Earnings Call Transcript - STEL Q4 2024

Operator, Operator

Good morning, and welcome everyone to Stellar Bank, Q4 Earnings Release. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. I would now like to turn the call over to Courtney Theriot. Please go ahead.

Operator, Operator

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 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 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, Jr., CEO

Thank you, Courtney, and good morning to everyone. Thank you for joining us for the Stellar Bancorp fourth quarter earnings call. I want to start by expressing my gratitude to the outstanding team at Stellar Bank. Their relentless efforts have laid a solid foundation that will support our journey as we grow into the future. As we move forward, our focus will be on growth. Our robust capital base and strong balance sheet, coupled with the vibrant markets we serve, pave the way for a promising future for Stellar Bank. With the election now behind us and interest rates stabilizing, we look ahead with optimism. Although we may not see significant relief in interest rates, the business environment remains favorable. We remain vigilant about inflation but continue to witness positive trends in job growth, population increases, limited housing inventories, and an increased push for oil and gas production for both domestic use and export. These factors will serve as tailwinds as we enter 2025. Our strategy remains clear. We will expand our relationship-generated, low-cost core funding base while broadening our loan offerings. Our commercial real estate portfolio remains well within regulatory guidelines, allowing us to provide a full spectrum of loans to our customers. The capital we have built up over the past few years will support our organic growth, assist in potential partnerships, and provide the flexibility for share repurchases or increased dividends. For Stellar Bank, 2025 is the year of the customer - internal, existing, and future. We will maintain a straightforward approach, grow our existing relationships, and cultivate new ones. We are eager to embark on this journey and excited for the year ahead. I'll now turn this call over to Paul Egge, our CFO, for more details on the quarter and the year.

Paul Egge, CFO

Thanks, Bob, and good morning, everybody. We are pleased to report fourth quarter net income of $27.8 million or $0.52 per diluted share, which represents an annualized ROAA of 1.04%, and an annualized ROATCE of 10.82%. For the full year 2024, net income was $117.6 million or $2.20 per diluted share, which also represents an ROAA of 1.1% and an ROATCE of 12.18%. A key highlight of our fourth quarter performance was the continuation of net interest margin and net interest income progress after inflection earlier in the year. We look forward to seeing incremental improvement in 2025 on these fronts, while we also seek to return to a reasonable level of growth in 2025. Thinking about 2024 as a whole, we have built a strong foundation from which to build upon while growing capital at a faster clip than much of the industry, de-risking our balance sheet, and protecting our earnings power, notwithstanding the expense increases that come from crossing the $10 billion asset threshold. Before moving on, I should note that the year-end size of the balance sheet benefited from certain seasonal increases in deposits and corresponding cash due to tax receipts from government banking clients during the last days of December, totaling over $300 million in non-interest-bearing and interest-bearing checking deposits at year-end. We expect these excess balances to normalize away during the first quarter. Net interest income for the quarter was $103 million, representing a slight increase from the $101.5 million booked in the third quarter. This translated into a net interest margin of 4.25% in the fourth quarter, relative to 4.19% in the third quarter. Purchase accounting accretion in the fourth quarter was $7.6 million relative to $5.8 million in the third quarter. Excluding purchase accounting accretion, tax-equivalent net interest income increased slightly in the quarter to $95.5 million from $94.8 million in the prior quarter, and net interest margin was 3.94% on an adjusted basis, up from 3.91% in the prior quarter. Key drivers to the margin performance during the fourth quarter included strength in our non-interest-bearing deposit portfolio, which at year-end represented 39% of our deposit base, a 14 basis point improvement in our cost of funds driven by a 19 basis point improvement in our cost of interest-bearing liabilities. We also had higher securities yields and maintained strong loan yields after purchase accounting accretion. Walking further down the income statement, we booked a provision for credit losses on loans in the fourth quarter of $942,000. In combination with net charge-offs during the quarter, this brings our allowance for credit losses on loans to $81.1 million or 1.09% of loans, from $84.5 million or 1.12% of loans at the end of the third quarter. Moving on to non-interest income. We earned $5 million for the fourth quarter versus $6.3 million in the third quarter. While noting that, that third quarter number benefited from $1.3 million of lumpy SBIC income and a small gain on the sale of assets. Next, non-interest expense for the quarter was $72 million, up from the $71.1 million in non-interest expense for the third quarter. Non-interest expense for the full year 2024 was $285.7 million, down from $290.5 million in 2023, but higher than our initial $280 million guidance in annual expenses for the year. Higher professional fees and outside operating expenses, severance expenses, and salaries were among the drivers of our expense story in 2024. For 2025, we expect modest growth in line with inflation of non-interest expense to about $295 million, although we are continuously seeking to hold the line where we can on expenses. Our strong bottom line results have driven a continuation of our track record of growing our regulatory capital ratios and tangible book value per share since the merger. Total risk-based capital was 16.06% at the end of the fourth quarter, relative to 14.02% at the end of 2023 and 12.39% at the end of 2022. Since that first quarter end post-merger at the end of 2022, we have grown tangible book value per share 36.2% from $14.02 per share to $19.10 per share after dividends, representing a compound annual growth rate of 19.3% over the last two years. We continue to like our prospects for strong internal capital generation and the optionality that it creates, which we feel is very valuable in the current operating environment. During the fourth quarter, we did not repurchase any shares of our stock, but we did redeem the $40 million of bank level sub-debt in December. We will continue to evaluate share repurchases in 2025, notwithstanding our preference to find more strategic uses of capital deployment like M&A. Entering into 2025, we really like where we sit both financially and strategically. It is our goal to deliver positive operating leverage during the year, while we continue to manage through what we expect to be an improving operating environment for banks. We've laid the foundation to support adding more scale to the Stellar Bank platform, which will drive our ability to deliver more meaningful operating leverage as we create space from that $10 billion asset threshold. Meanwhile, Stellar Bank will continue to seek to exploit our home-field advantage in some of the best markets in the country. Thank you. And I will now turn the call back over to Bob.

