Q3 2023 S&T Bancorp Inc Earnings Call
Participants
Christopher J. McComish; CEO & Director; S&T Bancorp, Inc.
David G. Antolik; President & Director; S&T Bancorp, Inc.
Mark Kochvar; Senior EVP & CFO; S&T Bancorp, Inc.
Daniel Tamayo; Research Analyst; Raymond James & Associates, Inc., Research Division
Daniel Edward Cardenas; Director; Janney Montgomery Scott LLC, Research Division
Manuel Antonio Navas; VP & Research Analyst; D.A. Davidson & Co., Research Division
Matthew M. Breese; MD & Analyst; Stephens Inc., Research Division
Michael Anthony Perito; MD; Keefe, Bruyette, & Woods, Inc., Research Division
Presentation
Operator
Welcome to the S&T Bancorp Third Quarter 2023 Conference Call.
(Operator Instructions)
Now I would like to turn the call over to the Chief Financial Officer, Mark Kochvar. Please go ahead.
Mark Kochvar
Great. Thank you. Good afternoon, everyone, and thank you for participating in today's earnings call.
Before beginning the presentation, I want to take time to refer you to our statement about forward-looking statements and risk factors. This statement provides the cautionary language required by the Securities and Exchange Commission for forward-looking statements that may be included in this presentation. A copy of the third quarter 2023 earnings release as well as this earnings supplement slide deck can be obtained by clicking on the Materials button in the low right section of your screen. This will open up a panel on the right where you can download these items. You can also obtain a copy of these materials by visiting our Investor Relations website at stbancorp.com.
With me today are Chris McComish, S&T's CEO; and Dave Antolik, S&T's President. I'd now like to turn the call over to Chris.
Christopher J. McComish
Mark, thank you, and good afternoon, everybody, and welcome to our call. I certainly appreciate all the analysts being here with us this afternoon. We look forward to your questions. I also want to thank our shareholders and employees 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.
Before I get into the numbers, I want to further emphasize how good I feel about the progress we're making to move S&T forward around what we have defined as our people forward purpose. This purpose is guided by our values that shape who we are as a company and is propelled by our key performance drivers. One, growth and health of our deposit franchise; two, solid credit quality; three best-in-class core profitability; and four, all of this is underpinned by our focus on enhancing employee engagement and talent. This work translates in delivering for both our customers and the communities that we serve in a differentiated way, and it's further evidenced by the efforts of all of our team and in the results that we'll discuss today.
You'll see on the page highlighted that for the quarters, third quarter, we delivered $0.87 a share or just over $33 million in net income. That's driven by our fourth straight quarter of net interest income in the high $80 million range. We're very happy with our continued top quartile net interest margin at 4.9 -- 4.09%, though it did decline quarter-to-quarter. Our PPNR again is top quartile at just under 2% at 1.99%, and our return metrics are also very strong, and that combined with our capital levels certainly position us well for the future. Net charge-offs were 20 basis points in the quarter, and our efficiency ratio remained well within our range at 52.68%, little bit up over Q2. We'll talk further about that, but still where we expected it to be.
Moving forward, before I turn it over to Dave to talk about our -- the loan side of our balance sheet, you can see the deposit mix basically stabilized for the quarter. We showed about flat customer deposits with mix shifting a little bit from our DDA balances and savings into CDs at $80 million of customer CD growth was split between about $30 million of deposits new to the company and $50 million of shifts within the balance sheet.
We continue to proactively work hard on customer relationships, expanding those deposit opportunities, protecting what we have while balancing growth and margin and cost, and focusing, as I said, on our relationships.
I'll turn it over to Dave to talk about the loan side of our balance sheet. I look forward to your questions in a little bit.
David G. Antolik
Well, thank you, Chris. And continuing this review of our balance sheet, we did see increased loan growth in Q3 of $196 million or almost 11% annualized. This growth was driven by increases in both our residential mortgage and commercial real estate categories. Regarding our residential mortgage activities, we continue to see solid demand for construction and purchase-related products and anticipate this demand to -- and the pace of this growth to continue in the coming quarters. We are closely monitoring the pricing of these products and believe that keeping this activity on our balance sheet provides for the most favorable economic benefit for S&T.
