Stellar Bancorp Inc

NYSE:STEL

Earnings Call Transcript 2024-Q3

[Operator]

Greetings, and welcome to the Stellar Bancorp Third Quarter Earnings Release Conference Call. [Operator Instructions]

I will now turn the call over to Courtney Theriot, Chief Accounting Officer. You may now begin.

[Courtney Theriot, executive]

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 2024.

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'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 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.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 will now turn the call over to our CEO, Bob Franklin.

[Robert Franklin, executive]

Yes. Thank you, Courtney, and welcome to the Stellar Bancorp Third Quarter Earnings Call. I begin by thanking our team for the great work they're doing every day to build our brand and to continue to provide the great service our bank is known for in our markets. As we pass our second anniversary of Stellar Bancorp, we are proud of our progress towards building a strong infrastructure needed to cross the $10 billion mark and our focus on capital, liquidity and credit. We have derisked our balance sheet by significantly increasing our liquidity, reducing our CRE concentrations and building capital. We believe that we have provided the bank maximum optionality and are well positioned for the future. Soon, we will have the stress of the presidential election behind us, and it appears that interest rates are attempting to normalize. Combined with the strong markets we serve, the runway for 2025 appears to be good. We will be approaching the market with a more balanced lending philosophy and we will continue to build strong relationships to support both sides of the balance sheet. Our capital base is strong and allows us optionality. Top of mind will always be safety and organic growth.

With respect to M&A, we will continue our efforts to look at well-balanced franchises that will help us grow our bank with an emphasis on funding profiles. We will also weigh our opportunities to buy back our stock, increase our dividends or pay down subordinated debt in an effort to return excess capital to shareholders. The markets we serve are some of the best in the country, and we are well positioned to succeed in these markets in the coming years.

I'll now turn over the call to Paul Egge, our CFO, for more detail on the quarter.

[Paul Egge, executive]

Thanks, Bob, and good morning, everybody. We are pleased to report third quarter net income of $33.9 million or $0.63 per diluted share, which represents an annualized ROAA of 1.27% and an annualized ROATCE of 13.63%. This compares with second quarter earnings of $29.8 million or $0.56 per diluted share, which signified an ROAA of 1.13% and a return on average tangible common equity of 12.82%. A key driver of our performance in the third quarter was an approximate $6 million reversal of provision for credit losses on loans primarily due to a decrease in the specific allowance related to individually evaluated loans, thanks to significantly lower nonperforming loans and, to a lesser extent, lower loan balances.

While net charge-offs were elevated in the third quarter totaling $3.9 million, more than 88% of the charge-offs had been previously specifically reserved for. Setting aside the provision reversal, we feel very good about our quarter-over-quarter progress in our core pre-tax, pre-provision earnings power, largely due to improvement in our net interest margin, excluding purchase accounting adjustments. We are very pleased with our ability to protect our earnings power over this rate cycle while derisking the balance sheet, bringing our CRE and C&D concentrations solidly within regulatory guidance and lowering our loan deposit ratio from approximately 92% a year ago to about 86% at the most recent quarter [ end ]. Not to mention, all while managing the increased expense associated with crossing the $10 billion asset threshold.

Net interest income for the quarter was $101.5 million representing a slight increase from the $101.4 million booked in the second quarter of 2024. This translated into a net interest margin of 4.19% in the third quarter relative to 4.24% in the second quarter of 2024. Purchase accounting accretion in the third quarter was $6.8 million relative to $10.1 million in the prior quarter. Excluding this purchase accounting accretion, net interest income increased in the quarter about $3.4 million to $94.8 million from $91.4 million in the prior quarter. and net interest margin was 3.91%, up from 3.82% in the prior quarter.

Key drivers to the margin performance in the third quarter included stability in our noninterest-bearing deposit portfolio, representing about 38% of our deposit base, a 3 basis point improvement in our cost of funds, driven by a 5 basis point improvement in our cost of interest-bearing liabilities, higher securities yields and higher loan yields after excluding purchase accounting accretion, offsetting those lower loan balances.

