Stellar Bancorp Inc
NYSE:STEL
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Earnings Call Analysis
Q3-2023 Analysis
Stellar Bancorp Inc
The executive team of Stellar Bancorp, including CEO Bob Franklin and CFO Paul Egge, provided insights into the company's performance and strategy during the third quarter earnings call. Courtney Theriot, the Chief Accounting Officer, opened the session with a standard disclaimer on forward-looking statements, indicating the speculative nature of such comments and the company's lack of obligation to update them.
Stellar Bancorp's net income stood at $30.9 million, or $0.58 per diluted share, marking a slight dip from the prior quarter's $35.2 million, attributed to increased funding costs and noninterest expenses, as well as reduced noninterest income. The net interest margin (NIM) tightened by 10 basis points, settling at 3.87%, but showed month-to-month steadiness since May amid challenging conditions. Encouraging signs of capital generation were evident, with regulatory capital ratios increasing notably over recent quarters.
While the earnings results were not at an ideal level, stability in the net interest margin indicates a resilient earnings power for Stellar Bancorp, forming a basis for cautious optimism. If economic conditions improve in 2024, the company is positioned to harness growth opportunities, given their solid capital creation, robust earnings, and disciplined expense management. Effective balance sheet management remains a top priority for Stellar as the financial landscape and the Federal Reserve's actions continue to evolve.
Stellar Bancorp aims to continue its strong performance in managing funding costs and achieving relatively stable net interest margins in the face of intense market competition. Although market conditions and funding costs may vary, the company believes there is room for asset gains and overall financial improvements, particularly if the trends remain on the current trajectory. The focus is to maintain this balance, fostering an environment conducive to potential margin expansion in the latter half of 2024.
Accretion income has been higher than expected, partly due to greater paydowns within the loan portfolio. This fortuitous trend has effectively accelerated the repricing process, positioning loans to reset at current market rates. Consequently, the bank is capturing higher interest rates during the repricing, which may have a substantial impact on future performance. This dynamic represents a foundational shift in the portfolio that could bolster the bank's interest income and margin profile.
There has been a recent slight uptick in renewal activity, with $680 million in renewals this quarter compared to the typical $500 million to $600 million range. This activity may reflect borrowers' responses to high interest rates and suggest greater churn within the loan book. However, the overall pace is expected to align more with historical rates, providing consistency for portfolio management strategies going forward.
Amidst the second phase of Stellar's merger activities, the leadership is conscious of aligning expenses with current revenue realities without compromising growth potential. The bank aspires to maintain core expenses from 2023 into 2024, marking a flat to slight increase in growth. This attuned management approach is a testament to their strategy of balancing stakeholder returns with the bank's long-term growth aspirations.
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Good day and thank you for standing by. Welcome to the Stellar Bancorp Inc. Reports Third Quarter 2023 Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.I would now like to hand the conference over to your speaker today, Courtney Theriot, Chief Accounting Officer.
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 third quarter of 2023. This morning's earnings call will be led by our 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 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 may be required by law. Please see the last page of the text in this morning's earnings release, which is available on our website at ir.stellrbancorpinc.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 will now turn the call over to our CEO, Bob Franklin.
Thank you, Courtney, and good morning, and welcome to the Stellar Bancorp third quarter earnings call. I begin my comments by thanking our fine team at Stellar Bank for their great work and extra effort to strengthen Stellar Bank's infrastructure.Our combination just over a year ago, is now in its second phase of refinement following our core conversion, developing one culture, developing and better defining our staffing needs, refining our expenses to scale to an $11 billion organization, and aligning our efforts to make Stellar Bank, the bank of choice in our markets.Though the industry continues to experience pressure on the deposit side, due mainly to interest rates, we have seen our base move towards stabilization. Rates have also put pressure on our net interest margin, but the negative effects are beginning to minimize. And though we would not call a bottom, with the uncertainties that still exist in the market, we feel we are close.Our credit metrics remain good and our markets remain strong, but we must be cautious as the effects of rapidly rising interest rates work through the economy. We did charge off one loan in the quarter, which was the result of a continued deterioration of a previously identified credit noted in the fourth quarter of 2022. The issues experienced in this credit are specific to the borrower and do not appear to be a trend within our loan book. We continue to believe that our underwriting in our markets remain good. We are determined to concentrate on building capital, liquidity and staying focused on good underwriting. We are also making sure that we monitor our existing portfolio for any negative trends that may form in the future.We are pleased with our balance sheet positioning as we move to the fourth quarter of the year. Our goal is to put our institution in a position of having all options available to it as we move into 2024. Achieving our goal will create value for our shareholders, our employees, our customers and our communities.I'll now turn the call over to Paul Egge, our CFO.
