Earnings Call Transcript - STEL Q3 2025

Operator, Operator

Good morning. My name is Audra, and I will be your conference operator. At this time, I would like to welcome everyone to the Stellar Bank Third Quarter Earnings Call. Today's conference is being recorded. After the speakers' remarks, there will be a question-and-answer session. At this time, I would like to turn the conference over to Courtney Theriot, Chief Accounting Officer. Please go ahead.

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 2025. This morning, the 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 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'll open the line and allow time for questions. I will now turn the call over to our CEO, Bob Franklin.

Robert Franklin, CEO

Thank you, Courtney. Good morning and welcome to the Stellar Bancorp's Third Quarter Earnings Call. I'm pleased to report that we delivered solid results, including increasing our net interest income and our net interest margin. Our balance sheet expansion was driven primarily by deposit growth, reflecting our bankers' emphasis on getting the full client relationship. Credit quality has found its way back into the headlines. While we experienced some charge-offs in the quarter, they were spread over several small credits, most of which were already identified and appropriately reserved. We feel comfortable at our present level of reserve based on our portfolio and the markets that we serve. We have little exposure to non-originated credits and only have three shared national credits, all with longstanding and additional business ties to the bank. Overall, credit trends remain favorable and our market's stability is reassuring. Paul will provide more detail on our expenses during the quarter, including some one-time expenses and increased advertising spend. As we continue to strengthen our capital position, we have repurchased shares and paid down $30 million of our subordinated debt just after the quarter end. Our well-capitalized position gives us valuable flexibility, and we remain committed to deploying capital in ways to enhance our shareholder value. We are focused on growing our company. We believe that if we continue to be disciplined in building quality assets, protecting margins, and focusing on full balance relationships, we will drive long-term value for our shareholders. Now, I'll turn the call over to Paul Egge, our CFO, for more content.

Paul Egge, CFO

Thanks, Bob. Good morning, everybody. We are pleased to report third quarter 2025 net income of $25.7 million, or $0.50 per diluted share, as compared to net income of $26.4 million, or $0.51 per share, in the second quarter. These represent an annualized ROAA of 0.97% and an annualized ROATCE of 11.45%. Key highlights of our third quarter performance were improvements in our net interest income and margin on incrementally larger interest-earning assets. Our balance sheet growth was driven by strong deposit growth, and we feel great about our liquidity, capital, and overall balance sheet positioning. During the third quarter, net interest income was $100.6 million, representing an increase from the $98.3 million booked in the second quarter, largely due to higher earning assets and net interest margin for the quarter. This translated into a net interest margin of 4.2% relative to 4.18% posted in the second quarter. Purchase accounting accretion in the third quarter was $4.8 million, down from $5.3 million in the second quarter. If you were to exclude purchase accounting accretion, tax-equivalent net interest income increased slightly more to $95.9 million from $93.1 million in the prior quarter, and that change in net interest margin, excluding purchase accounting accretion, was also greater, going from 3.95% in the prior quarter to 4% in the third quarter. We're really proud to get NIM excluding purchase accounting accretion back to a 4% level, and we continue to feel good about our ability to defend and perhaps incrementally improve our top-tier margin profile by focusing on staying true to our core relationship banking model. Walking further down the income statement, we booked a provision for loan losses of $305,000 in the third quarter, which was driven primarily by an increase in our allowance for unfunded commitments and growth in that category. While we did experience $3.3 million in net charge-offs in the third quarter relating to over 10 relationships, most of these were previously identified and already specifically reserved for, therefore, not impacting our quarterly provision. For a year-to-date perspective, our net charge-offs totaled $3.7 million or approximately 7 basis points annualized. Our allowance for credit losses on loans ended the quarter at $78.9 million, or 1.1% of loans, which is down slightly from $83.2 million, or 1.14% of loans at the end of the second quarter. Moving on to non-interest income, we earned $5 million in the third quarter versus $5.8 million in the second quarter of 2025. This third quarter decrease was mostly due to approximately $445,000 of write-downs on foreclosed assets and lower non-interest income during the quarter. On to non-interest expense, our expense increased to $73.1 million from $70 million in the second quarter, primarily driven by an increase in salaries and benefits and to a lesser extent, increases in professional fees and advertising. Salary benefits expense included severance expenses related to two upcoming branch closures in the fourth quarter, totaling about $0.5 million, as well as elevated medical insurance expenses relative to prior quarters. We view our third quarter expenses as an outlier and expect fourth quarter expenses to be closer to our run rate for the first half of the year. All of this drove solid bottom-line results of $25.7 million in net income, which continues to fuel our track record of internal capital generation and our very strong capital position. Total risk-based capital was 16.33% at the end of the third quarter, relative to 15.98% at the end of the second quarter. Year-over-year tangible book value per share increased 9.3% from $19.28 to $21.08 per share, which is after the effect of dividends and meaningful share repurchases. I should note that our share repurchases in the third quarter were lighter than prior quarters, totaling just under $5 million, relative to a total of approximately $64 million in share repurchases year-to-date. In closing, we really like where we sit, both financially and strategically. Even more so, since recent M&A disruption in Texas accentuates our key differentiation among the only truly focused franchises with scale in a competitive landscape comprised of increasingly larger out-of-state competitors. We've built a strong balance sheet that can support quality growth, and with growth, we're positioned to deliver positive operating leverage through adding scale to the Stellar Bank platform while maintaining the financial flexibility to be opportunistic. Thank you, and I will now pass the call back over to Bob.

