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 fiscal years and results of operations for each of the past three fiscal years. The Company's discussion and analysis focuses on significant factors impacting the financial condition and results of operations for the year ended December 31, 2023 as compared to the year ended December 31, 2022. This discussion and analysis should be read in conjunction with our Consolidated Financial Statements and Supplementary Data and related notes within this Annual Report on Form 10-K. A similar discussion and analysis that compares the year ended December 31, 2022 to the year ended December 31, 2021 may be found in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations” on our Form 10-K for the year ended December 31, 2022, filed with the Securities and Exchange Commission, or SEC, on February 24, 2023. Certain reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation.
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, 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; any remaining uncertainties with 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; developments affecting the industry and the soundness of financial institutions and further disruption to the economy and U.S. banking system; 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; ESG practices and disclosures, including climate change, hiring practices, the diversity of the work force, and racial and social justice issues; 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 and geopolitical tensions and conflicts between nations.
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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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 2023. We have reviewed these critical accounting estimates and related disclosures with the Audit Committee.
Allowance for Credit Losses
Our expected credit loss methodology 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 70 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.
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
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carrying amount. An impairment charge would be recognized if the carrying amount exceeds the reporting unit's fair value. A qualitative assessment is performed to determine whether it is more likely than not that the reporting unit's fair value is less than it's carrying value. We perform a quantitative impairment test only if we conclude that it is more likely than not that a reporting unit's fair value is less than the carrying amount. 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.
Based upon our qualitative assessment performed for our annual impairment analysis as of October 1, 2023, 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 financial measures presented in accordance with GAAP, our management uses, and this report contains or references, certain non-GAAP financial measures discussed below. We believe these non-GAAP financial measures provide information useful to investors in understanding our underlying business, operational performance 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.
The following table reconciles interest and dividend income and net interest 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,
Plus: taxable equivalent adjustment 0.03 % 0.02 % 0.03 %
Net Interest Margin on an FTE Basis (Non-GAAP) 4.13 % 3.76 % 3.22 %
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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: net gains on sale of securities — (198) (29)
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 1,042 1,199 1,400
Executive Overview
We are a bank holding company that is headquartered in Indiana, Pennsylvania with assets of $9.6 billion at December 31, 2023. We operate in Pennsylvania and Ohio providing 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.
Our purpose is building a better future together through people-forward banking. We believe that all banking should be personal. We cultivate relationships rooted in trust, strengthened by going above and beyond and renewed with every interaction. Our strategic priorities for 2024 and beyond will be focused on our deposit franchise, core profitability, asset quality and talent and engagement.
During the first quarter of 2023, the banking industry experienced significant volatility with several high-profile bank failures and industry wide concerns related to liquidity, deposit outflows, unrealized securities losses and eroding consumer confidence in the banking system. Despite these negative industry developments, our liquidity position and balance sheet remain well-positioned. We have a well-diversified deposit base with a balance mix of 56.4 percent personal, 34.1 percent business, 4.5 percent public funds and 5.0 percent brokered deposits at December 31, 2023. We have total uninsured deposits of $2.3 billion, or 30 percent of our total deposit base. At December 31, 2023, we had remaining borrowing availability of $4.1 billion, which includes $2.7 billion with the FHLB of Pittsburgh, $769.7 million from the Federal Reserve Borrower-in-Custody Program and $637.0 million from the Federal Reserve Bank Term Funding Program, or BTFP. Furthermore, our capital remains strong with a Common Equity Tier 1 Ratio of 13.37 percent and a total capital ratio of 15.27 percent at December 31, 2023.
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RESULTS OF OPERATIONS
Year Ended December 31, 2023
Earnings Summary
The following table presents a summary of key profitability metrics for the periods presented:
Years ended December 31,
Earnings per share - diluted $ 3.74 $ 3.46 $ 2.81
Return on average shareholders' equity 11.80 % 11.47 % 9.30 %
We earned record net income of $144.8 million for the second consecutive year, representing an increase of $9.3 million or 6.83 percent, compared to net income of $135.5 million in 2022. Earnings per diluted share increased 8.1 percent to a record $3.74 in 2023 compared to $3.46 in 2022. The increase in net income was primarily due to higher net interest income related to higher interest rates. Return on average assets increased 8 basis points to 1.56 percent for 2023 compared to 1.48 percent for 2022. Return on average shareholders' equity increased 33 basis points to 11.80 percent for 2023 compared to 11.47 percent for 2022.
Net interest income increased $33.6 million, or 10.65 percent, to $349.4 million compared to $315.8 million in 2022. Interest and dividend income increased $137.2 million and interest expense increased $103.5 million compared to 2022. The net interest margin, or NIM, on an FTE basis (non-GAAP) increased 37 basis points to 4.13 percent compared to 3.76 percent in 2022. The increases in net interest income and NIM on an FTE basis (non-GAAP) were primarily due to higher interest rates during 2023 and an asset sensitive balance sheet. 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 Management’s Discussion and Analysis, or MD&A.
The provision for credit losses increased $9.5 million to $17.9 million for 2023 compared to $8.4 million for 2022. The increase in the provision for credit losses was mainly due to an increase in net charge-offs in 2023 and our qualitative reserve. Net loan charge-offs were $13.2 million, or 0.18 percent of average loans, in 2023 compared to $2.6 million, or 0.04 percent of average loans, in 2022.
Noninterest income was relatively consistent at $57.6 million compared to $58.3 million in 2022. Mortgage banking income decreased $1.1 million due to a decline in loan sale activity caused by rising interest rates and a shift to holding originated mortgage loans on the balance sheet. Various other customer fees were down compared to the prior year due to lower activity. Offsetting these decreases was an increase of $2.5 million in other noninterest income primarily related to valuation adjustments and a $0.8 million increase in net gain on the sale of OREO partially offset by a $0.8 million decrease in fees on commercial loan swaps.
Noninterest expense increased $13.6 million to $210.3 million compared to $196.7 million in 2022. Salaries and employee benefits increased $8.2 million primarily due to higher salaries related to inflationary wage pressure, the acquisition of new talent and a change in the valuation adjustment on a nonqualified benefit plan. Loan-related expense increased $2.1 million primarily due to an increase in loan collection and legal expenses for the workout of criticized and classified loans. Furniture, equipment and software expense increased $1.3 million due to new software implemented in 2023. FDIC insurance increased $1.3 million due to a two basis point increase in the assessment rate. The efficiency ratio (non-GAAP) for 2023 improved to 51.35 percent compared to 52.34 percent for 2022 due to higher revenue in 2023. 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 $0.6 million to $34.0 million in 2023 compared to $33.4 million in 2022. The increase in our income tax provision was primarily due to a $9.9 million increase in pretax income in 2023 compared to 2022. The effective tax rate decreased 0.8 percent to 19.0 percent in 2023 compared to 19.8 percent in 2022. The decrease in the effective tax rate was primarily due to an increase in Low Income Housing Tax Credits, or LIHTCs, in 2023 compared to 2022.
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
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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. There were no new interest rates swaps entered into in 2023. 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 SOFR rate. Interest rates have increased substantially in 2022 and 2023 resulting in an unrealized loss on the cash flow hedges of $11.6 million, which is reported in Other Comprehensive Income (Loss), or OCI, net of applicable taxes.
Average Balance Sheet and Net Interest Income Analysis (FTE) (non-GAAP)
The following tables provide 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 periods presented:
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ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
(1) Tax-exempt interest income is on an FTE basis (non-GAAP) using the statutory federal corporate income tax rate of 21 percent.
(2) Taxable investment income is adjusted for the dividend-received deduction for equity securities.
(3) Nonaccruing loans are included in the daily average loan amounts outstanding.
Net interest income on an FTE basis (non-GAAP) increased $34.1 million, or 10.7 percent, compared to 2022. The net interest margin, or NIM, on an FTE basis (non-GAAP) increased 37 basis points to 4.13 percent compared to 3.76 percent in 2022. The increases in net interest income and NIM on an FTE basis (non-GAAP) were primarily due to higher interest rates during 2023.
