Summary
- Thanks to the loan and deposit mixes, the net interest income is highly sensitive to rate changes.
- Loan growth will likely decline from the second quarter’s level but remain at a decent level. Improvement in regional job markets will sustain loan growth.
- The December 2022 target price suggests a high upside from the current market price. Further, STBA is offering a good dividend yield for a bank holding company.
Earnings of S&T Bancorp, Inc. (STBA) will most probably increase this year due to the sharp increase in market interest rates and their significant impact on net interest income. Further, the loan portfolio will likely continue to grow, albeit at a slower pace than in the second quarter. Overall, I'm expecting S&T Bancorp to report earnings of $3.06 per share for 2022, up 9% year-over-year. Compared to my last report on the company, I've increased my earnings estimate mostly because I've raised my margin estimate. For 2023, I'm expecting earnings to grow by 2% to $3.11 per share. The year-end target price suggests a high upside from the current market price. Therefore, I'm maintaining a buy rating on S&T Bancorp.
Topline’s High Rate-Sensitivity to Propel Earnings
The interest rate hikes so far this year have been greater and earlier than expected. Moreover, the length of the up-rate cycle is probably only half over as the Federal Reserve is projecting the fed funds rate to increase by a further 125 to 150 basis points by the end of 2023. S&T Bancorp stands to gain significantly from the up-rate cycle because its net interest income is highly sensitive to interest rate changes.
The average loan yield has a high beta as floating-rate loans made up 52% of total loans at the end of June 2022, as mentioned in the earnings presentation . Further, the management has successfully improved its deposit mix over the last year and a half in anticipation of rising interest rates. Non-interest-bearing deposits were 36.0% of total deposits at the end of June 2022, up from 30.5% at the end of December 2020.
Unfortunately, the deposit cost is still quite rate-sensitive as non-interest-bearing demand, money market, and savings accounts altogether made up 51.2% of total deposits at the end of June 2022. Due to their high beta, these deposits will restrict margin expansion.
The results of the management’s interest-rate sensitivity analysis given in the 10-Q filing show that a 200-basis points hike in interest rate could boost the net interest income by a whopping 15.2% in the first year and 18.5% in the second year of the rate hike.
2Q 2022 10-Q Filing
Additionally, the management mentioned in the conference call that it expects rates on new loans to be higher than the rates on loan pay downs by the third quarter of 2022. Therefore, anticipated loan additions (discussed below) will further boost the net interest margin going forward.
Overall, I'm expecting the margin to increase by 30 basis points in the second half of 2022 and a further 10 basis points in 2023. Compared to my last report on S&T Bancorp, I've increased my margin estimate as my interest rate outlook is now more hawkish than before.
Regional Job Markets to Buoy Loan Growth
S&T Bancorp’s loan portfolio grew by 1.1% during the second quarter of 2022, in line with my expectations. Loan growth will most probably decelerate in the second half of the year from the second quarter’s level because of high interest rates. Consumer real estate loans, which make up around 23% of total loans, are especially susceptible to high borrowing costs. As shown below, mortgage rates are near a decade high.
On the other hand, strong job markets will keep loan growth from declining too much. S&T Bancorp mainly operates in Pennsylvania and Ohio and has a limited presence in Buffalo. Although both Pennsylvania and Ohio currently have higher unemployment rates than the national average, the job markets have improved substantially in a historical context.
The states’ coincident indices also show a satisfactory level of current economic activity.
Considering these factors, I'm expecting the loan portfolio to grow by 0.75% every quarter till the end of 2023. In my last report on S&T Bancorp, I was expecting higher loan growth of around 1.0% for every quarter. I've reduced my loan growth estimate because my outlook on economic activity is more pessimistic than before.
Meanwhile, I'm expecting other balance sheet items to grow somewhat in line with loans. The following table shows my balance sheet estimates.
FY18 | FY19 | FY20 | FY21 | FY22E | FY23E | |
Financial Position | ||||||
Net Loans | 5,886 | 7,075 | 7,108 | 6,901 | 7,047 | 7,261 |
Growth of Net Loans | 3.2% | 20.2% | 0.5% | (2.9)% | 2.1% | 3.0% |
Other Earning Assets | 770 | 914 | 933 | 1,768 | 1,353 | 1,395 |
Deposits | 5,674 | 7,037 | 7,421 | 7,997 | 7,727 | 7,961 |
Borrowings and Sub-Debt | 604 | 416 | 228 | 161 | 117 | 121 |
Common equity | 936 | 1,192 | 1,155 | 1,206 | 1,137 | 1,211 |
Book Value Per Share ($) | 26.8 | 34.4 | 29.6 | 30.9 | 29.1 | 31.0 |
Tangible BVPS ($) | 18.5 | 23.3 | 19.8 | 21.2 | 19.4 | 21.3 |
Source: SEC Filings, Author's Estimates (In USD million unless otherwise specified) |
The Recent Improvement in Asset Quality to Keep Provisioning Subdued Despite Inflation
S&T Bancorp’s provision expense remained below the historical average during the first half of 2022. Further, the credit quality improved rapidly, due to which S&T Bancorp’s allowances-to-nonperforming loan ratio surged to 309% by the end of June 2022 from 149% at the end of December 2021. Last quarter's allowance coverage appears sufficient considering the repercussions of the high-inflation environment. Therefore, I'm not expecting much pressure on provisioning from the existing portfolio. Loan additions will likely be the biggest drivers of provision expense in the remainder of the year.
