Good morning. My name is Crista, and I'll be your conference operator today. I would like to welcome everyone to the Stellar Bancorp Fourth Quarter Earnings Conference Call. All lines have been muted to avoid background noise. After the presentations, there will be a question-and-answer session. I now turn the conference over to your speaker today, Courtney Theriot, Chief Accounting Officer. Courtney, you may begin.

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 fourth 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.stellar.bank 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 fourth quarter earnings call. As we conclude 2023, I will begin by thanking the outstanding team at Stellar Bank. Their hard work and dedication allowed us to bring two banks together while dealing with the external pressures of current economic circumstances. Every day, we make strides in developing the Stellar way. Our team is working hard to ingrain our values across our organization, and our culture becomes more clear each day. We are pleased with our results for 2023, given all of the industry stresses while we focused on capital, liquidity and credit. Our discipline around these tenants allowed us to build capital to stabilize our valuable deposit franchise, maintain strong net interest margin while maintaining good credit metrics and finished the year with a nice return on shareholders' equity for our shareholders. Our mantra for 2024 is optimized. The heavy lifting is behind us. We must seek to optimize process, expense, people and future. We will keep our focus on capital, liquidity and credit as we expect a less robust economy in '24 as the Federal Reserve continues to tame inflation. However, we operate in some of the best markets in the country, and we are well positioned to take advantage of the opportunities we expect to be presented to us over the year. We believe that these efforts and market dynamics will provide for a rewarding value creation for our shareholders. I will now turn the call over to Paul Egge, our CFO, for more details on the quarter and the year.

Thanks, Bob, and good morning, everybody. After a year marked by industry disruption, we are very pleased to close out a strong and transformational 2023 for Stellar Bancorp. Our net income for the year was up $130.5 million, representing diluted earnings per share of $2.45, an ROAA of 1.21% and return on tangible common equity of 15.75%. As Bob noted, our focus entering into 2023 was on capital, liquidity and credit. And we feel we have performed well on all of these fronts, all while protecting earnings power, notwithstanding significant industry turbulence and competitive pressure during the year. On capital, in particular, we were very successful growing our regulatory capital ratios in 2023. We increased our total risk-based capital ratio to 14.02% at year-end from a starting point of 12.39% at year-end 2022 and showed similar improvement across all of our regulatory capital ratios. Driving this capital build was our growth in tangible book value, which grew 21.4% over the year to $17.02 per share at the end of 2023 from $14.02 per share at the end of 2022. During the year, we also maintained a very strong funding profile marked by 40% non-interest-bearing deposits, along with a disciplined strategy with respect to our interest-bearing funding. As a result, we've been able to manage pretty well through a competitive high interest rate environment to maintain healthy margins and core earnings balance. All the while, we've been able to maintain a strong credit profile. Turning our focus to the fourth quarter. We earned $27.3 million or $0.51 per diluted share, making for an ROAA of 1.02% and a return on tangible common equity of 12.61%. This was despite a higher expense flow during the quarter due primarily to nonrecurring items that I'll detail shortly. Fourth quarter earnings were incrementally lower than the $30.9 million or $0.58 per diluted share earned in the third quarter due mostly to higher non-interest expenses more than offsetting higher non-interest income and lower provision. Notable among non-interest items during the quarter was nearly $2.4 million in other non-interest income from FDIC investments. And on the expense side, we recognized a $2.4 million expense relating to the FDIC special assessment, $1.9 million of severance expense and elevated professional fees during the quarter, relating mostly to initiatives associated with crossing the $10 billion asset thresholds. During the fourth quarter, we saw our net interest margin tick up a few basis points from the third quarter. Net interest margin was 4.40% during the fourth quarter, up from 4.37% in the third quarter. And excluding purchase accounting accretion, NIM was 3.91% in the fourth quarter relative to 3.87% in the prior quarter. We have been very pleased with the relative stability in our net interest margin during the back half of 2023, as the continued repricing of our assets has kept pace to offset an upward trend in funding growth, which has showed some signs of leveling off in the fourth quarter. We feel pretty good about stabilization in our margin trends and outlook, which continues to compare favorably relative to the industry, and we also feel good about our ability to protect our relatively strong profitability profile in this challenging environment. With respect to purchase accounting items, we ended the year with $106.8 million in loan discount remaining and a core deposit intangible asset of $116.7 million. Strong earnings, notwithstanding accelerated amortization of CDI expense, has been a really strong driver to our internal capital generation in 2023, and we like our prospects for continued internal capital generation in 2024 as well. In summary, we believe Stellar is well positioned to perform in 2024. Our capital, funding and liquidity position puts us in a good spot to maintain favorable margins and earnings power. On credit, we feel appropriately reserved given current economic unknown, and we otherwise take comfort in our credit underwriting discipline and perhaps most importantly, the fact that we operate in some of the strongest markets in Texas and the country. Thank you. And I will now turn the call back over to Bob.

