S&T Bancorp, Inc. (NASDAQ:STBA) Q2 2022 Earnings Conference Call July 21, 2022 1:00 PM ET
Company Participants
Mark Kochvar – CFO
Chris McComish – CEO
Dave Antolik – President
Conference Call Participants
Daniel Tamayo – Raymond James
Michael Perito – KBW
Russell Gunther – D.A. Davidson
Samuel Varga – Stephens Inc
Operator
Good day, ladies and gentlemen, and welcome to the S&T Bancorp, Inc. Second Quarter Earnings Conference Call [Operator Instructions].
It is now my pleasure to turn the floor over to your host, Mark Kochvar. Sir, the floor is yours.
Mark Kochvar
Thanks very much, and good afternoon, everybody. 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 the cautionary language required by the Securities and Exchange Commission for forward-looking that may be included in this presentation. A copy of the second quarter 2022 earnings release can be obtained by clicking on the press release link on your screen or by visiting our Investor Relations Web site at www.stbancorp.com. We will be reviewing an earnings supplement slide deck as part of the presentation. You can obtain a copy of those slides on our Web site under Events and Presentations second quarter 2022 Earnings Conference Call, click on the second 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 program over to Chris. Chris?
Chris McComish
Mark, thank you, and good afternoon, everybody, and welcome to our second quarter call. Really appreciate you being with us and look forward to your questions afterwards. I’m starting on Page 3. And before we get into the numbers, I do want to take just a moment of personal privilege as I’ve essentially been here for one year with the company,while our company at the same time is celebrating 120 — our 120 year anniversary. It’s obviously been a year of significant change, both internally and externally. And before that, I need to recognize our employees. Through pandemics and hybrid work, inflation challenges and a new CEO, they stayed and committed to our customers. This is evidenced by yet another form of external recognition. Following on the heels of our J.D. Power award for retail customer experience that we received in April, we announced this week a best in-state bank for the state of Pennsylvania Award from Ford. We certainly don’t take this type of recognition lightly as it’s a clear proof point around the customer trust that’s embedded in this company from our customers — both our customers as well as the markets we serve. And for me, it’s the best reflection of the talent level of our team and it’s the position you want to be in as a banker during more uncertain economic times.
As you may recall from our previous discussions, my primary focus has been to strengthen our foundation built on S&T’s distinctive customer trust and improve the core of the organization, including safety and soundness, while positioning our company for further growth and impact in the marketplace. I’ve been clear throughout that our financial performance and results will be driven through a focus on building and enhancing employee engagement and the engagement and commitment of our teams to deliver for customers, and that will rise and fall on the effectiveness and the work we are doing as leaders. We’ve made a conscious effort here at S&T over the past 12 months to create a blend of new talent into the organization as well as providing promotional and expanded leadership opportunities for talented leaders already here at S&T. It’s actually reflected of the three — by the three of us on this call, between Dave and Mark, we’ve got more than 60 years of S&T experience and me being here new for a year. But taking that combination of outside industry expertise with deep S&T knowledge and knowledge of the markets that we serve and how we win and who we are as a company is creating a great recipe for success as we move forward today.
It’s also reflected in some of the new roles that we have in the company, including both of our heads of Commercial and Consumer Banking, our Head of Marketing and Customer Experience, our Head of — our Chief Human Resources Officer as well as the top two individuals, both running our credit risk management organization and our risk management organizations. This blend of talented individuals committed to S&T and the customers we serve, really, I can’t be more excited about the future and the team that we’ve built as well as the progress we’re seeing to date. In that light, here’s a couple of highlights from the quarter’s results, $29 million of net income, meaningful year-over-year and quarter-over-quarter increases in PPNR, driven through significant margin expansion. Additionally, we’ve seen further declines in our NPA levels and improvement in credit quality with NPAs down 35% linked quarter. This has been a significant priority for our company and will continue to be so.