Our commercial real estate balances grew during the quarter primarily as a result of new production in our multifamily, storage, retail and industrial segments. As a reminder, a few quarters back, we provided details on our office portfolio. We continue to remain comfortable with our exposure to the office segment. And as a reminder, that represents approximately 7% of our total loans. We have not seen changes in that segment since that disclosure and balances remained flat quarter-over-quarter.
It's also worth mentioning that our healthcare related exposure remains flat quarter-over-quarter, and we believe that -- and we remain comfortable with that exposure as well. In our C&I book, we did not see significant changes in any of the core metrics that we measure, including things like utilization and collateral advance rates.
We have seen reduced payoff levels in both our resi mortgage and CRE books primarily related to increased interest rates. And based on our current pipeline and these reduced payoff levels, we anticipate total loan growth in the mid-single-digit range for the coming quarters.
Turning to asset quality. Nonperforming assets declined by $1.6 million to $16.4 million when compared to Q2. Net charge-offs for the quarter were $3.7 million or 20 basis points of total loans. And primarily as a result of loan growth that I described earlier, and the qualitative factors in our model, our ACL grew by $2.4 million during the quarter and remained at 1.44% of total loans.
I'll now turn it over to Mark to dig in a little deeper.
Mark Kochvar
Great. Thanks, Dave. Before right started moving higher back in the fourth quarter of '21, our net interest income was $68.4 million and the net interest margin was 3.12%. While there has been and we'll continue to be some pressure on funding costs, our asset-sensitive balance sheet has provided significant revenue improvements over the past 7 quarters. In the third quarter of 2023, the net interest margin is 97 basis points higher, and we're generating almost 28% or $19 million of additional revenue per quarter compared to the beginning of the cycle.
The third quarter net interest margin rate of 4.09% is down 13 basis points from the second quarter as earning asset yield improvement of 13 basis points and that keep pace with a 35-basis point increase in costing liabilities. The cost of total deposits, including DDA, increased by 24 basis points to 1.38% bringing the cycle to date beta to 25%.
Our deposit mix remains much improved compared to the end of the last rates up cycle in 2019 when we had just 24% of deposits in DDA compared to almost 32% today. Customers continue to seek higher rates but the pace has moderated. DDA declines were $54 million in the third quarter. That's far less than the $138 million decline in the second quarter and the lowest decline since this rate cycle began. We expect the funding cost pressure to continue with an interest margin compression of approximately 10 to 12 basis points in the fourth quarter and into the first quarter of 24. Assuming no fed changes, we expect compression to moderate and the net interest margin to stabilize midyear '24.
Noninterest income decreased by $2 million in the third quarter compared to the second. Most of the variance is in the other category. This is primarily related to a $1.6 million of changes in valuation adjustments. A little over half of this is due to the transition from LIBOR to SOFR and its impact on our back-to-back customer swap program. While the remainder of the valuation adjustment is related to changes in the value of a deferred benefit plan that is offset in expenses and is P&L neutral.
In addition to that, we had a gain on OREO of $600,000 in the second quarter and no activity in the third quarter. Remaining fee category line items were fairly consistent quarter-over-quarter. Our quarterly fee outlook is in the $13 million to $14 million range.
Expenses continue to be well controlled with an efficiency ratio of 52.68%, increase in expenses came primarily in salaries and benefits and was in line with our expectations. In the second quarter, we lowered our incentive accruals as full year expectations have changed, and this quarter, we're back on a more normal pace. Our quarterly expense expectations remain in the $52 million to $53 million per quarter range. And as we look ahead to 2024, we expect that the pace of expense growth will reduce back to lower single digits.
The TCE ratio declined 11 basis points this quarter due to loan growth and higher AOCI. TCE remains quite strong and has been stable over the last year due to good earnings and a relatively small securities portfolio. So a reminder, all of our securities are classified as available for sale. Our capital positions us well for the environment and to take advantage of organic or inorganic growth opportunities.
Our remaining share repurchase authorization of just under $10 million, we did not execute any buybacks in the third quarter. We cautiously look for opportunities to deploy the remaining authorization depending on economic conditions, our financial performance and outlook, along with the price of the stock.