Interest income on an FTE basis (non-GAAP) increased $137.6 million compared to 2022. The increase in interest income on an FTE basis (non-GAAP) was primarily due to higher interest rates. Average loan balances increased $326.3 million compared to 2022. The average yield on loan balances increased 154 basis points compared to 2022 due to higher interest rates. Average interest-bearing deposits with banks decreased $236.4 million compared to 2022 due to declines in deposit balances and loan growth. The average yield on interest-bearing deposits with banks increased 439 basis points compared to 2022 due to
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increased interest rates. Overall, the FTE rate (non-GAAP) on interest-earning assets increased 158 basis points compared to 2022.
Interest expense increased $103.5 million compared to 2022. The increase in interest expense was primarily due to higher interest rates and a shift in our funding mix to higher cost certificates of deposits and borrowings. Average interest-bearing deposits decreased $98.0 million compared to 2022 due to the competitive market driven by rising interest rates. The average rate paid on interest-bearing deposits increased 152 basis points due to higher interest rates. Certificates of deposit increased $308.8 million compared to 2022. The increase in certificates of deposits was primarily due to higher interest rates resulting in customers moving deposits to higher yield accounts. Average borrowings increased $435.0 million compared to 2022 primarily due to decreased deposit balances and increased loans. The average rate paid on borrowings increased 258 basis points compared to 2022 due to higher interest rates. Overall, the cost of interest-bearing liabilities increased 185 basis points compared to 2022.
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) Total Volume (4) Rate (4) Total
Interest earned on:
Interest paid on:
Securities sold under repurchase agreements (36) — (36) (38) (5) (43)
(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.
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Provision for Credit Losses
The provision for credit losses includes a provision for losses on loans and on unfunded commitments. The provision for credit losses fluctuates based on changes in loan balances, risk ratings, net loan charge-offs/recoveries, the macro environment and our Current Expected Credit Loss, or CECL, forecast. The provision for credit losses increased $9.5 million to $17.9 million for 2023 compared to $8.4 million for 2022. The provision for credit losses included a reduction of $1.4 million for the reserve for unfunded commitments for 2023 compared to an increase of $3.0 million for 2022.
The increase in the provision for credit losses for 2023 compared to 2022 was primarily due to increases in net loan charge-offs and our qualitative reserve. Net loan charge-offs for 2023 were $13.2 million, or 0.18 percent of average loans, compared to $2.6 million, or 0.04 percent of average loans for 2022. Offsetting loan charge-offs during 2023 were $11.5 million of loan recoveries which included a $9.3 million recovery related to a 2020 customer fraud compared to $9.0 million of loan recoveries during 2022. The increase in qualitative reserve was primarily due to deterioration in the CRE Price Index and our qualitative reserve capturing additional expected losses in commercial loans that are not included in the model. Offsetting the increase in provision for credit losses during 2023 was a $4.4 million decrease in the provision for unfunded loan commitments primarily due to a decrease 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,
Twelve Months Ended December 31,
(dollars in thousands) 2023 2022 $ Change % Change
Net gain on sale of securities $ — $ 198 $ (198) (100.0) %
NM - not meaningful
Noninterest income decreased $0.6 million to $57.6 million compared to $58.2 million in 2022. Mortgage banking income decreased $1.1 million due to a decline in loan sale activity caused by rising interest rates and a shift to holding originated mortgage loans on the balance sheet. Debit and credit card income decreased by $0.8 million due to decreased customer activity. Service charges on deposit accounts decreased by $0.6 million due to decreases in returned check and the elimination of non-sufficient funds, or NSF, fees. Other noninterest income increased $2.5 million primarily related to a $3.3 million increase 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, and an increase in net gain on the sale of OREO of $0.8 million, partially offset by a $0.7 million decrease in the valuation of our commercial loan swaps and a $0.8 million decrease in fees on our commercial loan swaps.
Noninterest Expense
Years Ended December 31,
(dollars in thousands) 2023 2022 $ Change % Change
Noninterest expense increased $13.6 million to $210.3 million compared to $196.7 million in 2022. Salaries and employee benefits increased $8.2 million during 2023 primarily due to inflationary wage pressure, the acquisition of new talent, higher
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medical costs and an increase in the fair value of assets in a nonqualified benefit plan, partially offset by a decrease in incentives. Loan-related expense increased $2.1 million primarily due to an increase in loan collection and legal expenses for the workout of criticized and classified loans. Furniture, equipment and software expense increased $1.3 million mainly due to new software implemented in 2023. FDIC insurance increased $1.3 million due to a two basis point increase in the assessment rate.
Provision for Income Taxes
The provision for income taxes increased $0.6 million to $34.0 million in 2023 compared to $33.4 million for 2022. The increase in our income tax provision was primarily due to a $9.9 million increase in income before taxes in 2023 compared to 2022.
The effective tax rate, which is total tax expense as a percentage of income before taxes, decreased to 19.0 percent in 2023 compared to 19.8 percent in 2022. The decrease in the effective tax rate was primarily due to an increase in LIHTCs in 2023 compared to 2022. 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 LIHTCs.
Financial Condition as of December 31, 2023
Total assets increased $441.0 million to $9.6 billion at December 31, 2023 compared to $9.1 billion at December 31, 2022. Total portfolio loans increased $469.4 million to $7.7 billion at December 31, 2023 compared to $7.2 billion at December 31, 2022. The increase in loans is primarily related to consumer loan growth of $352.9 million with an increase in consumer real estate of $362.9 million compared to December 31, 2022. The commercial loan portfolio increased $116.5 million at December 31, 2023 compared to December 31, 2022 due to an increase of $229.4 million in CRE loans offset by decreases of $76.9 million in C&I and $36.1 million in construction.
Securities remained relatively unchanged at $970.4 million at December 31, 2023 compared to $1.0 billion at December 31, 2022. The bond portfolio was in a net unrealized loss position of $82.0 million at December 31, 2023 compared to a net unrealized loss position of $102.3 million at December 31, 2022. The decrease in the net unrealized loss portion of the bond portfolio of $20.3 million was due to a change in interest rates.
Our deposits increased $301.8 million to $7.5 billion at December 31, 2023 compared to $7.2 billion at December 31, 2022. The increase related to the addition of $375.7 million of brokered deposits, including $200.7 million of brokered money market accounts and $175.0 million of brokered certificates of deposit. Customer deposits decreased $73.9 million compared to the prior year with decreases in noninterest-bearing demand deposits of $366.8 million and savings of $168.0 million partially offset by an increase in certificates of deposit of $472.1 million. Customer deposits decreased primarily due to lower commercial and consumer deposits due to the competitive pricing in this higher interest rate environment. Additionally, noninterest-bearing demand decreased due to the shift into interest-bearing deposits as a result of the elevated interest rate environment.
Total borrowings increased $64.4 million to $503.6 million at December 31, 2023 compared to $439.2 million at December 31, 2022 primarily due to loan growth.
Total shareholders’ equity increased by $98.8 million to $1.3 billion at December 31, 2023 compared to $1.2 billion at December 31, 2022. The increase was primarily due to net income of $144.8 million and other comprehensive income of $21.2 million, offset by dividends of $49.9 million and common stock repurchases of $20.0 million.
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Securities Activity
The balances and average rates of our securities portfolio are presented below as of December 31:
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. Our securities portfolio represents 10.2 percent of total assets and is classified as available for sale.The portfolio primarily consists of structured agency backed fixed income securities with limited credit exposure. Securities decreased $32.4 million to $970.4 million at December 31, 2023 compared to $1.0 billion at December 31, 2022.
At December 31, 2023, our bond portfolio was in a net unrealized loss position of $82.0 million compared to a net unrealized loss position of $102.3 million at December 31, 2022. At December 31, 2023, our bond portfolio had gross unrealized losses of $83.8 million offset by $1.8 million in gross unrealized gains, compared to December 31, 2022, when total gross unrealized losses were $102.6 million offset by gross unrealized gains of $0.3 million.
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, 2023 or December 31, 2022. 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, 2023. 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 2023, 2022 or 2021. The securities portfolio 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, 2023 and the weighted average yields of such securities. Taxable-equivalent adjustments for 2023 have been made in calculating yields on obligations of state and political subdivisions.