We also saw solid consumer loan growth in the quarter, I’m particularly pleased by this. I talked about this last quarter, but this is the result of a strategic focus of our organization to deepen customer relationships. These are customers that have meaningful relationships with us and these lending opportunities represent expansion of those relationships. As we move forward, our foundation buildings remains the focus, enhancing capabilities to deliver for customers, with an eye towards safety and soundness, all underpinned and led by a great team. As I said in the beginning, I’m honored to be here and I’m excited about who we are, our team and our ability to deliver. I look forward to your questions. And again, I’ll turn it over to Dave and Mark for more details.
Dave Antolik
Great. Well, thank you, Chris, and thanks to all on the line for your interest in our progress. Slide 4 provides an overview of quarterly balance sheet changes. The reduction in cash was in part the result of an increase in loans of $107 million when you exclude PPP. As Chris mentioned, this is primarily driven by consumer loan balance growth. This activity was a result of newly originated production in our mortgage division, along a combination of increased utilization and newly originated debt consolidation activity in our home equity book. This is all focused on helping our customers manage their payment obligations in a rising rate environment. In our commercial book, we saw C&I balances increase by $20 million as our customers continue to actively manage cash and focus on rebuilding inventory levels as supply chain issues stabilize. For the quarter, C&I utilization rates increased by approximately 2% to 43%. As a reference point, utilization peaked at about 45% in the months leading up to the pandemic. In our CRE book, we continue to see reductions. We saw a reduction to the tune of $65 million during the quarter as projects continue to be sold and refinanced into the permanent market.
Looking forward, loan pipeline activity has shifted with mortgage and consumer pipelines down from the end of Q1 and commercial and business banking pipelines up compared to Q1. In total, we would anticipate Q3 loan activity to produce results similar to what we saw in Q2. Our production deposits of $348 million was the primary driver of our cash reduction. It’s important to note that the majority of this change was focused in approximately highly — 30 highly interest rate sensitive depositors and our strategy to reduce deposit concentrations and manage deposit costs. Also factoring into this change were the sunsetting of a deposit offering that was tied to the Fed funds rate and the result of our strategy of referring customers into wealth products as a means of providing better yields, particularly to our municipal and corporate customers and building wealth balances and fee income. We’re very pleased with the health of our deposit franchise. And this is best reflected in our noninterest bearing demand and savings balances, which in total, experienced a modest increase this quarter. Other balance sheet items worth noting are $41 million increase in securities and a $30 million reduction in PPP balances, signaling that we are nearing the end of that very successful program here at S&T.
Turning to Page 5, you will see that our asset quality statistics continue to improve highlighted by a significant reduction in our NPAs by nearly $21 million or 35% in the quarter. Included in these results is the complete resolution of one C&I credit that had taken nearly two years to complete. Further highlighting our progress is the year-over-year reduction in NPAs of $75 million or nearly 66%. Net charge offs for the quarter totaled $3 million or 17 basis points for the quarter. Moving forward, we remain focused on monitoring customer liquidity, customer margins, collateral values and the impact that this might have on customer cash flow. I’ll now turn it over to Mark to provide more detail on the reserve for the quarter and additional comments on our performance.
Mark Kochvar
Great. Thanks, Dave. The ACL decreased overall in the second quarter by 4 basis points to 1.39%. The C&I resolution mentioned by Dave resulted in a charge off in the second quarter that we had a specific reserve for at the end of Q1. This resulted in a decline in the ACL, which was partially offset by a modest increase in the qualitative part of our ACL. Our outlook has become more cautious given broader economic concerns related to higher rates and the potential for a recession. Net interest income increased by $7.5 million or 11% compared to the first quarter. Ex PPP, the increase was $8.2 million or 12.6%. PPP continues to wind down for us with just $11.7 million outstanding and only about $300,000 of fees remaining at the end of the second. The net interest margin rate is up 40 basis points, 42 ex PPP as loan yields improved by 34 basis points.
The asset mix improved with lower cash and the cost of interest bearing deposits was flat compared to the first quarter. In mid June, we made our first adjustment to core money market rates and introduce short term specials as part of our core deposit retention strategies. We’ve experienced only modest pressure to make exceptions, which we evaluate individually based on customer relationships. Our loan portfolio is over 50% tied to short-term rates and beyond the impact of our floors. So going forward, every 25 basis point increase translates into approximately $9 million of annual additional interest income. Our net income and net interest margin outlook for the next few quarters remains positive given expectations for additional short term rate increases.