Robert Franklin, CEO

Thank you, Paul. And operator, we're ready for questions.

Operator, Operator

We'll take our first question from David Feaster at Raymond James.

David Feaster, Analyst

I just wanted to start on the growth side. I know somewhat of the decline is strategic, and we've talked about that given your focus on a balanced approach. But I just wanted to get a sense on, first off, what's driving the payoffs and paydowns? How much of that is competition versus just asset sales and those kinds of things? And then just how do you think about the growth outlook as we look forward? I mean, Texas is a very competitive market on one hand, so maybe that could be a headwind. But at the same time, you talked about the disruption and that creates a ton of opportunities, just given the strength of your franchise and your relationships. Just wanted to kind of take that all together, like how do you think about growth? And just any insights you can provide on that?

Ramon Vitulli, President and CEO of the Bank

Sure, David. I'll start maybe a little bit with what's impacting the growth when we talk about the payoffs, like you asked, the color around that. So payoffs this last quarter were about $50 million more than the previous quarter. So we talked about a run rate of around $300 million of payoffs. They were $330 million in last quarter. Year-to-date, about 44% of our payoffs are related to sale of collateral, sale of business. About 25% is kind of in that competitive area of refinancing elsewhere. Those are the things that we take a look at around us remaining disciplined around full relationships. So some of that will go away. But on that refinancing elsewhere, we put our best foot forward to try to keep some of that, but that's some of what we're faced with. On the other component of that waterfall is what we call our carry, which is our advances versus our paydowns and scheduled payments. As Paul mentioned, we had a reserve related to unfunded that continues to grow, but we're still not seeing the lift from that. Compared to the previous quarter, that was almost another $50 million of increase in the payments and paydowns exceeding the advances. That's an area where we think we will get a lift as we continue to originate loans. We're really pleased with the originations last third quarter; we originated almost $500 million of loans compared to $640 million the previous quarter. But the real thing that I think we want to make sure we communicate is just overall year-to-date or compared to last year, first three quarters, we're up 62% in loan originations and the mix that we like with a little bit more C&I in that mix. So things are headed in the right direction. We just have to continue to convert on our pipeline, which remains healthy, and we're really pleased with where we stand there.