Thank you, Paul. And operator, we'll be happy to take questions.

Your first question comes from David Feaster from Raymond James. Please go ahead. Your line is open.

Hi. Good morning, everybody.

Good morning, Dave.

Maybe just starting on the rate sensitivity side. You've obviously got a great core deposit franchise. We've seen core margin expansion throughout this rising rate cycle. But today, you actually screen closer to rate neutral, maybe modestly liability sensitive. Just given the increased prospects of rate cuts, I'm curious how you think about the impacts of potential cuts on the margin and how quickly you'd expect to be able to reprice deposits lower if we do get cuts this year.

We are comfortable with our neutral interest rate risk profile. Our focus for 2024 is to be ready for anything, which applies to our interest rate sensitivity as well. We maintain a neutral stance, and if rates decrease, we do have some sensitivity at the front end of the curve, especially with money markets and very short-term CDs. Therefore, we believe our ability to adjust pricing in that area is quite strong. However, we are not attempting to speculate on rates with our interest rate position, and we feel well-prepared for any rate outcome in 2024.

Okay. That's helpful. Regarding the loan declines, how do you view your ability to adjust deposit rates and how sensitive those clients are? We were quite slow to raise deposit rates. Do you think we'll be able to manage the repricing of those deposits, especially considering the liquidity challenges in the market? I'm interested in your thoughts on repricing in relation to the competitive landscape.

I believe the best opportunities for repricing will be in your exception universe, along with the wholesale funding that remains relatively short, which you can reprice.

I would just add that our largest opportunity is in the money market where we took a very measured approach to our sheet rates. We weren't very aggressive on the increase, so we would likely handle any reductions in a similar manner. As we manage the exception pricing, that will be our first target. The time deposits we issued during this period were short term, and we benefit from a 40% plus NIB. As Paul mentioned, it will be in that money market segment.

David, I'd like to add that regarding our approach to deposits, when the market shifted and others aggressively sought to fund their balance sheets, we decided not to enter that competition. The prices were higher than we were willing to pay, so we aimed to return to a strategy that made sense for us while still protecting our strong deposit franchise. Now that deposit rates are stabilizing, we can compete effectively in the deposit market. We believe we can adjust our pricing accordingly to remain competitive. We just want rates to stabilize or provide some assurance that we won't be paying excessively for deposits.

Okay. That's helpful. And maybe just touching on the loan side and the declines in the quarter. I'm just curious, how much of that is strategic and tightening and pushing higher pricing to kind of slow growth versus weaker market demand and just uncertainty in the economy from the client perspective? And just your appetite for growth today, where you're seeing opportunities and kind of where pricing is holding up.

It's a mix of our underwriting strategy and some demand pressure as our customers adjust to the current rate environment. We've seen a consistent decline in our construction and development originations over several quarters, which has been intentional, while our commercial and industrial loans have remained stable. As a result, the percentage of C&I loans has increased slightly. In the fourth quarter, total originations dipped a bit compared to the third quarter, but we feel positive about the rates at which these originated, with new loans still showing an 8% rate and an additional $600 million renewed at a similar rate. Overall, we're satisfied with this performance.

Okay. Terrific. That's great. Last one for me. Maybe just touching on the expense side. Core expenses ticked up a bit. A lot of moving parts in the quarter. I'm just curious, how do you think about a good core expense level? And then just the run rate through this year, I mean how do you think about managing expenses just in light of some of the revenue challenges that we've talked about? Curious how you think about that.

We expect core expenses for 2024 to be around $280 million. There are several factors we will focus on optimizing, as Bob mentioned, to see if we can improve that figure. However, to achieve our goals and support the initiatives we plan to pursue in 2024, we believe this is the appropriate spending level. The first quarter typically has some seasonality, which means expenses will likely be somewhat higher than if we simply divided that amount by four. But this is our target.

Terrific. Thank you, everybody.

Thanks, Dave.

Your next question comes from the line of Matthew Olney from Stephens. Please go ahead. Your line is open.

