can control and very focused on delivering results and performance and building a currency that gives us an opportunity in the future.
Daniel Cardenas
That’s all I have for right now. I will step back. Thanks, guys.
Chris McComish
Thank you.
Dave Antolik
Thanks, Dan.
Operator
[Operator Instructions]
Mark Kochvar
Operator, we have one question that we got through the online that we would like to go through.
Operator
Sure.
Mark Kochvar
That question is, I think, that last time your net interest margin was above 4% was in 2010. Are there any structural or competitive reasons the NIM can’t stay above 4% in a flat to higher rate environment or do you think that net interest margin will ultimately revert back to the 3.60%, 3.70% pre-pandemic level as funding costs play catch up.
So it is right. The last time I was looking at them myself last time we were above 4% was in 2010. So it has been quite a while to that low rate environment. We think that we should be able to stay at a much higher rate and that 4% will be a good level to be able to do that.
There are some structural differences that we are enjoying right now and our emphasis on the deposit franchise is to try to keep to maintain those and that’s namely a higher level of deposits and also a better mix.
So that DDA percent in the mid-30s compares to probably mid-20s or low 20s pre-2010 and so if we are able to maintain those levels that we currently have, that should give us a much better structural opportunity to maintain that 4%.
And then also the higher level of deposits and keeping that loan deposit below 100, certainly, if not lower, should allow us to stay away from in that higher rate environment will be higher cost wholesale fundings to finish up that gap. So that is one of the main reasons why we are so focused on the deposit franchise especially as we move potential into that higher rate environment for a longer period of time.
Operator, that takes care of the question we had anything else that you are seeing?
Operator
No. There are no additional questions in the queue from the lines at this time. At this time, I would like to turn the floor back over to S&T Bancorp’s CEO, Chris McComish, for any closing remarks.
Chris McComish
No. Again, thanks to everybody on the call and for your interest in our company. Obviously, we are very proud of the quarter. I am really proud of this leadership team and our employee base, what we are doing every day to take care of customers and we look forward to being back with you in another quarter, if not between now and then. So thank you all very much.
Operator
Thank you, ladies and gentlemen. This does conclude today’s conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.
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