Thanks very much. At this time, I'd like to turn the call back over to the operator to provide instructions for asking questions.
Question and Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Daniel Tamayo of Raymond James.
Daniel Tamayo
Good afternoon, guys. Maybe just starting on the margin. I appreciate the guidance that you gave. Just curious kind of where you entered the quarter, if you could talk about kind of margin or loan yields or deposit costs that you had kind of at the end of the third quarter.
Mark Kochvar
Again, it's trending down slightly. So we exited the quarter a couple of basis points below the full quarter number.
Daniel Tamayo
Okay. And then I guess just -- we can talk a little bit about credit here. Just curious your thoughts on how things are trending there. And then if you have levels of shared national credits and/or leverage loans or participations that you have in the books?
David G. Antolik
Yes. I mean, generally speaking, you saw the increase in the ACL and some of what's reflected in that is the qualitative factors that enter into that calculation. So we are anticipating that there may be some headwinds in terms of macroeconomic conditions that will impact our customers.
Christopher J. McComish
And it relates to shared national credit, we basically have very little exposure at all.
Daniel Tamayo
Okay. Great. And then lastly, just a cleanup question. Do you have the actual MSR valuation adjustment in the third quarter?
Mark Kochvar
The -- we didn't have any impairment or anything like that. Is that what you're referring to? We didn't...
Daniel Tamayo
Yes, the -- sorry, you had the valuation adjustment, the $1.6 million change. I was just curious what the actual number was?
Mark Kochvar
That wasn't MSR related. That was related to the back-to-back swap program. We have like a difference between the 2 rates, between the customer rate and the rate with counterparties. So that adjustment was around $900,000 of that $1.6 million. The rest of that was defined benefit trust that's in the stock market. So it has both an asset and liability component and those get offset between fees and expenses but it creates variances when the stock market value changes.
Daniel Tamayo
Okay. So the amount that we should view as kind of volatile or non-core is the $0.9 million. The $1.6 million is just the change from the second quarter. Is that right?
Mark Kochvar
The $1.6 million is the change quarter-over-quarter, depending on how you view this defined benefit plan. Sometimes that goes in our -- is a positive, sometimes negative. So that one's harder to -- hard to measure. The other piece on that just quarter-over-quarter with the OREO gain that was in the second quarter. (inaudible) helpful to you?
Daniel Tamayo
No, no. Yes, I got the OREO game that makes sense. All right. I appreciate that, guys.
Operator
Your next question comes from the line of Matthew Breese of Stephens.
Matthew M. Breese
First of all, I wanted to touch on deposits. So one of the surprising in a very good way, thing is about this interest rate cycle for you all is how noninterest-bearing deposits have kind of really held up a lot better than your peers. And it feels like at this point, there's probably a pretty good line of sight at where the bottom is. I did want to get a sense for where you all are projecting that "bottom" and whether or not you think you can kind of hold noninterest-bearing deposits north of 30% as we get into 2024?
Mark Kochvar
I think you're right. I mean, we are very pleased with that. We've put a lot of work into the -- our treasury management activities and have -- are developing programs, especially for the small business segment. We feel like there's some support that will come with that. So even though we might lose other deposits, we're doing we're very active in trying to cultivate new relationships and additions otherwise.
I mean, the internal modeling, we try -- we experiment with very multiple scenarios. But we do think that we will stay well above where we were last cycle, whether we can maintain above 30%. We do expect to stay at least in that general area as is bottoms.
Christopher J. McComish
Matt, it's Chris. To further speak to some of what Mark touched on. We've got a number of programs and initiatives that we've been focused on all around what we define as the health of our deposit franchise, which actually started before some of these rates -- this rates up cycle just because we know that is how you define a customer relationship. So we've talked in previous quarters about more and -- more talented people focused within the treasury management space.
In addition to that, we've enhanced our product set for our customers as well as our delivery mechanisms, including some inside -- what we would define as inside customer relationship teams that are very focused on proactively managing and growing these relationships. We've got very strong customer loyalty and very high customer engagement. Those are not our words. Those are the words of those that measure these things.