Maturing
Available-for-Sale
U.S. Treasury securities $ — — % $ 133,786 1.71 % $ — — % $ — — % $ — — %
Corporate bonds — — % — — % — — % — — % — — %
Marketable equity securities — — % — — % — — % — — % 1,083 3.06 %
(1)Weighted-average yields are calculated on a taxable-equivalent basis using the federal statutory tax rate of 21 percent for 2023.
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 represented 70.1 percent of total portfolio loans at December 31, 2023 compared to 73.0 percent at December 31, 2022. Within our commercial portfolio, the CRE and commercial construction portfolios combined comprised $3.7 billion, or 69.4 percent, of total commercial loans and 48.6 percent of total portfolio loans at December 31, 2023 compared to $3.5 billion, or 67.2 percent, of total commercial loans and 49.1 percent of total portfolio loans at December 31, 2022.
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Our multi-family and office segments are the most significant CRE and commercial construction concentrations for us. The multi-family segment was $658.9 million, or 8.6 percent of total portfolio loans at December 31, 2023 compared to $568.3 million, or 7.9 percent at December 31, 2022. Criticized and classified loans in the multi-family segment are minimal at only $7.4 million at December 31, 2023. The office segment represents $516.5 million, or 6.7 percent of total portfolio loans at December 31, 2023 compared to $511.8 million, or 7.1 percent at December 31, 2022. Criticized and classified loans in the office segment were only $11.6 million at December 31, 2023. Approximately 85 percent of the office portfolio is located in non central business districts, or CBD, with the remaining 15 percent in CBD within our direct markets. We completed a target review of the office portfolio in the third quarter of 2023 and did not identify any material credit risk.
We lend primarily in Pennsylvania and the contiguous states of Ohio, New York, West Virginia, New Jersey, Delaware 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 3.9 percent of the combined portfolios and 1.9 percent of total portfolio loans at December 31, 2023. This compares to 5.8 percent of the combined portfolios and 2.9 percent of total portfolio loans at December 31, 2022.
Total portfolio loans increased $469.4 million, or 6.5 percent, to $7.7 billion at December 31, 2023 compared to $7.2 billion at December 31, 2022. As of December 31, 2023, 65.0 percent of our total loans were variable rate loans and 35.0 percent were fixed rate loans.
Commercial loans increased $116.5 million related to an increase of $229.4 million in CRE offset by decreases of $76.9 million in C&I and $36.1 million in commercial construction compared to December 31, 2022. Our loan demand was influenced by the uncertain macroeconomic environment during 2023.
Consumer loans represent 29.9 percent of our total portfolio loans at December 31, 2023 and 27.0 percent at December 31, 2022. Consumer loans increased $352.9 million compared to December 31, 2022 primarily due to an increase of $343.2 million in the residential real estate portfolio and $19.7 million in consumer construction. Portfolio consumer real estate loans increased in 2023 based on a shift from mortgage loans sold to loans held in the portfolio on our balance sheet due to increased jumbo loans and the pricing of loans in the secondary market compared to December 31, 2022.
We originate traditional fixed rate mortgage loans and adjustable rate mortgages with a maximum amortization term of 30 years. 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. 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 typically 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. During 2023, our strategy changed whereby we held more mortgages on our balance sheet versus selling these loans in the secondary market. This shift in strategy was mainly due to loan pricing in the secondary market and the desire to reduce our variable rate loan exposure in this interest rate environment. We continue to monitor this strategy and could shift back to selling more residential mortgages into the secondary market in future periods. We sold $0.2 million of 1-4 family mortgages in 2023 and $28.6 million in 2022 to Fannie Mae. Our servicing portfolio of mortgage loans that we had originated and sold into the secondary market was $707.8 million at December 31, 2023 compared to $772.9 million at December 31, 2022. 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, 2023:
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 16 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 group that performs an annual review of all commercial relationships greater than $1.5 million and a quarterly review of our Watch rated portfolio. 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 and OREO. The following represents NPAs as of December 31:
Nonaccrual Loans
Nonaccrual loans as a percent of total loans 0.30 % 0.27 %
Nonperforming assets as a percent of total loans plus OREO 0.30 % 0.31 %
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 increased $0.9 million, or 4.1 percent, resulting in a nonperforming assets to total loans plus OREO ratio of 0.30% at December 31, 2023 compared to 0.31% at December 31, 2022. Nonaccrual loans increased $3.9 million, or 20.4 percent, to $22.9 million at December 31, 2023 compared to $19.1 million at December 31, 2022. The decrease in OREO related to the sale of a commercial property that resulted in a gain on sale of OREO of $3.9 million, which is included in other noninterest income.
The following represents delinquency as of December 31:
(dollars in thousands) Amount % ofLoans Amount % ofLoans
90 days or more:
Commercial construction 22 0.01 % — — %
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 increased $3.9 million compared to December 31, 2022 and represented 0.30 percent of total loans at December 31, 2023. Loans past due by 30 to 89 days decreased $5.2 million and represented 0.20 percent of total loans at December 31, 2023.
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
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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 or present value of expected future cash flows 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 that sufficient collateral exists to protect the remaining loan balance and a strategy exists to liquidate the collateral, or (ii) management has determined that the present value of expected future cash flows is sufficient to protect the remaining loan balance. 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 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.
The following table presents activity in the ACL for each of the three years presented below:
Years Ended December 31,
Charge-offs:
Commercial construction (451) — (55)
Recoveries:
Commercial construction 2 1 14
Net loan charge-offs for 2023 were $13.2 million, or 0.18 percent of average loans, compared to $2.6 million, or 0.04 percent of average loans for 2022. The most significant charge-offs during 2023 were for three C&I relationships totaling $16.9 million. Offsetting loan charge-offs during 2023 were $11.5 million of loan recoveries, which included a $9.3 million recovery related to a 2020 customer fraud compared to $9.0 million of loan recoveries during 2022.
The following table summarizes net charge-offs as a percentage of average loans for the years presented:
Commercial and industrial 0.64 % 0.03 % 1.17 %
Commercial construction 0.12 % — % 0.01 %
Net charge-offs to average loans outstanding 0.18 % 0.04 % 0.49 %
Allowance for credit losses to total nonaccrual loans 471 % 532 % 149 %
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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 $108.0 million, or 1.41 percent of total portfolio loans, at December 31, 2023, compared to $101.3 million, or 1.41 percent of total portfolio loans, at December 31, 2022. The increase in the ACL of $6.7 million was primarily due to a $7.7 million increase in our qualitative reserve mainly related to deterioration in the Commercial Real Estate Price Index and a higher C&I segment specific reserve which captures additional expected losses that are not included in the quantitative model. Our quantitative reserve decreased $1.0 million primarily due to a reduction in criticized and classified loans mainly in our CRE healthcare and CRE hotel portfolios partially offset by higher C&I substandard loans and loan growth during 2023.
Federal Home Loan Bank and Other Restricted Stock
At December 31, 2023, we held FHLB of Pittsburgh stock of $24.0 million compared to $22.0 million at December 31, 2022. 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 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, 2023. The FHLB exceeds all required capital ratios. Additionally, we considered that the FHLB has been paying dividends and actively redeeming stock throughout 2023 and 2022. Accordingly, we believe sufficient evidence exists to conclude that no impairment existed at December 31, 2023.
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Deposits
Deposits are our primary source of funds. We have a well-diversified deposit base with a balance mix of 56.4 percent personal, 34.1 percent business, 4.5 percent public funds and 5.0 percent brokered at December 31, 2023.
The following table presents the composition of deposits at December 31:
(dollars in thousands) 2023 2022 $ Change
Customer deposits
Brokered deposits
Total deposits increased $301.8 million, or 4.18 percent, at December 31, 2023 compared to December 31, 2022. Total customer deposits decreased $73.9 million from December 31, 2022 primarily due to lower commercial and consumer deposits due to the competitive pricing in this higher interest rate environment. Additionally, noninterest-bearing demand decreased due to the shift into interest-bearing deposits as a result of the elevated interest rate environment. Total brokered deposits increased $375.7 million from December 31, 2022. 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.
As a member of the IntraFi network, we are able to offer our customers insurance coverage on interest-bearing demand, money market and certificate of deposit balances in excess of the FDIC insurance limits. IntraFi balances increased $210.4 million to $277.7 million at December 31, 2023 compared to $67.3 million at December 31, 2022.
