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Good day and thank you for standing by. Welcome to the Stellar Bancorp First Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today’s conference is being recorded.
I would now like to hand the conference over to your host today, Courtney Theriot, Chief Accounting Officer. Please go ahead.
Thank you, operator, and thank you to all who have joined our call today. Good morning. Our team would like to welcome you to our earnings call for the first quarter of 2023. This morning’s earnings call will be led by Stellar’s CEO, Bob Franklin; and CFO, Paul Egge.
Also in attendance today are Steve Retzloff, Executive Chairman of the company; Ray Vitulli, President of the company and CEO of the Bank; and Joe West, Senior Executive Vice President and Chief Credit Officer of the Bank.
Before we begin, I need to remind everyone that some of the remarks made today constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, as amended. We intend all such statements to be covered by the Safe Harbor provisions for forward-looking statements contained in the Act. Also note that if we give guidance about future results, that guidance is only a reflection of management’s beliefs at the time the statement is made and such beliefs are subject to change. We disclaim any obligation to publicly update any forward-looking statements, except as maybe required by law. Please see the last page of the text in this morning’s earnings release, which is available on our Web site at ir.stellarbancorpinc.com for additional information about the risk factors associated with forward-looking statements. At the conclusion of our remarks, we will open the line and allow time for questions.
I now turn the call over to our CEO, Bob Franklin.
Thank you, Courtney, and good morning. Welcome to Stellar Bancorp's first quarter earnings call. I will begin by thanking the great team at Seller Bank for their hard work and dedication in making Stellar truly stellar. During the long weekend provided in February, our team completed a successful system conversion of our merged banks, bringing all Stellar Bank customers under one system. Our staff worked tirelessly to get this right, and I congratulate them on their success.
The other major event during the quarter cannot go without mention, the failure of Silicon Valley Bank and Signature Bank. These failures stunned and stressed our industry and the customers we serve. Despite the suddenness of the failures, Stellar Bank has strong relationships with those customers developed over many years that form our customer base.
Though we faced some deposit runoff during the quarter, some seasonal, some due to rank, some frightened by media reports, the team will give some more granular information around deposits, but I would be remiss in not thanking our incredible customers who have supported our bank, as the industry experiences stress.
In the wake of the failures, we saw again that the closeness to the customer is what fuels confidence in local institutions. We have relied on those customers and they have relied on us, and we will believe -- we believe that that will continue. Since the Federal Reserve began raising interest rates, we have concentrated our efforts on building capital, managing liquidity and maintaining our credit quality. We believe that these efforts are paying dividends as we continue to work to maintain our strong core funded franchise.
We continue to gain efficiencies as we learn to operate together as one organization. We have made a concentrated effort to maintain our margins in a difficult operating environment, with some in our markets paying much higher interest rates. We have strengthened our underwriting to help combat the effects of rapidly rising interest rates. But today, our customers remain strong and our markets are good.
As we move through the balance of the year, we will continue to be mindful of our core franchise and building capital, maintaining liquidity and strengthening our credit underwriting. Our goal is to be well positioned as the Federal Reserve finishes its work to take advantage of the opportunities that we believe will be available. And I remind our shareholders that we reside in one of the most robust markets in the United States. The future of Stellar is bright.
And now, I'll turn this over to Paul Egge, our CFO.
Thanks, Bob, and good morning, everybody. We are very pleased to report strong operating performance for what was a very challenging quarter for our industry due to the cumulative effects of quantitative tightening and the fallout from a couple of high profile bank failures in March.
Our net income in the first quarter was $37.1 million, representing diluted earnings per share of $0.70, an annualized ROA of 1.38% and return on tangible common equity of 19.32%. All this was notwithstanding approximately $6.2 million in merger expenses and modest reserve build during the quarter.
This is our second quarter together as Stellar, and a quarter removed from what was a very noisy initial post merger quarter. So it is gratifying to see progress on nearly every earnings line item and metric on both the stated and adjusted basis. We experienced incremental gains in efficiency and our level core pre-tax pre-provision earnings power in the first quarter, reflected in our adjusted pre-tax pre-provision ROA of 1.99%.