And so that gives us the opportunity to be having these conversations and be proactive in a trusting way to build on the most important part of the customer relationships that the day-to-day operating account and operating business. And so that's a big part of our focus. And you can -- you never provide a complete direct drive as to one versus the other, but we know it's critically important to us, and that's where we're allocating resources.
Matthew M. Breese
Understood. And maybe along these lines, where do you expect for this interest rate cycle, the total cost of deposits to kind of peak out? Or do you have a terminal deposit beta estimate? .
Mark Kochvar
Well, as guidance, we look at how the last cycle panned out. We think we'll do a little bit better than that just because we have a much better mix. So last cycle, we were around 35%. We're at 25% now. So kind of my best guess is kind of about the middle there, so closer to 30%, when it's all said and done.
Matthew M. Breese
Okay. And then I know you had mentioned a near-term outlook for the NIM, it sounds like down 10, 12 basis points for the fourth quarter and the first quarter and then stabilization in the mid -- middle of 2024. Should that be kind of in the 380 -- 375 range. Is that a fair estimate of where the NIM should stabilize?
Mark Kochvar
Yes.
Christopher J. McComish
You're good. You're still on.
Matthew M. Breese
I got that last question there. Balance sheet is $9.5 billion. Obviously, there is the $10 billion threshold. I know we've discussed this in the past as being something that you could kind of -- it's not as close as it looks. I just wanted to get a sense or a reminder of, one, what the Durbin impact is? And two, at what point do you feel like will realistically be crossing that $10 billion thresholds?
Christopher J. McComish
So, to -- the way we look at it, the Durbin threshold itself is quantified in that kind of $6 million, $7 million range. I mean we made $30-some million this quarter. That financial impact is things that we're planning for to move through. We're going to -- we're working every day to prepare for growth. And the $10 billion threshold is a number, and we know that it's there. We've enhanced significantly our compliance and risk management capabilities and our team, all under the guidance of building a foundation for growth.
We believe organically, this is something that we're going to celebrate as we get there, and we're looking sometime in the next 2 calendar years depending upon growth.
Operator
Your next question comes from the line of Manuel Navas of D.A. Davidson.
Manuel Antonio Navas
Once you get to that kind of NIM stabilization point, do you guys expect cut the NIM to drift around a couple of basis points up, a couple of basis points down? Or is there still maybe some residual pressure? Or does it kind of turn up a little bit? What are kind of thoughts about that stage ?
It's probably -- there's a lot of moving parts but just kind of initial thoughts?
Mark Kochvar
Yes. So there -- I mean, you're right. I mean, there's a ton of moving parts. Like for example, we've historically been much more concerned about rates down than rates up, especially now that rates are higher. So we put on $0.5 billion worth of received fixed swaps. And those come off over as we [rendered] them out, they come off over like a 2-year period starting in '25. And so as those come off, those are going to provide some relief to the margin. We'll have to reevaluate at that time whether renewing those positions and what the impact of that will be because that will depend on the shape of the curve.
So we have some more positive headwinds like that further out beyond '24 into '25 that should help us out as well. But you're right, it's very complicated. There's a lot of moving parts between now and a couple of years from now.
Manuel Antonio Navas
I appreciate that. Is -- on the deposit side, you talk about those initiatives, and you've added talent, you've added new technology, new products. Do you have a quantifiable deposit pipeline? And just kind of give me some way to frame the deposit growth opportunity to year-end or possibly near term in general?
Christopher J. McComish
Yes. From a pure dollar pipeline standpoint, it's a little harder to measure the pipeline simply because the change in the portfolio is so dependent upon things that we don't control and that balances and in customers' accounts. So the way we're measuring things today from a pipeline perspective is really more about numbers of activities. The numbers of times in the depth of those, for example, Manuel like treasury management products, we know exactly the number of customers that we've enhanced the treasury management relationship around. We know the number of products, we know the revenue associated with that. It's really harder from a pipeline standpoint to say and that, by itself, is going to translate to $1 or $2 of balances. So at this point in time, we're very focused on activity levels, numbers of opportunities, which gives us a proxy for growth.
The other thing that we have introduced are some tools that give us the capability to understand flow of deposits. So the stat that I gave you earlier in that $80 million of CD growth -- that you saw customer CD growth, we know that there was $30 million that was a shift -- a mix shift, I'm sorry, a $50 million from 1 bucket to the other within our balance sheet. And then there was actually $30 million of new deposits that came into the company.