Thanks, Bob and good morning, everybody. We are very pleased to report strong operating performance in the third quarter. Our net income was $30.9 million, representing diluted earnings per share of $0.58, an annualized ROAA of 1.14%, and a return on tangible common equity of 14.5%. This was incrementally lower than the $35.2 million of diluted EPS of $0.66 per share earned in the second quarter due mostly to increases in funding costs more than offsetting increases in interest income, higher noninterest expense and lower noninterest income.Notable among the noninterest items was our control of core noninterest expense after excluding merger expenses and for noninterest income, the decreased revenue effect from the Durbin Amendment on our debit card and ATM card line item and reduction in NSF fees.During the third quarter, core net interest margin, which excludes purchase accounting adjustments, contracted by 10 basis points versus the second quarter and was 3.87% in the third quarter. That said, we are pleased to have experienced relative stability in our core net interest margin since May on a monthly basis.Since May, after experiencing meaningful funding dislocation in March and April, our funding costs have continued to trend upward, but at a more measured pace and the repricing of our assets has been able to keep pace enough to maintain stable monthly core net interest margins as we entered and exited the third quarter.While we do not like to see a decrease in our NIM or pretax provision profitability, we feel pretty good about the stabilization in our margin trends and earnings power, which continues to compare favorably relative to the industry. And we also feel good about our ability to protect our relative profitability profile in this challenging environment.With respect to purchase accounting items, we had $119 million in loan discount remaining and a core deposit intangible of $122.9 million at the end of the quarter. Strong earnings not withstanding accelerated amortization of CDI expense has really helped us to internally generate capital at a nice pace, reflected in having shown well over 100 basis point increases in all of our regulatory capital ratios over the last 3 quarters.In summary, we believe Stellar is well positioned to manage through the current operating environment and thrive. Our funding composition and liquidity position puts us in a great spot to maintain favorable margins and earnings power. Finally, on credit, we feel appropriately reserved given the current economic unknowns and we otherwise take comfort in our credit underwriting discipline from lending in one of the -- and from lending in one of the strongest markets in the country.Thank you. And I will now turn the call back over to Bob.
Thank you, Paul. And we're ready for questions, operator.
[Operator Instructions] Our first question comes from Eric Spector with Raymond James.
This is Eric dialing in for Dave Feaster. Just wanted to touch on maybe some of the trends on the core funding side. Obviously, you've seen some migration, but just curious some of the underlying trends you're seeing, maybe how new core deposit prices trending for core products as well as CDs and just kind of how you think about deposit balance is going forward?
Yes. Eric, this is Ray. Yes, on those deposit trends, we felt good about third quarter that when we look at the dollar amount of new -- that exceeded closed that really held nicely. It's actually held nicely over 3 quarters in a row. And then if you look at our, what we call the carried, which is what's existing prior to the new and closed, those outflows -- there still were some outflows, but they really decelerated at a nice pace to where we almost got to core. There's still a core outflow to the net for the total, but it's significantly decreased from the previous 2 quarters.
Yes. While there was some shrinkage, we kept the composition relatively similar. So when you think about our funding base, we still -- we succeeded in having stability in our noninterest-bearing deposits ratio. And everything else, including our wholesale funding dependency, really mirrored where we were at the second quarter.
Just kind of following up on that. Just curious how you think about the balance sheet and just the margin trajectory, assuming a higher prolonged environment. Just kind of any color on the bank's performance or broader economic issues that you think could arise in a prior for longer environment, just kind of how new loan yields are trending, color on like loan-free dynamics and how new loan yields are versus roll-off rates, any color on that end would be great?