Considering these factors, I'm expecting the provision expense to increase to a normal level in the second half of 2022. I'm expecting the net provision expense to make up around 0.25% of total loans every quarter till the end of 2023. In comparison, the net provision expense averaged 0.24% of total loans from 2017 to 2019.
Expecting Earnings to Grow by 9%
Hikes in interest rates and the resultant margin expansion will likely be the biggest driver of earnings this year. Further, the bottom line will receive some support from low-single-digit loan growth. On the other hand, non-interest income will fall because of the impending normalization of mortgage refinancing as well as lower wealth fee income. The management is projecting a quarterly fee outlook of $14 to $15 million, which is 6% - 12% below the average quarterly income for the second half of last year.
Overall, I'm expecting S&T Bancorp to report earnings of $3.06 per share for 2022, up 9% year-over-year. For 2023, I'm expecting earnings to grow by a further 2% to $3.11 per share. The following table shows my income statement estimates.
FY18 | FY19 | FY20 | FY21 | FY22E | FY23E | |
Income Statement | ||||||
Net interest income | 234 | 247 | 279 | 276 | 304 | 337 |
Provision for loan losses | 15 | 15 | 131 | 16 | 12 | 18 |
Non-interest income | 49 | 53 | 60 | 65 | 56 | 53 |
Non-interest expense | 145 | 167 | 187 | 189 | 198 | 219 |
Net income - Common Sh. | 105 | 98 | 21 | 110 | 120 | 122 |
EPS - Diluted ($) | 3.01 | 2.82 | 0.53 | 2.81 | 3.06 | 3.11 |
Source: SEC Filings, Earnings Releases, Author's Estimates (In USD million unless otherwise specified) |
In my last report on S&T Bancorp, I estimated earnings of $2.87 per share for 2022. I've increased my earnings estimate mostly because I've revised upwards my margin estimate.
Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, a stronger or longer-than-anticipated recession can increase the provisioning for expected loan losses beyond my estimates.
Maintaining a Buy Rating Due to a High Price Upside
S&T Bancorp is offering a dividend yield of 4.0% at the current quarterly dividend rate of $0.30 per share. The earnings and dividend estimates suggest a payout ratio of 39% for 2023, which is in line with the 2017-2021 (ex-2020) average of 38%. Therefore, I’m not expecting an increase in the dividend level.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value S&T Bancorp. The stock has traded at an average P/TB ratio of 1.67 in the past, as shown below.
FY18 | FY19 | FY20 | FY21 | Average | |
T. Book Value per Share ($) | 18.5 | 23.3 | 19.8 | 21.2 | |
Average Market Price ($) | 42.5 | 38.2 | 25.4 | 30.8 | |
Historical P/TB | 2.29x | 1.64x | 1.29x | 1.46x | 1.67x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/TB multiple with the forecast tangible book value per share of $19.4 gives a target price of $32.3 for the end of 2022. This price target implies a 6.5% upside from the September 26 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
P/TB Multiple | 1.47x | 1.57x | 1.67x | 1.77x | 1.87x |
TBVPS - Dec 2022 ($) | 19.4 | 19.4 | 19.4 | 19.4 | 19.4 |
Target Price ($) | 28.4 | 30.4 | 32.3 | 34.3 | 36.2 |
Market Price ($) | 30.4 | 30.4 | 30.4 | 30.4 | 30.4 |
Upside/(Downside) | (6.3)% | 0.1% | 6.5% | 12.8% | 19.2% |
Source: Author's Estimates |
The stock has traded at an average P/E ratio of around 12.9x in the past, as shown below (I’ve excluded the outlier in 2020 from the average).
FY18 | FY19 | FY20 | FY21 | T. Average | |
Earnings per Share ($) | 3.01 | 2.82 | 0.53 | 2.81 | |
Average Market Price ($) | 42.5 | 38.2 | 25.4 | 30.8 | |
Historical P/E | 14.1x | 13.6x | 48.0x | 11.0x | 12.9x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/E multiple with the forecast earnings per share of $3.06 gives a target price of $39.4 for the end of 2022. This price target implies a 29.7% upside from the September 26 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
P/E Multiple | 10.9x | 11.9x | 12.9x | 13.9x | 14.9x |
EPS 2022 ($) | 3.06 | 3.06 | 3.06 | 3.06 | 3.06 |
Target Price ($) | 33.3 | 36.3 | 39.4 | 42.4 | 45.5 |
Market Price ($) | 30.4 | 30.4 | 30.4 | 30.4 | 30.4 |
Upside/(Downside) | 9.6% | 19.6% | 29.7% | 39.8% | 49.9% |
Source: Author's Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $35.8 , which implies an 18.1% upside from the current market price. Adding the forward dividend yield gives a total expected return of 22.0%. Hence, I’m maintaining a buy rating on S&T Bancorp.
For further details see:
S&T Bancorp: Interest Rate Hikes Are The Biggest Earnings Catalyst Ahead