David Feaster, Analyst

That's great. Maybe touching on the credit side a little bit. Concerns have heightened in the industry right now. I guess first, I was hoping you could maybe touch on what are you seeing on the credit front? Is there anything that you're seeing broadly that's causing you any concern? And then secondarily, I was hoping you could maybe touch a bit on your approach to credit. Collateral management, stress testing, and ongoing monitoring. It seems like some of those are what maybe the investors are concerned about in the industry. So just was hoping you could elaborate a little bit on your process and your approach to managing credit.

Paul Egge, CFO

Yes. I think the best way to manage credit is when they come in through the front door, David. That's how we manage that most of the time. However, we do stress testing. We do all the things that folks do to monitor portfolios. And we're moving our portfolio from those two smaller community banks into a larger community bank. It has a different look. I think you see that on our balance sheet as we've gone from where we used to run our banks at say 90% to 100% loan to deposits; we're now down about in the low 80s, and we feel comfortable there. We're able to make money there. We're changing the mix of debt to try to have a little more emphasis on stickier C&I credits. We're very careful about how we approach C&I and how that's getting monitored and what we do to make sure that we have solid results around C&I. But we also continue to do real estate loans, and those things have been good to us over the years. We're in a market that continues to grow, and so real estate continues to be a good active place for us to put money. I think we would be more concerned if we were in a less dynamic market, but we're in a very dynamic market. All the things that are affecting the world, tariffs, and various things happening today, I think are being absorbed pretty well in Houston and Dallas and the markets we're in. We feel supported by our markets, and I think it's about decision-making with them. That's kind of how we approach it.

David Feaster, Analyst

Okay, that's helpful. And then just wanted to maybe switch gears to the deposit side. I mean, your growth was really strong this quarter, cost decline. Just wanted to get a sense of some of the drivers behind that—how much of that is new clients versus increasing liquidity or relationships with existing clients? And then, again, with the liquidity build, I mean, even after paying down borrowings and buying a little bit of security, just kind of curious what your plans are for some of that excess liquidity going forward?

Ramon Vitulli, President and CEO of the Bank

David, I'll touch on the deposit growth piece. We are really pleased there, as we've already mentioned. Of our new deposits that were onboarded in the quarter, 51% were to new customers that have not been here before. We've seen that kind of hover in that 40% to 50% all year, which we really like, and we think that's reflective of continued brand awareness of Stellar. Our bankers are really having good success with market share gains. We've had improvement in our Net Promoter Score, really getting into a best-in-class area there, and customer satisfaction is all heading in the right direction. I think that just points to the fact that we continue to bring new customers to the bank, as well as the expansion of our existing customer base, which represents that other 50%. The growth is really around those new accounts and the deposits associated with them, which are well exceeding in dollar amount the closed accounts. Our carry was nice and gave us a little lift.

Robert Franklin, CEO

Yes, David, we just feel very strongly that low-cost deposits are something that everyone is going to be fighting over, and it's something we put a big emphasis on in any relationship that we have. So we're going to continue to do that. I think we've seen some success as we did this quarter, and hopefully, we'll continue to see that as we keep the push on that going forward. We are building some liquidity, and I think deploying that in both loans and securities is something that we intend to do in the future. But we want to grow the loan portfolio. That's where we grow customers and how we continue to grow the bank. It's essential to us to keep on that block. A lot of turmoil in our markets, a lot of M&A going on, giving us opportunities for customers to join our company, which is great, but it's had some negatives to it, and you have new players that want to buy the market, and you're seeing some interesting things around not only pricing but covenant packages and credit light. We're not going to join that party. That doesn't fit us, and if we have to retreat a little bit, we'll do it. But we've been operating in a competitive market for a long time. We feel like we know how to do that. We'll get our share, and if we continue to do the right things from a customer acquisition standpoint, we will grow the bank. That's kind of how we're approaching it.

Operator, Operator

We'll move next to Stephen Scouten at Piper Sandler.

Stephen Scouten, Analyst

Just following up on the deposits quickly. You've tended to have some seasonal strength in the fourth quarter. Is that something you would expect here this coming quarter as well?