Certainly. I mean, the best takeaway we have that we feel good about coming out of September and really the last 5 months is a relative measure of stability in our net interest margin. And so notwithstanding the fact that the cost of funding continues to trend upwards, it's very much been in equilibrium and locked up with the rate of change in our asset, on the asset side. So we feel good about the stability there.We think the more time we're higher for longer, it'll give more time for our asset book to reprice. And over the longer term, we see net benefit there, but we're very, very cautious around how we manage really the uncertainties of this unprecedented interest rate environment. So right now, we feel pretty pleased. We're just cautious about outlook and feel good about where we sit.
Hey, Eric, I can give you some numbers, some color on the new loans. So new loans for the quarter originated $340 million. That was at 8.12. We picked up 50 basis points from the prior quarter on that. And then we renewed over $600 million loans in the quarter at 8.71 and that was a pick up of 65 basis points from the previous quarter.
And then just wanted to touch on the securities book. You have the advantage of having a truly liquid portfolio. Just I guess if we continue to see these deposit outflows, how do you think about security sales versus borrowings versus CDs and other types of noncore funding? Where are you comfortable with that loan-to-deposit ratio shaking out? Maybe if you could just remind us what cash flows in your securities portfolio are? That would be helpful.
Certainly. So in the fourth quarter, we have well over $100 million in security of cash flows coming off the securities portfolio. If you take that forward 15 months, you're talking about probably $300 million of securities of cash flows coming off the securities portfolio. But -- and then every day, we talk about the puts and takes as it relates to how we manage the balance sheet and what do we do with that cash.We feel comfortable with our current level of loan deposits, and we want to take part in the repricing opportunities out there. So currently, we're leaning towards reinvestment of those cash flows, but it does afford us a high level of flexibility going forward. So we can -- we are able to call audibles around that depending on how a broader funding base gets.
Our next question comes from Will Jones with KBW.
So I just wanted to start on loan growth. I know we've kind of been talking about this low to mid single-digit range for the full year. And if you look at the first half, it was a little stronger, but we saw a little more softness this quarter. I guess the theme maybe that we continue to see a little bit of softness as we into the fourth quarter. So round-trip, we may wind up still in that mid to low single-digit range for the year. I guess, a, is that kind of how you're thinking about the near term and fourth quarter kind of growth outlook?
Yes. I'll let Ray give a little more color. But for the most part, loan growth is going to be fairly muted through the end of the year. And as we kind of watch the market and see what's available to us, we've increased our underwritings quite a bit. So it's cleared the deck a bit on what can actually clear the hurdles to get on the book. So it's going to be slower than it was in the first part of the year. But Ray, you might you can add on.
Yes. Well, the -- so a couple of things just that how we got to that where you saw the little negative growth for the quarter. When you look at the waterfall, the posture that we started last year around managing credit and liquidity. And it's a function of our loan originations. Those were in the second quarter, about $550 million in new loans in this quarter, around $350 million. So that's definitely one component of probably where we're headed.The other thing is our payoffs, where we've normally experienced something like $250 million a quarter, that continues is actually around $275 million in the third quarter. So a combination of lower originations plus not a return to the payoff levels, but at least a little increase in the payoffs, which we think is probably healthy. That's contributing to probably what Bob's talking about of that muted, probably low single-digits.
And Will, I would just add, as you think about our approach to this, and I know others have different views on it, but we really feel strongly about our core deposit funding. And so, right now, the [ knife fights ] that we're going through on deposits with some pretty high rates out there, and a lot of those high rates don't even pertain to what core funding really is. So we haven't chased that to try to increase the loan volume. We like our position from a loan deposit. We probably even pull it down a bit.This is a good time to really focus on strength of balance sheet, but we feel -- like we've been able to keep the noncore funding to a percentage that we feel comfortable with and would rather not increase loan volume by going out and borrowing more money at tighter margins. So we're sort of staying within the boundaries of what we feel like is a way to grow the bank. We think that the true value in our organization is around our core funding profile and we don't really want to disturb that.