We have total uninsured deposits of $2.3 billion, or 30.0 percent of our total deposit base, compared to $2.5 billion, or 34.0 percent, at December 31, 2022. Included in uninsured deposits is $296.0 million, or 4.0 percent of our total deposit base, of municipal deposits which are fully collateralized.
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 4.7 percent and 3.0 percent of total deposits at December 31, 2023 and December 31, 2022. These primarily represent deposit relationships with local customers in our market area.
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Maturities of CDs of $250,000 or more outstanding at December 31, 2023 are summarized as follows:
(dollars in thousands) 2023
Over three through six months 60,757
Over six through twelve months 61,953
Borrowings
(dollars in thousands) December 31, 2023 December 31, 2022 $ Change
Borrowings are an additional source of funding for us. Total borrowings increased $64.4 million to $503.6 million compared to $439.2 million at December 31, 2022 primarily due to loan growth.
Information pertaining to short-term borrowings is summarized in the table below for the years ended December 31, 2023 and December 31, 2022.
Short-Term Borrowings
Average interest rate during the period 5.44 % 4.15 %
Maximum month-end balance during the period $ 630,000 $ 370,000
Average interest rate at the period end 5.65 % 4.49 %
Information pertaining to long-term borrowings and junior subordinated debt securities is summarized in the tables below for the years ended December 31, 2023 and December 31, 2022.
Long-Term Borrowings
Average balance during the period $ 31,706 $ 19,090
Average interest rate during the period 4.20 % 2.15 %
Maximum month-end balance during the period $ 39,589 $ 22,344
Average interest rate at the period end 4.52 % 2.61 %
Junior Subordinated Debt Securities
Average balance during the period $ 52,215 $ 54,421
Average interest rate during the period 7.87 % 4.40 %
Maximum month-end balance during the period $ 54,483 $ 54,453
Average interest rate at the period end 7.98 % 7.09 %
In 2023, we redeemed $5.0 million of junior subordinated debt securities, along with $0.2 million in common equity issued by DNB Capital Trust I and held by us.
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Wealth Management Assets
The fair value of the S&T Bank Wealth Management assets under administration, which are not accounted for as part of our assets, remained unchanged at $2.2 billion at December 31, 2023 and December 31, 2022. Assets under administration consisted of $1.0 billion in S&T Trust, $1.0 billion in S&T Financial Services and $0.2 billion in Stewart Capital Advisors.
Liquidity and Capital Resources
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 deposits and attract new deposits, mitigating any funding dependency on other more volatile funding sources. Refer to the "Financial Condition as of December 31, 2023 - 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. Additional funding sources accessible to S&T include borrowing availability at the Federal Home Loan Bank of Pittsburgh, or FHLB, federal funds lines with other financial institutions and the brokered deposit market. Additionally, S&T has borrowing availability through the Federal Reserve Borrower-in-Custody Program and the Federal Reserve BTFP.
In response to recent bank failures, the Federal Reserve authorized additional funding availability to eligible depository institutions through the BTFP. The program is intended to help assure depositors that their institutions have an additional source of liquidity to meet their needs. Under the BTFP, any collateral eligible for purchase by the Federal Reserve Banks in open market operations can be pledged including U.S. Treasury securities, U.S. Agencies and U.S. Agency mortgage-backed securities. Collateral advances will be equal to 100 percent of the par value of the collateral pledged with a term of up to one year. Interest was charged at a fixed rate equal to the one-year overnight index swap rate plus 10 basis points with no prepayment penalty. The rate on new advances, beginning on January 25, 2024, is set to be no lower than the interest rate on reserve balances in effect on the day the loan is made. As of December 31, 2023, we have $637.0 million of collateral available to pledge under the program and no outstanding balance. The Federal Reserve has announced that it is ending the BTFP and will cease making new loans under this program on March 11, 2024.
Available borrowing capacity exceeds uninsured deposits of $2.3 billion at December 31, 2023 and $2.5 billion at December 31, 2022. The following table summarizes borrowing funding sources available as of the dates presented:
(1) Emergency lending program created by the Federal Reserve in March 2023.
At December 31, 2023, we had available borrowing capacity of $4.1 billion, of which $2.7 billion was remaining borrowing availability with the FHLB of Pittsburgh. 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, the liquidity of the overall capital markets and the current state of the economy.
In the normal course of business, we enter into various contractual obligations, which require future payments that could impact our liquidity and capital resources. We also utilize interest rate swaps to add stability and manage exposure to interest rate movements, under which we are required to either receive cash from, or pay cash to, counterparties depending on changes
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in interest rates. Derivative contracts are carried at fair value representing the net present value of expected future cash receipts or payments based on market rates as of the balance sheet date.
The following table summarizes our material contractual obligations as of December 31, 2023:
Payments Due In
Junior subordinated debt securities(1) — — — 49,358 49,358
Funding commitments on Low Income Housing Partnerships 7,262 4,727 — — 11,989
(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, 2023, S&T Bank had $897.4 million in highly liquid assets, which consisted primarily of $160.3 million in interest-bearing deposits with banks and $736.9 million in unpledged securities. This resulted in a highly liquid assets to total assets ratio of 9.4 percent at December 31, 2023 compared to 9.6 percent at December 31, 2022. Highly liquid assets have increased by $27.3 million when comparing December 31, 2023 to December 31, 2022. The majority of the increase in liquid assets is attributed to increases in cash balances. Refer to Note 12. Qualified Affordable Housing, Note 13 Deposits, Note 14 Short Term Borrowings, Note 15 Long Term Borrowings and Subordinated Debt and Note 7 Right-Of-Use Assets and Lease Liabilities to the consolidated financial statements included in Part II, Item 8. Financial Statements and Supplementary Data, and the Deposits and Borrowings section of this MD&A, for more details.
Capital Resources
Shareholders’ equity increased $98.8 million, or 8.3 percent, to $1.3 billion at December 31, 2023 compared to $1.2 billion at December 31, 2022. The increase was primarily due to net income of $144.8 million and other comprehensive income of $21.2 million, partially offset by dividends of $49.9 million and common stock repurchases of $20.0 million. The other comprehensive income was primarily due to a $15.9 million improvement in unrealized losses on our available-for-sale debt securities, net of tax and an improvement of $5.2 million in unrealized losses on our interest rate swaps, net of tax.
We continue to maintain a strong capital position with a leverage ratio of 11.21 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 13.37 percent compared to the regulatory guideline of 6.50 percent to be well-capitalized. Our risk-based Tier 1 and Total capital ratios were 13.69 percent and 15.27 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.
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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, 2023, we had not issued any securities pursuant to the shelf registration statement.
Inflation
Inflation can have a significant impact on interest rates and, accordingly, can impact our financial performance. Inflation can influence our asset growth, deposits, noninterest income and expense and credit quality. As a result, we closely monitor the the rate of inflation in the economy. We do so 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 our management committee, ALCO, in order to manage the impact of inflation and the level of interest rates on net interest income. We also manage the effects of inflation on S&T by reviewing the prices of our products and services, by introducing new products and services and by controlling overhead expenses. Additionally, management is aware of the potential impacts that inflation can have on our loan portfolio and our customer's ability to operate their businesses. We seek to minimize the various inflationary inputs through a robust annual review process and sensitivity analysis when considering extensions of credit. Additionally, we leverage our internal credit risk review in support of the current economic cycle. We continuously monitor our portfolio for potential and emerging risks. See Risk Factors in Item 1A for further information regarding the impact of inflation on the economy and on S&T.
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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 also 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 percentage change in EVE by graduated risk tolerance levels of minimal, moderate and high.
The table below reflects the rate shock analyses results for the 1-12 and 13-24 month periods of pretax net interest income and EVE.
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Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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.
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, 2023 to December 31, 2022 primarily because we have a different deposit mix, more short-term borrowings and a larger fixed-rate loan portfolio. The percentage change in pretax net interest income in the rates down scenario shows an improvement when comparing December 31, 2023 to December 31, 2022 because of our increased ability to cut liability costs as deposit rates have increased and we have more short-term borrowings. The changes in our percentage changes in pretax net interest income reflect our strategic efforts to reduce our exposure to changes in interest rates. Our EVE analyses show a decline in the percentage change in EVE in the rates up scenarios and an improvement in rates down scenarios when comparing December 31, 2023 to December 31, 2022. These changes are mainly the result of the impact of interest rates on the value of nonmaturity deposits and deposit valuation methodology enhancements that recognize changes in customer behavior.
