Item 1A. RISK FACTORS
Investments in our common stock involve risk. The following discussion highlights the risks that we believe are material to S&T, potentially impacting our business, results of operations, financial condition and cash flows. However, other factors not discussed below or elsewhere in this Annual Report on Form 10-K could adversely affect our businesses, results of operations and financial condition. Therefore, the risk factors below do not necessarily include all risks that we may face.
Risks Related to Credit
Our ability to assess the credit-worthiness of our customers may diminish, which may adversely affect our results of operations.
We incur credit risk by virtue of making loans and extending loan commitments and letters of credit. Credit risk is one of our most significant risks. Our exposure to credit risk is managed through the use of consistent underwriting standards that emphasize “in-market” lending while avoiding excessive industry and other concentrations. Our credit administration function employs risk management techniques to ensure that loans adhere to corporate policy and problem loans are promptly identified. There can be no assurance that such measures will be effective in avoiding undue credit risk. If the models and approaches that we use to select, manage and underwrite our consumer and commercial loan products change and our underwriting standards do not reflect or capture the rapid changes in the economy, we may have higher credit losses.
The value of the collateral used to secure our loans may not be sufficient to compensate for the amount of unpaid loans and we may be unsuccessful in recovering the remaining balances from our customers.
Decreases in real estate values, particularly with respect to our commercial real estate, or CRE, and mortgage activities, could adversely affect the value of property used as collateral for our loans and our customers’ ability to repay these loans, which in turn could impact our profitability. Repayment of our commercial loans is often dependent on the cash flow of the borrower, which may become unpredictable. If the value of the assets, such as real estate, serving as collateral for the loan portfolio were to decline materially, a significant part of the loan portfolio could become under-collateralized. If the loans that are secured by real estate become troubled when real estate market conditions are declining or have declined, in the event of foreclosure, we may not be able to realize the amount of collateral that was anticipated at the time of originating the loan. This could result in higher charge-offs which could have a material adverse effect on our operating results and financial condition.
Changes in the overall credit quality of our portfolio can have a significant impact on our earnings.
Like other lenders, we face the risk that our customers will not repay their loans. We reserve for losses in our loan portfolio based on our assessment of expected credit losses. This process, which is critical to our financial results and condition, requires complex judgment including our assessment of economic conditions, which are difficult to predict. Through a periodic review of the loan portfolio, management determines the amount of the ACL by considering historical losses, the national unemployment forecast produced by the Federal Reserve combined with qualitative factors around current conditions including changes in lending policies and practices, economic conditions, changes in the loan portfolio, changes in lending management, results of internal loan reviews, asset quality trends, collateral values, concentrations of credit risk and other external factors. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control. Although we have policies and procedures in place to determine future losses, due to the subjective nature of this area, there can be no assurance that our management has accurately assessed the level of allowances reflected in our consolidated financial statements. We may underestimate our expected credit losses and fail to hold an ACL sufficient to account for these losses. Incorrect assumptions could lead to material underestimates of expected losses and an inadequate ACL. As our assessment of expected losses changes, we may need to increase or decrease our ACL, which could significantly impact our financial results and profitability.
Our loan portfolio is concentrated within our market area, and our lack of geographic diversification increases our risk profile.
The regional economic conditions within our market area affect the demand for our products and services as well as the ability of our customers to repay their loans and the value of the collateral securing these loans. A significant decline in the regional economy caused by inflation, recession, unemployment or other factors could negatively affect our customers, the quality of our loan portfolio and the demand for our products and services. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in our market area could adversely affect the value of our assets, revenues, results of operations and financial condition. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market area.
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Our loan portfolio has a significant concentration of commercial loans that have a higher risk of loss.
The majority of our loans are to commercial borrowers including commercial and industrial, or C&I, CRE, and construction loans. The commercial loan portfolio typically involves a higher degree of credit risk than other types of loans. For the C&I segment this is due to the customer’s repayment ability being based upon the success of its business operations, the susceptibility of the customer’s business to changing economic conditions, the dependence of our customer on maintaining sufficient cash flow to make payments on the loan and our reliance on the underlying collateral, which is usually only the business assets that may not have sufficient value when the borrower encounters financial difficulties. For the CRE segment higher risk is due to higher loan principal amounts, where the repayment of these loans is generally dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Because payments on loans secured by CRE often depend upon the successful operation and management of the properties, repayment of these loans may be affected by factors outside the borrower’s control, including adverse conditions in the real estate market or the economy. Additionally, we have a number of significant credit exposures to commercial borrowers, and while the majority of these borrowers have numerous projects that make up the total aggregate exposure, if one or more of these borrowers default or have financial difficulties, we could experience higher credit losses, which could adversely impact our financial condition and results of operations. Further, an individual commercial loan balance is typically larger than other loans in our portfolio, creating the potential for larger credit losses on an individual loan. The deterioration of one or a few of these loans could have a material adverse effect on our financial condition and results of operations.
Risks Related to General Economic Conditions
General economic conditions may adversely impact our business, financial condition, results of operations, or cash flows.
Various aspects of our business could be impacted by general macroeconomic conditions including, among others, inflation, which has increased to levels not experienced in years, interest rates, rising or elevated unemployment, declines in GDP, consumer spending, property values, supply chain complications and economic uncertainty. These conditions generally have a negative impact on businesses, financial markets and consumers, which may impact the underlying credit quality of our customers. Increased cost of borrowings, additional borrowings and increased leverage, drawdowns from savings and business disruption, financial difficulties, or business losses, particularly for borrowers in our C&I or CRE portfolio, could increase the risk of our customers defaulting or becoming delinquent in their obligations to us, which could increase credit losses and adversely affect our credit portfolios and provision for credit losses. If the macroeconomic environment worsens, our credit portfolio and allowance for credit losses could be adversely impacted. These unfavorable economic conditions could, also, impact the demand for loans and other products and services offered by us, the level of customer deposits, the value of our investment securities, loans held for sale or other assets secured by residential or commercial real estate, or the level of net interest income or net interest margin. Any of these developments could adversely impact our business, financial condition, results of operations or cash flows.
We may not accurately predict the nature and timing of the policies of the Federal Reserve and other governmental agencies and their impact on interest rates and financial markets, which could negatively impact our financial condition and results of operations.
The monetary policies of the Federal Reserve have a significant impact on interest rates, the value of financial instruments and other assets and liabilities, and overall financial market performance. These policies have a significant impact on the activities and results of operations of banks and bank holding companies such as S&T. An important function of the Federal Reserve is to monitor the national supply of bank credit and set certain interest rates. The actions of the Federal Reserve influence the rates of interest that we charge on loans and that we pay on borrowings and interest-bearing deposits. In addition, monetary policy actions by governmental authorities in the European Union or other countries could have an impact on global interest rates, which could affect rates in the U.S. We may not accurately predict the nature or timing of future changes in monetary policies and interest rates or the precise effects that they may have on our activities and financial results, which could negatively impact our financial condition and results of operations.
Russia’s invasion of Ukraine has created significant economic and financial disruptions and uncertainties, which could adversely affect our business, financial condition and results of operations
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In late February 2022, Russia launched a large-scale military attack on Ukraine. In response to the military action by Russia, government actions, including broad-ranging economic sanctions against Russia, have been taken by the United States, the United Kingdom, the European Union and other countries. The U.S. and global markets are experiencing volatility and disruption following the start of this military conflict and imposition of sanctions, impacting the financial and commodities markets. The continued impact on financial markets, including the level and volatility of interest rates, could impact our earnings. Furthermore, continued increases in commodity prices contributing to higher inflation could negatively impact our customers and our earnings. Russian military actions and the resulting sanctions could further adversely affect the global economy and financial markets and lead to instability and lack of liquidity in capital markets. In addition, Russia may take retaliatory actions and other counter measures including cyberattacks against the U.S., its government, infrastructure and businesses, including S&T. Although the extent and duration of the military action or future escalation of such hostilities, the extent and impact of existing and future sanctions, market disruptions and volatility and the result of any diplomatic negotiations remains uncertain, these consequences, including those we cannot yet predict, may cause our business, financial condition, results of operations and the price of our common stock to be adversely affected.
Risks Related to Our Operations
Failure to keep pace with technological changes could have a material adverse effect on our results of operations and financial condition.
The financial services industry is constantly undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better service customers and reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy their demands, as well as create additional efficiencies within our operations. Many of our large competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services quickly or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business, financial condition and results of operations.
A cyber attack, information or security breach, or a failure of ours or of a third-party's infrastructure, computer and data management systems could adversely affect our ability to conduct our business or manage our exposure to risk, result in the disclosure or misuse of confidential or proprietary information, increase our costs to maintain and update our operational and security systems and infrastructure, and adversely impact our results of operations, liquidity and financial condition, as well as cause reputational harm.
Our business is highly dependent on the security and efficacy of our infrastructure, computer and data management systems, as well as those of third parties with whom we interact. Cyber security risks for financial institutions have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including foreign state actors. Our operations rely on the secure processing, transmission, storage and retrieval of confidential, proprietary and other information in our computer and data management systems and networks, and in the computer and data management systems and networks of third parties. We rely on digital technologies, computer, database and email systems, software, and networks to conduct our operations. In addition, to access our network and products and services, our customers and third parties may use personal mobile devices or computing devices that are outside of our network environment. We have taken measures to implement backup systems and other safeguards to support our operations, but our ability to conduct business may be adversely affected by any significant disruptions to us or to third parties with whom we interact.
Financial services institutions have been subject to, and are likely to continue to be the target of, cyber attacks, including computer viruses, malicious or destructive code, phishing attacks, denial of service or other security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information of the institution, its employees or customers or of third parties, or otherwise materially disrupt network access or business operations. For example, denial of service attacks have been launched against a number of large financial institutions and several large retailers have disclosed substantial cyber security breaches affecting debit accounts of their customers. We have experienced cyber security incidents in the past and although not material, we anticipate that, as a growing regional bank, we could experience further incidents. There can be no assurance that we will not suffer material losses or other material consequences relating to technology failure, cyber attacks or other information or security breaches.
In addition to external threats, insider threats also present a risk to us. Insiders, having legitimate access to our systems and the information contained in them, have the opportunity to make inappropriate use of the systems and information, or as a result
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of human error, misconduct or malfeasance, expose us to risk. We have policies, procedures, and controls in place designed to prevent or limit this risk, but we cannot guarantee that these policies, procedures and controls fully mitigate this risk.
As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify and enhance our protective measures or to investigate and remediate any information security vulnerabilities or incidents. Any of these matters could result in our loss of customers and business opportunities, significant disruption to our operations and business, misappropriation or destruction of our confidential information and/or that of our customers, or damage to our customers’ and/or third parties’ computers or systems, and could result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in our security measures, reputational damage, reimbursement or other compensatory costs, and additional compliance costs. In addition, any of the matters described above could adversely impact our results of operations and financial condition.
Fraudulent activity associated with our products and services could adversely affect our results of operations, financial condition and stock price, negatively impact our brand and reputation, and result in regulatory intervention or sanctions.
As a financial institution we are exposed to operational risk in the form of fraudulent activity that may be committed by customers, other third parties, or employees, targeting us and our customers. The risk of fraud continues to increase for the financial services industry. Fraudulent activity has escalated, become more sophisticated, and continues to evolve, as there are more options to access financial services. In our Form 8-K filed May 26, 2020, we disclosed that we discovered customer fraud resulting from a check kiting scheme by a business customer of S&T. We recognized a pre-tax loss of $58.7 million during the second quarter of 2020 related to this customer fraud. As a result of our internal review of the fraud, we have made process and monitoring enhancements. While we believe we have operational risk controls in place to prevent or detect future instances of fraud or to mitigate the impact of any fraud, we cannot provide assurance that we can prevent or detect fraud or that we will not experience future fraud losses or incur costs or other damage related to such fraud, at levels that adversely affect our results of operation, financial condition, or stock price. Furthermore, fraudulent activity could negatively impact our brand and reputation, which could also adversely affect our results of operation, financial condition, or stock price. Fraudulent activity could also lead to regulatory intervention or regulatory sanctions.
We rely on certain critical third-party providers for a number of services that are important to our business. An interruption or cessation of an important service by any critical third-party provider could have a material adverse effect on our business.
We are dependent for the majority of our technology, including our core operating system, on certain critical third-party providers. If these companies were to discontinue providing services to us, we may experience significant disruption to our business. In addition, each of these third parties faces the risk of cyber attack, information breach or loss, or technology failure. If any of our critical third-party service providers experience such difficulties, or if there is any other disruption in our relationships with them, we may be required to find alternative sources of such services. We are dependent on these critical third-party providers securing their information systems, over which we have limited control, and a breach of their information systems could adversely affect our ability to process transactions, service our clients or manage our exposure to risk and could result in the disclosure of sensitive, personal customer information, which could have a material adverse impact on our business through damage to our reputation, loss of business, remedial costs, additional regulatory scrutiny or exposure to civil litigation and possible financial liability. Assurance cannot be provided that we could negotiate terms with alternative service sources that are as favorable or could obtain services with similar functionality as found in existing systems without the need to expend substantial resources, if at all, thereby resulting in a material adverse impact on our business and results of operations.