Paul Egge, CFO

We talk about that all the time because we do have seasonal strength from some of our government banking deposits. In fact, last year, we had about $200 million deposits that came in on the last day of 2024. It's kind of hard to predict related to that. We'll keep you guys abreast if there's anything that creates a meaningful deviation from the norm, as we did last year. A lot of it really hits in January and February and is kind of gone by March. Last year was a great example, where sometimes it comes in right before the end of the year.

Robert Franklin, CEO

But that's not reflected in this quarter's deposit growth. It doesn't happen until late in the fourth quarter in most government deposits.

Paul Egge, CFO

Precisely.

Stephen Scouten, Analyst

Perfect. Great. That's great color. When you talked about the expense ratio, saying it looked like this was maybe a bit of an outlier this quarter, and can get back to that $70 million level. What makes this quarter more of an outlier? I know there was the severance payment in there in salaries. But what makes this an outlier? And do you think that kind of $70 million range is the level you can maintain in '26? Or should we see just some kind of general inflation build from here?

Paul Egge, CFO

To be more specific, I said that we'll see fourth quarter earnings closer to our first-half run rate than what we posted in the third quarter. It might not be just as great as the $70 million we were posting in the first half of the year, but definitely closer to that than the $73 million we posted in the third quarter. Separately, we will see some inflation. As you know, we've been focused on holding the line where we can and really being focused on just that. We feel great about how we've been able to stop the creep in expenses, particularly as it relates to a lot of what we had to build when crossing over the $10 billion threshold. We're in optimization mode going forward, and we've been really pleased with how we've been able to do just that while remixing kind of with attrition and things along those lines in our human capital base. So we feel good about where we sit, and the goal is to continue optimizing and holding the line as much as we can going into 2026 and beyond.

Operator, Operator

We'll move on to Will Jones at KBW.

William Jones, Analyst

So Paul, maybe just sticking with you and moving to the margin discussion. I mean, if you exclude purchase accounting, we've kind of hit that 4% and felt like kind of the overarching near-term target for you guys. And I go back to your comments on the call about feeling good about the ability just to defend that level, if not even improve from here. But as we think about this next period of Fed easing, will that ability to defend really be more of just some tailwinds from fixture pricing, or do you intend to be relatively aggressive in lowering deposit costs from here?

Paul Egge, CFO

We're going to focus on lowering deposit costs where we can. That predominantly is going to be on more of your specials and exception level pricing. That's where we've got some index pricing for certain deposit products that we're going to get immediate benefit from when rates change. We feel really good about the initial repricing dynamics. There are also some tail trends that are helping us in how our securities and loans reprice. We're still in a pretty good backdrop to defend that margin. As the deck gets reshuffled at every rate cut, there could be some timing distinctions. But we feel like we've got benefits likely to sufficiently mitigate the drawbacks of how those reprices go on. We're feeling good about pending. Actually, we're pleasantly surprised to have gotten the 4% NIM, excluding purchase accounting accretion as fast as we did. We certainly did not promise that to the market and did not expect it necessarily to materialize as quickly, but we're really pleased we were able to do that, notwithstanding being a little less loaned up than what our budget and forecast are in our plans to drive loan growth.

William Jones, Analyst

Yes. Well done there. And could you just remind us is there a terminal interest-bearing deposit beta that you are trying to manage through this cycle, maybe just as you look at what you were able to accomplish on the uprate cycle?

Paul Egge, CFO

We don't necessarily think of it in terminal basis. We're trying to gain as much ground as we can where we can. Just like in the upswing, we weren't as aggressive in moving a lot of our balance sheet rates. We're more focused on how to manage this exception population and what in this index population. How do you really manage your most price-sensitive customers on the deposit side and we're going to continue to do that on the way down. It's a nuanced approach. We feel like we're approaching it with more discipline than we really ever have, having a game plan for every rate cut and being ready to manage all those conversations and really get the highest beta out of our most valuable exception customers. That's all a reasonable ask, and so far has functioned pretty well in the September rate cut. We'll follow the same game plan as we go forward.