And I know core funding is a huge advantage to you guys. But I guess to that point, it feels like when a company was combined and put together, it was really built to be more higher growth oriented. So what do you really need to see to get more offensive on the growth fund? Do we need to see the positive costs really kind of stabilize and just overall pressure on the positive stabilize or does there need to be a little more clarity over rates and credit or just how do you think about -- what would kind of drive a more offensive step for you guys on loan growth?
Well, we agree with you. We were built to really drive growth and do things that we wanted to do. Unfortunately, when we closed our deal in November of '21, the Fed was in the process of raising interest rates at the fastest pace that it ever had. That has to change your trajectory. You can't just continue to push on with what you wished were going to happen and to something that didn't happen for you. So you pull back, you figure out what your next strategy is, but right now there's not a level playing field for deposits.So deposit gains are really coming at a pretty high cost in many ways, unless you're JPMorgan, I guess, but the people are running the safety. But for the rest of us, we're out here battling for deposits on a relationship basis type approach. And as long as rates continue to move and people are aggressive around what they're paying for things, we don't think that's the right call. So we're trying to take the right approach on the deposit side to make sure we're still developing relationship-type deposits, making sure we're looking for the funnel account. That's the approach we've taken for years and years, and it's done well for us.On the loan side, these high interest rates are going to have to move their way through the economy. We have not seen the effects of them yet. I think it's coming. We happen to be in a really nice place in Houston, Texas that is still pretty strong from an economic standpoint. That doesn't always mean you drive right through that hole to increase your balance sheet when you know there's some dust on the horizon.So it's something we're just approaching cautiously. We're still continuing to make loans. We still have increased our underwriting standards to make sure that we feel comfortable in the things that we do put on. But we're cautious, we'll admit it, and we just want to make sure that we preserve a really nice balance sheet and a good nice core earnings profile. And I think we're doing that. I think our earnings are not exactly where we would like them to be, but they're still pretty good. And so we feel good about where we are.
I just wanted to touch on credit for a bit. We obviously saw a little bit higher kick up and charge off this quarter. And there's really kind of been a theme across the broader southeast of maybe some of these idiosyncratic noise within the C&I space. Is that kind of really how you characterize this credit we saw this quarter?
I wouldn't. I think it was really relative to one loan that one company that frankly wasn't managed really well and we ended up in the position that we did. We worked with it for a long time trying to figure out a better way and it ended up in this position. It's not indicative of our portfolio. You could nonperformers actually went down fairly significantly and we didn't backfill after we charged the loan off.So I think the trend is not that direction. We want to make sure that we head off having a trend in that direction. And I don't think that's really indicative of where we are. But we are cautious about what's out there. Because as we see renewals happen and how people are handling higher interest rates, It's been interesting as we go through that to see how people are going about dealing with the increase in rates at a renewal time.So there's a lot of things available to us, and we're using all those tools. And I think the market here helps us because it is so good, it remains good and hopefully, if we get this soft landing that people like to talk about that's great. If it's a little harder, I think we're still well positioned and if it doesn't happen, I think we have the ability to take advantage of things as we move into '24.
So it feels like the pulse on credit, at least as it pertains to Stellar, is maybe a bit of cautious optimism. Would you characterize it that way?
Yes. I would. I mean, if we get better signals in '24, we're well positioned to move back to where we would like to have been positioned over a year ago. But I think you have to be sure that the Fed is through. You have to make sure that we're not running into an economy that the Fed was so successful at slowing the economy that it's hurt all of us. And we want to make sure of kind of where we believe things are as we get into '24. And I think that's sort of been our position.We feel really good about where we are and we're leaving ourselves every option available open. So we're creating capital, our earnings are pretty good, we're repositioning expenses so that we can make sure that we're in a good place from an earnings standpoint and we're going to see what it provides us as we move into '24.
Our next question comes from Graham Dick with Piper Sandler.