Failure to continue to attract, develop, and maintain a highly skilled workforce may have an adverse effect on our business.
Our business requires that we attract, develop, and maintain a highly skilled workforce. Competition for qualified employees and personnel in the banking industry is strong, and there are a limited number of qualified persons with knowledge of, and experience in, the banking industry where we conduct our business. Our ability to attract and retain skilled personnel cost effectively is subject to a variety of external factors, including the limited availability of qualified personnel in the workforce in the local markets in which we operate, unemployment levels within those markets, prevailing wage rates, which have increased significantly, health and other insurance costs, and changes in employment and labor laws. Furthermore, the complexities introduced into the labor market as a result of the transition to increased work-from-home arrangements have impacted the competitive landscape in our labor market. Based on current conditions in the labor market, we have experienced some difficulty in retaining and attracting personnel and there is no assurance that we will be able to continue to successfully do so.
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Risks Related to Our Business Strategy
Our strategy includes growth plans through organic growth and by means of acquisitions. Our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.
We intend to continue pursuing a growth strategy through organic growth within our current footprint and through market expansion. We also actively evaluate acquisition opportunities as another source of growth. We cannot give assurance that we will be able to expand our existing market presence, or successfully enter new markets or that any such expansion will not adversely affect our results of operations. Failure to manage our growth effectively could have a material adverse effect on our business, future prospects, financial condition or results of operations and could adversely affect our ability to successfully implement our business strategy.
Our failure to find suitable acquisition candidates, or successfully bid against other competitors for acquisitions, could adversely affect our ability to fully implement our business strategy. If we are successful in acquiring other entities, the process of integrating such entities will divert significant management time and resources. We may not be able to integrate efficiently or operate profitably any entity we may acquire. We may experience disruption and incur unexpected expenses in integrating acquisitions. These failures could adversely impact our future prospects and results of operation.
We are subject to competition from both banks and non-banking companies.
The financial services industry is highly competitive, and we encounter strong competition for deposits, loans and other financial services in our market area, including online providers of these products and services. Our principal competitors include other local, regional and national financial services providers, such as other financial holding companies, commercial banks, credit unions, finance companies and brokerage and insurance firms, including competitors that provide their products and services online. Many of our non-bank competitors are not subject to the same degree of regulation that we are and have advantages over us in providing certain services. Additionally, many of our competitors are significantly larger than we are and have greater access to capital and other resources. Failure to compete effectively for deposit, loan and other financial services customers in our markets could cause us to lose market share, slow our growth rate and have an adverse effect on our financial condition and results of operations.
We may be required to raise capital in the future, but that capital may not be available or may not be on acceptable terms when it is needed.
We are required by federal regulatory authorities to maintain adequate capital levels to support operations. While we believe we currently have sufficient capital, if we cannot raise additional capital when needed, we may not be able to meet these requirements. In addition, our ability to further expand our operations through organic growth, which includes growth within our current footprint and growth through market expansion, may be adversely affected by any inability to raise necessary capital. Our ability to raise additional capital at any given time is dependent on capital market conditions at that time and on our financial performance and outlook.
Risks Related to Interest Rates and Investments
Our net interest income could be negatively affected by interest rate changes which may adversely affect our financial condition.
Our results of operations are largely dependent on net interest income, which is the difference between the interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. Therefore, any change in general market interest rates, including changes resulting from the Federal Reserve Board’s policies, can have a significant effect on our net interest income and total income. There may be mismatches between the maturity and repricing of our assets and liabilities that could cause the net interest rate spread to compress, depending on the level and type of changes in the interest rate environment. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and the policies of various governmental agencies. In addition, some of our customers often have the ability to prepay loans or redeem deposits with either no penalties or penalties that are insufficient to compensate us for the lost income. A significant reduction in our net interest income will adversely affect our business and results of operations. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially harmed.
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Declines in the value of investment securities held by us could require write-downs, which would reduce our earnings.
In order to diversify earnings and enhance liquidity, we own debt instruments of government agencies and municipalities. We may be required to record impairment charges on our debt securities if they suffer a decline in value due to the underlying credit of the issuer. Additionally, the value of these investments may fluctuate depending on the interest rate environment, general economic conditions and circumstances specific to the issuer. Volatile market conditions may detrimentally affect the value of these securities, such as through reduced valuations due to the perception of heightened credit or liquidity risks. Changes in the value of these instruments may result in a reduction to earnings and/or capital, which may adversely affect our results of operations and financial condition.
Risks Related to Regulatory Compliance and Legal Matters
We are subject to extensive governmental regulation and supervision.
We are subject to extensive state and federal regulation, supervision and legislation that govern nearly every aspect of our operations. The regulations are primarily intended to protect depositors, customers and the banking system as a whole, not shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes. Other changes to statutes, regulations or policies could affect us in substantial and unpredictable ways. The regulatory environment of the current administration may take a more active approach to financial services regulation with respect to its major policy goals, such as climate change, racial equity, and consumer protection. Any regulatory changes could subject us to additional costs of regulatory compliance and of doing business, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things, and could divert management’s time from other business activities. Failure to comply with applicable laws, regulations, policies or supervisory guidance could lead to enforcement and other legal actions by federal or state authorities, including criminal or civil penalties, the loss of FDIC insurance, the revocation of a banking charter, other sanctions by regulatory agencies, and/or damage to our reputation. The ramifications and uncertainties of the level of government intervention in the U.S. financial system could also adversely affect us.
Our controls and policies and procedures may fail or be circumvented, which may result in a material adverse effect on our business, financial condition and results of operations.
Management regularly reviews and updates our internal controls, disclosure controls and procedures and operating, risk management and corporate governance policies and procedures. Any system of controls, policies and procedures, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of internal controls, disclosure controls and procedures, or operating, risk management and corporate governance policies and procedures, whether as a result of human error, misconduct or malfeasance, or failure to comply with regulations related to controls and policies and procedures could have a material adverse effect on our business, results of operations and financial condition.
Furthermore, we may in the future discover areas of our internal controls, disclosure controls and procedures, or operating, risk management and corporate governance policies and procedures that need improvement. Failure to maintain effective controls or to timely implement any necessary improvement of our internal and disclosure controls, or operating, risk management and corporate governance policies and procedures, could, among other things, result in losses from errors, harm our reputation, or cause investors to lose confidence in our reported financial information, all of which could have a material adverse effect on our results of operations and financial condition.
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Negative public opinion could damage our reputation and adversely impact our earnings and liquidity.
Reputational risk, or the risk to our business, earnings, liquidity and capital from negative public opinion, is inherent in our operations. Negative public opinion could result from our actual or alleged conduct in a variety of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues or inadequate protection of customer information. Financial companies are highly vulnerable to reputational damage when they are found to have harmed customers, particularly retail customers, through conduct that is illegal or viewed as unfair, deceptive, manipulative or otherwise wrongful. We are dependent on third-party providers for a number of services that are important to our business. Refer to the risk factor titled, “We rely on third-party providers for a number of services that are important to our business. An interruption or cessation of an important service by any third-party provider could have a material adverse effect on our business.” for additional information. A failure by any of these third-party service providers could cause a disruption in our operations, which could result in negative public opinion about us or damage to our reputation. We expend significant resources to comply with regulatory requirements, and the failure to comply with such regulations could result in reputational harm or significant legal or remedial costs. Damage to our reputation could adversely affect our ability to retain and attract new customers and employees, expose us to litigation and regulatory action and adversely impact our earnings and liquidity.
Our ability to pay dividends on our common stock may be limited
Holders of our common stock will be entitled to receive only such dividends as our Board of Directors may declare out of funds legally available for such payments. The payment of common stock dividends by S&T is subject to certain requirements and limitations of Pennsylvania law. Although we have historically declared cash dividends on our common stock, we are not required to do so and our Board of Directors could reduce, suspend or eliminate our dividend at any time. Substantial portions of our revenue consist of dividend payments we receive from S&T Bank. The payment of common dividends by S&T Bank is subject to certain requirements and limitations under federal and state laws and regulations that limit the amount of dividends it can pay to S&T. In addition, both S&T and S&T Bank are subject to various general regulatory policies relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. Any decrease to or elimination of the dividends on our common stock could adversely affect the market price of our common stock.
We may be adversely impacted by the transition from LIBOR as a reference rate.
On July 27, 2017, the Financial Conduct Authority in the United Kingdom announced that it would phase out LIBOR as a benchmark by the end of 2021. In late 2020, the ICE Benchmark Administration (IBA) extended the cessation date for submission and publication of rates for all LIBOR currency-tenor pairs until June 30, 2023, except for the one-week and two-month USD LIBOR tenors, which ceased on December 31, 2021. U.S. regulators, including the U.S. Federal Reserve, published a statement supporting the IBA’s plans and urged banks to phase out LIBOR as soon as practicable. On March 5, 2021, IBA stated that it will cease the publication of (i) the overnight and 1, 3, 6 and 12 months USD LIBOR settings immediately following the LIBOR publication on June 30, 2023 and (ii) all other LIBOR settings, including the 1 week and 2 month USD LIBOR settings, immediately following the LIBOR publication on Friday, December 31, 2021. In October 2021, five federal financial institution regulatory agencies, in conjunction with the state bank and state credit union regulators, jointly issued a statement to emphasize the expectation that supervised institutions with LIBOR exposure continue to progress toward an orderly transition away from LIBOR. In that guidance, the agencies offered their regulatory expectations and outlined potential supervisory and enforcement consequences for banks that fail to adequately plan for and implement the transition away from LIBOR. The failure to properly transition away from LIBOR may result in increased supervisory scrutiny. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, has identified the Secured Overnight Financing Rate, or SOFR, a new index calculated by short-term repurchase agreements, backed by Treasury securities, as its preferred alternative rate for LIBOR however, other market alternatives have been developed. While SOFR has been adopted in select product areas it has not achieved full implementation as an alternative reference rate. At this time, it is not possible to predict how markets will respond to alternative reference rates as markets continue to transition away from LIBOR. While several states have enacted legislation addressing the LIBOR transition and others may do so and the U.S. House of Representatives passed LIBOR transition legislation on December 8, 2021, it remains unclear that these initiatives will fully address the issues with the LIBOR transition.
Furthermore, because of the complexity of the transition from LIBOR, at this time, it is not possible to predict what rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in views or alternatives may be on the value of LIBOR-based securities and variable rate loans, subordinated debentures, or other securities or financial arrangements.
We have a significant number of loans, derivative contracts, borrowings and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. We have established a committee to guide our transition from LIBOR and have begun efforts to transition to alternative rates consistent with industry timelines. We have identified products that utilize
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LIBOR and are revising fallback language to facilitate the transition to alternative reference rates. Our failure to adequately manage the transition could have a material adverse effect on our business, financial condition and results of operations.
Our business could be negatively impacted by environmental, social and governance (ESG) matters, including climate change and related legislative and regulatory initiatives.
There has been an increased focus from regulators, investors, customers, employees and other stakeholders concerning environmental, social and governance, or ESG, practices and disclosure, including climate change, hiring practices, the diversity of the work force, racial and social justice issues and shareholder rights.
With respect to environmental in particular, increased focus and concern over the effects of climate change have resulted in increased political and social initiatives directed toward climate change. Governments have entered into international agreements with respect to climate change, and U.S. federal and state legislatures, regulatory agencies, and supervisory authorities, including those with oversight of financial institutions, have proposed initiatives seeking to mitigate the effects of climate change. While many of the current regulatory proposals do not apply directly to S&T, continued focus on climate change may lead to the promulgation of new regulations or supervisory guidance applicable to S&T and, as a result, we may experience increased compliance costs and other compliance-related risks. Furthermore, our customers could be impacted by regulatory initiatives focused on addressing and mitigating the effects of climate change resulting in an adverse impact on their financial condition and creditworthiness. Depending on the nature of the initiative, the business impacted, and the composition of loan portfolio, our business and results of operations could be negatively impacted by climate change initiatives directed at our customers. Additionally, our business and the business of our customers could be negatively impacted by disruptions in economic activity resulting from the physical impacts of climate change.
Furthermore, new government regulations with respect to other environmental, social or governance matters could also result in new or more stringent forms of ESG oversight and expanded mandatory and voluntary reporting, diligence, disclosure and ESG-related compliance costs. In addition, we could be criticized for the scope of such initiatives or goals or perceived as not acting responsibly in connection with these matters. Failure to adapt to or comply with regulatory requirements or investor or stakeholder expectations and standards with respect to ESG matters could have a material adverse impact on our future results of operations, financial position, cash flows, ability to do business with certain third parties and our stock price.
Risks Related to Liquidity
We rely on a stable core deposit base as our primary source of liquidity.
We are dependent for our funding on a stable base of core deposits. Our ability to maintain a stable core deposit base is a function of our financial performance, our reputation and the security provided by FDIC insurance, which combined, gives customers confidence in us. If any of these considerations deteriorates, the stability of our core deposits could be harmed. In addition, deposit levels may be affected by factors such as general interest rate levels, rates paid by competitors, returns available to customers on alternative investments and general economic conditions. Accordingly, we may be required from time to time to rely on other sources of liquidity to meet withdrawal demands or otherwise fund operations.