Robert Franklin, Jr., CEO

Thank you, Paul, and we're ready for questions. Operator?

Operator, Operator

And our first question comes from Will Jones with KBW. Will, please go ahead.

Will Jones, Analyst

Yes. Hey guys. Thanks. Good morning.

Robert Franklin, Jr., CEO

Good morning, Will.

Will Jones, Analyst

So Paul, I just wanted to start on expenses. I know that full year, they came maybe a little bit ahead of where you were expecting to be, but broadly speaking, expenses containment was still a pretty strong suit for you guys this year. I did want to ask about higher professional fees this quarter, whether there's anything to kind of read into or anything kind of unique that was happening in that line this year or in this quarter?

Paul Egge, CFO

No, it's timing related to certain outside auditing engagements.

Will Jones, Analyst

Okay. And then, Bob, maybe just one for you broader picture. I read into your operating leverage comments in the press release, I know, you know, kind of relative to your size presents kind of some of its own challenges and you really need to see growth come back in earnest to see organic operating leverage. But to really kind of take the next step on profitability, do you feel like M&A needs to play a role for you guys?

Robert Franklin, Jr., CEO

I believe it really depends on speed. We can definitely reach our goals faster if we pursue mergers and acquisitions, but we want to avoid making any major mistakes. Therefore, we are very deliberate in seeking M&A partners. We can achieve our goals organically, but it will take longer. We aim to manage our expenses as we grow the bank. We haven't prioritized growth in recent years, and now it is a key focus for us. We expect to face some initial challenges, but we believe we'll gain momentum in the first couple of quarters. We anticipate positive results from organic growth, but M&A could also help us reach our objectives more quickly in terms of operating leverage.

Will Jones, Analyst

Yes, okay. That's helpful. And last one, Paul, maybe just jump into the margin real quick. I know in the past, you kind of talked about, you know, we're relatively neutral from a rate positioning standpoint. I guess just would you just reaffirm that that's still how you guys are viewing it today? And, now as we look to '25, whether we see two cuts, three cuts, five cuts? Just confirm maybe that you still see the same glide path to the margin as we kind of move through the balance of next year?

Paul Egge, CFO

We sit in a great position of strength as it relates to our margin. And that we're really pleased with where it sits on an absolute basis, and then as well when you adjust for purchase accounting accretion. As long as we're able to maintain a core funded balance sheet, which is really our goal, we see continued strength. Now, with respect to our positioning, we try to stay neutral, and we're pleased with the fact that even if rates were to stay up high, we have a continued repricing that should benefit us incrementally. That being said, we are big fans of an upward sloping yield curve. So, we kind of feel like we win no matter what. We're sitting in a great spot and we can withstand the current environment we think better than a lot of the industry.