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 51
Consolidated Statements of Net Income 52
Consolidated Statements of Comprehensive Income 53
Consolidated Statements of Changes in Shareholders’ Equity 54
Consolidated Statements of Cash Flows 55
Notes to Consolidated Financial Statements 57
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CONSOLIDATED BALANCE SHEETS
December 31,
(in thousands, except share and per share data) 2023 2022
ASSETS
Loans held for sale 153 16
Federal Home Loan Bank and other restricted stock, at cost 25,082 23,035
LIABILITIES
Deposits:
SHAREHOLDERS’ EQUITY
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 35,655 5,061 2,393
NONINTEREST INCOME
Net gain on sale of securities — 198 29
NONINTEREST EXPENSE
Earnings per share—diluted $ 3.74 $ 3.46 $ 2.81
Dividends declared per share $ 1.29 $ 1.20 $ 1.13
See Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31,
Available-for-Sale Debt Securities
Net available-for-sale securities gains reclassified into earnings(1) — (198) —
Tax effect — 42 —
Interest Rate Swaps
Net change in fair value of interest rate swaps (5,753) (21,459) —
Net interest rate swap losses reclassified into earnings(2) 12,382 91 —
Net effect on other comprehensive income 5,204 (16,806) —
Employee Benefit Plans
Adjustment to funded status of employee benefit plans 142 (2,526) 363
Net employee benefit plan losses reclassified into earnings(3) — 2,080 3,198
Net effect on other comprehensive income 110 (339) 2,796
(1) Reclassification adjustments are comprised of realized security gains or losses. The realized gains or losses have been recorded in net gain on sale of securities in the Consolidated Statements of Net Income.
(2) Reclassification adjustments have been recorded in interest income in the Consolidated Statements of Net Income.
(3) Reclassification adjustments are comprised of realized actuarial gains or losses and settlement charges. These gains or losses and settlement charges have been recorded in salaries and employee benefits in the Consolidated Statements of Net Income.
See Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Other comprehensive loss, net of tax — — — (16,061) — (16,061)
Cash dividends declared ($1.13 per share) — — (44,336) — — (44,336)
Recognition of restricted stock compensation expense — 2,427 — — — 2,427
Other comprehensive loss, net of tax — — — (105,035) — (105,035)
Cash dividends declared ($1.20 per share) — — (47,023) — — (47,023)
Recognition of restricted stock compensation expense — 3,188 — — — 3,188
Other comprehensive income, net of tax — — — 21,224 — 21,224
Cash dividends declared ($1.29 per share) — — (49,850) — — (49,850)
Recognition of restricted stock compensation expense — 3,874 — — — 3,874
See Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
OPERATING ACTIVITIES
Net amortization of discounts and premiums on securities 4,666 6,062 5,482
Gain on sale of securities — (198) (29)
(Gain) loss on sale of fixed assets (100) 61 30
Net change in:
Net (increase) decrease in interest receivable (7,094) (10,033) 3,561
INVESTING ACTIVITIES
Proceeds from sales of securities — 30,490 1,917
(Purchases) redemption of Federal Home Loan Bank stock (2,047) (13,515) 3,511
Proceeds from the sale of premises and equipment 710 161 14
Proceeds from life insurance settlement 1,696 214 353
Net payments from cash flow hedge (12,383) (91) —
FINANCING ACTIVITIES
Proceeds from long-term borrowings 25,000 — —
Repurchase of shares for taxes on restricted stock (798) (808) (630)
See Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
Supplemental Disclosures
Loans transferred to portfolio from held for sale $ — $ — $ 4,467
Transfers of loans to other real estate owned $ 163 $ 23 $ 12,392
See Notes to Consolidated Financial Statements
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
S&T Bancorp, Inc., or S&T, was incorporated on March 17, 1983 under the laws of the Commonwealth of Pennsylvania as a bank holding company and has four active direct wholly owned subsidiaries, S&T Bank, 9th Street Holdings, Inc., STBA Capital Trust I and DNB Capital Trust II, and owns a 50 percent interest in Commonwealth Trust Credit Life Insurance Company, or CTCLIC.
We are presently engaged in non-banking activities through the following six entities: 9th Street Holdings, Inc.; S&T Bancholdings, Inc.; CTCLIC; S&T Insurance Group, LLC; Stewart Capital Advisors, LLC; and DN Acquisition Company, Inc.
Our investment holding companies are 9th Street Holdings, Inc. and S&T Bancholdings, Inc. CTCLIC, which is a joint venture with another financial institution, acts as a reinsurer of credit life, accident and health insurance policies sold by S&T Bank and the other institution. S&T Insurance Group, LLC, through its subsidiaries, offers a variety of insurance products. Stewart Capital Advisors, LLC is a registered investment advisor that manages private investment accounts for individuals and institutions. DN Acquisition Company, Inc. was acquired with the DNB merger and was incorporated for the purpose of acquiring and holding OREO acquired through foreclosure or deed in-lieu-of foreclosure, as well as Bank-occupied real estate.
Accounting Policies
Our consolidated financial statements have been prepared in accordance with generally accepted accounting principles, or GAAP. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as disclosures of contingent assets and liabilities as of the dates of the balance sheets and revenues and expenses for the periods then ended. Actual results could differ from those estimates. Our significant accounting policies are described below.
Principles of Consolidation
The consolidated financial statements include the accounts of S&T and its wholly owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation. Investments of 20 percent to 50 percent of the outstanding common stock of investees are accounted for using the equity method of accounting.
Reclassification
Amounts in prior years' financial statements and footnotes are reclassified whenever necessary to conform to the current period presentation. Reclassifications had no effect on our results of operations or financial condition.
Business Combinations
We account for business combinations using the acquisition method of accounting. All identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree are recognized and measured as of the acquisition date at fair value. We record goodwill for the excess of the purchase price over the fair value of net assets acquired. Results of operations of the acquired entities are included in the Consolidated Statement of Net Income from the date of acquisition.
Acquired loans are recorded at fair value on the date of acquisition with no carryover of the related ACL. Determining the fair value of acquired loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. In estimating the fair value of our acquired loans, we consider a number of factors including loss rates, internal risk rating, delinquency status, loan type, loan term, prepayment rates, recovery periods and the current interest rate environment. The premium or discount estimated through the loan fair value calculation is recognized into interest income on a level yield basis over the remaining life of the loans.
Acquired loans, including those acquired in a business combination, are evaluated to determine if they have experienced more-than-insignificant deterioration in credit quality since origination. When the condition exists, these loans are referred to as purchased credit deteriorated, or PCD. An allowance is recognized for a PCD loan by adding it to the purchase price or fair value in a business combination. There is no provision for credit losses, or PCL, recognized upon acquisition of a PCD loan since the initial allowance is established through the purchase accounting. After initial recognition, the accounting for a PCD loan follows the credit loss model that applies to that type of asset. Purchased financial loans that do not have a more-than-significant deterioration in credit quality since origination are accounted for in a manner consistent with originated loans. An ACL is recorded with a corresponding charge to PCL. Subsequent to the acquisition date, the methods utilized to estimate the required ACL for these loans is similar to the method used for originated loans.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value Measurements
We use fair value measurements when recording and disclosing certain financial assets and liabilities. Available-for-sale debt securities, equity securities, trading securities held in a deferred compensation plan and derivative financial instruments are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record other assets at fair value on a nonrecurring basis, such as loans held for sale, individually assessed loans, other real estate owned, or OREO, and other repossessed assets, mortgage servicing rights, or MSRs, and certain other assets.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. In determining fair value, we use various valuation approaches, including market, income and cost approaches. The fair value standard establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability, which are developed based on market data we have obtained from independent sources. Unobservable inputs reflect our estimates of assumptions that market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.
The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:
Level 1: valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets.
Level 2: valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data.
Level 3: valuation is derived from other valuation methodologies, including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our policy is to recognize transfers between any of the fair value hierarchy levels at the end of the reporting period in which the transfer occurred.