Our ability to meet contingency funding needs, in the event of a crisis that causes a disruption to our core deposit base, is dependent on access to wholesale markets, including funds provided by the FHLB of Pittsburgh.
We own stock in the Federal Home Loan Bank of Pittsburgh, or FHLB, in order to qualify for membership in the FHLB system, which enables us to borrow on our line of credit with the FHLB that is secured by a blanket lien on a significant portion of our loan portfolio. Changes or disruptions to the FHLB or the FHLB system in general may materially impact our ability to meet short and long-term liquidity needs or meet growth plans. Additionally, we cannot be assured that the FHLB will be able to provide funding to us when needed, nor can we be certain that the FHLB will provide funds specifically to us, should our financial condition and/or our regulators prevent access to our line of credit. The inability to access this source of funds could have a materially adverse effect on our ability to meet our customer’s needs. Our financial flexibility could be severely constrained if we were unable to maintain our access to funding or if adequate financing is not available at acceptable interest rates.
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Risks Related to Owning Our Stock
The market price of our common stock may fluctuate significantly in response to a number of factors.
Our quarterly and annual operating results have varied significantly in the past and could vary significantly in the future, which makes it difficult for us to predict our future operating results. Our operating results may fluctuate due to a variety of factors, many of which are outside of our control, including the changing U.S. economic environment and changes in the commercial and residential real estate market, any of which may cause our stock price to fluctuate. If our operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:
•volatility of stock market prices and volumes in general;
•changes in market valuations of similar companies;
•changes in the conditions of credit markets;
•changes in accounting policies or procedures as required by the Financial Accounting Standards Board, or FASB, or other regulatory agencies;
•legislative and regulatory actions, including the impact of the Dodd-Frank Act and related regulations, that may subject us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;
•government intervention in the U.S. financial system and the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board;
•additions or departures of key members of management;
•fluctuations in our quarterly or annual operating results; and
•changes in analysts’ estimates of our financial performance.
General Risk Factors
We may be a defendant from time to time in a variety of litigation and other actions, which could have a material adverse effect on our financial condition and results of operations.
From time to time, customers and others make claims and take legal action pertaining to the performance of our responsibilities. Whether customer claims and legal action related to the performance of our responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant expenses, attention from management and financial liability. Any financial liability or reputational damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
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Item 1B. UNRESOLVED STAFF COMMENTS
There are no unresolved SEC staff comments.
Item 2. PROPERTIES
S&T Bancorp, Inc. headquarters is located in Indiana, Pennsylvania. We operate in Pennsylvania and Ohio. At December 31, 2022, we operate 73 banking branches and four loan production offices, of which 43 are leased facilities.
Item 3. LEGAL PROCEEDINGS
The nature of our business generates a certain amount of litigation that arises in the ordinary course of business. However, in management’s opinion, there are no proceedings pending that we are a party to or to which our property is subject that would be material in relation to our financial condition or results of operations. In addition, no material proceedings are pending nor are known to be threatened or contemplated against us by governmental authorities or other parties.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Stock Prices and Dividend Information
Our common stock is listed on the NASDAQ Global Select Market System, or NASDAQ, under the symbol STBA. As of the close of business on January 31, 2023, we had approximately 2,655 shareholders of record. The number of record-holders does not reflect the number of persons or entities holding stock in nominee name through banks, brokerage firms and other nominees.
As discussed under "Our ability to pay dividends on our common stock may be limited." included in Item 1A. Risk Factors in Part I, the amount and timing of dividends is subject to the discretion of the Board and depends upon business conditions and regulatory requirements. The Board has the discretion to change the dividend at any time for any reason. The Board of Directors presently intends to continue the policy of paying quarterly cash dividends. The amount of any future dividends will depend on economic and market conditions, our financial condition and operating results and other factors, including applicable government regulations and policies. S&T’s Board of Directors approved a quarterly cash dividend of $0.32 per share on January 25, 2023.
Certain information relating to securities authorized for issuance under equity compensation plans is set forth under the heading Equity Compensation Plan Information in Part III, Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this Report.
Purchases of Equity Securities
The following table is a summary of our purchases of common stock during the fourth quarter of 2022:
(1)On January 25, 2023, our Board of Directors authorized an extension of its $50 million share repurchase plan, which was set to expire March 31, 2023. This authorization extended the expiration date of the repurchase plan through March 31, 2024. The plan permits S&T to repurchase shares up to the previously authorized $50 million in aggregate value of S&T's common stock through a combination of open market and privately negotiated repurchases. The specific timing, price and quantity of repurchases will be at the discretion of S&T and will depend on a variety of factors, including general market conditions, the trading price of common stock, legal and contractual requirements, applicable securities laws and S&T's financial performance. The repurchase plan does not obligate us to repurchase any particular number of shares. We expect to fund any repurchases from cash on hand and internally generated funds. Share repurchases will not occur unless permissible under applicable laws.
Five-Year Cumulative Total Return
The following chart compares the cumulative total shareholder return on our common stock with the cumulative total shareholder return of the NASDAQ Composite Index(1) and the NASDAQ Bank Index(2) assuming a $100 investment in each on December 31, 2017 and the reinvestment of dividends.
Source: Bloomberg
Period Ending
(1)The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on the Nasdaq Stock Market.
(2)The NASDAQ Bank Index contains securities of NASDAQ-listed companies classified according to the Industry Classification Benchmark as Banks. These companies include banks providing a broad range of financial services, including retail banking, loans and money transmissions.
Item 6. [RESERVED]
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section reviews our financial condition for each of the past two years and results of operations for each of the past three years. Certain reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation. Some tables may include additional time periods to illustrate trends within our consolidated financial statements. The results of operations reported in the accompanying consolidated financial statements are not necessarily indicative of results to be expected in future periods.
Important Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains or incorporates statements that we believe are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally relate to our financial condition, results of operations, plans, objectives, outlook for earnings, revenues, expenses, capital and liquidity levels and ratios, asset levels, asset quality, financial position and other matters regarding or affecting S&T and its future business and operations. Forward-looking statements are typically identified by words or phrases such as “will likely result,” “expect,” “anticipate,” “estimate,” “forecast,” “project,” “intend,” “believe,” “assume,” “strategy,” “trend,” “plan,” “outlook,” “outcome,” “continue,” “remain,” “potential,” “opportunity,” “comfortable,” “current,” “position,” “maintain,” “sustain,” “seek,” “achieve,” and variations of such words and similar expressions, or future or conditional verbs such as will, would, should, could or may. Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. The matters discussed in these forward-looking statements are subject to various risks, uncertainties and other factors that could cause actual results and trends to differ materially from those made, projected, or implied in or by the forward-looking statements depending on a variety of uncertainties or other factors including, but not limited to: credit losses and the credit risk of our commercial and consumer loan products; changes in the level of charge-offs and changes in estimates of the adequacy of the allowance for credit losses, or ACL; cyber-security concerns; rapid technological developments and changes; operational risks or risk management failures by us or critical third parties, including fraud risk; our ability to manage our reputational risks; sensitivity to the interest rate environment including a prolonged period of low interest rates, a rapid increase in interest rates or a change in the shape of the yield curve; a change in spreads on interest-earning assets and interest-bearing liabilities; the transition from LIBOR as a reference rate; regulatory supervision and oversight, including changes in regulatory capital requirements and our ability to address those requirements; unanticipated changes in our liquidity position; unanticipated changes in regulatory and governmental policies impacting interest rates and financial markets; changes in accounting policies, practices or guidance; legislation affecting the financial services industry as a whole, and S&T, in particular; the outcome of pending and future litigation and governmental proceedings; increasing price and product/service competition; the ability to continue to introduce competitive new products and services on a timely, cost-effective basis; managing our internal growth and acquisitions; the possibility that the anticipated benefits from acquisitions cannot be fully realized in a timely manner or at all, or that integrating the acquired operations will be more difficult, disruptive or costly than anticipated; containing costs and expenses; reliance on significant customer relationships; an interruption or cessation of an important service by a third-party provider; our ability to attract and retain talented executives and employees; general economic or business conditions, including the strength of regional economic conditions in our market area; environmental, social and governance practices and disclosures, including climate change, hiring practices, the diversity of the work force, and racial and social justice issues; the duration and severity of the coronavirus, or COVID-19 pandemic, both in our principal area of operations and nationally, including the ultimate impact of the pandemic on the economy generally and on our operations; our participation in the Paycheck Protection Program; deterioration of the housing market and reduced demand for mortgages; deterioration in the overall macroeconomic conditions or the state of the banking industry that could warrant further analysis of the carrying value of goodwill and could result in an adjustment to its carrying value resulting in a non-cash charge to net income; the stability of our core deposit base and access to contingency funding; re-emergence of turbulence in significant portions of the global financial and real estate markets that could impact our performance, both directly, by affecting our revenues and the value of our assets and liabilities, and indirectly, by affecting the economy generally and access to capital in the amounts, at the times and on the terms required to support our future businesses.
Many of these factors, as well as other factors, are described elsewhere in this report, including Part I, Item 1A, Risk Factors and any of our subsequent filings with the SEC. Forward-looking statements are based on beliefs and assumptions using information available at the time the statements are made. We caution you not to unduly rely on forward-looking statements because the assumptions, beliefs, expectations and projections about future events may, and often do, differ materially from actual results. Any forward-looking statement speaks only as to the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect developments occurring after the statement is made.
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles, or GAAP. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, the consolidated financial statements could reflect different estimates, assumptions and judgments. Certain policies are based to a greater extent on estimates, assumptions and judgments of management and, as such, have a greater possibility of producing results that could be materially different than originally reported.
Our most significant accounting policies are presented in Note 1 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Report. These policies, along with the disclosures presented in the Notes to Consolidated Financial Statements, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how those values are determined.
We view critical accounting policies to be those which are highly dependent on subjective or complex estimates, assumptions and judgments and where changes in those estimates and assumptions could have a significant impact on the consolidated financial statements. Further, we view critical accounting estimates as those estimates made in accordance with
GAAP that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. We currently view the determination of the ACL and goodwill and other intangible assets to be critical accounting policies. We did not significantly change the manner in which we applied our critical accounting policies or developed related assumptions or estimates during 2022. We have reviewed these critical accounting estimates and related disclosures with the Audit Committee.
Allowance for Credit Losses
In January 2020, we adopted ASC 326, which replaced the former incurred loss methodology with an expected credit loss methodology that requires consideration of a broader range of information to estimate expected credit losses over the lifetime of an asset. The ACL is a valuation reserve established and maintained by charges against operating income. It is an estimate of expected credit losses, measured over the contractual life of a loan, that considers historical loss experience, current conditions and forecasts of future economic conditions.
Management’s evaluation process used to determine the appropriateness of the ACL is complex and requires the use of estimates, assumptions and judgments which are inherently subject to high uncertainty. The evaluation process combines several factors: historical loan loss experience, managements ongoing review of lending policies and practices, experience and depth of staff, quality of the loan grading system, the fair value of underlying collateral, concentration of loans to specific borrowers or industries, existing economic conditions and forecasts, segment specific risks and other quantitative and qualitative factors which could affect future credit losses. Our reasonable and supportable forecast is based primarily on the national unemployment forecast produced by the Federal Reserve and is for a period of two years. For periods beyond our two-year forecast, we revert to historical loss rates utilizing a straight-line method over a one-year reversion period. Because current economic conditions and forecasts can change and future events are inherently difficult to predict, the anticipated amount of estimated credit losses on loans and the appropriateness of the ACL could change significantly. It is challenging to estimate how potential changes in any one economic factor or input might affect the overall allowance because a wide variety of factors and inputs may be directionally inconsistent, such that improvement in one factor may offset deterioration in others.
In conjunction with our capital stress testing process, we consider different economic scenarios that impact the ACL. Among other balance sheet and income statement changes, our severely adverse scenario would have resulted in an increase to the ACL of approximately 90 percent. This severely adverse scenario shows how sensitive the ACL can be to key qualitative and quantitative assumptions underlying the overall ACL calculation. To the extent actual losses are higher than management estimates, additional provision for credit losses could be required and could adversely affect our earnings or financial position in future periods.
Goodwill and Other Intangible Assets
As a result of acquisitions, we have recorded goodwill and identifiable intangible assets in our Consolidated Balance Sheets. Goodwill represents the excess of the purchase price over the fair value of net assets acquired.
The acquisition method of accounting requires that assets acquired and liabilities assumed in business combinations are recorded at their fair values. This often involves estimates based on third-party valuations or internal valuations based on discounted cash flow analyses or other valuation techniques which are inherently subjective. Business combinations also typically result in goodwill which is subject to ongoing periodic impairment tests based on the fair values of the reporting units to which the acquired goodwill relates.