Will Jones, Analyst

Yes, not a bad spot to be. We're looking forward to 2025. Thanks, guys.

Paul Egge, CFO

Thanks.

Robert Franklin, Jr., CEO

Thanks, Will.

Operator, Operator

And your next question comes from the line of Matt Olney with Stephens. Matt, please go ahead.

Matthew Olney, Analyst

Hey, yes, thanks. Good morning. Just want to clarify the loan growth outlook for 2025. I think back in October, we talked around a mid-single-digit growth for 2025. And as you look at the pipelines and consider some of the paydowns that you referenced on the existing book, just want to see if that mid-single-digit level is still a reasonable goal for 2025.

Robert Franklin, Jr., CEO

I think that's still a good number. I think as we see some real estate payoffs around people finally understanding that interest rates are probably going to stick around in this neighborhood for a while, we'll fight some payoffs at first, but then our goal is to get back to around that mid-single-digit. So, that's the plan.

Ramon Vitulli, President

Matt, you mentioned our momentum, and I want to highlight that fourth quarter loan originations were the highest we've seen in six quarters. We are entering 2025 with this positive momentum and expect it to continue.

Matthew Olney, Analyst

Okay, thanks for that, Ray. And then on the other side, on the deposit side, I think those deposit balances were relatively flat in 2024. Would love just to hear a bit of thoughts on expectations to grow deposit levels in 2025.

Ramon Vitulli, President

Looking ahead to 2024, while the number is important, we really appreciate the leading indicator of what we've onboarded. We had 58% of our accounts represent new customers who weren’t with us before, and we’re monitoring those accounts as they grow and mature. In terms of dollar value, our net new accounts were very strong. Overall, these leading indicators suggest a positive trajectory for 2025. We are continuing to onboard valuable clients. Additionally, on the loan side, we experienced good growth in commercial and industrial loans as a percentage of our originations, which supports our deposit proposition as we establish those treasury accounts linked to those loans.

Matthew Olney, Analyst

Thank you for that information. Finally, regarding the goal of achieving positive operating leverage by 2025, the expense guidance you provided suggests a low to mid-single-digit year-over-year growth. To achieve that positive operating leverage, should we anticipate revenue growth in a similar low to mid range or perhaps a bit higher? How do you view the positive operating leverage remark?

Paul Egge, CFO

You somewhat answered your own question. It's about 3% in growth in non-interest expense. And the revenue dynamics, we believe support that much or higher on a higher base of revenue, and that will deliver operating leverage as long as we can execute on incremental growth.

Matthew Olney, Analyst

Okay. Thanks for the commentary, guys.

Robert Franklin, Jr., CEO

Thanks, Matt.

Paul Egge, CFO

Thanks, Matt.

Operator, Operator

And your next question comes from the line of Stephen Scouten with Piper Sandler. Stephen, please go ahead.

Stephen Scouten, Analyst

Yes, thanks. Good morning, guys. Appreciate it. I guess if I could follow up one more question on operating leverage, if I look at consensus numbers, maybe assuming earnings are down on a year-over-year basis and some of that provision-related, but I'm just wondering, I guess, are you guys thinking about operating leverage, core ex-accretion or are you thinking about that on a GAAP basis? And if so, what do you think analysts' expectations are kind of missing as it relates to that trend line?

Paul Egge, CFO

We're seeking to deliver it on both bases. And I think you guys will reset your expectations based on where our year-end was, and how we've delivered throughout 2024. It does feel like either the margin outlook or the combination of growth and margin has been relatively light, and we're seeking to do better clearly than what's out there in consensus numbers.

Stephen Scouten, Analyst

Got it. That's helpful. And then for that accretion, I think it was in the $47 million range in 2023, $33 million, give or take, this year. Would you expect that to kind of decline at a similar pace, apart from obviously some unexpected paydowns and such? Is that the right way to think about it?

Paul Egge, CFO

That's the right way to think about it. I mean, we've benefited from a decent amount of windfall earnings over the last two years in addition to what's scheduled accretion. We have currently remaining a loan discount of $73.7 million left, and we see it diminishing and flattening out in the next year or so.