Noninterest income decreased by $2.6 million in the second quarter compared to the first. The largest item is the decline in the fair value of the assets in a nonqualified benefit plan, which relates to stock market performance. This was a negative $1.4 million in the second quarter compared to a negative $0.4 million in the first quarter, resulting in a $1 million quarter-over-quarter unfavorable variance. This also shows up as a reduction in salaries and benefits. So it’s P&L neutral. Mortgage banking decreased by $0.5 million compared to the first quarter as we directed the majority of our production to the portfolio. Total mortgage production was actually higher in the second quarter by almost 25%. While management fees were essentially flat despite the drag of the lower stock market as activity continues to be very good as we engage with our customers. We expect the mortgage and wealth fee income numbers to be under some pressure for the remainder of the year, resulting in a lower quarterly fee outlook of $14 million to $15 million.
Expenses were up by $1 million compared to the first quarter. Salary and benefits increased primarily due to higher incentives related to our improved performance and also elevated medical costs. Improved revenue drove the efficiency ratio lower by 200 basis points and resulted in positive operating leverage. Our quarterly expense expectations remain in the $49 million to $50 million range. We have strong capital levels and are well positioned for growth. We executed just over $4 million in buybacks during the quarter and we’ll continue to look for opportunities depending on economic conditions, our financial performance and the price of our stock. We have approximately $33.3 million of repurchase capacity remaining in our buyback authorization. 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
[Operator Instructions] And the first question is coming from Daniel Tamayo from Raymond James.
Daniel Tamayo
Maybe we — if I got the fee income and expense guidance there at the end, did you give expectations for NII or the margin?
Mark Kochvar
Not specific. I mean, given the Fed outlook, we do have a better read on the interest income side of that. The deposits and the timing of — and the reaction of our customers is a little bit harder to predict, but we do expect the NIM and the interest income to increase fairly significantly, at least for the next two quarters. If the Fed stops as expected by the market, we would then expect net interest income to come down slightly as the pricing catches up over time.
Daniel Tamayo
I guess, maybe digging a little further into the NIM in particular there. Looking historically, you guys are — I guess, if you do continue to see some pretty substantial expansion in the next couple of quarters if rates rise as expected here. It will take you to levels on the margin that you haven’t seen in quite a while. Obviously, the deposit base has improved substantially over the last few years. But how are you thinking about that level of performance on the margin relative to S&T historically and how the biggest drivers of that? Is it just — it looks like the loan portfolio mix is pretty similar. Is this simply a function of the deposit base being better? And if so, do you expect deposit betas to be better than they — historically?
Mark Kochvar
I think you’re right. On the loan side, we’re very similar. We’ve always had a fairly high concentration in the floating rate area. I think the difference will come in deposit. We have much higher demand deposit levels than we’ve ever had previously. As we have talked about before, we relied historically on a product that — whose rate was tied to the Fed funds rate. That no longer is the case that’s just a regular money market. And also historically, we’ve had a lot more borrowings than we currently have. Most of those were floating rate borrowings. So the liability side, to the extent we’re able to manage that successfully, will be the differentiator in both the improvement in the net interest income and margin and how much of that over time we’re able to retain.
Daniel Tamayo
Okay, that’s very helpful. I appreciate that.
Chris McComish
This is Chris. I’ll just add, we’re spending a lot of time talking about the health of that deposit franchise and the importance of it, not just from the financial results but what it says about the relationship with customers. And that’s where the loyalty comes and that’s where our work is. So to see things like external recognition around that feels pretty good right now in the environment that we’re in and we’ll continue to maintain that focus on the deposit franchise. The move that we made relative to that product, Mark talked about that was tied to more market rates, that was a proactive decision that we made towards the end of last year, recognizing that there are alternatives for our customers that we can help them with. Dave mentioned being able to move some things off balance sheet for customers and then being able to then help control the margin a little bit better by unlinking that product to the treasury market. So there’s some strategic decisions that we’ve made, as well as just being — understanding the importance of paying attention to the deposit franchise that’s reflected in our customer relationships.