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The carrying value of goodwill is tested annually for impairment each October 1st or more frequently if events and circumstances indicate that it may be impaired. We test for impairment by comparing the fair value of the reporting unit with its carrying amount. An impairment charge would be recognized if the carrying amount exceeds the reporting unit's fair value. Determining the fair value of a reporting unit is judgmental and involves the use of significant estimates and assumptions. The fair value of the reporting unit is determined by using both a discounted cash flow model and market based models. The discounted cash flow model has many assumptions including future earnings projections, a long-term growth rate and discount rate. The market based method calculates the fair value based on observed price multiples for similar companies. The fair values of each method are then weighted based on the relevance and reliability in the current economic environment.
We last completed a quantitative goodwill impairment test as of November 30, 2020 and concluded that goodwill was not impaired. A discount rate of 11.50 percent was used for the income approach. If the discount rate was increased 2 percent to 13.50 percent, our fair value would have still exceeded carrying value resulting in no goodwill impairment. Based upon our qualitative assessment performed for our annual impairment analysis as of October 1, 2022, we concluded that goodwill is not impaired.
Recent Accounting Pronouncements and Developments
Note 1 Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements, which is included in Part II, Item 8 Financial Statements and Supplementary Data of this Report, discusses new accounting pronouncements that we have adopted and the expected impact of accounting pronouncements recently issued or proposed, but not yet required to be adopted.
Explanation of Use of Non-GAAP Financial Measures
In addition to traditional measures presented in accordance with GAAP, our management uses, and this report contains or references, certain non-GAAP financial measures identified below. We believe these non-GAAP financial measures provide information useful to investors in understanding our underlying operational performance and our business and performance trends as they facilitate comparisons with the performance of other companies in the financial services industry. Although we believe that these non-GAAP financial measures enhance investors’ understanding of our business and performance, these non-GAAP financial measures should not be considered alternatives to GAAP or considered to be more important than financial results determined in accordance with GAAP, nor are they necessarily comparable with non-GAAP measures which may be presented by other companies.
The interest income on interest-earning assets, net interest income and net interest margin are presented on an FTE basis (non-GAAP). The FTE basis (non-GAAP) adjusts for the tax benefit of income on certain tax-exempt loans and securities and the dividend-received deduction for equity securities using the federal statutory tax rate of 21 percent for each period. We believe this to be the preferred industry measurement of net interest income that provides a relevant comparison between taxable and non-taxable sources of interest income.
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table reconciles interest and dividend income per the Consolidated Statements of Net Income to interest income, net interest income and net interest margin on an FTE basis (non-GAAP) for the periods presented:
Years Ended December 31,
Net Interest Margin on an FTE Basis (Non-GAAP) 3.76 % 3.22 % 3.38 %
The efficiency ratio is noninterest expense divided by noninterest income plus net interest income, on an FTE basis (non-GAAP), which ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Below is a reconciliation of the non-GAAP efficiency ratio.
Years ended December 31,
Efficiency Ratio (Non-GAAP)
Less: merger related expenses — — (2,342)
Less: net (gains) losses on sale of securities (198) (29) (142)
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Return on average tangible shareholders' equity (non-GAAP) is a key profitability metric used by management to measure financial performance. The following table provides a reconciliation of return on average tangible shareholders' equity (non-GAAP) by reconciling net income (GAAP) per the Consolidated Statements of Net Income to net income before amortization and intangibles and average shareholder's equity to average tangible shareholders' equity for the periods presented:
Years Ended December 31,
Plus: amortization of intangibles, net of tax 1,199 1,400 2,001
Executive Overview
We are a bank holding company that is headquartered in Indiana, Pennsylvania with assets of $9.1 billion at December 31, 2022. We operate in Pennsylvania and Ohio. We provide a full range of financial services with retail and commercial banking products, cash management services, trust and brokerage services. Our common stock trades on the NASDAQ Global Select Market under the symbol "STBA."
We earn revenue primarily from interest on loans and securities and fees charged for financial services provided to our customers. We incur expenses for the cost of deposits and other funding sources, provision for credit losses and other operating costs such as salaries and employee benefits, data processing, occupancy and tax expense.
In 2022, we celebrated a great milestone, our 120-year anniversary. We finished 2022 with two consecutive quarters of record net income and earnings per share and record full year net income and earnings per share. We are focused on living our purpose of building a better future together through people-forward banking. Our future at S&T is a world where everything we do daily reflects our purpose and is guided by our values. Our strategic priorities for 2023 and beyond will be focused on our deposit franchise, core profitability, asset quality and talent and engagement.
Results of Operations
Year Ended December 31, 2022
Earnings Summary
Years ended December 31,
Earnings per share - diluted $ 3.46 $ 2.81 $ 0.53
Return on average shareholders' equity 11.47 % 9.30 % 1.80 %
We earned record net income of $135.5 million, an increase of $25.2 million or 22.8 percent, compared to net income of $110.3 million in 2021. Earnings per diluted share increased 23.1 percent to $3.46 in 2022 compared to $2.81 in 2021.The increase in net income was primarily due to higher net interest income related to rising interest rates and a lower provision for credit losses related to improving economic conditions. Net income in 2020 was impacted by a pre-tax loss of $58.7 million related to a customer fraud resulting from a check kiting scheme. The fraud was perpetrated by a single business customer and the customer has plead guilty in a criminal investigation. We continue to pursue all available sources of recovery to mitigate the loss. Return on average assets increased 30 basis points to 1.48 percent for 2022 compared to 1.18 percent for 2021. Return on average shareholders' equity increased 217 basis points to 11.47 percent for 2022 compared to 9.30 percent for 2021.
Net interest income increased $39.7 million, or 14.4 percent, to $315.8 million compared to $276.1 million in 2021. Interest and dividend income increased $51.5 million and interest expense increased $11.8 million compared to 2021. The net
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interest margin, or NIM, on an FTE basis (non-GAAP) increased 54 basis points to 3.76 percent compared to 3.22 percent in 2021. The increases in net interest income and NIM on an FTE basis (non-GAAP) were primarily due to higher interest rates during 2022. NIM is reconciled to net interest margin adjusted to an FTE basis (non-GAAP) above in the "Explanation of Use of Non-GAAP Financial Measures" section of this MD&A.
The provision for credit losses decreased $7.8 million to $8.4 million for 2022 compared to $16.2 million for 2021. The decrease in the provision for credit losses during 2022 was mainly due to a reduction in net charge-offs in 2022. Net loan charge-offs were $2.6 million, or 0.04 percent of average loans, in 2022 compared to $34.5 million, or 0.49 percent of average loans, in 2021.
Noninterest income decreased $6.4 million to $58.3 million compared to $64.7 million in 2021. Mortgage banking decreased $7.5 million due to a decline in loan sale activity caused by rising interest rates and a shift to holding originated mortgage loans. Other noninterest income decreased $1.8 million primarily related to a $3.1 million decline in the fair value of assets in a nonqualified benefit plan partially offset by a net gain on the sale of OREO. Service charges on deposit accounts and debit and credit card fees increased $2.8 million due to increased customer activity.
Noninterest expense increased $7.8 million to $196.7 million compared to $188.9 million in 2021. Salaries and employee benefits increased $3.0 million primarily due to base rate increases and higher incentives. Professional and legal increased $2.0 million due to increased consulting engagements compared to 2021. Marketing increased $1.0 million due to increased marketing efforts. Other noninterest expense increased $1.8 million in 2022 primarily due to a lease impairment and increased travel and entertainment expenses. These higher expenses were offset by decreases in FDIC insurance of $1.4 million in 2022 compared to 2021. The efficiency ratio (non-GAAP) for 2022 improved to 52.34 percent compared to 55.06 percent for 2021. A reconciliation of the efficiency ratio (non-GAAP) is provided above in the "Explanation of Use of Non-GAAP Financial Measures" section of this MD&A.
The provision for income taxes increased $8.1 million to $33.4 million in 2022 compared to $25.3 million in 2021. The increase in our income tax provision was primarily due to a $33.3 million increase in pretax income in 2022 compared to 2021. The effective tax rate increased 1.1 percent to 19.8 percent in 2022 compared to 18.7 percent in 2021. The increase in the effective tax rate was primarily due to significantly higher income before taxes in 2022 compared to 2021.
Net Interest Income
Our principal source of revenue is net interest income. Net interest income represents the difference between the interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. Net interest income is affected by changes in the average balance of interest-earning assets and interest-bearing liabilities and changes in interest rates and spreads. The level and mix of interest-earning assets and interest-bearing liabilities is managed by our Asset and Liability Committee, or ALCO, in order to mitigate interest rate and liquidity risks of the balance sheet. A variety of ALCO strategies were implemented, within prescribed ALCO risk parameters, to produce what we believe is an acceptable level of net interest income.
As part of our interest rate risk management strategy, we use interest rate swaps to add stability to net interest income by managing our exposure to interest rate movements. During 2022, we entered into interest rate swaps with a total notional amount of $500.0 million with original maturities ranging from three to five years. Our strategy is to reduce our exposure to variability in expected future cash flows related to interest payments on commercial loans that are currently indexed to the 1-month LIBOR rate. Interest rates have increased substantially in 2022 resulting in a loss on the cash flow hedges of $16.8 million which is reported in Other Comprehensive Income (Loss), or OCI, net of applicable taxes.
Average Balance Sheet and Net Interest Income Analysis
The following table provides information regarding the average balances, interest and rates earned on interest-earning assets and the average balances, interest and rates paid on interest-bearing liabilities for the years ended December 31:
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ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
Total other costing liabilities 15,163 560 3.69 % — — — % — — — %
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent .
(3)Taxable investment income is adjusted for the dividend-received deduction for equity securities.
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The following table sets forth for the periods presented a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates:
(dollars in thousands) Volume(4) Rate(4) Net Volume(4) Rate(4) Net
Interest earned on:
Interest paid on:
Securities sold under repurchase agreements (38) (5) (43) 36 (126) (90)
Total other costing liabilities $ 560 $ — $ 560 $ — $ — $ —
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent.
(3)Taxable investment income is adjusted for the dividend-received deduction for equity securities.
(4)Changes to rate/volume are allocated to both rate and volume on a proportionate dollar basis.
Net interest income on an FTE basis (non-GAAP) increased $39.4 million, or 14.2 percent, compared to 2021. The net interest margin, or NIM, on an FTE basis (non-GAAP) increased 54 basis points to 3.76 percent compared to 3.22 percent in 2021. The increases in net interest income and NIM on an FTE basis (non-GAAP) were primarily due to higher interest rates during 2022. NIM on an FTE basis (non-GAAP) was also positively impacted by lower average cash balances. Average interest-bearing deposits with banks decreased $343.7 million compared to 2021.
Interest income on an FTE basis (non-GAAP) increased $51.2 million compared to 2021. The increase in interest income was primarily due to higher interest rates partially offset by lower Paycheck Protection Program, or PPP, income. Average PPP loans decreased $301.7 million compared to 2021. Average loan balances, excluding PPP loans, increased $254.5 million compared to 2021. The average yield on loans increased 66 basis points compared to 2021 due to higher interest rates. Average securities increased $185.2 million compared to 2021 due to interest-bearing deposits with banks being redeployed to higher yielding assets. Average interest-bearing deposits with banks decreased $343.7 million compared to 2021 due to decreased deposit balances and increased securities. Overall, the FTE rate (non-GAAP) on interest-earning assets increased 69 basis points compared to 2021.
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Interest expense increased $11.8 million compared to 2021. The increase in interest expense was primarily due to higher interest rates. Average interest-bearing deposits decreased $350.1 million compared to 2021 due to the competitive market driven by rising interest rates. The average rate paid on interest-bearing deposits increased 20 basis points due to increased interest rates. Average demand deposits increased $111.1 million compared to 2021; however, overall deposit balances were down year-over-year. Average borrowings decreased $11.6 million compared to 2021 primarily due to the discontinuation of the customer repurchase agreement product and the payoff of a subordinated debt. Short-term borrowings increased $33.7 million and the average rate paid increased 396 basis points. Overall, the cost of interest-bearing liabilities increased 25 basis points compared to 2021.
Provision for Credit Losses
The provision for credit losses includes a provision for losses on loans and on unfunded loan commitments. The provision for credit losses fluctuates based on changes in loan balances, risk ratings, net loan charge-offs and our CECL assumptions. The provision for credit losses decreased $7.8 million to $8.4 million for 2022 compared to $16.2 million for 2021. The provision for credit losses included $3.0 million for the reserve for unfunded commitments for 2022 compared to $0.7 million for 2021.
The decrease in the provision for credit losses was primarily due to significantly lower net charge-offs in 2022 compared to 2021. Net loan charge-offs were $2.6 million in 2022 compared to $34.5 million in 2021. Contributing to the decrease in the provision for credit losses was a $1.7 million reduction in specific reserves on loans individually assessed due to the resolution of a C&I relationship through a note sale which resulted in a $5.5 million charge-off during the second quarter of 2022. Offsetting the decrease in provision for credit losses during 2022 was a $2.3 million increase in the provision for unfunded loan commitments primarily due to an increase in loss rates and unused commitments in the construction portfolio.
Refer to the Credit Quality section of this MD&A for further details.