So we're trying to look at 3 factors on the deposit portfolio, what we would call diminishment. So (inaudible) full relationship, there's just fewer dollars; two, increases in existing relationships; and then three new to company, and that's how we're measuring all of it.
Obviously, it's tough to put a bogey on there from a balance sheet growth standpoint because as you know, you look year-over-year and the whole industry is down about 6%. So we've got to be realistic into how big the pie is that we're going after as well.
David G. Antolik
And measuring that opportunity and shaping up that opportunity is a lot of what we're focused on. We know there is latent opportunity within our own customer base. And we talk a lot about developing primacy in terms of those deposit relationships. So we've developed tools and calling lists and products in order to achieve primacy with the -- but those customers who like us, they do business with us, we just don't have their primary account, and that's where we are focusing our efforts.
Manuel Antonio Navas
As I look across those initiatives, which ones do you feel are -- without giving away internal numbers or anything like that, do you feel happy across all of them? Or do you feel some of them are outperforming others?
Christopher J. McComish
Some of them -- well, they didn't all start at the same time, correct? So for example, an initiative we put in place earlier in this year was an enhanced in a more efficient way for our bankers in our branches and our business bankers to build treasury management capabilities with what we would define as business banking and small business customers. And that has resulted in significant numbers of new opportunities that where -- as Mark -- as Dave talked about, that were latent opportunities, our job was to make it easier for our teams to fulfill those opportunities and develop expertise.
So we added talent. We added an ability for information to move between our teams more effectively and ability to put the business on the books for the customer more efficiently. And these are -- we're seeing -- we're very pleased with the progress there. An announcement that we made just within the past 30 days is the introduction of an integrated payables product for our largest commercial banking customers. That puts us closer to par with the biggest banks that we compete against from a treasury management standpoint, and what we're doing today there is having conversations with customers that will lead the business down the road. So some of these things are phased in over time.
Manuel Antonio Navas
That color is great. Is there like a near-term loan-to-deposit target that this can kind of help move you towards given they are 103% now, just kind of -- maybe that's a different way to approach it.
Mark Kochvar
Yes. I think we are looking to reduce that over time. Right now, we don't have specific goals for certain dates because we want that [to be] quality improvement. But that's also embedded in there as we're able to do that, is some opportunity back to the kind of the margin argument as we're able to replace some of the borrowings and wholesale funding that we have with deposit growth. There's an opportunity to improve margin by adding deposits replacing some of those wholesale borrowings. So we think there's a lot of value in being able to -- that we don't have specific loan deposit goals by time frame at this point.
Operator
Your next question comes from the line of Daniel Cardenas of Janney Montgomery Scott.
Daniel Edward Cardenas
Just quickly, can you give me some color as to how much of your securities portfolio is scheduled to mature or reprice in Q4 and our expectations to put that to work in the loan portfolio? Or are you going to reinvest in securities? .
Mark Kochvar
We're on the securities -- we have a relatively small securities portfolio. So we're looking to maintain the size of that just to maintain a level of on-balance sheet liquidity that we're comfortable with. So we typically have anywhere from $25 million to $35 million rolling off between cash flow and maturities in any given quarter. So we would look to reinvest that in securities book to maintain the balance at approximately where it is now.
Daniel Edward Cardenas
All right. Great. And then maybe if you could give me some additional color on the credit quality side. How does your watch list look? What [would] trends this quarter? And what are your level of classified assets look like compared to last quarter?
David G. Antolik
Yes. I mean as you can see, starting with the NPLs, we saw a reduction. The level of C&C and watch rate credits has remained relatively stable. And that's ultimately in the ACL remaining stable as a percentage of loans quarter-over-quarter. Any changes in terms of the risk rating stack would be reflected in the -- ultimately in the ACL.
Daniel Edward Cardenas
Good. And then in terms of the $30 million of new deposits that were won this past quarter, what kind of rate did it take to get those -- on average did it take to get those new deposits in? .
Mark Kochvar
Well, that $30 million was specifically for CDs. And so our -- those probably range between mid-4s to low 5s to secure those.