Walking further down the income statement, we booked the aforementioned $6 million reversal of provision for credit losses on loans in the third quarter. In combination with the net charge-offs during the quarter, this brings our allowance for credit losses on loans to $84.5 million or 1.12% of loans from $94.8 million or 1.23% of loans at the end of the second quarter. That said, since NPLs decreased nearly 37% from $50.9 million to $32.1 million during the third quarter, we ended the quarter with an allowance coverage ratio to nonperforming loans of 262.9% from 186.2% at the end of the second quarter.

Moving on to noninterest income. We earned $6.3 million for the quarter versus $5.4 million in the second quarter. I'll note that the current quarter benefited from $1.3 million of SBIC income and a small gain on asset sales. Last, noninterest expense for the quarter was $71.1 million, down slightly from the $71.2 million in noninterest expense from the second quarter, excluding some nonrecurring items such as severance and certain other items, noninterest expense was roughly in line with our expectations. Our strong bottom line results have driven a continuation of our track record of growing our regulatory capital ratios since the merger.

Total risk-based capital was 15.91% at the end of the third quarter relative to 14.02% at the end of 2023 and 12.39% at the end of 2022. This progress has been consistent across all regulatory capital ratios and is reflective of our tangible book value growth since closing the merger, thanks to a relatively strong earnings profile, notwithstanding accelerated amortization of CDI expense. Since our first quarter end post-merger at the end of 2022, we have grown tangible book value per share by 37.5% from $14.02 per share to $19.28 per share after dividends, representing a compound annual growth rate of 20%. We continue to like our prospects for strong internal capital generation and the optionality it creates which we feel is very valuable in the current operating environment.

During the third quarter, we started to repurchase shares for the first time since the merger, buying back 108.9 -- 108,000 shares at an average price of $26.10 under our repurchase program. While on the topic of capital, we also intend to redeem the $40 million of bank-level sub-debt that we have on our books in September -- or in December, pardon me. So given cumulative industry pressures and our position at just over $10 billion in assets, we feel very good about our balance sheet and earnings power relative to the industry. Our positioning for future organic and organic growth opportunities and the potential for meaningful operating leverage when we add more scale to the Stellar Bank platform.

Texas and more specifically, our markets within Texas continue to exhibit strength relative to the rest of the country. We feel the combination of the economic strength and resilience of our core markets, and our home field advantage as the largest locally focused banks in the market we serve will sustain growth and success into 2025 and beyond.

Thank you, and I will now turn the call back over to Bob.

[Robert Franklin, executive]

Yes. Thanks, Paul. Operator, I think we're ready for questions, please.

[Operator]

[Operator Instructions] Our first question comes from David Feaster from Raymond James.

[David Feaster, analyst]

I wanted to start on the loan side and dig into some of the dynamics that you're seeing there. Obviously, loans declined more than expected. But I wanted to get a sense of the drivers of that. How much of that's less appetite for growth? And and strategic declines in the CRE? Or are more of a function of weaker demand and continued payoffs and paydowns. Just kind of curious what you saw in the quarter, the pulse of your clients and just how you think about growth near term as we head into 2025.

[Ramon Vitulli, executive]

David, I think you touched on all of it. The -- particular to the third quarter, we originated about a little in excess of $300 million for the quarter, which was $50 million more than the second quarter. So we're pleased with that number. It didn't fund up to a level pro rata as the previous quarter. So we have -- we'll probably get a little lift there in future quarters from that. And then our payoffs actually were a little bit less. So we had payoffs of $230 million in the quarter. And then what we call -- I think you know our waterfall, but what we call our carried, which is our advances compared to our payments, that because of our posture around construction and development, for the last few quarters, we're starting to see that to be actually a negative to loan growth. So our -- now our payments are exceeding our advances because of that posture around C&D. I think as this -- our track record now of -- in that $300 million, we feel good about that and think that we're really positioned for when we see some increased demand in the economy, [indiscernible] our team. We have a track record of being able to originate more than that to get some growth, and we're ready for that.