Hey. Great. Thanks. Good morning, everybody.

Good morning, Matt.

I'll start on the professional fees. I think Paul mentioned professional fees were elevated due to some initiatives of crossing $10 billion of assets. Any more color on these initiatives? And then how do you see that line item trending in 2024?

It was more of a timing dynamic. If you saw the third quarter, it was relatively with a dip from the second quarter. And a lot of work has been done here in the fourth quarter to kind of achieve the goals we wanted to achieve by the end of the year as it relates to all things in the new standards of being over $10 billion in assets. When we look forward, we think about a run rate of professional fees that would be certainly lower than the fourth quarter. I'd probably say more like $2.5 million, but that has some timing variation on a quarterly basis, similar to what we saw in our trend when you look at that line from the second quarter to the third quarter and the fourth quarter.

Okay. And I assume that's all embedded in that '24 guidance you mentioned, Paul, of the $280 million.

Exactly.

Okay. That's helpful. And then, I guess, switching over to the loan yields. If I take out the accretion levels, I'm getting a pretty nice uptick in the core loan yields. Any color on the drivers there? And then just remind us on the fixed rate loan repricing dynamics of the bank. Remind us what you expect to reprice higher during the year. And I heard Ray mention some of these newer yields are still at the 8% level. Just remind us on kind of on the reprice dynamic, what they're coming from in some cases. Thanks.

Matt, regarding the renewed loans, we have an annual rate of approximately $600 million per quarter. For the fourth quarter, these were renewed at $8.51 million, up from $7.79 million. Moving forward, we expect them to be closer to the higher end of the range, likely starting from the 7s and renewing to the 8s. Additionally, there was $250 million in new loans issued at an 8% rate. I hope this provides clarity on your expectations for fixed rate repricing. Keep in mind that the $600 million includes both fixed and floating rates, but I don't have the exact breakdown of the fixed rate portion available at the moment.

Yeah. That's helpful. I guess you mentioned the floating portion. And I think in our models, we're all assuming various things behind what the Fed does this year. Remind us of what's floating at the bank and the Fed were to cut at some point this year, just a dollar amount of loans that would reprice downward pretty quickly from the yield side.

Yes. Over 40% is variable, but truly floating. You would be looking at a little over 20%. That's what will change more quickly in relation to Fed SOFR in particular.

Yes, direct one.

Yes.

Okay. Perfect. And then on the deposit side, you hit on some levers you can pull there if rates were to move lower. What about on the non-interest-bearing side? A little bit of give up in the fourth quarter, but still one of the highest levels amongst the peers. Any more color or thoughts on where you see the balances kind of stabilizing and what timeline?

We ask you to consider the average for the quarter. At the end of the year, it appeared we dropped from about 42% or 41.5% to approximately 40% on the non-interest-bearing ratio. However, if you look at it more on an average basis, we currently have around 41% of non-interest-bearing deposits, and we are very pleased with how well that has held up. A significant factor on December 31 was the substantial growth in interest-bearing demand deposits, which somewhat overshadowed the non-interest-bearing figures. In fact, the non-interest-bearing deposits saw a slight decrease point-to-point. Overall, we are very satisfied with the strength of our non-interest-bearing customer portfolio and are eager to maintain a robust proportion of these deposits moving forward.

Okay, guys. I appreciate all the commentary, and congrats on the quarter.

Thanks, Matt.

Thanks, Matt.

Your next question comes from the line of John Rodis from Janney Montgomery Scott. Please go ahead. Your line is open.

Hey. Good morning, guys.

Good morning, John.

Good morning.

Switching gears to fee income, what was the SBIC impact in the quarter?

$2.4 million. We recognized $2.4 million of revenue on that SBIC gain.

And how should we think about that going forward?

Yeah. Since we can't set our watch to how we recognize gains there, we are very conservative as it relates to how we think about that source of revenue. So I would look at our non-interest expense base ex $2.4 million and think about that as our pace in 2024.

Okay. And then...

But we are always working on initiatives to build that. And Ray can speak to that.

Paul, just one other question on fee income. The card fees were down, I don't know, about $400,000 from the third quarter. Anything going on there? How should we think about that number going forward?

Interchange, fees.

That's the impact we're experiencing from Durbin. We are making concerted efforts as a team to increase our card penetration to help offset that. Additionally, we've had a strong performance in our new account onboarding, and I'm optimistic that we can grow despite the decrease we've seen due to Durbin.