Daniel Tamayo
Overlap on what you just said, but you talked about the [letting] rate sensitive to run off. The loan deposit ratio jumped up pretty significantly in the quarter because of that and the good loan growth. How do you think about the interplay there, where are you comfortable letting deposits come down, or is that portfolio that balances in that rate sensitive product small enough now — focus on growing from here?
Mark Kochvar
I mean historically, we’ve run over 100%. I think our appetite for that is not what it probably used to be and would probably be more comfortable closer to where we are now. So I mean, our focus right now is on retention and we’d like to see that loan deposits stay more stable at this level or even lower as we put more effort on that cultivating that deposit franchise.
Daniel Tamayo
And I apologize, just one clean up question here. Did you mention how the fair value changes were in the quarter?
Mark Kochvar
You mean the bond portfolio?
Daniel Tamayo
They were — it played in the noninterest income and expenses.
Mark Kochvar
It was — for the quarter, it was $1.4 million quarter-over-quarter because last quarter we also had a $0.4 million hit as well [Multiple Speakers] more in the current quarter.
Operator
And the next question is coming from Michael Perito from KBW.
Michael Perito
Mike I wanted to start on the credit side. Obviously, just looking at the nonperformers over the last six quarters, tremendous improvement. Just as we look at the [Technical Difficulty]…
Dave Antolik
So if you look at what we see heading into the second half of the year in terms of individual credit issues, we continue to work the NPA downward and we would expect that to continue. Formation has been far lower than what we’ve been able to move out — and expected improvement in the NPA. But we are very cautious about particularly in the commercial book, we have a lot of exposure and I mentioned in my prepared comments monitoring liquidity, inventory levels are high as folks rebuilt inventories in order to keep with sales expectations. And the value of that collateral then is — we see some risk in that being overvalued, so we’re very cautious on how we grow with our customers and monitor those activities very closely.
In the consumer book, we know there are pressures from a credit perspective on folks in terms of their — again, their obligations and their ability to make payments of working a lot on helping our customers with managing that process. So there is a fair amount of uncertainty from a macro environment. But we do know that with the Fed — each Fed increase comes additional credit pressure and cash flow pressure on many of our customers. So far we haven’t seen it manifest itself in additional deterioration on an ad hoc basis, a lot of this is just anecdotal in conversations with commrecial clients and customers and folks in the branch world. But we know that there will be pressure as we move forward and I think that’s reflected in the qualitative analysis.
Chris McComish
And so Mike, the qualitative piece, a large part of that was driven just by that reasonable quarter over quarter forecast element in there. We saw a little bit of an uptick in the unemployment rate but still historically low. But from management perspective when we look at that given the concerns out there on the inflation and without any for a recession, we started to make some adjustments related to that. And also just some concerns that we have with certain portfolios where there maybe more stress going forward. We’ve also made a few adjustments. Prior to this strong rates up and the recession appears, I would have said that we would expect the reserve to come back to sort of pre-pandemic post-CECL levels, which for us was maybe around 110 or so. But given the outlook, I guess I wouldn’t expect us to get there unless the Fed is able to engineer a nice soft landing for us, then post that, we could potentially get to something that looks like that low 1% area.
Michael Perito
And then secondly, just to spend a minute on capital here. Obviously, you guys have been insulated relative to a lot of peers on these AOCI impacts to tangible capital and book value levels and your [reg] ratios, leverage specifically took a nice step up at a very healthy level. Your NPAs are down, your cash balances are still high, the balance sheet looks conservative. I know it’d be nice to have a little bit more clarity on the macro, but I feel like we’re just kind of in this perpetual environment where you’re never going to get it. So thinking about the buyback here it seems like the balance sheet relative to when we were asking this question a year ago is in a really strong position, it’s obviously saw the activity in the quarter. Do you think that can continue for the the near term here? And just any other broader thoughts on capital deployment would be great.