Our earning power and bottom line results were driven by a strong net interest margin of 4.80% in the quarter versus 4.71% in the fourth quarter of 2022, which was thanks in part to $10 million of purchase accounting accretion, up from about $8.2 million in the fourth quarter.
Excluding purchase accounting accretion, our adjusted NIM was strong and stable at 4.38%, equal to our adjusted net interest margin in the previous quarter. We're very pleased with our ability to maintain such strong NIM despite the culmination of industry pressures in the first quarter impacting our cost of funds.
From a balance sheet perspective, we feel as though our focus as we entered 2023 on maintaining flexibility on the liquidity front has proven strategic for us. During late January, we sold approximately $320 million in predominantly longer duration municipal securities at a slight gain to put us in a position to leverage relative deposit pricing discipline, and to not have to chase more price sensitive deposits seeking effectively wholesale rates due to the cumulative effect of quantitative tightening.
In the current backdrop, our primary goal is to keep our core funding core and to maintain strong margins and pre-tax pre-provision earnings power. So we're seeking to prudently manage the liability side of the balance sheet to maintain core funding with a willingness to shrink and/or backfill with wholesale funding sources, as we allow our assets to reprice and the funding environment to stabilize.
Deposits at March 31 were $8.7 billion, a decrease of $529 million or 5.8% from $9.3 billion at year end. The majority of this decrease in deposits actually occurred before the failures of SVB and Signature in March, and approximately 186 million of our decrease in deposits during the quarter came from seasonality in our government banking group.
Among the principal drivers, broadly speaking, were seasonality, industry-wide pressures, and our strategy of maintaining relative discipline in the face of an intensely competitive market for deposits. Through all this, we retained a favorable mix of non-interest bearing deposits, representing 44.4% of the total.
Digging deeper into our deposit base, our average account balance was $81,000 after excluding government deposits. At the end of the quarter, our uninsured deposits net of collateralized deposits were about $4.1 billion, or 46.4% of deposits. We believe our access to contingent sources of liquidity, outlined in Page 7 of our accompanying investor presentation, compares favorably to our uninsured deposits net of collateralized deposits of approximately 4 billion.
Immediate liquidity sources of $4.5 billion covers about 110% of these balances. And when you add policy-driven capacity for broker deposits, total liquidity sources covers about 149% of uninsured deposits, net of collateral deposits.
In summary, we feel good about our liquidity position and our ability to manage the liability side of the balance sheet, stay core funded and maintain strong margins and earnings power. In the meantime, our ability to harvest strong earnings will help us build capital and grow our tangible book value at a nice clip.
During the quarter, tangible book value per share increased 8.7% from $14.02 per share to $15.24 per share in tangible equity/tangible assets increased to 8.15% from 7.24% in the fourth quarter. Contributing to our capital build in the near term will be the recognition of predominantly interest-based purchase accounting accretion from the merger more than offsetting the accelerated amortization of our core deposit intangible asset from the merger.
At the end of the quarter, we had $144 million in loan discount remaining and a core deposit intangible asset of $136.7 million. Strong credit continues to be a strategic focus, and we are pleased with credit performance so far in 2023. Although nonperforming assets have ticked down and net charge-offs have been minimal, we took a provision of $3.7 million relative to modest loan growth of just over $130 million, putting our allowance for credit losses to total loans of 1.22% at the end of the quarter.
If the first quarter has taught us anything, it is to manage liquidity, capital and credit to be ready for a wide range of economic outcomes, and even shocks to the system. We believe Stellar is well positioned to manage through a challenging operating environment and thrive. Our confidence is driven by the strategic and financial underpinnings of our merger to create Stellar, our franchise value and credit profile from operating in one of the best markets in the U.S., and perhaps most importantly, the Stellar team that's making it all happen.
Thank you. And I will now turn the call back over to Bob.
Thanks, Paul. Operator, I think we'll open it for questions.
[Operator Instructions]. Our first question comes from Eric Spector with Raymond James.
Hi. Good morning, everybody. This is Eric on the line for David Feaster. Thanks for taking the questions. Just wanted to dig a little bit more to deposit trends in the quarter. As you just said, some of the attribution that you talked about how flows play out over the course of the quarter and what the drivers were, what cash appointments [indiscernible] clients migrating out of the bond market, or paying down higher cost debt, like how you can stabilize early here in 2Q? Any color on that would be great.
