2023-04-26 20:59:14 ET
Summary
- Loan growth is the major earnings catalyst for 2023.
- I’ve reduced both my margin and non-interest expense estimates.
- The risk level appears manageable because unrealized mark-to-market losses are limited. Further, the deposit book has not undergone any significant erosion during March’s banking crisis.
- The year-end target price suggests a very high upside from the current price. Further, STBA is offering a high dividend yield.
Earnings of S&T Bancorp, Inc. (STBA) will most probably continue to grow this year mostly on the back of loan growth. I’m expecting the company to report earnings of $3.60 per share for 2023, up 4% year-over-year. Compared to my last report on the company, I’ve increased my earnings estimate as I’ve reduced my non-interest expense estimate. Due to the recent market price rout, the year-end target price suggests a very high upside. The price rout wasn’t completely justified as S&T Bancorp’s risk level is manageable. As a result, I’m upgrading S&T Bancorp stock to a buy rating.
Further Loan Growth Deceleration Ahead
Loan growth for the first quarter of 2023 was close to expectations. The loan portfolio grew by 0.85% during the quarter, down from 1.22% for the fourth quarter of 2022. I’m expecting loan growth to further slow down to around 0.75% in the second quarter as interest rates are higher now compared to the first quarter.
Loan growth will also get restricted by the pressure on deposits. The deposit book dipped by 9.7% in 2022, so there was already some pressure on STBA’s deposits before the emergence of SVB Financial’s ( OTC:SIVBQ ) deposit run. The first quarter’s results show that First Republic Bank ( FRC ) also experienced a significant bank run on its deposits. However, S&T Bancorp’s deposit book has shown only mild slippage in the first quarter, so I’m not too worried. Technically, deposits should not restrict loan growth as banks can borrow. However, borrowing in the current high-rate environment will be tough to bear; therefore, I’m expecting the pressure on deposits to have a small effect on loans.
On the other hand, regional economic activity will sustain loan growth. S&T Bancorp mostly operates in Pennsylvania and Ohio with some presence in New York. As shown below, Ohio’s economic activity has grown well over the last few months. However, Pennsylvania’s economic activity index is flattening.
Considering these factors, I’m expecting the loan portfolio to grow by 0.75% in each of the three remaining quarters of 2023, leading to full-year growth of 3.1%. Further, I’m expecting deposit growth to trail loan growth. The following table shows my balance sheet estimates.
Financial Position | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
Net Loans | 5,886 | 7,075 | 7,108 | 6,901 | 7,083 | 7,305 |
Growth of Net Loans | 3.2% | 20.2% | 0.5% | (2.9)% | 2.6% | 3.1% |
Other Earning Assets | 770 | 914 | 933 | 1,768 | 1,141 | 1,006 |
Deposits | 5,674 | 7,037 | 7,421 | 7,997 | 7,220 | 7,315 |
Borrowings and Sub-Debt | 604 | 416 | 228 | 161 | 439 | 568 |
Common equity | 936 | 1,192 | 1,155 | 1,206 | 1,185 | 1,291 |
Book Value Per Share ($) | 26.8 | 34.4 | 29.6 | 30.9 | 30.4 | 33.1 |
Tangible BVPS ($) | 18.5 | 23.3 | 19.8 | 21.2 | 20.6 | 23.5 |
Source: SEC Filings, Earnings Releases, Author's Estimates (In USD million unless otherwise specified) |
The Asset Mix Outlook Counters the Unfavorable Outlook on the Deposit Mix
The net interest margin remained almost stable during the first quarter of 2023 even as the fed funds rate rose by 50 basis points. The below-benchmark performance was partly attributable to the migration of deposits from low-yielding accounts to higher-yielding accounts, as seen in the chart below from the earnings presentation .
1Q 2023 Earnings Presentation
The management mentioned in the conference call that it expects the migration from core deposit categories into certificates of deposits (“CD”) to continue. The management also mentioned that it expects margin compression of 5 – 10 basis points for the next couple of quarters.
While the outlook for the deposit mix is unfavorable, the outlook for the asset mix is better. As loan growth will likely outpace deposit growth, it’s likely that, in order to bridge the funding gap, the management will let securities run off and shift proceeds into the loan portfolio. The resultant shift away from low-yielding securities into higher-yielding loans will lift the average earning asset yield, and consequently the margin.
Overall, I’m expecting the margin to remain mostly unchanged until the end of this year. Compared to my last report on the company, I’ve reduced my margin estimate because the outlook on deposit and asset mixes is different from before.
Raising the Earnings Estimate
The anticipated loan growth will be the chief earnings catalyst this year. On the other hand, a more normal provision expense after a year of subdued provisioning will restrict earnings growth.
Further, inflation will drive up operating expenses in the year ahead, which will restrict earnings growth. In my last report, I estimated non-interest expenses of $233 million for 2023. Operating expenses were better than expected in the first quarter. The management also mentioned in the conference call that it expects the expense run rate to be between $52 million to $53 million, which is $208 million to $212 million on an annualized basis. Therefore, I’ve decided to reduce my estimate for the full year to $218 million.
Overall, I’m expecting the company to report earnings of $3.60 per share for 2023. The following table shows my income statement estimates.