Daniel Edward Cardenas
Okay. And where does that put you guys in terms of your competitors kind of middle of the pack, higher end of the pack?
Mark Kochvar
Let's say maybe probably just above middle overall. I mean we have an active exception pricing program. So we view that as a way to help build and enhance the relationship that we have with customers. So the rate on the sheet may not be exactly the rate that the customer gets depending on what the relationship is and what the opportunity is.
Daniel Edward Cardenas
Got it. Okay. And then what was your AOCI level at the end of the quarter?
Mark Kochvar
It did pick up by about, I think, about $15 million. (inaudible) it's over 100 -- around $100 million.
Operator
Your next question comes from the line of Michael Perito of KBW.
Michael Anthony Perito
A lot of it's been asked or answered but just a couple more things I wanted to clarify. Number one, just as I'm sure you guys are starting to think about next year and the budget for '24. And just curious if you're probably not willing to get too specific but just any high-level commentary around expenses and rate of investment. Obviously, it sounds like NIM pressure will persist into the early part of next year. So does that impact the time line or any of your kind of scheduling around investments you were planning on making, just as we think about kind of the rate of expense growth in '24? Just curious if you guys have any kind of high-level commentary that would be helpful for us.
Mark Kochvar
Yes. I'll address a couple of those. I mean the -- on the expense side, we did have higher expense growth this year. A lot of that was labor market driven. It was very competitive, especially early in the year. We've seen that improve. And we've also added some people. So we have a higher staff level going in. So that is the big driver monitoring somewhat. We're looking at expense growth more in the 3% range versus 6% this year. So we would expect that to be down quite a bit.
I don't think it has had a big influence on the timing of things. Do we have imperatives and things that we want to work on and those things are going to move ahead because we've decided they're very important.
Christopher J. McComish
Yes. I mean we come into this -- the margins are contracting. We come into this situation with a very efficient company and a PPNR that's really strong. And Mike, we believe this given use -- it gives us an opportunity as we move forward in addition to the capital levels and strength of our balance sheet.
On top of that, there is significant disruption in the marketplace. And we have the opportunity to have conversations with bankers and teams of bankers, and we're going to be opportunistic as we move into '24, and build for the future that we believe we've got an operating model and an ability to deliver into the marketplace that is attractive to not only customers but to employees, and we're going to continue to look for opportunities strategically to build this thing out, build the business out, and that's going to be dependent upon the right and number of people.
Michael Anthony Perito
Got it. That's helpful. And then just maybe a question for Mark. Obviously, the uncertain -- it's not uncertain but an unusual rate cycle, right, just the rapidness of it in the short time period in which we saw the increases. And obviously, right now, I think consensus is kind of honing in on this higher for longer environment but that's this week, right?
And so just curious if you guys have any initial thoughts around what a rate cut would do to margin? I mean it feels like there's probably like the static analysis but then there's like the realistic analysis in which the environment's kind of bizarre relative to what we've seen historically in terms of how rapidly rates have gone up. Just curious if you guys have thought about that at all and do you have any context you're willing to offer?
Mark Kochvar
Yes, we think about that all the time. I guess -- I mean just a few comments I'll make is that, as I said, kind of our baseline, just given where we're at is that we are going to have some margin compression. That kind of uses the Fed doesn't do much from here, at least through '24, so kind of the higher for longer. But with that, that is a better scenario for us than a rate down on the front-end scenario.
Even though we have hedged out some of our exposure on the -- to the front of the curve because we are still our asset-sensitive bank, not all of that goes away. So we're still better off with a higher rate environment on the front end than we were if they were to cut 100 or 200 basis points, we would have more difficulty on the margin side, keeping pace with that.
So higher for longer, even though it represents compression or a challenge for us on a baseline is still better than a Fed down scenario.
Operator
I would like to turn the call over to Chief Executive Officer, Chris McComish for closing remarks.
Christopher J. McComish
Okay. Well, thank you. We really appreciate the engagement of the analyst community and the questions. And again, there's a lot to feel proud of in the quarter. We look forward to finishing the year strong and moving on to a productive 2024. So thanks to everybody for joining us this afternoon. Have a good rest of the week.
Operator
This concludes today's conference call. You may now disconnect.