Noninterest Income
Years Ended December 31,
(dollars in thousands) 2022 2021 $ Change % Change
Noninterest income decreased $6.4 million to $58.3 million compared to $64.7 million in 2021. Mortgage banking decreased $7.5 million due to a decline in loan sale activity caused by rising interest rates and a shift to holding originated mortgage loans. Other noninterest income decreased $1.8 million primarily related to a $3.1 million decline in the fair value of assets in a nonqualified benefit plan, which has a corresponding offset in salaries and benefits resulting in no impact to net income, partially offset by a net gain on the sale of OREO. Service charges on deposit accounts increased $1.8 million and debit and credit card fees increased $1.1 million due to increased customer activity.
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Noninterest Expense
Years Ended December 31,
(dollars in thousands) 2022 2021 $ Change % Change
Noninterest expense increased $7.8 million to $196.7 million compared to $188.9 million in 2021. Salaries and employee benefits increased $3.0 million during 2022 primarily due to base rate increases and higher incentives offset by a change in the fair value of assets in a nonqualified benefit plan. Professional services and legal increased $2.0 million due to higher consulting expense compared to 2021. Marketing expense increased $1.0 million due to increased marketing efforts and timing of various promotions. Other noninterest expense increased $1.8 million primarily due to a lease impairment and increased travel and entertainment expenses. FDIC insurance expense decreased $1.4 million due to a lower assessment base and improvements in the components used to determine the assessment.
Income Taxes
The provision for income taxes increased to $33.4 million in 2022 compared to $25.3 million for 2021. The increase in our income tax provision was primarily due to a $33.3 million increase in income before taxes in 2022 compared to 2021.
The effective tax rate, which is total tax expense as a percentage of income before taxes, increased to 19.8 percent in 2022 compared to 18.7 percent in 2021. The increase in the effective tax rate was primarily due to significantly higher income before taxes in 2022 compared to 2021. We have generated an annual effective tax rate that is less than the statutory rate of 21 percent due to benefits resulting from tax-exempt interest, excludable dividend income, tax-exempt income on Bank Owned Life Insurance, or BOLI, and tax benefits associated with Low Income Housing Tax Credits, or LIHTC.
Results of Operations
Year Ended December 31, 2021
COVID-19 Pandemic Update
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security, or CARES Act was signed into law. It contained substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act included the Paycheck Protection Program, or PPP, a $349 billion program designed to aid small and medium sized businesses through federally guaranteed loans distributed through banks. The PPP and Health Care Enhancement Act, or PPP/HCEA, was signed into law on April 24, 2020. The PPP/HCEA authorized an additional $310 billion of funding under the CARES Act for PPP loans among other provisions. On July 4, 2020, legislation was passed to extend the application period for the PPP through August 8, 2020.These loans are intended to cover eight weeks of payroll and other permitted expenses to help those businesses remain viable. The PPP ended on May 31, 2021.
We originated $771.5 million of PPP loans during 2020 and 2021. PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted expenses in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00 percent and a term of two years, or five years for loans approved by the SBA, on or after June 5, 2020. Payments are deferred for at least six months of the loan. The loans are 100 percent guaranteed by the SBA.
We increased our ACL in 2021 to be responsive to the additional risk related to the COVID-19 pandemic. We did experience improvement in our asset quality during 2021, but remain cautious given the current environment. The hotel portfolio improved in the second half of 2021 with $34.0 million of loans being returned to performing status due to improved operating performance. Our balance sheet is asset sensitive resulting in our net interest income and net interest margin, or NIM, being negatively impacted in this low interest rate environment. Loan demand was challenging in the first half of 2021, but we saw growth trends improving late in the second quarter and for the third and fourth quarter of 2021. Net interest income was favorably impacted by PPP loans which contributed to net interest income $17.3 million for 2021 and $11.4 million for 2020.
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In order to assist our customers through this difficult period, we have provided the following assistance, which may have an adverse impact on our results in the short term, but which we believe will provide better outcomes in the long term for our customers and for S&T.
•We provided needs-based payment deferrals and modifications to interest only periods to commercial loans during 2020 and 2021 totaling $995.7 million. Only $28.8 million remain on deferral at December 31, 2021.
•We provided loan payment deferrals, with no negative credit bureau reporting, to mortgage and consumer loans during 2020 and 2021 totaling $81.6 million. No loans remain on deferral at December 31, 2021.
None of these were designated troubled debt restructurings, or TDRs, for accounting purposes.
Earnings Summary
Net income increased $89.3 million to $110.3 million, or $2.81 per diluted share, in 2021 compared to $21.0 million, or $0.53 per diluted share in 2020. This net increase was primarily due to a lower provision for credit losses related to improving economic conditions, as well the offsetting impact of the 2020 customer fraud that reduced net income by $46.3 million, or $1.19 per share. We experienced a pre-tax loss of $58.7 million related to a customer fraud resulting from a check kiting scheme during 2020. The fraud was perpetrated by a single business customer and the customer has plead guilty in a criminal investigation. We continue to pursue all available sources of recovery to mitigate the loss.
Return on average assets, or ROA, was 1.18 percent and return on average equity, or ROE, was 9.30 percent for 2021 compared to ROA of 0.23 percent and ROE of 1.80 percent for 2020.
Net interest income decreased $3.3 million to $276.1 million compared to 2020. The decrease in interest income was primarily due to lower average loan balances and the low rate interest environment compared to 2020. Average loan balances decreased $325.8 million compared to 2020. Net interest income was favorably impacted by PPP loans which contributed $17.3 million compared to $11.4 million in 2020. Average interest-bearing deposits decreased $126.2 million compared to 2020. The net interest margin, or NIM, on an FTE basis (non-GAAP) decreased 16 basis points compared to 2020. The decrease is primarily due to higher average cash balances and the low interest rate environment. PPP loans positively impacted the NIM on an FTE basis (non-GAAP) by 8 basis points compared to the negative impact of 3 basis points in 2020. NIM is reconciled to net interest income adjusted to an FTE basis (non-GAAP) above in the "Explanation of Use of Non-GAAP Financial Measures" section of this MD&A.
The provision for credit losses was $16.2 million for 2021 compared to $131.4 million in 2020. Excluding a customer fraud loss of $58.7 million, the provision for credit losses was $72.7 million for 2020. The significant decrease in the provision for credit losses during 2021 was mainly due to the customer fraud in 2020 and an improved outlook for the economy and our loan portfolio. Net loan charge-offs were $34.5 million, or 0.49 percent of average loans, in 2021 compared to $103.4 million, or 1.40 percent of average loans, during 2020. Excluding the customer fraud, net loan charge-offs were $44.7 million, or 0.61 percent of average loans in 2020.
Noninterest income increased $4.9 million to $64.6 million compared to $59.7 million in 2020. Wealth management income increased $2.9 million due to customer growth and improved market conditions. Debit and credit card fees increased $2.9 million and service charges on deposit accounts increased $1.4 million due to increased customer activity. These were offset by lower commercial loan swap income of $3.6 million and mortgage banking income of $1.2 million.
Noninterest expense increased $2.2 million to $188.8 million compared to $186.6 million in 2020. Salaries and employee benefits increased $10.1 million primarily due to higher incentives. Data processing and information technology increased $1.2 million due to new products and services in 2021. These higher expenses were offset by decreases in other noninterest expense of $4.1 million, merger related expenses of $2.3 million and marketing of $1.4 million. The efficiency ratio (non-GAAP) for 2021 was 55.05 percent compared to 53.86 percent for 2020.
The efficiency ratio is noninterest expense divided by noninterest income plus net interest income, on an FTE basis, which ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. A reconciliation of the efficiency ratio (non-GAAP) is provided above in the "Explanation of Use of Non-GAAP Financial Measures" section of this MD&A.
The provision for income taxes increased to $25.3 million in 2021 compared to nearly zero for 2020. The increase in our income tax provision was primarily due to a $114.6 million increase in pretax income in 2021 compared to 2020 when pretax income was impacted by significantly higher provision for credit losses. The effective tax rate increased to 18.7 percent in 2021 compared to a nominal negative annual effective tax rate in 2020. The increase in the effective tax rate was primarily due to significantly higher income before taxes in 2021 compared to 2020.
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Net Interest Income
The interest income on interest-earning assets and the net interest margin are presented on an FTE basis. The FTE basis adjusts for the tax benefit of income on certain tax-exempt loans and securities and the dividend-received deduction for equity securities using the federal statutory tax rate of 21 percent and the dividend-received deduction for equity securities. We believe this to be the preferred industry measurement of net interest income that provides a relevant comparison between taxable and non-taxable sources of interest income.
Interest and dividend income per the Consolidated Statements of Net Income is reconciled to interest income, net interest income and net interest margin on an FTE basis (non-GAAP) above in the "Explanation of Use of Non-GAAP Financial Measures" section of this MD&A.
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Average Balance Sheet and Net Interest Income Analysis
The following table provides information regarding the average balances, interest and rates earned on interest-earning assets and the average balances, interest and rates paid on interest-bearing liabilities for the years ended December 31:
ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent .
(3)Taxable investment income is adjusted for the dividend-received deduction for equity securities.
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The following table sets forth for the periods presented a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates:
(dollars in thousands) Volume(4) Rate(4) Net Volume(4) Rate(4) Net
Interest earned on:
Interest paid on:
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent.
(3)Taxable investment income is adjusted for the dividend-received deduction for equity securities.
(4)Changes to rate/volume are allocated to both rate and volume on a proportionate dollar basis.
Net interest income on an FTE basis (non-GAAP) decreased $4.2 million compared to 2020. The decline was primarily due to lower average loan balances compared to 2020. Net interest income was favorably impacted by PPP loans which contributed $17.3 million compared to $11.4 million in 2020. The net interest margin, or NIM, on an FTE basis (non-GAAP) decreased 16 basis points compared to 2020. The decrease is primarily due to higher average cash balances and the low interest rate environment. PPP loans positively impacted the net interest margin on an FTE basis (non-GAAP) by 8 basis points compared to the negative impact of 3 basis points in 2020.
Interest income on an FTE basis (non-GAAP) decreased $32.1 million compared to 2020. The decrease in interest income was primarily due to lower average loan balances compared to 2020 and the continued low interest rate environment. Average loan balances decreased $325.8 million compared to 2020. Average PPP loans decreased $53.7 million compared to 2020. The average rate earned on loans decreased 25 basis points primarily due to lower short-term interest rates. Average interest-bearing deposits with banks increased $542.2 million compared to 2020 due to PPP loan forgiveness, lower loan balances and a significant increase in average deposits as a result of customer PPP loans and stimulus payments along with customers' liquidity preferences. Overall, the FTE rate on interest-earning assets (non-GAAP) decreased 50 basis points compared to 2020.
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Interest expense decreased $27.9 million compared to 2020. The decrease was primarily due to lower short-term interest rates. Average interest-bearing deposits decreased $126.2 million compared to 2020. The average rate paid on interest-bearing deposits decreased 46 basis points compared to 2020 primarily due to lower short-term interest rates. The interest-bearing deposit decreases are favorably offset by a $521.8 million increase in demand deposits. We experienced demand deposit growth due to customer PPP loans and stimulus payments along with customers' liquidity preferences. Brokered deposits decreased $216.0 million and borrowings decreased $164.6 million compared to 2020 due to maturities and a reduced need for wholesale funding. Overall, the cost of interest-bearing liabilities decreased 48 basis points compared to 2020.
Provision for Credit Losses
The provision for credit losses, which includes a provision for losses on loans and on unfunded loan commitments, is a charge to earnings to maintain the ACL at a level consistent with management's assessment of expected losses in the loan portfolio at the balance sheet date. The provision for credit losses decreased $115.2 million to $16.2 million for 2021 compared to $131.4 million for 2020. Excluding the customer fraud loss of $58.7 million, the provision for credit losses was $72.7 million for 2020.
The significant decrease in the provision for credit losses during 2021 was mainly due to the customer fraud in 2020 and an improved outlook for the economy and our loan portfolio. Our total qualitative reserve decreased $7.3 million compared to 2020. The decrease was primarily due to improved economic conditions offset by additional segment allocations for our healthcare and C&I portfolios along with the increased uncertainty at year-end related to the COVID-19 Omicron variant. Specific reserves on loans individually assessed decreased $11.7 million to $1.8 million at December 31, 2021 compared to $13.5 million in 2020. The decrease in specific reserves was the result of approximately $7.8 million of loan charge-offs and the release of $5.7 million of specific reserves due to improved operating performance within our hotel portfolio. Offsetting this decrease in specific reserve was the addition of a $1.8 million specific reserve related to a $21.7 million C&I relationship that also had a $10.3 million charge-off in 2021 based on an estimated enterprise value of the company.
Net loan charge-offs were $34.5 million, or 0.49 percent of average loans, in 2021 compared to $103.4 million, or 1.40 percent of average loans, during 2020. Excluding the customer fraud, net loan charge-offs were $44.7 million, or 0.61 percent of average loans in 2020. The decrease in net loan charge-offs in 2021 was primarily due to improving economic conditions.
Refer to the Credit Quality section of this MD&A for further details.