Income Statement | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
Net interest income | 234 | 247 | 279 | 276 | 316 | 356 |
Provision for loan losses | 15 | 15 | 131 | 16 | 8 | 18 |
Non-interest income | 49 | 53 | 60 | 65 | 58 | 55 |
Non-interest expense | 145 | 167 | 187 | 189 | 197 | 218 |
Net income - Common Sh. | 105 | 98 | 21 | 110 | 135 | 140 |
EPS - Diluted ($) | 3.01 | 2.82 | 0.53 | 2.81 | 3.46 | 3.60 |
Source: SEC Filings, Earnings Releases, Author's Estimates (In USD million unless otherwise specified) |
In my last report, I projected earnings of $3.46 per share for 2023. I’ve increased my earnings estimate mostly because I’ve reduced my non-interest expense estimate.
Low-Risk Company in Turbulent Times
Following First Republic Bank’s shocking results that showed a massive reduction in deposits, there is widespread panic in the market, which has also enveloped S&T Bancorp as well. In my opinion, the panic in STBA’s case is unwarranted because the company’s deposits declined by just 0.9% during the first quarter.
Additionally, the risk due to unrealized mark-to-market losses on the securities portfolio is low. As interest rates rose over the last twelve months, the market value of the Available-for-Sale (“AFS”) securities dropped, leading to a buildup of unrealized losses and a consequent drop in accumulated other comprehensive income, AOCI. The AOCI related to the securities portfolio amounted to $69.4 million at the end of March 2023, as mentioned in the earnings presentation. To put this number in perspective, $69.4 million is just 6% of total equity. If realized, the AOCI related to the securities portfolio could reduce the common equity tier 1 (“CET1”) ratio by 94 basis points from 13.1% at the end of March 2023, as mentioned in the presentation. Please note that my target price (discussed below) is based on total equity, which already incorporates unrealized losses. My target price is not based on CET 1.
The only cause for vigilance in S&T Bancorp’s case is the uninsured and uncollateralized deposits, which made up a sizable 29% of total deposits, as mentioned in the presentation.
Upgrading to Buy
S&T Bancorp is offering a dividend yield of 4.8% at the current quarterly dividend rate of $0.32 per share. The earnings and dividend estimates suggest a payout ratio of 36% for 2023, which is in line with the five-year average of 37%. Therefore, I’m not expecting another dividend hike in the remainder of the year.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value S&T Bancorp. The stock has traded at an average P/TB ratio of 1.47x in the past, as shown below.
FY19 | FY20 | FY21 | FY22 | Average | |
T. Book Value per Share ($) | 23.3 | 19.8 | 21.2 | 20.6 | |
Average Market Price ($) | 38.2 | 25.4 | 30.8 | 31.2 | |
Historical P/TB | 1.64x | 1.29x | 1.46x | 1.51x | 1.47x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/TB multiple with the forecast tangible book value per share of $23.5 gives a target price of $34.6 for the end of 2023. This price target implies a 30.1% upside from the April 25 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
P/TB Multiple | 1.27x | 1.37x | 1.47x | 1.57x | 1.67x |
TBVPS - Dec 2023 ($) | 23.5 | 23.5 | 23.5 | 23.5 | 23.5 |
Target Price ($) | 29.9 | 32.3 | 34.6 | 37.0 | 39.3 |
Market Price ($) | 26.6 | 26.6 | 26.6 | 26.6 | 26.6 |
Upside/(Downside) | 12.4% | 21.3% | 30.1% | 38.9% | 47.8% |
Source: Author's Estimates |
The stock has traded at an average P/E ratio of around 11.2x in the past, as shown below. I've excluded the anomaly in 2020 from the average calculation.
FY19 | FY20 | FY21 | FY22 | T. Average | |
Earnings per Share ($) | 2.82 | 0.53 | 2.81 | 3.46 | |
Average Market Price ($) | 38.2 | 25.4 | 30.8 | 31.2 | |
Historical P/E | 13.6x | 48.0x | 11.0x | 9.0x | 11.2x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the trimmed average P/E multiple with the forecast earnings per share of $3.60 gives a target price of $40.2 for the end of 2023. This price target implies a 51.1% upside from the April 25 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
P/E Multiple | 9.2x | 10.2x | 11.2x | 12.2x | 13.2x |
EPS 2023 ($) | 3.60 | 3.60 | 3.60 | 3.60 | 3.60 |
Target Price ($) | 33.0 | 36.6 | 40.2 | 43.8 | 47.4 |
Market Price ($) | 26.6 | 26.6 | 26.6 | 26.6 | 26.6 |
Upside/(Downside) | 24.0% | 37.5% | 51.1% | 64.6% | 78.1% |
Source: Author's Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $37.4 , which implies a 40.6% upside from the current market price. Adding the forward dividend yield gives a total expected return of 45.4%.
Due to the riskiness of the entire banking sector, the stock price may not fully rise to the target price. However, I’m expecting the stock price to rise enough in the year ahead to warrant a buy rating. In my last report, I adopted a hold rating with a target price of $36.9 for December 2023. Due to the excessive rout in the last few months (not all of which was justified as discussed in the risk section above) my updated target price implies a much larger upside now. As a result, I’m upgrading S&T Bancorp to a buy rating.
For further details see:
S&T Bancorp: Attractively Valued With Manageable Risks