So Paul, I just wanted to circle back to the NIM quickly. I heard there's stability from quarter start to quarter end, which is obviously great to hear. Funding pressures can be volatile, but assuming trends continue to level off like you guys have seen and there's no more increases in the Fed funds rate. Is there any reason to think that the pressure from the funding side can start to abate as the asset side continues to reprice higher. And there's a bit of a handoff maybe in the back half of '24 that could lead to some stabilization in the first part of the year and then maybe even some expansion in the core margin later on in the year?
As long as composition stays constant, I believe there's a lot more room to go up in the asset side than on the funding side. But that is obviously a big contingency. We feel really good about our performance over the last 5 months and we're going to work hard to defend that. It does stand to reason that the asset side has more room to go. But we're still taking, I guess, a cautiously optimistic approach there, particularly because we are still in some really, really competitive markets.I feel like what we've been able to do up to this point has been herculean. We're going to continue to work on continuing the track record of relative outperformance on our cost of funds, which is translating into meaningful outperformance in what has been a stable NIM post the tumult earlier in the year.
Yes. I absolutely understand the cautious approach there, but still good to hear that things seem to be at least trending in the right direction, I guess, from what we saw at the very first part of the year around the industry. And then I guess, just quickly, what are you guys assuming on accretion income, I guess, over the next couple of quarters, is a little bit higher than I thought it would be this quarter. I don't know if there was some early payoffs or what might have driven a little bit of the stable accretion essentially quarter-by-quarter. Is there any color on what you guys are looking at there would be helpful?
Certainly. It has been higher than we expected and granted we've welcomed the accretion income. We try to look at the business both ways and being extra mindful of the windfall nature of some of it because that's really what's driven a higher level of accretion income, more paydowns in the portfolio than expected, which we'll absolutely take.Recall, all of this accretion income is interest accretion. And that's pretty powerful because ultimately, it just brought forward the repricing on the entire required portfolio of loans. And those loans when they do reprice are repricing at market rates and we feel like that's really powerful. So ultimately, aside from the fact that what I'll call, windfall accretion has represented about 35% to 40% of what we've been experiencing here today.We'll obviously take that, but there's repricing going on and we see much of the accretion as core when it reprices into a market-based loan, especially at the nice rates that Ray outlined with respect to those recurring loans where we're ultimately getting over 8.5%, 8.7% when we reprice loans. So we feel we feel good about it if it's repricing to those types of levels but we definitely think of most of it as a pull forward of market pricing.
And then I guess just on that repricing front, you just mentioned, Ray, is that $600 million of repricing that happened or renewals that happened this quarter, is that typical? Is that kind of like the run rate we could expect in terms of the current loan book churn going forward?
It's probably a little higher than normal. Normally you kind of think about our originations and renewals generally kind of track together. And this was a little bit probably outsized where the first 2 quarters were more like $500 million of renewals and this was $680 million. So probably something between $500 million and $680 million is probably the way to think about it. It was a little outsized.
And then I guess just turning to expenses quickly. I know you said that you've got some increased focus on expenses going forward and optimizing the expense base to kind of align with the revenue environment in the current economy. But what does that mean for your all's approach to expense growth in 2024 as it relates maybe to that. I think we talked about a $265 million dollar number for 2023?
Well, we're trying to be as strategic as thoughtful with how we manage expenses and there's competing dynamics going on. First and foremost, we're completing and moving onto the second stage of our merger to create Stellar Bank and what that means. We want to be well positioned to grow when the opportunity presents itself. So we don't want to fall into a trap of underinvesting. But at the same time, we have to be really mindful of current revenue trends and delivering for investors. So we are seeking to balance that in a way so as to achieve both ends.So what that means in 2024 is seeking to control and stayed level as it relates to our core expenses from 2023 and going into 2024. And to the extent and really being thoughtful about how and where we allocate expenses. So it's something just like our balance sheet management that we're thinking about every day. And we haven't made any sudden moves as it relates to that, but this is budgeting season and we're hyper-focused.
Our next question comes from John Rodis with Janney.
Bob, I like your cautious view on things. I wouldn't be apologetic about that. I think that's the environment we're in. Paul, you made the comment just before on expenses, I think quarter or 2 ago you talked about $265 million and you just said sort of full year '24 sort of level. So just reading between the lines, that sort of implies flat to low single-digit growth for next year? Does that make sense?