We see a lot of the flows driven by rate peaking, and that's really consistent with most of our outflows being before the stress as a byproduct of the rate changes. We really didn't see account closures meaningfully higher than typical. And we see an increased level of sweeping excess funds. But Ray might be able to add a little bit of color.
Yes. The portion of the outflows, and if you think about it in a waterfall, not the open and not the closed, the majority came in what we call the carried, the balance of the existing portfolio. And when you look at that, do a little deeper dive into that, you just see basically some outflows but not what I would say material bleeding down of the balances and those existing customers. It's just like Paul said. There were some sweeping out, probably a little bit rate peaking. But we feel good about the stability of that in that section of what we call our carried and the behavior in there. And also, as Paul mentioned, about a third of the outflows were in our government banking group, which is a scheduled and the normal behavior of that. And the other thing I do want to add is that during the quarter, Bob mentioned we successfully had a conversion. So we're already close to our customers, but we're extremely close to the customers kind of mid quarter right around this time, kind of giving white glove treatment to our power users, treasury customers to assist them through the conversion.
Got it. That's helpful color. And then I was just curious if you could touch on just loan pricing dynamics and what you're seeing and just like how new loan yields are trending versus roll off rates and any color on the repricing front would be helpful?
Sure. So we originated about 530 million of loans in the quarter. And that came on at a rate face amount of those loans. It's 7.59%, up almost 100 basis points from the fourth quarter loan originations, really pleased there. And then it's not uncommon to renew about the same amount. And the renewed loans came on at 7.63, off of a rate that was 6.92 the prior rate. So yes, we had a repricing opportunity and we're delivering on that.
And now is probably a good time to stress the repricing opportunity that we had out in October 1 of the entire acquired portfolio from legacy CBTX in what effectively was an interest rate market that portfolio we repriced the entire loan portfolio right then and there. So really, the purchase accounting accretion that you see is a heck of a lot more recurring than a typical credit-driven purchase accounting discount, in that when those loan -- if rates stay the same and when those loans reprice, they're going to be repricing back at today's market rates, we just got to pull that forward. So we see that as meaningful recurring revenue, if rates were to continue to stay higher for longer.
Got it. That's helpful. And then just kind of going with that, just curious where you're seeing good risk adjusted returns at this point. If there's any segments you're kind of throttling back on and just where you're cautious where you see more opportunity?
Well, I think we're taking a very cautious approach to new credit, especially in the commercial real estate part of the market. We're presented with opportunities all the time with loans that are being maturing in other banks and coming our way. We're just taking a really pure go slow approach on that. We don't want to add to that space unless there are strategic opportunities, and we want to keep the dropout or available for our existing customers, and be able to meet their needs, the customers that are maintaining the deposit balances. And so we're being very, very cautious in that space looking for new credits, looking for credit enhancements, or whatever that might be, additional guarantors, collateral, the pledge of liquid assets to back it up. So we're being very cautious in that space, knowing that there'll be some opportunities come to us now and then. But just is the time to be pretty cautious about that, and just emphasize the quality of the credit.
Okay. And then is there anywhere that you see attractive risk adjusted returns? Obviously, you're cautious on CRE. But is there any areas that look a little bit more attractive? Are you getting rewarded for the risk that you take, just looking at your pipeline early here 2Q and whatnot?
In the quarter of the 100 million and so that we did generate in loan growth, that came from -- there were C&I component in there, which we do a good job underwriting those loans. And that was nice to see some C&I in there. And then it was also kind of split of the CREs split, just like our portfolio as owner occupied and non-owner occupied. And then we had a piece of residential construction. So we still have extremely strong market in Houston, and we do a good job on the residential construction side. And that's reflected in the growth for the first quarter as well.
But anyone that brings along nice deposits along with the loan, we don't look at loans in isolation. So we want both sides of the relationship. Folks that are just shopping loans, we don't have a lot of interest in at this point.
Right. That seems like a good approach, obviously, at this point. So I appreciate you guys taking the questions, and I'll step back.
Thank you.