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Noninterest Income
Years Ended December 31,
(dollars in thousands) 2021 2020 $ Change % Change
Noninterest income increased $4.9 million, or 8.2 percent, in 2021 compared to 2020. Wealth management fees increased $2.9 million compared to the prior year. Brokerage fees increased $1.6 million primarily due to the addition of six new financial advisors added during 2021. Trust income increased $1.3 million mainly due to new customer growth resulting in higher assets under management and improved market conditions. Debit and credit card fees increased $2.9 million due to increased debit and credit card usage. Other noninterest income increased $2.6 million due to a $1.4 million change in the credit valuation adjustment for our commercial loan swaps for risk associated with our hotel loan portfolio, a $0.8 million change in the equity securities portfolio and a $0.5 million change in the valuation of a deferred compensation plan, which has a corresponding offset in salaries and benefit expense resulting in no impact to net income. Service charges on deposit accounts increased $1.4 million due to the improving economic environment which drove higher customer activity. Commercial loan swap income decreased $3.6 million due to the lower customer activity related to the pandemic and interest rate environment. Mortgage banking decreased $1.2 million due to changes in the valuation of the mortgage interest rate locks offset by an improved mortgage servicing rights valuation compared to 2020.
Noninterest Expense
Years Ended December 31,
(dollars in thousands) 2021 2020 $ Change % Change
Merger-related expenses — 2,342 (2,342) NM
NM - percentage not meaningful
Noninterest expense increased $2.2 million, or 1.2 percent, to $188.8 million in 2021 compared to 2020. Total merger-related expense decreased $2.3 million compared to 2020 due to no merger during 2021. Salaries and employee benefits increased $10.1 million during 2021 primarily due to higher incentive, restricted stock, commissions and pension expense due to an increase in retirees electing lump-sum distributions. Data processing and information technology increased $1.2 million due to new products and services in 2021. Offsetting these increases, other noninterest expense decreased $4.1 million due to lower loan related expenses and lower amortization of both our qualified affordable housing projects and core deposit intangible assets. Marketing expense decreased $1.4 million due to the pandemic and a reduction in promotions. FDIC insurance decreased $0.9 million due to the improvement of the financial ratios used to determine the assessment.
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Income Taxes
The provision for income taxes increased to $25.3 million in 2021 compared to nearly zero for 2020. The increase in our income tax provision was primarily due to a $114.6 million increase in income before taxes in 2021 compared to 2020 when income before taxes was impacted by a customer fraud of $58.7 million.
The effective tax rate, which is total tax expense as a percentage of income before taxes, increased to 18.7 percent in 2021 compared to a nominal negative annual effective tax rate in 2020. The increase in the effective tax rate was primarily due to significantly higher income before taxes in 2021 compared to 2020. Historically, we have generated an annual effective tax rate that is less than the statutory rate of 21 percent due to benefits resulting from tax-exempt interest, excludable dividend income, tax-exempt income on Bank Owned Life Insurance, or BOLI, and tax benefits associated with Low Income Housing Tax Credits, or LIHTC.
Financial Condition
December 31, 2022
Total assets decreased $378.0 million to $9.1 billion at December 31, 2022 compared to $9.5 billion at December 31, 2021. Cash and due from banks decreased $712.2 million to $210.0 million at December 31, 2022 compared to $922.2 million at December 31, 2021 primarily related to decreases in deposits due to competition driven by rising interest rates. Total portfolio loans increased $184.0 million, or 2.6 percent, to $7.2 billion at December 31, 2022 compared to $7.0 billion at December 31, 2021. The increase in portfolio loans is primarily related to an increase in the consumer loan portfolio of $344.0 million due to $327.1 million of growth in consumer real estate. The consumer loan portfolio increase was offset by decreases in commercial loans. Commercial loans decreased $160.1 million with decreases of commercial real estate loans of $108.5 million, C&I loans of $10.0 million, which included a decrease of $84.3 million of loans from the PPP, and a decrease of $41.6 million in commercial construction compared to December 31, 2021. Excluding the PPP loans, portfolio loans increased $268.3 million compared to December 31, 2021 due a modest increase in activity.
Securities increased $92.0 million to $1.0 billion at December 31, 2022 from $910.8 million at December 31, 2021. The increase in securities was primarily due to interest-bearing deposits with banks being redeployed to higher yielding assets earlier in 2022. The bond portfolio had an unrealized loss of $102.3 million at December 31, 2022 compared to an unrealized gain of $9.4 million at December 31, 2021 due to higher interest rates.
Our deposits decreased $776.6 million, with total deposits of $7.2 billion at December 31, 2022 compared to $8.0 billion at December 31, 2021. Customer deposits decreased $771.6 million from December 31, 2021. The decrease in customer deposits was driven by competition related to rising interest rates. Customer noninterest-bearing demand deposits decreased $159.9 million, interest-bearing demand decreased $132.5 million, money market deposits decreased $339.1 million and certificates of deposits decreased $148.5 million offset by an increase in savings of $8.4 million.
Total borrowings increased $277.9 million to $439.2 million at December 31, 2022 compared to $161.3 million at December 31, 2021 due to a decrease in funding provided by customer deposits. The increase in borrowings consisted of increases in short-term borrowings of $370.0 million offset by decreases in long term borrowings of $7.7 million and a decrease of $84.5 million due to the discontinuation of securities sold under repurchase agreements.
Total shareholders’ equity decreased $21.8 million to $1.2 billion at December 31, 2022 compared to $1.2 billion at December 31, 2021. The decrease was primarily due to other comprehensive losses of $105.0 million and dividends paid of $47.0 million offset by net income of $135.5 million. Other comprehensive losses were mainly due to unrealized losses of $87.9 million, net of tax, on our available-for-sale debt securities and $16.8 million, net of tax, on interest rate swaps due to the rising interest rate environment.
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Securities Activity
The balances and average rates of our securities portfolio are presented below as of December 31:
(1)Weighted-average yields are calculated on a taxable-equivalent basis using the federal statutory tax rate of 21 percent for 2022, 2021 and 2020.
We invest in various securities in order to maintain a source of liquidity, to satisfy various pledging requirements, to increase net interest income, and as a tool of ALCO to reposition the balance sheet for interest rate risk purposes. Securities are subject to market risks that could negatively affect the level of liquidity available to us. Security purchases are subject to an investment policy approved annually by our Board of Directors and administered through ALCO and our treasury function. Securities increased $92.0 million to $1.0 billion at December 31, 2022 from $910.8 million at December 31, 2021. The increase in securities is primarily due to increased investing activities due to excess liquidity earlier in 2022. These increases were partially offset by unrealized losses due to a rising interest rate environment.
At December 31, 2022 our bond portfolio was in a net unrealized loss position of $102.3 million compared to a net unrealized gain position of $9.4 million at December 31, 2021. At December 31, 2022, total gross unrealized gains in the bond portfolio were $0.3 million offset by gross unrealized losses of $102.6 million compared to December 31, 2021, when total gross unrealized gains were $15.2 million offset by gross unrealized losses of $5.8 million. The decrease in the net unrealized gain position was primarily due to an increase in interest rates from December 31, 2021 to December 31, 2022. Management evaluates the securities portfolio to determine if an ACL is needed each quarter. We did not record an ACL related to the securities portfolio at December 31, 2022 or December 31, 2021.
Management evaluates the bond portfolio for impairment on a quarterly basis. The unrealized losses on debt securities were primarily attributable to changes in interest rates and not related to the credit quality of these securities. All debt securities were determined to be investment grade and paying principal and interest according to the contractual terms of the security at December 31, 2022. We do not intend to sell and it is more likely than not that we will not be required to sell any of the securities in an unrealized loss position before recovery of their amortized cost. We did not recognize any impairment charges on our securities portfolio in 2022, 2021 or 2020. The performance of the debt securities markets could generate impairments in future periods requiring realized losses to be reported.
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The following table sets forth the maturities of securities at December 31, 2022 and the weighted average yields of such securities. Taxable-equivalent adjustments for 2022 have been made in calculating yields on obligations of state and political subdivisions.
Maturing
Available-for-Sale
Corporate bonds — — % 500 7.67 % — — % — — % — — %
Marketable equity securities — — % — — % — — % — — % 994 3.32 %
(1)Weighted-average yields are calculated on a taxable-equivalent basis using the federal statutory tax rate of 21 percent for 2022.
Lending Activity
The following table summarizes our loan portfolio as of December 31:
Commercial
Consumer
The loan portfolio represents the most significant source of interest income for us. The risk that borrowers will be unable to pay such obligations is inherent in the loan portfolio. Other conditions such as downturns in the borrower’s industry or the overall economic climate can significantly impact the borrower’s ability to pay.
We maintain a General Lending Policy to control the quality of our loan portfolio. The policy delegates the authority to extend loans under specific guidelines and underwriting standards. The General Lending Policy is formulated by management and reviewed and ratified annually by the Board of Directors.
We attempt to limit our exposure to credit risk by diversifying our loan portfolio by segment, geography, collateral and industry and actively managing concentrations. When concentrations exist in certain segments, we assess the credit risk within those segments to determine if additional reserve is needed in the qualitative portion of the ACL. Total commercial loans
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represented 73.0 percent of total portfolio loans at December 31, 2022 compared to 77.2 percent at December 31, 2021. Within our commercial portfolio, the CRE and commercial construction portfolios combined comprised $3.5 billion, or 67.2 percent, of total commercial loans and 49.1 percent of total portfolio loans at December 31, 2022 compared to $3.7 billion, or 68.0 percent, of total commercial loans and 52.5 percent of total portfolio loans at December 31, 2021.
We lend primarily in Pennsylvania and the contiguous states of Ohio, New York, West Virginia and Maryland. The majority of our commercial and consumer loans are made to businesses and individuals in these states resulting in a geographic concentration. We believe our knowledge of these markets outweighs the geographic concentration risk. Our operating knowledge at the local and regional level is derived from our front-line connection to the customer and our understanding of their businesses. We also have a portfolio management group that utilizes multiple data sources including customer information, publicly available data and subscription service data to assess risk on an on-going basis and strong overall risk management practices which help us understand and evaluate concentration risk. Our CRE and commercial construction portfolios have exposure outside this geography of 5.8 percent of the combined portfolios and 2.9 percent of total portfolio loans at December 31, 2022. This compares to 5.7 percent of the combined portfolios and 3.0 percent of total portfolio loans at December 31, 2021.
Total portfolio loans increased $184.0 million, or 2.6 percent, to $7.2 billion at December 31, 2022 compared to $7.0 billion at December 31, 2021. Commercial and industrial loans, or C&I, included $4.0 million of loans originated under the PPP at December 31, 2022 compared to $88.3 million at December 31, 2021. On March 27, 2020, the CARES Act was signed into law. The CARES Act included the PPP, a program designed to aid small and medium sized businesses through federally guaranteed loans distributed through banks.
As of December 31, 2022, 72 percent of our total loans were variable rate loans and 28 percent were fixed rate loans. Commercial loans, including CRE, C&I and commercial construction, comprised 73.0 percent of total portfolio loans at December 31, 2022 and 77.2 percent at December 31, 2021. The decrease of $160.1 million in commercial loans related to a decrease of $108.5 million in CRE, $41.6 million in commercial construction loans and $10.0 million in C&I, which included a decrease of $84.3 million of loans from the PPP compared to December 31, 2021. Excluding the PPP loans, portfolio loans increased $268.3 million compared to December 31, 2021. Our loan demand was influenced by the downturn of the macroeconomic environment during 2022, but we did see loan growth in the second half of 2022.
Consumer loans represent 27.0 percent of our total portfolio loans at December 31, 2022 and 22.8 percent at December 31, 2021. Consumer loans increased $344.0 million compared to December 31, 2021 primarily due to an increase of $216.6 million in the residential real estate portfolio, $87.8 million in the home equity portfolio and $39.6 million in installment and other consumer loans. Portfolio consumer real estate loans increased in 2022 due to a shift from mortgage loans sold to loans held in the portfolio due to increased jumbo loans and the pricing of loans in the secondary market compared to December 31, 2021. The consumer loan portfolio increase was offset by decreases in commercial loans.
Residential mortgage lending continues to be a focus for us. The loan to value, or LTV, policy guideline is 80 percent for residential first lien mortgages. Higher LTV loans may be approved within unique program guidelines and the appropriate private mortgage insurance coverage. We originate traditional fixed rate mortgage loans and adjustable rate or balloon mortgages with a maximum amortization term of 30 years. We may originate home equity loans with a lien position that is second to unrelated third-party lenders, but normally only to the extent that the combined LTV considering both the first and second liens does not exceed 100 percent of the fair value of the property. Combo mortgage loans consisting of a residential first mortgage and a home equity second mortgage are also available.
We originate and sell loans into the secondary market, primarily to Fannie Mae. We sell these loans in order to mitigate interest-rate risk associated with holding lower rate, long-term residential mortgages in the loan portfolio and to generate fee revenue from sales and servicing of the loans. We sold $28.6 million of 1-4 family mortgages in 2022 and $288.3 million in 2021 to Fannie Mae. The volume of loans sold to Fannie Mae decreased due to a shift from mortgage loans sold to loans held in the portfolio due to increased jumbo loans and the pricing of loans in the secondary market compared to December 31, 2021. Our servicing portfolio of mortgage loans that we had originated and sold into the secondary market was $772.9 million at December 31, 2022 compared to $841.7 million at December 31, 2021. We also offer a variety of unsecured and secured consumer loan products.