Mark Kochvar
Again, I think a quarter ago, I probably said it was unlikely that we would do any buybacks. And the fact that we started to do a little bit towards the end of the quarter, indications that we’re taking a much harder look at that, especially given — even though the out — you said the outlook is tough, but we expect our earnings to be good over the next several quarters, which should be supportive of the capital levels which then should support the buyback. So I think we’re looking at it a little bit more seriously now than we were in past quarters, but again, with an eye on what the macro environment does. But again, we’ll probably take a much harder look in the second half here.
Chris McComish
And how all these things weave together, right, focusing on safety and soundness, focusing on the credit book, focusing on the deposit book, all of those things represent the customer relationships and helping guide them through these times. And the strength of our balance sheet gives us not only the ability to work through these issues, but creates optionality for us as we move forward. So in that reason it’s the reason to be optimistic as we’re heading towards the second half of this year.
Operator
And the next question is coming from Russell Gunther from D.A. Davidson.
Russell Gunther
Chris, congrats on the one year anniversary of S&T. I guess as you look forward, maybe circle back to some loan growth comments and mix. 2Q was more consumer, 3Q looking more commercial. Chris, as you look ahead, maybe bigger picture strategically, any updated thoughts on what you think the right mix is for S&T going forward?
Chris McComish
I mean, I talked a little bit about foundationally who are we as an organization, and what is it that we’re distinctive and really good at. And my opinion is we’ve got a very strong commercial bank from the standpoint of ability to grow. That’s vested in human beings that are talented and known, respected and delivering in the marketplace. So the leadership changes that we’ve made, from a leadership standpoint within Commercial Banking are significant, both our Head of Commercial Banking as well as newly appointed Chief Operating Officer in Commercial Banking. Our field leadership teams are a group of people that have got tons of confidence in from the standpoint of being out in the marketplace and delivering. So that middle market commercial focus and CRE focus will continue to be really important to us. We have a — for the size of our company, we have a sizable business bank. And those are the smaller companies, let’s call it, around $10 million in revenue, a really strong and deep team of business bankers that I think that we have opportunities to build capabilities around, not just in asset generation, but more importantly, going back to that deposit focus on — the deposit-rich segment of the market that is highly dependent upon physical distribution, both human beings and the branches that we have. So we’ll continue to emphasize that area of the company.
We’re going to be bringing in some additional capabilities from a treasury management and payments capability. We’re going to build some things over time. But asset growth in the commercial space will continue to be important for us, and it is how we can be distinctive in the marketplace, both from a name recognition standpoint as well as a reputation. Foundationally, our deposit book is very much rooted in our consumer business. And those consumers who are giving us the results from J.D. Power and Forbes and all of that tells me that we’ve got a story to tell. Dave and I were talking earlier today. Dave made the statement to be but we got to be more bold and we’ve got to take the opportunity to promote who we are as an organization. Still capabilities to build. We’ve got functional capabilities from a digital banking standpoint that we’ll continue to enhance and grow over time. But foundationally, a year later, we’ve got a team here that I’m really excited about. Now we’re going to turn our attention and to focus on some of those foundational opportunities.
Russell Gunther
I appreciate the commentary. From a volume perspective, ex PPP, you guys are around 6% annualized and comments suggest a similar result for 3Q. So is that the right way to think about S&T going forward, that kind of mid single digit result? Do near term macro headwinds put that at risk in the short term or are there anything strategic contemplated to try to push that into the high single digits over time?
Chris McComish
I think there’s so much on — there’s a lot of variability externally in the market right now. And so we’re going to control those things that we can control, and that is the number of and talent level of our team and the capabilities that they have. We will respond accordingly to the marketplace as we see it. And our ability to respond is very much dependent upon our financial condition, the strength of our balance sheet and all of the things that we talked about. So growth for the sake of growth in an environment like this is not necessarily something that we’re going to put at the top of our list, but we certainly want to be opportunistic. And to be opportunistic, you’ve got to have the foundation underneath you in order to make that happen.