Our next question comes from Matt Olney with Stephens.
Hi. Thanks. Good morning. Can you hear me?
Yes. Hi, Matt.
Great. Paul, I think you mentioned in prepared remarks that the bank sold some securities in the first quarter to help improve the liquidity profile of the bank. Would love to appreciate just kind of where the appetite is from here for additional sales?
We continue to evaluate these dynamics. The opportunity to sell securities in January was kind of the rare no-brainer where the tax equivalent yield was lower than what we could put the money out in the Fed. We took a ton of duration in AOCI risk off the books. So if the stars line up again and there's an opportunity like that, we kind of have our heads on a swivel. But we don't feel like we have to see that at this point. And we're going to have a pretty decent amount of cash flow coming off the securities book here in the next 12 months and 24 and 36 months. So we feel good, but we're going to continue to be opportunistic as we were in January.
Okay. And just following up on your points there, any update on kind of what the duration of the overall book is now versus 12/31 after that trade? And then those securities cash flows, any kind of ballpark number you can give us as far as expectations over the next year?
Sure. The next three years each expect around $200 million in cash flow coming off securities portfolio. We're pretty pleased with our effective duration. Every month, we're walking down the yield curve. As of 3/31, effectively we were at 4.29 years. And we feel good about kind of the overall stance of that portfolio.
Okay. Thanks for that. And then on the expense side, I think when we adjust out those merger charges, I think the first quarter levels came in below expectations. Any color on just how much of the cost saves have been recognized so far, what's still remaining? And then just any update to that full year number of expenses, I think you pointed towards last time on the call?
Sure. We feel like we're on plan. And we feel good about the nature of our kind of merger adjusted core expense base guidance that we gave earlier. Naturally, we're being very mindful of revenue dynamics and how we evaluate expense, but everything is moving forward on the brand.
And just to follow up on that, Paul, as far as the cost savings, I think you mentioned last quarter was $265 million for the full year. It seems like we're essentially at that run rate right now in the first quarter. Should we see any improvement, any declines in that first quarter, or do you think we're at a run right now where we'll see some kind of flatten out or even modest build?
We've had a little bit of the first quarter [indiscernible] noise among as well as merger adjustments, and we had a big conversion this quarter. But we kind of -- as we go forward, we see it as establishing flat line status, obviously, with that being highly dependent on how they have more variable expenses such as bonus accruals and really any audibles [ph] we make with respect to the plan.
Okay, good. And then I think you guys noted that the tangible book value per share improved nicely, it was up 9% linked quarter. That AOCI position is still I think negative $113 million. Any color as far as kind of recapturing that amount over the next few years?
Well, we'll certainly recapture it as we walked down the yield curve. We recaptured a good bit in that January securities trade, not because there was a meaningful gain. But it's really about the AOCI risk that we took off the table. So we feel that as we walk down the yield curve, we're going to see that shrink ratably. And ultimately, it's a function of how we decide to reinvest funds as well, but all that will be at market. So we feel good about where we sit and especially the relative size of that AOCI position with respect to our capital. We are in a position that if push came to shove, or we thought that it made sense to sell each and every security in our book, we don't put our capital status even close to at risk. And we feel like that's a good position to be in. That's not our intention. But we feel like we have a good amount of flexibility and I think it's symbolic of the way we're trying to run the bank with a focus on capital credit and liquidity and maintaining a great measure of flexibility.
Okay, all right. And just lastly, I want to give Joe some airtime here. Any more color within the CRE bucket, the office exposure in terms of kind of what the exposure is or any color you can give as far as puts and takes around the exposure there at the bank?
Hi, Matt. Let me jump on that and then turn it over to Joe. We talked about before, but the granularity in the office loan type, our average loan size in that category is $773,000. So you see right there it's kind of the granularity. And then also if you take the -- if you just look at the non-owner occupied piece of that, that represents about 4.2% of our total loan portfolio. So extremely manageable, and again with about 50% owner occupied the other non. But I'll turn it over to Joe for some more color.