The following are descriptions of the valuation methodologies that we use for financial instruments recorded at fair value on either a recurring or nonrecurring basis.
Recurring Basis
Available-for-Sale Debt Securities
We obtain fair values for debt securities from a third-party pricing service which utilizes several sources for valuing fixed-income securities. We validate prices received from our pricing service through comparison to a secondary pricing service and broker quotes. We review the methodologies of the pricing services which provide us with a sufficient understanding of the valuation models, assumptions, inputs and pricing to reasonably measure the fair value of our debt securities. The fair value of U.S. treasury securities are based on quoted market prices in active markets and are classified as Level 1. The market valuation sources for other debt securities include observable inputs rather than significant unobservable inputs and are classified as Level 2. The service provider utilizes pricing models that vary by asset class and include available trade, bid and other market information. Generally, the methodologies include broker quotes, proprietary models and extensive quality control programs.
Equity Securities
Marketable equity securities with quoted prices in active markets for identical assets are classified as Level 1. Marketable equity securities in markets that are not active are classified as Level 2.
Securities Held in a Deferred Compensation Plan
Securities Held in a Deferred Compensation Plan are reported at fair value with the gains and losses included in other noninterest income in our Consolidated Statements of Net Income. These assets are held in a deferred compensation plan and are invested in readily quoted mutual funds. Accordingly, these assets are classified as Level 1. Deferred compensation plan assets are reported in other assets in the Consolidated Balance Sheets.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Derivative Financial Instruments
We use derivative instruments, including interest rate swaps that qualify as cash flow hedges, interest rate swaps for commercial loans with our customers, interest rate lock commitments and forward commitments related to the sale of mortgage loans in the secondary market. We calculate the fair value for derivatives using accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. Each valuation considers the contractual terms of the derivative, including the period to maturity, and uses observable market-based inputs, such as interest rate curves and implied volatilities. We incorporate credit valuation adjustments into the valuation models to appropriately reflect both our own nonperformance risk and the respective counterparties’ nonperformance risk in calculating fair value measurements. We consider the impact of master netting agreements and collateral postings with our counterparties to determine the credit valuation adjustment. Interest rate swaps are classified as Level 2. Interest rate lock commitments and forward commitments related to mortgage loans are classified as Level 3 due to significant unobservable inputs.
Nonrecurring Basis
Loans Held for Sale
Loans held for sale consist of 1-4 family residential loans originated for sale in the secondary market and, from time to time, certain loans transferred from the loan portfolio to loans held for sale, all of which are carried at the lower of cost or fair value. The fair value of 1-4 family residential loans, when marked to fair value, is based on the principal or most advantageous market currently offered for similar loans using observable market data. Loans held for sale marked to fair value are classified as Level 2 if the fair value is determined using a sales or market approach and Level 3 if the fair value is determined using an income approach.
Loans Individually Evaluated
Loans that are individually evaluated to determine whether a specific allocation of ACL is needed are reported at the lower of amortized cost or fair value. Fair value is determined using either the present value of expected future cash flows discounted at the loan's original effective interest rate, the loan’s observable market price or the fair value of the collateral less estimated selling costs when the loan is collateral dependent and we expect to liquidate the collateral. However, if repayment is expected to come from the operation of the collateral, rather than liquidation, then we do not consider estimated selling costs in determining the fair value of the collateral. Collateral values are generally based upon appraisals by approved, independent state certified appraisers. Appraisals may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or our knowledge of the borrower and the borrower’s business. If the fair value of loans individually evaluated is determined based on an independent market based appraisal less estimated costs to sell, it is classified as Level 2. If the fair value of loans individually evaluated is determined using an internal valuation, it is classified as Level 3.
OREO and Other Repossessed Assets
OREO and other repossessed assets obtained in partial or total satisfaction of a loan are recorded at fair value less cost to sell. Fair value, when recorded, is generally based upon appraisals by approved, independent state certified appraisers. Appraisals on OREO may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or other information available to us. If the fair value for OREO is determined based on an independent market-based appraisal less estimated costs to sell or an executed sales agreement, it is classified as Level 2. If the fair value for OREO is determined using an internal valuation, it is classified as Level 3.
Mortgage Servicing Rights
MSRs are reported using the amortization method and are evaluated for impairment quarterly by comparing the carrying value to the fair value of the MSRs. The fair value of MSRs is determined by calculating the present value of estimated future net servicing cash flows, considering expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. The expected rate of mortgage loan prepayments is the most significant factor driving the value of MSRs. MSRs are considered impaired if the carrying value exceeds fair value. The valuation model includes significant unobservable inputs; therefore, MSRs are classified as Level 3 when marked to fair value.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Instruments
Fair value accounting guidance requires disclosure of the fair value of all of an entity’s assets and liabilities that are considered financial instruments. The majority of our assets and liabilities are considered financial instruments. Many of these instruments lack an available trading market as characterized by a willing buyer and willing seller engaged in an exchange transaction. Also, it is our general practice and intent to hold our financial instruments to maturity and to not engage in trading or sales activities with respect to such financial instruments. For fair value disclosure purposes, we substantially utilize the fair value measurement criteria as required and explained above. In cases where quoted fair values are not available, we use present value methods to determine the fair value of our financial instruments.
Cash and Cash Equivalents
The carrying amounts reported in the Consolidated Balance Sheets for cash and due from banks, including interest-bearing deposits approximate fair value.
Loans
Our methodology to fair value loans includes an exit price notion. The fair value of loans is estimated using discounted cash flow analyses that utilize interest rates currently being offered for similar loans and adjusted for liquidity and credit risk. The valuation models include significant unobservable inputs; therefore, loans are classified as Level 3. The carrying amount of interest receivable approximates fair value.
Federal Home Loan Bank, or FHLB, and Other Restricted Stock
It is not practical to determine the fair value of our FHLB and other restricted stock due to the restrictions placed on the transferability of these stocks; it is presented at carrying value.
Collateral Receivable
Collateral receivable is cash that is made available to counterparties as collateral for our interest rate swaps. The carrying amount included in other assets on our Consolidated Balance Sheets approximates fair value.
Deposits
The fair values disclosed for deposits without defined maturities (e.g., noninterest and interest-bearing demand, money market and savings accounts) are by definition equal to the amounts payable on demand. Deposits without defined maturities are classified as Level 1. The carrying amounts for variable rate, fixed-term time deposits approximate their fair values. Estimated fair values for fixed rate and other time deposits are based on discounted cash flow analysis using interest rates currently offered for time deposits with similar terms. Fixed rate and other time deposits are classified as Level 2. The carrying amount of accrued interest approximates fair value.
Short-Term Borrowings
The carrying amounts of securities sold under repurchase agreements, or REPOs, and other short-term borrowings approximate their fair values. Fair values are based on observable inputs in a secondary market; therefore, these are classified as Level 2.
Long-Term Borrowings
The fair values disclosed for fixed rate long-term borrowings are determined by discounting their contractual cash flows using current interest rates for long-term borrowings of similar remaining maturities. The carrying amounts of variable rate long-term borrowings approximate their fair values. Fair values are based on observable inputs in a secondary market; therefore, these are classified as Level 2.
Junior Subordinated Debt Securities
The interest rate on the variable rate junior subordinated debt securities is reset quarterly; therefore, the carrying values approximate their fair values. Fair values are based on observable inputs in a secondary market; therefore, these are classified as Level 2.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Collateral Payable
Collateral payable is cash that is received from counterparties as collateral for our interest rate swaps. The carrying amount included in other liabilities on our Consolidated Balance Sheets approximates fair value.
Cash and Cash Equivalents
We consider cash and due from banks, interest-bearing deposits with banks and federal funds sold as cash and cash equivalents.
Securities
We determine the appropriate classification of securities at the time of purchase. Debt securities are classified as available-for-sale with the intent to hold for an indefinite period of time, but may be sold in response to changes in interest rates, prepayment risk, liquidity needs or other factors.