[Robert Franklin, executive]

Yes, David, I think -- from our standpoint, when we put the 2 banks together, we look very much like 2 community banks coming together. And I think there was a reason for us to reformulate our loan portfolio into something that looks more like a larger bank. And the market actually gave us that opportunity to do that. I think we've sort of repositioned ourselves. We've hired some really nice C&I people to help us sort of balance out what that portfolio looks like going forward. But we feel really good about what our position is today about making loans.

[David Feaster, analyst]

That's great. And then maybe on the other side of the coin, too, I mean it's been pretty impressive what you've done on the funding cost side. And it seems like the benefit of some of those hires are coming to fruition. But I'm just curious, what are you seeing on the deposit front? I mean you were able to reduce deposit costs even ahead of Fed cuts. So I'm just curious, how has reception been from clients thus far as you start reducing rates? And just how you think about the deposit outlook just in general, as rates are coming down and your ability to reprice is lower.

[Ramon Vitulli, executive]

Well, on the customer -- how we feel around the customer sentiment. Third quarter was the largest of the last 3 quarters as far as the dollar amount of opened accounts, real pleased with that, came on at a lower rate than the previous quarter. So that's good, too. And that the NIB mix of those new accounts support where we have on the whole as far as our NIB balance. So all those are encouraging.

[Paul Egge, executive]

Yes. And we really feel good about how our deposit cost has played out through this cycle. We've been able to exhibit a high level of discipline. And what you saw in the third quarter was reflective of that, definitely reflective of letting wholesale funds roll off incrementally. And then otherwise, just good core execution that we think has position potential to bear fruit in the future, but it takes time.

[David Feaster, analyst]

Okay. And then I just wanted to get a sense of the margin trajectory as we look forward, inclusive of Fed cuts. I mean the core NIM was -- expansion was better than we had expected. And it's, again, great to see the decline in deposit costs ahead of a cuts. But obviously, there's a lot of moving parts, right? You got the sub-debt redemption, too, that's going to help. But just wanted to get a sense of -- of the margin trajectory as we look forward, assuming more cuts are on the horizon?

[Paul Egge, executive]

Certainly. We feel pretty good about where our margin sits. There are a lot of moving parts. So we know that we're going to be able to defend it very well. It's all going to be about execution -- now late in the quarter is when we'll redeem that sub-debt, which obviously will be a positive. But early in this quarter, we had a sub-debt issuance that went variable. So you really hit the nail on the head as it relates to there being a lot of moving parts, but we're very comfortable about where we sit. And especially, we feel like if and when we get rate cuts, we'll take what the market gives us in terms of that front-end exposure of deposits, taking away a little bit of that pressure on costs. And of course, we tend to invest all across the curve, and we think that has long-term benefits. It's hard to give great guidance as to where it's going to be in the next 3 months and the next 6 months with all the moving parts. But actually, we feel we're in a great position to defend it and depending on how loan growth and other factors play out perhaps even improve it.

[Operator]

Your next question comes from Matt Olney from Stephens.

[Matt Olney, analyst]

I want to go back to the loan growth discussion. And it sounds like there's still some uncertainty maybe in the near term in the fourth quarter. Just looking for more color on the borrower sentiment and kind of what borrowers are saying. And then as we think about 2025, I'm curious if we think we can get back to that mid-single-digit pace that we've talked about previously in a more, more normal kind of macro economy? Is that a reasonable goal, especially as you kind of layer in some of these new C&I producers as they gain more traction?

[Robert Franklin, executive]

Yes, Matt. I think that is what we're focused on. But I think that we're still -- I want to see the smoke clear on the election and really more around this inflation rate and where rates are going to go. Our markets are still pretty good. I wouldn't say that loan demand is huge. It's, it's good. It's still -- Houston still provides in our markets, other markets also, still provide good places for us to make loans. But our goal would be to get back to that mid-single digit. And that's what we're shooting for next year, if we're giving the proper market to do it in. So that's kind of what our thoughts are.