Russell Gunther
And then just last one to follow up on the deposit beta conversation. I appreciate the guide for every 25 basis points. Could you share your thoughts on what your through-the-cycle deposit beta might be as you kind of go through that once all the hikes are in and kind of digested, where you think that total deposit beta through the cycle shakes out?
Mark Kochvar
I mean it’s really just a guess. We look to our prior performance as a starting point. So with a better mix, if we apply betas at a little more granular level beyond just the total, that better mix gives us a better number compared to what we did last cycle. So depending on how you measure it, you go from kind of — we go from kind of mid-30s or higher maybe to something south of 30%. The other factor in here is that just the pace and the size of the change being so different where we may not have had time for the cumulative betas to really find their way all the way through that cycle and to the extent this one goes a little bit further, will that be an impact or will it get cut off because of the recession fears and people won’t expect or get increased rates. So my best guess is it’s certainly better than last time, probably something less than 30%. But again, I might have a different answer next quarter.
Dave Antolik
And Russ, I think to add to Mark’s comments, if you compare where we are today, in terms of our overall funding sources, we’re in a much, much better position in a rates-up environment than we were through the last cycle. We were forced to compete on deposit rate. So for us, it’s not just deposit beta. I mean, S&P took a step back and looked at costing liabilities data or the funding data that was higher still for us, again, because of the borrowing position that was mostly floating that we had. So without that, that gives us a better position. There’s more in that deposit beta than there was last time around. So everything else equal, the borrowing beta was 100%. So to the extent we can stay with a better loan deposit ratio and stay away from the borrowings, we’re going to have a better, what’s more important, NIM beta than we had in the prior cycle.
Operator
[Operator Instructions] Next question is coming from Samuel Varga from Stephens Inc.
Samuel Varga
I just had a couple of follow-up questions around the balance sheet liquidity and asset sensitivity. So thanks for comments around the loan-to-deposit ratio, that’s very helpful. And I wanted to ask if you could give us some color on the market cash flows from the securities book where it is today?
Mark Kochvar
The what cash flow?
Samuel Varga
Just around the monthly cash flow that you get from the securities book.
Mark Kochvar
So we have — in our — the mortgage backs that we have, it ranges is probably around $5 million to $10 million per month. And then we might have another $10 million of — have fully maturing securities every quarter. So on a quarterly basis, it’s probably $25 million, $30 million.
Samuel Varga
And then on the asset sensitivity side, could you give some numbers around the roll on of dynamics, specifically for the loan book at this point?
Mark Kochvar
Just on the rates, you mean?
Samuel Varga
Yes, that’s correct.
Mark Kochvar
In this past quarter, we were just about at parity where the new loans was about the same as the payoffs. With the higher Fed move, we expect that to turn the corner in Q3 where I would expect the new rates to outpace the paid rates beginning in Q3. So we’re just at that transition point in Q2.
Samuel Varga
And my last question, just around the conversation of margins, understanding that I think just previously noted your historically high levels here. Is there any sort of strategic thinking around stabilizing that margin [point] through hedging or some other options that you’re looking at, at this point?
Mark Kochvar
So a couple of things we’ve done. We have added modestly to the securities book and we’ve done that mostly with a little bit longer duration purchases and what we typically buy when we do that is securities that have a pretty good lock out so that we’re not subject to cash flow. So we’re not buying pass throughs, for example, we’re buying structure — a more structured product. And then we have started a program of received fixed swaps and we’re continuing to evaluate that and add to that to try to lock in some of the some of this rate environment and to take some — we do have that over 50% of floating to bring that back for the overall balance sheet somewhat. So I think at the end of the last — at the end of this quarter, we had about $300 million of received fixed swaps and we will evaluate potentially doing more of that as the rest of the year goes on.
Operator
And there were no other questions in queue at this time.
Chris McComish
Well, listen, thanks, everybody for your attention and your meaningful important questions in the dialog. We certainly appreciate your interest in our company and we’re very enthused to be moving forward in light of the market and the environment that we’re in. So have a great rest of the day and we look forward to talking to you soon.
Operator
Thank you, ladies and gentlemen. This does conclude today’s conference. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.
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