A determination will be made on whether a decline in the fair value below the amortized cost basis is due to credit-related factors or noncredit-related factors. Any impairment that is not credit-related is recognized in OCI, net of applicable taxes. Credit-related impairment is recognized as an ACL on the balance sheet with a corresponding adjustment to provision for credit losses in the Consolidated Statements of Net Income. Both the allowance and the adjustment to net income can be reversed if conditions change. Our policy for credit impairment within the available-for-sale debt securities portfolio is based upon a number of factors, including but not limited to, the financial condition of the underlying issuer, the ability of the issuer to meet contractual obligations, the likelihood of the security’s ability to recover any decline in its estimated fair value and whether management intends to sell the security or if it is more likely than not that management will be required to sell the investment security prior to the security’s recovery of any decline in its estimated fair value.
Realized gains and losses on the sale of these securities are determined using the specific-identification method and are recorded within noninterest income in the Consolidated Statements of Net Income. Bond premiums are amortized to the call date, if any, and bond discounts are accreted to the maturity date, both on a level yield basis.
Equity securities are measured at fair value with net unrealized gains and losses recognized in other noninterest income in the Consolidated Statements of Net Income.
Loans Held for Sale
Loans held for sale consist of 1-4 family residential loans originated for sale in the secondary market and, from time to time, certain loans transferred from the loan portfolio to loans held for sale, all of which are carried at the lower of cost or fair value. If a loan is transferred from the loan portfolio to the held for sale category, any write-down in the carrying amount of the loan at the date of transfer is recorded as a charge-off against the ACL. Subsequent declines in fair value are recognized as a charge to other noninterest income. When a loan is placed in the held for sale category, we stop amortizing the related deferred fees and costs. The remaining unamortized fees and costs are recognized as part of the cost basis of the loan at the time it is sold. Gains and losses on sales of mortgage loans held for sale are included in mortgage banking in noninterest income in the Consolidated Statements of Net Income.
Loans
Loans are reported at the principal amount outstanding net of unearned income. Unearned income consists of net deferred loan origination fees and costs and a discount or premium on acquired loans. Loan origination fees and direct loan origination costs are deferred and amortized as an adjustment of loan yield over the lives of the loans without consideration of anticipated prepayments. If a loan is paid off, the remaining unaccreted or unamortized net origination fees and costs are immediately recognized into income. Accretion of discounts and amortization of premiums on loans are included in interest income in the Consolidated Statements of Net Income. Interest is accrued and interest income is recognized on loans as earned.
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.
Generally, consumer loans are charged off against the ACL upon the loan reaching 90 days past due. Commercial loans are charged off as management becomes aware of facts and circumstances that raise doubt as to the collectability of all or a portion of the principal and when we believe a confirmed loss exists.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Nonaccrual Loans
We stop accruing interest on a loan when the borrower’s payment is 90 days past due. Loans are also placed on nonaccrual status when we have doubt about the borrower’s ability to comply with contractual repayment terms, even if payment is not past due. When the interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. As a general rule, a nonaccrual loan may be restored to accrual status when its principal and interest is paid current and the bank expects repayment of the remaining contractual principal and interest, or when the loan otherwise becomes well secured and in the process of collection.
Allowance for Credit Losses
The ACL is a valuation reserve established and maintained by charges against operating income and is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the ACL when they are deemed uncollectible. The ACL is an estimate of expected credit losses, measured over the contractual life of a loan, that considers our historical loss experience, current conditions and forecasts of future economic conditions. Determination of an appropriate ACL is inherently subjective and may have significant changes from period to period.
The methodology for determining the ACL has two main components: evaluation of expected credit losses for certain groups of homogeneous loans that share similar risk characteristics and evaluation of loans that do not share similar risk characteristics with other loans and are individually evaluated.
The ACL for homogeneous loans is calculated using a life-time loss rate methodology with both a quantitative and a qualitative analysis that is applied on a quarterly basis. The ACL model is comprised of six distinct portfolio segments: 1) Commercial Construction, 2) Commercial Real Estate, or CRE, 3) Commercial and Industrial, or C&I, 4) Business Banking, 5) Consumer Real Estate and 6) Other Consumer. Each segment has a distinct set of risk characteristics monitored by management. We further evaluate the ACL at a disaggregated level which includes type of collateral and our internal risk rating system for the commercial and business banking segments and type of collateral, lien position and FICO score, for the consumer segments. Historical credit loss experience is the basis for the estimation of expected credit losses. Our quantitative model uses historic data back to the second quarter of 2009. We apply historical loss rates to pools of loans with similar risk characteristics. After consideration of the historic loss calculation, management applies qualitative adjustments to reflect the current conditions and reasonable and supportable forecasts not already reflected in the historical loss information at the balance sheet date. Our reasonable and supportable forecast is for a period of two years and is based on the unemployment forecast and management judgment. For periods beyond our two year reasonable and supportable forecast, we revert to historical loss rates utilizing a straight-line method over a one year reversion period. The qualitative adjustments for current conditions are based upon changes in lending policies and practices, experience and ability of lending staff, quality of the bank’s loan review system, value of underlying collateral, the existence of and changes in concentrations, other external factors and segment specific risks. These modified historical loss rates are multiplied by the outstanding principal balance of each loan to calculate a required reserve.
The ACL for individual loans begins with the use of normal credit review procedures to identify whether a loan no longer shares similar risk characteristics with other pooled loans and therefore, should be individually assessed. We evaluate all commercial loans greater than $1.0 million that meet the following criteria: 1) when it is determined that foreclosure is probable, 2) substandard, doubtful and nonaccrual loans when repayment is expected to be provided substantially through the operation or sale of the collateral, 3) when it is determined by management that a loan does not share similar risk characteristics with other loans. Specific reserves are established based on the following three acceptable methods for measuring the ACL: 1) the present value of expected future cash flows discounted at the loan’s original effective interest rate; 2) the loan’s observable market price; or 3) the fair value of the collateral when the loan is collateral dependent. Our individual loan evaluations consist primarily of the fair value of collateral method because most of our loans are collateral dependent. Collateral values are discounted to consider disposition costs when appropriate. A specific reserve is established or a charge-off is taken if the fair value of the loan is less than the loan balance.
Our ACL Committee meets quarterly to verify the overall appropriateness of the ACL. Additionally, on an annual basis, the ACL Committee meets to validate our ACL methodology. This validation includes reviewing the loan segmentation, critical model assumptions, forecast and the qualitative framework. As a result of this ongoing monitoring process, we may make changes to our ACL to be responsive to the economic environment.
Bank Owned Life Insurance
We have purchased life insurance policies on certain executive officers and employees. We receive the cash surrender value of each policy upon its termination or benefits are payable to us upon the death of the insured. Changes in net cash surrender value are recognized in other noninterest income in the Consolidated Statements of Net Income.
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Premises and Equipment
Premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation. Maintenance and repairs are charged to expense as incurred, while improvements that extend an asset’s useful life are capitalized and depreciated over the estimated remaining life of the asset. Depreciation expense is computed by the straight-line method for financial reporting purposes and accelerated methods for income tax purposes over the estimated useful lives of the particular assets. Depreciation expense is included in occupancy on the Consolidated Statements of Net Income. Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. No events or changes in circumstances occurred during the years ended December 31, 2023 and 2022.
The estimated useful lives for the various asset categories are as follows:
1) Land and Land Improvements Non-depreciating assets
2) Buildings 25 years
3) Furniture and Fixtures 5 years
4) Computer Equipment and Software 5 years or term of license
5) Other Equipment 5 years
6) Vehicles 5 years
Right-of-Use Assets and Lease Liabilities
We determine if a contract is or contains a lease at inception. Leases are classified as either finance or operating leases. We recognize leases on our Consolidated Balance Sheets as right-of-use, or ROU, assets and related lease liabilities. Finance ROU assets are included in premises and equipment and related finance lease liabilities are included in long-term borrowings. Operating lease ROU assets are included in other assets and related operating lease liabilities are included in other liabilities. Our lease liability is calculated as the present value of the lease payments over the lease term discounted using our estimated incremental borrowing rate with similar terms at commencement date. Lease terms include options to extend or terminate the lease when it is reasonably certain that we will exercise those options. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term for operating leases. Interest and amortization expenses are recognized for finance leases over the lease term. Leases with an initial term of 12 months or less are not recorded on the balance sheet and the related lease expense is recognized on a straight-line basis over the lease term in occupancy on our Consolidated Statements of Net Income. Lease and amortization expenses are included in occupancy expense and interest on finance lease liabilities is included in borrowings interest expense in our Consolidated Statements of Net Income.