Stephen Scouten, Analyst

Okay. Great. And then the deposit growth this quarter was pretty fantastic, especially some really strong non-interest bearing deposit growth, and you paid down borrowing. So, you guys have a ton of on-balance sheet liquidity at this point. What do you start to do now that you've kind of tackled the borrowings? Like, how do you think about the investments of that liquidity as you move forward, assuming the strength of your deposit base continues to shine through?

Paul Egge, CFO

We need to recognize that part of the growth and year-end balance sheet will be temporary, linked to the seasonal nature of our operating accounts in the government sector. When factoring that out, our quarter-over-quarter performance in deposits appears more stable. This is why there is a particularly high level of cash on our balance sheet, as we don't anticipate this funding remaining for more than a month or so. Some of that excess liquidity might seem misleading, but we have actively sought to maintain a significant amount of securities and cash, which we find beneficial, as long as it doesn’t hinder our ability to achieve solid earnings.

Stephen Scouten, Analyst

Okay, very helpful. The last thing I want to ask is, you mentioned in the release the potential interest in partnerships and pursuing some mergers and acquisitions. How do you view the value of your stock, around $150 a share, in terms of your ability to engage in M&A, or does the current share price present a challenge?

Robert Franklin, Jr., CEO

Well, I think at this point, it's basically neutral, if you really look at it. It's not necessarily a benefit, but it's not necessarily a detriment either. We'd like to see it higher, I think, you know, as we continue through the year and people get used to what we're doing. Hopefully, that'll improve. So, we're going to seek to try to do that, but however, I think there's partners out there for us that understand our story and find us an attractive alternative to maybe what they're facing.

Stephen Scouten, Analyst

Got it. Very helpful. Thanks for all the time, and congrats on closing out the year very strongly. Appreciate it.

Robert Franklin, Jr., CEO

Thank you, Steve.

Operator, Operator

And your next question comes from the line of John Rodis with Janney. John, please go ahead.

John Rodis, Analyst

Good morning, guys.

Robert Franklin, Jr., CEO

Good morning.

John Rodis, Analyst

Paul, maybe a question for you on the securities portfolio, given, you know, your conversation just about deposit flows and outflows and then liquidity. How do you see securities portfolio trending in 2025?

Paul Egge, CFO

We like to keep our securities portfolio around 15% to 16% of our balance sheet, and we value the opportunity to consider increasing that, but we're really mindful of trying to drive the right overall return profile, and that I think is what drives that level currently.

John Rodis, Analyst

Okay. Thank you, Paul. Helpful. And then just one other question on provisioning, and I guess the reserve level and so forth, and I know CECL plays a big part, but can you just talk about how we should view the provision for 2025?

Paul Egge, CFO

Yes. Credit has been great in 2024, and as we look at 2025, it is, you know, covering the waterfall of growth in loans, relative to charge-offs, and from a planning perspective, we assume a little bit more normalization in credit, but naturally the last year in particular, we've benefited a ton from a strong credit. And then there has been a measure of drivers in our reserve, and it's partially a function of CECL, that has been very asset-specific, loans that are individually evaluated. You know, we're very conservative when something falls into that bucket, and to the extent that a situation works itself out, it ends up creating a release situation. So there were a lot of idiosyncrasies there that drove our experience in 2024. We seek to continue to have strong credit in 2025, but we have normalized expectations, and we'll continue to manage as best we can.

John Rodis, Analyst

Paul, what do you think, you know, talking about normal, what do you think is sort of a normalized net charge-off rate for your company?

Paul Egge, CFO

Well, fortunately, we don't have a history of having high net charge-off rates, either Stellar or predecessor companies, but we do think it's prudent to have normalized expectations since this great run of credit in the nation is pretty long in the tooth. So we think where you guys are at in consensus around the mid-teens is the right expectation to have, and we'll continue to seek to continue our track record of driving better results than expectations tend to dictate.

John Rodis, Analyst

Paul, just to clarify, is that mid-teens on net charge-offs, or is that mid-teens on provision expense?

Paul Egge, CFO

Mid-teens on net charge-offs, maybe 16 or so. Okay.

John Rodis, Analyst

Okay. Okay, thank you guys. Have a nice day.

Operator, Operator

And your next question comes from the line of David Feaster with Raymond James. Please go ahead, David.

David Feaster, Analyst

Hey, good morning, everybody.

Robert Franklin, Jr., CEO

Hey, David.