Yes, Matt, if you look at that portfolio and look at the individual properties within it, they typically -- or the large sides of that in our portfolio, there's suburban office buildings, three, four, five storey type buildings. We basically stay in that range. That’s good occupancy. Only one is in downtown Houston, and it's under $5 million of a loan balance. It's not a big building. It's a smaller building downtown. So most of our exposure in this space is scattered in the suburban markets, primarily around Houston, a few in Beaumont and that type of property, and one in Dallas.
Okay. Thanks, guys. I appreciate it.
Thanks, Matt.
Thank you, Matt.
Our next question comes from Will Jones with KBW.
Great. Good morning, guys.
Good morning.
So I wanted to go back to the loan yield discussion for just a minute. That was helpful data points you gave us on where you're renewing loans and where you're originating loans today is obviously well above where the portfolio is yielding today. Could you just help us guide us and maybe walk us through where you’re seeing loan yields trending as we continue throughout the year here? I don't know if you guys have a loan beta expectation, if you will, but just any kind of help on where you see loan yields going from here would be great? Thanks.
Well, sure. So yes, at all there's a waterfall for all that. And if you take those components that I mentioned earlier around new loan yields and then what's happening in the advances and payoffs, the kind of beginning to end of the waterfall went from -- on the whole portfolio weighted average went from 5.56 to 5.76, so all of that that happened in the quarter allowed us to pick up 20 basis points on the whole portfolio. I guess if we're -- the thought would be that if we continue to originate at these levels with similar that we would pick up, continue to pick up some increases on the whole portfolio. I don't know, Paul, if you have anything to add to that.
So really good quarter on that. And we're seeing in committee and seeing that loans that are in the pipeline are coming in at that, and maybe even a little bit higher of what we reported for the coupon in the first quarter.
Okay, great. That's helpful. And then, as you think about the margin story as a whole, you have some more benefit coming from asset repricing; at the same time, deposit beta and deposit costs are kind of accelerating here. Do you feel like the margin has really kind of peaked and we may be on a decline here, or how do you like the margin, what will trend as we continue throughout the year here?
I feel extremely proud of the organization's ability to maintain such strong margins. And I feel good about our ability to maintain such high absolute value margins. It's hard to be bullish with respect to it expanding from here. But everything that we're going to do is to be -- is in an effort to protect our high level of margins in the current environment. Last quarter, I didn't think that we’d do as great of a job of maintaining our margin, and we did. So I don't want to sell it short. But it's hard to imagine that we can do anything other than maintain. And it'd be a great win to maintain.
Market pressures on deposits continues and that's not going to stop, but we are able to put loans on at pretty good rates. So our expectation is to try to defend our margin a bit. So that's what we're going to attempt to do.
It’s worth noting just how competitive the deposit market has been. So there's a heck of a lot of moving parts there on margin, but we feel well positioned as anyone to fight that battle.
Awesome. That's great. That's definitely a win to keep the margin stable in this environment. So I would echo that sentiment there. And then just lastly for me, guys, on loan growth, it feels like maybe you grew loans at a little better pace than you were expecting to, or at least relative to that low to mid single digit guide you gave last quarter. Can you give any more confidence or maybe conviction is a better word that you can grow loans that is more of the upper part of that guidance, or maybe we even see it drift to the high single digit range as we go through the year, or do you still stay conservative here and just kind of stay the course on loan growth?
I think it's staying the course what we've been talking about. When you look at the results of the first quarter, of course, that was -- I think that's indicative of at least what we're looking at for the next quarter. Not sure what will happen in the back half of the year, but I think the answer is that that mid single digit is probably still what we're thinking. Not anymore.
Okay, great. Thanks, guys.
Thank you.
[Operator Instructions]. Our next question comes from Brad Milsaps with Piper Sandler.
Hi. Good morning.
Hi, Brad.
Good morning.
Thanks for taking my questions. You guys have addressed a lot. But Paul did want to follow up on the margin. I think you guys have shown something like a 16% cumulative deposit beta, maybe a 31% interest bearing to-date. Just wanted to get a sense of kind of where you think those are ultimately headed and where they could top out?