I think we're right on a core basis, flat to low single-digit, yes. And we're still formulating around all that, but we seek to manage this effectively in 2024.
Back to the yield accretion, certainly the higher payoffs have been pulling some of the accretion forward. I think a quarter or 2 ago you talked about $26 million to 28 million for the year, which would put you at what, $6 million to $7 million per quarter. For modeling purposes, does that -- while it could come in higher, does $6 million to $7 million a quarter for yield accretion over the next few quarters still seem reasonable?
I think it's hard to predict these things. That's if you're going straight on and we were conservative thinking that we wouldn't get really much or any paydowns. And as it happens, we've gotten a lot more. So I think that's been our conservative view and we've been surprised to the positive. So taking a recent path, I think it's safe to say that our conservatism has been a little less warranted, but once again, it's hard to predict deposit, pardon me, loan repayment behavior, especially with these higher rates. It's been interesting that it's outpaced our expectations at this point.
Back to the charge-off, can you guys say what sort of industry that company was in?
John, I think we should leave it as it is. We're still in negotiations, still have some ongoing stuff with these guys. And I don't want to call them out in any way. And being more specific is probably not a good idea for us right now.
I understand. Just one follow-up on that though. It was in the Houston market, correct?
Yes.
[Operator Instructions] Our next question comes from Matt Olney with Stephens.
Most of my questions have been addressed, but I know the bank typically has some seasonality late in the fourth quarter and into the first quarter with respect to that deposit base. As it stands today, we'd love to hear about expectations of that seasonality and if you expect to kind of maintain those normal seasonal patterns?
Sure. We do expect a measure of seasonality, but I will say, especially given that we're currently using a higher level of wholesale funding than we'd like to. We kind of would see a substitution dynamic going on, so we're probably not expecting much by way of asset growth. More, we'll seek to let certain seasonality on the funding side substitute away a measure of our usage of FHLB borrowings or broker deposits, what have you.
I assume those wholesale FHLB, those are all eligible to be paid down pretty short duration, it sounds like?
It's mixed, but we definitely have a certain amount that is on the short side that we're kind of thoughtful about how we play that composition of both food groups and that wholesale funding, and we're able to manage that relative to the expectations around seasonality. To the extent it drives a little bit of asset growth will be enjoying a meaningful level of spread, if we put that at the Fed -- if we put the excess cash at the Fed.
Appreciate that. And then on the fees side, fees were a little bit slower this quarter. I know the Durbin impact started in 3Q, but it still looks like there were maybe some other impacts in there in the third quarter or perhaps Durbin may have been more than we expected. I can't -- its tough to see from my seat. Any -- give me color on fees in third quarter in the outlook here?
All I can tell is that Durbin has been a little bit more than our expected impact. We also sort of followed the trend of we are not charging NSF fees any longer.
And Bob, on that last point, when did you implement that? Is that third quarter start?
That's last quarter, yes.
Mid-August.
And then I guess on capital, we are seeing a nice capital build. I know when the bank was put together, there was expectation of some rapid capital build. And Bob mentioned earlier, the environment has changed over the last year since the deal was put together. So we'd love to hear any updated thoughts on capital, expectations of continued build, and then with the excess capital, what your updated thoughts are around deployment of such capital?
Yes, Matt, I think we're very comfortable with the fact that we're building capital. They give us some optionality. We think it allows us to look at various ways to deploy that, whether that be M&A, whether that be buybacks, whether that be increased dividends. There's all these things we're looking at. There's also safety in capital bill to make sure that you can get through difficult times if those approach us.So we're trying to keep all options on the table to see where we go with that, but it's a good problem to have, I think, in trying to give optionality to -- as we move into '24 and decide what that looks like for us and what we want to do with that. But we want to continue to build this organization. So the best use of that is to help us continue to build and grow.
I'd now like to turn the call back over to Bob Franklin for any closing remarks.
Thank you for your interest in Stellar Bancorp Corp. And with that, we are adjourned.
Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.