David Feaster, Analyst

I wanted to start by discussing the current state of the economy and what you are hearing from clients. Houston appears to be one of the overlooked markets in Texas, which is performing exceptionally well overall. I would appreciate your insights on what you are observing across your area and what feedback you are receiving from the market.

Robert Franklin, Jr., CEO

Well, thanks, David, for the question, because I do agree with you. I think Houston's underappreciated. The economics here in Houston are really good. And I think if you think about it in terms of what the effect of interest rates were over the last couple of years, people needed to digest that. But I think the economy has allowed people to digest that in a pretty good way. So, we haven't seen tremendous damage across the industry, other than, you know, certain aspects of it, office buildings to be one, which is something we don't play a lot in, but it's been has had its own damage. But for the most part, the resiliency of the economy here has allowed us to come through this crazy interest rate environment we've been going through the last couple of years in a pretty good way. So, we feel good about where we are. As we look forward, we feel like we've got the wind behind us in a number of ways. With the administration that's changed, the regulatory environment we think is going to change a bit, and the economy still rolling on, I do worry a bit about inflation. But for the most part, I think there's clear sailing for us, and we haven't seen that in a while. And so, with interest rates stabilized, I think people are able to make better decisions when they think they have a clear understanding of what that borrowing cost is going to be and the cost of capital.

Ramon Vitulli, President

David, we're waiting on year-end numbers, but we were trending towards population growth still in excess of 100,000, job growth still in excess of 60,000. And as Bob mentioned around rate stabilization, we're definitely seeing that with deal flow as far as what we're seeing in committee around, you know, just more opportunity there and more activity, I think, as Bob mentioned, because of the kind of stabilization in the rate environment. And we're winning business, which is great.

David Feaster, Analyst

That's great. Markets definitely matter, and you got a good one. With a really healthy economy, that’s where folks want to go. We've seen a lot of increase in focus on Texas. I was hoping you could touch on competition for loans and deposits. It's always competitive; it's a tough market and an extremely attractive market. I'm curious about what you are seeing from the competitive landscape regarding pricing, structure, and both loans and deposits.

Robert Franklin, Jr., CEO

Houston's tax environment is well recognized globally, and we have numerous banks and financial institutions on our doorstep. Competition is something we're accustomed to. Our offering to customers is very localized, and we've seen a positive response in the Houston market. JP Morgan still holds 50% of the market, which is remarkable, given that they acquired it back in the 80s and have maintained their position. Our objective is to reclaim some of that market share. We have now reached a scale that allows us to offer a wide range of loans. While we're not directly competing with JP Morgan, the top four banks in our market are large institutions that have captured business over the years. We believe we can gradually make progress against them. We will continue to enhance our brand, which is crucial for people to recognize our presence and understand the alternatives available to them compared to what they've previously experienced.

Ramon Vitulli, President

And David, we've got, I mean, back to the momentum, we've got momentum there. I mean, over 50% of our new accounts, number of new accounts were to customers that had not been here before. So, we really love that trend.

David Feaster, Analyst

That's great. What about hiring? There are many new players entering your market and larger banks gaining share. What do you see in terms of hiring? I know you have a strong training program, but are there opportunities to bring in new talent? I'm curious about your perspective because recruiting lenders has always been a focus for the bank.

Robert Franklin, Jr., CEO

Yes. I mean, hiring is always competitive. I mean, a good lender around here with experience, it's going to be a competitive environment, especially as more people have a focus on C&I and we're seeing that out there. But our ODP program has been really fantastic and been able to provide us with some young people that we can train from the ground up and let them hit the road with some direction from some of our experienced team members here. And they've been very effective in gaining inroads into some really nice pieces of business. So, as we build out our full spectrum from small business to C&I sort of middle, lower middle market to even some corporate business, we're making inroads on all of those levels. And I think we'll continue to do that. And we're 24/7 looking for people that can help us build and grow this bank. So, that's always top of mind and we'll continue to do that in the future.

David Feaster, Analyst

That's great. Thanks, everybody.

Robert Franklin, Jr., CEO

Thank you.

Operator, Operator

There is no further question at this time. I will now turn the call back over to Bob Franklin for closing remarks. Bob?

Robert Franklin, Jr., CEO

Thank you, operator, and we appreciate everyone's interest in Stellar Bank, and we'll conclude this call. Thank you.

Operator, Operator

This concludes the meeting. Thank you all for joining. You may now disconnect.