Okay. But the hit was started in the third quarter, so it was down and then it was down even some more in the fourth quarter. So okay.

Yeah.

But nothing unusual or outside of Durbin in that line item?

No. We have observed that the impact of Durbin was a little bit higher than we initially estimated.

Okay. And then just one other question, I know this is a bit challenging. Regarding provisioning, how should we consider the provision level moving forward?

Well, I mean it's formula-driven, guys. So we're based on what happens with our loan portfolio, good or bad. And what the increases in that portfolio are will drive loan provision. It's hard to project that almost as hard as interest rates.

Are...

We do expect credit and we have a conservative stance on it, especially given the economic uncertainties. Therefore, our planning is based on a more typical level of charge-offs in the industry for 2024, which will obviously impact our results.

Paul, when you say normal, what do you think is more normal?

I would say normal to elevated. I mean for us, both legacy companies have been able to maintain, for the most part, single-digit net charge-off numbers. But when you think about industry and what's a prudent expectation to set when there is an expectation of a credit cycle finally hitting the industry, you have to assume something in the high teens, low 20s in net charge-offs just to provide a little bit of a baseline. And we feel really good about our ability on a relative basis because of where we operate to do better than whatever the industry nationwide metrics end up being.

Okay. Thanks for the thoughts and Paul, just one other question. The tax rate is around 20%, still a good number?

Yes.

Thank you, guys.

Thanks, John.

Thanks, John.

Your next question comes from the line of Matthew Olney from Stephens. Please go ahead. Your line is open.

Yeah, guys. Thanks for the follow-up. Just want to go back to the core margin. We saw the stabilization in the fourth quarter, I think, if you take out the accretion levels. I think a quarter ago, you were a little hesitant to call for the bottom. But assuming the Fed holds off on any moves for a few quarters, any color on kind of what's the confidence level that the core NIM has, in fact, bottomed here in the fourth quarter?

No. It's a real uncertain backdrop. You're going to have a hard time teasing out a bottom out of us. But we feel really good about how positioned we are to defend our margin and defend our net interest income. And we'll let the results speak for themselves.

Okay. And then on the capital front, I think, Paul, maybe it was your prepared remarks on the call. Lots of good capital build, not just in the fourth quarter but also throughout the year. Any updated thoughts around deployment this year? Could this be a year of you leaning the stock buybacks? Or do you think the environment for something more significant is something you want to focus on and maybe buybacks take a backseat this year?

We've dedicated significant effort to restore our capital levels to a point where everyone feels more secure, providing us with various options moving forward. Our goal is to have as many choices as possible, as capital enables that flexibility. I'm curious to see how the year unfolds. While there's a lot of anticipation regarding decreasing rates, I'm uncertain whether that will happen. The economy appears to be performing reasonably well, although we may experience some slowdown at some stage this year. Until we gain more clarity regarding interest rates and economic conditions, we will maintain our current approach. Ultimately, this strategy aims to ensure we have options available to us. If opportunities arise, whether for buybacks or acquisitions, we wish to explore all of those avenues and select the most suitable one for our shareholders.

Okay, thanks for that, Bob. And let me ask it this way. The capital level is built really nicely in '23. It looks like they're going to build considerably in '24, absent any kind of other actions. Would that be acceptable, you think, for capital level to continue to build? Or at what point do you feel more urgency to deploy capital? I'm trying to figure out if this is something where we're getting close to that or give the uncertainty we could let capital levels build here for a while before we feel any urgency to deploy it.

That's a great question, Matt. I appreciate the challenge. If we consider the economic outlook and the possibility of multiple interest rate cuts this year, it suggests that unemployment may rise, the economy could slow down, and credit might shift in unexpected ways. There's a lot of uncertainty in that scenario. If interest rates remain stable, even with a few minor reductions, we could gain more clarity as we progress into the second and third quarters. We are not opposed to buybacks; in fact, we support them. However, it's important for us to maintain a strong capital base that assures stakeholders of our capabilities. We want to keep our options flexible and are committed to making the best decisions for our shareholders with the available capital.

Okay, guys. Appreciate all the commentary, and see you guys in a few weeks.

Thanks.

Thanks, Matt.

We have no further questions in our queue at this time. I will now turn the call over to Bob Franklin, Chief Executive Officer, for closing remarks.

Thank you, everyone, for their interest today. We look forward to 2024 and continuing to build Stellar Bank in a great way. Thank you very much.

This concludes today's conference call. Thank you for your participation, and you may now disconnect.