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The following table presents the maturity of commercial and consumer loans outstanding as of December 31, 2022:
Maturity
Off Balance Sheet Arrangements
In the normal course of business, we offer off-balance sheet credit arrangements to enable our customers to meet their financing objectives. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. Our exposure to credit loss, in the event the customer does not satisfy the terms of the agreement, equals the contractual amount of the obligation less the value of any collateral. We apply the same credit policies in making commitments and standby letters of credit that are used for the underwriting of loans to customers. Commitments generally have fixed expiration dates, annual renewals or other termination clauses and may require payment of a fee. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
The following table sets forth our commitments and letters of credit as of the dates presented:
December 31,
See Note 18 Commitments and Contingencies in Part II, Item 8. Financial Statements and Supplementary Data of this Report for details on allowance for credit losses on unfunded commitments.
Credit Quality
On a quarterly basis, a criticized asset meeting is held to monitor all special mention and substandard loans greater than $1.5 million and all business banking special mention and substandard loans greater than $0.5 million to establish action plans for these loans. These loans typically represent the highest risk of loss to us. We monitor these loans through regular contact with the borrower, review of current financial information and other documentation, review of all loan or potential loan restructures or modifications and the regular re-evaluation of assets held as collateral.
Additional credit risk management practices include periodic review, at least annually, and updates of our lending policies and procedures to support sound underwriting practices and portfolio management through portfolio stress testing. We have a portfolio monitoring process in place that includes an annual review of all commercial relationships greater than $1.5 million. Business banking relationships less than $1.5 million are monitored through portfolio management software that identifies credit risk indicators. Our Credit Risk Review process serves to independently monitor credit quality and assess the effectiveness of credit risk management practices to provide oversight of all corporate lending activities. The Credit Risk Review function has the primary responsibility for assessing commercial credit administration and credit decision functions of consumer and mortgage underwriting, as well as providing input to the loan risk rating process.
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Nonperforming assets, or NPAs, consist of nonaccrual loans, nonaccrual TDRs and OREO. The following represents NPAs as of December 31:
Nonaccrual Loans
Commercial construction 384 384
Nonaccrual Troubled Debt Restructurings
Commercial real estate — 1,968
Commercial construction — 2,087
Other consumer 9 —
Total Nonaccrual Troubled Debt Restructurings 2,894 21,774
Nonaccrual loans as a percent of total loans 0.27 % 0.95 %
Nonperforming assets as a percent of total loans plus OREO 0.31 % 1.13 %
Our policy is to place loans in all categories in nonaccrual status when collection of interest or principal is doubtful, or generally when interest or principal payments are 90 days or more past due.
Nonperforming assets decreased $57.5 million, or 72.2 percent, resulting in a nonperforming assets to total loans plus OREO ratio of 0.31% at December 31, 2022 compared to 1.13% at December 31, 2021. Nonaccrual loans decreased $47.2 million, or 71.3 percent, to $19.1 million at December 31, 2022 compared to $66.3 million at December 31, 2021. The significant decrease in nonaccrual loans during 2022 primarily related to minimal inflow of new nonaccrual loans and the payoff of two C&I relationships totaling $14.1 million, two CRE relationships totaling $9.2 million and the return to performing status of hotel loans totaling $9.1 million. The significant decrease in OREO related to the sale of two properties during 2022.
TDRs decreased $19.9 million to $11.8 million at December 31, 2022 compared to $31.7 million at December 31, 2021. Total TDRs of $11.8 million at December 31, 2022 included $8.9 million, or 75.4 percent, that were accrual and $2.9 million, or 24.6 percent, that were nonaccrual. This is a decrease from December 31, 2021 when we had $31.7 million in TDRs, including $9.9 million, or 31.2 percent, that were accrual and $21.8 million, or 68.8 percent, that were nonaccrual. The decrease in nonaccrual TDRs during 2022 primarily related to the payoff of two C&I relationships totaling $14.1 million.
Loan modifications resulting in new TDRs during 2022 included 27 modifications for $2.2 million compared to 40 modifications for $17.6 million in 2021. Included in the 2022 new TDRs were 23 loans totaling $1.4 million related to consumer bankruptcy filings that were not reaffirmed, thus resulting in discharged debt, which compares to 25 loans totaling $1.1 million in 2021.
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following represents delinquency as of December 31:
(dollars in thousands) Amount % ofLoans Amount % ofLoans
90 days or more:
Commercial real estate $ 8,772 0.28 % $ — — %
Commercial construction — — % 502 0.11 %
Loans held for sale — — % — — %
Closed-end installment loans, amortizing loans secured by real estate and any other loans with payments scheduled monthly are reported past due when the borrower is in arrears two or more monthly payments. Other multi-payment obligations with payments scheduled other than monthly are reported past due when one scheduled payment is due and unpaid for 30 days or more. We monitor delinquency on a monthly basis, including early-stage delinquencies of 30 to 89 days past due for early identification of potential problem loans. Loans past due 90 days or more decreased $47.2 million compared to December 31, 2021 and represented 0.27 percent of total loans at December 31, 2022. The change in loans past due 90 days or more is explained above in nonperforming assets discussion under Credit Quality. Loans past due by 30 to 89 days increased $14.6 million and represented 0.28 percent of total loans at December 31, 2022.
Allowance for Credit Losses
We maintain an ACL at a level determined to be adequate to absorb estimated expected credit losses within the loan portfolio over the contractual life of a loan that considers our historical loss experience, current conditions and forecasts of future economic conditions as of the balance sheet date. We develop and document a systematic ACL methodology based on the following portfolio segments: 1) CRE, 2) C&I, 3) Commercial Construction, 4) Business Banking, 5) Consumer Real Estate and 6) Other Consumer.
Our charge-off policy for commercial loans requires that loans and other obligations that are not collectible be promptly charged-off when the loss is confirmed, regardless of the delinquency status of the loan. We may elect to recognize a partial charge-off when management has determined that the value of collateral is less than the remaining investment in the loan. A loan or obligation does not need to be charged-off, regardless of delinquency status, if (i) management has determined there exists sufficient collateral to protect the remaining loan balance and (ii) there exists a strategy to liquidate the collateral. Management may also consider a number of other factors to determine when a charge-off is appropriate. These factors may include, but are not limited to:
•The status of a bankruptcy proceeding;
•The value of collateral and probability of successful liquidation; and/or
•The status of adverse proceedings or litigation that may result in collection.
Consumer unsecured loans and secured loans are evaluated for charge-off after the loan becomes 90 days past due. Unsecured loans are fully charged off and secured loans are charged down to the estimated fair value of the collateral less the cost to sell.
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table presents activity in the ACL for each of the three years presented below:
Years Ended December 31,
Charge-offs:
Commercial construction — (55) (454)
Recoveries:
Commercial construction 1 14 183
Impact of CECL adoption — — 27,346
(1)Represents ALL for year presented
Net loan charge-offs for 2022 were $2.6 million, or 0.04 percent of average loans, compared to $34.5 million, or 0.49 percent of average loans for 2021. The most significant charge-off during 2022 was to a C&I relationship in the amount of $5.5 million. Offsetting loan charge-offs during 2022 were $6.6 million of loan recoveries related to two C&I relationships.
The following table summarizes net charge-offs as a percentage of average loans for the years presented:
Commercial and industrial 0.03 % 1.17 % 3.65 %
Commercial construction — % 0.01 % 0.06 %
Net charge-offs to average loans outstanding 0.04 % 0.49 % 1.40 %
Allowance for credit losses to total nonaccrual loans 532 % 149 % 80 %
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is the ACL balance by portfolio segment as of December 31:
(dollars in thousands) Amount % ofTotal Amount % ofTotal
Significant to our ACL is a higher concentration of commercial loans. The ability of borrowers to repay commercial loans is dependent upon the success of their business and general economic conditions. Due to the greater potential for loss within our commercial portfolio, we monitor the commercial loan portfolio through an internal risk rating system. Loan risk ratings are assigned based upon the creditworthiness of the borrower and are reviewed on an ongoing basis according to our internal policies. Loans rated special mention or substandard have potential or well-defined weaknesses not generally found in high quality, performing loans, and require attention from management to limit loss.
The ACL was $101.3 million, or 1.41 percent of total portfolio loans, at December 31, 2022, compared to $98.6 million, or 1.41 percent of total portfolio loans, at December 31, 2021. The increase in the ACL of $2.8 million was due to a shift between the qualitative and quantitative reserves as well as loan growth. Our total qualitative reserve increased $9.3 million primarily related to a $4.0 million increase in our forecast due to concern with the overall outlook of the economy and a $5.3 million increase in other qualitative factors. Our quantitative reserve decreased $4.8 million primarily due to significant improvement in our CRE hotel portfolio, which was partially offset by deterioration in the C&I portfolio primarily related to a large relationship downgraded to substandard during the year. Specific reserves on loans individually assessed decreased $1.7 million from prior year due to the resolution of a C&I relationship through a note sale.
Federal Home Loan Bank and Other Restricted Stock
At December 31, 2022 and 2021, we held FHLB of Pittsburgh stock of $22.0 million and $8.5 million. This investment is carried at cost and evaluated for impairment based on the ultimate recoverability of the par value. We hold FHLB stock because we are a member of the FHLB of Pittsburgh. The FHLB requires members to purchase and hold a specified level of FHLB stock based upon on the members’ asset values, level of borrowings and participation in other programs offered. Stock in the FHLB is non-marketable and is redeemable at the discretion of the FHLB. Members do not purchase stock in the FHLB for the same reasons that traditional equity investors acquire stock in an investor-owned enterprise. Rather, members purchase stock to obtain access to the products and services offered by the FHLB. Unlike equity securities of traditional for-profit enterprises, the stock of the FHLB does not provide its holders with an opportunity for capital appreciation because, by regulation, FHLB stock can only be purchased, redeemed and transferred at par value. We reviewed and evaluated the FHLB capital stock for impairment at December 31, 2022. The FHLB exceeds all required capital ratios. Additionally, we considered that the FHLB has been paying dividends and actively redeeming stock throughout 2022 and 2021. Accordingly, we believe sufficient evidence exists to conclude that no impairment existed at December 31, 2022.
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Deposits
The following table presents the composition of deposits at December 31:
(dollars in thousands) 2022 2021 $ Change
Customer deposits
Brokered deposits
Deposits are our primary source of funds. Our deposit base increased substantially through the pandemic related to PPP and stimulus programs, but we have experienced a decrease in deposits during 2022 related to the competitive market driven by rising interest rates. Total deposits decreased $776.6 million, or 10 percent, at December 31, 2022 compared to December 31, 2021. Total customer deposits decreased $771.6 million from December 31, 2021. Total brokered deposits decreased $5.0 million from December 31, 2021 due to a reduced need for this type of funding. Brokered deposits are an additional source of funds utilized by ALCO as a way to diversify funding sources, as well as manage our funding costs and structure.
The daily average balance of deposits and rates paid on deposits are summarized in the following table for the years ended December 31:
(dollars in thousands) Amount Rate Amount Rate Amount Rate
CDs of $250,000 and over accounted for 3.0 percent of total deposits at December 31, 2022 and December 31, 2021 and primarily represent deposit relationships with local customers in our market area.
Maturities of CDs of $250,000 or more outstanding at December 31, 2022 are summarized as follows:
(dollars in thousands) 2022
Over three through six months 31,922
Over six through twelve months 46,907
Borrowings
The following table represents the composition of borrowings for the years ended December 31:
(dollars in thousands) 2022 2021 $ Change
Securities sold under repurchase agreements, retail $ — $ 84,491 $ (84,491)
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Borrowings are an additional source of funding for us. Total borrowings increased $277.9 million compared to December 31, 2021 due to a decrease in funding from lower deposit levels. Short-term borrowings increased $370.0 million offset by the discontinuation of the customer repurchase agreement product and the maturity of a $7.0 million long-term borrowing compared to December 31, 2021.
Information pertaining to short-term borrowings is summarized in the tables below:
Securities Sold Under Repurchase Agreements
Average interest rate during the year 0.10 % 0.11 % 0.29 %
Average interest rate at December 31 — % 0.10 % 0.25 %
Short-Term Borrowings
Average interest rate during the year 4.15 % 0.19 % 0.92 %
Average interest rate at December 31 4.49 % — % 0.19 %
Information pertaining to long-term borrowings is summarized in the tables below:
Long-Term Borrowings
Average interest rate during the year 2.15 % 1.99 % 2.50 %
Average interest rate at December 31 2.61 % 1.94 % 2.03 %
Junior Subordinated Debt Securities
Average interest rate during the year 4.40 % 2.99 % 3.57 %
Average interest rate at December 31 7.09 % 2.69 % 3.01 %
We have completed three private placements of trust preferred securities to financial institutions. As a result, we own 100 percent of the common equity of STBA Capital Trust I, DNB Capital Trust I, and DNB Capital Trust II, or the Trusts. The Trusts were formed to issue mandatorily redeemable capital securities to third-party investors. The proceeds from the sale of the securities and the issuance of the common equity by the Trusts were invested in junior subordinated debt securities issued by us. The third-party investors are considered the primary beneficiaries of the Trusts; therefore, the Trusts qualify as variable interest entities, but are not consolidated into our financial statements. The Trusts pays dividends on the securities at the same rate as the interest paid by us on the junior subordinated debt held by the Trusts. DNB Capital Trust I and DNB Capital Trust II were acquired with the DNB Merger. Refer to Note 16 Short-Term Borrowings and Note 17 Long-Term Borrowings and Subordinated Debt to the consolidated financial statements included in Part II, Item 8. Financial Statements and Supplementary Data, of this Report, for more details.