[Matt Olney, analyst]

Okay. Appreciate that, Bob. And then, I guess, switching gears on the expense side. I think there were some noncore items this year. I think we've been targeting about $280 million for the full year, but it looks like we're trending a little bit above that. Just any updated thoughts on expense levels from here?

[Paul Egge, executive]

Certainly. That $70 million quarterly run rate is what we target. And unfortunately, there tends to be noise, and we had some noise and seasonality in all our quarters year-to-date, generally trending more of that $71 million run rate. We are working as hard as we can to position the bank well from an infrastructure standpoint and really hold the line on that expense growth. So yes, we've had some items that have had us $1 million -- running about $1 million above our $70 million target. But we're still doing our best to hold the line, and we see fourth quarter expenses, we're going to be targeting that same level and managing it along those lines.

[Matt Olney, analyst]

Your next question comes from Andrew Gorczyca from Piper Sandler.

[Andrew Gorczyca, analyst]

I just had a couple of questions. One on the purchase accounting accretion, just looking for what you guys expect that to be going forward kind of more in 2025.

[Paul Egge, executive]

It should be waning in the near -- in the fourth quarter, we expect around $7 million, and we'll see it kind of trail off. Purchase -- recognition of purchase accounting accretion income has been hard to predict with paydowns and the waxing and waning of that. So I'd expect a run rate that starts to decay from that $7 million that we expect in the fourth quarter. We still have a remaining loan discount of $81 million, and that will be extinguished over time, and it -- I think you can assume that it will continue to decay and also be subject to some lumpiness.

[Andrew Gorczyca, analyst]

Okay. Sounds good. That's helpful. And then just the other one I had really quick. You guys mentioned earlier that as far as M&A goes, looking at some targets that maybe have a better funding profile, just I was curious if you had any other commentary around M&A if conversations are picking up and if we get an administration change here in November, if that affects anything going forward?

[Robert Franklin, executive]

I don't know if the administration change really changes it very much, but we're certainly hanging around the hoop on a lot of different fronts around M&A. And it's really finding the right partner for us. We do think there is a need for us to kind of get away from this between $10 billion and $11 billion to help us with some of the expense level that we have. But we want to make sure we do the right thing when we do it and find the right partner. So we're having a lot of conversations with a lot of different banks, whether they're private or public, and that's kind of how we're approaching the deal. We have several folks that we really like out there and that are doing a good job and -- but we'll just -- we'll see where that takes us. There's no -- you can't really necessarily judge timing on that. A lot of it has to do with when somebody wants to come to market.

[Operator]

[Operator Instructions] Our next question comes from Matt Olney from Stephens.

[Matt Olney, analyst]

Just want to hit on the securities portfolio, another big quarter of growth there. Just curious on, I guess, a few things. One, are you -- just remind us, are you targeting any certain size of that portfolio? Or is that just a temporary kind of placeholder in the absence of loan growth? And then two, just updated thoughts on duration. Are you seeing any kind of duration at this point?

[Paul Egge, executive]

Certainly. Well, a big push early on was to get ourselves to a minimum of 15% of our balance sheet, and we'd consider even increasing that because we believe in the value of a good strong balance sheet and good liquidity profile. We have a great cash flow and securities portfolio. We -- in the next 24 months, we projected to bring in 30% of that back in cash flows. Our current adjusted duration, effective duration is about 3.5 years. And we have about $300 million in principal cash flows that we expect just in the next 12 months. So we, we definitely value the norm -- look forward to and we'll value the normalization of the yield curve and the ability to choose our spot as it relates to duration to optimize our earnings profile, notwithstanding having a higher proportion of securities on our balance sheet.

[Matt Olney, analyst]

Okay. Okay. And then I guess, on the credit side, a little higher charge-offs, but nonaccrual loans move lower. Any more color on the credits you addressed this quarter? I know there was some deterioration earlier this year with a few -- I think there are a few smaller C&I credits that you placed on nonaccrual status. Were these credits addressed in the third quarter? Just looking for any color there.