William Jones, Analyst

Yes. Okay. And then maybe to follow-up, when we talked about deposits and the growth that's happened there and kind of the excess liquidity that you have as a result, if we continue to find the paydown bug a little bit and to the extent loans don't ramp up in growth meaningfully in the near term, could you look to be a little more opportunistic adding to the bond book from here?

Paul Egge, CFO

It's definitely an option. It's something that we talk about every day, really what is the right size of the bond book, how do we manage our balance sheet best? We feel awesome about the fact that we're building an even more fortress-like balance sheet with strong capital, strong liquidity, and a nice foundation to grow upon. We think that flexibility can allow us to be opportunistic when more meaningful loan growth presents itself or when other strategic opportunities can present themselves. We're pleased to have a very healthy and strong balance sheet.

Operator, Operator

We'll now turn to Matt Olney at Stephens.

Matt Olney, Analyst

I want to circle back on the loan growth discussion. We talked about the elevated payoffs a few months ago. I'm just curious, when do you expect this to slow? I mean we're seeing rates move lower in the fourth quarter, with the expectation that continues now for a little bit more. I would think that would just create more payoffs, not less. But just curious what your expectations are as when we could see this pressure ease up?

Ramon Vitulli, President and CEO of the Bank

Matt, one of the things that we will get a lift from our advances exceeding our paydowns and payments. When we look at our history of when we were getting a lift, it patterns kind of match up with our loan originations. As I said, loan originations were up 62%, but we will get some lift there. We may be a couple of quarters away from that, helping us, and not taking away from loan growth. That's in the good news category. We're going to have to manage through the fact that we've got the portfolio's nature with $350 million of payoffs that we have, and we'll do our best to limit that through some of those loans that are refinancing elsewhere to put our best foot forward. The real story will be the funded portion of the new loans that we originate. If we have $600 million in originations last quarter, that's getting closer to where that will give the fundings, even with the payoffs. Last quarter, we had a slight gain or increase in net funded loan balances, so it's just a matter of delivering on that pipeline and continuing on the path we've seen in the last couple of quarters and year-to-date. We believe growth will manifest in the second half of the year. Of course, we still have the fourth quarter. But going into '26, we feel good that we will pivot to that.

Matt Olney, Analyst

Okay, appreciate that, Ray. And also want to get your updated thoughts around M&A. We're definitely seeing more M&A deal announcements in your backyard. Just curious about the conversations you're having with strategic partners and expectations for finding a partner for Stellar Bank?

Robert Franklin, CEO

Yes, Matt. We continue to have conversations. We've talked to a lot of folks. I think you've seen some transactions that we have some interest in and some not. But I think the thing to remember and the thing that we want everyone to understand is that we're very protective of the balance sheet and the deposit base we've built. Looking at partners out there and how they've structured their funding, it would not be wise for us to join somebody that takes away from the funding base we have just to be larger. We want to find the right partners that think about the world the same way we do and find themselves in a similar fashion. We continue to have conversations. I think there's a possibility that we could be active in this space, but we're going to be careful about how we approach it.

Matt Olney, Analyst

Okay, thanks for the commentary, and I agree it's a high-class problem to have protecting the balance sheet. Just lastly for me, I guess over to Paul. Paul, I heard you mention the purchase accounting accretion in the prepared remarks, looking for the updated fair value mark on that portfolio?

Paul Egge, CFO

I believe that $58.1 million of what's left of the loan discount.

Operator, Operator

And that concludes our Q&A session. I will now turn the conference back over to Bob Franklin for closing remarks.

Robert Franklin, CEO

Thank you very much for joining our call today. And with that, we are adjourned.

Operator, Operator

And this concludes today's conference call. Thank you for your participation. You may now disconnect.