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Wealth Management Assets
As of December 31, 2022, the fair value of the S&T Bank Wealth Management assets under administration, which are not accounted for as part of our assets, decreased to $2.2 billion from $2.3 billion as of December 31, 2021. Assets under administration consisted of $1.0 billion in S&T Trust, $0.8 billion in S&T Financial Services and $0.4 billion in Stewart Capital Advisors.
Liquidity and Capital Resources
Liquidity
Liquidity is defined as a financial institution’s ability to meet its cash and collateral obligations at a reasonable cost. Our primary future cash needs are centered on the ability to (i) satisfy the financial needs of depositors who may want to
withdraw funds or of borrowers needing to access funds to meet their credit needs and (ii) to meet our future cash commitments
under contractual obligations with third parties. In order to manage liquidity risk, our Board of Directors has delegated authority to ALCO for the formulation, implementation and oversight of liquidity risk management for S&T. The ALCO’s goal is to maintain adequate levels of liquidity at a reasonable cost to meet funding needs in both a normal operating environment and for potential liquidity stress events. The ALCO monitors and manages liquidity through various ratios, reviewing cash flow projections, performing stress tests and having a detailed contingency funding plan. The ALCO policy guidelines define graduated risk tolerance levels. If our liquidity position moves to a level that has been defined as high risk, specific actions are required, such as increased monitoring or the development of an action plan to reduce the risk position.
Our primary funding and liquidity source is a stable customer deposit base. We believe S&T has the ability to retain existing and attract new deposits, mitigating any funding dependency on other more volatile sources. Refer to the Deposits section of this MD&A for additional discussion on deposits. Although deposits are the primary source of funds, we have identified various other funding sources that can be used as part of our normal funding program when either a structure or cost efficiency has been identified. Additional funding sources accessible to S&T include borrowing availability at the Federal Home Loan Bank, or FHLB, of Pittsburgh, federal funds lines with other financial institutions, the brokered deposit market and borrowing availability through the Federal Reserve Borrower-In-Custody program. We believe that these funding sources will provide adequate resources to fund our short-term and long-term operating and financing needs. In addition, our ability to access capital markets provides additional sources of funding with respect to strategic investing opportunities. Our access to and the availability of funds in the future will be affected by many factors, including, but not limited to our financial condition and prospects, our credit rating, the liquidity of the overall capital markets and the current state of the economy.
The following table summarizes our material contractual obligations as of December 31, 2022:
Payments Due In
Junior subordinated debt securities(1) — — — 54,453 54,453
(1)Excludes interest
An important component of our ability to effectively respond to potential liquidity stress events is maintaining a cushion of highly liquid assets. Highly liquid assets are those that can be converted to cash quickly, with little or no loss in value, to meet financial obligations. ALCO policy guidelines define a ratio of highly liquid assets to total assets by graduated risk tolerance levels of minimal, moderate and high. At December 31, 2022, S&T Bank had $870.0 million in highly liquid assets, which consisted of $137.6 million in interest-bearing deposits with banks and $732.4 million in unpledged securities. This resulted in a highly liquid assets to total assets ratio of 9.6 percent at December 31, 2022. Highly liquid assets have declined by $431.0 million when comparing December 31, 2022 to December 31, 2021. The majority of the decrease in liquid assets is attributed to decreases in cash balances which are primarily a result of decreased deposits. At December 31, 2022, we had remaining borrowing availability of $2.4 billion with the FHLB of Pittsburgh. Refer to Note 16 Short-Term Borrowings and Note 17 Long-Term Borrowings and Subordinated Debt to the consolidated financial statements included in Part II, Item 8. Financial Statements and Supplementary Data, and the Borrowings section of this MD&A, for more details.
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Capital Resources
Shareholders’ equity decreased $21.8 million, or 1.8 percent, to $1.2 billion at December 31, 2022 compared to $1.2 billion at December 31, 2021. The decrease was primarily due to a $105.0 million decrease in other comprehensive income and dividends of $47.0 million, partially offset by net income of $135.5 million. The decrease in other comprehensive income was primarily due to a $87.9 million increase in unrealized losses on our available-for-sale securities, net of tax and an increase of $16.8 million in unrealized losses on our interest rate swaps.
We continue to maintain our capital position with a leverage ratio of 11.06 percent as compared to the regulatory guideline of 5.00 percent to be well-capitalized and a risk-based Common Equity Tier 1 ratio of 12.81 percent compared to the regulatory guideline of 6.50 percent to be well-capitalized. Our risk-based Tier 1 and Total capital ratios were 13.21 percent and 14.73 percent, which places us above the federal bank regulatory agencies’ well-capitalized guidelines of 8.00 percent and 10.00 percent, respectively. Our ratios are also above the required minimum ratios after the capital conservation buffer, discussed further below, of common equity tier 1 risk-based capital ratio greater than 7.00 percent, tier 1 risk-based capital ratio greater than 8.50 percent and a total risk-based capital ratio greater than 10.50 percent. We believe that we have the ability to raise additional capital, if necessary.
On March 27, 2020, the regulators issued interim final rule, or IFR, “Regulatory Capital Rule: Revised Transition of the Current Expected Credit Losses Methodology for Allowances” in response to the disrupted economic activity from the spread of COVID-19. The IFR provides financial institutions that adopt CECL during 2020 with the option to delay for two years the estimated impact of CECL on regulatory capital, followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided by the initial two-year delay (“five year transition”). We adopted CECL effective January 1, 2020 and elected to implement the five year transition.
In July 2013 the federal banking agencies issued a final rule to implement Basel III and the minimum leverage and risk-based capital requirements of the Dodd-Frank Act. The rule requires a banking organization to maintain a capital conservation buffer composed of common equity tier 1 capital in an amount greater than 2.50 percent of total risk-weighted assets. Banking organizations must maintain a common equity tier 1 risk-based capital ratio greater than 7.00 percent, a tier 1 risk-based capital ratio greater than 8.50 percent and a total risk-based capital ratio greater than 10.50 percent; otherwise, it will be subject to restrictions on capital distributions and discretionary bonus payments. The minimum capital requirements plus the capital conservation buffer exceeds the regulatory capital ratios required for an insured depository institution to be well-capitalized under the FDIC's prompt corrective action framework.
Federal regulators periodically propose amendments to the regulatory capital rules and the related regulatory framework and consider changes to the capital standards that could significantly increase the amount of capital needed to meet applicable standards. The timing of adoption, ultimate form and effect of any such proposed amendments cannot be predicted.
We have filed a shelf registration statement on Form S-3 under the Securities Act of 1933 as amended, with the SEC, which allows for the issuance of a variety of securities including debt and capital securities, preferred and common stock and warrants. We may use the proceeds from the sale of securities for general corporate purposes, which could include investments at the holding company level, investing in, or extending credit to subsidiaries, possible acquisitions and stock repurchases. As of December 31, 2022, we had not issued any securities pursuant to the shelf registration statement.
Inflation
Management is aware of the significant effect inflation has on interest rates and can have on financial performance and is closely monitoring the increased inflation rates being experienced in the economy. Our ability to cope with this is best determined by analyzing our capability to respond to changing interest rates and our ability to manage noninterest income and expense. We monitor the mix of interest-rate sensitive assets and liabilities through ALCO in order to reduce the impact of inflation on net interest income. We also control the effects of inflation by reviewing the prices of our products and services, by introducing new products and services and by controlling overhead expenses.
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Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is defined as the degree to which changes in interest rates, foreign exchange rates, commodity prices or equity prices can adversely affect a financial institution’s earnings or capital. For most financial institutions, including S&T, market risk primarily reflects exposures to changes in interest rates. Interest rate fluctuations affect earnings by changing net interest income and other interest-sensitive income and expense levels. Interest rate changes also affect capital by changing the net present value of a bank’s future cash flows, and the cash flows themselves, as rates change. Accepting this risk is a normal part of banking and can be an important source of profitability and enhancing shareholder value. However, excessive interest rate risk can threaten a bank’s earnings, capital, liquidity and solvency. Our sensitivity to changes in interest rate movements is continually monitored by the ALCO. The ALCO monitors and manages market risk through rate shock analyses, economic value of equity, or EVE, analyses and by performing stress tests and simulations to mitigate earnings and market value fluctuations due to changes in interest rates.
Rate shock analyses results are compared to a base case to provide an estimate of the impact that market rate changes may have on 12 and 24 months of pretax net interest income. The base case and rate shock analyses are performed on a static balance sheet. A static balance sheet is a no growth balance sheet in which all maturing and/or repricing cash flows are reinvested in the same product at the existing product spread. Rate shock analyses assume an immediate parallel shift in market interest rates and include management assumptions regarding the impact of interest rate changes on non-maturity deposit products (noninterest-bearing demand, interest-bearing demand, money market and savings) and changes in the prepayment behavior of loans and securities with optionality. S&T policy guidelines limit the change in pretax net interest income over 12- and 24-month horizons using rate shocks in increments of +/- 100 basis points. Policy guidelines define the percentage change in pretax net interest income by graduated risk tolerance levels of minimal, moderate, and high.
In order to monitor interest rate risk beyond the 24-month time horizon of rate shocks on pretax net interest income, we also perform EVE analyses. EVE represents the present value of all asset cash flows minus the present value of all liability cash flows. EVE change results are compared to a base case to determine the impact that market rate changes may have on our EVE. As with rate shock analyses on pretax net interest income, EVE analyses incorporate management assumptions regarding prepayment behavior of fixed rate loans and securities with optionality and the behavior and value of non-maturity deposit products. S&T policy guidelines limit the change in EVE using rate shocks in increments of +/- 100 basis points. Policy guidelines define the percent change in EVE by graduated risk tolerance levels of minimal, moderate, and high.
The table below reflects the rate shock analyses results for the 1 to 12 and 13 to 24 month periods of pretax net interest income and EVE.
The results from the rate shock analyses on net interest income are consistent with having an asset sensitive balance sheet. Having an asset sensitive balance sheet means more assets than liabilities will reprice during the measured time frames. The implications of an asset sensitive balance sheet will differ depending upon the change in market interest rates. For example, with an asset sensitive balance sheet in a declining interest rate environment, more assets than liabilities will decrease in rate. This situation could result in a decrease in net interest income and operating income. Conversely, with an asset sensitive balance sheet in a rising interest rate environment, more assets than liabilities will increase in rate. This situation could result in an increase in net interest income and operating income.
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Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our rate shock analyses show less improvement in the percentage change in pretax net interest income in the rates up scenarios when comparing December 31, 2022 to December 31, 2021 because we have less excess cash and $500 million of received-fixed interest rate swaps were executed throughout 2022. The percentage change in pretax net interest income in the rates down scenario shows a decline when comparing December 31, 2022 to December 31, 2021 because the higher rate environment has increased our asset yields more than our liability costs. A decline in interest rates would result in less interest income with limited interest expense reduction. Our EVE analyses show a decline in the percentage change in EVE in the rates up scenarios and an improvement in the rates down scenario when comparing December 31, 2022 to December 31, 2021 due to the impact of interest rates on the value of nonmaturity deposits.
In addition to rate shocks and EVE analyses, we perform a market risk stress test at least annually. The market risk stress test includes sensitivity analyses and simulations. Sensitivity analyses are performed to help us identify which model assumptions cause the greatest impact on pretax net interest income. Sensitivity analyses may include changing prepayment behavior of loans and securities with optionality and the impact of interest rate changes on non-maturity deposit products. Simulation analyses may include the potential impact of rate changes other than the policy guidelines, yield curve shape changes, significant balance mix changes, and various growth scenarios.
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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated Financial Statements
Consolidated Balance Sheets 57
Consolidated Statements of Net Income 58
Consolidated Statements of Comprehensive Income 59
Consolidated Statements of Changes in Shareholders’ Equity 60
Consolidated Statements of Cash Flows 61
Notes to Consolidated Financial Statements 63
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CONSOLIDATED BALANCE SHEETS
December 31,
( in thousands, except share and per share data) 2022 2021
ASSETS
Federal Home Loan Bank and other restricted stock, at cost 23,035 9,519
LIABILITIES
Deposits:
SHAREHOLDERS’ EQUITY
Accumulated other comprehensive loss (112,125) (7,090)
See Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF NET INCOME
Years ended December 31,
INTEREST AND DIVIDEND INCOME
Investment securities:
INTEREST EXPENSE
Borrowings, junior subordinated debt securities and other 5,061 2,393 5,090
NONINTEREST INCOME