[Robert Franklin, executive]

Yes, Matt. We did have some increase in NPLs throughout the balance of the year. And what happened in the third quarter was that we had some -- some favorable things happened when we were working toward some resolution on those. And that all kind of came into focus and incurred in Q3. We had payoffs as well as significant paydowns in that group.

[Matt Olney, analyst]

Okay. And I guess anything beyond that as you look at classified list, watch list, any other notable migrations to call out in recent -- in recent months?

[Robert Franklin, executive]

Not so much. We've seen some increase in our loans that we have risk rated special mention as we've -- we've taken a really hard look at loans in the portfolio. And so we have a little bit of an increase in the special mention loans compared to previous times. But I think what you'll see is that we're working hard on a resolution of problem credits. And so we're also keeping a really clear eye toward the cash flows that support the credits. And so if we see some diminution in cash flow, we'll, we'll grade along appropriately.

[Operator]

Your next question comes from Catherine Mealor from KBW.

[Catherine Mealor, analyst]

I want just to follow up on the margin. And if you could just give us a little bit more commentary on your expectations for loan yield repricing. I know you've said previously that you've got about 20% truly floating, 40% variable, 40% fixed. And so just if you could kind of talk us through the 3 buckets and the repricing opportunity just to kind of give us a sense to where you think loan yields are going.

[Paul Egge, executive]

Well, let me kind of correct a little bit. We're about 55% fixed and about 45% variable, and that variable is what split amongst kind of pure floating and otherwise. But we do still have...

[Catherine Mealor, analyst]

Say that again, what the truly floating again?

[Paul Egge, executive]

The truly floating is, I think, about 20% of that variable number -- pardon me, 20% of the total, [ close ] to 40% to 50% of the variable number.

[Catherine Mealor, analyst]

20% of the total number?

[Paul Egge, executive]

Yes. But what you see is the fixed rate loans are about 5.59%, which still represents repricing of -- a northward repricing opportunity and the variable loans are sitting spot at 7.07%, and Ray can give a little bit of guidance on how the loans that we're originating are coming on to the books. But we feel like our spot levels have at least some room for improvement as the fixed rate loans pay down or pay off and reprice higher? And Ray, why don't you share some...

[Ramon Vitulli, executive]

Yes, Catherine. So on the $300 million of new loans that we originated, weighted average rate was 7.58% on those loans. And in the quarter, we also renewed another $750 million of loans that renewed at 8.47%. So between the $750 million and the $300 million, call it $1 billion in the quarter that receive the market rate.

[Catherine Mealor, analyst]

Okay. Great. And then mostly of that 20% floating, is that mostly tied to SOFR?

[Paul Egge, executive]

Combined with SOFR.

[Ramon Vitulli, executive]

Combined with SOFR.

[Catherine Mealor, analyst]

Okay. Okay. Great. Okay. So still significant upward repricing opportunities, it feels like. And then on the funding side, you mentioned that you still had a large amount of new deposit accounts come in this quarter. Do you have the kind of average pricing of what that looks like?

[Ramon Vitulli, executive]

Yes. That -- all in, that came on at $297 million which was about a little bit more than 40 -- 40 basis point improvement from the prior quarter of our new onboarded deposit accounts.

[Catherine Mealor, analyst]

Okay. Great. And then all in the NIM even with Fed cuts, it feels like you can keep that core NIM fairly stable just given the kind of balance between those 2 things. And maybe even up a little bit, Paul, you're saying.

[Paul Egge, executive]

We want to set expectations appropriately. We feel really good about our ability to defend NIM and that there is potential for upside. There's a lot of moving parts, but we've got great confidence in our ability to maintain really strong NIM.

[Operator]

Thank you. I'd now like to hand back over to Bob Franklin for further remarks.

[Robert Franklin, executive]

Thank you very much for attending the -- and your interest in Stellar Bancorp. With that, we'll conclude our call. Thank you.

[Operator]

Thank you for attending today's call. You may now disconnect. Have a wonderful day.