Yes, our cumulative beta to-date, you nailed it. That comes right on top of my numbers. In Q1, unfortunately, for all deposits, it was about 43%. And for interest bearing is unfortunately closer to 80%. So there's definitely a measure of catch up being played in what is intensely competitive deposit market. So we're pleased to be close to the end of the rate hike cycle. And we certainly hope that that's the case. But that's why we are managing our balance sheet for maximum flexibility. And really what isn't shown here is probably your core customer data. And what we're focused on is strong core customer relationships that support both sides of the balance sheet. And when you peel out what we believe to be temporary wholesale funds as we seek out to kind of grow customers, that core beta is even lower, but it's all about what we're trying to do. We feel like being close to the company, close to our customers is what's going to drive our customer acquisition and ultimately customer retention. And that's what makes us special and ultimately we're going to -- we're going to seek to drive value on the liability side of the balance sheet and core funding where it’s at.
I certainly appreciate all that, but I guess maybe -- I appreciate your willingness to want to try to stabilize the margin but just trying to kind of drill down on the facts a little bit. Maybe what betas would be sort of driving that forecast? If I look, your lowest cost category shifted into your higher cost; CDs, brokered, FHLB advances. It would seem that the core NIM would -- just the math of it would have kind of a decent step down from kind of this 438 number in the first quarter. So just trying to get a sense of that magnitude?
Yes, I can't speak to the magnitude, but you're right to not be hugely bullish on NIM. We feel well positioned, but it's really hard to comment on the magnitude. The pressure is there.
Okay, got it, understand. And then just on the accretion, thanks for the update on what you guys have left. The pace, I know, is difficult to predict. But just kind of curious kind of what you might expect this year or next just from a scheduled standpoint?
You're absolutely right. We did not expect to be banking $10 million of accretion income in the first quarter. The pace of our recognitions was planned to be more like $6.7 million or $7 million a quarter. So we benefited from what's been called measured windfall accretion in excess. We just didn't expect the loans to be down, because ultimately that's what drives this. In the current rate environment, you're going to have people selling assets and ultimately or for one reason or another, paying down loans early. We didn't expect to have as much. So our expectation now that we've seen the first quarter behavior is probably going to be able to a little bit north of what we initially had planned for the year. But I don't want to kind of -- I'm certainly not banking on another $10 million of accretion income. But when you think about what's scheduled, think about more in the terms of 6.5 million or so. And then there's probably some upside to that. Naturally, we can't predict the future and/or the behavior. But when I think about that accretion income, there's -- in May we'll provide better info on this in the future. There's scheduled accretion income, which is what I posit to be recurring revenue, because those loans will either reprice or be replaced by new market base loans. It's that excess that comes from -- excess or windfall that comes from accelerated paydowns. That doesn't fall into that category.
Got it. And maybe just final bigger picture question for you, Bob. You guys are accreting capital at a relatively fast pace. And it seems like you'll continue to do so, particularly with the accretion coming back. Any thoughts around a buyback or the environment as such, like most banks have said it's too volatile right now, too much uncertainty to even speak about that as you get later in the year as the capital ratios continue to climb higher.
I think, Brad, right now it's certainly in the back of our mind -- I'd say it's in the back of our minds as we accrete capital. We want to get through this uncertainty of what's happening out there. And I think as we get through that and understand better where we are, what our capital levels need to be and the growth that we want to achieve, we'll look at buybacks, look at dividends, look at several things. But we want to be well positioned as we get to the other side of this thing and the Fed stops doing what it's doing to really look at opportunities out there. So we're trying to position ourselves to have all the options available to us.
In that vein, we do have an active authorization.
Right. That's helpful. And Paul, just kind of final two housekeeping. Still expect the tax rate to touch under 20%? And then is the Durbin and tax bill about, I don't know, 0.5 million or $600,000 a quarter starting in the second half. Is that still the number to think about?
Yes, so no reason -- no updates on that front. And the tax rate has crept up a tad by virtue of having sold some of our muni book. But the current quarter’s a fine run rate too, maybe a hair lower going forward.
Perfect. Thank you, guys. I appreciate it.
Thank you.
Thanks.
That concludes today's question-and-answer session. I'd like to turn the call back to Bob Franklin for closing remarks.
Thank you. Thank you for everyone's interest today in Stellar Bancorp. And with that, I think our call is done.
This concludes today's conference call. Thank you for participating. You may now disconnect.