Restricted Investment in Bank Stock
FHLB stock 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 member's asset value, 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 low-cost 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. Both cash and stock dividends are reported as income in taxable investment securities in the Consolidated Statements of Net Income. FHLB stock is evaluated for impairment when events and circumstance indicate that impairment could exist.
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. We have one reporting unit.
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. A qualitative assessment is performed to determine whether it is more likely than not that the reporting unit's fair value is less than its carrying value. We perform a quantitative impairment test only if we conclude that it is more likely than not that a reporting unit's fair value is less than the carrying amount. Determining the fair value of a reporting unit is judgmental and involves the use of significant estimates and assumptions. The fair value of the
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reporting unit is determined by using both a discounted cash flow model and a market based model. The discounted cash flow model has many assumptions including future earnings projections, a long-term growth rate and discount rate. The market based model calculates fair value based on observed price multiples for similar companies. The fair values of each method are then weighted based on relevance and reliability in the current economic environment.
We determine the amount of identifiable intangible assets based upon independent core deposit and insurance contract valuations at the time of acquisition. Intangible assets with finite useful lives, consisting primarily of core deposit and customer list intangibles, are amortized using straight-line or accelerated methods over their estimated weighted average useful lives, ranging from 10 to 20 years. Intangible assets with finite useful lives are evaluated for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. No such events or changes in circumstances occurred during the years ended December 31, 2023 and 2022.
Variable Interest Entities
Variable interest entities, or VIEs, are legal entities that generally either do not have equity investors with voting rights or that have equity investors that do not provide sufficient financial resources for the entity to support its activities. When an enterprise has both the power to direct the economic activities of the VIE and the obligation to absorb losses of the VIE or the right to receive benefits of the VIE, the entity has a controlling financial interest in the VIE. A VIE often holds financial assets, including loans, receivables or other property. The company with a controlling financial interest, the primary beneficiary, is required to consolidate the VIE into its Consolidated Balance Sheets. S&T has two wholly-owned trust subsidiaries, STBA Capital Trust I and DNB Capital Trust II, or the Trusts, for which it does not absorb a majority of expected losses or receive a majority of the expected residual returns. DNB Capital Trust II was acquired with the DNB merger. At inception, these Trusts issued floating rate trust preferred securities to the Trustees and used the proceeds from the sale to invest in junior subordinated debt securities issued by us. The Trusts pay dividends on the trust preferred securities at the same rate as the interest we pay on the junior subordinated debt held by the Trusts. The Trusts are VIEs with the third-party investors as their primary beneficiaries, and accordingly, the Trusts and their net assets are not included in our consolidated financial statements. However, the junior subordinated debt securities issued by S&T are included in liabilities in our Consolidated Balance Sheets.
Qualified Affordable Housing
We have made investments directly in Low Income Housing Tax Credit, or LIHTC, partnerships formed with third parties. As a limited partner in these operating partnerships, we receive tax credits and tax deductions for losses incurred by the underlying properties. These investments are amortized over a maximum of 10 years, which represents the period over which the tax credits will be utilized. Our investments in Low Income Housing Partnerships, or LIHPs, represent unconsolidated VIEs and the assets and liabilities of the partnerships are not recorded on our balance sheet. We have determined that we are not the primary beneficiary of these VIEs because we do not have the power to direct the activities that most significantly impact the economic performance of the partnership nor do we have both the obligation to absorb expected losses and the right to receive benefits. We use the cost method to account for these partnerships. These investments are recorded in other assets in our Consolidated Balance Sheets. Amortization expense is included in other noninterest expense in the Consolidated Statements of Net Income.
OREO and Other Repossessed Assets
OREO and other repossessed assets are included in other assets in the Consolidated Balance Sheets and are comprised of properties acquired through foreclosure proceedings or acceptance of a deed in lieu of a foreclosure. OREO and other repossessed assets are recorded at fair value less cost to sell at the time of acquisition and when subsequent declines in fair value occur. Subsequent declines in the fair value of OREO are recorded through a valuation allowance. Subsequent increases in the fair value reduce the valuation allowance, but only to the amount that does not exceed the OREO foreclosure date cost basis. Loan losses arising from the acquisition of any such property initially are charged against the ACL. Gains or losses realized upon disposition of these assets are recorded in other noninterest income or expense in the Consolidated Statements of Net Income depending on whether the net position is a gain or loss.
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Securities Held in a Deferred Compensation Plan
A nonqualified deferred compensation plan is offered to certain management employees providing an opportunity to continue to defer income on a tax deferred basis in excess of annual contribution or compensation limits for qualified plans. The plan assets are held in a grantor trust, are legally assets of S&T and are beneficially owned by the participants. The assets are available to satisfy the claims of general creditors in the event we would need to file bankruptcy. Securities held in the nonqualified deferred compensation plan are recorded in other assets in the Consolidated Balance Sheets at fair value. A corresponding deferred compensation liability is recorded in other liabilities in the Consolidated Balance Sheets. Gains and losses related to the change in value of plan assets are recorded in other noninterest income and salaries and employee benefits expense in our Consolidated Statements of Net Income, resulting in no impact to net income.
Mortgage Servicing Rights
MSRs are recognized as separate assets when a mortgage loan is sold. MSRs represents the estimated fair value of future net cash flows expected to be realized for performing the servicing activities. The fair value of the MSRs is estimated by calculating the present value of estimated future net servicing cash flows, considering expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. The expected rate of mortgage loan prepayments is the most significant factor driving the value of MSRs. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced. MSRs are reported in other assets in the Consolidated Balance Sheets and are amortized into mortgage banking in noninterest income in the Consolidated Statements of Net Income in proportion to, and over the period of, the estimated future net servicing income of the underlying mortgage loans.
MSRs are evaluated for impairment based on the estimated fair value of those rights. MSRs are stratified by certain risk characteristics, primarily loan term and note rate. If temporary impairment exists within a risk stratification tranche, a valuation allowance is established through a charge to income equal to the amount by which the carrying value exceeds the estimated fair value. If it is later determined that all or a portion of the temporary impairment no longer exists for a particular tranche, the valuation allowance is reduced.
Derivative Financial Instruments
Derivatives are recognized as either other assets or other liabilities on the balance sheet at fair value. All derivatives are evaluated at inception to determine whether it is a hedging or non-hedging activity. The accounting for changes in the fair value of derivatives depends on whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting based on whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting.
Pursuant to our agreements with various financial institutions, we may receive collateral or may be required to post collateral based upon mark-to-market positions. Beyond unsecured threshold levels, collateral in the form of cash or securities may be made available to counterparties of interest rate swap transactions. Interest income on collateral receivable is included in loan interest income in the Consolidated Statements of Net Income. Interest expense on collateral payable is included in borrowings, junior subordinated debt securities and other interest expense in the Consolidated Statements of Net Income.
Derivatives contain an element of credit risk, the possibility that we will incur a loss because a counterparty, which may be a financial institution or a customer, fails to meet its contractual obligations. All derivative contracts with financial institutions may be executed only with counterparties approved by our Asset and Liability Committee, or ALCO, and derivatives with customers may only be executed with customers within credit exposure limits approved in accordance with our credit policy. We have entered into agreements with counterparty financial institutions, which include master netting agreements that provide for the net settlement of all contracts with a single counterparty in the event of default. We elect, however, to account for all derivatives with counterparty institutions on a gross basis in the Consolidated Balance Sheets.
Interest Rate Swaps Designated as Hedging Instruments
As part of our interest rate risk management strategy, we use interest rate swaps to add stability to interest income and to manage exposure to interest rate movements. Interest rate swaps designated as cash flow hedges involve the receipt of fixed-rate amounts from a counterparty in exchange for making variable rate payments over the life of the agreements without exchange of the underlying notional amount.
Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the earnings effect of the hedged forecasted transactions in a cash flow hedge. As long as the cash flow hedge continues to qualify for hedge accounting, the entire change in the fair value of the hedging instrument is recognized in OCI, net of applicable taxes, and reclassified into interest income as interest payments are received. The change in the fair value is included in the change in other liabilities in the Consolidated Statements of Cash Flows.
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